-----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, L3KVtbrs/WtAJDSVDcHrEExrwKDfrRyVGK0ZlSjZ7dYJ4f0l87WBh4K2IQgFRxXK 1IN5kcuisHPH74aNpjuwqA== 0000909012-01-000220.txt : 20010409 0000909012-01-000220.hdr.sgml : 20010409 ACCESSION NUMBER: 0000909012-01-000220 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 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 SEC ACT: SEC FILE NUMBER: 000-22345 FILM NUMBER: 1589305 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 10-K 1 0001.txt ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2000 0-22345 ----------------------------------- Commission File No. SHORE BANCSHARES, INC. ---------------------- (Exact name of registrant as specified in its charter) MARYLAND 52-1974638 - -------------------------------------- ------------------ (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 18 EAST DOVER STREET, EASTON, MARYLAND 21601 - --------------------------------------- --------------------- (Address of Principal Executive Offices) (Zip Code) (410) 822-1400 ------------------------------------------------------------------- Registrant's Telephone Number, Including Area Code Securities Registered pursuant to Section 12(b) of the Act: None. Securities Registered pursuant to Section 12(g) of the Act: Common Stock Par Value $.01 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 the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X The aggregate market value of the Corporation's voting stock held by non-affiliates of the registrant as of March 23, 2001 was $76,263,844 The number of shares outstanding of the registrant's common stock, as of March 23, 2001 was 5,324,380. Documents Incorporated by Reference Portions of the Shore Bancshares, Inc. definitive Proxy Statement for its 2001 Annual Stockholders' Meeting, as filed with the Securities and Exchange Commission on March 27, 2001 are incorporated by reference into Part III of this report. Portions of the Annual Report to Stockholders for the year ended December 31, 2000 are incorporated by reference into Parts I and II of this report. Except for parts of the Shore Bancshares, Inc. Annual Report expressly incorporated herein by reference, the Annual Report is not to be deemed filed with the Securities and Exchange Commission. FORM 10-K INDEX Page(s) Part I Item 1. Business 3 Item 2. Properties 12 Item 3. Legal Proceedings 12 Item 4. Submission of Matters to a Vote of Security Holders 13 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 13 Item 6. Selected Financial Data 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 7a. Quantitative and Qualitative Disclosures About Market Risk 13 Item 8. Financial Statements and Supplementary Data 13 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 13 Part III Item 10. Directors and Executive Officers of the Registrant 14 Item 11. Executive Compensation 14 Item 12. Security Ownership of Certain Beneficial Owners and Management 14 Item 13. Certain Relationships and Related Transactions Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 14 2 PART I ITEM 1. BUSINESS GENERAL 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 "BHC Act"). The Company engages in the business of banking through its two subsidiaries, The Centreville National Bank of Maryland ("Centreville National Bank") and The Talbot Bank of Easton, Maryland ("Talbot Bank"), collectively referred to as the "Banks". Centreville National Bank commenced operations in 1876 and is a national banking organization. Talbot Bank commenced operations in 1885 and is a commercial bank chartered under the laws of the State of Maryland. The Banks operate ten full service branches and fourteen Automated Teller Machines ("ATM's"), providing a full range of commercial and consumer banking products and services to individuals, businesses, and other organizations in Kent, Queen Anne's, Caroline, Talbot and Dorchester counties in Maryland. Deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC"). On November 30, 2000, the Company completed its merger with Talbot Bancshares, Inc. ("Talbot"), whereby Talbot was merged into the Company in a tax-free exchange of stock accounted for as a pooling of interests. Shareholders of Talbot received 2.85 newly issued shares of the Company common stock, or a total of 3,407,098 shares, for all 1,195,534 outstanding shares of Talbot and cash in lieu of each fractional share at the rate of $14.65 per share. The Company currently has 5,324,380 shares of common stock, par value $0.01 per share ("shares") held by 1,463 holders of record March 1, 2001. The Company's and Talbot Bank's main office is located in Talbot County, Maryland, at 18 East Dover Street, Easton, Maryland 21601. Centreville National Bank's main office is located at 109 North Commerce Street, Centreville, Maryland 21617. As of December 31, 2000 the Company had assets of approximately $553 million, net loans of approximately $378 million, and deposits of approximately $464 million. Stockholders' equity at December 31, 2000 was approximately $65 million. BANKING PRODUCTS AND SERVICES The Banks are independent community banks providing service to businesses and individuals in their respective market areas. Services offered are essentially the same as those offered by larger regional institutions that compete with the Banks. Services provided to businesses include commercial checking, savings, certificate of deposit and overnight investment sweep accounts. The Banks offer all forms of commercial lending including secured and unsecured loans, working capital loans, lines of credit, term loans, accounts receivable financing, real estate acquisition development, construction loans and letters of credit. Merchant credit card clearing services are available as well as direct deposit of payroll, PC and internet banking and telephone banking services. 3 Services to individuals include checking accounts, various savings programs, mortgage loans, home improvement loans, installment and other personal loans, credit cards, personal lines of credit, automobile and other consumer financing, safe deposit boxes, debit cards, 24 hour telephone banking, PC and internet banking, and 24-hour automatic teller machine services. The Banks also offer nondeposit products such as mutual funds and annuities, and discount brokerage services to their customers. Additionally, the Banks have Saturday hours and extended hours on certain evenings during the week as an added customer convenience. LENDING ACTIVITIES The Company originates secured and unsecured loans for business purposes. It is typical for commercial loans to be secured by real estate, accounts receivable, inventory equipment or other assets of the business. Commercial loans generally involve a greater degree of credit risk than one to four family residential mortgage loans. Repayment is often dependent on the successful operation of the business and may be affected by adverse conditions in the local economy or real estate market. The financial condition and cash flow of commercial borrowers is therefore, carefully analyzed during the loan approval process, and continues to be monitored by obtaining business financial statements, personal financial statements and income tax returns. The frequency of this ongoing analysis depends upon the size and complexity of the credit and collateral that secures the loan. It is also the Company's general policy to obtain personal guarantees from the principals of the commercial loan borrowers. The Company provides residential real estate construction loans to builders and individuals for single family dwellings. Residential construction loans are usually granted based upon "as completed" appraisals and are secured by the property under construction. Additional collateral may be taken if loan to value ratios exceed 75%. Site inspections are performed to determine pre-specified stages of completion before loan proceeds are disbursed. These loans typically have maturities of six to twelve months and may be fixed or variable rate. Permanent financing for individuals offered by the Company includes fixed and variable rate loans with three-year or five-year balloons, and one, three or five year Adjustable Rate Mortgages. Third party lenders often provide permanent financing for borrowers seeking longer term fixed rate loans. The risk of loss associated with real estate construction lending is controlled through conservative underwriting procedures such as loan to value ratios of 75% or less, obtaining additional collateral when prudent, and closely monitoring construction projects to control disbursement of funds on loans. The Company originates fixed and variable rate residential mortgage loans. As with any consumer loan, repayment is dependent on the borrower's continuing financial stability, which can be adversely impacted by job loss, divorce, illness, or personal bankruptcy. Underwriting standards recommend loan to value ratios of 75% based on appraisals performed by approved appraisers of the Company. Title insurance protecting the Company's lien priority as well as fire, and casualty insurance is required. Commercial real estate loans are primarily those secured by office condominiums, retail buildings, warehouses and general purpose business space. Low loan to value ratio standards as well as the thorough financial analysis performed and the Company's knowledge of the local economy in which it lends can reduce the risk associated with these loans. A variety of consumer loans are offered to customers including home equity loans, credit cards and other secured and unsecured lines of credit and term loans. Careful analysis of an applicant's creditworthiness is performed before granting credit and on going monitoring of loans outstanding is performed in an effort to minimize risk of loss by identifying problem loans early. BANKING SERVICE CORPORATION Centreville National Bank, the Company's subsidiary, owns one-third of the outstanding common stock of The Delmarva Bank Data Processing Center, Inc. ("Delmarva"). Delmarva is a Maryland corporation located in Easton, Maryland, which provides data processing services to banks located in Maryland, Delaware, Virginia and the District of Columbia. Delmarva provides these services to Centreville National Bank and Talbot Bank. COMPETITIVE CONDITIONS The Company is subject to substantial competition in all aspects of its business. Recent changes in federal banking laws have resulted in an even greater degree of competition in the banking industry. The Company competes with larger regional banks and other locally owned banks within its market area. The regional banks have resources substantially greater than the Company which can often give them a competitive advantage. The Company competes for loans and deposits against these institutions, as well as credit unions, savings institutions, brokerage firms, insurance companies and mortgage companies. The Company engages in traditional marketing activities such as advertising in local newspapers, trade journals and other publications, and radio advertising to attract new customers. In addition, personal contact by officers, directors and employees, their involvement on boards of nonprofit organizations and other community organizations, as well as their participation in community events often results in new business. The Banks also rely on referrals from satisfied customers. The following table sets forth deposit data for Kent, Queen Anne's, Caroline, Talbot and Dorchester Counties as of June 30, 2000, the most recent date for which comparative information is available. 4 % of Kent County Deposits Total - -------------------------------------------------------------------------------- (in thousands) Peoples Bank of Kent County, Maryland $106,559 32.53% The Chestertown Bank of Maryland 98,384 30.03 Chesapeake Bank and Trust Co. 46,801 14.29 Farmers Bank of Maryland 30,450 9.30 SunTrust Bank 25,706 7.85 THE CENTREVILLE NATIONAL BANK OF MARYLAND 19,646 6.00 -------- ------ Total $327,546 100.00% ======== ======= SOURCE: FDIC DATABOOK % of Queen Anne's County Deposits Total - -------------------------------------------------------------------------------- (in thousands) The Queenstown Bank of Maryland $156,595 37.72% THE CENTREVILLE NATIONAL BANK OF MARYLAND 129,349 31.15 The Chestertown Bank of Maryland 37,240 8.97 Bank of America, National Association 37,128 8.94 Allfirst Bank 25,380 6.11 Farmers Bank 15,197 3.66 The Annapolis National Bank 14,313 3.45 -------- ------- Total $415,202 100.00% ======== ======= SOURCE: FDIC DATABOOK % of Caroline County Deposits Total - -------------------------------------------------------------------------------- (in thousands) Peoples Bank of Maryland $78,978 30.26% Provident State Bank of Preston, Maryland 71,803 27.51 Allfirst Bank 34,226 13.11 Farmers Bank of Maryland 25,925 9.93 THE CENTREVILLE NATIONAL BANK OF MARYLAND 17,325 6.64 Bank of America, National Association 15,770 6.04 Atlantic Bank 13,897 5.32 Easton Bank & Trust 3,097 1.19 -------- ------- Total $261,021 100.00% ======== ======= SOURCE: FDIC DATABOOK % of Talbot County Deposits Total - -------------------------------------------------------------------------------- (in thousands) THE TALBOT BANK OF EASTON, MARYLAND $258,146 41.32% St. Michaels Bank 113,057 18.10 Bank of America, National Association 76,298 12.21 SunTrust Bank 58,449 9.36 Easton Bank & Trust 52,085 8.34 Allfirst Bank 28,956 4.63 Farmers Bank 26,840 4.30 First Mariner Bank 10,523 1.68 The Queenstown Bank of Maryland 396 .06 -------- ------- Total $624,750 100.00% ======== ======= SOURCE: FDIC DATABOOK 5 % of Dorchester County Deposits Total - -------------------------------------------------------------------------------- (in thousands) The National Bank of Cambridge $136,344 33.99% Bank of the Eastern Shore 98,549 24.57 Hebron Savings Bank 35,690 8.90 Bank of America, National Association 32,472 8.10 Allfirst Bank 28,146 7.02 Atlantic Bank 27,292 6.80 SunTrust Bank 19,204 4.79 Provident State Bank of Preston, Maryland 16,987 4.24 THE TALBOT BANK OF EASTON, MARYLAND 6,386 1.59 -------- ------ Total $401,070 100.00% ======== ====== SOURCE: FDIC DATABOOK SUPERVISION AND REGULATION The following is a summary of the material regulations and policies applicable to the Company and its subsidiaries and is not intended to be a comprehensive discussion. Changes in applicable laws and regulations may have a material effect on the business of the Company and Banks. GENERAL The Company is a bank holding company, registered with the Federal Reserve under the BHC Act and as such is subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve Board (the "FRB"). Talbot Bank is a state chartered bank in Maryland and is a member of the FDIC. Talbot Bank is subject to the regulation, supervision, and reporting requirements of the FDIC, as well as the Maryland Commissioner of Financial Regulation. Centreville National Bank is a federally chartered national bank and member of the FDIC. Centreville National Bank is subject to the regulation, supervision, and reporting requirements of the Office of the Comptroller of the Currency ("OCC"). The Banks are also subject to numerous state and federal statutes and regulations that affect the business of banking. REGULATION OF BANK HOLDING COMPANIES Under the BHC Act, the Company generally may not directly or indirectly acquire the ownership or control of five percent or more of the voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the FRB. The BHC Act also restricts the types of businesses and activities in which a bank holding company and its subsidiaries may engage. Activities are generally limited to those which the FRB finds to be closely related to, or incidental to, the business of banking. Pursuant to the Gramm-Leach-Bliley Act, the Company has elected to become a "financial holding company" and, as such, may engage in activities that are in addition to the business of banking. A financial holding company may engage in a full range of financial activities, including, insurance and securities sales and underwriting activities, and real estate development, with new expedited notice procedures. The Gramm-Leach-Bliley Act is described in more detail below. Subsidiary banks of bank holding companies are subject to certain statutory limits of the transfer of funds to the holding company or any of its nonbank subsidiaries, whether in the form of loans or other extensions of credit, investments in their securities and on the use of their securities as collateral for loans to any borrower. Such transfers of a subsidiary bank to a holding company or one of its nonbanking subsidiaries is limited in amount, and such loans and extensions of credit are required to be collateralized in specified amounts. 6 Under FRB policy, the Company is expected to act as a source of strength to its subsidiary banks and the FRB may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. In addition, under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), depository institutions insured by the FDIC can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. Accordingly in the event that any insured subsidiary of the Company causes a loss to the FDIC, other insured subsidiaries of the Company could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss. Such cross guaranty liabilities generally are superior in priority to obligations of a financial institution to its stockholders and obligations to other affiliates. FEDERAL BANKING REGULATION Federal Banking regulators, such as the OCC and the FDIC, may prohibit the institutions over which they have supervisory authority from engaging in activities or investments that the agency believes are unsafe or unsound banking practices. Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities which violate law, regulation or a regulatory agreement or which are deemed to be unsafe or unsound practices. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions. The Banks are subject to certain restriction on extensions of credit to executive officers, directors, principal stockholders or any related interest of such persons which generally require that such credit extensions be made on substantially the same terms as are available to third parties dealing with the Banks and not involve more than the normal risk of repayment. Other laws tie the maximum amount which may be loaned to any one customer and its related interests to capital levels. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies have adopted standards covering internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. An institution which fails to meet those standards may be required by the agency to develop a plan acceptable to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Company, on behalf of the Banks, believes that it meets substantially all standards which have been adopted. FDICIA also imposes new capital standards on insured depository institutions. See "Capital Requirements." DEPOSIT INSURANCE As FDIC member institutions, the Banks deposits are insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"), administered by the FDIC, and each institution is required to pay semi-annual deposit insurance premium assessments to the FDIC. The BIF assessment rates have a range of 0 to 27 cents for every $100 in assessable deposits. In addition, as a result of the April 1997 merger of Kent Savings and Loan Association, F.A. into Centreville National Bank, approximately $25.2 million of the Centreville National Bank's deposits are assessed at SAIF rates. The SAIF assessment rates are determined quarterly and the SAIF is also administered by the FDIC. The federal Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the"1996 Act"), included provisions that, among other things, recapitalized the Savings Association Insurance Fund ("SAIF") through a special assessment on savings association deposits and bank deposits that had been acquired from savings associations. CAPITAL REQUIREMENTS The Company is 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 financial statements. Under capital adequacy guidelines there are two basic measures: a risk-based measure and a leverage measure. 7 The risk-based capital guidelines are established to make regulatory capital requirements more sensitive to risk profiles of banks and bank holding companies and to account for off balance sheet exposure. Assets and off balance sheet items are assigned to broad risk categories, each with appropriate weights. A banking organization's capital is divided into two tiers. "Tier 1", or core capital, includes common equity, retained earnings, minority interest in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets. "Tier 2", or supplementary capital, includes, among other things, limited life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations, and less required deductions. "Total Capital" is the sum of Tier 1 and Tier 2 capital. The Tier 1 component must comprise at least 50% of qualifying total capital. Regulatory guidelines require a minimum of total capital to risk-adjusted assets ratio of 8 percent and a minimum Tier 1 capital to risk weighted assets ratio of 4 percent. Institutions which meet or exceed a Tier 1 ratio of 6 percent, a total capital ratio of 10 percent and a Tier 1 leverage ratio of 5 percent are considered well capitalized by regulatory standards. Before establishing new branch offices, the Banks must meet certain minimum capital stock and surplus requirements and obtain regulatory approval. At December 31, 2000 both Banks had the necessary capital levels to be considered "well capitalized." FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 In December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) a recapitalization of the Bank Insurance Fund of the FDIC (the "BIF") by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; and (v) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on institutions with lower levels of capital. FDICIA establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system the federal banking regulators are required to rate supervised institutions on the basis of five capital categories: "well -capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized;" and to take certain mandatory actions, and are authorized to take other discretionary actions, with respect to institutions in the three undercapitalized categories. The severity of the actions will depend upon the category in which the institution is placed. A depository institution is "well capitalized" if it has a total risk based capital ratio of 10% of greater, a Tier 1 risk based capital ratio of 6% of greater, and a leverage ratio of 5% or greater and is not subject to any order, regulatory agreement, or written directive to meet and maintain a specific capital level for any capital measure. An "adequately capitalized" institution is defined as one that has a total risk based capital ratio of 8% of greater, a Tier 1 risk based capital ratio of 4% or greater and a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with a composite CAMEL rating of 1). FDICIA generally prohibits a depository institution from making any capital distribution, including the payment of cash dividends, or paying a management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. For a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee (subject to certain limitations) that the institution will comply with such capital restoration plan. Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized and requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized depository institutions are subject to the appointment of a receiver or conservator, generally within 90 days of the date such institution is determined to be critically undercapitalized. 8 INTERSTATE BANKING LEGISLATION The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 was enacted into law on September 29, 1994. The law provides that, among other things, substantially all state law barriers to the acquisition of banks by out of state bank holding companies are eliminated effective September 29, 1995. The law also permitted interstate branching by banks effective June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date. Maryland generally established an earlier effective date of September 29, 1995. GRAMM-LEACH-BLILEY ACT In November, 1999 the Gramm-Leach-Bliley Act ("GLBA") was signed into law. Effective in pertinent part on March 11, 2000, GLBA revises the Bank Holding Company Act of 1956 and repeals the affiliation provisions of the Glass-Steagall Act of 1933, which, taken together, limited the securities, insurance and other non-banking activities of any company that controls an FDIC insured financial institution. Under GLBA, bank holding companies can elect, subject to certain qualifications, to become a "financial holding company." GLBA provides that a financial holding company may engage in a full range of financial activities, including insurance and securities sales and underwriting activities, and real estate development, with new expedited notice procedures. Maryland law generally permits Maryland State chartered banks, including Talbot Bank, to engage in the same activities, directly or through an affiliate, as national banking associations. GLBA permits certain qualified national banking associations, including Centreville National Bank, to form financial subsidiaries, which have broad authority to engage in all financial activities except insurance underwriting, insurance investments, real estate investment or development, or merchant banking. Thus, the GLBA has the effect of broadening the permitted activities of both banks. EFFECTS OF MONETARY POLICY The Company and its bank subsidiaries are effected by the ongoing and changing monetary policies set forth by regulatory authorities including the FRB. Through its powers the FRB can influence the supply of bank credit and affect the level of economic activity. Changes in the discount rate and reserve requirements are among the instruments used to influence the market. These influences can impact the overall growth and distribution of bank loans, investments, and deposits, and can also, affect the rates charged on loans and paid for deposits. The monetary policies of the FRB have in the past and will continue to affect the operating results of all financial institutions including the Company and its subsidiaries. FEDERAL SECURITIES LAW The Company's common stock is registered with the SEC under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act. EMPLOYEES At March 23, 2001 the Company had no employees and the Banks had 146 full-time employees and 19 part-time employees. SEASONALITY Management of the Company does not believe that the deposits or business of the Company are seasonal in nature. Deposits may vary depending on local and national economic conditions, however, not enough to have a material impact on the Company's planning or policy making. 9 RISK FACTORS REGULATORY RISKS. The banking industry is subject to many laws and regulations. Regulations protect depositors, not stockholders. Regulators such as the Maryland Division of Financial Regulation, Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Board of Governors of the Federal Reserve System regulate the Company and the Banks. Regulations and laws increase the Company's operating expenses, affect the Company's earnings, and put the Company at a disadvantage with less regulated competitors, such as finance companies, mortgage banking companies, and leasing companies. EXPOSURE TO LOCAL ECONOMIC CONDITIONS. Most of the loans made by the Banks are made to Maryland borrowers. A decline in local economic conditions would affect the Company's earnings. CREDIT RISKS AND INADEQUACY OF LOAN LOSS RESERVE. When borrowers default and do not repay the loans made to them by the Banks, the Company loses money. Experience shows that some borrowers either will not pay on time or will not pay at all. In these cases, the Banks will cancel, or "write off," the defaulted loan or loans. A "write off" reduces the Company's assets and affects the Company's earnings. The Company anticipates losses by reserving what it believes to be an adequate cushion so that it does not have to take a large loss at any one time. However, actual loan losses cannot be predicted, and the Company's loan loss reserve may not be sufficient. INTEREST RATE RISK. The Company's earnings depend greatly on its net interest income, the difference between the interest earned on loans and investments and the interest paid on deposits. If the interest rate paid on deposits is high and the interest rate earned on loans and investments is low, net interest income is small and the Company earns less. Because interest rates are established by competition, the Company cannot completely control its net interest income. RISKS ASSOCIATED WITH REAL ESTATE LENDING. The Banks make many real estate secured loans. Real estate loans are in greater demand when interest rates are low and economic conditions are good. Even when economic conditions are good and interest rates are low, these conditions may not continue. The Company may lose money if the borrower does not pay a real estate loan. If real estate values decrease, then the Company may lose more money when borrowers default. NO ASSURANCE OF GROWTH. The Company's ability to increase assets and earnings depends upon many factors, including competition for deposits and loans, the Company's branch and office locations, avoidance of credit losses, and hiring and training of personnel. Many of these factors are beyond the Company's control. COMPETITION. Other banks and non-banks, including savings and loan associations, credit unions, insurance companies, leasing companies, small loan companies, finance companies, and mortgage companies, compete with the Company. Some of the Company's competitors offer services and products that the Company does not offer. Larger banks and non-bank lenders can make larger loans and service larger customers. Law changes now permit interstate banks which may increase competition. Increased competition may decrease the Company's earnings. NO ASSURANCE OF CASH OR STOCK DIVIDENDS. Whether dividends may be paid to stockholders depends on the Company's earnings, its capital needs, law and regulations, and other factors. The Company's payment of dividends in the past does not mean that the Company will be able to pay dividends in the future. STOCK NOT INSURED. Investments in the shares of the Company's common stock are not deposits that are insured against loss by the government. RISK INVOLVED IN ACQUISITIONS. Part of the Company's growth may come from buying other banks and companies. A newly purchased bank or company may not be profitable after the Company buys it and may lose money, particularly at first. The new bank or company may bring with it unexpected liabilities or bad loans, bad employee relations, or the new bank or company may lose customers. 10 RISK OF CLAIMS. Customers may sue the Company for losses due to the Company's alleged breach of fiduciary duties, errors and omissions of employees, officers and agents, incomplete documentation, the Company's failure to comply with applicable laws and regulations, or many other reasons. Also, employees of the Company conduct all of the Company's business. The employees may knowingly or unknowingly violate laws and regulations. Company management may not be aware of any violations until after their occurrence. This lack of knowledge may not insulate the Company from liability. Claims and legal actions may result in legal expenses and liabilities that may reduce the Company's profitability and hurt its financial condition. DEVELOPMENTS IN TECHNOLOGY. Financial services use technology, including telecommunications, data processing, computers, automation, Internet-based banking, debit cards, and "smart" cards. Technology changes rapidly. The Company's ability to compete successfully with other banks and non-banks may depend on whether it can exploit technological changes. The Company may not be able to exploit technological changes and expensive new technology may not make the Company more profitable. MARKET FOR COMMON STOCK. The Company's shares of common stock are not listed on any exchange, and there is currently no organized trading market. Prices for the Company's common stock may not be the actual value or the trading price in a liquid trading market. ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS. The Company's Articles of Incorporation and Bylaws divide the Company's Board of Directors into three classes and each class serves for a staggered three-year term. No director may be removed except for cause and then only by a vote of at least two-thirds of the total eligible stockholder votes. In addition, Maryland law contains anti-takeover provisions that apply to the Company. These provisions may discourage or make it more difficult for another company to buy the Company or may reduce the market price of the Company's common stock. STATISTICAL INFORMATION The following statistical information required under the SEC's Guide 3 for the respective periods and at the indicated respective dates is set forth on the pages indicated below. The information should be read in conjunction with the related Consolidated Financial Statements and Notes thereto for the year ended December 31, 2000.
MATURITIES OF LOAN PORTFOLIO December 31, 2000 (In Thousands) Maturing Maturing After one Maturing Within But Within After Five One Year Five Years Years Total Real Estate Construction and land development $ 9,188 $9,399 $ - $ 18,587 Commercial, financial and agricultural 31,190 19,873 3,579 54,642 Mortgage 49,624 148,522 92,990 291,136 Consumer 5,684 11,327 1,130 18,141 -------- ------- -------- -------- Total $95,686 $189,121 $97,699 $382,506 ======= ======== ======= ======== CLASSIFIED BY SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES Fixed-Interest Rate Loans $64,546 $172,547 $43,657 $280,750 Adjustable-Interest Rate Loans 31,140 16,574 54,042 101,756 ------- ------- -------- --------- Total $95,686 $189,121 $97,699 $382,506 ======= ======== ======= ======== ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES (In Thousands) December 31, 2000 1999 1998 1997 1996 -------------------------------------------------------------- Commercial Financial and Agricultural $1,694 $1,437 $947 $1,074 $1,385 Real Estate-Construction 126 108 148 138 112 Real Estate-Mortgage 1,807 1,991 1,628 1,508 1,109 Consumer 412 438 296 350 250 Unallocated 160 17 912 871 1,375 -------- --------- -------- -------- ------- $4,199 $3,991 $3,931 $3,942 $4,231 ====== ====== ====== ====== ======
11 Other statistical information required in this Item 1 is incorporated by reference from the information appearing in the Company's Annual Report to Stockholders for the year ended December 31, 2000, as follows:
DISCLOSURE REQUIRED BY GUIDE 3 REFERENCE TO 2000 ANNUAL REPORT - ------------------------------ ------------------------------- (I) Distribution of Assets, Liabilities and Average Balances; Yields and Rates (page 4) Stockholders' Equity; Interest Rates and Rate/Volume Analysis (page 5) Interest Differential Non-performing Assets (page 8) (II) Investment Portfolio Weighted Average Maturities and Weighted Average Yields (page 11) Notes to Financial Statements, Note 4 - Investment in Debt Securities - (pages 25 and 26) (III) Loan Portfolio Year End Loan Composition (page 11) Non-performing Assets (page 8) (IV) Summary of Loan Loss Experience Provision and Allowance for Credit Losses (pages 6,7 and 8) (V) Deposits Deposits (page 12) (VI) Return on Equity and Assets Return on Equity and Assets (page 17) (VII) Short Term Borrowings Short Term Borrowings (page 13) Notes to Financial Statements, Note 9 -Short Term Borrowings (page 29) Notes to Financial Statements, Note 16 - Line of Credit (page 34)
Item 2. PROPERTIES The Company owns no real property. Talbot Bank owns real property at the location of its main office at 18 East Dover Street, Easton, Maryland, and at two of its four branch locations at 210 Marlboro Road, Easton, Maryland 21601 ("Tred Avon Square Branch"), 8275 Elliott Road, Easton, Maryland 21601 ("Elliott Road Branch") and 21 E. Dover Street, Easton, Maryland 21601 where certain administrative offices of the bank are located. Two additional banking offices are leased under operating leases. The Saint Michaels Branch is located at 1013 S. Talbot Street, St. Michaels, Maryland 21663 and the Cambridge Branch is located at 2745 Dorchester Square, Cambridge, Maryland 21613. The St. Michaels Branch operating lease expires in July 2006 and calls for annual rental payments from $38,850 to $42,000 over the term of the lease. The Cambridge Branch lease expires in July 2001 and calls for annual rental payments of $42,360. The bookkeeping department of the Talbot Bank is located at 118 N. Dover Street. This space is leased under an operating lease expiring in January 2004 for an annual rent of $47,500. Centreville National Bank owns real property at the location of its main office at 109 North Commerce Street, Centreville, Maryland 21617, and at its five branch locations at 2609 Centreville Road, Centreville Maryland 21617("Route 213 South Branch Office"), at 408 Thompson Creek Road, Stevensville, Maryland 21666 ("Stevensville Branch Office"), at 21913 Shore Highway, Hillsboro, Maryland 21641 ("Hillsboro Branch Office"), at 305 East High Street, Chestertown, Maryland 21620("Kent Office"), and at 850 S. 5th Avenue, Denton, Maryland 21629 ("Denton Office"). Item 3. LEGAL PROCEEDINGS There are no material pending legal proceedings other than the ordinary routine litigation incidental to the business to which the Company, the Bank, or its subsidiaries is a party or to which any of their properties is subject. There are also no material proceedings known to management to which any Director, officer, or affiliate of the Company, any person holding beneficially in excess of five (5) percent of the Company's shares, or any associate of any such Director, officer or security holder is a party. 12 Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS The Company called a Special Meeting of Stockholders' on November 21, 2000 for the purpose of approving the Plan and Agreement to Merge dated July 25, 2000, between Shore Bancshares, Inc. and Talbot Bancshares, Inc. and the merger of Talbot Bancshares, Inc. into the Company. The agreement and merger were approved by the Company's stockholders by a vote of 1,441,067 in favor, 17,099 against, and 1,045 abstain/broker non-votes. The agreement and merger was approved by the stockholders of Talbot Bancshares, Inc. by a vote of 937,307 in favor, 3,505 against, and 1,648 abstaining/broker non-votes. The approval of the merger agreement and the merger included approval of certain amendments to the Company's charter and bylaws and the election of persons to serve as directors of the Company after the merger. PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Incorporated by reference from Annual Report to Stockholders for the year ended December 31, 2000 under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Stock Prices and Dividends," page 16, and "Notes to Financial Statements - Regulatory Capital Requirements" on pages 33 and 34. The Company has issued and outstanding 5,324,380 shares of common stock, par value $0.01 per share held by 1,463 holders of record March 1, 2001. Item 6. SELECTED FINANCIAL DATA Incorporated by reference from Annual Report to Stockholders for the year ended December 31, 2000, page 17. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated by reference from Annual Report to Stockholders for the year ended December 31, 2000 under "Management's Discussion and Analysis of Financial Condition and Results of Operations," pages 3 through 16. Reference is also made to the information provided under the heading "Statistical Information" in Part I, Item I, incorporated by reference herein. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For information regarding the Market Risk of the Company's financial instruments see "Management's Discussion and Analysis of Financial Condition and Results of Operations, Market Risk and Interest Rate Sensitivity" on pages 13 through 15 of the Annual Report to Stockholders for the year ended December 31, 2000. The Company's principal market risk exposure is to interest rates. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Incorporated by reference from the Annual Report to Stockholders for the year ended December 31, 2000 under "Consolidated Financial Statements and Independent Auditors' Report" on pages 18 through 37. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no changes in or disagreements with accountants on accounting and financial disclosure. 13 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT A listing of Directors of the Registrant is incorporated by reference from Definitive Proxy Statement to Stockholders for the 2001 Annual Meeting under "Election of Directors," pages 1 through 5. A listing of Executive Officers of the Registrant is incorporated by reference from the Definitive Proxy Statement to Stockholders for the 2001 Annual Meeting under "Executive Officers, " page 13. A description of compliance with reporting requirements under Section 16(a) of the Securities and Exchange Act is incorporated by reference from the Definitive Proxy Statement to Stockholders for the 2001 Annual Meeting under "Section 16(a) Beneficial Ownership Reporting Compliance," page 12. Item 11. EXECUTIVE COMPENSATION Incorporated by reference from the Definitive Proxy Statement to Stockholders for the 2001 Annual Meeting under "Executive Compensation," " Benefit Plans" and "Executive Compensation Committee Report," pages 6 through 11, under "Performance Graph," page 14, and the Director compensation discussion on page 5. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference from the Definitive Proxy Statement to Stockholders for the 2001 Annual Meeting under "Beneficial Ownership of Common Stock," pages 5 and 6. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference from the Definitive Proxy Statement to Stockholders for the 2001 Annual Meeting under "Election of Directors" pages 1 through 5. Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1),(2) FINANCIAL STATEMENTS Consolidated Balance Sheets at December 31, 2000 and 1999 Consolidated Statements of Income -- Years Ended December 31, 2000, 1999, and 1998 Consolidated Statements of Changes in Stockholders' Equity -- Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows -- Years Ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements as of December 31, 2000, 1999 and 1998 Report of Independent Auditors (3) Exhibits Required to be Filed by Item 601 of Regulation S-K 2.1 Plan and Agreement to Merge, dated July 25, 2000, by and between Shore Bancshares, Inc. and Talbot Bancshares, Inc. (incorporated by reference to Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 2.2 Amendment to Plan and Agreement to Merge, dated November 30, 2000, by and between Shore Bancshares, Inc. and Talbot Bancshares, Inc. (incorporated by reference to Exhibit 2.2 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 3.1 Shore Bancshares, Inc. Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 3.2 Shore Bancshares, Inc. Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 10.1 Form of Employment Agreement with W. Moorhead Vermilye (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 10.2 Form of Employment Agreement with Daniel T. Cannon (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 14 13 2000 Annual Report of Shore Bancshares, Inc., filed herewith. 21 Subsidiaries of Shore Bancshares, Inc., filed herewith. 23 Consent of Stegman & Company, filed herewith. 99.1 1998 Employee Stock Purchase Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed with the Commission on September 25, 1998 Registration No. 333-64317). 99.2 1998 Stock Option Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed with the Commission on September 25, 1998 (Registration No. 333-64319)). 99.3 Talbot Bancshares, Inc. Employee Stock Option Plan, filed herewith. (b) Reports on Form 8-K The Company filed a Current Report on Form 8-K on December 14, 2000, as amended on Form 8-K/A on February 9, 2001, pursuant to Item 1 (Change in Control of Registrant), Item 2 (Acquisition or Disposition of Assets), and Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits). (c) Exhibits required by Item 601 of Regulation S-K See the Exhibits described in Item 14 (a)(3) above. 15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 28, 2001. Shore Bancshares, Inc. Date: March 29, 2001 By: /S/W. MOORHEAD VERMILYE ------------------------------ W. Moorhead Vermilye, President and CEO Date: March 29, 2001 By: /S/SUSAN E. LEAVERTON --------------------------------- Susan E. Leaverton, Treasurer (Principal Accounting and Financial Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/Herbert L. Andrew, III Director March 29, 2001 - ------------------------- Herbert L. Andrew, III /s/ Lloyd L. Beatty, Jr. Director March 29, 2001 - ------------------------ Lloyd L. Beatty, Jr. /s/Paul M. Bowman Director March 29, 2001 - ----------------- Paul M. Bowman /s/David C. Bryan Director March 29, 2001 - ----------------- David C. Bryan /s/ Daniel T. Cannon Director March 29, 2001 - -------------------- Daniel T. Cannon /s/B. Vance Carmean Director March 29, 2001 - ------------------- B. Vance Carmean Director March 29, 2001 - ------------------ Ronald N. Fox /s/Richard C. Granville Director March 29, 2001 - ----------------------- Richard C. Granville /s/Neil R. LeCompte Director March 29, 2001 - ------------------- Neil R. Le Compte /s/David L. Pyles Director March 29, 2001 - ----------------- David L. Pyles /s/W. Moorhead Vermilye Director March 29, 2001 - ----------------------- W. Moorhead Vermilye 16 EX-13 2 0002.txt ANNUAL REPORT SHORE BANCSHARES, INC. [LOGO OMITTED] 2000 ANNUAL REPORT CONTENTS 1 Financial Highlights 2 Letter to Shareholders 3 Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Selected Financial Data 18 Consolidated Financial Statements 38 Independent Auditors' Report 39 Directors and Officers 42 Branch Locations and Information
[LOGO] FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- Percent Years ended December 31, 2000 1999 Increase - -------------------------------------------------------------------------------- (Dollars in thousands, except per share data) FOR THE YEAR Interest income $ 39,480 $ 35,435 11.4% Interest expense 17,888 16,040 11.5% Net interest income 21,592 19,395 11.3% Net income 7,957 6,805 16.9% Cash dividends 2,783 2,405 15.7% - -------------------------------------------------------------------------------- AVERAGE Total assets $524,721 $497,812 5.4% Total loans 367,075 324,507 13.1% Total deposits 434,296 415,488 4.5% Stockholders' equity 61,285 57,377 6.8% - -------------------------------------------------------------------------------- AT YEAR END Total assets $553,097 $518,217 6.7% Total loans, net of unearned income 382,506 345,791 10.6% Total deposits 464,485 436,021 6.5% Stockholders' equity 65,024 58,485 11.2% - -------------------------------------------------------------------------------- PER SHARE Net income per common share: Basic $ 1.50 $ 1.28 17.2% Diluted net income $ 1.48 $ 1.27 16.5% Cash dividends $ .52 $ .45 15.6% Book value at year-end $ 12.21 $ 11.00 11.0% - --------------------------------------------------------------------------------
-1- [LOGO] LETTER TO SHAREHOLDERS - -------------------------------------------------------------------------------- To our Shareholders and Friends, The year 2000 was exceptional for Shore Bancshares, Inc. as we were able to merge Shore Bancshares, Inc. and Talbot Bancshares, Inc., to create the ninth largest independent financial institution in Maryland, and the largest on the Eastern Shore. The Centreville National Bank and The Talbot Bank are both long-standing institutions which, combined, provide a natural market extension for each. The two institutions now span a five county area starting in the north with Kent County, and covering Queen Anne's, Caroline, Talbot and Dorchester counties. ATM sharing arrangements now provide customers with fourteen ATM locations where they can access their accounts with no fees. Additional jointly offered services are planned for the benefit of our customers in the future. We are pleased with the amount of progress made in the very short period of time since the merger was completed on December 1, 2000. 2000 marked a record year for earnings of the Company, with net income totaling $7,957,000, an increase of 16.9% over the previous year. On a per share basis, net income was $1.48, an increase of 16.5% for the year. Return on average stockholders' equity and return on average assets both increased totaling 12.98% and 1.52%, respectively. Return on average stockholders' equity and return on average assets were 11.85% and 1.37%, respectively, for 1999. Total assets of the Company were $553,097,000 and $518,217,000 at December 31, 2000 and 1999, respectively, and total loans at December 31, 2000 were $382,506,000, an increase of 10.6% over 1999. Loan growth was funded primarily by increased deposits which grew $28,464,000 totaling $464,485,000 at December 31, 2000, an increase of 6.5% over 1999. Earnings growth in 2000 was the result of increases in both net interest income and noninterest income. Increased rates earned on interest earning assets as well as increased volume of loans were the sources of increased interest income. However, the competitive market for certificates of deposit drove the average rate paid for interest bearing deposits up 21 basis points for the year. The average rate paid for certificates of deposit increased 35 basis points during the year. The effect of the increased yield on earning assets exceeded that of the increase in the cost of interest bearing liabilities producing a higher overall net interest margin for the year of 4.40%. The Company also realized a one-time gain of $750,000 from the proceeds of life insurance policies in 2000 which is included in noninterest income. The Company continues to maintain a very strong capital position with capital ratios well above regulatory minimums. Average stockholders' equity to average assets, a measure of the Company's capital strength, was 11.68% at December 31, 2000. Total stockholders' equity at December 31, 2000 was $65,024,000, an increase of $6,539,000 when compared to December 31, 1999. This strong capital position will enable us to pursue future business combinations or expansion of services through affiliate organizations. The Company also increased the total cash dividend paid for the year from $.45 to $.52, an increase of 15.6%. The banking industry experienced significant changes in the 1990's. Regulatory reform rapidly changed the environment of banking into a financial services industry where banks can offer all forms of financial related services and products to their customers. Our history of personal banking relationships is something we will continue to emphasize in this era of change. While we hope to expand our services to enhance shareholder value and address the needs of our customers, our focus is to remain a high performance community banking organization. As always, we thank you for your continued support of Shore Bancshares, Inc., The Talbot Bank and The Centreville National Bank. [PICTURE OMITTED] /S/ W. MOORHEAD VERMILYE ------------------------- W. Moorhead Vermilye President & CEO, Shore Bancshares, Inc. President and CEO, The Talbot Bank /s/ DANIEL T. CANNON -------------------- Daniel T. Cannon Executive Vice President & COO Shore Bancshares, Inc. President and CEO, The Centreville National Bank /S/ B. VANCE CARMEAN, JR. ------------------------- B. Vance Carmean, Jr. Chairman of the Board, Shore Bancshares, Inc. President, Carmean Grain, Inc. -2- [LOGO] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- GENERAL Shore Bancshares, Inc. (the "Company") is a two-bank holding company, which was formed on March 15, 1996. The Company is based in Easton, Maryland and is the sole shareholder of The Talbot Bank of Easton, Maryland ("Talbot Bank") and The Centreville National Bank of Maryland ("Centreville National Bank"), collectively referred to as the "Banks". Talbot Bank commenced operation in 1885 and is a Maryland chartered commercial bank. The Centreville National Bank commenced operations in 1876 and is a national banking association. The Banks operate ten full service branches and fourteen Automated Teller Machines ("ATM's"), providing a full range of commercial and consumer banking products and services to individuals, businesses, and other organizations in Kent, Queen Anne's, Caroline, Talbot and Dorchester counties in Maryland. Deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC"). On November 30, 2000, the Company completed its merger with Talbot Bancshares, Inc. ("Talbot"), whereby Talbot was merged into the Company in a tax-free exchange of stock accounted for as a pooling of interests. Shareholders of Talbot received 2.85 newly issued shares of the Company common stock, or a total of 3,407,098 shares, for all 1,195,534 outstanding shares of Talbot and cash in lieu of each fractional share at the rate of $14.65 per share. All historical data in the financial statements is that of the Company and Talbot, restated to reflect the exchange of shares, combined in accordance with accounting procedures for the pooling of interests method of business combinations. Services provided to businesses include commercial checking, savings and related depository services, including telephone and PC banking. The Banks offer all forms of commercial lending including lines of credit, term loans, accounts receivable financing, commercial and construction real estate, and other forms of secured financing. Services provided to individuals include checking accounts, various savings programs, mortgage loans, home improvement loans, installment and other personal loans, credit cards, personal lines of credit, automobile and other consumer financing, safe deposit services, debit cards, 24 hour ATM's, telephone banking and PC Banking. FORWARD LOOKING STATEMENTS Portions of this Annual Report contain forward-looking statements within the meaning of The Private Securities Litigation and Reform Act of 1995. Such statements are not historical facts and include expressions about the Company's confidence, policies, and strategies, the adequacy of the allowance for credit losses, realization of deferred taxes, interest rate risk, capital levels and liquidity. Such forward-looking statements involve certain risks and uncertainties, including general economic conditions, competition in the geographic and business areas in which the Company and its affiliates operate, inflation, fluctuations in interest rates, legislation, and governmental regulation. These risks and uncertainties are described in more detail in the Company's Form 10-K, under the heading "Risk Factors". Actual results may differ materially from such forward-looking statements, and the Company assumes no obligation to update forward-looking statements at any time. OVERVIEW Net income increased $1.15 million, totaling $7.96 million at December 31, 2000. This represents a 16.9% increase over the $6.81 million net income for 1999. On a per share basis, fully diluted net income was $1.48 compared to $1.27 for 1999. Return on average assets and return on shareholders' equity for 2000 were 1.52% and 12.98%, respectively. Total assets of the Company increased 6.7% in 2000 totaling $553 million. Total asset growth was comprised primarily of growth in loans. Increased deposits and a decline in investment securities and federal funds sold funded this growth. Total loans increased $36.7 million or 10.6%, totaling $382.5 million at December 31, 2000. Total deposits increased $28.5 million or 6.5%, totaling $464.5 million at December 31, 2000. -3- - -------------------------------------------------------------------------------- RESULTS OF OPERATIONS NET INTEREST INCOME AND NET INTEREST MARGIN Net interest income remains the most significant component of the Company's earnings. It is the excess of interest and fees earned on loans, federal funds sold, and investment securities, over interest paid on deposits and borrowings. The increase in net interest income for 2000 is the result of changes in the volume and mix of earning assets and interest bearing funding sources, as well as the changes in market interest rates. Net interest income for 2000 was $21,592,000 compared to $19,395,000 for 1999 and $18,672,000 for 1998. This represents an increase of 11.3% and 3.9% for 2000 and 1999, respectively. The following table sets forth the major components of net interest income, on a tax equivalent basis, as of December 31, 2000, 1999 and 1998.
(Dollars in thousands) 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------ Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate (1) Balance Interest Rate (1) Balance Interest Rate (1) - ------------------------------------------------------------------------------------------------------------------ Earning Assets Investment securities: Taxable $ 109,687 $ 6,688 6.10% $115,577 $ 6,773 5.86% $ 96,218 $ 5,812 6.04% Non-taxable 11,149 756 6.78 13,213 894 6.77 15,800 1,071 6.78 Loans (2)(3) 367,075 31,700 8.64 324,507 27,148 8.37 297,786 26,308 8.83 Federal funds sold 10,397 670 6.44 19,603 987 5.04 23,042 1,259 5.46 --------- ------- ---- --------- -------- ---- --------- -------- ---- Total earning assets 498,308 39,814 7.99% 472,900 35,802 7.57% 432,846 34,450 7.96% ------- ------- ------- Cash and due from banks 12,292 11,636 10,910 Other assets 18,243 17,174 16,303 Allowance for credit losses (4,122) (3,898) (3,944) ------- ---------- ---------- Total assets $524,721 $497,812 $456,115 ======== ======== ======== - ------------------------------------------------------------------------------------------------------------------ Interest bearing liabilities: Demand $ 76,232 $ 1,990 2.61% $ 70,200 $ 1,807 2.57% $ 65,298 $ 1,982 3.04% Savings 102,651 3,065 2.99 104,834 3,139 2.99 99,133 3,072 3.10 Certificates of deposit $100,000 or more 71,111 4,071 5.72 61,962 3,147 5.08 50,588 2,725 5.39 Other time 134,245 7,351 5.48 132,355 6,985 5.28 123,611 6,717 5.43 ------- ------ ---- --------- ------- ---- ---------- ------- ---- Interest bearing deposits 384,239 16,477 4.29 369,351 15,078 4.08 338,630 14,496 4.28 Short term borrowings 21,522 1,096 5.09 17,813 687 3.86 14,561 603 4.16 Long term debt 5,000 315 6.30 4,959 274 5.52 5,000 287 5.74 --------- -------- ---- -------- ------- ---- ---------- ------- ---- Total interest bearing liabilities 410,761 17,888 4.36% 392,123 16,039 4.09% 358,191 15,386 4.30% ------- ----- ------ ----- ------ ----- Noninterest bearing deposits 50,058 46,137 40,028 Other liabilities 2,617 2,175 2,025 Stockholders' equity 61,285 57,377 55,871 ------- -------- -------- Total liabilities and stockholders' equity $524,721 $497,812 $456,115 ======== ======== ======== - ------------------------------------------------------------------------------------------------------------------ Net interest spread $21,926 3.63% $19,763 3.48% $19,064 3.66% ======= ======= ======= Net interest margin 4.40% 4.18% 4.40% - ------------------------------------------------------------------------------------------------------------------ (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) Average loan balances include nonaccrual loans. (3) Interest income on loans includes amortized loan fees, net of costs, for each category and yields are stated to include all.
-4- - -------------------------------------------------------------------------------- Net interest income on a tax equivalent basis increased $2,163,000 or 10.9% in 2000. The increase is attributed to higher yields and growth in the average balances of interest earning assets. The tax equivalent yield on earning assets was 7.99% for 2000, compared to 7.57% and 7.96% for 1999 and 1998, respectively. Interest rates, which declined in 1998, began to rise again in the middle of 1999 and continued to increase during 2000. All categories of earning assets experienced some increase in yield, but the impact of a 27 basis point increase in loan yields generated $888,000 in increased interest income for the Company. Even more significant than the impact of increased yields was the effect of the increased volume of loans on the Company's interest income. Increased loan volume contributed a $3.7 million increase to loan interest. Growth in the average balance of earning assets was $25.4 million or 5.4% for the year. This was less than the growth in average loans, which totaled $42.6 million or 13.1% during 2000 when compared to 1999. This shift in earning assets from investment securities and federal funds sold, which have lower overall yields, to loans contributed to the growth in interest income experienced during the year. The average balance of investment securities decreased $8 million or 6.2% and the average balance of federal funds sold decreased $9.2 million or 47%. As a percentage of total average earning assets, loans and investment securities totaled 73.7% and 24.3%, respectively, for 2000 compared to 68.6% and 27.2%, respectively for 1999. The following Rate/Volume Variance Analysis identifies the portion of the changes in net interest income, which are attributable to changes in volume of average balances or to changes in the yield on earning assets and rates paid on interest bearing liabilities.
2000 OVER (UNDER) 1999 1999 OVER (UNDER) 1998 ---------------------- ---------------------- TOTAL CAUSED BY Total CAUSED BY --------- --------- (Dollars in thousands) VARIANCE RATE VOLUME Variance Rate Volume - ------------------------------------------------------------------------------------------------------------------ Interest income from earning assets: Federal funds sold $ (318) $ 227 $ (545) $ (272) $ (93) $ (179) Taxable investment securities (85) 266 (351) 961 (172) 1,133 Non-taxable investment securities (138) 2 (140) (177) (2) (175) Loans 4,553 888 3,665 840 (1,481) 2,321 Total interest income 4,012 1,383 2,629 1,352 (1,748) 3,100 Interest expense on deposits and borrowed funds: Interest bearing demand 183 26 157 (175) (346) 171 Savings deposits (74) (9) (65) 67 (107) 174 Time deposits 1,290 694 596 690 (329) 1,019 Short term borrowings 409 197 212 84 (50) 134 Long term debt 41 39 2 (13) (11) (2) Total interest expense 1,849 947 902 653 (843) 1,496 - ------------------------------------------------------------------------------------------------------------------ Net interest income $2,163 $ 436 $ 1,727 $ 699 $ (905) $1,604 - ------------------------------------------------------------------------------------------------------------------
The rate and volume variance for each category has been allocated on a consistent basis between rate and volume variances, based on a percentage of rate, or volume, variance to the sum of the absolute two variances. -5- The Company's net interest margin (its tax equivalent net interest income divided by average earning assets), represents the net yield on earning assets. The net interest margin increased from 4.18% for 1999 to 4.40% for 2000. The increase was the result of increased yields on interest earning assets and the effects of the shift in composition of earning assets. The Company's net interest spread, which is the difference between the average yield on earning assets and the rate paid for interest bearing liabilities, also increased from 3.48% to 3.63%. Interest expense increased $1.8 million during 2000, with approximately half of the increase attributable to rate increases and half attributable to increased volume. The average rate paid on interest bearing deposits in 2000 increased 21 basis points as the result of increased rates paid for certificates of deposit in an increasing rate environment and very competitive deposit market. The average rate paid for certificates of deposit over $100,000 increased 64 basis points, and for all other time deposits the increase was 20 basis points. The most significant growth in average interest bearing deposits occurred in time deposits with the average balance of those deposits increasing $11 million during the year. The most significant portion of the time deposit increase was the result of $9 million growth in CD's $100,000 or more. Average interest bearing transaction accounts increased $6 million during the year, however, the rate paid for those deposits remained relatively unchanged at 2.61%, compared to 2.57% for 1999. Short-term liabilities, consisting primarily of securities sold under agreements to repurchase, increased $3.7 million, with the average rate paid for those funds increasing 123 basis points to 5.09%. The Company's long term debt was converted to a variable rate instrument resulting in an increase in cost from 5.52 % to 6.30%. PROVISION AND ALLOWANCE FOR CREDIT LOSSES The Company recorded a provision for credit losses of $437 thousand in 2000 compared to $240 thousand in both 1999 and 1998. Provisions for credit losses are adjusted to bring the allowance for credit losses within the range of balances which is considered adequate to absorb inherent losses in the loan portfolio. Provisions made in 1999 and 1998 reflected the stable economy in our market areas and continued growth of the loan portfolio over that time. During 2000, an increasing trend in net charge offs, growth in loans, as well as concerns over deteriorating economic indicators and industry wide trends in loan delinquencies and nonperforming loan statistics had an effect on the amount of the provision for the year. The allowance for credit losses is increased by provisions charged against earnings and recoveries of previously charged off loans. The allowance is decreased by current period charge off of uncollectible loans. In 1996, the Company increased the provision for credit losses due to concerns over local economic trends, continuing high levels of net losses charged off and nonperforming loans, and the rapid growth of the loan portfolio. Improved credit quality and stable economic conditions in 1997 enabled the Company to reduce the provision for credit losses to $225,000; net loans charged off and nonperforming loans both declined in 1998 and 1999, which allowed management to further stabilize the provision for credit losses. Past due loans at December 31, 2000 were unchanged from 1999, and they consisted primarily of well-secured loans. The adequacy of the allowance for credit losses is determined based upon management's estimate of the inherent risks associated with lending activities, estimated fair value of collateral, past experience and present indicators such as loan delinquency trends, nonaccrual loans and current market conditions. The allowance for credit losses is comprised of two parts: the allocated allowance and the unallocated allowance. The allocated allowance is the portion of the allowance which results from management's evaluation of specific loss allocations for problem loans and pooled reserves based on historical loss experience for each loan category. The unallocated allowance is determined based on management's assessment of industry trends and economic factors in the markets in which the Company operates. The determination of the unallocated reserve involves a higher risk of uncertainty and considers current risk factors that may not have yet manifested themselves in the Company's historical loss factors. The Banks maintain separate allowances for credit losses which are only available to absorb losses from their own loan portfolios. Each Bank's allowance is subject to regulatory examinations and determinations as to its adequacy. The allocated allowance is based on quarterly analysis of the loan portfolio by each Bank and is determined based upon the analysis of collateral values, cash flows and guarantor's financial capacity, whichever are applicable. In addition, allowance factors are applied to internally classified loans for which specific allowances have not been determined and historical loss factors are applied to homogenous pools of unclassified loans. Historical loss factors may be adjusted by management in situations where no historical losses have occurred or when current conditions are not reflective of the specific history of the Company. -6- The unallocated allowance is based upon management's evaluation of external conditions, the effects of which are not directly measured in the determination of the allocated allowance. The conditions evaluated in connection with the unallocated allowance include: general economic and business conditions affecting the Company's primary lending area, credit quality trends, collateral values, loan values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within the portfolio segments, recent loss experience, duration of the current business cycle, bank regulatory examination results, and findings of internal loan review personnel. Management reviews the conditions which impact the unallocated allowance quarterly and to the extent any of these conditions relate to specifically identifiable loans may reflect the adjustment in the allocated allowance. Where any of these conditions is not related to a specific loan, management's evaluation of the probable loss related to the condition is reflected in the unallocated allowance. During 1998, 1999 and 2000 the methodology used to calculate the adequacy of the allowance for credit losses was unchanged, except that loss factors were adjusted to reflect trends in the industry which were not evidenced by true historical factors. In 1998 and 1999, despite a decline in net losses, management noted increases in commercial and real estate loan balances. Losses inherent in those loans are more difficult to assess because the Company's loss history has been volatile. In 2000 nonaccrual loans declined, however, net charge offs increased due to a reduction in recoveries, by approximately $50,000. At December 31, 2000 the allowance for credit losses was $4,199,000, or 1.14% of outstanding loans, and 674% of total nonaccrual loans. This compares to an allowance of $3,991,000, or 1.23% of outstanding loans and 220% of nonaccrual loans at December 31, 1999 and an allowance for credit losses of $3,931,000 or 1.32% of outstanding loans and 450% of nonaccrual loans at December 31, 1998. The following table sets forth a summary of the Company's loan loss experience for the years ended December 31.
(Dollars in thousands) 2000 1999 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Balance, beginning of year $ 3,991 $ 3,931 $ 3,942 $ 4,232 $ 3,556 -------- -------- -------- -------- -------- Loans charged off: Real estate loans (61) (121) (69) (159) (117) Installment loans (73) (146) (122) (169) (129) Commercial and other (244) (162) (193) (305) (242) ------ ------- ------ ------ ------- (378) (429) (384) (633) (488) ------ ------- ------ ------ ------- Recoveries: Real estate loans 18 50 26 4 21 Installment loans 50 43 57 74 73 Commercial and other 81 156 50 25 115 -------- -------- -------- -------- ------- 149 249 133 103 209 ------- -------- -------- --------- ------- Net losses charged off (229) (180) (251) (530) (279) Allowance applicable to loans of acquired institution - - - 15 - Provision for credit losses 437 240 240 225 955 ------- -------- ------- ------- ------- Balance, end of year $ 4,199 $ 3,991 $ 3,931 $ 3,942 $ 4,232 ------- ------- ------- ------- ------- Average loans outstanding $367,075 $324,507 $297,786 $278,607 $257,374 ======== ======== ======== ======== ======== - -------------------------------------------------------------------------------------------------------------------- Percentage of net charge-offs to average loans outstanding during the year .06% .06% .08% .19% .16% Percentage of allowance for loan losses at year-end to average loans 1.14% 1.23% 1.32% 1.41% 1.61% - --------------------------------------------------------------------------------------------------------------------
-7- - -------------------------------------------------------------------------------- Total non-accrual loans of the Company decreased during 2000 and represented .16% of total loans, net of unearned income at December 31, 2000 compared to .52% one year earlier. Loan delinquencies remained unchanged at $1.3 million for 2000 and 1999. The following table summarizes the past due and non-performing assets of the Company as of December 31.
(Dollars in thousands) 2000 1999 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------- Non-performing assets: Non-accrual loans $ 623 $ 1,812 $ 873 $1,481 $2,423 Other real estate and other assets owned 14 137 164 114 299 ------ ------ ------ ------ ------- Total non-performing assets 637 1,949 1,037 1,595 2,722 Past due loans 1,333 1,333 1,436 1,673 1,244 ------ ------ -------- ------- ------- Total non-performing assets and past due loans $1,970 $3,282 $2,473 $3,268 $3,966 ====== ====== ====== ====== ====== - ---------------------------------------------------------------------------------------------------------------------------- Non-accrual loans to total loans, net of unearned income, at period end .16% .52% .29% .50% .93% Non-accrual loans and past due loans, to total loans, net of unearned income, at period end .51% .91% .76% 1.07% 1.41% - ----------------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME Noninterest income increased $966,000 or 45.2% in 2000 compared to an increase of $478,000 or 28.8% in 1999. The primary sources of increased noninterest income in 2000 were service charges on deposit accounts ($182,000) and a one-time gain from the proceeds of life insurance policies held by the Company ($750,000). Direct service charge income or nonsufficient funds check charges caused the majority of the increase in service charge income on deposit accounts. Life insurance gains resulted upon collection of policies held by the Company as an investment. The Company realized losses on investment securities available for sale of $48,000 during the year in order to take advantage of higher investment yields available in the market. Unconsolidated subsidiaries generated income for the first time in recent years as a result of the liquidation of Eastern Shore Mortgage Corporation in 2000. Other noninterest income increased 41% primarily as a result of increased fees earned on sales of nondeposit products of approximately $50,000.
YEARS ENDED CHANGE FROM PRIOR YEAR 2000/99 1999/98 (Dollars in thousands) 2000 1999 1998 AMOUNT PERCENT Amount Percent - -------------------------------------------------------------------------------------------------------------------------- Service charges on deposit accounts $1,751 $1,569 $1,310 $182 11.6% $259 19.8% Other service charges and fees 376 375 250 1 0.3% 125 49.8% Gain (loss) on sale of securities (48) 34 (3) (82) (242.5)% 37 -- % Gain on life insurance policies 750 -- -- 750 -- % -- -- % Earnings (loss) from unconsolidated subsidiaries 15 (24) (70) 39 162.4% 46 65.7% Other noninterest income 260 184 173 76 41.1% 11 7.3% - -------------------------------------------------------------------------------------------------------------------------- Total $3,104 $2,138 $1,660 $966 45.2% $478 28.8% - --------------------------------------------------------------------------------------------------------------------------
-8- NONINTEREST EXPENSES Total noninterest expense increased $944,000 or 8.6% in 2000 compared to an increase of $326,000 or 3.1% in 1999. Increased salaries and employee benefits and expenses related to the merger are the primary causes of the increase. The company had 154 full-time equivalent employees at December 31, 2000 compared to 152 at December 31, 1999 and 146 at December 31, 1998. Salaries and employee benefits increased $430,000 in 2000. Increases in health insurance and the cost associated with the termination of the Company's frozen defined benefit plan accounted for $233,000 of the increase. Data processing costs and occupancy expenses increases were minimal during 2000 when compared to 1999. Increases in data processing and occupancy expenses from 1998 to 1999 were the result of increased lease expense for two branches, three new ATM locations, increased repair and maintenance expenses, and increased depreciation expense associated with leasehold improvements. Other operating expense increased as a result of $376,000 in merger related expenses incurred by the Company in the merger of Talbot Bancshares, Inc. into Shore Bancshares, Inc.
YEARS ENDED CHANGE FROM PRIOR YEAR 2000/99 1999/98 (Dollars in thousands) 2000 1999 1998 AMOUNT PERCENT Amount Percent - -------------------------------------------------------------------------------------------------------------------------- Salaries and employee benefits $ 6,472 $6,042 $5,803 $430 7.1% $239 4.1% Occupancy and equipment 1,373 1,373 1,305 -- --% 68 5.2% Data processing 764 748 659 16 2.2% 89 13.5% Amortization of goodwill 147 147 171 -- --% (24) (13.7)% Other operating expenses 3,148 2,650 2,696 498 18.8% (46) (1.7)% - -------------------------------------------------------------------------------------------------------------------------- Total $11,904 $10,960 $10,634 $944 8.6% $326 3.1% - --------------------------------------------------------------------------------------------------------------------------
INCOME TAXES Income tax expense was $4.4 million for 2000 compared to $3.5 million for 1999 and $3.2 million for 1998. The effective tax rates on earnings were 35.6%, 34.1% and 34.1%, respectively. The increase in the Company's overall effective tax rate in 2000 is primarily attributable to a reduction in the amount of tax-exempt income from the investment portfolio and an increase in non-deductible expenses. Deferred tax assets and liabilities are recognized based on the differences between financial statement and tax bases of assets and liabilities measured using current tax rates. If it is likely that deferred tax assets will not be fully realized a valuation allowance is provided against deferred tax assets. Management feels that no such valuation allowance is necessary at December 31, 2000 and 1999. Deferred tax expense is measured by the change in net deferred tax assets or liabilities for the period. -9- - -------------------------------------------------------------------------------- REVIEW OF FINANCIAL CONDITION Asset and liability composition, asset quality, capital resources, liquidity, market risk and interest sensitivity are all factors which are used to measure the Company's financial condition. ASSETS Total assets increased 6.7% to $553,097,000 at December 31, 2000 compared to an increase of 7.2% for 1999. Average total assets increased 5.4% for 2000 compared to an increase of 9.1% for 1999. The loan portfolio represents 73.7% of average earning assets and is the primary source of income for the Company. Funding for loans is primarily provided by core deposits and short term borrowings. Total deposits increased 6.5% to $464,485,000 at December 31, 2000 compared to an 8.4% increase for 1999. The following table sets forth the average balance of the components of average earning assets as a percentage of total average earning assets as of December 31.
2000 1999 1998 1997 1996 ------- ------- ------- ------- ------- Investment Securities 24.25% 27.23% 25.88% 26.35% 26.52% Loans 73.66 68.62 68.80 69.63 69.24 Federal funds sold 2.09 4.15 5.32 4.02 4.24 ------- ------- ------- ------- ------- 100.00% 100.00% 100.00% 100.00% 100.00% ====== ====== ====== ====== ======
INVESTMENT SECURITIES The investment portfolio is structured to provide liquidity for the Company and also plays an important role in the overall management of interest rate risk. The securities in the investment portfolio are classified as either held to maturity or available for sale. Investment securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts. The Company has the intent and ability to hold such securities until maturity. Investment securities available for sale are stated at estimated fair value based on quoted market prices. They represent securities which may be sold as part of the Company's asset/liability strategy or which may be sold in response to changing interest rates. Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income, a separate component of stockholders' equity. At December 31, 2000 the Company had classified 81% of the portfolio as available for sale and 19% as held to maturity compared to 79% and 21% one year ago. The percentage of securities designated as available for sale has continued to increase since 1996 to support the anticipated growth and liquidity needs of the Company. With the exception of municipal securities it is the general practice of the Company to place all newly purchased securities in the available for sale portfolio. The average balance of the investment portfolio decreased $7,954,000 or 6.2% for 2000 as result of strong loan growth for the year. The increase in the average balance of investment securities for 1999 was $16,772,000 or 15%. Reinvestment of maturities in the investment portfolio and new investments resulting from growth were concentrated in U.S. Government Agency bonds whose earnings are exempt from state income tax. These bonds yield higher returns without affecting the overall safety and liquidity of the portfolio. The Company does not generally invest in structured notes or other derivative securities. -10- - -------------------------------------------------------------------------------- The following table sets forth the maturities and weighted average yields of the investment portfolio based upon the earliest possible repricing date as of December 31, 2000.
1 YEAR OR LESS 1-5 YEARS 5-10 YEARS OVER 10 YEARS -------------- --------- ---------- ------------- Carrying Average Carrying AverageCarrying Average Carrying Average (Dollars in thousand) Amount Yield Amount Yield Amount Yield Amount Yield Held to Maturity: U.S. Treasury securities and obligations of U.S. government agencies $ 2,000 5.97 % $8,007 6.40% $2,500 7.00 %$ - - % Obligations of states and political subdivisions (1) 853 6.26 5,985 6.79 3,206 6.78 - - Other securities - - - - 14 8.00 - - -------- -------- --------- ----------------- ------- ------------------ Total Held to Maturity $ 2,853 6.06 % $13,992 6.57% $5,720 6.88 % $ - - ======= ======= ======= ===== ======= ======== =================== Available for Sale: U.S. Treasury securities and obligations of U.S. government agencies $20,703 5.95 % $64,046 5.85% 2,088 5.74 %$ - -% Obligations of states and political subdivisions (1) 196 5.89 210 6.16 - - - - Other securities 13 9.65 1,445 7.12 - - 6,334 2.90 -------- ------- ------ ------ ------- ------- ----- ---- Total Available for Sale $20,912 5.95 % $65,701 5.88% $ 2,088 5.74 % $6,334 2.90% ======= ===== ======= ==== ======= ==== ====== ==== (1) Yields adjusted to reflect a tax equivalent basis assuming a federal tax rate of 34%.
LOANS Average loans increased 13.1% in 2000 compared to 9% growth experienced in 1999. Total loans, net of unearned income totaled $382,506,000 on December 31, 2000 an increase of $36,715,000 or 10.6% when compared to 1999. The most significant component of loan growth in 2000 was mortgage loans. Mortgage loans increased 12.6% or $32,693,000 totaling $291,136,000 at December 31, 2000. A strong local economy was the primary reason for the healthy lending environment in 2000 and 1999. Refinancing activity resulting from lower long-term interest rates made it difficult to grow the loan portfolio in 1998. Real estate construction loans increased $2,944,000 or 18.8%, totaling $18,587,000 and consumer loans increased $1,904,000 or 11.7% totaling $18,141,000 for the year. Loan growth in 1999 occurred in all categories of loans with commercial and mortgage loans having the most significant increases. The table below sets forth the composition of the loan portfolio at December 31.
(Dollars in thousands) 2000 1999 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------ Commercial, financial and agricultural $ 54,642 $ 55,468 $ 42,109 $ 35,721 $ 38,001 Real estate - construction 18,587 15,643 13,228 12,483 10,072 Real estate - mortgage 291,136 258,443 235,830 232,419 196,548 Consumer 18,141 16,237 14,393 13,837 15,973 ---------- ---------- --------- --------- --------- Total Loans $382,506 $345,791 $305,560 $294,460 $260,594 ======== ======== ======== ======== ======== - ------------------------------------------------------------------------------------------------------------------------
-11- FEDERAL FUNDS SOLD The Company invests excess cash balances in overnight investments, or federal funds sold, with its correspondent banks. Federal funds sold are maintained at a level necessary to meet the immediate liquidity needs of the Company. The average balance of federal funds sold decreased $9,206,000 to $10,397,000 during 2000 representing a 47% decrease when compared to 1999. In 1999, the average balance of federal funds sold decreased $3,439,000 to $19,603,000 a decrease of 15% compared to 1998. DEPOSITS The Company primarily utilizes core deposits to fund its earning assets. At December 31, 2000 and 1999 deposits provided funding for 77% and 78% of average earning assets, respectively. Average deposits increased 4.7% in 2000 and 9.7% in 1999. The average rate paid on interest bearing deposits increased 21 basis points to 4.29% for 2000 compared to 4.08% for 1999. During 2000, the rates paid for deposits increased in all categories. The most significant increase was in certificates of deposit $100,000 or more. In 1999, there was a decline in the rates paid for interest bearing deposits. The average balances of certificates of deposit $100,000 or more increased $9,149,000 or 14.8% in 2000 and $11,374,000 or 22.5% in 1999. The growth from 1998 through 2000 was primarily attributable to growth in deposits of counties and municipalities in the Company's market area. The Company has maintained a long-term relationship with these local governments and therefore does not consider the deposits to be volatile. The average balance of other time deposits increased $1,890,000 or 1.9% in 2000. An additional $9,970,000 of deposit growth was achieved through increased balances of transaction accounts offset by a $1,405,000 decline in money management and savings accounts. The decline in savings balances is the result of depositors shifting money into investment vehicles with higher returns. The Company does not accept br okered deposits, nor does it rely on purchased deposits as a funding source for loans. The following table sets forth the average balances of deposits and the percentage of each category to total deposits for the years ended December 31.
(Dollars in thousands) Average Balances 2000 1999 1998 - -------------------------------------------------------------------------------------------------------------------- Noninterest-bearing demand $50,058 11.53% $46,137 11.10% $40,028 10.57% Interest bearing deposits NOW and Super NOW 76,232 17.55% 70,200 16.90% 65,298 17.24% Savings 30,863 7.11% 31,565 7.60% 30,832 8.14% Money Management 71,788 16.53% 73,269 17.63% 68,301 18.04% CD's and other time deposits less than $100,000 134,245 30.91% 132,355 31.86% 123,611 32.64% CD's $100,000 or more 71,111 16.37% 61,962 14.91% 50,588 13.36% -------- ------- -------- ------- -------- ------- $434,297 100.00% $415,488 100.00% $378,658 100.00% ======== ======= ======== ======= ======== ======= - --------------------------------------------------------------------------------------------------------------------
The following table sets forth the maturity ranges of certificates of deposit with balances of $100,000 or more on December 31, 2000. (Dollars in thousands). - -------------------------------------------------------------------------------- Three months or less $39,881 Three through twelve month 11,777 Over twelve months 26,615 -------- $78,273 - -------------------------------------------------------------------------------- -12- - -------------------------------------------------------------------------------- SHORT TERM BORROWINGS Short term borrowings consist primarily of securities sold under agreement to repurchase. These short term obligations are issued in conjunction with cash management services for deposit customers. The average balance of these borrowings decreased $681,000 or 2.5% in 2000 and $178,000 or 1% in 1999. From time to time in order to meet short term liquidity needs the Company may borrow from a correspondent bank under a federal funds line of credit arrangement. The following table sets forth the Company's position with respect to short term borrowings.
(Dollars in thousands) 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------ INTEREST Interest Interest BALANCE RATE Balance Rate Balance Rate - ------------------------------------------------------------------------------------------------------------------------ FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: Average outstanding for the year $21,522 5.09% $17,813 3.86% $14,561 4.16% Outstanding at year end 16,252 4.96 16,933 3.95 17,111 3.99 Maximum outstanding at any month end 32,498 - 23,297 - 19,879 - - ------------------------------------------------------------------------------------------------------------------------
LIQUIDITY Liquidity describes the ability of the Company to meet financial obligations that arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of customers and to fund current and planned expenditures. Liquidity is derived through increased customer deposits, maturities in the investment portfolio, loan repayments and income from earning assets. To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short term funds markets. The Company has arrangements with correspondent banks whereby it has $17,000,000 available in federal funds lines of credit and a reverse repurchase agreement available to meet any short term needs which may not otherwise be funded by its portfolio of readily marketable investments that can be converted to cash. The Banks are also members of the Federal Home Loan Bank of Atlanta, which provides another source of liquidity. At December 31, 2000, the Company's loan to deposit ratio was 82%, compared to 79% one year ago. Investment securities available for sale totaling $95,034,000 were available for the management of liquidity and interest rate risk. Cash and cash equivalents at December 31, 2000 were $39,715,000, up $5,149,000 from one year ago. Management is not aware of any demands, commitments, events or uncertainties, which will materially affect the Company's ability to maintain liquidity at satisfactory levels. MARKET RISK AND INTEREST RATE SENSITIVITY Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates or equity pricing. The Company's principal market risk is interest rate risk that arises from its lending, investing and deposit taking activities. The Company's profitability is dependent on the Banks' net interest income. Interest rate risk can significantly affect net interest income to the degree that interest bearing liabilities mature or reprice at different intervals than interest earning assets. The Asset/Liability Committee of the Board of Directors (the "ALCO") of both Banks oversees the management of interest rate risk. The ALCO's primary purpose is to manage the exposure of net interest margins to unexpected changes due to interest rate fluctuations. These efforts affect the loan pricing and deposit rate policies of the Company as well as the asset mix, volume guidelines, and liquidity and capital planning. -13- - -------------------------------------------------------------------------------- The Company does not utilize derivative financial or commodity instruments, or hedging strategies in its management of interest rate risk. Since the Company is not exposed to market risk from trading activities and does not utilize hedging strategies or off-balance sheet management strategies, the ALCO relies primarily on "gap" analysis as its primary tool in managing interest rate risk. Gap analysis summarizes the amount of interest sensitive assets and liabilities which will reprice over various time intervals. The difference between the volume of assets and liabilities repricing in each interval is the interest sensitivity "gap". "Positive gap" occurs when more assets reprice in a given time interval, while "negative gap" occurs when more liabilities reprice. As of December 31, 2000, the Company had a positive gap position within the one year repricing interval. The following table summarizes the Company's interest sensitivity at December 31, 2000. Loans, federal funds sold, time deposits and short term borrowings are classified based upon contractual maturities if fixed rate or earliest repricing date if variable rate. Investment securities are classified by contractual maturities or, if they have call provisions, by the most likely repricing date. Management has classified money market, savings and NOW accounts primarily in the over 1 year interval because they have not historically repriced in accordance with general changes in interest rates.
(Dollars in Thousands) 3 Months 1 Year Non- Within through through After Sensitive December 31, 2000 3 Months 12 Months 5 Years 5 Years Funds Total - -------------------------------------------------------------------------------------------------------------- EARNING ASSETS: Loans - net of unearned income $92,377 $59,771 $189,572 $40,589 $ 197 $382,506 Investment securities 11,141 13,852 78,819 8,084 5,704 117,600 Federal funds sold 19,676 - - - - 19,676 OTHER ASSETS - - - - 33,315 33,315 - -------------------------------------------------------------------------------------------------------------- TOTAL EARNING ASSETS $123,194 $73,623 $268,391 $48,673 $39,216 $553,097 INTEREST-BEARING LIABILITIES: Certificates of deposit $100,000 and over $39,882 $11,776 $26,615 $ - $ - $78,273 All other time deposits 17,816 41,196 83,111 - - 142,123 Savings and money market 31,874 10,804 53,437 2,555 - 98,670 Interest bearing transaction 26,818 1,859 50,137 10,675 - 89,489 Noninterest bearing liabilities - - - - 55,931 55,931 Short term borrowings 16,252 - - - - 16,252 Long term debt 5,000 - - - - 5,000 Other liabilities - - - - 2,335 2,335 STOCKHOLDERS' EQUITY - - - 65,024 65,024 - -------------------------------------------------------------------------------------------------------------- TOTAL INTEREST BEARING LIABILITIES $137,642 $65,635 $213,300 $13,230 $123,290 $553,097 - -------------------------------------------------------------------------------------------------------------- Excess $(14,448) $7,988 $55,091 $35,443 $(84,074) Cumulative Excess $(14,448) $(6,460) $48,631 $84,074 $ - Cumulative Excess as percent of total (2.61)% (1.17)% 8.79% 15.20% - - --------------------------------------------------------------------------------------------------------------
In addition to gap analysis, the Banks utilize simulation models to quantify the effect a hypothetical immediate plus or minus 200 basis point change in rates would have on net interest income and the fair value of capital. The model takes into consideration the effect of call features of investments as well as prepayments of loans in periods of declining rates. When actual changes in interest rates occur, the changes in interest earning assets and interest bearing liabilities may differ from the assumptions used in the model. As of December 31, 2000 the model produced the following sensitivity profile for net interest income and the fair value of capital. -14- - --------------------------------------------------------------------------------
Immediate Change in Rates Policy +200 Basis Points -200 Basis Points Limit % Change in Net Interest Income 7.2% (8.6)% + 25% - % Change in Fair Value of Capital (3.1)% (0.5)% + 15% -
CAPITAL RESOURCES AND ADEQUACY The Company continues to maintain capital at levels in excess of those required by the federal banking agencies. Total stockholders' equity was $65,024,000 at December 31, 2000, 11.2% higher than the previous year. Average stockholders' equity was $61,285,000 for 2000, an increase of 6.8% compared to 1999. The increase in stockholders' equity is primarily due to earnings of the Company for the year of $7.96 million, reduced by dividends paid on common stock of $2.8 million and a $1.2 million increase in other accumulated comprehensive income, consisting solely of unrealized losses from the Company's investment securities available for sale. The Company records unrealized holding gains (losses), net of tax, on investment securities available for sale as accumulated other comprehensive income (loss), a separate component of stockholder's equity. As of December 31, 2000 and 1999, the portion of the Banks' investment portfolio designated as "available for sale" had unrealized holding losses, net of tax, of $554,000 and $1,774,000, respectively. The following table compares the Company's capital ratios as of December 31, to the regulatory requirements.
Regulatory (Dollars in thousands) 2000 1999 Requirements - -------------------------------------------------------------------------------- Tier 1 capital $ 63,611 $ 58,088 Tier 2 capital 4,199 3,991 - -------------------------------------------------------------------------------- Total capital, less deductions $ 67,810 $ 62,069 Risk-adjusted assets 373,335 $ 336,288 Risk-based capital ratios: Tier 1 17.04% 17.27% 4.0% Total capital 18.16% 18.46% 8.0% - -------------------------------------------------------------------------------- Total capital $63,611 $ 58,078 Total adjusted assets $544,854 $ 512,600 Leverage capital ratio 11.67% 11.33% 4.0% - --------------------------------------------------------------------------------
Management knows of no trends or demands, commitments, events or uncertainties, which may materially affect capital. -15- - -------------------------------------------------------------------------------- RECENT STOCK PRICES AND DIVIDENDS The Company's stock is quoted on the OTC Bulletin Board (OTCBB) under the symbol SHBI and is traded infrequently. Price information listed on the OTCBB is based upon the participation of market makers for the Company's stock. The following table indicates cash dividends paid per share for each quarter of 2000, 1999 and 1998 and the ranges of representative sales prices for the stated periods, based on actual transfers recorded by the transfer agent.
2000 1999 1998 Price Range Dividends Price Range Dividends Price Range Dividends High Low Paid High Low Paid High Low Paid - ---------------------------------------------------------------------------------------------------------------- First Quarter $ 21.00 - 18.00 $ .12 $ 33.50 - 27.00 $ .10 $ 23.25 - 22.50 $.09 Second Quarter 19.00 - 12.00 .12 32.00 - 28.00 .10 33.50 - 24.00 .09 Third Quarter 22.00 - 13.00 .12 30.00 - 20.00 .10 34.00 - 27.75 .09 Fourth Quarter 18.25 - 11.00 .16 21.00 - 18.00 .15 33.00 - 31.00 .13 ----- ----- ---- $.52 $ .45 $.40 - ----------------------------------------------------------------------------------------------------------------
-16- [LOGO] SELECTED FINANCIAL DATA The following table sets forth certain selected financial data for the five years ended December 31, 2000 and is qualified in its entirety by the detailed information and financial statements, including notes thereto, included elsewhere or incorporated by reference in this annual report. This data should be read in conjunction with the financial statements and related notes thereto, included elsewhere in this annual report and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Years Ended December 31, (Dollars in thousands, except per shares data) 2000 1999 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------- SUMMARY OF OPERATING RESULTS: Total interest income $39,480 $35,435 $34,058 $32,077 $29,760 Total interest expense 17,888 16,039 15,386 14,044 12,924 ------- ------ ------ ------ ------ Net interest income 21,592 19,396 18,672 18,033 16,836 Provision for credit losses 437 240 240 225 955 --------- -------- -------- -------- -------- Net interest income after provision for credit losses 21,155 19,156 18,432 17,808 15,881 Noninterest income 3,104 2,138 1,660 1,622 1,573 Noninterest expense 11,904 10,961 10,634 10,194 9,002 ------ ------ ------ ------ ------ Income before income taxes 12,355 10,333 9,458 9,236 8,452 Provision for income taxes 4,398 3,528 3,224 3,192 2,924 ------ ------- ------- ------- ------ NET INCOME $ 7,957 $ 6,805 $ 6,234 $ 6,044 $5,528 ======= ======= ======= ======= ====== - ---------------------------------------------------------------------------------------------------------------- PER SHARE DATA: Diluted net income $ 1.48 $ 1.27 $ 1.15 $ 1.11 $ 1.02 Dividends paid .52 .45 .40 .37 .33 Book value 12.21 11.00 10.58 10.08 9.27 Tangible book value 11.91 10.67 10.22 9.69 9.25 Weighted average common shares (1) 5,388,486 5,376,200 5,425,172 5,432,369 5,393,267 OTHER DATA (AT YEAR END): Total assets $553,097 $518,217 $483,308 $442,144 $400,083 Total deposits 464,485 436,021 403,237 370,727 339,267 Total loans, net of unearned income and allowance for credit losses 378,307 341,800 301,629 290,519 256,361 Total stockholders' equity 65,024 58,485 56,188 54,487 50,016 RETURN ON EQUITY AND ASSETS: Return on average total assets 1.52% 1.37% 1.37% 1.43% 1.42% Return on average stockholders' equity 12.98% 11.85% 11.16% 11.59% 11.48% Dividend payout ratio 34.97% 35.34% 34.39% 32.88% 31.76% Average stockholders' equity to average total assets 11.68% 11.53% 12.25% 12.37% 12.39% - ---------------------------------------------------------------------------------------------------------------- (1) The weighted average common shares include the effect of dilution of stock options outstanding during the period.
-17- [LOGO] CONSOLIDATED BALANCE SHEETS - --------------------------------------------------------------------------------
December 31, 2000 and 1999 2000 1999 - -------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks 20,039,249 $ 8,880,109 Federal funds sold 19,676,215 25,685,466 Investment securities: Available for sale - at fair value 95,034,215 98,272,735 Held to maturity - at amortized cost - fair value of $22,576,492 (2000) and $25,382,995 (1999) 22,565,750 25,854,090 Loans, less allowance for credit losses (2000) $4,199,008 (1999) $3,990,558 378,307,130 341,800,293 Premises and equipment, net 7,039,100 6,361,677 Accrued interest receivable on loans and investment securities 4,333,567 3,584,579 Investment in unconsolidated subsidiary 1,082,128 1,067,228 Goodwill 1,622,229 1,769,617 Deferred income taxes 1,183,746 1,855,805 Other real estate 14,116 137,116 Other assets 2,199,267 2,948,271 ------------- ------------ Total assets $553,096,712 $518,216,986 ============ ============ - -------------------------------------------------------------------------------------------------- LIABILITIES Deposits: Noninterest bearing demand $ 55,930,929 $ 53,176,158 NOW and Super NOW 89,488,635 72,093,316 Certificates of deposit, $100,000 or more 78,272,816 74,096,883 Other time and savings 240,792,606 236,654,688 ------------- ------------ 464,484,986 436,021,045 Accrued interest payable 1,005,878 681,260 Short term borrowings 16,252,182 16,933,308 Long term debt 5,000,000 5,000,000 Other liabilities 1,329,413 1,096,001 ------------- ------------ Total liabilities 488,072,459 459,731,614 ------------- ------------ - -------------------------------------------------------------------------------------------------- COMMITMENTS STOCKHOLDERS' EQUITY Common stock, par value $.01, authorized 35,000,000 shares; issued and outstanding (2000) 5,324,157 shares; (1999) 5,314,819 shares 53,242 53,148 Surplus 22,923,707 22,776,437 Retained earnings 42,601,248 37,429,483 Accumulated other comprehensive loss (553,944) (1,773,696) ------------- ------------ Total stockholders' equity 65,024,253 58,485,372 ------------- ------------ Total liabilities and stockholders' equity $ 553,096,712 $518,216,986 ============= ============ - -------------------------------------------------------------------------------------------------- The notes to consolidated financial statements are an integral part of these statements.
-18- [LOGO] CONSOLIDATED STATEMENTS OF INCOME - --------------------------------------------------------------------------------
For the Years Ended December 31, 2000, 1999 and 1998 2000 1999 1998 - --------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans, including fees $31,619,234 $27,084,423 $26,273,162 Interest and dividends on investment securities: Taxable 6,691,678 6,772,876 5,833,609 Tax-exempt 499,215 589,996 692,727 Federal funds sold 669,823 987,303 1,258,721 ----------- -------------- ------------- Total interest income 39,479,950 35,434,598 34,058,219 ----------- ------------ ------------ INTEREST EXPENSE NOW and Super NOW accounts 1,989,954 1,806,684 1,981,946 Certificates of deposit, $100,000 or more 4,071,479 3,147,589 2,725,609 Other time and savings 10,414,939 10,123,976 9,788,866 Interest on short term borrowings 1,096,149 687,250 602,645 Interest on long term debt 315,467 273,889 286,930 ----------- -------------- -------------- Total interest expense 17,887,988 16,039,388 15,385,996 ----------- ------------ ------------- NET INTEREST INCOME 21,591,962 19,395,210 18,672,223 PROVISION FOR CREDIT LOSSES 437,045 240,000 240,000 ----------- ------------ ------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 21,154,917 19,155,210 18,432,223 NONINTEREST INCOME Service charges on deposit accounts 1,750,652 1,568,995 1,310,269 Gain (loss) on sale of securities (47,839) 33,582 (3,197) Gain on life insurance policies 750,004 - - Other operating income, net 650,739 535,251 352,444 ----------- ------------- ------------- 3,103,556 2,137,828 1,659,516 ----------- ------------- ------------- NONINTEREST EXPENSES Salaries and wages 4,783,091 4,586,511 4,435,821 Employee benefits 1,688,893 1,455,819 1,367,423 Occupancy expense 714,775 722,286 643,102 Furniture and equipment expense 657,696 650,686 662,137 Data processing 764,413 747,857 658,647 Amortization of goodwill 147,388 147,392 170,794 Other operating expenses 3,147,429 2,649,884 2,695,952 ----------- ----------- ------------ 11,903,685 10,960,435 10,633,876 ----------- ----------- ------------ INCOME BEFORE INCOME TAXES 12,354,788 10,332,603 9,457,863 Federal and State income taxes 4,397,824 3,527,915 3,224,238 ----------- ------------ ------------ NET INCOME $ 7,956,964 $ 6,804,688 $ 6,233,625 =========== =========== =========== - --------------------------------------------------------------------------------------------------------- Basic earnings per common share $1.50 $1.28 $1.16 ===== ===== ===== Diluted earnings per common share $1.48 $1.27 $1.15 ===== ===== ===== - --------------------------------------------------------------------------------------------------------- The notes to consolidated financial statements are an integral part of these statements.
[LOGO] CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - --------------------------------------------------------------------------------
For the Years Ended December 31, 2000, 1999 and 1998 ACCUMULATED OTHER TOTAL COMMON RETAINED COMPREHENSIVE STOCKHOLDERS' STOCK SURPLUS EARNINGS INCOME (LOSS) EQUITY ------------ ------------ ------------ ---------------- --------------- Balances, January 1, 1998 $ 43,977 $22,590,270 $31,760,687 $ 91,490 $54,486,424 Comprehensive income: Net income - - 6,233,625 - 6,233,625 Other comprehensive income, net of tax: Unrealized gain on available for sale securities, net of reclassification adjustment of $(19,020) - - - 308,562 308,562 ------------ Total comprehensive income 6,542,187 ----------- 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) 5,748 shares issued under 401(k) plan 58 101,723 - - 101,781 Exercise of stock options 17 13,258 - - 13,275 Cash dividends paid, $.40 per share - - (2,143,739) - (2,143,739) - ----------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 1998 53,113 22,705,251 33,029,549 400,052 56,187,965 Comprehensive income: Net income - - 6,804,688 - 6,804,688 Other comprehensive income, net of tax: Unrealized loss on available for sale securities, net of reclassification adjustment of $(141,636) - - - (2,173,748) (2,173,748) ----------- Total comprehensive income - - - - 4,630,940 ------------ Stock repurchased and retired (29) (58,709) - - (58,738) 6,070 shares issued under 401(k) plan 60 119,230 - - 119,290 Exercise of stock options 4 10,665 - - 10,669 Cash dividends paid, $.45 per share - - (2,404,754) - (2,404,754) - ----------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 1999 53,148 22,776,437 37,429,483 (1,773,696) 58,485,372 Comprehensive income: Net income - - 7,956,964 7,956,964 Other comprehensive income, net of tax: Unrealized gain on available for sale securities, net of reclassification adjustment of $(7,148) - - - 1,219,752 1,219,752 ----------- Total comprehensive income - - - - 9,176,716 ----------- Stock repurchased and retired (1) (1,461) - - (1,462) 9,191 shares issued under 401(k) plan 92 143,044 - - 143,136 Exercise of stock options 5 5,687 - - 5,692 Fractional shares redeemed (2) - (2,546) - (2,548) Cash dividend paid $.52 per share - - (2,782,653) - (2,782,653) - ----------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 2000 $ 53,242 $22,923,707 $42,601,248 $(553,944) $65,024,253 ======== =========== =========== ========== =========== - ----------------------------------------------------------------------------------------------------------------------------- The notes to consolidated financial statements are an integral part of these statements.
-19- [LOGO] CONSOLIDATED STATEMENTS OF CASH FLOWS - --------------------------------------------------------------------------------
For the Years Ended December 31, 2000, 1999 and 1998 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 7,956,964 $6,804,688 $ 6,233,625 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 926,318 1,068,935 882,467 Discount accretion on debt securities (467,105) (152,807) (132,156) Discount accretion on matured debt securities 441,861 98,199 204,278 Loss (gain) on sale of securities 47,839 (33,582) 3,197 Gain on life insurance policies (750,004) - - Provision for credit losses, net 208,450 59,320 (10,429) Deferred income taxes (89,489) (43,997) (116,014) Loss on disposal of premises and equipment 2,651 20,253 9,107 Loss on other real estate owned 17,566 7,614 18,124 Net changes in: Accrued interest receivable (748,988) (60,320) (99,657) Other assets 304,442 102,190 (8,180) Accrued interest payable 324,618 (10,321) 114,106 Other liabilities 233,412 15,449 (9,242) ------------- -------------- -------------- Net cash provided by operating activities 8,408,535 7,875,621 7,089,226 ------------- ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale 8,116,313 11,635,919 9,054,240 Proceeds from maturities and principal payments of securities available for sale 93,159,085 25,800,449 6,116,423 Purchases of securities available for sale (96,272,930) (45,727,609) (58,917,817) Proceeds from maturities and principal payments of securities held to maturity 3,580,036 23,819,309 48,594,922 Purchases of securities held to maturity (311,170) (12,911,397) (24,791,203) Net increase in loans (36,982,347) (39,761,816) (11,320,804) Purchase of loans - (1,400,000) - Proceeds from sale of loans - 880,837 - Purchase of premises and equipment (1,256,773) (746,263) (580,145) Proceeds from sale of other real estate owned 372,494 132,035 153,337 Proceeds from life insurance policies 1,170,966 - - Proceeds from sale of premises and equipment 20,700 450 19,203 ------------- ---------------- ---------------- Net cash used in investing activities (28,403,626) (38,278,086) (31,671,844) - ------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand, NOW, money market, and savings deposits 13,849,924 17,199,852 1,211,944 Net increase in certificates of deposit 14,614,017 15,584,351 31,297,969 Net (decrease) increase in short term borrowings (681,126) (178,067) 6,847,847 Proceeds from issuance of common stock 148,828 129,959 115,056 Repurchase of common stock (4,010) (58,738) (2,811,963) Dividends paid (2,782,653) (2,404,754) (2,143,739) -------------- ------------- ----------------- Net cash provided by financing activities 25,144,980 30,272,603 34,517,114 - --------------------------------------------------------------------------------------------------------------
[LOGO] CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) - --------------------------------------------------------------------------------
For the Years Ended December 31, 2000, 1999 and 1998 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,149,889 (129,862) 9,934,496 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 34,565,575 34,695,437 24,760,941 ----------- ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $39,715,464 $34,565,575 $34,695,437 =========== =========== =========== Supplemental cash flows information: Interest paid $17,563,370 $15,765,712 $14,989,302 =========== =========== =========== Income taxes paid $ 4,108,127 $3,475,246 $3,488,214 ============ ========== ========== Transfers from loans to other real estate $ 267,060 $ 113,000 $ 221,647 ============= =========== =========== The notes to consolidated financial statements are an integral part of these statements.
-20- [LOGO] NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 2000, 1999 and 1998 - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements include the accounts of Shore Bancshares, Inc. (the "Company") and it's subsidiaries, The Talbot Bank of Easton, Maryland ("Talbot Bank") and The Centreville National Bank of Maryland ("Centreville National Bank"), collectively referred to as the "Banks", with all significant intercompany transactions eliminated. The investments in subsidiaries are recorded on the Company's books on the basis of its equity in the net assets of the subsidiaries. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States and to prevailing practices within the banking industry. Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2000. NATURE OF OPERATIONS The Company, through its bank subsidiaries, provides commercial banking services from its locations in Talbot, Queen Anne's, Kent, Caroline, and Dorchester Counties, Maryland. Its primary source of revenue is from providing commercial, real estate and consumer loans to customers located on Maryland's Eastern Shore. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 AVAILABLE FOR SALE Investment securities available for sale are stated at estimated fair value based on quoted market prices. They represent those securities which management may sell as part of its asset/liability strategy or which may be sold in response to changing interest rates, changes in prepayment risk or other similar factors. The cost of securities sold is determined by the specific identification method. Net unrealized holding gains and losses on these securities are reported as accumulated other comprehensive income, a separate component of stockholders' equity, net of related income taxes. INVESTMENT SECURITIES HELD TO MATURITY Investment securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts. The Company intends and has the ability to hold such securities until maturity. When securities are transferred into the held to maturity category from available for sale, they are accounted for at estimated fair value with any unrealized holding gain or loss at the date of the transfer reported as accumulated other comprehensive income, net of income taxes, and amortized over the remaining life of the security as an adjustment of yield. LOANS Loans are stated at their principal amount outstanding net of any deferred fees and costs. Interest income on loans is accrued at the contractual rate based on the principal amount outstanding. Fees charged and costs capitalized for originating loans are being amortized substantially on the interest method over the term of the loan. A loan is placed on nonaccrual when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Loans are considered impaired when it is probable that the Banks will not collect all principal and interest payments according to the loan's contractual terms. The impairment of a loan is measured at the present value of expected future cash flows using the loan's effective interest rate, or at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Impaired loans do not include groups of smaller balance homogeneous loans such as residential mortgage and consumer installment loans that are evaluated collectively for impairment. Reserves for probable credit losses related to these loans are based upon historical loss ratios and are included in the allowance for credit losses. 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 when management believes that the collectibility of the principal is unlikely. The allowance for credit losses consists of an allocated component and an unallocated component. The components of allowance for credit losses represent an estimation done pursuant to either Statement of Financial Accounting Standards ("SFAS") No. 5 "Accounting for Contingencies" of SFAS No.114 "Accounting by Creditors for Impairment of a Loan". The allocated component of -21- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- the allowance for credit losses reflects expected losses resulting from analysis developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on a regular analysis of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The historical credit loss element is determined statistically using a loss migration analysis that examines loss experience and the related internal grading of loans charged-off. The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The allocated component of the allowance for credit losses also includes management's determination of the amounts necessary for concentrations and changes in portfolio mix and volume. The unallocated portion of the allowance is determined based on management's assessment of general economic conditions, as well as specific economic factors in the individual market in which the Company operates. This determination inherently involves a higher risk of uncertainty and considers current risk factors that may not have yet manifested themselves in the Company's historical loss factors used to determine the allocated component of the allowance and it recognizes knowledge of the portfolio may be incomplete. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed under the straight-line and accelerated methods over the estimated useful lives of the assets. INTANGIBLE ASSETS Goodwill represents the excess of the cost of assets acquired in purchase business combinations over the fair value of the net assets at the dates of acquisition and is being amortized on the straight-line method over a period of 15 years. Intangible 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 asset. OTHER REAL ESTATE Other real estate represents assets acquired in satisfaction of loans either by foreclosure or deeds taken in lieu of foreclosure. Properties acquired are recorded at the lower of cost or fair value less estimated selling costs at the time of acquisition with any deficiency charged to the allowance for credit losses. Thereafter, costs incurred to operate or carry the properties as well as reductions in value as determined by periodic appraisals are charged to operating expense. Gains and losses resulting from the final disposition of the properties are included in noninterest expense. SHORT TERM BORROWINGS Short term borrowing are comprised primarily of repurchase agreements which are securities sold to the Banks' customers, at the customers' request, under a continuing "roll-over" contract that matures in one business day. The underlying securities sold are U.S. Treasury notes or Government Agency bonds, which are segregated from the Company's other investment securities by the Banks' safekeeping agents. 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. Deferred income taxes are provided under the liability method based on the difference between the financial statement and taxes bases of assets and liabilities and are measured at the current statutory tax rates. CASH AND CASH EQUIVALENTS For purposes of the statements of cash flows, the Company considers cash and due from banks, and federal funds sold to be cash and cash equivalents. STOCK-BASED COMPENSATION Stock-based compensation is recognized using the intrinsic value method. For disclosure purposes, pro forma net income and earnings per share effects are provided as if the fair value method had been applied. NEW ACCOUNTING STANDARDS SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", requires derivative instruments be carried at fair value on the balance sheet. The statement continues to allow 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 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 Company adopted the provisions of this statement, as amended, for its quarterly and annual reporting beginning January 1, 2001, the statement's effective date. There was no effect on the Company's financial position, results of operations and cash flows upon adoption of the provisions of this statement because the Company does not invest in derivative instruments. -22- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 2. MERGER The Company completed its merger with Talbot Bancshares, Inc. ("Talbot"), headquartered in Easton, Maryland, whereby Talbot was merged into the Company in a tax free exchange of stock, accounted for as a pooling of interests which was effective December 1, 2000. Shareholders of Talbot received 2.85 newly issued shares of the Company common stock, or a total of 3,407,098 shares, for all 1,195,534 outstanding shares of Talbot and cash in lieu of each fractional share at the rate of $14.65 per share. At closing, Talbot had reported total assets of $337 million, loans of $248 million, and deposits of $279 million. Summarized results of operations of the separate companies for the period from January 1, 2000 through November 30, 2000 are as follows: COMPANY TALBOT ------- ------ Revenue: $14,270,707 $24,465,057 Net Income: $2,457,757 $5,159,950 Merger related expenses amounted to $375,501 and are included in the consolidated statement of income for the year ended December 31, 2000. NOTE 3. CASH AND DUE FROM BANKS The Federal Reserve requires banks to maintain certain minimum cash balances consisting of vault cash and deposits in the Federal Reserve Bank or in other commercial banks. Such balances averaged approximately $6,066,000 and $5,049,000 during 2000 and 1999, respectively. -23- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 4. INVESTMENT SECURITIES The amortized cost and estimated fair values of investment securities are as follows:
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR Available for sale securities: COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2000: U.S. Treasury securities $ 10,149,444 $ 24,643 $27,517 $ 10,146,570 Obligations of U.S. Government agencies and corporations 78,482,037 161,368 495,137 78,148,268 Obligations of states and political subdivisions 406,094 - 355 405,739 Federal Home Loan Bank stock 1,723,100 - - 1,723,100 Federal Reserve Bank stock 302,250 - - 302,250 Federal Home Loan Mortgage Corporation Cumulative preferred stock 3,480,513 - 418,475 3,062,038 Other Equity securities 1,390,036 1,651 145,437 1,246,250 ------------- ----------- ------------ ------------- $95,933,474 $187,662 $1,086,921 $95,034,215 =========== ======== ========== =========== December 31, 1999: U.S. Treasury securities $ 22,427,930 $ 31,294 $189,184 $ 22,270,040 Obligations of U.S. Government agencies and corporations 72,207,480 940 2,063,182 70,145,238 Obligations of states and political subdivisions 834,320 - 3,343 830,977 Federal Home Loan Bank stock 1,619,500 - - 1,619,500 Federal Reserve Bank stock 302,250 - - 302,250 Federal Home Loan Mortgage Corporation Cumulative preferred stock 2,480,513 - 494,500 1,986,013 Other Equity securities 1,290,001 - 171,284 1,118,717 -------------- -------------- ------------ ------------- $101,161,994 $ 32,234 $2,921,493 $98,272,735 ============ ======== ========== =========== -24- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR Held to Maturity securities: COST GAINS LOSSES VALUE -------------- -------------- ------------- ----------- DECEMBER 31, 2000: Obligations of U.S. Government agencies and corporations $12,507,562 $ 2,018 $37,048 $ 12,472,532 Obligations of states and political subdivisions 10,043,710 74,070 28,469 10,089,311 ------------ --------- --------- ------------ 22,551,272 76,088 65,517 22,561,843 Mortgage-backed securities 14,478 171 - 14,649 --------------- ----------- -------------- --------------- $22,565,750 $ 76,259 $ 65,517 $22,576,492 =========== ======== ======== =========== December 31, 1999: U.S. Treasury securities $ 2,001,083 $ 177 $ - $ 2,001,260 Obligations of U.S. Government agencies and corporations 12,509,150 846 305,457 12,204,539 Obligations of states and political subdivisions 10,694,024 17,432 177,462 10,533,994 ------------ ---------- ---------- ------------ 25,204,257 18,455 482,919 24,739,793 Mortgage-backed securities 649,833 231 6,862 643,202 -------------- ----------- ------------ -------------- $25,854,090 $ 18,686 $ 489,781 $25,382,995 =========== ======== ========= ===========
The amortized cost and estimated fair values of investment securities by contractual maturity date at December 31, 2000 are as follows:
AVAILABLE FOR SALE HELD TO MATURITY -------------------------- ------------------------------ Estimated Estimated Amortized Fair Amortized Fair COST VALUE COST VALUE ----------- ------------ ------------- ------------ Due in one year or less 20,926,622 $ 20,911,626 $ 2,852,828 $ 2,850,874 Due after one year through five years 66,007,525 65,701,141 13,992,448 14,007,117 Due after five years through ten years 2,103,428 2,087,810 5,720,474 5,719,501 ----------- ------------ ------------ ------------ 89,037,575 88,700,577 22,565,750 22,577,492 Investments in equity securities 6,895,899 6,333,638 - - ----------- --------------------------------------------- $95,933,474 $95,034,215 $22,565,750 $22,577,492 =========== =========== =========== ===========
The following table sets forth the amortized cost and estimated fair values of securities which have been pledged as collateral for obligations to federal, state and local government agencies and other purposes as required or permitted by law.
DECEMBER 31, 2000 DECEMBER 31, 1999 ------------------------- ----------------------------- ESTIMATED ESTIMATED AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ----------- ------------- ------------- ------------- Available for sale $70,464,535 $70,185,252 $67,718,723 $66,149,594 Held to maturity 15,484,161 15,507,605 17,972,846 17,666,571 ----------- ----------- ------------ ------------ $85,948,696 $85,692,857 $85,691,569 $83,816,165 =========== =========== =========== ===========
There were no obligations of states and political subdivisions whose carrying value, as to any issuer, exceeded 10% of stockholders' equity at December 31, 2000 or 1999. Proceeds from sales of investment securities were $8,116,313, $11,635,919, and $9,054,240 for the years ended December 31, 2000, 1999, and 1998, respectively. -25- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES The Company grants residential mortgage, consumer and commercial loans to customers primarily in Talbot, Queen Anne's, Kent, Caroline and Dorchester Counties in Maryland. The principal categories of the loan portfolio at December 31 are summarized as follows:
2000 1999 -------------- -------------- Real estate loans: Construction and land development $ 18,586,702 $ 15,642,909 Secured by farmland 19,187,868 15,043,220 Secured by residential properties 176,759,825 160,694,477 Secured by non farm, nonresidential properties 95,111,154 82,647,525 Loans to farmers (loans to finance agricultural production and other loans) 2,869,986 2,289,401 Commercial and industrial loans 49,430,302 51,624,666 Loans to individuals for household, family, and other personal expenditures 17,988,688 15,968,849 Obligations of States and political subdivisions in the United States, tax-exempt 2,303,982 1,515,284 All other loans 140,452 257,445 ---------------- ---------------- 382,378,959 345,683,776 Net deferred loan costs 127,179 107,075 ---------------- --------------- 382,506,138 345,790,851 Allowance for credit losses (4,199,008) (3,990,558) -------------- -------------- $378,307,130 $341,800,293 - --------------------------------------------------------------------------------------------------------------------------
In the normal course of banking business, loans are made to officers and directors and their affiliated interests. These loans are made on substantially the same terms and conditions as those prevailing at the time for comparable transactions with outsiders and are not considered to involve more than the normal risk of collectibility. As of December 31, 2000 and 1999, such loans outstanding, both direct and indirect (including guarantees), to directors, their associates and policy-making officers, totaled approximately $7,411,000 and $7,747,000, respectively. During 2000 and 1999, loan additions were approximately $543,000 and $4,424,000, and loan repayments were approximately $879,000 and $2,131,000, respectively. Activity in the allowance for credit losses is summarized as follows:
2000 1999 1998 - ------------------------------------------------------------------------------------- Balance, beginning of year $3,990,558 $3,931,238 $3,941,667 ---------- ---------- ---------- Loans charged off: Real estate loans (60,752) (121,659) (68,825) Installment loans (72,650) (145,681) (121,897) Commercial and other (244,170) (161,793) (192,991) ----------- ------------ ------------ (377,572) (429,133) (383,713) ----------- ------------ ------------ Recoveries: Real estate loans 18,047 49,556 26,543 Installment loans 50,339 43,046 57,087 Commercial and other 80,591 155,851 49,654 ---------- ----------- -------------- 148,977 248,453 133,284 ---------- ----------- ------------- Net losses charged off (228,595) (180,680) (250,429) Provision 437,045 240,000 240,000 ---------- ------------ ------------- Balance, end of year $4,199,008 $3,990,558 $ 3,931,238 ========== ========== =========== - -------------------------------------------------------------------------------------
-26- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Information with respect to impaired loans and the related valuation allowance as of December 31 is as follows:
2000 1999 - ---------------------------------------------------------------------------------------- Impaired loans with valuation allowance $ -- $ -- Impaired loans with no valuation allowance 640,092 1,820,114 ---------- ---------- Total impaired loans $ 640,092 $1,820,114 ========== ========== Allowance for loan losses related to impaired loans $ -- $ -- Allowance for loan losses related to other than impaired loans 4,199,008 3,990,558 - ---------------------------------------------------------------------------------------- Total allowance for loan losses $4,199,008 $3,990,558 ========== ========== Interest income on impaired loans recorded on the cash basis $ 22,304 $ 37,025 ========== ========== - ---------------------------------------------------------------------------------------- Average recorded investment in impaired loans for the year $1,230,048 $1,281,513 ========== ========== - ----------------------------------------------------------------------------------------
NOTE 6. PREMISES AND EQUIPMENT A summary of premises and equipment at December 31 is as follows: 2000 1999 - -------------------------------------------------------------------------------- Land $ 1,753,447 $ 1,050,394 Buildings and land improvements 6,012,123 5,788,560 Furniture and equipment 3,985,649 3,853,138 ----------- ----------- 11,751,219 10,692,092 Accumulated depreciation (4,712,119) (4,330,415) ----------- ----------- $ 7,039,100 $ 6,361,677 =========== =========== - -------------------------------------------------------------------------------- Depreciation expense totaled $556,000, $606,000 and $593,634 for the years ended December 31, 2000, 1999 and 1998, respectively. The Talbot Bank leases facilities under operating leases. Rental expense for the years ended December 31, 2000, 1999, and 1998 was $91,701, $89,373 and $49,555, respectively. Future minimum annual rental payments are approximately as follows: - -------------------------------------------------------------------------------- 2001 $123,000 2002 105,000 2003 96,000 2004 47,000 2005 47,000 Thereafter 47,000 - -------------------------------------------------------------------------------- NOTE 7. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY 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 DBDPC's undistributed income. DECEMBER 31 ---------------------------------------------- 2000 1999 1998 ---- ---- ---- Balance, beginning of year $ 1,057,331 $ 1,049,409 $ 1,007,809 Equity in net income 24,797 7,922 41,600 ----------- ----------- ----------- Balance, end of year $ 1,082,128 $ 1,057,331 $ 1,049,409 =========== =========== =========== Data processing expense paid to DBDPC totaled approximately $893,000, $734,000, and $641,000 for the years ended December 31, 2000, 1999 and 1998, respectively. -27- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The Company also had a 66% ownership interest in Eastern Shore Mortgage Corporation ("ESMC"). This investment was carried on the Company's books based on its proportionate share of the net realizable assets of the Corporation. ESMC was in the process of liquidation at December 31, 1999, and final distributions were received during 2000. DECEMBER 31 ---------------------------------------------- 2000 1999 1998 ---- ---- ---- Balance, beginning of year $ 9,897 $ 241,710 $ 352,933 Equity in net income (loss) - (31,813) (111,223) Equity distribution (9,897) (200,000) - -------- --------- --------- Balance, end of year $ - $ 9,897 $ 241,710 ========= ========= ========== The Company had $62,000 in outstanding letters of credit to Eastern Shore Mortgage Corporation at December 31, 1998. Interest income on loans to Eastern Shore Mortgage Corporation totaled approximately $70,200 for 1998. There was no interest income earned in 2000 or 1999. NOTE 8. SIGNIFICANT DEPOSITS The approximate maturities of certificates of deposit of $100,000 or more at December 31 are as follows: 2000 1999 -------------------------------------- Three months or less $ 39,881,000 $ 43,722,000 Three through twelve months 11,777,000 12,073,000 Over twelve months 26,615,000 18,302,000 ------------- ------------ $ 78,273,000 $ 74,097,000 ============ ============ NOTE 9. SHORT TERM BORROWINGS Short term borrowings, at December 31, 2000, consisted of securities sold under agreements to repurchase. These short term obligations represent securities sold to customers, at the customers' request, under a "roll-over" contract that matures in one business day. The underlying securities sold are U.S. Treasury Notes or Government agency securities, which are segregated, in the Company's custodial accounts from other investment securities. From time to time in order to meet short term liquidity needs the Company may borrow from a correspondent federal funds line of credit arrangement or a secured reverse repurchase agreement. The following table summarizes certain information for short term borrowings: 2000 1999 - -------------------------------------------------------------------------------- Average amount outstanding during the year $21,521,979 $17,812,527 Weighted average interest rate during the year 5.08% 3.85% Amount outstanding at year end $16,252,182 $16,933,308 Weighted average rate at year end 4.96% 3.95% Maximum amount at any month end $32,498,121 $23,297,131 - -------------------------------------------------------------------------------- NOTE 10. LONG TERM DEBT As of December 31, 2000, 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 6.44%. The advance is due September 30, 2009. The Bank has pledged its wholly owned residential real estate mortgage loan portfolio under a blanket floating lien as collateral for this advance. -28- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 11. BENEFIT PLANS 401(K) AND PROFIT SHARING PLANS The Company has 401(k) and profit sharing plans covering substantially all full-time employees of the Banks. The 401(k) plans call for matching contributions by the Company in cash and common stock of the Company. The Company makes discretionary contributions to the profit sharing plans based on profits. Company contributions to these plans included in expense totaled $407,384 (2000), $341,944 (1999), and $304,751 (1998). DEFINED BENEFIT PENSION PLAN During 2000 the Company terminated it's defined benefit pension plan, which has been frozen since 1995. All benefits were distributed to plan participants in 2000. The Plan covered substantially all full-time employees of the Talbot Bank with more than six months of service. Expense associated with the plan totaled $89,760 (2000), $7,915 (1999), and $(84,781) (1998). NOTE 12. STOCK OPTION PLANS The Company has three active stock option plans whereby incentive or nonqualified stock options may be granted periodically to directors, executive officers, and key employees at the discretion of the Company's Compensation Committee. The plans provide for both immediate and graduated vesting schedules. The plans allow for up to 123,860 options of common stock to be granted. The plans were adopted in 1999, 1998, and 1995 and the options granted have a life not to exceed ten years. The Company also has an Employee Stock Purchase Plan that was adopted in 1998 and allows employees to receive options to purchase common stock at an amount equivalent to 85% of the fair market value of the common stock. The Company has reserved 20,000 shares of common stock for issuance under the plan, however, options to purchase no more than 4,000 shares may be granted in any calendar year. Following is a summary of changes in shares under option for all Plans for the years indicated:
YEAR ENDED DECEMBER 31, 2000 1999 NUMBER WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE ----------------------------- ------------------------------- Outstanding at beginning of year 140,897 $11.21 106,588 7.74 Granted 8,243 20.34 34,833 22.02 Exercised (763) (19.96) (492) (23.55) Expired/Cancelled (27,963) (19.65) (32) (27.20) -------- -------- Outstanding at end of year 120,414 $9.82 140,897 $11.21 ======== ======== Weighted average fair value of options granted during the year $12.88 10.69 ====== ===== - ---------------------------------------------------------------------------------------------------------
The following summarizes information about options outstanding at December 31, 2000: OPTIONS OUTSTANDING AND EXERCISABLE - -------------------------------------------------------------------------------- WEIGHTED AVERAGE REMAINING EXERCISE PRICE NUMBER CONTRACT LIFE ---------------- ------ ------------------- $ 6.85 55,699 4.61 8.78 50,730 5.95 32.00 6,000 8.05 27.20 795 .29 21.00 6,000 9.05 17.85 1,190 1.29 - -------------------------------------------------------------------------------- -29- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for options that vest during the years ended December 31, 2000 and 1999. 2000 1999 ---- ---- Dividend yield 1.68 2.9% Expected volatility 15.0% 15.0% Risk free interest 5.68 6.55% Expected lives (in years) 10 10 The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation" (SFAS 123), but applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its Plan. No compensation expense related to the Plan was recorded during the year ended December 31, 2000. IF THE COMPANY HAD ELECTED TO RECOGNIZE COMPENSATION COST BASED ON FAIR VALUE AT THE GRANT DATES FOR AWARDS UNDER THE PLAN CONSISTENT WITH THE METHOD PRESCRIBED BY SFAS 123, NET INCOME AND EARNINGS PER SHARE WOULD HAVE BEEN CHANGED TO THE PRO FORMA AMOUNTS AS FOLLOWS FOR THE YEAR ENDED DECEMBER 31, 1999: 2000 1999 - -------------------------------------------------------------------------------- Net income: As reported $7,956,964 $6,804,688 Pro forma 7,935,586 6,533,950 Basic net income per share: As reported $1.50 $1.28 Pro forma 1.49 1.23 Diluted earnings per share As reported $1.48 $1.27 Pro forma 1.47 1.22 - -------------------------------------------------------------------------------- The pro forma amounts are not representative of the effects on reported net income for future years. NOTE 13. DEFERRED COMPENSATION The Company has a supplemental deferred compensation plan to provide retirement benefits to its President and Chief Executive Officer. The plan calls for fixed annual payments of $20,000 to be credited to the participant's account. The participant is 100% vested in amounts credited to his account. Contributions to the plan were $20,000 in 2000, 1999 and 1998. The Company also 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: 2000 1999 - -------------------------------------------------------------------------------- Cash surrender value $1,784,437 $ 1,731,977 Accrued benefit obligations 531,330 523,326 - -------------------------------------------------------------------------------- -30- - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 14. INCOME TAXES Income taxes included in the balance sheets as of December 31 are as follows: 2000 1999 - -------------------------------------------------------------------------------- Federal income taxes currently payable $ 14,273 $ 108,260 State income taxes currently payable (receivable) 136,487 (14,291) Deferred income tax benefits 1,183,746 1,855,805 - -------------------------------------------------------------------------------- Components of income tax expense for each of the three years ended December 31 are as follows: 2000 1999 1998 - ------------------------------------------------------------------------------ Currently payable: Federal $4,036,794 $3,285,627 $3,034,753 State 450,519 286,285 305,499 ---------- ---------- ---------- 4,487,313 3,571,912 3,340,252 ---------- ---------- ---------- Deferred income taxes (benefits): Federal (73,267) (35,367) (94,991) State (16,222) (8,630) (21,023) ---------- ----------- ----------- (89,489) (43,997) (116,014) ----------- ----------- ----------- $4,397,824 $3,527,915 $3,224,238 ========== ========== ========== A reconciliation of tax computed at the statutory federal tax rates of 34% to the actual tax expense for the three years ended December 31 follows: 2000 1999 1998 - -------------------------------------------------------------------------------- Tax at federal statutory rate 34.0% 34.0% 34.0% Tax effect of: Tax-exempt income (1.9) (2.1) (2.5) Non-deductible expenses 1.5 .5 .7 Other (.3) - (.1) State income taxes, net of federal benefit 2.3 1.7 2.0 ----- ------ ----- Income tax expense 35.6% 34.1% 34.1% ==== ==== ==== - -------------------------------------------------------------------------------- Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows: 2000 1999 - -------------------------------------------------------------------------------- Deferred tax assets: Allowance for credit losses $1,137,233 $ 989,959 Provision for off balance sheet liabilities 13,903 -- Loan interest 2,525 11,019 Provision for loss on other real estate -- 39,252 Loan fees 49,541 32,140 Deferred compensation 184,293 177,967 Unrealized losses on available for sale securities 353,955 1,115,940 ---------- ---------- Total deferred tax assets 1,741,450 2,366,277 ---------- ---------- Deferred tax liabilities: Depreciation 173,722 184,885 Cash to accrual conversion 12,370 24,740 Federal Home Loan Bank stock dividend 27,613 27,613 Undistributed income of unconsolidated subsidiary 62,845 61,329 Loan origination fees and costs 177,344 133,166 Other 103,810 78,739 ---------- ---------- Total deferred tax liabilities 557,704 510,472 ---------- ---------- Net deferred tax assets $1,183,746 $1,855,805 ========== ========== - -------------------------------------------------------------------------------- -31- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 15. REGULATORY CAPITAL REQUIREMENTS The Company and the Banks 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 financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes as of December 31, 2000, that the Company and the Banks meet all capital adequacy requirements to which they are subject. As of December 31, 2000, the most recent notification from the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Banks must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Banks' category. A comparison of the Company's and Banks' capital as of December 31, 2000 and 1999 with the minimum requirements is presented below:
TO BE WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS - ------------------------------------------------------------------------------------------------------------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - ------------------------------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 2000: TOTAL CAPITAL (TO RISK WEIGHTED ASSETS): COMPANY $67,810,000 18.16% $29,867,000 8.00% THE TALBOT BANK $43,087,000 17.52% $19,673,000 8.00% $24,591,000 10.00% THE CENTREVILLE NATIONAL BANK $24,372,000 19.30% $10,099,000 8.00% $12,623,000 10.00% TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS): COMPANY $63,611,000 17.04% $14,933,000 4.00% THE TALBOT BANK $40,288,000 16.38% $9,836,000 4.00% $14,755,000 6.00% THE CENTREVILLE NATIONAL BANK $22,972,000 18.20% $5,049,000 4.00% $7,574,000 6.00% TIER 1 CAPITAL (TO AVERAGE ASSETS): COMPANY $63,611,000 11.67% $21,794,000 4.00% THE TALBOT BANK $40,288,000 11.84% $13,608,000 4.00% $17,010,000 5.00% THE CENTREVILLE NATIONAL BANK $22,972,000 11.37% $8,083,000 4.00% $10,103,000 5.00% As of December 31, 1999: Total Capital (to Risk Weighted Assets): Company $62,069,000 18.46% $26,903,000 8.00% The Talbot Bank $38,948,000 17.57% $17,732,000 8.00% $22,164,000 10.00% The Centreville National Bank $22,499,000 19.66% $9,156,000 8.00% $11,455,000 10.00% Tier 1 Capital (to Risk Weighted Assets): Company $58,078,000 17.27% $13,452,000 4.00% The Talbot Bank $36,205,000 16.34% $8,866,000 4.00% $13,298,000 6.00% The Centreville National Bank $21,251,000 18.57% $4,578,000 4.00% $6,867,000 6.00% Tier 1 Capital (to Average Assets): Company $58,088,000 11.33% $20,504,000 4.00% The Talbot Bank $36,205,000 11.30% $12,811,000 4.00% $16,014,000 5.00% The Centreville National Bank $21,251,000 11.05% $7,693,000 4.00% $9,616,000 5.00% - -------------------------------------------------------------------------------------------------------------------------
-32- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Bank and holding company regulations, as well as Maryland law, impose certain restrictions on divided payments by the Banks, as well as restricting extensions of credit and transfers of assets between the Banks and the Company. At December 31, 2000, the Banks could have paid dividends to the parent company of approximately $7,161,000 without the prior consent and approval of the regulatory agencies. The Company had outstanding liabilities to the Banks of $318,624 at December 31, 2000. NOTE 16. LINE OF CREDIT The Banks had $17,000,000 in unsecured federal funds lines of credit and a reverse repurchase agreement available on a short term basis from correspondent banks. In addition, the Banks have credit availability of approximately $80,000,000 from the Federal Home Loan Bank of Atlanta. The Banks have pledged, under blanket lien, all qualifying residential loans as collateral under the borrowing agreements with the Federal Home Loan Bank. At December 31, 2000 the Federal Home Loan Bank had issued a letter of credit for $10,000,000 on behalf of the Talbot Bank to a local government entity as collateral for it's deposits. NOTE 17. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: CASH AND CASH EQUIVALENTS For those short-term instruments, the carrying amount is a reasonable estimate of fair value. INVESTMENT SECURITIES For all investments in debt securities, fair values are based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. LOAN RECEIVABLES The fair value of categories of fixed rate loans, such as commercial loans, residential mortgage, and other consumer loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Other loans, including variable rates loans, are adjusted for differences in loan characteristics. FINANCIAL LIABILITIES The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. These estimates do not take into consideration the value of core deposit intangibles. The fair value of securities sold under agreements to repurchase is estimated using the rates offered for similar borrowings. COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. The estimated fair values of the Bank's financial instruments, excluding goodwill, as of December 31 are as follows:
2000 1999 ----------------------------------------------------------------- ESTIMATED ESTIMATED CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE -------- ------------ ------- --------------- Financial assets: Cash and cash equivalents $39,715,464 $39,715,000 $34,565,575 $34,566,000 Investment securities 117,599,965 117,610,000 124,126,825 123,656,000 Loans 382,506,138 381,788,000 345,790,851 339,768,000 Less: allowance for loan losses (4,199,008) - (3,990,558) - ----------------------------------------------------------------- $535,622,559 $539,113,000 $500,492,693 $497,990,000 ============ ============ ============ ============
-33- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
2000 1999 ------------------------------------------------------------------------- Financial liabilities: Deposits $464,484,986 $465,261,000 $436,021,045 $421,618,000 Short term borrowings 16,252,035 16,252,000 16,933,308 16,933,000 Long-term debt 5,000,000 5,002,000 5,000,000 4,426,000 ------------- --------------- --------------- --------------- $485,737,021 $486,515,000 $457,954,353 $442,977,000 ============ ============ ============ ============ Unrecognized financial instruments: Commitments to extend credit $ 82,760,000 $ 82,760,000 $ 75,763,000 $ 75,763,000 Standby letters of credit 9,267,000 9,267,000 4,249,000 4,249,000 ------------- --------------- -------------- --------------- $ 92,027,000 $ 92,027,000 $ 80,012,000 $ 80,012,000 ============= ============= ============= =============
NOTE 18. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK In the normal course of business, to meet the financial needs of its customers, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. The Company's exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of the instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company generally requires collateral or other security to support the financial instruments with credit risk. The amount of collateral or other security is determined based on management's credit evaluation of the counterparty. The Company evaluates each customer's creditworthiness on a case-by-case basis. 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. 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. Commitments outstanding as of December 31 are as follows: 2000 1999 - -------------------------------------------------------------------------------- Commitments to extend credit $82,760,000 $75,763,000 Letters of credit 9,267,000 4,249,000 ----------- ----------- $92,027,000 $80,012,000 =========== =========== - -------------------------------------------------------------------------------- NOTE 19. COMMITMENTS In the normal course of business, the Company may become involved in litigation arising from banking, financial, and other activities of the Company. Management, after consultation with legal counsel, does not anticipate that the future liability, if any, arising out of these matters will have a material effect on the Company's financial condition, operating results, or liquidity. NOTE 20. PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Shore Bancshares, Inc. (Parent Company Only) is as follows: CONDENSED BALANCE SHEETS DECEMBER 31, 2000 AND 1999 2000 1999 - -------------------------------------------------------------------------------- Assets: Cash $ 91,516 $ 54,873 Securities purchased under agreement to resell -- 18,140 Investment in subsidiaries 64,890,249 58,117,980 Investment in equity securities 380,035 280,000 Other assets 6,227 14,379 ----------- ----------- Total assets $65,368,027 $54,485,372 =========== =========== - -------------------------------------------------------------------------------- -34- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 2000 1999 - -------------------------------------------------------------------------------- Liabilities: Accounts payable $ 25,150 $ -- Due to subsidiaries 318,624 -- ------------ ------------ 343,774 -- ------------ ------------ Stockholders' equity: Common stock 53,242 53,148 Surplus 22,923,707 22,776,437 Retained earnings 42,601,248 37,429,483 Accumulated other comprehensive loss (553,944) (1,773,696) ------------ ------------ Total stockholders' equity 65,024,253 58,485,372 ------------ ------------ Total liabilities and stockholders' equity $ 65,368,027 $ 58,485,372 ============ ============ - -------------------------------------------------------------------------------- CONDENSED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998 - ------------------------------------------------------------------------------------------------- Dividends from subsidiaries $2,782,653 $2,489,755 $4,955,701 Other investment income 10,000 -- -- Interest income 2,382 1,074 4,453 ---------- ---------- ---------- 2,795,035 2,490,829 4,960,154 Operating expenses 396,816 72,314 33,156 ---------- ---------- ---------- Income before income tax benefit and equity in undistributed income of subsidiary 2,398,219 2,418,515 4,926,998 Income tax benefit 6,227 14,379 9,914 ---------- ---------- ---------- Income before equity in undistributed income of subsidiary 2,404,446 2,432,894 4,936,912 Equity in undistributed income of subsidiary 5,552,518 4,371,794 1,296,713 ---------- ---------- ---------- Net income $7,956,964 $6,804,688 $6,233,625 ========== ========== ========== - -------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998 - ----------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 7,956,964 $ 6,804,688 $ 6,233,625 Adjustments to reconcile net income to cash provided by operating activities: Equity in undistributed income of subsidiaries (5,552,518) (4,371,794) (1,296,713) Net decrease in other assets 8,153 46,217 5,110 Net increase in other liabilities 343,774 -- -- ----------- ----------- ----------- Net cash provided by operating activities 2,756,373 2,479,111 4,942,022 ----------- ----------- ----------- Cash flows from investing activities: Sale (purchase) of securities under agreement to resell 18,140 158,238 (100,850) Purchase of other equity securities (100,035) (280,000) -- ----------- ----------- ----------- Net cash used by investing activities (81,895) (121,762) (100,850) ----------- ----------- ----------- Cash flows from financing activities: Proceeds from issuance of common stock 148,828 129,959 115,056 Purchase of common stock (4,010) (58,738) (2,811,963) Dividends paid (2,782,653) (2,404,755) (2,143,739) ----------- ----------- ----------- Net cash used by financing activities (2,637,835) (2,333,534) (4,840,646) ----------- ----------- ----------- Net increase in cash and cash equivalents 36,643 23,815 526 Cash and cash equivalents at beginning of year 54,873 31,058 30,532 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 91,516 $ 54,873 $ 31,058 =========== =========== =========== - -----------------------------------------------------------------------------------------------------
-35- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 21. EARNINGS PER COMMON SHARE Basic earnings per share is derived by dividing net income available to common stockholders by the weighted-average number of common shares outstanding and does not include the effect of any potentially dilutive common stock equivalents. The diluted earnings per share calculation method is derived by dividing net income by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding stock options and warrants. For purposes of comparability, all prior-period earnings per share data have been restated.
2000 1999 1998 - ---------------------------------------------------------------------------------- Basic: Net income (applicable to common stock) $7,956,964 $6,804,688 $6,233,625 Average common shares outstanding 5,318,377 5,312,243 5,378,651 Basic earnings per share $ 1.50 $ 1.28 $ 1.16 Diluted: Net income (applicable to common stock) $7,956,964 $6,804,688 $6,233,625 Average common shares outstanding 5,318,377 5,312,243 5,378,651 Diluted effect of stock options 70,108 63,957 46,521 Average common shares outstanding - diluted 5,388,486 5,376,200 5,425,172 Diluted earnings per share $ 1.48 $ 1.27 $ 1.15 - ----------------------------------------------------------------------------------
NOTE 22. QUARTERLY FINANCIAL RESULTS (UNAUDITED) A summary of selected consolidated quarterly financial data for the two years ended December 31, 200 is reported as follows:
FIRST SECOND THIRD FOURTH (IN THOUSANDS, EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER - -------------------------------------------------------------------------------------------------------- 2000 Interest income $ 9,335 $ 9,778 $ 9,977 10,390 Net interest income 5,181 5,432 5,409 5,570 Provision for credit losses 58 90 151 138 Income before income taxes 2,620 3,164 3,702 2,869 Net Income 1,668 2,086 2,358 1,845 Basic net income per share $0.32 $0.39 $0.44 $0.35 Diluted net income per share $0.31 $0.39 $0.44 $0.34 1999 Interest income $ 8,478 $ 8,704 $ 9,005 $ 9,248 Net interest income 4,527 4,806 4,952 5,110 Provision for credit losses 60 60 60 60 Income before income taxes 2,071 2,731 2,585 2,945 Net Income 1,365 1,811 1,694 1,935 Basic net income per share $0.26 $0.34 $0.32 $0.36 Diluted net income per share $0.25 $0.34 $0.32 $0.36 - -------------------------------------------------------------------------------------------------
-36- INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Shore Bancshares, Inc. Easton, Maryland We have audited the accompanying consolidated balance sheets of Shore Bancshares, Inc. as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. 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 auditing standards generally accepted in the United States. 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 consolidated financial position of Shore Bancshares, Inc. as of December 31, 2000 and 1999, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ STEGMAN & COMPANY --------------------- Baltimore, Maryland January 19, 2001 -37- SHORE BANCSHARES, INC. BOARD OF DIRECTORS Picture Omitted STANDING LEFT TO RIGHT ---------------------- RONALD N. FOX INVESTOR DANIEL T. CANNON EXECUTIVE VICE PRESIDENT/COO, SHORE BANCSHARES, INC PRESIDENT AND CEO, THE CENTREVILLE NATIONAL BANK OF MARYLAND LLOYD L. BEATTY, JR CERTIFIED PUBLIC ACCOUNTANT PRESIDENT, DARBY ADVISORS, INC. W. MOORHEAD VERMILYE PRESIDENT/CEO, SHORE BANCSHARES, INC. PRESIDENT AND CEO, THE TALBOT BANK OF EASTON, MARYLAND DAVID C. BRYAN MEMBER, LAW OFFICES OF FOUNTAIN BRYAN AND RITTER, LLC PAUL M. BOWMAN ATTORNEY, LAW OFFICE OF PAUL M. BOWMAN SEATED LEFT TO RIGHT -------------------- B. VANCE CARMEAN, JR. CHAIRMAN OF THE BOARD, SHORE BANCSHARES, INC. PRESIDENT, CARMEAN GRAIN, INC. RICHARD C. GRANVILLE INVESTOR NEIL R. LECOMPTE CERTIFIED PUBLIC ACCOUNTANT OFFICE OF NEIL R. LECOMPTE HERBERT L. ANDREW, III FARMER NOT PICTURED ------------ DAVID L. PYLES INVESTOR -------------------------------------------- OFFICERS SHORE BANCSHARES, INC. W. Moorhead Vermilye .................President and CEO Daniel T. Cannon. ....................Executive Vice President and COO Susan E. Leaverton ...................Treasurer Carol I. Brownawell ..................Secretary -38- THE CENTREVILLE NATIONAL BANK OF MARYLAND BOARD OF DIRECTORS Picture omitted STANDING LEFT TO RIGHT ---------------------- JERRY F. PIERSON PRESIDENT, JERRY F. PIERSON, INC. MARK M. FREESTATE PRESIDENT, W.M. FREESTATE & SON, INC PAUL M.BOWMAN ATTORNEY, LAW OFFICE OF PAUL M. BOWMAN DAVID C. BRYAN MEMBER, LAW OFFICES OF FOUNTAIN BRYAN AND RITTER, LLC Wm. MAURICE SANGER PRESIDENT, F.W., INC. PRESIDENT CLOVERBAY DEVELOPMENT CORPORATION NEIL R. LeCOMPTE CERTIFIED PUBLIC ACCOUNTANT, OFFICE OF NEIL R. LECOMPTE J. ROBERT BARTON RETIRED PRESIDENT AND CEO, THE CENTREVILLE NATIONAL BANK OF MARYLAND SEATED LEFT TO RIGHT -------------------- THOMAS K. HELFENBEIN FUNERAL DIRECTOR AND PARTNER FELLOWS, HELFENBEIN & NEWNAM FUNERAL HOME B. VANCE CARMEAN CHAIRMAN OF THE BOARD, SHORE BANCSHARES, INC. PRESIDENT, CARMEAN GRAIN, INC. DANIEL T.CANNON EXECUTIVEVICE PRESIDENT AND COO, SHORE BANCSHARES, INC. PRESIDENT AND CEO, THE CENTREVILLE NATIONAL BANK NOT PICTURED ------------ SUSANNE K. NUTTLE RETIRED VICE PRESIDENT, THE CENTREVILLE NATIONAL BANK OF MARYLAND OFFICERS THE CENTREVILLE NATIONAL BANK OF MARYLAND Daniel T. Cannon .............................. President & CEO Carol I. Brownawell ...........................Executive Vice President/CFO Thomas E. Beery ............................... Vice President/SLO Timothy J. Berrigan ........................... Vice President 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 Katherine 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 Florence R. Walls ............................. Assistant Cashier -39- THE TALBOT BANK OF EASTON, MARYLAND BOARD OF DIRECTORS Picture Omitted STANDING LEFT TO RIGHT ---------------------- Richard C. Granville INVESTOR Ronald N. Fox INVESTOR Gary L. Fairbank OWNER, FAIRBANK TACKLE Donald D. Casson CERTIFIED PUBLIC ACCOUNTANT AND REAL ESTATE BROKER Blenda W. Armistead INVESTOR Christopher F. Spurry PRESIDENT, SPURRY & ASSOCIATES, INC. SEATED LEFT TO RIGHT -------------------- Shari L. McCord OWNER, CHESAPEAKE TRAVEL SERVICES, INC. Herbert L. Andrew, III FARMER W. Moorhead Vermilye PRESIDENT AND CEO, SHORE BANCSHARES, INC. PRESIDENT AND CEO, THE TALBOT BANK Jerome M. McConnell EXECUTIVE VICE PRESIDENT, THE TALBOT BANK Lloyd L.Beatty, Jr. CERTIFIED PUBLIC ACCOUNTANT PRESIDENT, DARBY ADVISORS, INC. NOT PICTURED ------------ William H. Myers CHAIRMAN OF THE BOARD FARMER David L. Pyles INVESTOR OFFICERS THE TALBOT BANK OF EASTON, MARYLAND W. Moorhead Vermilye ........................ President & CEO Jerome M. McConnell ......................... Executive Vice President Matthew I. Werner ........................... Senior Vice President Susan E. Leaverton .......................... Vice President Finance Robert J. Meade .............................Vice President Human Resources Mildred C. Bullock .......................... Vice President Bookkeeping Bruce M. Burkhardt .......................... Vice President Operations Linda S. Cheezum ............................ Vice President Lending Robyn K. Gannon ............................. Vice President New Accounts W. David Morse .............................. Vice President Nancy B. Chance ............................. Assistant Vice President Deborah L. Danenmann ........................ Assistant Vice President Laura P. Heikes. ............................ Assistant Vice President Dawn D. Henckel. ............................ Assistant Vice President Wanda W. Hutchison. ......................... Assistant Vice President J. Michael Lawrence. ........................ Assistant Vice President Jennifer W. Lister .......................... Assistant Vice President Bonnie R. Meade ............................. Assistant Vice President Donald E. Morris. ........................... Assistant Vice President Robin B. O'Brien ............................ Assistant Vice President Donna D. Parks .............................. Assistant Vice President Valerie C. Pelkey ........................... Assistant Vice President Charles J. Selby ............................ Assistant Vice President Parker K. Spurry ............................ Assistant Vice President Samuel J. Townsend .......................... Commercial Banking Officer -40- THE TALBOT BANK OF EASTON, MARYLAND OFFICES - -------------------------------------------------------------------------------- MAIN OFFICE 18 East Dover Street Easton, MD 21601 TRED AVON SQUARE BRANCH 210 Marlboro Road Easton, Maryland 21601 ST. MICHAELS BRANCH 1013 S. Talbot Street St. Michaels, MD 21663 ELLIOTT ROAD BRANCH 8275 Elliott Road Easton, MD 21601 CAMBRIDGE BRANCH 2745 Dorchester Square Cambridge, MD 21613 ATM LOCATIONS ------------- MEMORIAL HOSPITAL AT EASTON 219 S. Washington Street Easton, MD 21601 SAILWINDS AMOCO 511 Maryland Avenue Cambridge, Maryland 21613 TALBOTTOWN 218 N. Washington Street Easton, Maryland 21601 CHESAPEAKE BAY OUTFITTERS 100 N Talbot St. St. Michaels, MD 21663 Phone (410) 822-1400 Fax (410) 820-4238 E-Mail: INFO@TALBOT-BANK.COM website: HTTP://WWW.TALBOT-BANK.COM -------------------- -------------------------- THE CENTREVILLE NATIONAL BANK OF MARYLAND OFFICES ------------------------------------------------- MAIN OFFICE STEVENSVILLE OFFICE 109 N. Commerce Street - PO Box 400 408 Thompson Creek Road - PO Box 279 Centreville, MD 21617 Stevensville, MD 21666 ROUTE 213 SOUTH OFFICE HILLSBORO OFFICE 2609 Centreville Road -PO Box 400 21913 Shore Highway - PO Box 118 Centreville, MD 21617 Hillsboro, MD 21641 KENT OFFICE DENTON OFFICE 305 East High Street - PO Box 388 850 S. 5th Avenue - PO Box 338 Chestertown, MD 21620 Denton, MD 21629 Phone (410) 758-1600 Fax (410) 758-2364 E-Mail: DIRECTIONS@CNB.MD.COM website: HTTP:// WWW.CNBMD.COM --------------------- ----------------------- SHAREHOLDER RECORDS Inquiries relating to shareholder records, stock transfers, change of ownership or address and dividend payments should be directed to the Company's transfer agent, The Centreville National Bank of Maryland at (410) 758-1600 or (877) 758-1600. Or visit their website at www.cnbmd.com. -41- EX-21 3 0003.txt LIST OF SUBSIDIARIES Shore Bancshares, Inc. owns all of the issued and outstanding shares of common stock of The Talbot Bank of Easton, Maryland, a Maryland state-chartered commercial bank, and The Centreville National Bank of Maryland, a national banking association. The Talbot Bank of Easton, Maryland owns all the issued and outstanding shares of common stock of Dover Street Realty, Inc., a Maryland corporation. The Centreville National Bank of Maryland owns one-third of the outstanding common stock of The Delmarva Bank Data Processing Center, Inc., a Maryland corporation and bank service corporation. The Delmarva Bank Data Processing Center, Inc., also located in Easton, Maryland, provides data processing services to financial institutions located in Maryland, Delaware, Virginia and the District of Columbia. EX-23 4 0004.txt CONSENT OF INDEPENDENT AUDITORS We hereby consent to the incorporation by reference in the Registration Statement No. 333-64317 and 333-64319 each on Form S-8, and in the Annual Report on Form 10-K of Shore Bancshares, Inc., for the year ended December 31, 2000, of our report dated January 19, 2001, relating to the consolidated financial statements of Shore Bancshares, Inc. /S/ Stegman and Company ----------------------- Baltimore, Maryland March 27, 2001 EX-99.3 5 0005.txt EMPLOYEE STOCK OPTION PLAN A. PURPOSE AND SCOPE The purposes of this Plan are to encourage stock ownership by key management employees of Talbot Bancshares, Inc. and its subsidiaries, to provide an incentive for such employees to expand and improve the profits and prosperity of the Company, and to assist the Company and its subsidiaries in attracting and retaining key personnel through the grant of options to purchase shares of the Company's common stock. B. DEFINITIONS Unless otherwise required by the context: 1. "Board" shall mean the Board of Directors of Talbot Bancshares, Inc. 2. "Committee" shall mean the Personnel Committee, as described in Section D. 3. "Company" shall mean Talbot Bancshares, Inc. 4. "Code" shall mean the Internal Revenue Code of 1986, as amended. 5. "Fair Market Value" shall mean the current fair market value of any Stock subject to an Option, as determined by the Committee in good faith. 6. "Incentive Stock Option" shall mean any Option granted under this Plan which qualifies as an incentive stock option, as described in Section 422 of the Code, at the time of its grant. 7. "Nonqualified Option" shall mean any Option granted under this Plan which is not an Incentive Stock Option. 8. "Option" shall mean a right to purchase Stock, granted pursuant to the Plan. 9. "Option Price" shall mean the purchase price for Stock under an Option, as determined in Section F below. 10. "Participant" shall mean an employee of the Company or any of its subsidiaries, to whom an Option is granted under the Plan. 11. "Plan" shall mean this Talbot Bancshares, Inc. Stock Option Plan. 12. "Restricted Stock" shall mean any Stock acquired through the exercise of an Option. 13. "Stock" shall mean the common stock of the Company, par value $.01. 14. "Ten Percent Shareholder" shall mean any individual who owns stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company. 15. "Total and Permanent Disability" shall mean total and permanent disability as defined in Code Section 422(e)(3). C. STOCK TO BE OPTIONED Subject to the provisions of Section L of the Plan, the maximum number of shares of Stock that may be optioned or conveyed under the Plan is 40,000 shares. Such shares shall be authorized, but unissued, shares of Stock of the Company. If any Option under this Plan shall terminate, expire, or be canceled as to any shares, new options may be granted covering those shares. D. ADMINISTRATION The Plan shall be administered by the Committee. The Committee shall be composed of three members of the Board and shall be appointed by the Board. Vacancies occurring in the membership of the Committee shall be filled by appointment by the Board. Every member of the Committee shall be a "disinterested person" within the meaning of Rule 16b-3 of the Securities Exchange Act of 1934. The Committee shall be responsible to the Board for the operation of the Plan. The interpretation and construction of any provision of the Plan by the Committee shall be final, unless otherwise determined by the Board. No member of the Board or the Committee shall be liable for any action or determination made by him in good faith with respect to the Plan. Notwithstanding anything in this Plan to the contrary, the Board reserves the right to terminate, by written resolution duly adopted by the Board, any and all powers delegated to the Committee in this Plan. In that event, those Committee powers so terminated by the Board shall revert to and be fully exercisable by the Board to the same extent as they were exercisable by the Committee, provided that no termination of the Committee's powers shall be retroactively effective. Any termination of the Committee's powers shall not be deemed to be a Plan amendment. E. ELIGIBILITY The Committee may grant Options at any time to any key management employee (including an employee who is an officer) of the Company or any of its subsidiaries. However, in no event shall Options be granted to any employee if that grant would cause the aggregate fair market value (determined as of the date the option is granted) of the stock for which incentive stock options (as that term is defined in Code Section 422) will become exercisable for the first time by that employee in any calendar year under all stock option plans of the Company and its subsidiaries to exceed $100,000. F. TERMS AND CONDITIONS OF OPTIONS Options granted pursuant to the Plan shall be authorized by the Board, upon recommendation of the Committee, and shall be evidenced by agreements in such form as the Committee shall from time to time adopt. Every Option agreement shall be subject to the following terms and conditions, and may also contain the terms and conditions described in Sections G and H, and any other terms and conditions as the Committee deems appropriate: 1. TIME OF PAYMENT. Each Option agreement shall state that the Option Price shall be paid in full, in cash or other valuable consideration as the Committee deems acceptable, at the time an Option is exercised under the Plan. Promptly after the exercise of an Option and the payment of the full Option Price, the Participant shall be entitled to the issuance of a certificate evidencing his ownership of such Restricted Stock. A Participant shall have none of the rights of a shareholder until shares are issued to him, and no adjustment will be made for dividends or other rights for which the record date is prior to the date such certificate is issued. 2. NUMBER OF SHARES. Each Option agreement shall state the total number of shares of Stock to which it pertains. No Option may be exercised for a fractional share of Stock. 3. TIME OF EXERCISE. Each Option agreement shall specify the period during which the Option thereunder may be exercised and provide that the Option shall expire at the end of that period. No Option may be exercised later than ten years from the date on which it is granted; PROVIDED, HOWEVER, that in the case of an Incentive Stock Option granted to an individual who, at the time of grant, is a Ten Percent Shareholder, the Option may not be exercised more than five years after the date on which it was granted. In addition, no Option may be exercised prior to the approval of this Plan by the stockholders of the Company, as described in Section O. 4. OPTION PRICE. Each Option agreement shall state the purchase price for the Stock underlying that Option (the "Option Price"). In the case of an Incentive Stock Option granted to a Ten Percent Shareholder, the Option Price shall not be less than one hundred and ten percent (110%) of the Fair Market Value of the Stock at the time of the grant and, in the case of any other Participant, the Option Price shall not be less than one hundred percent (100%) of the Fair Market Value of the Stock at the time of the grant, except where an option of the Company is being substituted for an option to purchase shares of a subsidiary, in accordance with the requirements of Code Section 424. In no event shall the option price be less than the par value of the Stock. 5. ALIENATION. Each Option agreement shall state that the Option shall not be transferable other than by will or by the laws of descent and distribution, and that during the Participant's lifetime may only be exercised by that Participant. 6. STOCK APPRECIATION RIGHT. Each Option agreement may provide that upon the exercise of all or any part of the Option, the Participant shall receive the payment of an amount of cash with a value equivalent to a multiplier, determined by the Committee at the time of the Option's grant, times the excess of the aggregate Fair Market Value at the time of the Option exercise of the shares subject to the Option exercise over the aggregate purchase price for those shares (i.e., the Option Price times the number of shares subject to the Option exercise). G. INVESTMENT REPRESENTATIONS The Committee may, in its discretion, include in any Option agreement a condition that the person exercising any portion of that Option shall represent and warrant at the time of the exercise that any shares of Stock acquired upon exercise are being acquired only for investment and without any present intention to sell or distribute those shares. H. RESTRICTIONS ON STOCK ACQUIRED THROUGH OPTION EXERCISE The Committee may, in its discretion, include in any Option agreement restrictions on the disposition of any shares of Stock acquired through the exercise of that Option; PROVIDED, HOWEVER, that such restrictions shall not limit the transfer of those shares of Stock by will or by the laws of descent or distribution. Each certificate representing shares of Stock acquired through the exercise of an Option granted under this Plan shall bear a legend indicating any such restrictions. I. CANCELLATION OF OPTIONS UPON TERMINATION OF EMPLOYMENT Except as provided in Section J below, if a Participant ceases to be employed by the Company, his Options shall terminate immediately; PROVIDED, HOWEVER, that if a Participant's cessation of employment is due to Total and Permanent Disability or his retirement with the consent of the Company, or one year after his Total and Permanent Disability, the Participant may, at any time within three months after the retirement with consent of his employment, or one year after his disability, exercise his Options to the extent that he was entitled to exercise them on the date of his cessation of employment, but in no event shall any Option be exercisable more than ten years after the date upon which it was granted. The Committee shall determine in each case whether a termination of employment shall be considered to be due to Total and Permanent Disability or retirement with the consent of the Company and, subject to applicable law, whether a leave of absence shall constitute a termination of employment. Any such determination of the Committee shall be final and conclusive. J. RIGHTS IN EVENT OF DEATH If a Participant dies without having fully exercised his Options, the executors, administrators, legatees or heirs of his estate shall have the right to exercise those Options, subject to the same terms and to the same extent as the deceased Participant was on the date of his death. K. EFFECT OF CHANGE IN STOCK SUBJECT TO THE PLAN The aggregate number of shares of Stock available for Options under the Plan, the shares subject to any Option, and the Option Price provided for in any Option agreement then outstanding, shall be proportionately adjusted to reflect any change in the number or kind of shares of Stock subsequent to the effective date of the Plan resulting from (1) a subdivision or consolidation of shares or any other capital adjustment, (2) the payment of a dividend, (3) an increase or decrease in the number of shares of issued Stock effected without receipt of consideration by the Company (other than as a result of contributions of Stock by the Company to any employee benefit plan), or (4) any other transaction or occurrence which, in the judgment of the Committee, has a similar effect upon the Stock. Such an adjustment shall be made in any manner deemed by the Committee to equitably prevent the substantial dissolution or enlargement of the rights granted to, or available for, Participants in the Plan. Upon dissolution or liquidation of the Company, or upon a merger or consolidation in which the Company is not the surviving corporation, all Options outstanding under the Plan shall terminate; PROVIDED, HOWEVER, that each Participant (and each other person entitled under Section J to exercise an Option) shall have the right, immediately prior to any such dissolution, liquidation, merger or consolidation, to exercise his Options, notwithstanding that such Options may not have vested, but only to the extent that his Options are otherwise exercisable under the terms of the Plan. L. COMPLIANCE WITH APPLICABLE LAWS AND REGULATIONS This Plan, and the obligations of any party hereunder are subject to federal and state laws, rules and regulations. The inability of the Company to fulfill its obligations under this Plan because, in the opinion of counsel to the Company, those obligations are in conflict with any applicable law shall relieve the Company of its obligation(s) to the extent necessary to avoid that conflict. M. RESERVATION OF SHARES OF STOCK The Company, during the term of this Plan, will at all times reserve and keep available, and will seek or obtain from any regulatory body having jurisdiction any requisite authority necessary to issue and to sell, the number of shares of Stock that shall be sufficient to satisfy the requirements of this Plan. The inability of the Company to obtain from any regulatory body having jurisdiction the authority deemed necessary by counsel for the Company for the lawful issuance and sale of its Stock hereunder shall relieve the Company of any liability in respect of the failure to issue or sell Stock as to which the requisite authority has not been obtained. N. AMENDMENT AND TERMINATION The Board, by resolution, may terminate, amend, or revise the Plan. Any such revisions shall apply equally to all Participants. Except as otherwise provided by this Plan, neither the Board nor the Committee may, without the consent of the holder of an Option, alter or impair any Option previously granted under the Plan. Unless sooner terminated, the Plan shall remain in effect for a period of ten years from time date of the Plan's adoption by the Board. Termination of the Plan shall not affect any Option previously granted. O. EFFECTIVE DATE OF PLAN The Plan shall be effective from the date that the Plan is adopted by the Board, subject, however, to the Plan's approval by the Company's stockholders within twelve (12) months before or after that date. If stockholder approval is not obtained within 12 months of the Board's adoption of the Plan, then this Plan, and all Stock Options and Option agreements granted under this Plan, shall automatically be null and void, AB INITIO. SIGNATURES The Company has caused this Plan to be executed, effective this 9th day of April, 1997. ATTEST: TALBOT BANCSHARES, INC. /S/ SUSAN E. LEAVERTON By: /S/ W. MOORHEAD VERMILYE - ---------------------- ---------------------------- W. Moorhead Vermilye President -----END PRIVACY-ENHANCED MESSAGE-----