-----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, BbDu82EmNJCJcgvTDNuVo1242nFh9iK4xTV7JSP9qemjTt3Szx3VXm0bQpu/QVZH Ax4ARVmDzyqg6YTTQMh+Sw== 0000909012-02-000267.txt : 20020415 0000909012-02-000267.hdr.sgml : 20020415 ACCESSION NUMBER: 0000909012-02-000267 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 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: 1934 Act SEC FILE NUMBER: 000-22345 FILM NUMBER: 02596129 BUSINESS ADDRESS: STREET 1: 18 EAST DOVER STREET CITY: EASTON STATE: MD ZIP: 21601-3013 BUSINESS PHONE: 4108221400 MAIL ADDRESS: STREET 1: 18 EAST DOVER STREET CITY: EASTON STATE: MD ZIP: 21601-3013 10-K 1 t23950.txt ANNUAL REPORT 12/31/01 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, 2001 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. The aggregate market value of the Corporation's voting stock held by non-affiliates of the registrant as of March 22, 2002 was $101,328,343. The number of shares outstanding of the registrant's common stock, as of March 22, 2002 was 5,333,023. Documents Incorporated by Reference Portions of the Shore Bancshares, Inc. definitive Proxy Statement for its 2002 Annual Stockholders' Meeting, as filed with the Securities and Exchange Commission on April 1, 2002 are incorporated by reference into Part III of this report. Portions of the Annual Report to Stockholders for the year ended December 31, 2001 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 14 Item 3. Legal Proceedings 15 Item 4. Submission of Matters to a Vote of Security Holders 15 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 15 Item 6. Selected Financial Data 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 15 Item 8. Financial Statements and Supplementary Data 15 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 15 Part III Item 10. Directors and Executive Officers of the Registrant 16 Item 11. Executive Compensation 16 Item 12. Security Ownership of Certain Beneficial Owners and Management 16 Item 13. Certain Relationships and Related Transactions Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 16 -2- PART I ITEM 1. BUSINESS GENERAL Shore Bancshares, Inc. (the "Company"), a Maryland corporation incorporated on March 15, 1996, is a financial holding company registered 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 eleven full service branches and sixteen 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 and the Company acquired Talbot Bank. On December 21, 2001, the Company entered into an Asset Purchase Agreement with The Avon-Dixon Agency, Inc., Elliott Wilson Insurance, Inc., Avon-Dixon Financial Services, Inc., Joseph M. George & Son, Inc. and 59th Street Finance Company, whereby the Company will purchase certain assets and assume certain liabilities of these entities. In contemplation of this transaction (the "Asset Purchase"), the Company has established The Avon Dixon Agency, LLC, a Maryland limited liability company, Elliott Wilson Insurance, LLC, a Maryland limited liability company, and Mubell Finance, LLC, a Maryland limited liability company (collectively, the "Avon-Dixon Subsidiaries"). The Avon-Dixon Subsidiaries do not currently engage in any activities. After the Asset Purchase is consummated, which is expected to take place in the second quarter of 2002, The Avon-Dixon Subsidiaries will engage in insurance producer activities and insurance premium finance activities. The Company currently has 5,333,023 shares of common stock, par value $0.01 per share ("shares") held by 1,437 holders of record March 1, 2002. 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, 2001 the Company had assets of approximately $582 million, net loans of approximately $388 million, and deposits of approximately $487 million. Stockholders' equity at December 31, 2001 was approximately $71 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, internet banking and telephone banking services. 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 for added customer convenience. -3- 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 80%. 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 80% 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 not to exceed 80% 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 29.25% of the issued and 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. 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. -4- The following table sets forth deposit data for Kent, Queen Anne's, Caroline, Talbot and Dorchester Counties as of June 30, 2001, the most recent date for which comparative information is available.
% of Kent County Deposits Total - ---------------------------------------------------------------------------------------- (in thousands) Peoples Bank of Kent County, Maryland $116,307 32.24% The Chestertown Bank of Maryland 112,924 31.30 Chesapeake Bank and Trust Co. 52,857 14.65 Farmers Bank of Maryland 30,734 8.52 SunTrust Bank 24,464 6.78 THE CENTREVILLE NATIONAL BANK OF MARYLAND 23,500 6.51 -------- ------ Total $360,786 100.00% ======== ======= SOURCE: FDIC DATABOOK % of Queen Anne's County Deposits Total - ---------------------------------------------------------------------------------------- (in thousands) The Queenstown Bank of Maryland $166,251 37.06% THE CENTREVILLE NATIONAL BANK OF MARYLAND 142,276 31.72 The Chestertown Bank of Maryland 40,071 8.93 Bank of America, National Association 39,776 8.87 Allfirst Bank 29,418 6.56 BankAnnapolis 17,295 3.86 Farmers Bank 13,514 3.00 -------- ------- Total $448,601 100.00% ======== ======= SOURCE: FDIC DATABOOK % of Caroline County Deposits Total - ---------------------------------------------------------------------------------------- (in thousands) Provident State Bank of Preston, Maryland $82,558 29.46% Peoples Bank of Maryland 78,266 27.93 Allfirst Bank 34,023 12.14 Farmers Bank of Maryland 28,195 10.06 THE CENTREVILLE NATIONAL BANK OF MARYLAND 22,418 8.00 Bank of America, National Association 16,054 5.73 Atlantic Bank 14,224 5.08 Easton Bank & Trust 4,473 1.60 -------- ------- Total $280,211 100.00% ======== ======= SOURCE: FDIC DATABOOK -5- % of Talbot County Deposits Total - ---------------------------------------------------------------------------------------- (in thousands) THE TALBOT BANK OF EASTON, MARYLAND $257,310 40.69% St. Michaels Bank 112,555 17.80 Bank of America, National Association 71,599 11.32 Easton Bank & Trust 59,419 9.40 SunTrust Bank 54,138 8.56 Allfirst Bank 32,330 5.11 Farmers Bank 25,571 4.04 First Mariner Bank 11,279 1.78 The Queenstown Bank of Maryland 8,223 1.30 -------- -------- Total $632,424 100.00% ======== ======= SOURCE: FDIC DATABOOK % of Dorchester County Deposits Total - ---------------------------------------------------------------------------------------- (in thousands) The National Bank of Cambridge $140,848 33.51% Bank of the Eastern Shore 110,968 26.40 Hebron Savings Bank 35,717 8.50 Bank of America, National Association 29,132 6.93 Atlantic Bank 27,114 6.45 Allfirst Bank 25,945 6.17 Provident State Bank of Preston, Maryland 20,480 4.87 SunTrust Bank 17,198 4.09 THE TALBOT BANK OF EASTON, MARYLAND 12,868 3.08 -------- ------ Total $420,270 100.00% ======== ====== 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 financial holding company registered with the Board of Governors of the Federal Reserve System (the "FRB") 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 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. -6- REGULATION OF FINANCIAL HOLDING COMPANIES Pursuant to the Gramm-Leach-Bliley Act (the "GLBA"), the Company elected to become a "financial holding company" as of April 26, 2001 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 financial 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. Under FRB policy, the Company is expected to act as a source of strength to its subsidiary banks, and the FRB may charge the 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 restrictions on extensions of credit to executive officers, directors, and 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 that 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 the Banks meet 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 $27.8 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. -7- 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. 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, 2001, 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 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 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% or greater, a Tier 1 risk based capital ratio of 6% or 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% or 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. -8- 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. 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 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, a bank holding company 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 GLBA has the effect of broadening the permitted activities of both of the 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 affected the operating results of all financial institutions, including the Company and its subsidiaries, and will continue to do so in the future. 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 reporting, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act. EMPLOYEES At March 22, 2002 the Company had no employees and the Banks had 147 full-time employees and 29 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 THE COMPANY'S FUTURE DEPENDS ON THE SUCCESSFUL GROWTH OF ITS SUBSIDIARIES The Company's primary business activity for the foreseeable future will be to act as the holding company of the Banks and of the recently-established Avon-Dixon Subsidiaries. Therefore, the Company's future profitability will depend on the success and growth of these subsidiaries. In the future, part of the Company's growth may come from buying other banks and buying or establishing other companies. Such entities may not be profitable after they are purchased or established, and they may lose money, particularly at first. A new bank or company may bring with it unexpected liabilities, bad loans, or bad employee relations, or the new bank or company may lose customers. THE MAJORITY OF THE COMPANY'S BUSINESS IS CONCENTRATED IN MARYLAND; A SIGNIFICANT AMOUNT OF THE COMPANY'S BUSINESS IS CONCENTRATED IN REAL ESTATE LENDING Because most of the Banks' loans are made to Maryland borrowers, a decline in local economic conditions may have a greater effect on the Company's earnings and capital than on the earnings and capital of larger financial institutions whose loan portfolios are geographically diverse. Further, the Banks make many real estate secured loans, which 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. Additionally, the market values of the real estate securing these loans may deteriorate, and the Company may lose money if a borrower fails to repay a real estate loan. THE BANKS MAY EXPERIENCE LOAN LOSSES IN EXCESS OF THEIR ALLOWANCES The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management of each of the Banks maintains an allowance for credit losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectability is considered questionable. If management's assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require the Banks to increase their respective allowance for loan losses as a part of their examination process, the Banks' earnings and capital could be significantly and adversely affected. Although management uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to the Banks' non-performing or performing loans. Material additions to the allowance for loan losses of one of the Banks would result in a decrease in that Bank's net income and capital, and could have a material adverse effect on the Company. INTEREST RATES AND OTHER ECONOMIC CONDITIONS WILL IMPACT RESULTS OF OPERATION Results of operations for financial institutions, including the Company and its subsidiaries, may be materially and adversely affected by changes in prevailing economic conditions, including declines in real estate values, rapid changes in interest rates and the monetary and fiscal policies of the federal government. The Company's profitability is in part a function of the spread between the interest rates earned on assets and the interest rates paid on deposits and other interest-bearing liabilities (I.E., net interest income), including advances from the Federal Home Loan Bank of Atlanta (the "FHLB"). Interest rate risk arises from mismatches (I.E., the interest sensitivity gap) between the dollar amount of repricing or maturing assets and liabilities and is measured in terms of the ratio of the interest rate sensitivity gap to total assets. More assets repricing or maturing than liabilities over a given time period is considered asset-sensitive and is reflected as a positive gap, and more liabilities repricing or maturing than assets over a given time period is considered liability-sensitive and is reflected as negative gap. An asset-sensitive position (I.E., a positive gap) could enhance earnings in a rising interest rate environment and could negatively impact earnings in a falling interest rate environment, while a liability-sensitive position (I.E., a negative gap) could enhance earnings in a falling interest rate environment and negatively impact earnings in a rising interest rate environment. Fluctuations in interest rates are not predictable or controllable. The Company has attempted to structure its asset and liability management strategies to mitigate the impact on net interest income of changes in market interest rates. -10- THE MARKET VALUE OF THE COMPANY'S INVESTMENTS COULD DECLINE As of December 31, 2001, the Company had classified 91.3% of its investment securities as available-for-sale pursuant to Statement of Financial Accounting Standards No. 115 ("SFAS 115") relating to accounting for investments. SFAS 115 requires that unrealized gains and losses in the estimated value of the available-for-sale portfolio be "marked to market" and reflected as a separate item in stockholders' equity (net of tax) as accumulated other comprehensive income. The remaining investment securities are classified as held-to-maturity in accordance with SFAS 115, and are stated at amortized cost. In the past, gains on sales of investment securities have not been a significant source of income for the Company. There can be no assurance that future market performance of the Company's investment portfolio will enable the Company to realize income from sales of securities. Stockholders' equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. There can be no assurance that the market value of the Company's investment portfolio will not decline, causing a corresponding decline in stockholders' equity. Management believes that several factors will affect the market values of the Company's investment portfolio. These include, but are not limited to, changes in interest rates or expectations of changes, the degree of volatility in the securities markets, inflation rates or expectations of inflation and the slope of the interest rate yield curve (the yield curve refers to the differences between shorter-term and longer-term interest rates; a positively sloped yield curve means shorter-term rates are lower than longer-term rates). Also, the passage of time will affect the market values of our investment securities, in that the closer they are to maturing, the closer the market price should be to par value. These and other factors may impact specific categories of the portfolio differently, and management cannot predict the effect these factors may have on any specific category. THE COMPANY'S ABILITY TO PAY DIVIDENDS IS LIMITED Holders of shares of the Company's common stock are entitled to dividends if, when, and as declared by the Company's Board of Directors out of funds legally available for that purpose. Although the Board of Directors has declared cash dividends in the past, the current ability to pay dividends is largely dependent upon the receipt of dividends from the Banks. Federal and state laws impose restrictions on the ability of the Banks to pay dividends. Additional restrictions are placed upon the Company by the policies of federal regulators, including the FRB's November 14, 1985 policy statement, which provides that bank holding companies should pay dividends only out of the past year's net income, and then only if their prospective rate of earnings retention appears consistent with their capital needs, asset quality, and overall financial condition. In general, future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors, including the future earnings, capital requirements, regulatory constraints, and the Company's financial condition as well as those of the Banks. THE COMPANY'S STOCK IS NOT HEAVILY TRADED The Company's common stock is traded on The NASDAQ Small Cap Market and is thinly traded. Thinly traded stock can be more volatile than stock trading in an active public market. Factors such as the Company's financial results, the introduction of new products and services by the Company or its competitors, and various factors affecting the banking industry generally may have a significant impact on the market price of the Company's common stock. Management cannot predict the extent to which an active public market for the Company's common stock will develop or be sustained in the future. In recent years, the stock market has experienced a high level of price and volume volatility, and market prices for the stock of many companies have experienced wide price fluctuations that have not necessarily been related to their operating performance. Therefore, the Company's stockholders may not be able to sell their shares at the volumes, prices, or times that they desire. THE COMPANY'S STOCK IS NOT INSURED Investments in the shares of the Company's common stock are not deposits and are not insured against loss by the government. -11- THE COMPANY OPERATES IN A COMPETITIVE MARKET The Company and its subsidiaries operate in a competitive environment, competing for loans, deposits, and customers with commercial banks, savings associations and other financial entities. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market and mutual funds and other investment alternatives. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Competition for other products, such as insurance and securities products, comes from other banks, securities and brokerage companies, insurance companies, insurance agents and brokers, and other nonbank financial service providers in the Company's market area. Many of these competitors are much larger in terms of total assets and capitalization, have greater access to capital markets, and/or offer a broader range of financial services, such as trust services, than those offered by the Company and its subsidiaries. In addition, banks with a larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the needs of larger customers. Finally, the Company's growth and profitability will depend upon its ability to attract and retain skilled managerial, marketing and technical personnel. Competition for qualified personnel in the financial services industry is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. THE BANKING INDUSTRY IS HEAVILY REGULATED; SIGNIFICANT REGULATORY CHANGES COULD ADVERSELY AFFECT THE COMPANY'S OPERATIONS The Company's operations and those of the Banks are and will be affected by current and future legislation and by the policies established from time to time by various federal and state regulatory authorities. The Company is subject to supervision by the FRB. The Talbot Bank is subject to supervision and periodic examination by the Maryland Commissioner and the FDIC, and The Centreville National Bank is subject to supervision and periodic examination by the OCC and the FDIC. Banking regulations, designed primarily for the safety of depositors, may limit a financial institution's growth and the return to its investors by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, interest rates paid on deposits, expansion of branch offices, and the offering of securities or trust services. The Banks are also subject to capitalization guidelines established by federal law and could be subject to enforcement actions to the extent that the Banks are found by regulatory examiners to be undercapitalized. It is not possible to predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on the Company's future business and earnings prospects, as well as those of the Banks. Management also cannot predict the nature or the extent of the effect on the Company's business and earnings of future fiscal or monetary policies, economic controls, or new federal or state legislation. Further, the cost of compliance with regulatory requirements may adversely affect the Company's ability to operate profitably. THE COMPANY MAY BE ADVERSELY AFFECTED BY RECENT LEGISLATION The GLBA was signed into law on November 12, 1999. Among other things, GLBA repeals restrictions on banks affiliating with securities firms. It also permits bank holding companies that become financial holding companies to engage in additional financial activities, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities that are currently not permitted for bank holding companies. GLBA may have the result of increasing the competition the Company faces from larger banks and other companies. It is not possible to predict the full effect that GLBA will have on the Company. In addition, recent changes in other federal banking laws facilitate interstate branching and merger activity among banks. Such changes may result in an even greater degree of competition in the banking industry, and the Company may be brought into competition with institutions with which it does not presently compete. From time to time other changes are proposed to laws affecting the banking industry, and these changes could have a material effect on the Company's business and prospects. The Company's future profitability may be adversely affected by increased competition resulting from this legislation. THE COMPANY MAY BE SUBJECT TO CLAIMS Customers may sue the Company and its subsidiaries for losses due to alleged breaches of fiduciary duties, errors and omissions of employees, officers and agents, incomplete documentation, the failure of the Company and/or its subsidiaries to comply with applicable laws and regulations, or many other reasons. Also, the employees of the Company and/or its subsidiaries 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 and its subsidiaries 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. -12- THE COMPANY MAY NOT BE ABLE TO KEEP PACE WITH DEVELOPMENTS IN TECHNOLOGY The Company and its subsidiaries use various technologies in their respective businesses, including telecommunication, data processing, computers, automation, internet-based banking, and debit 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 any investment it does make may not make it more profitable. THE COMPANY'S ARTICLES OF INCORPORATION AND BY-LAWS MAY DISCOURAGE A CORPORATE TAKEOVER The Company's Amended and Restated Articles of Incorporation ("Articles") and By-Laws contain certain provisions designed to enhance the ability of the Board of Directors to deal with attempts to acquire control of the Company. These provisions provide for the classification of the Company's Board of Directors into three classes; directors of each class generally serve for staggered three-year periods. 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. Although these provisions do not preclude a takeover, they may have the effect of discouraging a future takeover attempt which would not be approved by the Company's Board of Directors, but pursuant to which stockholders might receive a substantial premium for their shares over then-current market prices. As a result, stockholders who might desire to participate in such a transaction might not have the opportunity to do so. Such provisions will also render the removal of the Company's Board of Directors and of management more difficult and, therefore, may serve to perpetuate current management. As a result of the foregoing, such provisions could potentially adversely affect the market price of the 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, 2001.
MATURITIES OF LOAN PORTFOLIO December 31, 2001 (In Thousands) Maturing Maturing After one Maturing Within But Within After Five One Year Five Years Years Total Real Estate Construction and land development $ 14,482 $5,773 $ - $ 20,255 Commercial, financial and agricultural 34,380 17,023 7,550 58,953 Mortgage 63,288 148,399 82,234 293,921 Consumer 7,168 10,934 1,475 19,577 -------- ------- -------- -------- Total $119,318 $182,129 $91,259 $392,706 ======== ======== ======= ======== CLASSIFIED BY SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES Fixed-Interest Rate Loans $65,032 $158,696 $40,260 $263,988 Adjustable-Interest Rate Loans 54,286 23,433 50,999 128,718 ------- ------- -------- --------- Total $119,318 $182,129 $91,259 $392,706 ======== ======== ======= ========
-13-
ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES (In Thousands) December 31, 2001 2000 1999 1998 1997 -------------------------------------------------------------- Commercial Financial and Agricultural $1,563 1,694 $1,437 $947 $1,074 Real Estate-Construction 135 126 108 148 138 Real Estate-Mortgage 1,918 1,807 1,991 1,628 1,508 Consumer 387 412 438 296 350 Unallocated 186 160 17 912 871 -------- ---------- ------- -------- ----- $4,189 $4,199 $3,991 $3,931 $3,942 ====== ====== ====== ====== ======
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, 2001, as follows:
DISCLOSURE REQUIRED BY GUIDE 3 REFERENCE TO 2001 ANNUAL REPORT - ------------------------------ ------------------------------- (I) Distribution of Assets, Liabilities and Average Balances; Yields and Rates (page 9) Stockholders' Equity; Interest Rates and Rate/Volume Analysis (page 10) Interest Differential Non-performing Assets (page 13) (II) Investment Portfolio Weighted Average Maturities and Weighted Average Yields (page 6) Notes to Financial Statements, Note 4 - Investment in Debt Securities - (pages 26 and 27) (III) Loan Portfolio Year End Loan Composition (page 6) Non-performing Assets (page 13) (IV) Summary of Loan Loss Experience Provision and Allowance for Credit Losses (pages 11,12,13) (V) Deposits Deposits (page 7) (VI) Return on Equity and Assets Return on Equity and Assets (page 17) (VII) Short Term Borrowings Short Term Borrowings (page 8) Notes to Financial Statements, Note 9 -Short Term Borrowings (page 29) Notes to Financial Statements, Note 17 - Line of Credit (page 33)
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 2004 and calls for annual rental payments of $42,840. 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 $48,402. 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"). Another property, the future site of a branch of The Centreville National Bank, is owned at the intersection of Castle Marina Road and MD Rte 18, Chester, Maryland 21619 -14- 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. Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS There were no matters submitted for vote to shareholders in the Fourth quarter of 2001. 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, 2001 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 32 and 33. The Company has issued and outstanding 5,333,023 shares of common stock, par value $0.01 per share held by 1,437 holders of record as of March 1, 2002. See also "Risk Factors - The Company's Ability to Pay Dividends is Limited" under Item I. Item 6. SELECTED FINANCIAL DATA Incorporated by reference from Annual Report to Stockholders for the year ended December 31, 2001, 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, 2001 under "Management's Discussion and Analysis of Financial Condition and Results of Operations," pages 4 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 15 and 16 of the Annual Report to Stockholders for the year ended December 31, 2001. 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, 2001 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. -15- 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 2002 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 2002 Annual Meeting under "Executive Officers, " page 12 and 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 2002 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 2002 Annual Meeting under "Executive Compensation," " Benefit Plans" and "Executive Compensation Committee Report," pages 7 through 11, under "Performance Graph," page 13, 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 2002 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 2002 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, 2001 and 2000 Consolidated Statements of Income -- Years Ended December 31, 2001, 2000, and 1999 Consolidated Statements of Changes in Stockholders' Equity -- Years Ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows -- Years Ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements as of December 31, 2001, 2000 and 1999 Report of Independent Auditors (3) Exhibits Required to be Filed by Item 601 of Regulation S-K 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). -16- 13 2001 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 (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed May 4, 2001 (Registration No. 333-60214)) (b) Reports on Form 8-K On December 21, 2001, the Company filed a Current Report on Form 8-K to report the pending acquisition of certain assets and assumption of certain liabilities of The Avon-Dixon Agency, Inc. and its subsidiaries. (c) Exhibits required by Item 601 of Regulation S-K See the Exhibits described in Item 14 (a)(3) above. -17- 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 29, 2002. Shore Bancshares, Inc. Date: March 29, 2002 by: /S/W. MOORHEAD VERMILYE ------------------------------ W. Moorhead Vermilye, President and CEO Date: March 29, 2002 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, 2002 - ------------------------- Herbert L. Andrew, III - ------------------- Director March 29, 2002 Blenda W. Armistead /s/Lloyd L. Beatty, Jr. Director March 29, 2002 - ----------------------- Lloyd L. Beatty, Jr. /s/Paul M. Bowman Director March 29, 2002 - ----------------- Paul M. Bowman /s/David C. Bryan Director March 29, 2002 - ------------------ David C. Bryan /s/ Daniel T. Cannon Director March 29, 2002 - -------------------- Daniel T. Cannon /s/B. Vance Carmean Director March 29, 2002 - ------------------- B. Vance Carmean /s/Richard C. Granville Director March 29, 2002 - ----------------------- Richard C. Granville /s/Neil R. LeCompte Director March 29, 2002 - ------------------- Neil R. Le Compte /s/David L. Pyles Director March 29, 2002 - ----------------- David L. Pyles /s/W. Moorhead Vermilye Director March 29, 2002 - ----------------------- W. Moorhead Vermilye -18- EX-13 3 exh13.txt FINANCIALS SHORE BANCSHARES, INC. LOGO 2001 ANNUAL REPORT CONTENTS 1. Letter to Shareholders 3. Financial Highlights 4. Management's Discussion and Analysis of Financial Condition and Results of Operations 17. Selected Financial Data 18. Consolidated Financial Statements 37. Independent Auditors' Report 38. Directors and Officers 41. Branch Locations and Information Dear Shareholders and Friends, We are pleased to report that 2001 was another successful year for Shore Bancshares, Inc. Growth in loans, core deposits and fee income during the year, resulted in record earnings of $7,994,000, compared to $7,957,000 for 2000. On a per share basis, diluted earnings were $1.49 and $1.48 for the years ended December 31, 2001 and 2000, respectively. Shore Bancshares, Inc. remains the largest independently owned financial institution on the Eastern Shore. Through its subsidiaries, the Talbot Bank and The Centreville National Bank, the Company provides banking services to customers in five Eastern Shore Counties. With eleven full service branches, sixteen ATM's, telephone and internet banking, customers can easily access their accounts from anywhere. FINANCIAL RESULTS The interest rate environment in 2001 was challenging. The Federal Reserve lowered short-term interest rates eleven times during the year, resulting in a 475 basis point decline in the federal funds rate from 6.50% to 1.75%. A corresponding reduction in the New York Prime rate followed each of the federal funds rate cuts. This trend in interest rates resulted in a decline in the overall yield on earning assets for 2001. Net interest income increased $285,000, totaling $21,877,000 for the year ended December 31, 2001, an increase of 1.3% when compared to 2000. Increased interest income associated with loan growth and a decline in interest expense were the reasons for the increase. The average balance of loans, the primary earning asset of the Company, grew 5.2% totaling $386,161,000 for the year ended December 31, 2001, compared to $367,075,000 for 2000. Average deposits increased 7.5%, totaling $466,772,000 for the year ended December 31, 2001, compared to $434,296,000 for 2000. Noninterest income, which had continued to grow in each of the previous four years, declined in 2001. Absent the effect of securities gains and losses and a one-time gain on life insurance policies in 2000, noninterest income would have increased 9.7% or $234,000 for 2001. It is one of the Company's goals to focus on value added services for retail and commercial customers, which will contribute to growth in noninterest income. Return on average assets and shareholders' equity were 1.42% and 11.70%, respectively, for 2001, compared to 1.52% and 12.98%, respectively for 2000. Growth in the average balances of assets and stockholder's equity exceeded earnings growth resulting in decline in these ratios. Total average assets of the Company grew 7.1% totaling $562,026,000 for the year ended December 31, 2001, compared to $524,721,000 one year ago. Average Stockholders' equity was $68,332,000 for 2001, compared to $61,285,000 for 2000. The Company continues to maintain capital ratios well in excess of the required regulatory minimums, with a tier 1 capital ratio of 11.85% and a risk based capital ratio of 17.64% at December 31, 2001. Total stockholders' equity was $70,971,000, an increase of $5,947,000 when compared to December 31, 2000. Dividends paid to shareholders were $0.60 per share compared to $0.52 in 2000. In an effort to enhance the liquidity of the Company's stock, we became listed on the NASDAQ Small Cap Market in April of 2001, and are quoted under the symbol SHBI. OUR PEOPLE J. Robert Barton retired from the Centreville National Bank Board of Directors in 2001 after 33 Years of service. He served as Senior Vice President from 1979 to 1992, President and CEO from 1992 until he retired in 1995, and as a member of the Board of Directors since 1981. Mr. Barton remains an active civic leader in Queen Anne's County. We wish to thank Mr. Barton for the many contributions he made to the success of Shore Bancshares, Inc. and The Centreville National Bank. We were also saddened in 2001 by the loss of two long time members of the Talbot Bank Board of Directors. William H. Myers, Chairman of the Board of The Talbot Bank, passed away in February after 53 years of service to the Bank. Mr. Myers brought many years of wisdom to our organization and his contributions to local organizations in Talbot County and Oxford were numerous. Ronald N. Fox, a prominent local businessman and community leader who served on the Board of The Talbot Bank for 20 years and on the Shore Bancshares Board since December 2000, passed away in October 2001. The contributions of both of these individuals will be greatly missed. -1- GROWTH STRATEGIES On December 21, 2001, the Company entered into an agreement to acquire certain assets of the Avon-Dixon Agency, Inc. and its subsidiaries, a full service insurance agency. All necessary regulatory approvals have been received and it is anticipated that the purchase will be completed in April 2002. This acquisition plays an important role in the strategic vision of Shore Bancshares, Inc. to expand the range of financial products and services offered to our customers. Avon-Dixon is a well-known agency serving the Mid-Atlantic region, and is the 2001 recipient of the "Best Practices" award from the Independent Insurance Agents of America. We are very excited about this addition to our Company. The history and reputation of Avon-Dixon resembles in many ways that of our financial institutions, making it a natural addition to our organization. Achieving excellence in customer service remains a primary goal of the Company. We do this through the talented staff we employ, and by providing valuable products and convenience to our customers. With that in mind, a new branch of The Centreville National Bank was opened in Denton this year with another branch in Chester planned in 2002. Also during 2001, the Company enhanced the convenience of banking by making Talbot Bank and Centreville National Bank ATM's and check cashing services available to customers of either institution free of charge. Internet banking is now available to customers of both Banks, further enhancing our delivery channels. In the second quarter of 2002, customers of either Bank, will be able to make deposits or loan payments at any branch of The Centreville National Bank or the Talbot Bank. IN CONCLUSION We feel confident about the Company's ability to enhance profitability and shareholder value in 2002. We will do this by building on our reputation of excellent customer service, through growth and an expansion of our products and services. We are proud of the quality individuals working for Shore Bancshares, Inc. and recognize that they are the key to our continued success. And, as always, would like to take this opportunity to thank you for your continued support. Sincerely, W. Moorhead Vermilye President and CEO, Shore Bancshares, Inc. President and CEO, The Talbot Bank Daniel T. Cannon Executive Vice President and COO, Shore Bancshares, Inc. President and CEO, The Centreville National Bank B. Vance Carmean, Jr. Chairman of the Board, Shore Bancshares, Inc. -2-
FINANCIAL HIGHLIGHTS Percent Increase Years ended December 31, 2001 2000 (Decrease) - ------------------------------------------------------------------------------------ (Dollars in thousands, except per share data) FOR THE YEAR Interest income $ 38,938 $ 39,480 (1.4%) Interest expense 17,061 17,888 (4.6%) Net interest income 21,877 21,592 1.3% Net income 7,994 7,957 .5% Cash dividends 3,198 2,783 14.9% - ------------------------------------------------------------------------------------ AVERAGE Total assets $562,026 $524,721 7.1% Total loans 386,161 367,075 5.2% Total deposits 466,772 434,296 7.5% Stockholders' equity 68,332 61,285 11.5% - ------------------------------------------------------------------------------------ AT YEAR END Total assets $582,403 $553,097 5.3% Total loans, net of unearned income 392,706 382,506 2.7% Total deposits 487,470 464,485 4.9% Stockholders' equity 70,971 65,024 9.1% - ------------------------------------------------------------------------------------ PER SHARE Net income per common share: Basic $ 1.50 $ 1.50 --% Diluted $ 1.49 $ 1.48 0.7% Cash dividends $ .60 $ .52 15.4% Book value at year-end $ 13.31 $ 12.21 9.0% - ------------------------------------------------------------------------------------
-3- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Shore Bancshares, Inc. (the "Company") is a financial 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 eleven full service branches and sixteen 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 ("FDIC"). Services provided to businesses include commercial checking, savings and related depository services, including telephone and internet 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 internet banking. In December 2001, the Company entered into an agreement to purchase certain assets of the Avon-Dixon Agency, Inc., a full service insurance agency, and its subsidiaries, all located in Easton, Maryland. The transaction is expected to be complete in the second quarter of 2002, after which time the Company will be able to offer a full range of insurance products to its customers. 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 for the year ended December 31, 2001 was $7.99 million, compared to $7.96 million for December 31, 2000. On a per share basis, fully diluted net income was $1.49, compared to $1.48 for 2000. Return on average assets and return on shareholders' equity for 2001 were 1.42% and 11.70%, respectively. Total assets of the Company increased 5.3% in 2001, totaling $582.4 million. Deposits increased $23.0 million totaling $487.5 million at December 31, 2001. This increase in deposits along with an increase in stockholders' equity funded asset growth. Interest bearing deposits with other banks, investment securities and loans all increased during the year. Total loans were $392.7 million at December 31, 2001, an increase of $10.2 million when compared to 2000. Interest bearing deposits with other banks and federal funds sold totaled $34.2 million at December 31, 2001, compared to $19.7 million one year ago. Investment securities increased $8.2 million, totaling $125.8 million at the end of the year. -4- 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 5.3% to $582,403,000 at December 31, 2001, compared to an increase of 6.7% for 2000. Average total assets were $562,026,000, an increase of 7.1% in 2001. Average total assets increased 5.4% in 2000, totaling $524,721,000 for the year. The loan portfolio represents 72.3% 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 4.9% to $487,470,000 at December 31, 2001, compared to a 6.5% increase for 2000. 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.
2001 2000 1999 1998 1997 ------- ------- ------- ------- ------- Investment securities 21.42% 24.25% 27.23% 25.88% 26.35% Loans 72.28 73.66 68.62 68.80 69.63 Interest bearing deposits with other Banks 2.00 - - - - Federal funds sold 4.30 2.09 4.15 5.32 4.02 ------ ------- ------- ------- ------- 100.00% 100.00% 100.00% 100.00% 100.00% ====== ====== ====== ====== ======
INVESTMENT SECURITIES The average balance of investment securities decreased $6,397,000 or 5.3% in 2001. As interest rates continued to decline in 2001, many bonds with call features were called and the proceeds were not immediately reinvested. A portion of the proceeds from callable bonds were shifted into interest bearing deposits and federal funds sold, which have lower yields than investment securities. The average balance of investment securities decreased $7,954,000 or 6.2% in 2000. Investment purchases in 2001 were concentrated in U.S. Government Agency bonds and mortgage backed securities. Earnings on certain U.S. Government Agency Bonds are exempt from state income tax and provide 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. 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, 2001, the Company had classified 91% of the portfolio as available for sale and 9% as held to maturity, compared to 81% and 19%, 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. -5- 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, 2001.
1 YEAR OR LESS 1-5 YEARS 5-10 YEARS OVER 10 YEARS -------------- --------- ---------- ------------- Carrying Average Carrying Average Carrying 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 $ 500 5.87 % $1,077 3.59% $ -- -- % $ -- -- % - % Obligations of states and political subdivisions (1) 1,066 7.02 5,537 6.54 2,705 6.80 -- -- Mortgage backed securities -- -- 8 9.56 3 8.00 -- -- -------- ------------------- ----------------- ------- ------------------ Total Held to Maturity $ 1,566 6.65 % $ 6,622 6.06% $2,708 6.81% $ -- -- ======= ======= ======= ===== ======= ======== ===================
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 - --------------------------------------------------------------------------------------------------------------------------- Available for Sale: U.S. Treasury securities and obligations of U.S. government agencies $13,013 5.82 % $55,898 5.07% $2,567 5.39% $ -- --% Obligations of states and political subdivisions (1) 100 6.08 110 6.23 -- -- -- -- Mortgage backed securities 2 9.91 8,660 5.20 9,949 5.73 14,415 6.16 Other securities -- -- -- -- -- -- 9,459 4.76 ------- ------ ------- ---- ------ ----- --------- ----- Total Available for Sale $13,115 5.83 % $64,668 5.09% $12,516 5.41% $23,874 4.98% ======= ===== ======= ==== ======= ==== ======= ==== (1) Yields adjusted to reflect a tax equivalent basis assuming a federal tax rate of 34%.
LOANS Average loans increased $19,086,000 or 5.2% in 2001, totaling $386,161,000, compared to an increase in average loans of 13.1% in 2000. Growth in loans for the year 2001 was more difficult than in 2000 due to borrowers seeking long-term fixed rate financing for mortgage loans. The Company does not invest in long-term fixed rate mortgage loans because of the increased interest rate risk associated with them. Total loans, net of unearned income totaled $392,706,000 on December 31, 2001, an increase of $10,200,000 or 2.7% when compared to 2000. The local economy remained strong throughout 2001, however loans refinanced with other lenders offset a portion of the new loan growth. Loan growth occurred in all components of the loan portfolio during 2001. Commercial loans increased $4,311,000 or 7.9%, construction loans increased $1,668,000 or 9%, mortgage loans increased $2,785,000 or 1%, and consumer loans increased $1,436,000 or 7.9% for the year ended December 31, 2001. The table below sets forth the composition of the loan portfolio at December 31.
(Dollars in thousands) 2001 2000 1999 1998 1997 Commercial, financial and agricultural $ 58,953 $ 54,642 $ 55,468 $ 42,109 $ 35,721 Real estate - construction 20,255 18,587 15,643 13,228 12,483 Real estate - mortgage 293,921 291,136 258,443 235,830 232,419 Consumer 19,577 18,141 16,237 14,393 13,837 ---------- ---------- --------- --------- --------- Total Loans $392,706 $382,506 $345,791 $305,560 $294,460 ======== ======== ======== ======== ========
-6- INTEREST BEARING DEPOSITS WITH OTHER BANKS AND FEDERAL FUNDS SOLD The Company invests excess cash balances in interest bearing accounts or federal funds sold, with its correspondent banks. These liquid investments in cash are maintained at a level necessary to meet the immediate liquidity needs of the Company. The average balance of interest bearing deposits with other banks and federal funds sold increased $23,277,000 to $33,674,000 during 2001. In 2000, the average balance of federal funds sold declined $9,206,000 to $10,397,000, a 47% decrease when compared to 1999. DEPOSITS The Company primarily utilizes core deposits to fund its earning assets. At December 31, 2001 and 2000 deposits provided funding for 87% and 77% of average earning assets, respectively. Average deposits increased 7.5% in 2001, compared to 4.7% in 2000. The average rate paid on interest bearing deposits decreased 34 basis points to 3.95% for 2001, compared to 4.29% for 2000. Increased deposit growth in 2001 is attributable in part to depositors looking for principal protection that they could not achieve in the stock markets. Deposit growth is primarily in certificates of deposit, whose average balance increased $19,930,000 or 9.7%. The average balances of certificates of deposit $100,000 or more increased $5,469,000 or 7.7%, compared to an increase of $9,149,000 or 14.8% in 2000 and $11,374,000 or 22.5% in 1999. Many depositors locked in high certificate of deposit rates late in 2000 and, although rates offered for certificates of deposit decreased throughout 2001, the overall rate paid declined only 9 basis points to 5.47%. The rate paid for certificates of deposit of $100,000 or more, which represent 34% of the total time deposits, declined 46 basis points to 5.26%. The majority of these jumbo certificates mature in less than 12 months, which accounts for the significant reduction in the rate paid. The average balance of noninterest-bearing demand deposits increased $6,069,000 and the average balance of NOW and SuperNOW deposits increased $9,868,000 in 2001. In 2000, the rate paid for deposits increased in all categories. The most significant increase was in certificates of deposit $100,000 or more, again because of the short -term maturities associated with thesedeposits. The growth in jumbo certificates of deposit in 1999 and 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, with an additional $9,953,000 of deposit growth in the average balance of noninterest bearing demand, NOW and SuperNOW accounts. The average balance of money management and savings accounts decreased by a $2,183,000 in 2000 as a result of depositors shifting money into investment vehicles with higher returns. The Company does not accept brokered 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 2001 2000 1999 Noninterest-bearing demand $56,127 12.02% $50,058 11.53% $46,137 11.10% Interest bearing deposits NOW and Super NOW 86,100 18.45% 76,232 17.55% 70,200 16.90% Savings 30,380 6.51% 30,863 7.11% 31,565 7.60% Money Management 68,879 14.76% 71,788 16.53% 73,269 17.63% CD's and other time deposits less than $100,000 148,706 31.86% 134,245 30.91% 132,355 31.86% CD's $100,000 or more 76,580 16.40% 71,111 16.37% 61,962 14.91% -------- ------ -------- ------- -------- ------- $466,772 100.00% $434,297 100.00% $415,488 100.00% ======== ======= ======== ======= ======== =======
The following table sets forth the maturity ranges of certificates of deposit with balances of $100,000 or more on December 31, 2001 (in thousands). Three months or less $35,447 Over three through twelve month 19,794 Over twelve months 19,855 -------- $75,096 -7- 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 $2,207,000 or 10.3% in 2001, compared to an increase of $3,709,000 or 20.8% in 2000. 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) 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------- BALANCE RATE Balance Rate Balance Rate - -------------------------------------------------------------------------------------------------------------- FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: Average outstanding for the year $19,315 2.87% $21,522 5.09% $17,813 3.86% Outstanding at year end 17,054 1.15% 16,252 4.96 16,933 3.95 Maximum outstanding at any month end 25,175 -- 32,498 -- 23,297 --
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 $70,971,000 at December 31, 2001, 9.1% higher than the previous year. Average stockholders' equity was $68,332,000 for 2001, an increase of 11.5% when compared to 2000. The increase in stockholders' equity is primarily due to earnings of the Company for the year of $7,994,000, reduced by dividends paid on common stock of $3,198,000 and a $1,020,000 increase in other accumulated comprehensive income, consisting solely of unrealized gains 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, 2001, the portion of the Banks' investment portfolio designated as "available for sale" had unrealized holding gains, net of tax, of $466,000, compared to net unrealized holding losses of $554,000 at December 31, 2000. The following table compares the Company's capital ratios as of December 31 to the regulatory requirements.
Regulatory (Dollars in thousands) 2001 2000 Requirements - -------------------------------------------------------------------------------------- Tier 1 capital $ 68,657 $ 63,611 Tier 2 capital 2,313 4,199 - -------------------------------------------------------------------------------------- Total capital, less deductions $70,970 $ 67,810 Risk-adjusted assets 402,436 $ 373,335 Risk-based capital ratios: Tier 1 17.06% 17.04% 4.0% Total capital 17.64% 18.16% 8.0% - -------------------------------------------------------------------------------------- Total capital $68,657 $ 63,611 Total adjusted assets $579,349 $ 544,854 Leverage capital ratio 11.85% 11.67% 4.0% - --------------------------------------------------------------------------------------
During the second quarter of 2002, the Company expects to issue shares of stock representing a market value of $800,000 to complete the purchase of certain assets of the Avon-Dixon Agency, Inc. and its subsidiaries in accordance with the asset purchase agreement. The remainder of the purchase price will be paid in cash. Management knows of no other trends or demands, commitments, events or uncertainties, which will materially affect capital. -8- 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. Although interest income decreased in 2001, net interest income increased as a result of a decline in interest expense. The Federal Reserve cut short-term interest rates eleven times during 2001, reducing the federal funds rate from 6.50% at the beginning of the year to 1.75% at December 31, 2001. New York Prime, which is the index most commonly used to price loans, fell a corresponding 4.75% from 9.50% at January 1, 2001 to 4.75% at December 31, 2001. The rate paid for interest bearing liabilities decreased 44 basis points from 4.36% to 3.92%. The average balance of earning assets increased during the year, totaling $534,224,000, compared to $498,308,000 for 2000; however, the yield on earning assets declined 64 basis points to 7.35%. During 2000, the yield on earning assets increased 42 basis points from 7.57% to 7.99%. Net interest income for 2001 was $21,877,000, compared to $21,592,000 for 2000 and $19,395,000 for 1999. This represents an increase of 1.3% and 11.3% for 2001 and 2000, respectively. The following table sets forth the major components of net interest income, on a tax equivalent basis, as of December 31, 2001, 2000 and 1999.
(Dollars in thousands) 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------- Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate (1) Balance Interest Rate (1) Balance Interest Rate (1) - ------------------------------------------------------------------------------------------------------------------- Earning Assets: Investment securities: Taxable $104,547 $5,977 5.72% $109,687 $ 6,688 6.10% $115,577 $ 6,773 5.86% Non-taxable 9,892 673 6.80 11,149 756 6.78 13,213 894 6.77 Loans (2)(3) 386,161 31,320 8.11 367,075 31,700 8.64 324,507 27,148 8.37 Interest Bearing Deposits 10,701 370 3.46 - - - - - - Federal funds sold 22,923 912 3.98 10,397 670 6.44 19,603 987 5.04 ------- ----- ---- --------- -------- --- --------- ------ ---- Total earning assets 534,224 39,252 7.35% 498,308 39,814 7.99% 472,900 35,802 7.57% ------- ------- Cash and due from banks 14,815 12,292 11,636 Other assets 17,240 18,243 17,174 Allowance for credit losses (4,253) (4,122) (3,898) ------- ---------- ---------- Total assets $562,026 $524,721 $497,812 ======== ======== ======== Interest bearing liabilities: Demand $ 86,100 $1,494 1.74% $ 76,232 $ 1,990 2.61% $ 70,200 $ 1,807 2.57% Savings 99,259 2,409 2.43 102,651 3,065 2.99 104,834 3,139 2.99 Certificates of deposit $100,000 or more 76,580 4,026 5.26 71,111 4,071 5.72 61,962 3,147 5.08 Other time 148,706 8,307 5.59 134,245 7,351 5.48 132,355 6,985 5.28 ------- ----- ---- --------- ------- ---- ---------- ------- ---- Interest bearing deposits 410,645 16,236 3.95 384,239 16,477 4.29 369,351 15,078 4.08 Short-term borrowings 19,315 554 2.87 21,522 1,096 5.09 17,813 687 3.86 Long-term debt 5,000 271 5.42 5,000 315 6.30 4,959 274 5.52 ----------- ---------------- -------- ------- --- ---------- ------- ---- Total interest bearing liabilities 434,960 17,061 3.92% 410,761 17,888 4.36% 392,123 16,039 4.09% ------- ------ ----- ------ ----- Noninterest bearing deposits 56,127 50,058 46,137 Other liabilities 2,607 2,617 2,175 Stockholders' equity 68,332 61,285 57,377 ------ -------- -------- Total liabilities and stockholders' equity $562,026 $524,721 $497,812 ======== ======== ======== Net interest spread $22,191 3.43% $21,926 3.63% $19,763 3.48% ======= ======= ======= Net interest margin 4.15% 4.40% 4.18% (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) (3) Interest income on loans includes amortized loan fees, net of costs, for each category and yields are stated to include all.
-9- Net interest income on a tax equivalent basis increased $265,000 or 1.2% in 2001. The Company's tax equivalent yield on loans declined in 2001 as new loans and loans refinanced with the Company were recorded at rates which were much lower than 2000. Interest income generated by the increased volume of loans was not enough to exceed the affect of the declining interest rates in 2001. The tax equivalent yield on earning assets was 7.35% for 2001, compared to 7.99% and 7.57% for 2000 and 1999, respectively. Interest rates, which began to rise in the middle of 1999 and continued to increase during 2000, declined throughout 2001. With the exception of nontaxable investment securities, all categories of earning assets experienced a decline in yields. The opposite was true in 2000, when all categories of earning assets experienced some increase in yield. The impact of a 27 basis point increase in loan yields in 2000 generated $888,000 in increased interest income for the Company. Even more significant than the impact of increased loan yields in 2000, was the effect of increased loan volume that contributed $3,665,000 to loan interest for the year. Growth in the average balance of earning assets was $35.9 million or 7.2% for the year ended December 31, 2001. Average loans increased $19.1 million or 5.2%, totaling $386.2 million, compared to an increase of $42.6 million during 2000. The average balance of investment securities increased $6.4 million and federal funds sold and interest bearing deposits in other banks increased $23.3 million. The growth in earning assets in investment securities, federal funds sold and interest bearing deposits in other banks generated lower overall yields than growth in the loan portfolio would have produced. This contributed to the overall decline in yield on earning assets. In 2000, the composition of earning assets shifted to loans which contributed to the growth in interest income for the year. Average loans increased $42.6 million in 2000, while the average balance of investment securities decreased $8 million and the average balance of federal funds sold decreased $9.2 million. As a percentage of total average earning assets, loans and investment securities totaled 72.3% and 21.4%, respectively, for 2001, compared to 73.7% and 24.3%, respectively for 2000. 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.
2001 OVER (UNDER) 2000 2000 OVER (UNDER) 1999 ---------------------- ------------------ TOTAL CAUSED BY Total CAUSED BY --------- --------- (Dollars in thousands) VARIANCE RATE VOLUME Variance Rate Volume Interest income from earning assets: Interest Bearing Deposits $370 $ - $370 $ - $ - $ - Federal funds sold 242 (113) 355 (318) 227 (545) Taxable investment securities (711) (411) (300) (85) 266 (351) Non-taxable investment securities (83) 2 (85) (138) 2 (140) Loans (380) (1,949) 1,569 4,553 888 3,665 Total interest income (562) (2,471) 1,909 4,012 1,383 2,629 Interest expense on deposits and borrowed funds: Interest bearing demand (496) (808) 312 183 26 157 Savings deposits (656) (557) (99) (74) (9) (65) Time deposits 911 (608) 1,519 1,290 694 596 Short term borrowings (542) (494) (48) 409 197 212 Long term debt (44) (44) - 41 39 2 Total interest expense (827) (2,511) 1,684 1,849 947 902 Net interest income $ 265 $ 40 $ 225 $ 2,163 $ 436 $1,727
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. -10- 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 is managed through loan and deposit pricing and assets liability strategies. Even though short-term rates declined 475 basis points in 2001, the Company's net interest margin declined only 25 basis points from 4.40% for 2000 to 4.15% for 2001. The decrease was the result of lower yields on interest 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 decreased from 3.63% to 3.43%. Declining interest rates throughout 2001 resulted in a reduction in the average rate paid for interest bearing liabilities of 44 basis points for the year. Interest expense for 2001 decreased $827,000. Lower rates accounted for a $2,511,000 reduction in interest expense, while the increased volume of deposits and other interest bearing liabilities generated additional interest expense of $1,684,000 for 2001. The average rate paid for interest bearing demand deposits in 2001 was 1.74%, compared to 2.61% in 2000, and the average rate paid for savings deposits was 2.43% for 2001, compared to 2.99% one year ago. Other time deposits, which consist primarily of certificates of deposit, paid an average rate of 5.59% for 2001, compared to 5.48% one year ago, while the average rate paid for certificates of deposit over $100,000 decreased 46 basis points from 5.72% to 5.26% for 2000 and 2001, respectively. The rate paid for short-term borrowings, which consist primarily of securities sold under agreements to repurchase, decreased 222 basis points to 2.87%, compared to 5.09% in 2000. The rate paid on the Company's long-term debt, which was converted to a variable rate instrument in 2000, was 5.42% for 2001, compared to 6.30% and 5.52% for 2000 and 1999, respectively. Interest expense increased $1,849,000 during 2000, with approximately half of the increase attributable to rate increases and half attributable to increased volume of deposits. The average rate paid for certificates of deposit $100,000 or more increased 64 basis points, and for all other time deposits the increase was 20 basis points. Average interest bearing demand deposits increased $6,032,000 during the year; however, the rate paid for those deposits remained relatively unchanged at 2.61%, compared to 2.57% for 1999. PROVISION AND ALLOWANCE FOR CREDIT LOSSES The Company recorded a provision for credit losses of $226,000 in 2001 compared to $437,000 in 2000 and $240,000 in 1999. Provisions for credit losses are adjusted to bring the allowance for credit losses within the range of balances that are considered adequate to absorb inherent losses in the loan portfolio. Net charge-offs increased slightly in 2001 as a result of a reduction in recoveries for the year. The local economy did not seem to experience the level of weakness or "recession" that many regions of the United States felt in 2001. Loan demand remained strong as evidenced by continued loan growth during the year. During 2000, an increasing trend in net charge offs, growth in loans, as well as concerns over deteriorating national 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. 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 where current conditions are not reflective of the specific history of the Company. -11- 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. The methodology used to calculate the adequacy of the allowance for credit losses incorporates assumptions necessary to reflect trends in the industry that may not be evidenced by true historical factors. Management's decision regarding the amount of the loan loss provision is also influenced by growth in commercial and real estate loan balances because the losses inherent in those loans can be more difficult to assess. In 2001, past due and nonaccrual loans increased, however they represented primarily well-secured loans with limited exposure to the Company. In 2000, nonaccrual loans declined and net charge offs increased due to a reduction in recoveries of $100,000. At December 31, 2001, the allowance for credit losses was $4,189,000, or 1.08% of outstanding loans, and 444% of total nonaccrual loans. This compares to an allowance of $4,199,000, or 1.14% of outstanding loans and 674% of nonaccrual loans, at December 31, 2000, and an allowance for credit losses of $3,991,000, or 1.23% of outstanding loans and 220% of nonaccrual loans, at December 31, 1999. The following table sets forth a summary of the Company's loan loss experience for the years ended December 31.
(Dollars in thousands) 2001 2000 1999 1998 1997 Balance, beginning of year $ 4,199 $ 3,991 $ 3,931 $ 3,942 $ 4,232 --------- -------- -------- -------- -------- Loans charged off: Real estate loans (5) (61) (121) (69) (159) Installment loans (155) (73) (146) (122) (169) Commercial and other (175) (244) (162) (193) (305) ------ ------- ------ ------ ------- (335) (378) (429) (384) (633) ------ ------- ------ ------ ------- Recoveries: Real estate loans 2 18 50 26 4 Installment loans 60 50 43 57 74 Commercial and other 37 81 156 50 25 -------- ------- --------- -------- ------ 99 149 249 133 103 ------ -------- -------- --------- ------- Net losses charged off (236) (229) (180) (251) (530) Allowance applicable to loans of acquired institution - - - - 15 Provision for credit losses 226 437 240 240 225 ------- -------- ------- ------- ------- Balance, end of year $ 4,189 $ 4,199 $ 3,991 $ 3,931 $ 3,942 ------- ------- ------- ------- ------- Average loans outstanding $386,161 $367,075 $324,507 $297,786 $278,607 ======== ======== ======== ======== ======== Percentage of net charge-offs to average loans outstanding during the year .06% .06% .06% .08% .19% Percentage of allowance for loan losses at year-end to average loans 1.08% 1.14% 1.23% 1.32% 1.41%
-12- Total non-accrual loans of the Company increased during 2001 and represented .24% of total loans, net of unearned income at December 31, 2001, compared to .16% one year earlier. Loan delinquencies increased to $1,532,000 for 2001, compared to $1,333,000 for 2000. The following table summarizes the past due and non-performing assets of the Company as of December 31.
(Dollars in thousands) 2001 2000 1999 1998 1997 Non-performing assets: Non-accrual loans $943 $ 623 $ 1,812 $ 873 $1,481 Other real estate and other assets owned 56 14 137 164 114 ------ ----- ------ ------ ------- Total non-performing assets 999 637 1,949 1,037 1,595 Past due loans 1,532 1,333 1,333 1,436 1,673 ------ ------ -------- ------- ------- Total non-performing assets and past due loans $2,531 $1,970 $3,282 $2,473 $3,268 ====== ====== ====== ====== ====== Non-accrual loans to total loans, net of unearned income, at period end .24% .16% .52% .29% .50% Non-accrual loans and past due loans, to total loans, net of unearned income, at period end .64% .51% .91% .76% 1.07%
NONINTEREST INCOME Noninterest income decreased $458,000 or 14.8% in 2001, compared to an increase of $966,000 or 45.2% in 2000. Excluding the effect of securities gains and losses and the one-time gain on life insurance policies in 2000, noninterest income increased $234,000 or 9.7%. During 2001, service charges on deposit accounts increased $126,000 or 7.2%, while gains on sales of securities increased $58,000. Other noninterest income increased 38.1% in 2001, primarily as a result of increased fees earned on credit card programs offered to commercial customers. The primary sources of increased noninterest income in 2000 were service charges on deposit accounts of $182,000 and a one-time gain from the proceeds of life insurance policies held by the Company of $750,000. The Company realized losses on investment securities available for sale of $48,000 during 2000 in order to take advantage of higher investment yields available in the market. The following table summarizes noninterest income of the Company as of December 31:
YEARS ENDED CHANGE FROM PRIOR YEAR 2001/00 2000/99 (Dollars in thousands) 2001 2000 1999 AMOUNT PERCENT Amount Percent Service charges on deposit accounts $1,877 $1,751 $1,569 $126 7.2% $182 11.6% Other service charges and fees 371 376 375 (5) (1.3%) 1 0.3% Gain (loss) on sale of securities 10 (48) 34 58 120.8% (82) (242.5)% Gain on life insurance policies -- 750 -- (750) (100.0%) 750 100.0% Earnings (loss) from unconsolidated subsidiaries 29 15 (24) 14 93.3% 39 162.4% Other noninterest income 359 260 184 99 38.1% 76 41.1% Total $2,646 $3,104 $2,138 $(458) (14.8 %) $966 45.2% - --------------------------------------------------------------------------------------------------------------------
-13- NONINTEREST EXPENSES Total noninterest expense increased $122,000 or 1.0% in 2001, compared to an increase of $944,000 or 8.6% in 2000. Salaries and employee benefits increased $253,000 or 3.9% and occupancy and equipment expense increased $139,000 or 10.2%. The Company opened a new branch of The Centreville National Bank in April of 2001, which accounts for some of the increase in salaries and benefits and occupancy and equipment costs for the year. Salaries and employee benefits increased $430,000 in 2000 as a result of increases in health insurance and costs associated with the termination of the Company's frozen defined benefit plan. During 2001, the Banks began using image technology, which combined with growth in customer bases and other enhanced services contributed to the overall increase in data processing costs of $94,000. The Company had 163 full-time equivalent employees at December 31, 2001, compared to 154 at December 31, 2000 and 152 at December 31, 1999. Other operating expenses decreased $364,000 in 2001 due to non-recurring merger related expenses of $376,000, which were incurred in 2000. The following table summarizes noninterest expense of the Company as of December 31:
YEARS ENDED CHANGE FROM PRIOR YEAR 2001/00 2000/99 ------- ------- (Dollars in thousands) 2001 2000 1999 AMOUNT PERCENT Amount Percent Salaries and employee benefits $6,725 $6,472 $6,042 $253 3.9% $430 7.1% Occupancy and equipment 1,512 1,373 1,373 139 10.2% - -% Data processing 859 764 748 94 12.3% 16 2.2% Amortization of goodwill and and other intangible assets 147 147 147 - - % - -% Other operating expenses 2,783 3,148 2,650 (364) (11.6%) 498 18.8% Total $12,026 $11,904 $10,960 $122 1.0 % $944 8.6%
INCOME TAXES Income tax expense was approximately $4,277,000 for 2001, compared to $4,398,000 for 2000 and $3,528,000 for 1999. The effective tax rates on earnings were 34.9%, 35.6% and 34.1%, respectively. The decrease in the Company's overall effective tax rate in 2001 is primarily attributable to a reduction in non-deductible expenses which were incurred in 2000 as a result of the merger of Talbot Bancshares, Inc. into the Company. 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, 2001 and 2000. Deferred tax expense is measured by the change in net deferred tax assets or liabilities for the period. 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, 2001, the Company's loan to deposit ratio was 81%, compared to 82% one year ago. Investment securities available for sale totaling $114,932,000 were available for the management of liquidity and interest rate risk. Cash and cash equivalents at December 31, 2001 were $51,638,000, up $11,923,000 from one year ago. Management is not aware of any demands, commitments, events or uncertainties that will materially affect the Company's ability to maintain liquidity at satisfactory levels. -14- 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. 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 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, 2001, the Company had a negative gap position within the one-year repricing interval. The following table summarizes the Company's interest sensitivity at December 31, 2001. 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.
3 Months 1 Year Non- Within through through After Sensitive December 31, 2001 3 Months 12 Months 5 Years 5 Years Funds Total (Dollars in Thousands) ASSETS: Loans - net of unearned income $117,237 $54,318 $185,981 $34,936 $ 234 $392,706 Investment securities 4,047 11,803 67,604 34,227 8,148 125,829 Interest bearing deposits with other banks 14,179 - - - - 14,179 Federal funds sold 20,035 - - - - 20,035 OTHER ASSETS - - - - 29,654 29,654 - --------------------------------------------------------------------------------------------------------------------------- Total Assets $155,498 $66,121 $253,585 $69,163 $38,036 $582,403 LIABILITIES: Certificates of deposit $100,000 and over $35,447 $19,794 $19,855 $ - $ - $75,096 Other time deposits 31,355 54,255 62,076 - - 147,686 Savings and money market 39,002 11,129 55,315 2,649 - 108,095 NOW and SuperNOW 25,557 2,222 52,584 10,925 - 91,288 Noninterest bearing demand - - - - 65,305 65,305 Short term borrowings 17,054 - - - - 17,054 Long-term debt - - 5,000 - - 5,000 Other liabilities - - - - 1,909 1,909 STOCKHOLDERS' EQUITY - - - - 70,970 70,970 - --------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $148,415 $87,400 $194,830 $13,574 $138,184 $582,403 - --------------------------------------------------------------------------------------------------------------------------- Excess $7,083 $(21,279) $58,755 $55,589 $(100,148) Cumulative Excess $7,083 $(14,196) $44,559 $100,148$ - Cumulative Excess as percent of total 1.22% (2.44)% 7.66% 17.20% -
-15- 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, 2001, the model produced the following sensitivity profile for net interest income and the fair value of capital.
Immediate Change in Rates Policy +200 Basis Points -200 Basis Points Limit % Change in Net Interest Income (.43)% (2.79)% + 25% -- % Change in Fair Value of Capital (.16)% (4.40)% + 15%
RECENT STOCK PRICES AND DIVIDENDS The Company's stock is traded over-the-counter and is quoted on the NASDAQ Small Cap Market under the symbol SHBI. Prior to April 2001, the Company's stock was quoted on the OTC Bulletin Board under the symbol SHBI, and was traded infrequently. Price information prior to April 2001 is based upon the participation of market makers for the Company's stock and actual transfers recorded by the transfer agent. As of March 1, 2002, the Company had 1,437 holders of record of its common stock. The Board of Directors establishes the amount of the dividend to be paid each quarter based upon such factors as operating results, financial condition, capital adequacy, regulatory requirements, and shareholder return. The following table indicates cash dividends paid per share for each quarter of 2001, 2000 and 1999 and the ranges of representative sales prices for the stated periods.
2001 2000 1999 Price Range Dividends Price Range Dividends Price Range Dividends High Low Paid High Low Paid High Low Paid First Quarter $17.50 - 13.50 $ .15 $ 21.00 - 18.00 $ .12 $ 33.50 - 27.00 $.10 Second Quarter 20.00 - 14.75 .15 19.00 - 12.00 .12 32.00 - 28.00 .10 Third Quarter 20.45 - 18.88 .15 22.00 - 13.00 .12 30.00 - 20.00 .10 Fourth Quarter 19.25 - 17.10 .15 18.25 - 11.00 .16 21.00 - 18.00 .15 ----- ----- ---- $ .60 $ .52 $.45 ===== ===== ====
-16- SELECTED FINANCIAL DATA The following table sets forth certain selected financial data for the five years ended December 31, 2001 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) 2001 2000 1999 1998 1997 SUMMARY OF OPERATING RESULTS: Total interest income $38,938 $39,480 $35,435 $34,058 $32,077 Total interest expense 17,061 17,888 16,039 15,386 14,044 ------- ------ ------ ------ ------ Net interest income 21,877 21,592 19,396 18,672 18,033 Provision for credit losses 226 437 240 240 225 --------- ------ -------- -------- -------- Net interest income after provision for credit losses 21,651 21,155 19,156 18,432 17,808 Noninterest income 2,646 3,104 2,138 1,660 1,622 Noninterest expense 12,026 11,904 10,961 10,634 10,194 ------ ------ ------ ------ ------- Income before income taxes 12,271 12,355 10,333 9,458 9,236 Provision for income taxes 4,277 4,398 3,528 3,224 3,192 ------ ------- ------- ------- ------ NET INCOME $7,994 $ 7,957 $ 6,805 $ 6,234 $6,044 ======= ======= ======= ======= ====== PER SHARE DATA: Diluted net income $1.49 $ 1.48 $ 1.27 $ 1.15 $ 1.11 Dividends paid .60 .52 .45 .40 .37 Book value 13.31 12.21 11.00 10.58 10.08 Tangible book value 13.03 11.91 10.67 10.22 9.69 Weighted average common shares (1) 5,382,398 5,388,486 5,376,200 5,425,172 5,432,369 OTHER DATA (AT YEAR END): Total assets $582,403 $553,097 $518,217 $483,308 $442,144 Total deposits 487,470 464,485 436,021 403,237 370,727 Total loans, net of unearned income and allowance for credit losses 388,516 378,307 341,800 301,629 290,519 Total stockholders' equity 70,971 65,024 58,485 56,188 54,487 RETURN ON EQUITY AND ASSETS: Return on average total assets 1.42% 1.52% 1.37% 1.37% 1.43% Return on average stockholders' equity 11.70% 12.98% 11.85% 11.16% 11.59% Dividend payout ratio 40.00% 34.97% 35.34% 34.39% 32.88% Average stockholders' equity to average total assets 12.16% 11.68% 11.53% 12.25% 12.37% (1) The weighted average common shares include the effect of dilution of stock options outstanding during the period.
-17-
CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000 2001 2000 - ------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 17,424,346 $ 20,039,249 Interest bearing deposits with other banks 14,178,789 -- Federal funds sold 20,035,061 19,676,215 Investment securities: Available for sale - at fair value 114,932,289 95,034,215 Held to maturity - at amortized cost - fair value of (2001) $11,041,923 and (2000) $22,576,492 10,896,293 22,565,750 Loans, less allowance for credit losses (2001) $4,189,368 (2000) $4,199,008 388,516,236 378,307,130 Premises and equipment, net 7,224,093 7,039,100 Accrued interest receivable on loans and investment securities 3,320,923 4,333,567 Investment in unconsolidated subsidiary 1,125,567 1,082,128 Goodwill and other intangible assets 1,474,841 1,622,229Deferred income taxes 681,441 1,183,746 Other real estate 56,116 14,116 Other assets 2,537,486 2,199,267 ------------- ------------- Total assets $ 582,403,481 $ 553,096,712 ============= ============= LIABILITIES Deposits: Noninterest bearing demand $ 65,305,024 $ 55,930,929 NOW and Super NOW 91,287,765 89,488,635 Certificates of deposit, $100,000 or more 75,096,165 78,272,816 Other time and savings 255,780,674 240,792,606 ------------- ------------- 487,469,628 464,484,986 Accrued interest payable 784,994 1,005,878 Short term borrowings 17,053,864 16,252,182 Long term debt 5,000,000 5,000,000 Other liabilities 1,124,362 1,329,413 ------------- ------------- Total liabilities 511,432,848 488,072,459 ------------- ------------- STOCKHOLDERS' EQUITY Common stock, par value $.01, authorized 35,000,000 shares; issued and outstanding (2001) 5,332,947 shares; (2000) 5,324,157 shares 53,330 53,242 Surplus 23,039,084 22,923,707 Retained earnings 47,411,873 42,601,248 Accumulated other comprehensive income (loss) 466,346 (553,944) ------------- ------------- Total stockholders' equity 70,970,633 65,024,253 ------------- ------------- Total liabilities and stockholders' equity $ 582,403,481 $ 553,096,712 ============= =============
The notes to consolidated financial statements are an integral part of these statements. -18-
CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2001, 2000 and 1999 2001 2000 1999 - ----------------------------------------------------------------------------------------------------- INTEREST INCOME Loans, including fees $ 31,256,323 $ 31,619,234 $ 27,084,423 Interest and dividends on investment securities: Taxable 5,955,160 6,691,678 6,772,876 Tax-exempt 443,986 499,215 589,996 Federal funds sold 912,517 669,823 987,303 Other interest 369,903 -- -- ------------ ------------ Total interest income 38,937,889 39,479,950 35,434,598 ------------ ------------ ------------ INTEREST EXPENSE NOW and Super NOW accounts 1,483,160 1,989,954 1,806,684 Certificates of deposit, $100,000 or more 4,025,784 4,071,479 3,147,589 Other time and savings 10,727,057 10,414,939 10,123,976 Interest on short term borrowings 554,585 1,096,149 687,250 Interest on long term debt 270,602 315,467 273,889 ------------ ------------ ------------ Total interest expense 17,061,188 17,887,988 16,039,388 ------------ ------------ ------------ NET INTEREST INCOME 21,876,701 21,591,962 19,395,210 PROVISION FOR CREDIT LOSSES 226,000 437,045 240,000 ------------ ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 21,650,701 21,154,917 19,155,210 NONINTEREST INCOME Service charges on deposit accounts 1,876,591 1,750,652 1,568,995 Gain (loss) on sale of securities 9,631 (47,839) 33,582 Gain on life insurance policies -- 750,004 -- Other operating income, net 759,906 650,739 535,251 ------------ ------------ ------------ 2,646,128 3,103,556 2,137,828 ------------ ------------ ------------ NONINTEREST EXPENSE Salaries and wages 5,046,246 4,783,091 4,586,511 Employee benefits 1,678,466 1,688,893 1,455,819 Occupancy expense 824,164 714,775 722,286 Furniture and equipment expense 687,548 657,696 650,686 Data processing 858,635 764,413 747,857 Amortization of goodwill and other intangible assets 147,388 147,388 147,392 Other operating expenses 2,783,430 3,147,429 2,649,884 ------------ ------------ ------------ 12,025,877 11,903,685 10,960,435 ------------ ------------ ------------ INCOME BEFORE INCOME TAXES 12,270,952 12,354,788 10,332,603 Federal and State income taxes 4,276,857 4,397,824 3,527,915 ------------ ------------ ------------ NET INCOME $ 7,994,095 $ 7,956,964 $ 6,804,688 ============ ============ ============ Basic earnings per common share $ 1.50 $ 1.50 $ 1.28 ============ ============ ============ Diluted earnings per common share $ 1.49 $ 1.48 $ 1.27 ============ ============ ============
The notes to consolidated financial statements are an integral part of these statements. -19-
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 2001, 2000 and 1999 ACCUMULATED OTHER TOTAL COMMON RETAINED COMPREHENSIVE STOCKHOLDERS' STOCK SURPLUS EARNINGS INCOME (LOSS) EQUITY ------------ ------------ ------------ ---------------- --------------- Balances, January 1, 1999 $ 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 COMPREHENSIVE INCOME: NET INCOME -- -- 7,994,095 -- 7,994,095 OTHER COMPREHENSIVE INCOME, NET OF TAX: UNREALIZED GAIN ON AVAILABLE FOR SALE SECURITIES, NET OF RECLASSIFICATION ADJUSTMENT OF $(7,110) -- -- -- 1,020,290 1,020,290 ------------ TOTAL COMPREHENSIVE INCOME -- -- -- -- 9,014,385 ------------ STOCK REPURCHASED AND RETIRED -- (1,020) -- -- (1,020) 2,722 SHARES ISSUED UNDER 401(K) PLAN 27 41,143 -- -- 41,170 EXERCISE OF STOCK OPTIONS 61 75,254 -- -- 75,315 PREMIUM RECEIVED ON ISSUANCE OF SHARES IN UNCONSOLIDATED SUBSIDIARY -- -- 14,170 -- 14,170 CASH DIVIDEND PAID $.60 PER SHARE -- -- (3,197,640) -- (3,197,640) ------------ ------------ ------------ ------------ ------------ BALANCES, DECEMBER 31, 2001 $ 53,330 $ 23,039,084 $ 47,411,873 $ 466,346 $ 70,970,633 ============ ============ ============ ============ ============
The notes to consolidated financial statements are an integral part of these statements. -20-
CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2001, 2000 and 1999 2001 2000 1999 - ---------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 7,994,095 $ 7,956,964 $ 6,804,688 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 995,676 926,318 1,068,935 Discount accretion on debt securities (155,811) (467,105) (152,807) Discount accretion on matured debt securities 24,751 441,861 98,199 (Gain) loss on sale of securities (9,631) 47,839 (33,582) Gain on life insurance policies -- (750,004) -- Provision for credit losses, net (9,640) 208,450 59,320 Deferred income taxes (136,433) (89,489) (43,997) Loss on disposal of premises and equipment 328 2,651 20,253 Loss on other real estate owned 5,000 17,566 7,614 Net changes in: Accrued interest receivable 1,012,644 (748,988) (60,320) Other assets (367,486) 304,442 102,190 Accrued interest payable (220,884) 324,618 (10,321) Other liabilities (205,051) 233,412 15,449 ------------- ------------- ------------- Net cash provided by operating activities 8,927,558 8,408,535 7,875,621 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale 5,509,843 8,116,313 11,635,919 Proceeds from maturities and principal payments of securities available for sale 77,482,056 93,159,085 25,800,449 Purchases of securities available for sale (101,367,542) (96,272,930) (45,727,609) Proceeds from maturities and principal payments of securities held to maturity 13,274,235 3,580,036 23,819,309 Purchases of securities held to maturity (1,622,415) (311,170) (12,911,397) Net increase in loans (9,588,339) (36,982,347) (39,761,816) Purchase of loans (980,837) -- (1,400,000) Proceeds from sale of loans 322,710 -- 880,837 Purchase of premises and equipment (738,686) (1,256,773) (746,263) Proceeds from sale of other real estate owned -- 372,494 132,035 Proceeds from life insurance policies -- 1,170,966 -- Proceeds from sale of premises and equipment -- 20,700 450 ------------- ------------- ------------- Net cash used in investing activities (17,708,975) (28,403,626) (38,278,086) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand, NOW, money market, and savings deposits 20,424,729 13,849,924 17,199,852 Net increase in certificates of deposit 2,559,913 14,614,017 15,584,351 Net increase (decrease) in short term borrowings 801,682 (681,126) (178,067) Proceeds from issuance of common stock 116,485 148,828 129,959 Repurchase of common stock (1,020) (4,010) (58,738) Dividends paid (3,197,640) (2,782,653) (2,404,754) ------------- ------------- ------------- Net cash provided by financing activities 20,704,149 25,144,980 30,272,603 ------------- ------------- -------------
-21-
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) For the Years Ended December 31, 2001, 2000 and 1999 2001 2000 1999 - --------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 11,922,732 5,149,889 (129,862) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 39,715,464 34,565,575 34,695,437 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 51,638,196 $ 39,715,464 $ 34,565,575 ============ ============ ============ Supplemental cash flows information: Interest paid $ 17,282,072 $ 17,563,370 $ 15,765,712 ============ ============ ============ Income taxes paid $ 4,439,933 $ 4,108,127 $ 3,475,246 ============ ============ ============ Transfers from loans to other real estate $ 47,000 $ 267,060 $ 113,000 ============ ============ ============
The notes to consolidated financial statements are an integral part of these statements. -22- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 2001, 2000 and 1999 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 of America and to prevailing practices within the banking industry. Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2001. 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 of America 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. The allowance for credit losses is a material estimate that is particularly susceptible to significant changes in the near-term. Management believes that the allowance for credit losses is sufficient to address the risks in the current portfolio. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the Bank's allowance for credit losses. Such agencies may require the Banks to recognize additions to the allowance based on their judgements about information available to them at the time of their examination. 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. -23- 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" or SFAS No.114 "Accounting by Creditors for Impairment of a Loan". The allocated component of 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 markets 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. GOODWILL AND OTHER 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. Identifiable intangible assets other than goodwill were fully amortized as of December 31, 2001. See RECENT ACCOUNTING PRONOUNCEMENTS for additional discussion regarding goodwill and intangible assets. 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 Bank'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, interest bearing deposits with other banks, and federal funds sold to be cash and cash equivalents. -24- 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. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 102, SELECTED LOAN LOSS ALLOWANCE METHODOLOGY AND DOCUMENTATION ISSUES. SAB 102 summarizes certain SEC views on the development, documentation, and application of a systematic methodology as required by Financial Reporting Release No. 28 for determining allowances for loan losses in accordance with accounting principles generally accepted in the United States of America. In particular, the guidance focuses on the documentation the staff normally would expect registrants to prepare and maintain in support of their allowances for loan losses. SAB 102 provides parallel guidance to the federal banking agencies guidance issued through the Federal Financial Institutions Examination Council as interagency guidance, "Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions". Management believes the Company is in compliance with the provision of SAB 102. In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, BUSINESS COMBINATIONS and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. The provisions of SFAS No. 142 were adopted by the Company as required effective January 1, 2002. Application of the nonamortization provisions of the statement is expected to increase net income approximately $140,000 or $.03 per diluted share in 2002 as compared to 2001. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, which supersedes both SFAS No 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS TO BE DISPOSED OF and the accounting and reporting provisions of APB Opinion No. 30, REPORTING THE RESULTS OF OPERATIONS--REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS, for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing and measuring impairment losses in long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS No. 121. The provisions of SFAS No. 144 are effective for years beginning after December 15, 2001, and its adoption is not expected to affect the financial position or results of operations of the Company. NOTE 2. PENDING ACQUISITION During December 2001, the Company reached an agreement to acquire certain assets of The Avon-Dixon Agency, Inc., a full service insurance agency, and its subsidiaries, all located in Easton, Maryland. The final purchase price has not yet been determined, however it is expected to be approximately $7 million. The purchase price is subject to adjustment based upon certain performance criteria. Consideration is expected to be comprised of approximately 89% cash and 11% common stock issued by the Company. It is anticipated that the transaction will be completed early in the second quarter of 2002, pending satisfaction of the conditions contained in the agreement. 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 $7,049,000 and $6,066,000 during 2001 and 2000, respectively. -25- 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, 2001: U.S. Treasury securities $ 5,076,925 $ 95,265 $ -- $ 5,172,190 Obligations of U.S. Government agencies and corporations 66,401,110 1,288,871 42,613 67,647,368 Obligations of states and political subdivisions 210,000 3,246 -- 213,246 Other securities: Mortgage backed securities 33,025,586 113,745 262,510 32,876,821 Federal Home Loan Bank stock 1,786,100 -- -- 1,786,100 Federal Reserve Bank stock 302,250 -- -- 302,250 Federal Home Loan Mortgage Corporation Cumulative preferred stock 5,980,513 10,000 310,588 5,679,925 Equity securities 1,390,036 1,765 137,412 1,254,389 ------------ ------------ ------------ ------------ $114,172,520 $ 1,512,892 $ 753,123 $114,932,289 ============ ============ ============ ============ 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 77,047,387 138,302 495,133 76,690,556 Obligations of states and political subdivisions 406,094 -- 355 405,739 Other securities: Mortgage backed securities 1,434,650 23,066 4 1,457,712 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 Equity securities 1,390,036 1,651 145,437 1,246,250 ------------ ------------ ------------ ------------ $ 95,933,474 $ 187,662 $ 1,086,921 $ 95,034,215 ============ ============ ============ ============ Held to Maturity securities: ------------ DECEMBER 31, 2001: Obligations of U.S. Government agencies and corporations $ 1,576,772 $ 5,470 $ -- $ 1,582,242 Obligations of states and political subdivisions 9,307,674 154,008 14,876 9,446,806 Other securities: Mortgage backed securities 11,847 1,028 -- 12,875 ------------ ------------ ------------ ------------ $ 10,896,293 $ 160,506 $ 14,876 $ 11,041,923 ============ ============ ============ ============ December 31, 2000: Obligations of U.S. Government agencies and corporations $ 12,497,724 $ 1,485 $ 37,048 $ 12,462,161 Obligations of states and political subdivisions 10,043,710 74,070 28,469 10,089,311 Other securities: Mortgage backed securities 24,316 704 -- 25,020 ------------ ------------ ------------ ------------ $ 22,565,750 $ 76,259 $ 65,517 $ 22,576,492 ============ ============ ============ ============
-26- The amortized cost and estimated fair values of investment securities by contractual maturity date at December 31, 2001 are as follows:
AVAILABLE FOR SALE HELD TO MATURITY ----------------------------------------------------------- Amortized Estimated Amortized Estimated COST FAIR VALUE COST FAIR VALUE ------------- ----------- ----------------------------- Due in one year or less $ 13,114,913 $ 13,396,549 $1,565,578 $ 1,588,681 Due after one year through five years 64,668,598 65,539,096 6,621,817 6,723,850 Due after five years through ten years 12,515,529 12,539,016 2,708,898 2,729,392 Due after ten years 15,914,581 15,904,364 -- -- ---------- ---------------------------- ------------ 106,213,621 107,379,025 10,896,293 11,041,923 Investments in equity securities 7,958,899 7,553,264 -- -- ------------- -------------------------------------------- $114,172,520 $114,932,289 $10,896,293 $11,041,923 ============ ============ =========== ===========
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, 2001 DECEMBER 31, 2000 ------------------------- ----------------------------- AMORTIZED ESTIMATED Amortized Estimated COST FAIR VALUE COST FAIR VALUE ----------- -------------- ------------- -------------- Available for sale $68,120,674 $69,492,758 $70,464,535 $70,185,252 Held to maturity 3,316,387 3,369,126 15,484,161 15,507,605 --------- --------- ------------ ------------ $71,437,061 $72,861,884 $85,948,696 $85,692,857 =========== =========== =========== ===========
There were no obligations of states and political subdivisions whose carrying value, as to any issuer, exceeded 10% of stockholders' equity at December 31, 2001 or 2000. Proceeds from sales of investment securities were $5,509,843, $8,116,313, and $11,635,919 for the years ended December 31, 2001, 2000, and 1999, respectively. 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:
2001 2000 -------------- -------------- Real estate loans: Construction and land development $20,255,290 $ 18,586,702 Secured by farmland 14,705,994 19,187,868 Secured by residential properties 184,949,866 176,759,825 Secured by non farm, nonresidential properties 94,214,420 95,111,154 Loans to farmers (loans to finance agricultural production and other loans) 3,100,465 2,869,986 Commercial and industrial loans 51,744,215 49,430,302 Loans to individuals for household, family, and other personal expenditures 19,291,850 17,988,688 Obligations of States and political subdivisions in the United States, tax-exempt 4,070,462 2,303,982 All other loans 272,617 140,452 -------------- --------------- 392,605,179 382,378,959 Net deferred loan costs 100,425 127,179 -------------- --------------- 392,705,604 382,506,138 Allowance for credit losses (4,189,368) (4,199,008) ------------- -------------- $388,516,236 $378,307,130 ============= ===============
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, 2001 and 2000, such loans outstanding, both direct and indirect (including guarantees), to directors, their associates and policy-making officers, totaled approximately $5,942,000 and $7,411,000, respectively. During 2001 and 2000, loan additions were approximately $1,295,000 and $543,000, and loan repayments were approximately $2,764,000 and $879,000, respectively. -27- Activity in the allowance for credit losses is summarized as follows:
2001 2000 1999 -------- ----------- ---------- Balance, beginning of year $ 4,199,008 $ 3,990,558 $ 3,931,238 ----------- ----------- ----------- Loans charged off: Real estate loans (5,338) (60,752) (121,659) Installment loans (154,631) (72,650) (145,681) Commercial and other (175,225) (244,170) (161,793) ----------- ----------- ----------- (335,194) (377,572) (429,133) ----------- ----------- ----------- Recoveries: Real estate loans 1,847 18,047 49,556 Installment loans 60,694 50,339 43,046 Commercial and other 37,013 80,591 155,851 ----------- ----------- ----------- 99,554 148,977 248,453 ----------- ----------- ----------- Net losses charged off (235,640) (228,595) (180,680) Provision 226,000 437,045 240,000 ----------- ----------- ----------- Balance, end of year $ 4,189,368 $ 4,199,008 $ 3,990,558 =========== =========== ===========
Information with respect to impaired loans and the related valuation allowance as of December 31 is as follows:
2001 2000 ----------- ------------ Impaired loans with valuation allowance $ 560,539 $ -- Impaired loans with no valuation allowance 382,537 640,092 ---------- ------------- Total impaired loans $ 943,076 $ 640,092 ========== ============= Allowance for loan losses related to impaired loans $ 76,935 $ -- Allowance for loan losses related to other than impaired loans 4,112,433 4,199,008 ---------- ------------- $4,189,368 $4,199,008 Total allowance for loan losses Interest income on impaired loans recorded on the cash basis $ 19,467 $ 22,304 ========== ============= Average recorded investment in impaired loans for the year $ 644,549 $1,230,048 ========== =============
NOTE 6. PREMISES AND EQUIPMENT A summary of premises and equipment at December 31 is as follows:
2001 2000 -------- --------- Land $1,768,393 $ 1,753,447 Buildings and land improvements 6,317,658 6,012,123 Furniture and equipment 4,321,221 3,985,649 ----------- ----------- 12,407,272 11,751,219 Accumulated depreciation (5,183,179) (4,712,119) ------------ ----------- $ 7,224,093 $ 7,039,100 =========== ===========
Depreciation expense totaled $553,000, $556,000 and $606,000 for the years ended December 31, 2001, 2000 and 1999, respectively. The Company leases facilities under operating leases. Rental expense for the years ended December 31, 2001, 2000, and 1999 was $147,198, $91,701 and $89,373, respectively. Future minimum annual rental payments are approximately as follows: 2002 $144,319 2003 136,841 2004 71,042 2005 48,257 2006 30,490 Thereafter 17,417 -28- NOTE 7. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY The Company owns 29.25% 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 -------------------------------------------- 2001 2000 1999 ---- ---- ---- Balance, beginning of year $1,082,128 $1,057,331 $ 1,049,409 Premium received on issuance of stock 14,170 - - Equity in net income 29,269 24,797 7,922 ---------- --------------- ------------- Balance, end of year $1,125,567 $ 1,082,128 $ 1,057,331 =========== =========== ===========
Data processing and other expenses paid to DBDPC totaled approximately $954,000, $893,000, and $734,000 for the years ended December 31, 2001, 2000 and 1999, respectively. NOTE 8. SIGNIFICANT DEPOSITS The approximate maturities of certificates of deposit of $100,000 or more at December 31 are as follows: 2001 2000 ------------------------------- Three months or less $35,447,000 $39,881,000 Over three through twelve months 19,794,000 11,777,000 Over twelve months 19,855,000 26,615,000 ----------- ----------- $ 75,096,000 $ 78,273,000 ============ ============ NOTE 9. SHORT TERM BORROWINGS Short-term borrowings, at December 31, 2001, 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 Bank'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: 2001 2000 ---- ---- Average amount outstanding during the year $19,315,474 $21,521,979 Weighted average interest rate during the year 2.87% 5.08% Amount outstanding at year end $17,053,864 $16,252,182 Weighted average rate at year end 1.15% 4.96% Maximum amount at any month end $25,174,790 $32,498,121 NOTE 10. LONG TERM DEBT As of December 31, 2001, 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 4.97%. The advance is due March 29, 2006 and has a one time call provision in 2004 . The Company has pledged its wholly owned residential real estate mortgage loan portfolio under a blanket floating lien as collateral for this advance. 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 $387,764 (2001), $407,384 (2000), and $341,944 (1999). -29- DEFINED BENEFIT PENSION PLAN During 2000, the Company terminated its defined benefit pension plan, which had 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) and $7,915 (1999). 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, 2001 2001 ------------------------------------------------------------------- NUMBER WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE ------------------------------- ------------------------------- Outstanding at beginning of year 120,414 $9.82 140,897 $ 11.21 Granted - - 8,243 20.34 Exercised (6,853) (10.39) (763) (19.96) Expired/Cancelled (1,015) (26.44) (27,963) (19.65) ------- ------- Outstanding at end of year 112,546 $9.67 120,414 $9.82 ======== ======= Weighted average fair value of options granted during the year $ - $ 12.88 =========== ========
The following summarizes information about options outstanding at December 31, 2001:
OPTIONS OUTSTANDING AND EXERCISABLE OPTIONS OUTSTANDING WEIGHTED AVERAGE ------------------- REMAINING EXERCISE PRICE NUMBER NUMBER CONTRACT LIFE ---------------- ------ ------ ------------------- $ 6.85 52,739 52,739 3.61 8.78 47,880 47,780 4.95 17.85 927 927 .29 32.00 5,500 2,200 7.05 21.00 5,500 1,100 8.05
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. No options were granted during the year ended December 31, 2001. 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 years ended December 31, 2001 or December 31, 2000. If the Company had elected to recognize compensation cost based on fair value at the vesting 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 years ended December 31: -30- 2001 2000 1999 ---- ---- ---- Net income: As reported $7,994,095 $7,956,964 $6,804,688 Pro forma 7,975,861 7,935,586 6,533,950 Basic net income per share: As reported $1.50 $1.50 $1.28 Pro forma 1.50 1.49 1.23 Diluted earnings per share As reported $1.49 $1.48 $1.27 Pro forma 1.48 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 2001, 2000 and 1999. 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: 2001 2000 ---- ---- Cash surrender value $1,828,724 $ 1,784,437 Accrued benefit obligations 519,743 531,330 NOTE 14. INCOME TAXES Income taxes included in the balance sheets as of December 31 are as follows: 2001 2000 -------- ----------- Federal income taxes currently (receivable) payable $(35,026) $ 14,273 State income taxes currently payable 4,255 136,487 Deferred income tax benefits 681,441 1,183,746 Components of income tax expense for each of the three years ended December 31 are as follows: 2001 2000 1999 --------- ----------- -------- Currently payable: Federal $ 3,897,184 $ 4,036,794 $ 3,285,627 State 521,055 450,519 286,285 ----------- ----------- ----------- 4,418,239 4,487,313 3,571,912 ----------- ----------- ----------- Deferred income tax benefits: Federal (115,756) (73,267) (35,367) State (25,626) (16,222) (8,630) ----------- ----------- ----------- (141,382) (89,489) (43,997) ----------- ----------- ----------- $ 4,276,857 $ 4,397,824 $ 3,527,915 =========== =========== =========== 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: 2001 2000 1999 -------- -------- ------- Tax at federal statutory rate 35.0% 34.0% 34.0% Tax effect of: Tax-exempt income (1.8) (1.9) (2.1) Non-deductible expenses .5 1.5 .5 State income taxes, net of federal benefit 2.4 2.3 1.7 Other (1.2) (.3) - ----- ------ ------- Income tax expense 34.9% 35.6% 34.1% ===== ==== ==== -31- Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows: 2001 2000 -------- -------- Deferred tax assets: Allowance for credit losses $1,221,480 $1,137,233 Provision for off balance sheet liabilities 18,538 13,903 Loan interest 6,106 2,525 Provision for loss on other real estate 1,931 -- Loan fees 23,264 49,541 Deferred compensation 186,816 184,293 Unrealized losses on available for sale securities -- 353,955 ---------- ---------- Total deferred tax assets 1,458,135 1,741,450 ---------- ---------- Deferred tax liabilities: Depreciation 159,719 173,722 Cash to accrual conversion -- 12,370 Federal Home Loan Bank stock dividend 27,613 27,613 Undistributed income of unconsolidated subsidiary 60,585 62,845 Loan origination fees and costs 184,630 177,344 Unrealized gains on available for sale securities 293,423 -- Other 50,724 103,810 ---------- ---------- Total deferred tax liabilities 776,694 557,704 ---------- ---------- Net deferred tax assets $ 681,441 $1,183,746 ========== ========== NOTE 15. 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.
2001 2000 1999 ------------- ------------- ------------ Basic: Net income (applicable to common stock) $7,994,095 $7,956,964 $6,804,688 Average common shares outstanding 5,330,022 5,318,377 5,312,243 Basic earnings per share $1.50 $1.50 $1.28 Diluted: Net income (applicable to common stock) $7,994,095 $7,956,964 $6,804,688 Average common shares outstanding 5,330,022 5,318,377 5,312,243 Diluted effect of stock options 52,376 70,109 63,957 ----------- ----------- ---------- Average common shares outstanding - diluted 5,382,398 5,388,486 5,376,200 Diluted earnings per share $1.49 $1.48 $1.27
NOTE 16. 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. Management believes as of December 31, 2001, that the Company and the Banks meet all capital adequacy requirements to which they are subject. As of December 31, 2001, 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. -32- A comparison of the Company's and Banks' capital as of December 31, 2001 and 2000 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, 2001: TOTAL CAPITAL (TO RISK WEIGHTED ASSETS): COMPANY $70,970,000 17.64% $32,195,000 8.00% THE TALBOT BANK $44,570,000 16.28% $21,896,000 8.00% $27,370,000 10.00% THE CENTREVILLE NATIONAL BANK $25,957,000 20.22% $10,272,000 8.00% $12,840,000 10.00% TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS): COMPANY $68,657,000 17.06% $16,097,000 4.00% THE TALBOT BANK $43,730,000 15.98% $10,948,000 4.00% $16,422,000 6.00% THE CENTREVILLE NATIONAL BANK $24,484,000 19.07% $5,136,000 4.00% $7,704,000 6.00% TIER 1 CAPITAL (TO AVERAGE ASSETS): COMPANY $68,657,000 11.85% $23,174,000 4.00% THE TALBOT BANK $43,730,000 12.38% $14,128,000 4.00% $17,659,000 5.00% THE CENTREVILLE NATIONAL BANK $24,484,000 10.85% $9,029,000 4.00% $11,287,000 5.00% 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%
Bank and holding company regulations, as well as Maryland law, impose certain restrictions on dividend payments by the Banks, as well as restricting extensions of credit and transfers of assets between the Banks and the Company. At December 31, 2001, the Banks could have paid dividends to the parent company of approximately $10,027,000 without the prior consent and approval of the regulatory agencies. The Company had outstanding net receivables from the Banks of $17,906 at December 31, 2001. NOTE 17. 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 $80,937,000 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, 2001, the Federal Home Loan Bank had issued a letter of credit for $15,000,000 on behalf of the Talbot Bank to a local government entity as collateral for its deposits. NOTE 18. 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. -33- 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 and long-term debt 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 Company's financial instruments, excluding goodwill, as of December 31 are as follows:
2001 2000 ------------------------------------------------------------------ ESTIMATED Estimated CARRYING FAIR Carrying Fair AMOUNT VALUE AMOUNT VALUE -------- ------------ ------- --------------- Financial assets: Cash and cash equivalents $ 51,638,196 $ 51,638,000 $ 39,715,464 $ 39,715,000 Investment securities 125,828,582 125,974,000 117,599,965 117,610,000 Loans 392,705,604 395,561,000 382,506,138 381,788,000 Less: allowance for loan losses (4,189,368) - (4,199,008) - ------------------------------------------------------------------ $565,983,014 $573,173,000 $535,622,559 $539,113,000 ============ ============ ============ ============ Financial liabilities: Deposits $487,469,628 $490,970,000 $464,484,986 $465,261,000 Short term borrowings 17,053,864 17,054,000 16,252,035 16,252,000 Long-term debt 5,000,000 5,133,000 5,000,000 5,002,000 ------------ --------------- --------------- --------------- $509,523,492 $513,157,000 $485,737,021 $486,515,000 ============ ============ ============ ============ Unrecognized financial instruments: Commitments to extend credit $108,652,000 $108,652,000 $ 82,760,000 $ 82,760,000 Standby letters of credit 7,628,000 7,628,000 9,267,000 9,267,000 ------------ --------------- -------------- --------------- $116,280,000 $116,280,000 $ 92,027,000 $ 92,027,000 ============= ============= ============= =============
NOTE 19. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK In the normal course of business, to meet the financing 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. Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Letters of credit and other commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the letters of credit and commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. -34- Commitments outstanding as of December 31 are as follows: 2001 2000 ------------ ------------- Commitments to extend credit $108,652,000 $82,760,000 Letters of credit 7,628,000 9,267,000 ------------ ------------ $116,280,000 $92,027,000 ============ =========== NOTE 20. 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 21. PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Shore Bancshares, Inc. (Parent Company Only) is as follows: Condensed Balance Sheets December 31, 2001 and 2000 2001 2000 ---- ---- Assets: Cash $ 26,441 $ 91,516 Investment in subsidiaries 70,527,357 64,890,249 Investment in equity securities 380,035 380,035 Other assets 163,837 6,227 ------------ ------------ Total assets $ 71,097,670 $ 65,368,027 ============ ============ Liabilities: Accounts payable $ 119,210 $ 25,150 Due to subsidiaries 7,827 318,624 ------------ ------------ 127,037 343,774 Stockholders' equity: Common stock 53,330 53,242 Surplus 23,039,084 22,923,707 Retained earnings 47,411,873 42,601,248 Accumulated other comprehensive income (loss) 466,346 (553,944) ------------ ------------ Total stockholders' equity 70,970,633 65,024,253 ------------ ------------ Total liabilities and stockholders' equity $ 71,097,670 $ 65,368,027 ============ ============
Condensed Statements of Income For the years ended December 31, 2001, 2000 and 1999 2001 2000 1999 ------ ------ ------ Dividends from subsidiaries $3,489,328 $2,782,653 $2,489,755 Other investment income 11,000 10,000 -- Interest income 963 2,382 1,074 ---------- ---------- ---------- 3,501,291 2,795,035 2,490,829 Operating expenses 161,012 396,816 72,314 ---------- ---------- ---------- Income before income tax benefit and equity in undistributed income of subsidiary 3,340,279 2,398,219 2,418,515 Income tax benefit 51,167 6,227 14,379 ---------- ---------- ---------- Income before equity in undistributed income of subsidiary 3,391,446 2,404,446 2,432,894 Equity in undistributed income of subsidiary 4,602,649 5,552,518 4,371,794 ---------- ---------- ---------- Net income $7,994,095 $7,956,964 $6,804,688 ========== ========== ==========
-35-
Condensed Statements of Cash Flows For the years ended December 31, 2001, 2000 and 1999 2001 2000 1999 ---- ----- ---- Cash flows from operating activities: Net income $ 7,994,095 $ 7,956,964 $ 6,804,688 Adjustments to reconcile net income to cash provided by operating activities: Equity in undistributed income of subsidiaries (4,602,649) (5,552,518) (4,371,794) Net (increase) decrease in other assets (157,610) 8,153 46,217 Net (decrease) increase in other liabilities (216,736) 343,774 -- ----------- ----------- ----------- Net cash provided by operating activities 3,017,100 2,756,373 2,479,111 ----------- ----------- ----------- Cash flows from investing activities: Sale of securities under agreement to resell -- 18,140 158,238 Purchase of other equity securities -- (100,035) (280,000) ----------- ----------- ----------- Net cash used by investing activities -- (81,895) (121,762) ----------- ----------- ----------- Cash flows from financing activities: Proceeds from issuance of common stock 116,485 148,828 129,959 Purchase of common stock (1,020) (4,010) (58,738) Dividends paid (3,197,640) (2,782,653) (2,404,755) ----------- ----------- ----------- Net cash used by financing activities (3,082,175) (2,637,835) (2,333,534) ----------- ----------- ----------- Net (decrease) increase in cash and cash equivalents (65,075) 36,643 23,815 Cash and cash equivalents at beginning of year 91,516 54,873 31,058 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 26,441 $ 91,516 $ 54,873 =========== =========== ===========
NOTE 22. QUARTERLY FINANCIAL RESULTS (UNAUDITED) A summary of selected consolidated quarterly financial data for the two years ended December 31, 2001 is reported as follows:
FIRST SECOND THIRD FOURTH (IN THOUSANDS, EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER - ------------------------------------------------------------------------------------------------------------ 2001 Interest income 10,141 $ 9,781 $9,687 $ 9,329 Net interest income 5,456 5,369 5,472 5,580 Provision for credit losses 57 55 56 58 Income before income taxes 2,816 3,027 3,129 3,299 Net Income 1,801 2,011 2,018 2,164 Basic earnings per common share $.34 $.38 $.37 $.41 Diluted earnings per common share $.34 $.39 $.37 $.39 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 earnings per common share $0.32 $0.39 $0.44 $0.35 Diluted earnings per common share $0.31 $0.39 $0.44 $0.34
-36- INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Shore Bancshares, Inc. We have audited the accompanying consolidated balance sheets of Shore Bancshares, Inc. as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. 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 of America. 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, 2001 and 2000, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. Baltimore, Maryland January 25, 2002 -37- Shore Bancshares, Inc. Board of Directors
HERBERT L. ANDREW, III B. VANCE CARMEAN, JR. FARMER CHAIRMAN OF THE BOARD, SHORE BANCSHARES, INC. PRESIDENT, CARMEAN GRAIN, INC. BLENDA W. ARMISTEAD INVESTOR RICHARD C. GRANVILLE LLOYD L. BEATTY, JR. INVESTOR CERTIFIED PUBLIC ACCOUNTANT PRESIDENT, DARBY ADVISORS, INC. NEIL R. LECOMPTE CERTIFIED PUBLIC ACCOUNTANT PAUL M. BOWMAN OFFICE OF NEIL R. LECOMPTE ATTORNEY, LAW OFFICE OF PAUL M. BOWMAN DAVID C. BRYAN DAVID L. PYLES OF COUNSEL, LAW OFFICES OF FOUNTAIN INVESTOR BRYAN AND RITTER, LLC DANIEL T. CANNON W. MOORHEAD VERMILYE EXECUTIVE VICE PRESIDENT &COO, SHORE BANCSHARES, INC. PRESIDENT & CEO, SHORE BANCSHARES, INC. PRESIDENT & CEO, THE CENTREVILLE NATIONAL BANK OF MARYLAND PRESIDENT & CEO, THE TALBOT BANK OF EASTON, MARYLAND
- -------------------------------------------------------------------------------- SHORE BANCSHARES, INC. W. Moorhead Vermilye ....................President & CEO Daniel T. Cannon ........................Executive Vice President & COO Susan E. Leaverton ......................Treasurer Carol I. Brownawell .....................Secretary 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. -38- THE CENTREVILLE NATIONAL BANK OF MARYLAND BOARD OF DIRECTORS
PAUL M. BOWMAN THOMAS K. HELFENBEIN ATTORNEY, LAW OFFICE OF FUNERAL DIRECTOR AND PARTNER PAUL M. BOWMAN FELLOWS, HELFENBEIN & NEWNAM FUNERAL HOME DAVID C. BRYAN NEIL R. LeCOMPTE OF COUNSEL, LAW OFFICES OF FOUNTAIN CERTIFIED PUBLIC ACCOUNTANT, OFFICE OF BRYAN AND RITTER, LLC NEIL R. LECOMPTE DANIEL T. CANNON SUSANNE K. NUTTLE EXECUTIVE VICE PRESIDENT & COO, SHORE BANCSHARES, INC. RETIRED VICE PRESIDENT, PRESIDENT & CEO, THE CENTREVILLE NATIONAL BANK THE CENTREVILLE NATIONAL BANK OF MARYLAND B. VANCE CARMEAN JERRY F. PIERSON CHAIRMAN OF THE BOARD, SHORE BANCSHARES, INC. PRESIDENT, JERRY F. PIERSON, INC. PRESIDENT, CARMEAN GRAIN, INC. CHAIRMAN OF THE BOARD, THE CENTREVILLE NATIONAL BANK MARK M. FREESTATE President, W.M. Freestate & Son, Inc. WM. MAURICE SANGER VICE CHAIRMAN OF THE BOARD, PRESIDENT, F.W., INC. THE CENTREVILLE NATIONAL BANK PRESIDENT CLOVERBAY DEVELOPMENT CORPORATION
- -------------------------------------------------------------------------------- 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 Kathryn C. Walls ....................................... Vice President Katherine M. Crook ........................... Assistant Vice President Cassandra A. Guy ............................. Assistant Vice President Elizabeth T. Clough ........................................... Cashier Brenda M. Beaver .................................... Assistant Cashier Lorrie S. Twilley ................................... Assistant Cashier Florence R. Morris .................................. Assistant Cashier C. Wayne Gibson ...................................... Internal Auditor -39-
THE TALBOT BANK OF EASTON, MARYLAND BOARD OF DIRECTORS HERBERT L. ANDREW, III RICHARD C. GRANVILLE FARMER INVESTOR BLENDA W. ARMISTEAD JEROME M.MCCONNELL INVESTOR EXECUTIVE VICE PRESIDENT, THE TALBOT BANK LLOYD L. BEATTY, JR. SHARI L. MCCORD CERTIFIED PUBLIC ACCOUNTANT OWNER, CHESAPEAKE TRAVEL SERVICES, INC. PRESIDENT, DARBY ADVISORS, INC. DAVID L. PYLES DONALD D. CASSON INVESTOR CERTIFIED PUBLIC ACCOUNTANT AND REAL ESTATE BROKER CHRISTOPHER F. SPURRY CHAIRMAN OF THE BOARD, THE TALBOT BANK PRESIDENT, SPURRY & ASSOCIATES, INC. GARY L. FAIRBANK W. MOORHEAD VERMILYE OWNER, FAIRBANK TACKLE PRESIDENT & CEO, SHORE BANCSHARES, INC PRESIDENT & CEO, THE TALBOT BANK
OFFICERS THE TALBOT BANK OF EASTON, MARYLAND W. Moorhead Vermilye .................................. President & CEO Jerome M. McConnell ...................... Executive Vice President&SLO Matthew I. Werner ........................... Senior Vice President&COO Susan E. Leaverton ................................. Vice President&CFO Robert J. Meade ....................................... Vice President Mildred C. Bullock .................................... Vice President Bruce M. Burkhardt ..................................... Vice President Linda S. Cheezum ....................................... Vice President Robyn K. Gannon ....................................... Vice President W. David Morse ......................................... 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. .......................... Commercial Banking Officer Robin B. O'Brien ..............................Assistant Vice President Donna 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 C. Wayne Gibson .......................................Internal Auditor -40- THE TALBOT BANK OF EASTON, MARYLAND OFFICES MAIN OFFICE TRED AVON SQUARE BRANCH ST. MICHAELS BRANCH 18 East Dover Street 210 Marlboro Road 1013 S. Talbot Street Easton, MD 21601 Easton, Maryland 21601 St. Michaels, MD 21663 ELLIOTT ROAD BRANCH CAMBRIDGE BRANCH 8275 Elliott Road 2745 Dorchester Square Easton, MD 21601 Cambridge, MD 21613
ATM LOCATIONS MEMORIAL HOSPITAL AT EASTON SAILWINDS AMOCO TALBOTTOWN CHESAPEAKE BAY OUTFITTERS 219 S. Washington Street 511 Maryland Avenue 218 N. Washington Street 100 N Talbot St. Easton, MD 21601 Cambridge, Maryland 21613 Easton, Maryland 21601 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 ROUTE 213 SOUTH OFFICE STEVENSVILLE OFFICE 109 N. Commerce Street 2609 Centreville Road 408 Thompson Creek Road Centreville, MD 21617 Centreville, MD 21617 Stevensville, MD 21666 HILLSBORO OFFICE DENTON OFFICE KENT OFFICE 21913 Shore Highway 850 S. 5th Avenue 305 East High Street Hillsboro, MD 21641 Denton, MD 21629 Chestertown, MD 21620 ATM LOCATION Queenstown Harbor Golf Links Queenstown, MD 21658 Phone (410) 758-1600 Fax (410) 758-2364 E-Mail: DIRECTIONS@CNB.MD.COM website: HTTP://WWW.CNBMD.COM
-41- EX-21 4 exh21.txt LIST OF SUBSIDIARIES EXHIBIT 21 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. Shore Bancshares, Inc. owns all of the membership interests in the Avon-Dixon Agency, LLC, a Maryland limited liability company, Elliott Wilson Insurance, LLC, a Maryland limited liability company, and Mubell Finance, LLC, a Maryland limited liability company. 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 29.25% of the issued and 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 5 exh23.txt AUDITORS CONSENT EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We hereby consent to the incorporation by reference in the Registration Statement No. 333-60214 and 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, 2001, of our report dated January 25, 2002, relating to the consolidated financial statements of Shore Bancshares, Inc. /S/ Stegman and Company ----------------------- Baltimore, Maryland March 27, 2002 -----END PRIVACY-ENHANCED MESSAGE-----