-----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, MN4qH0M1neq2UZpGy9omsybMGHpqspWKnOjH02ihl6yrcHKTH+ZjYk9ZUqpKC1sm tE96hh875JKsI4IdL6Cb4Q== 0000950169-98-000352.txt : 19980331 0000950169-98-000352.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950169-98-000352 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SHORE BANCSHARES INC CENTRAL INDEX KEY: 0001035092 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 521974638 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22345 FILM NUMBER: 98579756 BUSINESS ADDRESS: STREET 1: 109 NORTH COMMERCE ST CITY: CENTREVILLE STATE: MD ZIP: 21617-0400 BUSINESS PHONE: 4107581600 MAIL ADDRESS: STREET 1: P O BOX 400 CITY: CENTREVILLE STATE: MD ZIP: 21617-0400 10-K 1 SHORE BANCSHARES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 Commission File Number: 0-22345 Shore Bancshares, Inc. (Exact name of registrant as specified in its charter) Maryland 52-1974638 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 109 North Commerce Street Centreville, Maryland 21617 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including are code: (410) 758-1600 Securities registered under Section 12(b) of the Act: None Securities registered under Section 12(g) of the Act: Common Stock, Par Value $0.01 (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __x__ No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___x__ The aggregate market value of Shore Bancshares, Inc. voting stock held by non-affiliates as of January 31, 1998 was $42,170,086, based on the sales price as of that date. As of January 31, 1998, Shore Bancshares, Inc. had 1,007,424 shares of Common Stock $.01 Par Value outstanding. DOCUMENTS INCORPORATED BY REFERENCE Parts II and IV: Portions of the Annual Shareholders Report for the year ended December 31, 1997 (the "Annual Report".) Part III: Portions of the definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 22, 1998 (the "Proxy Statement".) 1 PART I ITEM I BUSINESS GENERAL Shore Bancshares, Inc. (the "Company"), a Maryland corporation incorporated on March 15, 1996, became a registered bank holding company on July 1, 1996 under the Bank Holding Company Act of 1956, as amended. The Company engages in its business through its sole subsidiary, The Centreville National Bank of Maryland (the "Bank"), a national banking association. The Company acquired the Bank through the merger of the Bank into an interim national banking association formed as a Company subsidiary for the purpose of the merger, pursuant to a Plan of Reorganization and Agreement to Merge (the "Plan") proposed by Bank management and approved by the Bank's stockholders on April 16, 1996. Pursuant to the Plan, each outstanding share of Bank common stock was exchanged for two shares of the Company's common stock. The Bank's charter was not affected by the merger. Currently, the Company has issued and outstanding 1,007,424 shares of common stock, par value $0.01 per share ("Shares"), held by 963 holders of record on March 7, 1998. The Company's and the Bank's main office is located at 109 North Commerce Street, Centreville, Queen Anne's County, Maryland. The Bank has five full service branch offices located in Centreville, Chestertown, Stevensville and Hillsboro, Maryland. As of December 31, 1997, the Company had assets of approximately $175.1 million, net loans of approximately $107.8 million, and deposits of $145.8 million. Stockholders' equity has continued to grow over the last five years and has increased $5.4 million (30.0%) over the preceding five years. BANKING PRODUCTS AND SERVICES The Bank has been doing business in Maryland since 1876 and is engaged in both the commercial and consumer banking business. The Bank serves its customers through a network of five banking offices. The Bank provides a wide range of personal banking services designed to meet the needs of local consumers. Among the services provided are checking accounts, savings and time accounts, safe deposit boxes, and installment and other personal loans, especially residential mortgages, as well as home equity loans, automobile and other consumer financing. As a convenience to its customers, the Bank offers Saturday banking hours, drive-thru teller windows, "Direct Dial," a telephone banking service, debit cards, and 24-hour automated teller machines at four of our branch locations. The Bank is also engaged in the financing of commerce and industry by providing credit and deposit services for small to medium sized businesses and for the agricultural community in the Bank's market area. The Bank offers many forms of commercial lending, including lines of credit, revolving credit, term loans, accounts receivable financing, and commercial real estate mortgage lending and other forms of secured financing. A full range of commercial banking services is offered, including the acceptance of checking and savings deposits. Additional types of real estate loans, discount brokerage services, credit cards and related services are also offered through affiliates or correspondent banks. The Bank does not offer trust services and does not engage in municipal trading services. BANK SERVICE CORPORATIONS The Bank owns one-third of the outstanding common stock of two service corporations: The Delmarva Bank Data Processing Center, Inc. and The Eastern Shore Mortgage Corporation, both Maryland corporations. The Eastern Shore Mortgage Corporation, located in Easton, Maryland, is engaged in mortgage banking activities, including the origination of residential mortgage loans and the subsequent sale of the loans to permanent investors. Its primary customers are residents who live on Maryland's Eastern Shore. The Delmarva Bank Data Processing Center, Inc., also located in Easton, Maryland, provides data processing services to banks located in Maryland, Delaware, Virginia and the District of Columbia. EXPANSION ACTIVITIES On December 5, 1996, the Bank entered into a merger agreement with Kent Savings & Loan Association, F.A. 2 ("Kent Savings"), a federal savings and loan association located in Chestertown, Maryland, with the Bank as the surviving financial institution. Under the terms of the agreement, the Bank paid approximately $5.1 million in cash for all of the 140,305 shares of outstanding common stock of Kent Savings. At March 31, 1997, total assets of Kent Savings were $24.1 million and total stockholders' equity was approximately $2.9 million. The merger was approved by the appropriate federal regulators. The merger required the approval of stockholders of Kent Savings, which approval was given at their annual meeting on March 17, 1997. The merger was consummated on April 1, 1997. SEASONALITY The management of the Bank does not believe that the deposits or the business of the Bank in general are seasonal in nature. The deposits may, however, vary with local and national economic conditions but not enough to have a material effect on planning and policy making. EMPLOYEES As of December 31, 1997, the Bank employed 71 individuals, 11 of whom worked part-time. DEPOSITS No material portion of the Bank's deposits has been obtained from an individual or a few individuals (including federal, state and local governments and agencies) the loss of any one or more of which would have a materially adverse effect on the Bank, nor is a material portion of the Bank's loans concentrated within a single industry or group of related industries. On December 31, 1997, the Bank had approximately 1,400 deposit customers representing $145.8 million in deposits. COMMITMENTS As of the end of the last two fiscal years the Bank had the following commitments to lend:
- ------------------------------------------------------------------------------------------- % of % of 12/31/97 Total 12/31/96 Total - ------------------------------------------------------------------------------------------- (in thousands) (in thousands) Standby Letters of Credit $ 1,770 12.59% $ 1,786 13.45% Commitments to Grant Loans 12,293 87.41 11,491 86.55 - ------------------------------------------------------------------------------------------- Total $14,063 100.00% $13,277 100.00%
The above commitments are firm. The Bank expects approximately $4,000,000 of the commitments to lend described above to be funded within the current year. COMPETITION The Bank offers many personalized services and attracts customers by being responsive and sensitive to the needs of the community. The Bank relies on goodwill and referrals from satisfied customers as well as traditional media advertising to attract new customers. To enhance a positive image in the community, the Bank supports and participates in many local events. Employees, officers, and Directors represent the Bank on many boards and local civic and charitable organizations. The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market funds and other investment alternatives. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. 3 Recent changes in federal banking laws facilitate interstate branching and merger activity among banks. Since September, 1995, certain bank holding companies are authorized to acquire banks throughout the United States. In addition, as of June 1, 1997, certain banks are permitted to merge with banks organized under the laws of different states. These changes may result in an even greater degree of competition in the banking industry and the Company and the Bank may be brought into competition with institutions with which it does not presently compete. Regional and local banks dominate the banking industry in Centreville, Chestertown, Stevensville, and the Hillsboro areas where the Bank maintains offices. The Bank competes for deposits and loans with these institutions and with credit unions, savings institutions, insurance companies, and mortgage companies, as well as other companies that offer financial services. To attract new business and retain existing customers, the Bank offers a wide range of banking products and services and relies on local promotional activity, personal contact by its officers, staff, and Directors, referrals by current customers, extended banking hours, and personalized service. As of June 30, 1997, the most recent date for which comparative data is available, bank deposits in Queen Anne's County (where the Bank's main office, Centreville branch and Stevensville branch are located), Caroline County, Maryland (where the Bank's Hillsboro branch is located), and Kent County (where the Bank's Kent branch is located) ranked as follows: - ------------------------------------------------------------------------------ % of Queen Anne's County Deposits Total - ------------------------------------------------------------------------------ (in thousands) The Queenstown Bank of Maryland $124,494 34.99% THE CENTREVILLE NATIONAL BANK OF MARYLAND 113,373 31.87 The Chestertown Bank of Maryland 34,721 9.76 NationsBank, N.A. 31,217 8.77 The First National Bank of Maryland 21,551 6.06 Farmers Bank of Maryland 16,907 4.75 Annapolis National Bank 13,517 3.80 - ------------------------------------------------------------------------------ Total $355,780 100.00% - ------------------------------------------------------------------------------ SOURCE: FDIC DATA BOOK - ------------------------------------------------------------------------------ % of Caroline County Deposits Total - ------------------------------------------------------------------------------ (in thousands) The Peoples Bank of Maryland $ 72,104 29.94% Provident State Bank of Preston 58,259 24.19 The First National Bank of Maryland 40,663 16.88 The Caroline County Bank 26,242 10.89 NationsBank, N.A. 16,008 6.65 Bank of Maryland 15,594 6.47 THE CENTREVILLE NATIONAL BANK OF MARYLAND 11,985 4.98 - ------------------------------------------------------------------------------ Total $240,855 100.00% - ------------------------------------------------------------------------------ SOURCE: FDIC DATA BOOK 4 - ------------------------------------------------------------------------------ % of Kent County Deposits Total - ------------------------------------------------------------------------------ (in thousands) The Chestertown Bank of Maryland $106,342 34.18% Peoples Bank of Kent County 95,343 30.64 The Chesapeake Bank and Trust Company 41,574 13.36 Farmers Bank of Maryland 20,765 6.67 THE CENTREVILLE NATIONAL BANK OF MARYLAND 20,158 6.48 Crestar Bank 16,482 5.30 Signet 10,467 3.37 - ------------------------------------------------------------------------------ Total $311,131 100.00% - ------------------------------------------------------------------------------ SOURCE: FDIC DATA BOOK SUPERVISION AND REGULATION GENERAL. The Company and the Bank are extensively regulated under federal and state law. Generally, these laws and regulations are intended to protect depositors, not stockholders. The following is a summary description of certain provisions of certain laws which affect the regulation of bank holding companies and banks. The discussion is qualified in its entirety by reference to applicable laws and regulations. Changes in such laws and regulations may have a material effect on the business and prospects of the Company and the Bank. FEDERAL BANK HOLDING COMPANY REGULATION AND STRUCTURE. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and as such, it is subject to regulation, supervision, and examination by the Federal Reserve Board ("FRB"). The Company is required to file annual and quarterly reports with the FRB and to provide the FRB with such additional information as the FRB may require. The FRB may conduct examinations of the Company and its subsidiaries. With certain limited exceptions, the Company is required to obtain prior approval from the FRB before acquiring direct or indirect ownership or control of more than 5% of any voting securities or substantially all of the assets of a bank or bank holding company, or before merging or consolidating with another bank holding company. Additionally, with certain exceptions, any person proposing to acquire control through direct or indirect ownership of 25% or more of any voting securities of the Company is required to give 60 days' written notice of the acquisition to the FRB, which may prohibit the transaction, and to publish notice to the public. Generally, a bank holding company may not engage in any activities other than banking, managing or controlling its bank and other authorized subsidiaries, and providing services to these subsidiaries. With prior approval of the FRB, the Company may acquire more than 5% of the assets or outstanding shares of a company engaging in non-bank activities determined by the FRB to be closely related to the business of banking or of managing or controlling banks. The FRB provides expedited procedures for expansion into approved categories of non-bank activities. Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions on extensions of credit to the bank holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Company's ability to obtain funds from the Bank for its cash needs, including funds for the payment of dividends, interest and operating expenses. Further, subject to certain exceptions, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, the Bank may not generally require a customer to obtain other services from itself or the Company, and may not require that a customer promise not to obtain other services from a competitor as a condition to and extension of credit to the customer. Under FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital injections into a troubled subsidiary bank, and the FRB may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the holding company does not have the resources to provide it. In addition, 5 depository institutions insured by the Federal Deposit Insurance Corporation ("FDIC") can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with the default of, or assistance provided to, a commonly controlled FDIC-insured depository institution. 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 the obligations of the depository institution to its stockholders due solely to their status as stockholders and obligations to other affiliates. FEDERAL BANK REGULATION. The Company's banking subsidiary is a federally-chartered national bank regulated by the Office of Comptroller of the Currency ("OCC"). The OCC may prohibit the institutions over which it has supervisory authority from engaging in activities or investments that the agency believes constitutes 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 constitute 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 Bank is subject to certain restrictions on extensions of credit to executive officers, directors, principal stockholders or any related interest of such persons which generally require that such credit extensions be made on substantially the same terms as are available to third persons dealing with the Bank and not involve more than the normal risk of repayment. Other laws tie the maximum amount which may be loaned to any one customer and its related interests to capital levels. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies, including the OCC, 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 the agency, specifying the steps that the institution will take 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 Bank, believes that it meets substantially all standards which have been adopted. FDICIA also imposed new capital standards on insured depository institutions. See "Capital Requirements." Before establishing new branch offices, the Bank must meet certain minimum capital stock and surplus requirements and the Bank must obtain OCC approval. DEPOSIT INSURANCE. As a FDIC member institution, the Bank's 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 cents to 27 cents for every $100 in assessable deposits. 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. As a result of the merger of Kent Savings into the Bank, approximately $20.8 million of the Bank's deposits are assessed at SAIF rates. The SAIF assessment rates are determined quarterly and the SAIF is also administered by the FDIC. CAPITAL REQUIREMENTS. The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. For bank holding 6 companies with less than $150,000,000 in consolidated assets, the guidelines are applied on a bank-only basis. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which include off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. "Tier 1," or core capital, includes common equity, perpetual preferred stock (excluding auction rate issues) and minority interest in equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions. "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. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4% and a ratio of total capital to risk-weighted assets of at least 8%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. As of December 31, 1997, the Bank's ratio of Tier 1 to risk-weighted assets stood at 22.66% and its ratio of total capital to risk-weighted assets stood at 23.91%. In addition to risk-based capital, banks and bank holding companies are required to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage capital ratio, of at least 3%. As of December 31, 1997, the Bank's leverage capital ratio was 12.16%. In August, 1995 and May, 1996, the federal banking agencies adopted final regulations specifying that the agencies will include, in their evaluations of a bank's capital adequacy, an assessment of the Bank's interest rate risk ("IRR") exposure. The standards for measuring the adequacy and effectiveness of a banking organization's interest rate risk management includes a measurement of board of director and senior management oversight, and a determination of whether a banking organization's procedures for comprehensive risk management are appropriate to the circumstances of the specific banking organization. The Bank has internal IRR models that are used to measure and monitor IRR. Additionally, the regulatory agencies have been assessing IRR on an informal basis for several years. For these reasons, the Company does not expect the addition of IRR evaluation to the agencies' capital guidelines to result in significant changes in capital requirements for the Bank. Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions, including limitations on its ability to pay dividends, the issuance by the applicable regulatory authority of a capital directive to increase capital and, in the case of depository institutions, the termination of deposit insurance by the FDIC, as well as to the measures described under "--Federal Deposit Insurance Corporation Improvement Act of 1991" below, as applicable to undercapitalized institutions. In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends to the Company. FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. In December, 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants, (ii) the establishment of uniform accounting standards by federal banking agencies, (iii) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital, (iv) additional grounds for the appointment of a conservator or receiver, and (v) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements. FDICIA also provides for increased funding of the FDIC insurance funds and the implementation of risked-based premiums. See "Deposit Insurance." A central feature of FDICIA is the requirement that the federal banking agencies take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." The Bank is currently classified as "well-capitalized." An institution may be deemed by the 7 regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a cash dividend) or paying any management fees 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. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. 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, requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized 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. FDICIA provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions which fail to comply with capital or other standards. Such action may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. FDICIA also limits the circumstances under which the FDIC is permitted to provide financial assistance to an insured institution before appointment of a conservator or receiver. 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 were eliminated effective on September 29, 1995. The law also permits interstate branching by banks effective as of 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. MONETARY POLICY. The earnings of a bank holding company are affected by the policies of regulatory authorities, including the FRB, in connection with the FRB's regulation of the money supply. Various methods employed by the FRB are open market operations in United States Government securities, changes in the discount rate on member bank borrowing and changes in reserve requirements against member bank deposits. These methods used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits. The money policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Statistical Information: The following supplementary information required under 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 conjuction with the related Consolidated Financial Statements and Notes thereto for the year ended December 31, 1997. Table of Contents: Page Average Balances, Yields, and Rates 9 Rate and Volume Variance Analysis 10 Interest Rate Sensitivity Analysis 11 Investment Securities 12 Investment Securities Portfolio Analysis 12 Summary of Loan Portfolio 13 Maturities of Loan Portfolio 13 Risk Elements of Loan Portfolio 14 Analysis of the Allowance for Credit Losses 14 Allocation of the Allowance for Credit Losses 14 Maturity of Time Certificates of Deposit $100,000 or More 15 Summary of Significant Ratios 15 8 AVERAGE BALANCES, YIELDS, AND RATES (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------- FOR THE YEAR ENDED DECEMBER 31, 1997 For the Year Ended December 31, 1996 - ------------------------------------------------------------------------------------------------------------------------- AVERAGE INCOME/ YIELD/ Average Income/ Yield/ BALANCE EXPENSE RATE Balance Expense Rate - ------------------------------------------------------------------------------------------------------------------------- ASSETS Interest earning assets: Money market investments: Federal funds sold $ 6,493,959 $ 354,331 5.46% $ 7,095,343 $ 378,246 5.33% Investment securities: U.S. Treasury securities and obligations of U.S. government agencies 32,996,468 2,102,149 6.37 27,640,017 1,703,420 6.16 Obligations of States and political subdivisions(1) 8,858,428 673,659 7.60 8,896,963 683,213 7.68 All other investment securities 2,396,970 143,558 5.99 1,387,606 91,075 6.56 - ------------------------------------------------------------------------------------------------------------------------- Total investment securities 44,251,866 2,919,366 6.60 37,924,586 2,477,708 6.53 Loans, net of unearned income(2)(3) Commercial loans 9,293,896 982,599 10.57 10,263,061 1,074,769 10.47 Installment loans 5,264,677 536,637 10.19 5,097,131 512,414 10.05 Mortgage loans 89,183,164 7,827,395 8.78 73,406,929 6,516,800 8.88 - ------------------------------------------------------------------------------------------------------------------------- Total loans 103,741,737 9,346,631 9.01 88,767,121 8,103,983 9.13 - ------------------------------------------------------------------------------------------------------------------------- TOTAL INTEREST EARNING ASSETS 154,487,562 $ 12,620,328 8.17% 133,787,050 $ 10,959,937 8.19% Cash and due from banks 4,012,120 3,589,220 Other assets 8,641,143 5,503,965 Allowance for loan and lease losses (1,445,147) (1,469,856) - ------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $165,695,678 $141,410,379 ========================================================================================================================= LIABILITIES Interest-bearing liabilities Super NOW accounts $ 17,214,551 $ 510,209 2.96% $ 16,022,439 $ 489,828 3.06% Money market deposit account 21,027,750 702,261 3.34 19,112,185 639,654 3.35 Time, $100,000 or more 13,297,892 704,290 5.30 11,632,139 633,460 5.45 Other time deposits 41,023,454 2,135,522 5.21 30,099,425 1,582,081 5.26 IRA deposits 14,732,561 796,760 5.41 14,451,599 738,622 5.11 Savings deposits 16,636,078 521,015 3.13 12,324,479 392,334 3.18 Other borrowed funds 1,356,164 77,825 5.74 -- -- -- - ------------------------------------------------------------------------------------------------------------------------- TOTAL INTEREST BEARING LIABILITIES 125,288,450 5,447,882 4.35% 103,642,266 4,475,979 4.32% Demand deposits 16,216,396 15,303,365 Other liabilities 1,401,009 838,440 - ------------------------------------------------------------------------------------------------------------------------- Total liabilities 142,905,855 119,784,071 Stockholders' equity 22,789,823 21,626,308 - ------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $165,695,678 $141,410,379 ========================================================================================================================= Net interest income and interest rate spread $ 7,172,446 3.82% $ 6,483,958 3.87% Net interest income as a percent of earning assets 4.64% 4.85% ========================================================================================================================= For the Year Ended December 31, 1995 - ----------------------------------------------------------------------------- Average Income/ Yield/ Balance Expense Rate - ----------------------------------------------------------------------------- ASSETS Interest earning assets: Money market investments: Federal funds sold $ 2,354,943 $ 137,734 5.85% Investment securities: U.S. Treasury securities and obligations of U.S. government agencies 34,441,007 2,063,641 5.99 Obligations of States and political subdivisions(1) 10,025,129 822,951 8.21 All other investment securities 1,288,757 92,872 7.21 - ----------------------------------------------------------------------------- Total investment securities 45,754,893 2,979,464 6.51 Loans, net of unearned income(2)(3) Commercial loans 11,031,642 1,156,962 10.49 Installment loans 4,217,507 437,422 10.37 Mortgage loans 69,008,142 6,077,576 8.81 - ----------------------------------------------------------------------------- Total loans 84,257,291 7,671,960 9.11 - ----------------------------------------------------------------------------- TOTAL INTEREST EARNING ASSETS 132,367,127 $ 10,789,158 8.15% Cash and due from banks 3,431,939 Other assets 4,984,475 Allowance for loan and lease losses (1,470,381) - ----------------------------------------------------------------------------- TOTAL ASSETS $139,313,160 ============================================================================= LIABILITIES Interest-bearing liabilities Super NOW accounts $ 14,763,485 $ 458,095 3.10% Money market deposit account 20,708,692 704,005 3.40 Time, $100,000 or more 13,801,000 650,745 4.72 Other time deposits 26,826,207 1,370,902 5.11 IRA deposits 14,038,374 804,030 5.73 Savings deposits 13,868,563 456,851 3.29 Other borrowed funds 817,945 52,236 6.39 - ----------------------------------------------------------------------------- TOTAL INTEREST BEARING LIABILITIES 104,824,266 4,496,864 4.29% Demand deposits 13,400,204 Other liabilities 770,078 - ----------------------------------------------------------------------------- Total liabilities 118,994,548 Stockholders' equity 20,318,612 - ----------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $139,313,160 ============================================================================= Net interest income and interest rate spread $ 6,292,294 3.86% Net interest income as a percent of earning assets 4.75%
============================================================================= 1. All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate exclusinve of the alternative minimum tax rate of 34% and nondeductible interest expense. 2. Loan fee income is included in interest income for each loan category and yields are stated to include all. Fees approximated $84,000, $88,000, and $72,000 for 1997, 1996, and 1995, respectively. 3. Balances of nonaccrual loans and related income have been included for computational purposes. 9 RATE AND VOLUME VARIANCE ANALYSIS (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- 1997 COMPARED TO 1996 1996 compared to 1995 - ----------------------------------------------------------------------------------------------------------------------------- CHANGE DUE TO Change due to INCREASE Increase INTEREST INCOME (DECREASE) RATE(2) VOLUME (Decrease) Rate(2) Volume - ----------------------------------------------------------------------------------------------------------------------------- Federal funds sold $ (23,915) $ 8,144 $ (32,059) $ 240,512 $(36,741) $ 277,253 - ----------------------------------------------------------------------------------------------------------------------------- Total money market investments (23,915) 8,144 (32,059) 240,512 (36,741) 277,253 - ----------------------------------------------------------------------------------------------------------------------------- U.S. Treasury securities and obligations of U.S. government agencies 398,729 68,618 330,111 (360,221) 47,282 (407,503) Tax-exempt obligations of State and political subdivisions(1) (9,554) (6,595) (2,959) (139,738) (47,128) (92,610) All other investment securities 52,483 (13,766) 66,249 (1,797) (8,920) 7,123 - ----------------------------------------------------------------------------------------------------------------------------- Total investment securities 441,658 48,257 393,401 (501,756) (8,766) (492,990) - ----------------------------------------------------------------------------------------------------------------------------- Commercial loans (92,170) 9,323 (101,493) (82,193) (1,587) (80,606) Installment loans 24,223 7,380 16,843 74,992 (16,239) 91,231 Mortgage loans 1,310,595 (89,962) 1,400,557 439,224 51,821 387,403 - ----------------------------------------------------------------------------------------------------------------------------- Total loans(3) 1,242,648 (73,259) 1,315,907 432,023 33,995 398,028 - ----------------------------------------------------------------------------------------------------------------------------- Total interest income $1,660,391 $(16,858) $1,677,249 $ 170,779 $(11,512) $ 182,291 ============================================================================================================================= INTEREST EXPENSE Super NOW accounts $ 20,381 $(16,064) $ 36,445 $ 31,733 $ (7,331) $ 39,064 Money market deposit accounts 62,607 (1,504) 64,111 (64,351) (10,077) (54,274) Time deposits of $100,000 or more 70,830 (19,883) 90,713 (17,285) 84,981 (102,266) Other time deposits 553,441 (20,746) 574,187 211,179 43,907 167,272 IRA deposits 58,138 43,778 14,360 (65,408) (89,075) 23,667 Savings deposits 128,681 (8,573) 137,254 (64,517) (13,653) (50,864) Other borrowed funds 77,825 -- 77,825 (52,236) -- (52,236) - ----------------------------------------------------------------------------------------------------------------------------- Total interest expense $ 971,903 $(22,992) $ 994,895 $ (20,885) $ 8,752 $ (29,637) ============================================================================================================================= Net interest margin/income $ 688,488 $ 6,134 $ 682,354 $ 191,664 $(20,264) $ 211,928 =============================================================================================================================
1. Income and yields are computed on a tax equivalent basis using the statutory federal income tax rate of 34%, exclusive of the alternative minimum tax and nondeductible interest expense. 2. Variances caused by the change in yield/rate times the average balance are allocated to rate. 3. Balances of nonaccrual loans and related income have been included for computational purposes. 10 INTEREST RATE SENSITIVITY ANALYSIS December 31, 1997 (ALL DOLLAR AMOUNTS IN THOUSANDS)
AFTER 3 AFTER 1 NON - TOTAL MONTHS - YEAR - INTEREST ALL WITHIN WITHIN WITHIN AFTER SENSITIVE CATEGORIES 3 MONTHS 1 YEAR 5 YEARS 5 YEARS FUNDS ---------- ---------- ----------- ----------- ----------- ---------- ASSETS - ---------------------------------------- Loans $17,347 $7,101 $45,879 $39,004 ($1,567) $107,764 Taxable Investment Securities 4,342 6,691 19,198 6,849 37,080 Non-taxable Investment Securities 110 1,117 4,443 4,037 9,707 Investments in Equity Securities 887 1,068 1,955 Federal Funds Sold 3,504 3,504 Non-interest earning assets 15,105 15,105 -------- -------- -------- ------- -------- -------- TOTAL ASSETS 26,190 14,909 69,520 49,890 14,606 175,115 -------- -------- -------- ------- -------- -------- LIABILITIES - ---------------------------------------- Time Certificates of Deposit over $100,000 2,360 5,613 5,501 13,474 All Other Time Deposits 14,440 19,621 23,800 57,861 Savings and Money Market Deposits 37,575 37,575 Interest-bearing Transaction 19,176 19,176 Other borrowed funds 5,000 5,000 Noninterest-bearing Liabilities 18,514 18,514 -------- -------- -------- ------- -------- -------- TOTAL LIABILITIES 73,551 25,234 34,301 0 18,514 $151,600 -------- -------- -------- ------- -------- -------- NET (ASSETS LESS LIABILITIES) ($47,361) ($10,325) $35,219 $49,890 ($3,908) ======== ======== ======== ======= ======== NET (CUMULATIVE) ($47,361) ($57,686) ($22,467) $27,423 $23,515 ======== ======== ======== ======= ======== RSA-RSL (CUMULATIVE) / TOTAL ASSETS -27.05% -32.94% -12.83% 15.66% 13.43% ======== ======== ======== ======= ========
Interest Rate Sensitivity Analysis Assumptions Fixed rate loans are grouped in the appropriate category based on scheduled amortization. Variable rate loans are classified based on the next available repricing opportunity. Noninterest sensitive loans consists of the net of nonaccrual loans, allowance for credit losses and deferred fees and costs. Taxable and nontaxable investment securities are categorized by final maturity date or, if applicable, a definite call date. Investment in equity securities within three months consists of a U.S. Government Securities Mutual Fund. Noninterest sensitive funds combines Federal Reserve Bank and Federal Home Loan Bank of Atlanta stocks. Time deposits with contractual maturities are categorized based on the effective maturity of the deposit. Savings, money market and interest-bearing transaction accounts are assumed to be subject to repricing within a year, and generally within three months of a rate change, based on the Company's historical experience. 11 Investment Securities (In Thousands) Fair Value December 31, 1997 1996 -------------------- Available for Sale U.S. Treasury Securities $7,014 $9,458 Obligations of U.S. Government agencies and corporations 475 - U.S. Government Securities Mutual Funds 887 870 Federal Reserve Bank and Federal Home Loan Bank of Atlanta stock 1,068 863 -------------------- Total Available for Sale 9,444 11,191 -------------------- Amortized Cost December 31, 1997 1996 -------------------- Held to Maturity Obligations of U.S. Government and other government agencies and corporations 29,088 23,065 Obligations of states and political subdivisions 10,210 9,397 -------------------- Total Held to Maturity 39,298 32,462 -------------------- Total Investment Securities $48,742 $43,653 ==================== Investment Securities Portfolio Analysis December 31, 1997 (In Thousands) AVAILABLE FOR SALE
======================== ============================================ U.S. Govt. Agencies ===================== ========== U.S. Treasury U.S. Govt. Agencies Securities Mutual Fund Other Securities Book Avg.T.E. Book Avg.T.E. Book Avg.T.E. Book Avg.T.E. Total Description & Term Value Yield Value Yield Value Yield Value Yield Value - ------------------ ===================== ===================== ======================== ===================== ========== 0 - 3 Months $1,992 6.04 99 6.22 0 N/A 0 N/A $2,091 3 - 6 Months 0 N/A 0 N/A 0 N/A 0 N/A 0 6 - 12 Months 0 N/A 0 N/A 0 N/A 0 N/A 0 1 - 3 Years 4,974 6.32 0 N/A 0 N/A 0 N/A 4,974 3 - 4 Years 0 N/A 47 6.75 0 N/A 0 N/A 47 4 - 5 Years 0 N/A 0 N/A 0 N/A 0 N/A 0 5 - 10 Years 0 N/A 70 7.34 0 N/A 0 N/A 70 10 - 30 Years 0 N/A 249 7.50 1,010 7.33 1,068 6.88 2,327 ---------------------- --------------------- ------------------------ --------------------- ---------- Total $6,966 6.09 $465 7.38 $1,010 7.33 $1,068 6.88 9,509 ====================== ===================== ======================== ===================== ==========
HELD TO MATURITY
====================== ======================== ===================== ========== U.S. Govt. Agencies Municipals Municipals - In State Book Avg.T.E. Book Avg.T.E. Book Avg.T.E. Total Description & Term Value Yield Value Yield Value Yield Value - ------------------ ====================== ======================== ====================== ========== 0 - 3 Months $2,244 5.69 $110 5.76 $0 N/A $2,354 3 - 6 Months 2,199 5.67 250 5.68 85 8.11 2,534 6 - 12 Months 3,990 5.65 1,234 7.34 50 11.45 5,274 1 - 3 Years 3,495 6.18 2,239 7.82 1,085 7.98 6,819 3 - 4 Years 4,980 6.36 0 N/A 202 6.60 5,182 4 - 5 Years 5,661 6.45 0 N/A 917 7.50 6,578 5 - 10 Years 6,519 6.73 2,230 6.87 1,146 8.20 9,895 10 - 30 Years 0 N/A 662 7.22 0 N/A 662 ---------------------- ------------------------ --------------------- ---------- Total $29,088 6.23 $6,725 7.16 $3,485 7.90 39,298 ====================== ======================== ===================== ==========
The above yields have been adjusted to reflect a tax equivalent basis assuming a federal tax rate of 34% and a state tax rate of 7%. 12 Summary Of Loan Portfolio (In Thousands) Loans Outstanding as of December 31, ------------------------------------------ 1997 1996 ----------- ----------- Amount Amount ----------- ----------- Real Estate: Construction and land development $2,946 $3,264 Commercial 12,973 10,935 Residential 78,273 60,490 Commercial 8,353 7,739 Consumer 6,622 6,465 ----------- ----------- TOTAL $109,167 $88,893 =========== =========== Maturities Of Loan Portfolio December 31, 1997 (In Thousands) Maturing Maturing After One Maturing Within But Within After Five One Year Five Years Years Total ------------------------------------------- Real Estate: Construction and land development $ 2,867 $ 79 $ - $ 2,946 Commercial 6,605 3,242 2,953 12,800 Residential 7,595 34,631 36,220 78,446 Commercial 4,401 3,259 693 8,353 Consumer 1,449 4,582 591 6,622 ------------------------------------------- TOTAL $ 22,917 $ 45,793 $ 40,457 $ 109,167 =========================================== Classified by Sensitivities of Loans to Changes in Interest Rates Fixed - Interest Rate Loans $ 3,144 $ 15,490 $ 33,754 $ 52,388 Adjustable - Interest Rate Loans 21,481 30,303 4,995 56,779 ------------------------------------------- TOTAL $ 24,625 $ 45,793 $ 38,749 $ 109,167 =========================================== 13 Risk Elements Of Loan Portfolio (In Thousands) December 31, 1997 1996 ------------------- Non-accrual loans $199 $872 Accruing loans past due 90 Days or more 251 590 Restructured loans 209 0 Information with respect to non-accrual loans at December 31, 1997: Non-accrual loans $199 Interest income that would have been recorded under original terms: 33 Interest income recorded during the period 27 Analysis of the Allowance for Credit Losses (In Thousands)
For the Years Ended December 31, 1997 1996 --------------------- Balance at beginning of period $1,503 $1,479 Charge-offs: Real Estate: Construction and land development 0 0 Commercial 0 0 Residential 22 10 Commercial 37 5 Consumer installment 99 63 --------------------- 158 78 --------------------- Recoveries: Real Estate: Construction and land development 0 0 Commercial 0 0 Residential 0 10 Commercial 4 67 Consumer installment 40 25 --------------------- 44 102 --------------------- Net charge-offs (recoveries) 114 (24) Provision for credit losses 0 0 Allowance aquired 15 0 --------------------- Balance at end of period $1,404 $1,503 ===================== Average daily balance of loans $103,742 $88,767 Ratio of net charge-offs to average loans outstanding 0.11% (0.03%)
Allocation of the Allowance for Credit Losses (In Thousands)
Percent of loans Percent of loans December 31, in each category December 31, in each category 1997 to total loans 1996 to total loans ---------------------------------------------------------------------------- Real Estate: Construction and land development $38 2.70% $41 3.67% Commercial 518 11.88% 137 12.30% Residential 47 71.70% 36 68.05% Commercial 194 7.65% 502 8.71% Consumer 112 6.07% 95 7.27% Unallocated 495 N/A 692 N/A ---------------------------------------------------------------------------- TOTAL $1,404 100.00% $1,503 100.00% ============================================================================
14 Maturity of Time Certificates of Deposit $100,000 or More (In Thousands) December 31, December 31, 1997 1996 ----------------------------------- Three months or less $2,360 $7,769 Three months through six months 2,245 2,776 Six months through twelve months 3,368 2,196 Over twelve months 5,501 3,939 ----------------------------------- TOTAL $13,474 $16,680 =================================== Summary of Signifcant Ratios 1997 1996 --------------------- Return on average total assets 1.43% 1.63% Return on average total equity 10.40% 10.67% Dividend payout ratio 41.28% 40.17% Total average equity to total average assets ratio 13.75% 15.29%
1997 1996 1995 1994 1993 ---------------------------------------------------- Allowance for credit losses to non-performing loans 311.94% 102.82% 83.72% 77.44% 55.85%
ITEM 2 PROPERTIES The Bank owns real property at the location of its main office at 109 North Commerce Street, Centreville, Maryland 21617, and at its four branch locations at 2609 Centreville Road, Centreville, Maryland 21617 ("Route 213 South Branch Office"), 408 Thompson Creek Road, Stevensville, Maryland 21666 ("Stevensville Branch Office"), at 21913 Shore Highway, Hillsboro, Maryland 21614 ("Hillsboro Branch Office") and 305 East High Street, Chestertown, Maryland("Kent Branch Office".) There are no encumbrances on any of these properties. The Company owns no real property. ITEM 3 LEGAL PROCEEDINGS There are no material pending legal proceedings other than ordinary routine litigation incidental to the business to which the Company, the Bank, or its subsidiaries is a party or of which any of their properties is subject. Management is not aware of any material proceedings 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 securing holder is a party. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 1997 to a vote of security holders, through the solicitation of proxies. PART II ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The sections entitled "Market Price of and Dividends on Registrant's Common Equity and Related Stockholder Matters" and "Market Information" on page 36 of the Annual Report is hereby incorporated by reference. For information regarding regulatory restrictions on the Bank's and, therefore, the Company's payment of dividends, see Note 16 "Regulatory Matters" on page 30 of the Annual Report, which is hereby incorporated by reference. ITEM 6 SELECTED FINANCIAL DATA The table entitled "Selected Financial Data" on page 1 of the Annual Report is hereby incorporated by reference. ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATION AND FINANCIAL CONDITION Pages 5 through 11 of the Annual Report are hereby incorporated by reference. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For information regarding the market risk of the Company's financial instruments, see "Management Discussion and Analysis 15 of Results of Operation and Financial Condition - Market Risk Management" on page 10 of the Annual Report and hereby incorporated by reference. The Company's principal market risk exposure is to interest rates. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Pages 12 through 33 of the Annual Report are hereby incorporated by reference. ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The Board of Directors of the Company, upon recommendation of the Bank's Audit/Compliance Committee, proposed and recommended the election of Stegman & Company as independent certified public accountants to make an examination of the accounts of the Company and the Bank for the year ending December 31, 1997. Stegman and Company served as the Company's and the Bank's independent public auditor for 1996. Trice and Geary served as the Bank's independent public auditor for 1995, before the formation of the Company. In 1995, Trice and Geary performed various professional services for the Bank, including completion of the audit of financial statements for 1995 and preparation of corporate tax returns. On October 31, 1995, the Bank's Board of Directors, upon the recommendation of the Audit/Compliance Committee, selected Stegman and Company effective April 16, 1996 to audit the books of the Company and its subsidiaries for the year ending December 31, 1996, to report on the consolidated statements of financial position and related statements of earnings of the Company and its subsidiaries, and to perform such other accounting services as may be required by the Board of Directors. The Company has been advised by Stegman and Company that the firm did not have any direct financial interest or any material indirect financial interest in the Company and its subsidiaries in 1996 or currently. There were no disagreements with Trice and Geary on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements if not resolved to their satisfaction would have caused them to make reference in connection with their opinion to the subject matter of the disagreement. For the year ended December 31, 1995, its audit report did not contain any adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope, or accounting principles. PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference in the section entitled "Election of Directors" on pages 3 and 4 and section entitled "Executive Officers" on page 6 in the Proxy Statement as filed with the Securities and Exchange Commission March 23, 1998. ITEM 11 EXECUTIVE COMPENSATION Incorporated by reference in the section entitled "Executive Compensation" on pages 6 and 7 in the Proxy Statement as filed with the Securities and Exchange Commission March 23, 1998. 16 ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference in the section entitled "Beneficial Ownership of Common Stock" on pages 1 and 2 in the Proxy Statement as filed with the Securities and Exchange Commission March 23, 1998. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference in the section entitled "Election of Directors" on page 4 in the Proxy Statement as filed with the Securities and Exchange Commission March 23, 1998. PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1), (2) Financial Statements The following consolidated financial statements included in the Annual Report to Shareholders for the year ended December 31, 1997, are incorporated herein by reference in Item 8 of this Report. The following financial statements are filed as a part of this report: Consolidated Balance Sheets at December 31, 1997 and 1996 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995 Notes to the Consolidated Financial Statements Independent Auditors' Report All financial statement schedules have been omitted as the required information is either inapplicable or included in the consolidated financial statements or related notes. (a) Exhibits Required to be Filed by Item 601 of Regulation S-K EXHIBIT INDEX (2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession (2.1) Plan of Reorganization and Agreement to Merge dated March 15, 1996, is incorporated by reference from the Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration No. 0-22345). (2.2) Merger Agreement dated December 5, 1996 among Kent Savings and Loan Association, F.A., The Centreville National Bank of Maryland, and the Company is incorporated by reference from the Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration No. 0-22345). (3) Charter and Bylaws (3.1) Articles of Incorporation of the Company are incorporated by reference from the Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration No. 0-22345). 17 (3.2) Bylaws of the Company is incorporated by reference from the Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration No. 0-22345) (13) 1997 Annual Report filed herewith. (16) Letter re: Change in Certifying Accountants is incorporated by reference from the Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration No. 0-22345) (21) List of Subsidiaries is incorporated by reference from the Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration No. 0-22523) (27) Financial Data Schedule is filed electronically herewith via EDGAR. (b) Reports on Form 8-K None (c) Exhibits to Item 601 to Regulation S-K See the Exhibits described in Item 14(a)(3) above. 18 SIGNATURES Pursuant to the requirements in Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf on March 17, 1998 by the undersigned, thereunto duly authorized. SHORE BANCSHARES, INC. /s/ Daniel T. Cannon _____________________ Daniel T. Cannon President /s/ Carol I. Brownawell _____________________ Carol I. Brownawell Treasurer 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 indicated on March 17, 1998. /s/ Sydney G. Ashley Director _________________________ /s/ J. Robert Barton Director _________________________ /s/ David C. Bryan Director _________________________ /s/ Daniel T. Cannon Director _________________________ /s/ B. Vance Carmean, Jr. Director _________________________ /s/ Mark M. Freestate Director _________________________ /s/ Neil R. LeCompte Director _________________________ /s/ Jerry F. Pierson Director _________________________ /s/ Wm. Maurice Sanger Director _________________________ /s/ Walter E. Schmidt Director _________________________ 19 EX-13 2 EXHIBIT 13 [GRAPHIC LOGO GOES HERE] 1997 Annual Report SELECTED FINANCIAL DATA
- ------------------------------------------------------------------------------------------------------------------------ For the Year 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------ Net interest income $ 6,957,167 $ 6,265,431 $ 6,012,491 $ 6,097,626 Provision for credit losses -- -- -- 274,000 Net interest income after provision for credit losses 6,957,167 6,265,431 6,012,491 5,823,626 Non-interest income 909,049 999,423 877,386 856,585 Net income 2,370,198 2,307,742 2,138,500 2,030,864 - ------------------------------------------------------------------------------------------------------------------------ Per Share Data:* - ------------------------------------------------------------------------------------------------------------------------ Diluted net income $ 2.35 $ 2.29 $ 2.12 $ 2.02 Cash dividends declared 0.97 0.92 0.85 0.60 Book value 23.34 21.93 20.70 19.19 Number of common shares 1,007,424 1,007,424 1,007,424 1,007,424 - ------------------------------------------------------------------------------------------------------------------------ At Year End - ------------------------------------------------------------------------------------------------------------------------ Total Assets $ 175,115,011 $146,899,477 $138,100,669 $144,942,996 Loans, net of unearned income 109,167,283 88,892,757 87,049,483 79,329,222 Allowance for credit losses 1,403,747 1,503,268 1,478,555 1,481,501 Investment securities 48,742,568 43,652,747 37,131,443 53,209,881 Deposits 145,813,270 124,166,248 116,479,753 124,984,593 Long-term debt 5,000,000 -- -- -- Stockholders' equity 23,514,810 22,095,951 20,849,348 19,332,344 - ------------------------------------------------------------------------------------------------------------------------ Average Balances - ------------------------------------------------------------------------------------------------------------------------ Total assets $ 165,695,678 $141,410,379 $139,313,160 $143,919,722 Total deposits and borrowings 141,504,846 118,945,631 118,224,470 124,027,077 Stockholders' equity 22,789,823 21,626,308 20,318,612 19,027,257 Return on average total assets 1.43% 1.63% 1.54% 1.41% Return on average stockholders' equity 10.40% 10.67% 10.52% 10.67% ======================================================================================================================== For the Year 1993 - ------------------------------------------------------------------------ Net interest income $ 5,841,071 Provision for credit losses 1,000,000 Net interest income after provision for credit losses 4,841,071 Non-interest income 855,619 Net income 1,759,683 - ------------------------------------------------------------------------ Per Share Data:* - ------------------------------------------------------------------------ Diluted net income $ 1.75 Cash dividends declared 0.53 Book value 17.95 Number of common shares 1,007,424 - ------------------------------------------------------------------------ At Year End - ------------------------------------------------------------------------ Total Assets $144,079,772 Loans, net of unearned income 86,247,915 Allowance for credit losses 1,851,369 Investment securities 36,663,520 Deposits 125,249,716 Long-term debt -- Stockholders' equity 18,085,400 - ------------------------------------------------------------------------ Average Balances - ------------------------------------------------------------------------ Total assets $140,857,647 Total deposits and borrowings 122,441,750 Stockholders' equity 17,858,590 Return on average total assets 1.25% Return on average stockholders' equity 9.85% ========================================================================
* Per share data for 1992 through 1995 is restated to reflect the 100% stock dividend paid May 20, 1994 and the July 1, 1996 2 for 1 stock split effected upon conversion to Shore Bancshares, Inc. The year ended December 31, 1997 reflects the merger of Kent Savings and Loan Association, Inc. on April 1, 1997 and accounted as a purchase transaction. 1 - ------------------------------------------------------------------ CONTENTS - ------------------------------------------------------------------ Letter to Stockholders 4 Management's Discussion and Analysis of Results of Operations and Financial Condition 5-11 Consolidated Financial Statements 12-32 Independent Auditiors' Report 33 Average Balances, Yields, and Rates 34 Rate and Volume Variance Analysis 35 Market Price of and Dividends on Registrant's Common Equity and Related Stockholder Matters 36 Board of Directors 37 Officers 38 Employees and Offices 39 - ------------------------------------------------------------------ 2 BUSINESS PROFILE Shore Bancshares Inc. (the Company), a Maryland corporation, incorporated on March 15, 1996, became a registered bank holding company on July 1, 1996 under the Bank Holding Company Act of 1956, as amended. The Company engages in its business through its sole subsidiary, The Centreville National Bank of Maryland (the Bank), a national banking association. The Company's and Bank's main office is located at 109 North Commerce Street, Centreville, Queen Anne's County, Maryland. Banking business is conducted at 5 full service branch offices, all in Maryland with two located in Centreville, Queen Anne's County, a branch in Stevensville, Queen Anne's County, a Hillsboro location, serving Queen Anne's and Caroline Counties, and our most recent addition in Chestertown, Kent County. The Bank has been doing business in Centreville since 1876 and is engaged in both the commercial and consumer banking business. The Bank provides a wide range of personal banking services designed to meet the need of local consumers. The Bank engages in the financing of commerce and industry by providing credit and deposit services for small to medium sized businesses, local governments, and for the agricultural community in the Bank's market area. The Company's and the Bank's management are committed to providing personal, friendly, quality service to our customers while earning a reasonable return for our shareholders. Our commitment to the communities in which we operate and their economic vitality is a crucial element of our focus. We believe in giving back to the community we serve. We have grown and changed along with our local region. Shore Bancshares Inc. will continue to respond to the changing business environment through our investment in technology and products and services developed to meet the needs of our customers, while remaining true to our principle of excellent customer service. 3 TO OUR STOCKHOLDERS: The Board of Directors and management of Shore Bancshares, Inc. are pleased to present the Annual Report for the year ended December 31, 1997. It has truly been another eventful year for Shore Bancshares and The Centreville National Bank of Maryland. The acquisition and merger of Kent Savings and Loan Association, F.A. was completed as of the close of business March 31, 1997, resulting in the Bank's fifth branch, its first in Kent County. Several new products were introduced during 1997 including a Silver Certificate for depositors 62 and over and a Prime Rate Home Equity Line of Credit. The Company's and Bank's administrative offices moved into the newly renovated space on Commerce Street and the project was almost complete as of year end. The Annual Meeting will be held in the new facility this year, located at 109 North Commerce Street in Centreville. Among the projects facing us, is preparing our systems for the year 2000. As you may know, there is the potential for problems with computers and other types of electronic equipment as the date changes to January 1, 2000. We have assembled a team to assess our exposure and analyze and implement solutions to make the transition a smooth one. We fully expect to be prepared to provide our customary level of service into the next century. We attained record earnings for the year ended December 31, 1997 of $2.37 million, or $2.35 diluted earnings per common share, in net income after taxes compared to $2.31 million, or $2.29 diluted earnings per common share, in 1996. Total assets grew by 19.2% to $175.1 million, and deposits increased to $145.8 million or 17.4%, largely as a result of the Kent Savings merger. Cash dividends totaling $0.97 per share were paid to stockholders during 1997, an increase of $0.05 per share, or 5.4%, over the prior year. Stockholders' equity increased by 6.4% over the year ended December 31, 1996. The book value of your stock increased by the same percentage to $23.34 per share. Total capital remains well above regulatory requirements as discussed in the Notes to Consolidated Financial Statements. On behalf of the Board of Directors and the entire staff, we thank you for your continued support. We encourage your comments and suggestions. We look forward to another exciting year of change and challenge. However, our commitment to service in our communities will never change. /s/ Walter E. Schmidt /s/ Daniel T. Cannon _____________________ ____________________ Walter E. Schmidt Daniel T. Cannon Chairman of the Board President and CEO 4 MANAGEMENT'S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion is designed to provide a better understanding of the financial position of Shore Bancshares, Inc. (the Company), and should be read in conjunction with the Audited Consolidated Financial Statements and Notes. ORGANIZATIONAL BACKGROUND On July 1, 1996, the Company commenced operations as the parent company of its sole subsidiary, The Centreville National Bank of Maryland ("the Bank"), which has conducted the business of banking since 1876. Since the Bank is the primary possession of the Company, the assets and liabilities of the Company are comprised almost entirely of the assets and liabilities of the Bank. The same is true for the income and expense of the Company. All data for periods on and after July, 1996 is presented in this analysis in consolidated form and is compared to like data for the Bank for prior years. Comparative financial data for 1995 is that of the Bank restated to reflect the exchange of shares of Bank common stock for Company shares. Effective April 1, 1997, The Centreville National Bank of Maryland completed its merger with Kent Savings and Loan Association, F.A. (Kent Savings) of Chestertown Maryland. The transaction was accounted for as a purchase and, therefore, results of operations for Kent Savings subsequent to March 31, 1997 are included in the consolidated statements of income and cash flows from date of acquisition. Under the terms of the agreement the Bank paid approximately $5.1 million for all of the outstanding shares of Kent Savings resulting in $2.1 million in goodwill to be amortized over 15 years. Kent Savings has one office located on High Street in downtown Chestertown. RESULTS OF OPERATIONS OVERVIEW The Company reported $2.4 million in net income for 1997 or $2.35 diluted earnings per share compared to 1996 net income of $2.3 million or $2.29 diluted earnings per share and 1995 net income of $2,139,000 or $2.12 per share diluted earnings. Excluding the gain on the sale of investment securities of $9 thousand in 1997 and $204 thousand in 1996, net income before taxes in 1997 actually increased $266 thousand or 11.5% over the same period in 1996. Earnings for the year represent a record level of performance for the Company. The improvement was attributable to the 11% growth in net interest income, the Company's major income component. Non-interest income grew 13.2%, excluding the securities gains. Non-interest expenses increased 15.4% over the prior year. The increase was primarily attributable to expenses associated with the merger of Kent Savings, including goodwill amortization, and higher depreciation expense in the third and fourth quarters resulting from the renovation of the Centreville office. Return on average assets was 1.43%, 1.63% and 1.54% in 1997, 1996, and 1995, respectively, which reflects the Company's growth in assets in 1997, as a result of the Kent Savings merger, at a faster rate than the growth in earnings. Earnings growth reflects a lower net interest margin and the additional costs of the Kent Savings merger. The return on average stockholders' equity for 1997 was 10.40% compared to 10.67% and 10.52% in 1996 and 1995, respectively. NET INTEREST INCOME AND NET INTEREST MARGIN Net interest income is the principal source of earnings for a banking company. It represents the difference between interest and fees earned on the loan and investment portfolios and the interest paid on deposits and borrowings. The year ended December 31, 1997 was characterized by relatively stable interest rates whereas the years ended December 31, 1996 and 1995 have been represented by generally declining interest rates. For the Company, 1997 rate activity reflected slightly increasing loan rates in the first quarter and a reduction of rates in the fourth quarter. Deposit rates followed the same trends although rate reductions began in the third quarter. The years 1996 and 1995 reflect increasing loan rates and generally declining deposit rates until the second half of 1996 when deposit rates increased slightly. Net interest income (on a tax equivalent basis) for 1997 increased by $688 thousand or 10.6% compared to the year ended December 31, 1996, while 1996 increased by $192 thousand or 3.0% from the previous year ended December 31, 1995. Interest rate spread is the difference between the average yield on interest earning assets and the average rate paid 5 on interest bearing liabilities. Despite a decrease in interest rate spread, 1997 reflects an increase in net interest income due primarily to an increase in volume associated with the Kent Savings merger. The 1996 variances are largely the result of the effect of increased interest rate spread as of December 31, 1996 versus 1995. Interest rate spread for the years ended December 31, 1997, 1996 and 1995 was 3.82%, 3.87%, and 3.86%, respectively. The 1997 interest rate spread decreased compared to 1996 by .05%. The rate spread variance reflects a decrease in yield on earning assets of .02% as a result of a lower yielding loan portfolio and growth in the investment securities portfolio, a lower yielding asset when compared to loans. The yield on the loan portfolio was impacted by the introduction of the Kent Savings loans which yield slightly less than the loans originated by the Company prior to the acquisition. Federal funds and securities portfolio yields actually increased over 1996 by .13% and .07%, respectively. Interest-bearing liabilities' yield increased .03% over 1996, reflecting the higher cost of the $5,000,000 Federal Home Loan Bank of Atlanta (FHLB) long-term borrowing and IRA deposits. Other deposit accounts actually reflected a reduced yield compared to the previous year. Interest rate spread in 1996 increased by .01% over 1995 as a result of a modest increase in yield on earning assets of .04% and an increase in expense of interest-bearing liabilities of .03%. Overall, when compared to 1995, loan rates showed an increase during 1996, as did the average balance in loans, providing a higher return compared to investment securities. Total interest expense actually decreased in 1996 compared to 1995 by $21 thousand, or less than 1%, as a result of decreasing deposit rates in the first 6 months of 1996 and 1.1% decrease in average balance of interest bearing deposits as of December 31, 1996. See the table titled "Average Balances, Yields and Rates" on page 34 for additional information. Net interest margin is calculated as tax equivalent net interest income divided by average earning assets and represents the Company's net yield on its earning assets. For 1997, the net interest margin decreased to 4.64% from 4.85% in 1996. This decrease is the result of earning assets growing 15.5% while net interest income grew at a rate of 10.6%. The net interest margin for 1996 increased to 4.85% from 4.75% the previous year. These changes are the result of repricing as previously discussed and are illustrated in the table titled "Tax Equivalent Net Interest Income and Rate/Volume Analysis" on pages 34 and 35. Comparing 1997 and 1996 shows that changes in rates increased net interest margin $6 thousand, while changes in volume provided $682 thousand for a net increase of $688 thousand. Volume increases accounted for the growth in net interest margin and is attributed to the Kent Savings merger. Excluding the $20.3 million in total loans from Kent Savings, loan growth was actually flat. The majority of the $7 million growth in average investment securities is attributed to the purchase of bonds to leverage the FHLB borrowing. When comparing 1996 vs. 1995, repricing actually reduced the net interest margin $20 thousand in net interest income and volume changes provided $212 thousand for a net increase of $192 thousand. The 1.1% 1996 increase in average earning assets was assisted by a $4.5 million increase in average total loans and was tempered by a 17% or $7.8 million reduction in average total investment securities. The funds made available as a result of a declining investment portfolio and increased deposits which were not invested in the loan portfolio were invested federal funds. The balance of outstanding mortgage loans increased by approximately $4.4 million. This increase is attributed to an increase in commercial real estate loans and the addition of a 10 year draw home equity line of credit product as well as a significant increase in the outstanding balance of the first time home buyer product. Management and the Board of Directors monitor interest rates on a regular basis to assess the Company's competitive position and to maintain a reasonable and profitable interest rate spread. The Company also considers the maturity distribution of loans, investments, and deposits and its effect on net interest income as interest rates rise and fall over time. For additional analysis see the Notes to the Consolidated Financial Statements. PROVISION AND ALLOWANCE FOR CREDIT LOSSES For the year ended December 31, 1997, the Bank recorded net charge off of $115 thousand compared to net recoveries of $25 thousand in 1996 and net charge offs of $3 thousand in 1995. Internal loan review, in particular, has been effective in identifying problem credits and in achieving timely recognition of potential and actual losses within the loan portfolio. Improved overall credit quality and increased collection efforts have also contributed to the relatively small amount of net charge offs in 1997 and 1995 and net recoveries in 1996. 6 Gross charge offs amounted to $159 thousand, $78 thousand and $105 thousand in 1997, 1996, and 1995, respectively, the majority of which were installment loans. Efforts to collect charged off loans continue and are evidenced by the amount of recoveries, totaling $44 thousand in 1997, $103 thousand in 1996 and $102 thousand in 1995. The provision for credit losses has followed the same general trend as the amount of charge offs. No provision for credit losses was charged to expense in 1997, 1996, or 1995. $15 thousand was added to the allowance upon the merger with Kent Savings. The allowance for credit losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Management's quarterly evaluation of the adequacy of the allowance is based on analysis of the loan portfolio and its known and inherent risks, assessment of current economic conditions, diversification and size of the portfolio, adequacy of the collateral, past and anticipated loss experience and the amount of non- performing loans. The allowance for credit losses has remained relatively unchanged despite the increase in outstanding loan balances. The allowance for credit losses of $1.4 million as of December 31,1997 represented 1.29% of gross loans. The allowance for credit losses of $1.5 million as of December 31, 1996 amounted to 1.69% of the outstanding loan portfolio. The decrease in the percentage of allowance to outstanding loans, despite the increasing outstanding gross loans, is justified by lower levels of past due and classified loans. Analysis by loan review and internal audit supports the adequacy of the allowance. This reduction in percentage of allowance to outstanding loans reflects improvements in credit quality achieved through better credit underwriting and more aggressive collection efforts and is further evidenced by lower past due loan totals. In management's opinion, the allowance for credit losses is adequate as of December 31, 1997. See Note 5 in the Notes to the Consolidated Financial Statements. NON-INTEREST INCOME Non-interest income decreased $90 thousand or 9.04% as of December 31, 1997 compared to the year ended December 31, 1996. However, excluding the securities gains, non-interest income increased $105 thousand or 13.2%. Increased service charges from increased levels of checks drawn against insufficient funds accounted for $46 thousand of the increase. Gain on life insurance of $31 thousand and $47 thousand increase in earnings from unconsolidated subsidiaries also contributed to the improvement in non-interest income. As of December 31, 1996, non-interest income increased $122 thousand or 13.9% over 1995. The increase was due primarily to a $204 thousand gain on the sale of Sallie Mae Stock. Service charges on deposit accounts increased $45 thousand reflecting increased levels of checks drawn against insufficient funds. Income of unconsolidated subsidiaries declined in 1996 to $25 thousand; a $92 thousand reduction from the prior year. See details in Note 7 in the Notes to Consolidated Financial Statements. For the year ended December 31, 1995, non-interest income increased $21 thousand or 2.4% compared to the prior year. The increase was due largely to an increase of $43 thousand in service charges on deposit accounts which were the result of increased levels of checks drawn against insufficient funds and was offset by a $51 thousand decrease in income of unconsolidated subsidiaries. NON-INTEREST EXPENSES The year ended December 31, 1997 reflected a $583 thousand increase or 15.4% when compared to the year ended December 31, 1996. A significant portion, or $248 thousand, of the increase is related to employee salaries and benefits. The number of full time equivalent employees increased by four when comparing the year ended December 31, 1997 to the same period in 1996. The Company added 3 full time staff positions as well as a branch manager position with the addition of the Kent Branch. Salaries and benefits also include cost of living increases and benefit cost increases. FDIC insurance premiums increased in 1997 with the inclusion of SAIF deposits from Kent Savings. Premises and fixed assets expenses continued to increase. Facility improvements and equipment upgrades resulted in increased depreciation expense, maintenance costs and equipment service contracts. This trend is expected to continue in 1998 when a 7 full year of depreciation expense will be recorded for the Commerce Street renovation. Renovations and expansions at three branch locations were completed in 1995 and increased the Bank's investment in premises. The Company began the Commerce Street renovation in January 1997, and anticipates completion of this office in 1998. Larger buildings require more maintenance and the additional investment will be depreciated over the estimated useful life of the asset. The impact of this additional expense is not expected to have a material effect on the Company's net income. Increases were noted in marketing and stationery and supplies. These areas of increased expense include costs associated with the promotion and establishment of the Kent Branch. In addition, the Company has adopted a full scale marketing program including direct mail, cable television commercial and product promotion. Marketing plays a significant role in banking today, more so than in the past. As the banking industry continues to consolidate, both banking and non-banking companies are competing much more aggressively. Direct competition for deposits comes from other commercial banks, savings banks, savings and loan associations, and credit unions as well as brokerage houses, mutual funds and the securities market. The Bank also competes with the same banking entities for loans, as well as with mortgage banking companies and institutional lenders. Significant growth was also noted in "Other expenses" primarily due to $106 thousand of goodwill amortization produced from the Kent Savings merger. Non-interest expenses increased slightly by $1 thousand or less than 1% for the year ended December 31, 1996 from the previous year. The minimal fluctuation in other non-interest expense is primarily the result of reduced FDIC premiums offsetting the increase in other costs. FDIC deposit insurance premiums were reduced in 1996 to unusually low levels since the fund surpassed it recapitalization goal. Increases in costs were noted for salaries and benefits as the result of the reflection of a full year of salaries for the employees who were added in 1995, increased benefit costs and cost of living adjustments. The number of full time equivalent staff as of December 31, 1996 did not change from the previous year. Non-interest expenses for the year ended December 31, 1995 reflected a slight increase of less than 1% over the prior year end as well. This increase was slowed as a result of a 50% reduction in FDIC premiums for 1995. The Company added one full-time and eight part-time employees to the staff during 1995. Part-time employees were hired to provide a consistent level of service to our customers during peak times. The increase in salaries and benefit costs, which includes cost of living adjustments for current staff, amounted to $71 thousand or 3.9%. Increases were also noted in postage expense, marketing expense and mortgage appraisal fees. Postage rate and volume increases accounted for a 27.2% increase in postage expense. INCOME TAXES For 1997, the effective tax rate for the Company decreased to 32.3% compared to 33.7% for 1996 and 31.1% for 1995. The reduction in effective tax rate in 1997 resulted from a $51 thousand rehabilitation tax credit. The Company's income tax expense differs from the amount computed at statutory rates primarily due to tax-exempt interest from certain loans and investment securities and, in 1997, the rehabilitation tax credit. Note 13 to the Consolidated Financial Statements includes a reconciliation of the Federal tax expense computed using the Federal Statutory rate of 34% and provides additional detail. The Company noted a decrease in State income taxes beginning in 1996 as the Maryland legislature exempted a portion of the interest from securities issued by the United States Treasury, bank-qualified Maryland Municipals, and some United States Government Agencies. This change in State income taxes has not had a material impact on liquidity, financial condition or operations. Deferred tax assets and liabilities are based on the differences between financial statement and tax bases of assets and liabilities. The tax effect of these differences is calculated using current statutory rates. Management believes more likely than not that all deferred taxes will be realized and therefore no valuation allowance is deemed necessary. INVESTMENT SECURITIES Investment securities classified as available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the asset/liability management strategy. Available for 8 sale securities are carried at market value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity net of income taxes. Investment securities classified as held to maturity are those that management has both the positive intent and ability to hold to maturity, and are reported at amortized cost. The Company does not currently follow a strategy of making securities purchases with a view to near-term sales, and, therefore, does not own trading securities. The Company manages the investment portfolios within policies which seek to achieve desired levels of liquidity, manage interest rate sensitivity risk, meet earnings objectives, and provide required collateral support for deposit activities. Total investment securities amounted to $48.7 million and $43.7 million as of December 31, 1997 and 1996, respectively. The higher level of investments in securities resulted primarily from the investment of $5 million in funds borrowed from the FHLB. Excluding the U.S. Government and U.S. Government sponsored agencies, the Company had no concentrations of investment securities from any single issues that exceeded 10% of shareholders' equity. Note 4 to the Consolidated Financial Statements provides detail by type and contractual maturity for the years ended December 31, 1997 and 1996. LOAN PORTFOLIO The Company is actively engaged in originating loans to customers in Queen Anne's, Caroline, Kent, and Talbot Counties in the State of Maryland. The Company has policies and procedures designed to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for credit losses. These policies, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan and the experience of the lending officer. Note 5 to the Consolidated Financial Statements presents the composition of the Company's loan portfolio by significant concentration. The Company had no loan concentrations exceeding 10% of total loans which are not otherwise disclosed. The Company policy is to make the majority of its loan commitments in the market area it serves. This tends to reduce risk because management is familiar with the credit histories of loan applicants and has an in-depth knowledge of the risk to which a given credit is subject. The Company had no foreign loans in its portfolio as of December 31, 1997. It is the policy of the Company to place a loan in non-accrual status whenever there is substantial doubt about the ability of a borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan and the overall economic situation of the borrower when making a non-accrual decision. Non-accrual loans are closely monitored by management . A non-accruing loan is restored to current status when the prospects of future contractual payments are no longer in doubt. At December 31, 1997 and 1996, $199 thousand and $872 thousand, respectively, of non-accrual loans were secured by collateral with an estimated value of $1.1 million as of December 31, 1997 and $1.8 million as of December 31, 1996. At December 31, 1997, the Company had $3.3 million in loans on the watch list for which payments were current, but the borrowers have the potential for experiencing financial difficulties. These loans are subject to on going management attention and their classifications are reviewed regularly. DEPOSITS Deposit liabilities grew $21.6 million or 17.4% to 145.8 million compared to $124.2 million in 1996. The Kent Savings merger provided $20.8 million in time, savings and IRA deposits at April 1, 1997. In addition, deposit growth of 8.2% and 18.6% in non-interest bearing demand deposits and interest-bearing transaction accounts, respectively, have exhibited strong growth compared to the year ended December 31, 1996. The Company continues to experience strong competition from other commercial banks, credit unions, the stock market and mutual funds. The Company has no foreign banking offices. 9 LIQUIDITY MANAGEMENT Liquidity describes the ability of the Company to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet borrower and depositer withdrawal requirements and to fund current and planned expenditures. The Company maintains its asset liquidity position internally through short term investments, the maturity distribution of the investment portfolio, loan repayments and income from earning assets. As indicated in the Consolidated Statement of Cash Flows a primary source of cash is maturity of investment securities. A substantial portion of the investment portfolio contains readily marketable securities that could be converted to cash immediately. Refer to Note 4 in the Consolidated Financial Statements for a table showing the maturity distribution of the Company's securities portfolio and the related estimated fair value. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. Other sources, not currently in use, are available through borrowings from the Federal Reserve Bank, the FHLB and from lines of credit approved at correspondent banks. As of December 31, 1997 the Company had outstanding loan commitments and unused lines of credit of $12.0 million. Of this total, management expects to fund $ 4 million within one year. Loan growth of $19.9 million or 22.4% and deposit growth of $21.6 million or 17.4% in 1997 primarily resulted from the Kent merger. Investment security growth was funded by the long-term borrowing from the Federal Home Loan Bank of Atlanta. Deposit growth of $7.7 million or 6.6% during the later part of 1996, was used primarily to fund the $1.8 million or 2.1% increase in loans and $6.6 million or 18.2% increase in amortized cost of securities. Management knows of no trend or event which will have a material impact on the Company's ability to maintain liquidity at satisfactory levels. MARKET RISK MANAGEMENT Market risk is the risk of loss that arises from changes in interest rates, foreign currency exchange prices, commodity prices, equity prices, and other market changes that affect market sensitive financial instruments. The Company's subsidiary's, The Centreville National Bank of Maryland, risk is composed primarily of interest rate risk, which is the exposure of the Bank's earnings and capital arising from future interest rate changes. This risk is a normal part of the banking business because assets and liabilities do not reprice at the same rate, nor do they move to the same degree as rates change. In addition, the maturity distribution of the Bank's assets and liabilities do not match for given periods of time. The Bank's Board of Directors has adopted an Asset Liability Management Policy, which is administered by the Asset Liability Committee of the Board of Directors. The Committee is responsible for monitoring the Bank's interest rate sensitivity position and recommending policies to the Board of Directors to limit exposure to interest rate risk while maximizing net interest income. The Bank uses earnings simulation modeling to measure the effect specific rate changes would have on one year of net interest income. Key assumptions include calls and maturities of investment securities, depositors' rate sensitivity, maturity dates of fixed rate loans and investment securities and repricing date of variable rate loans. As with any method of gauging risk, there are inherent shortcomings and actual results may deviate significantly from assumptions used in the model. Actual results will differ from simulated results due to timing , magnitude and frequency of interest-rate changes as well as changes in market conditions and management strategies. At December 31, 1997 the Bank's estimated earnings sensitivity profile reflected a modest sensitivity to interest rate changes. Based on an assumed 100 basis point immediate change in interest rates the Bank's net interest income would decrease by $142 thousand if rates were to increase by that amount and would increase $199 thousand if rates would decline a similar amount. CAPITAL RESOURCES AND ADEQUACY Total stockholders' equity increased $1.4 million or 6.4% in 1997 to $23.5 million at the end of the year from $22.1 million at December 31, 1996. Earnings of $2.4 million was the primary contributor to this increase. The change in unrealized gain (loss) on investments classified as available for sale accounted for a $26 thousand improvement and dividends paid reduced stockholders' equity $977 thousand. Total stockholders' equity as of December 31, 1996 increased $1.2 million compared to the prior year where $2.3 million in earnings provided the majority of the increase. The change 10 in unrealized gain on investments classified as available for sale accounted for a $134 thousand reduction and dividends paid also decreased stockholders' equity $927 thousand. One measure of capital adequacy is the leverage capital ratio which is calculated by dividing average total assets for the most recent quarter into Tier 1 capital. The regulatory minimum for this ratio is 4%. The leverage capital ratio as of December 31, 1997 was 12.23% for the Company, and as of December 31, 1996 was 14.86% for the Bank. Another measure of capital adequacy is the risk based capital ratio or the ratio of total capital to risk adjusted assets. Total capital is composed of both core capital (Tier 1) and supplemental capital (Tier 2) including adjustments for off balance sheet items such as letters of credit and taking into account the different degrees of risk among various assets. Regulators require a minimum total risk based capital ratio of 8%. As of December 31, 1997, the Company's ratio was 23.61%. The Bank's ratio at December 31, 1996 was 28.25%. According to FDIC capital guidelines, the Bank is considered to be "Well Capitalized." Building and technological improvements continued in 1997. Renovations at the Commerce street location were started and substantially complete during 1997. Costs were approximately $1.2 million which includes improvements, furniture and equipment. The Kent Branch was updated with equipment and technology during the second quarter of 1997. During 1995, the Company rebuilt the branch located on Route 213, south of Centreville, converting it to a full service facility with a lender and customer service representative on staff, safe deposit facilities, and an automated teller machine ("ATM".) In 1995, the Company also completed an addition to the Stevensville branch. Approximately 1,500 square feet of office space and a third drive-thru lane were built. A new drive up ATM was installed in the new addition. The funding sources for these projects are primarily cash, federal funds and maturities of investment securities. The Hillsboro office was purchased from Signet Bank on January 31, 1992, and the Branch operated in a leased building on Maryland Route 404 until December 1993, when the building was purchased by the Company. A thorough renovation of the site has since been completed. This project included the addition of an ATM, a drive thru window, additional office space and a new roof and heating plant. On December 5, 1996 the Company entered into an agreement to acquire Kent Savings and Loan Association, F.A.(Kent Savings) of Chestertown, Maryland. The effective date of the merger was April 1, 1997 and was accounted for as a purchase transaction. Under the terms of the agreement, the Company paid approximately $5.1 million for all of the outstanding shares of Kent Savings. As of March 31, 1997, total assets of Kent Savings were approximately $24.0 million and total stockholders' equity was approximately $2.9 million. Management knows of no other trend or event which will have a material impact on capital. Please also refer to Note 16 in the Consolidated Financial Statements for additional discussion of regulatory matters. FUTURE TRENDS The Year 2000 issue is a potential problem that is facing all users of automated information systems and equipment. The concern is that many computers and equipment are based on two digits for the year of the transaction (for example "97") rather than a full four digits. These systems may not operate effectively when the last two digits become "00", as occurs on January 1, 2000. This could result in a systems failure or miscalculations, causing disruptions in operations and the inability to process transactions or engage in similar normal business activity. This is not just a banking problem, as corporations and business around the world are similarly impacted. To mitigate the effects of the Year 2000 issue, the Company's subsidiary, The Centreville National Bank of Maryland, adopted a plan and formed an internal task force to identify and assess impact of the Year 2000 issues, test the systems, and determine and implement the needed changes. The Bank is coordinating its efforts with other entities with which it interacts including suppliers, customers, creditors, borrowers and financial service organizations. The Bank's primary supplier of data processing services also has adopted a Year 2000 plan and timetable. Based on assessments made to date, the total cost of the project is estimated to be approximately $170 thousand which is being funded through operating cash flows. The majority of the cost is attributable to purchase of equipment and software to replace those systems which cannot be made Year 2000 compliant. The equipment and software will be capitalized. Additional costs including staff time will be expensed in the normal course of business and will not have a material impact on the Company's results of operations, liquidity, capital resources or financial condition. 11 CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996
- ----------------------------------------------------------------------------------------------------------------------- 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 5,091,798 $ 4,872,866 Federal funds sold 3,503,900 5,389,874 Investment securities available for sale, at fair value 9,444,463 11,190,591 Investment securities held to maturity, fair value of $39,498,436 (1997) and $32,647,262 (1996) 39,298,105 32,462,156 Loans, less allowance for credit losses of $1,403,747 (1997) and $1,503,268 (1996) 107,763,536 87,389,489 Premises and equipment, net 3,258,876 2,153,126 Accrued interest receivable 1,475,994 1,385,474 Investment in unconsolidated subsidiaries 1,187,206 1,114,228 Goodwill 2,087,803 97,516 Other assets 2,003,330 844,157 - ----------------------------------------------------------------------------------------------------------------------- Total assets $175,115,011 $146,899,477 ======================================================================================================================= LIABILITIES Deposits: Noninterest-bearing demand $ 17,727,129 $ 16,380,740 Interest-bearing transaction 19,176,281 16,172,211 Savings and money market 37,575,341 31,799,398 Time, $100,000 or more 13,473,763 16,679,534 Other time 57,860,756 43,134,365 - ----------------------------------------------------------------------------------------------------------------------- Total deposits 145,813,270 124,166,248 Long-term debt 5,000,000 -- Accrued interest payable 189,276 158,000 Other liabilities 597,655 479,278 - ----------------------------------------------------------------------------------------------------------------------- Total liabilities 151,600,201 124,803,526 - ----------------------------------------------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY Common stock, $.01 par value; authorized 10,000,000 shares; issued 1,007,424 shares 10,074 10,074 Surplus 10,064,166 10,064,166 Retained earnings 13,480,311 12,087,317 Unrealized loss on investment securities available for sale, net of income tax (39,741) (65,606) - ----------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 23,514,810 22,095,951 - ----------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $175,115,011 $146,899,477 =======================================================================================================================
See notes to consolidated financial statements. 12 CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Interest and fees on loans $ 9,346,631 $ 8,103,983 $ 7,671,960 Interest and dividends on investment securities Taxable 2,286,192 1,834,979 2,156,513 Tax-exempt 417,895 424,202 543,148 Interest on federal funds sold 354,331 378,246 137,734 - ------------------------------------------------------------------------------------------------------------------------- Total interest income 12,405,049 10,741,410 10,509,355 - ------------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Interest on deposits 5,370,057 4,475,979 4,444,628 Interest on short-term borrowings -- -- 52,236 Interest on long-term debt 77,825 -- -- - ------------------------------------------------------------------------------------------------------------------------- Total interest expense 5,447,882 4,475,979 4,496,864 - ------------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 6,957,167 6,265,431 6,012,491 PROVISION FOR CREDIT LOSSES -- -- -- - ------------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 6,957,167 6,265,431 6,012,491 - ------------------------------------------------------------------------------------------------------------------------- NON-INTEREST INCOME Service charges on deposit accounts 664,708 639,631 594,201 Gains on sales of investment securities, net 8,568 203,997 37,808 Equity in net income of unconsolidated subsidiaries 72,978 25,884 118,120 Other income 162,795 129,911 127,257 - ------------------------------------------------------------------------------------------------------------------------- Total non-interest income 909,049 999,423 877,386 - ------------------------------------------------------------------------------------------------------------------------- NON-INTEREST EXPENSES Salaries and employee benefits 2,238,125 1,990,238 1,891,327 Premises and equipment expenses 577,544 552,368 466,572 Federal deposit insurance premiums 21,410 2,000 143,723 Marketing and promotion 142,101 92,450 66,909 Stationery, printing and supplies 160,037 120,105 129,983 Professional fees 114,601 175,957 130,030 Director and committee fees 195,007 178,054 189,132 Outside data processing 283,164 248,579 221,610 Other expenses 634,046 423,683 545,437 - ------------------------------------------------------------------------------------------------------------------------- Total non-interest expenses 4,366,035 3,783,434 3,784,723 - ------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE TAXES ON INCOME 3,500,181 3,481,420 3,105,154 FEDERAL AND STATE INCOME TAXES 1,129,983 1,173,678 966,654 - ------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 2,370,198 $ 2,307,742 $ 2,138,500 ========================================================================================================================= Basic earnings per common share $ 2.35 $ 2.29 $ 2.12 ========================================================================================================================= Diluted earnings per common share $ 2.35 $ 2.29 $ 2.12 =========================================================================================================================
See notes to consolidated financial statements. 13 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- ----------------------------------------------------------------------------------------------------------------------- Unrealized Gain (Loss) on Investment Securities Total Common Retained Available Stockholders' Stock Surplus Earnings for Sale Equity - ----------------------------------------------------------------------------------------------------------------------- Balances, January 1, 1995 $10,074 $ 10,064,166 $ 9,437,570 $(179,466 ) $19,332,344 Premium paid on stock redemption of unconsolidated subsidiary -- -- (13,353) -- (13,353) Net income -- -- 2,138,500 -- 2,138,500 Cash dividends, $.85 per share -- -- (856,310) -- (856,310) Change in unrealized gain (loss) on investment securities available for sale, net of income tax -- -- -- 248,167 248,167 - ----------------------------------------------------------------------------------------------------------------------- Balances, December 31, 1995 10,074 10,064,166 10,706,407 68,701 20,849,348 Net income -- -- 2,307,742 -- 2,307,742 Cash dividends, $.92 per share -- -- (926,832) -- (926,832) Change in unrealized gain (loss) on investment securities available for sale, net of income tax -- -- -- (134,307 ) (134,307) - ----------------------------------------------------------------------------------------------------------------------- Balances, December 31, 1996 10,074 10,064,166 12,087,317 (65,606 ) 22,095,951 Net income -- -- 2,370,198 -- 2,370,198 Cash dividends, $.97 per share -- -- (977,204) -- (977,204) Change in unrealized gain (loss) on investment securities available for sale, net of income tax -- -- -- 25,865 25,865 - ----------------------------------------------------------------------------------------------------------------------- Balances, December 31, 1997 $10,074 $ 10,064,166 $13,480,311 $ (39,741 ) $23,514,810 =======================================================================================================================
See notes to consolidated financial statements. 14 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,370,198 $ 2,307,742 $ 2,138,500 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 424,302 296,599 217,869 Equity in net income of unconsolidated subsidiaries (72,978) (25,844) (118,120) Provision for credit losses, net (114,521) 24,713 (2,946) Deferred income taxes 265,591 59,892 77,473 Net gains on sales of assets 37,920 (205,286) (32,882) Decrease (increase) in accrued interest receivable 10,317 (48,626) 114,543 (Increase) decrease in other assets (1,346,040) 34,117 (90,209) Increase (decrease) in accrued interest payable (118,486) 7,162 15,625 (Decrease) increase in other liabilities (88,744) (141,452) 129,884 - ------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 1,367,559 2,309,017 2,449,737 - ------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of investment securities held to maturity 16,220,939 752,344 3,241,328 Proceeds from maturities of investment securities available for sale 1,081,113 10,776,721 9,829,678 Proceeds from sale of investment securities available for sale 3,373,351 957,127 4,024,922 Purchase of investment securities held to maturity (22,899,682) (11,034,144) (582,784) Purchase of investment securities available for sale (1,693,125) (7,988,166) -- Decrease (increase) in loans, net 46,114 (1,963,160) (7,720,261) Purchase of premises and equipment (1,276,182) (210,521) (1,362,801) Proceeds from sale of premises and equipment 301 7,200 -- Investment in unconsolidated subsidiary -- (15,000) -- Purchase of other real estate owned -- -- (155,305) Proceeds from sale of other real estate owned -- 118,070 518,417 Acquisition, net of cash acquired (2,799,492) -- -- - ------------------------------------------------------------------------------------------------------------------------- Net cash (used) provided by investing activities (7,946,663) (8,599,529) 7,793,194 - ------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Increase (decrease) in demand, transaction, savings, and money market deposits 6,923,212 2,928,474 (7,688,139) (Decrease) increase in time deposits (6,033,946) 4,758,021 (816,701) Proceeds from long-term debt 5,000,000 -- -- Cash dividends paid (977,204) (926,832) (856,310) - ------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 4,912,062 6,759,663 (9,361,150) - ------------------------------------------------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (1,667,042) 469,151 881,781 Cash and cash equivalents at beginning of year 10,262,740 9,793,589 8,911,808 - ------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 8,595,698 $ 10,262,740 $ 9,793,589 ========================================================================================================================= Supplementary cash flow information: Interest paid $ 5,416,606 $ 4,468,817 $ 4,481,239 ========================================================================================================================= Income taxes paid $ 1,120,005 $ 1,099,707 $ 788,076 ========================================================================================================================= Noncash investing activities: Transfers from loans to other real estate owned $ -- $ (119,886) $ -- =========================================================================================================================
See notes to consolidated financial statements. 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 - -------------------------------------------------------------------------------- NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements include the accounts of Shore Bancshares, Inc. (the "Company") and its subsidiary, The Centreville National Bank of Maryland (the "Bank") with all significant intercompany transactions eliminated. The investment in subsidiary is recorded on the Company's books on the basis of its equity in the net assets of the subsidiary. The accounting and reporting policies of the Company conform to generally accepted accounting principles and to general practices in the banking industry. Certain reclassifications have been made to amounts previously reported to conform with the classifications made in 1997. NATURE OF OPERATIONS The Company, through its bank subsidiary, provides domestic financial services primarily in the Maryland counties of Queen Anne's, Kent and Caroline. The primary financial services include real estate, commercial and consumer lending, as well as traditional demand deposits and savings products. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. INVESTMENT SECURITIES Investment securities that management has the ability and intent to hold to maturity are classified as held to maturity and carried at cost, adjusted for amortization of premium and accretion of discounts. Other investment securities are classified as available for sale and are carried at estimated fair value. Unrealized gains and losses on investment securities available for sale, net of related deferred income taxes, are recognized as direct increases or decreases in stockholders' equity. The cost of investment securities sold is determined using the specific identification method. LOANS Loans are stated at the principal amount outstanding, net of unearned income. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company's policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. Fees charged and costs capitalized for originating mortgage loans are being amortized on the interest method over the term of the loan. ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is established through a provision for credit losses charged to expense. Loans are charged against the allowance for credit losses when management believes that the collectibility of the principal is unlikely. The allowance, based on evaluations of the collectibility of loans and prior loan loss experience, is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, 16 review of specific problem loans, and current economic conditions and trends that may affect the borrowers' ability to pay. While management believes it has established the allowance for credit losses in accordance with generally accepted accounting principles and has taken into account the views of its regulators and the current economic environment, there can be no assurance that in the future the Company's and Bank's regulators or its economic environment will not require further increases in the allowance. LONG-LIVED ASSETS Premises and equipment are stated at cost less accumulated depreciation. Depreciation of physical properties is computed on the straight-line method over the estimated useful lives of the properties. Expenditures for maintenance, repairs, and minor renewals are charged to operating expenses; expenditures for betterments are charged to the property accounts. Upon retirement or other disposition of properties, the carrying value and the related accumulated depreciation are removed from the accounts. Long-lived assets are evaluated regularly for other-than-temporary impairment. If circumstances suggest that their value may be impaired and the write-down would be material, an assessment of recoverability is performed prior to any write-down of the assets. Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, was adopted on January 1, 1996. Implementation of this standard did not have a significant impact on the Company's financial condition or results of operations. OTHER REAL ESTATE OWNED Real estate acquired in foreclosure of loans is carried at cost or fair value, less estimated costs of disposal, whichever is lower. Fair value is based on independent appraisals and other relevant factors. At the time of acquisition, any excess of loan balance over fair value is charged to the allowance for credit losses. Any subsequent reduction in value, as well as any operating expenses, are included in other operating expenses. INCOME TAXES Income tax expense is based on the results of operations, adjusted for permanent differences between items of income or expense reported in the financial statements and those reported for tax purposes. Under the liability method, deferred income taxes are determined based on the differences between the financial statement carrying amounts and the income tax bases of assets and liabilities and are measured at the enacted tax rates that will be in effect when these differences reverse. NEW ACCOUNTING STANDARDS In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES (FASB 125), which provides new accounting and reporting standards for sales, securitizations, and servicing of receivables and other financial assets and extinguishments of liabilities. FASB 125 is effective for transactions occurring after December 31, 1996, except for the provisions relating to repurchase agreements, securities lending and other similar transactions and pledged collateral, which have been delayed until after December 31, 1997 by FASB 127, DEFERRAL OF THE EFFECTIVE DATE OF CERTAIN PROVISIONS OF FASB STATEMENT NO. 125, AN AMENDMENT OF FASB 125. Adoption of FASB 125 was not material; FASB 127 will be adopted as required in 1998 and is not expected to be material. 17 In February 1997, Statement of Financial Accounting Standards No. 128, EARNINGS PER SHARE (FASB 128), was issued and establishes new standards for computing and presenting earnings per share. FASB 128 is effective for the Company's December 31, 1997 financial statements, including restatement of interim periods; earlier application was not permitted. The effect of the new standard did not have a material impact on previously reported earnings per share. For the three years ended December 31, 1997, the Company had no common stock equivalents outstanding. In June 1997, Statement of Financial Accounting Standards No. 130 REPORTING COMPREHENSIVE INCOME (FASB 130), was issued and establishes standards for reporting and displaying comprehensive income and its components. FASB 130 requires comprehensive income and its components, as recognized under the accounting standard, to be displayed in a financial statement with the same prominence as other financial statements. The Company plans to adopt the standard, as required, beginning in 1998; adoption of this disclosure requirement will not have a material impact on the Company. Statement of Financial Accounting Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION (FASB 131), also issued in June 1997, establishes new standards for reporting information about operating segments in annual and interim financial statements. The standard also requires descriptive information about the way the operating segments are determined, the products and services provided by the segments, and the nature of differences between reportable segment measurements and those used for the consolidated enterprise. This standard is effective for years beginning after December 15, 1997. Adoption in interim financial statements is not required until the year after initial adoption, however, comparative prior period information is required. The Company is evaluating the standard and plans adoption as required in 1998; adoption of this disclosure requirement will not have a material financial impact on the Company. CASH AND CASH EQUIVALENTS The Company has included cash and due from banks and federal funds sold as cash and cash equivalents for the purpose of reporting cash flows. NOTE 2 ACQUISITIONS On April 1, 1997 the Company completed the acquisition of Kent Savings and Loan Association for a purchase price of $5,111,000 in cash. The transaction was accounted for as a purchase and, therefore, results of operations subsequent to March 31, 1997 are included in the consolidated statements of income and cash flows from the date of acquisition. The excess cost over the estimated fair value of the tangible net assets acquired was approximately $2,107,000 and is being amortized on a straight-line basis over 15 years. In accordance with the accounting and disclosure requirements governed by Accounting Principles Board Opinion No. 16, BUSINESS COMBINATIONS, the following supplemental data is presented for the years ended December 31, 1997 and 1996. This pro forma combined information reflects the results of operations for the current and prior periods as though Shore Bancshares, Inc. and Kent Savings and Loan Association had been combined at the beginning of each respective period.
- ------------------------------------------------------------------------------------------------------------------- 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Interest income $ 12,875,319 $ 12,611,196 Net income 2,455,125 2,457,843 Diluted earnings per share 2.44 2.44 ===================================================================================================================
18 NOTE 3 FORMATION OF HOLDING COMPANY Shore Bancshares, Inc., a one-bank holding company, commenced operations on July 1, 1996 pursuant to a Plan of Reorganization and Agreement to Merge proposed by management and approved by the stockholders on April 16, 1996. Under the Plan, each outstanding share of Bank common stock was exchanged for two shares of holding company common stock. The Bank continues its banking business under its same name as a wholly owned subsidiary of the holding company. Comparative data in the accompanying consolidated financial statements for 1995 are those of the Bank, the sole subsidiary and predecessor of the Company, restated to reflect the exchange of shares. NOTE 4 INVESTMENT SECURITIES The amortized cost and fair value of investment securities at December 31, 1997 are as follows:
- ------------------------------------------------------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE U.S. Treasury securities $ 6,965,733 $ 48,176 $ -- $ 7,013,909 Obligations of U.S. Government agencies and corporations 465,328 9,448 (6) 474,770 U.S. Government Securities Mutual Fund 1,010,001 -- (122,367) 887,634 Federal Reserve Bank stock 302,250 -- -- 302,250 Federal Home Loan Bank of Atlanta stock 765,900 -- -- 765,900 - ------------------------------------------------------------------------------------------------------------- $ 9,509,212 $ 57,624 $(122,373) $ 9,444,463 =============================================================================================================
- ------------------------------------------------------------------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------ HELD TO MATURITY Obligations of U.S. Government agencies and corporations $ 29,088,534 $ 47,182 $(22,780) $ 29,112,936 Obligations of states and political subdivisions 10,209,571 185,246 (9,317) 10,385,500 - ------------------------------------------------------------------------------------------------------------ $ 39,298,105 $232,428 $(32,097) $ 39,498,436 ============================================================================================================
19 The amortized cost and fair value of investment securities at December 31, 1996 are as follows:
- --------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - --------------------------------------------------------------------------------------------------------------------- AVAILABLE FOR SALE U.S. Treasury securities $ 9,434,329 $ 29,394 $ (5,892) $ 9,457,831 U.S. Government Securities Mutual Fund 1,000,001 -- (130,391) 869,610 Federal Reserve Bank stock 302,250 -- -- 302,250 Federal Home Loan Bank of Atlanta stock 560,900 -- -- 560,900 - --------------------------------------------------------------------------------------------------------------------- $ 11,297,480 $ 29,394 $(136,283) $ 11,190,591 =====================================================================================================================
- --------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - --------------------------------------------------------------------------------------------------------------------- HELD TO MATURITY Obligations of U.S. Government and other government agencies and corporations $ 23,065,234 $104,548 $ (79,012) $ 23,090,770 Obligations of states and political subdivisions 9,396,922 182,088 (22,518) 9,556,492 - --------------------------------------------------------------------------------------------------------------------- $ 32,462,156 $286,636 $(101,530) $ 32,647,262 =====================================================================================================================
Gross realized gains and gross realized losses on sales of investment securities available for sale are as follows:
- -------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------- Gross realized gains: U.S. Treasury securities $ 8,103 $ -- $ 22,496 Obligations of U.S. Government agencies and corporations -- 7 540 Obligations of states and political subdivisions -- -- 26,218 Sallie Mae stock 2,313 203,990 -- - -------------------------------------------------------------------------------------------------------------------- 10,416 203,997 49,254 Gross realized losses: U.S. Treasury securities 325 -- 11,446 Obligations of U.S. Government agencies and corporations 1,524 -- -- - -------------------------------------------------------------------------------------------------------------------- Net realized gains $ 8,567 $ 203,997 $ 37,808 ====================================================================================================================
Proceeds from the sale of investment securities were $3,373,351, $957,127 and $7,266,250 for the years ended December 31, 1997, 1996 and 1995, respectively. 20 The amortized cost and fair value of investment securities by contractual maturity is as follows:
- ----------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1997 - ----------------------------------------------------------------------------------------------------------------- AVAILABLE-FOR-SALE HELD-TO-MATURITY - ----------------------------------------------------------------------------------------------------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE - ----------------------------------------------------------------------------------------------------------------- Amounts maturing: One year or less $ 2,091,729 $ 2,098,345 $ 10,161,118 $ 10,173,623 After one year through five years 5,020,609 5,062,859 21,296,112 21,378,018 After five years through ten years 124,421 127,032 7,840,875 7,946,795 After ten years 194,302 200,443 -- -- - ----------------------------------------------------------------------------------------------------------------- 7,431,061 7,488,679 39,298,105 39,498,436 Investments in equity securities and mutual funds 2,078,151 1,955,784 -- -- - ----------------------------------------------------------------------------------------------------------------- $ 9,509,212 $ 9,444,463 $ 39,298,105 $ 39,498,436 ================================================================================================================= - --------------------------------------------------------------------------------------------------------------------- December 31, 1996 - --------------------------------------------------------------------------------------------------------------------- Available-for-Sale Held-to-Maturity - --------------------------------------------------------------------------------------------------------------------- Amortized Fair Amortized Fair Cost Value Cost Value - --------------------------------------------------------------------------------------------------------------------- Amounts maturing: One year or less $ 1,995,501 $ 1,999,376 $ 7,938,425 $ 7,994,151 After one year through five years 7,438,828 7,458,455 21,151,094 21,239,667 After five years through ten years -- -- 3,372,637 3,413,444 - --------------------------------------------------------------------------------------------------------------------- 9,434,329 9,457,831 32,462,156 32,647,262 Investments in equity securities and mutual funds 1,863,151 1,732,760 -- -- - --------------------------------------------------------------------------------------------------------------------- $ 11,297,480 $ 11,190,591 $ 32,462,156 $ 32,647,262 =====================================================================================================================
The Company has pledged certain investment securities as collateral for deposits of certain government agencies and municipalities at December 31 as follows:
- ------------------------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Amortized cost $ 17,415,482 $ 19,554,281 Fair value 17,337,504 19,619,056 ==================================================================================================================
21 NOTE 5 LOANS AND ALLOWANCE FOR CREDIT LOSSES The Company makes loans to customers primarily in the Maryland counties of Queen Anne's, Kent and Caroline, in an economy closely tied to the agricultural industry. A substantial portion of the Company's loan portfolio consists of residential and commercial real estate mortgages. The Company's loan portfolio at December 31 is as follows:
- ----------------------------------------------------------------------------------------------------------- 1997 1996 - ----------------------------------------------------------------------------------------------------------- Real estate: Construction and land development $ 2,945,617 $ 3,263,710 Commercial 12,973,142 10,934,757 Residential 78,273,549 60,489,725 Commercial 8,352,569 7,739,069 Consumer 6,622,406 6,465,496 - ----------------------------------------------------------------------------------------------------------- 109,167,283 88,892,757 Less: Allowance for credit losses (1,403,747) (1,503,268) - ----------------------------------------------------------------------------------------------------------- Loans -- net $107,763,536 $87,389,489 ===========================================================================================================
Loans on which the accrual of interest has been discontinued amounted to approximately $199,000, $872,000, and $1,277,000 at December 31, 1997, 1996, and 1995, respectively. If interest on those loans had been accrued, such income would have approximated $33,000, $58,000 and $32,000 for 1997, 1996 and 1995, respectively. In the normal course of banking business, loans are made to officers and directors and their affiliated interests. In the opinion of management, these loans are consistent with sound banking practices, are within regulatory lending limitations, and do not involve more than the normal risk of collectibility. Loans outstanding to such parties totaled $1,673,000 and $2,023,000 at December 31, 1997 and 1996, respectively. During 1997, $206,000 of new loans were made and repayments totaled $555,000. 22 Changes in the allowance for credit losses are as follows:
- ------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------- Balance at beginning of year $1,503,268 $1,478,555 $1,481,501 - ------------------------------------------------------------------------------------------------------------- Recoveries: Real estate loans -- 10,421 51,164 Consumer loans 40,080 25,599 37,338 Commercial and other loans 4,330 66,791 13,998 - ------------------------------------------------------------------------------------------------------------- 44,410 102,811 102,500 - ------------------------------------------------------------------------------------------------------------- Allowance applicable to loans of acquired institution 15,000 -- -- - ------------------------------------------------------------------------------------------------------------- Provision for credit losses -- -- -- - ------------------------------------------------------------------------------------------------------------- Loans charged-off: Real estate loans (22,288) (10,421) (14,209) Consumer loans (99,441) (62,699) (70,687) Commercial and other loans (37,202) (4,978) (20,550) - ------------------------------------------------------------------------------------------------------------- (158,931) (78,098) (105,446) - ------------------------------------------------------------------------------------------------------------- Balance at end of year $1,403,747 $1,503,268 $1,478,555 =============================================================================================================
Impaired loans are accounted for in accordance with Statement of Financial Accounting Standards No. 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, as amended by Statement No. 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN -- INCOME RECOGNITION AND DISCLOSURES. Statement No. 114 requires that impaired loans, within its scope, be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. The statement excludes smaller balance and homogeneous loans such as consumer and residential mortgage loans from impairment reporting. Information with respect to impaired loans at December 31 is as follows:
- ------------------------------------------------------------------------------------------------------------- 1997 1996 - ------------------------------------------------------------------------------------------------------------- Impaired loans with a valuation allowance $ -- $ -- Impaired loans without a valuation allowance 199,070 872,136 - ------------------------------------------------------------------------------------------------------------- Total impaired loans $ 199,070 $ 872,136 ============================================================================================================= Allowance for credit losses related to impaired loans $ -- $ -- Allowance for credit losses related to other than impaired loans 1,403,747 1,503,268 - ------------------------------------------------------------------------------------------------------------- Total allowance for credit losses $ 1,403,747 $ 1,503,268 ============================================================================================================= Average impaired loans for the year $ 631,749 $ 1,116,933 ============================================================================================================= Interest income on impaired loans recognized on the cash basis $ 26,740 $ 33,949 =============================================================================================================
23 NOTE 6 PREMISES AND EQUIPMENT Premises and equipment at December 31 consist of the following:
- ----------------------------------------------------------------------------------------------------------- 1997 - ----------------------------------------------------------------------------------------------------------- ACCUMULATED COST DEPRECIATION NET - ----------------------------------------------------------------------------------------------------------- Land $ 265,914 $ -- $ 265,914 Buildings and land improvements 2,785,789 553,128 2,232,661 Furniture and equipment 1,695,669 935,368 760,301 - ----------------------------------------------------------------------------------------------------------- $ 4,747,372 $1,488,496 $ 3,258,876 ===========================================================================================================
- ---------------------------------------------------------------------------------------------------------------- 1996 - ---------------------------------------------------------------------------------------------------------------- Accumulated Cost Depreciation Net - ---------------------------------------------------------------------------------------------------------------- Land $ 206,514 $ -- $ 206,514 Buildings and land improvements 1,732,651 455,325 1,277,326 Furniture and equipment 1,479,717 810,431 669,286 - ---------------------------------------------------------------------------------------------------------------- $ 3,418,882 $1,265,756 $ 2,153,126 ================================================================================================================
NOTE 7 INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES The Company owns 33 1/3% of the outstanding common stock of the Delmarva Bank Data Processing Center, Inc. (DBDPC). The investment is carried at cost, adjusted for the Company's equity in the DBDPC's undistributed net income. The excess of cost over the Company's equity in the DBDPC's underlying net assets at dates of acquisition, amounting to $20,099, has been classified as goodwill and is being amortized on the straight-line method over 15 years. 24
- ------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------- Balance at beginning of year $ 934,831 $ 876,889 $ 748,776 Equity in net income 72,978 57,942 128,113 - ------------------------------------------------------------------------------------------------------------- Balance at end of year $ 1,007,809 $ 934,831 $ 876,889 =============================================================================================================
Data processing expense paid to this company totaled approximately $248,000, $211,000 and $197,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The Company owns 33 1/3% of the outstanding common stock of Eastern Shore Mortgage Corporation (ESMC). The investment is carried at cost, adjusted for the Company's equity in ESMC's undistributed net earnings. The excess of cost over the Company's equity in ESMC's underlying net assets at dates of acquisition, amounting to $48,085, has been classified as goodwill and is being amortized over 15 years. In June of 1995, ESMC redeemed another owner bank's interest. The transaction was treated as if ESMC was a consolidated subsidiary.
- ------------------------------------------------------------------------------------------------------------ 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------ Balance at beginning of year $ 179,397 $196,495 $219,841 Premium paid on stock redemption -- -- (13,353) Equity in net (loss) income -- (32,098) (9,993) Capital contribution -- 15,000 -- - ------------------------------------------------------------------------------------------------------------ Balance at end of year $ 179,397 $179,397 $196,495 ============================================================================================================
Interest income from this affiliate totaled approximately $39,000, $21,000 and $3,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Outstanding loans to this affiliate at December 31, 1997 totaled $859,400. NOTE 8 DEPOSITS Certificates of deposit in amounts of $100,000 or more and their remaining maturities at December 31 are as follows:
- ------------------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------------ Three months or less $ 2,359,614 $ 7,769,309 Three months through twelve months 5,613,156 4,971,491 Over twelve months 5,500,993 3,938,734 - ------------------------------------------------------------------------------------------------------------ $ 13,473,763 $ 16,679,534 ============================================================================================================
Interest expense on deposits for each of the years ended December 31 is as follows:
- -------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- Interest bearing transaction $ 510,209 $ 489,827 $ 458,095 Savings and money market 1,223,276 1,027,146 1,156,768 Time, $100,000 or more 786,304 705,707 727,049 Other time 2,850,268 2,253,299 2,102,716 - -------------------------------------------------------------------------------------------------------------- $ 5,370,057 $ 4,475,979 $ 4,444,628 ==============================================================================================================
25 At December 31, 1997 and 1996, the Company had deposits of approximately $4,500,000 and $9,000,000, respectively, from a local County government. NOTE 9 SHORT-TERM BORROWINGS The Company has commitments from correspondent banks under which it can purchase up to $7,000,000 in federal funds and secured reverse repurchase agreements on a short-term basis. No borrowings were outstanding under these arrangements during 1997 or 1996. NOTE 10 LONG-TERM DEBT As of December 31, 1997, the Company had received a convertible advance from the Federal Home Loan Bank of Atlanta in the amount of $5,000,000 at an interest rate of 5.66%. The advance is callable September 24, 1999 and is due September 24, 2002. The Bank has pledged its wholly owned residential first mortgage loan portfolio under a blanket floating lien as collateral for this advance. NOTE 11 RETIREMENT PLAN The Company has a 401(k) profit sharing plan covering substantially all full-time employees. The plan requires the Company to match 50% of employee contributions of up to 6% of compensation as defined under the plan and permits additional contributions at the discretion of management. Expense under this plan totaled $130,000, $137,330, and $125,100 for the years ended December 31, 1997, 1996 and 1995, respectively. NOTE 12 DEFERRED COMPENSATION The Company has agreements with certain directors under which they have agreed to defer 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:
- ------------------------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Cash surrender value $ 1,654,838 $ 466,682 Accrued benefit obligations 529,106 466,682 ==================================================================================================================
26 NOTE 13 INCOME TAXES Components of income tax expense for each of the years ended December 31 are as follows:
- -------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- Currently payable: Federal $ 773,337 $ 929,996 $ 698,011 State 171,201 183,790 191,170 - -------------------------------------------------------------------------------------------------------------- 944,538 1,113,786 889,181 - -------------------------------------------------------------------------------------------------------------- Deferred income taxes: Federal 151,833 49,036 63,431 State 33,612 10,856 14,042 - -------------------------------------------------------------------------------------------------------------- 185,445 59,892 77,473 - -------------------------------------------------------------------------------------------------------------- $ 1,129,983 $ 1,173,678 $ 966,654 ==============================================================================================================
Components of the Company's deferred tax assets and liabilities at December 31 are as follows:
- ------------------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------------ Deferred tax assets: Allowance for credit losses $ 161,513 $ 247,710 Deferred compensation 132,213 144,207 Interest income 2,525 -- Unrealized loss on investment securities available for sale 25,009 41,283 - ------------------------------------------------------------------------------------------------------------ Total deferred tax assets 321,260 433,200 - ------------------------------------------------------------------------------------------------------------ Deferred tax liabilities: Cash to accrual conversion 53,356 -- Discount accretion 44,517 51,330 Depreciation 54,639 19,979 Federal Home Loan Bank dividends 27,613 -- Undistributed income of unconsolidated subsidiaries 59,824 57,228 Unearned income -- 23,386 Loan origination fees and costs 14,058 12,305 - ------------------------------------------------------------------------------------------------------------ Total deferred tax liabilities 254,007 164,228 - ------------------------------------------------------------------------------------------------------------ Net deferred tax assets $ 67,253 $ 268,972 ============================================================================================================
27 A reconciliation between income tax expense and taxes computed at the maximum statutory federal rate for 1997, 1996 and 1995 is as follows:
- -------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- PERCENT Percent Percent OF of of PRETAX Pretax Pretax AMOUNT INCOME Amount Income Amount Income - -------------------------------------------------------------------------------------------------------------- Computed at statutory rate $1,190,178 34.0% $1,183,683 34.0% $1,055,752 34.0% Increases (decreases) in tax resulting from: Tax-exempt interest income (130,930) (3.7) (138,947) (4.0) (165,491) (5.3) State income taxes, net of federal income tax benefit 101,760 2.9 128,157 3.7 135,440 4.4 Earnings of unconsolidated subsidiaries (9,139) (.3) (7,030) (.2) (40,160) (1.3) Goodwill amortization 37,211 1.1 -- .0 -- .0 Rehabilitation tax credit (51,245) (1.5) -- .0 -- .0 Other -- net (7,852) (.2) 7,815 .2 (18,887) (.7) - -------------------------------------------------------------------------------------------------------------- Actual tax expense $1,129,983 32.3% $1,173,678 33.7% $ 966,654 31.1% ==============================================================================================================
NOTE 14 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments may include commitments to extend credit, standby letters of credit and purchase commitments. The Company uses these financial instruments to meet the financing needs of its customers. Financial instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks and management does not anticipate any losses which would have a material effect on the accompanying financial statements. Outstanding loan commitments and lines and letters of credit at December 31 are as follows:
- ------------------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------------ Loan commitments $ 1,440,050 $ 1,312,155 ============================================================================================================ Unused lines of credit $ 10,853,207 $ 10,178,434 ============================================================================================================ Letters of credit $ 1,769,618 $ 1,786,024 ============================================================================================================
28 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments. The collateral is based on management's credit evaluation of the counterparty. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Each customer's credit-worthiness is evaluated on a case-by-case basis. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. NOTE 15 FAIR VALUE OF FINANCIAL INSTRUMENTS The following table shows the carrying values and the related estimated fair value of the Bank's financial instruments at December 31:
- ------------------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------------ CARRYING FAIR Carrying Fair AMOUNT VALUE Amount Value - ------------------------------------------------------------------------------------------------------------ Financial assets: Cash and due from banks $ 8,595,698 $ 8,595,698 $ 4,872,866 $ 4,872,866 Federal funds sold 3,503,900 3,503,900 5,389,874 5,389,874 Investment securities available for sale 9,444,463 9,444,463 11,190,591 11,190,591 Investment securities held to maturity 39,298,105 39,498,436 32,462,156 32,647,262 Loans, net of allowance for credit losses 107,763,536 110,420,000 87,389,489 88,637,000 Accrued interest receivable 1,475,994 1,475,994 1,385,474 1,385,474 Financial liabilities: Deposits 145,813,270 145,907,000 124,166,248 124,185,000 Accrued interest payable 189,276 189,276 158,000 158,000 Long-term debt 5,000,000 4,921,000 -- -- Unrecognized financial instruments: Commitments to extend credit 12,293,257 12,293,257 11,490,589 11,490,589 Standby letters of credit 1,769,618 1,769,618 1,786,024 1,786,024 ============================================================================================================
For purposes of the above disclosures of estimated fair value, the following assumptions were used. The estimated fair value for cash and due from banks and federal funds sold is considered to approximate cost. The estimated fair value for securities available for sale and securities held to maturity are based on quoted market values from the individual securities or for equivalent securities. The estimated fair value of loans is determined by discounting future cash flows using current rates at which similar loans would be made to 29 borrowers with similar credit ratings and for the same remaining maturities. The estimated fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The estimated fair value of fixed maturity certificates of deposits is estimated using the rates currently offered for deposits of similar remaining maturities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the company. Other assets, such as property and equipment, and certain liabilities of the Company that are not defined as financial instruments are not included in the above disclosures. Also, nonfinancial instruments typically not recognized in the financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the trained work force, customer goodwill, and similar items. NOTE 16 REGULATORY MATTERS The Company is required to maintain noninterest-bearing deposits with the Federal Reserve Bank. During 1997 and 1996, the daily average balances were approximately $2,247,000 and $2,095,000, respectively. The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitive measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitive measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997, that the Company and the Bank meet all capital adequacy requirements to which it is subject. 30 As of December 31, 1997, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. Because total assets of the Company exceeded $150 million during 1997, amounts and ratios are presented for both the Bank and the consolidated Company.
- ---------------------------------------------------------------------------------------------------------------- To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions - ---------------------------------------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio - ---------------------------------------------------------------------------------------------------------------- As of December 31, 1997: Total Capital (to Risk Weighted Assets): Company $22,633,000 23.61% $7,669,000 8.00% $9,586,000 10.00% Bank $22,482,000 23.91% $7,523,000 8.00% $9,403,000 10.00% Tier I Capital (to Risk Weighted Assets): Company $21,432,000 22.35% $3,836,000 4.00% $5,754,000 6.00% Bank $21,304,000 22.66% $3,761,000 4.00% $5,641,000 6.00% Tier I Capital (to Average Assets): Company $21,432,000 12.23% $7,010,000 4.00% $8,762,000 5.00% Bank $21,304,000 12.16% $7,008,000 4.00% $8,760,000 5.00% As of December 31, 1996: (Bank only) Total Capital (to Risk Weighted Assets) $21,793,000 28.25% $6,171,000 8.00% $7,713,000 10.00% Tier I Capital (to Risk Weighted Assets) $21,936,000 28.44% $3,085,000 4.00% $4,628,000 6.00% Tier I Capital (to Average Assets) $21,936,000 14.86% $5,905,000 4.00% $7,413,000 5.00% ================================================================================================================
Banking regulations also limit the amount of dividends that may be paid without prior approval of the Bank's regulatory agencies. Regulatory approval is required to pay dividends which exceed the Bank's net profits for the current year plus its retained net profits for the preceding two years. The amount of dividends that the Bank could have paid to the Company without approval from bank regulatory agencies at December 31, 1997 was $4,017,000. 31 NOTE 17 PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Shore Bancshares, Inc. (Parent Company only) is as follows:
- ------------------------------------------------------------------------------------------- CONDENSED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 - ------------------------------------------------------------------------------------------- 1997 1996 - ------------------------------------------------------------------------------------------- ASSETS Investment in subsidiary $ 23,475,091 $ 22,099,022 Other assets 39,719 43,454 - ------------------------------------------------------------------------------------------- TOTAL ASSETS $ 23,514,810 $ 22,142,476 =========================================================================================== LIABILITIES -- Accounts payable $ -- $ 46,525 - ------------------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY Common stock 10,074 10,074 Surplus 10,064,166 10,064,166 Retained earnings 13,440,570 12,021,711 - ------------------------------------------------------------------------------------------- Total stockholders' equity 23,514,810 22,095,951 - ------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 23,514,810 $ 22,142,476 =========================================================================================== CONDENSED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 - ------------------------------------------------------------------------------------------- 1997 1996 - ------------------------------------------------------------------------------------------- INCOME -- Dividends from subsidiary $ 1,025,855 $ 926,832 OPERATING EXPENSES 9,944 4,652 - ------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAX BENEFIT AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 1,015,911 922,180 INCOME TAX BENEFIT 3,382 1,582 - ------------------------------------------------------------------------------------------- INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 1,019,293 923,762 EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 1,350,905 1,383,980 - ------------------------------------------------------------------------------------------- NET INCOME $ 2,370,198 $ 2,307,742 =========================================================================================== CONDENSED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 - ------------------------------------------------------------------------------------------- 1997 1996 - ------------------------------------------------------------------------------------------- NET INCOME $ 2,370,198 $ 2,307,742 - ------------------------------------------------------------------------------------------- ADJUSTMENT TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Equity in undistributed income of subsidiary (1,350,905) (1,383,980) Net decrease (increase) in other assets 4,435 (43,455) Net decrease (increase) in accounts payable (46,525) 46,525 - ------------------------------------------------------------------------------------------- Net cash provided by operating activities 977,203 926,832 CASH FLOWS FROM FINANCING ACTIVITIES -- Dividends paid (977,203) (926,832) - ------------------------------------------------------------------------------------------- CASH AT BEGINNING OF YEAR -- -- - ------------------------------------------------------------------------------------------- CASH AT END OF YEAR $ -- $ -- ===========================================================================================
32 [GRAPHIC LOGO GOES HERE] INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors Shore Bancshares, Inc. Centreville, Maryland We have audited the accompanying consolidated balance sheets of Shore Bancshares, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended. 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. The financial statements of Shore Bancshares, Inc. for the year ended December 31, 1995 were audited by other auditors whose report dated January 18, 1996, expressed an unqualified opinion on those statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Shore Bancshares, Inc. as of December 31, 1997 and 1996, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ Stegman & Company _____________________ Baltimore, Maryland January 10, 1998 33 AVERAGE BALANCES, YIELDS AND RATES (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------- FOR THE YEAR ENDED DECEMBER 31, 1997 For the Year Ended December 31, 1996 - ------------------------------------------------------------------------------------------------------------------------- AVERAGE INCOME/ YIELD/ Average Income/ Yield/ BALANCE EXPENSE RATE Balance Expense Rate - ------------------------------------------------------------------------------------------------------------------------- ASSETS Interest earning assets: Money market investments: Federal funds sold $ 6,493,959 $ 354,331 5.46% $ 7,095,343 $ 378,246 5.33% Investment securities: U.S. Treasury securities and obligations of U.S. government agencies 32,996,468 2,102,149 6.37 27,640,017 1,703,420 6.16 Obligations of States and political subdivisions(1) 8,858,428 673,659 7.60 8,896,963 683,213 7.68 All other investment securities 2,396,970 143,558 5.99 1,387,606 91,075 6.56 - ------------------------------------------------------------------------------------------------------------------------- Total investment securities 44,251,866 2,919,366 6.60 37,924,586 2,477,708 6.53 Loans, net of unearned income(2)(3) Commercial loans 9,293,896 982,599 10.57 10,263,061 1,074,769 10.47 Installment loans 5,264,677 536,637 10.19 5,097,131 512,414 10.05 Mortgage loans 89,183,164 7,827,395 8.78 73,406,929 6,516,800 8.88 - ------------------------------------------------------------------------------------------------------------------------- Total loans 103,741,737 9,346,631 9.01 88,767,121 8,103,983 9.13 - ------------------------------------------------------------------------------------------------------------------------- TOTAL INTEREST EARNING ASSETS 154,487,562 $ 12,620,328 8.17% 133,787,050 $ 10,959,937 8.19% Cash and due from banks 4,012,120 3,589,220 Other assets 8,641,143 5,503,965 Allowance for loan and lease losses (1,445,147) (1,469,856) - ------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $165,695,678 $141,410,379 ========================================================================================================================= LIABILITIES Interest-bearing liabilities Super NOW accounts $ 17,214,551 $ 510,209 2.96% $ 16,022,439 $ 489,828 3.06% Money market deposit account 21,027,750 702,261 3.34 19,112,185 639,654 3.35 Time, $100,000 or more 13,297,892 704,290 5.30 11,632,139 633,460 5.45 Other time deposits 41,023,454 2,135,522 5.21 30,099,425 1,582,081 5.26 IRA deposits 14,732,561 796,760 5.41 14,451,599 738,622 5.11 Savings deposits 16,636,078 521,015 3.13 12,324,479 392,334 3.18 Other borrowed funds 1,356,164 77,825 5.74 -- -- -- - ------------------------------------------------------------------------------------------------------------------------- TOTAL INTEREST BEARING LIABILITIES 125,288,450 5,447,882 4.35% 103,642,266 4,475,979 4.32% Demand deposits 16,216,396 15,303,365 Other liabilities 1,401,009 838,440 - ------------------------------------------------------------------------------------------------------------------------- Total liabilities 142,905,855 119,784,071 Stockholders' equity 22,789,823 21,626,308 - ------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $165,695,678 $141,410,379 ========================================================================================================================= Net interest income and interest rate spread $ 7,172,446 3.82% $ 6,483,958 3.87% Net interest income as a percent of earning assets 4.64% 4.85% ========================================================================================================================= For the Year Ended December 31, 1995 - ----------------------------------------------------------------------------- Average Income/ Yield/ Balance Expense Rate - ----------------------------------------------------------------------------- ASSETS Interest earning assets: Money market investments: Federal funds sold $ 2,354,943 $ 137,734 5.85% Investment securities: U.S. Treasury securities and obligations of U.S. government agencies 34,441,007 2,063,641 5.99 Obligations of States and political subdivisions(1) 10,025,129 822,951 8.21 All other investment securities 1,288,757 92,872 7.21 - ----------------------------------------------------------------------------- Total investment securities 45,754,893 2,979,464 6.51 Loans, net of unearned income(2)(3) Commercial loans 11,031,642 1,156,962 10.49 Installment loans 4,217,507 437,422 10.37 Mortgage loans 69,008,142 6,077,576 8.81 - ----------------------------------------------------------------------------- Total loans 84,257,291 7,671,960 9.11 - ----------------------------------------------------------------------------- TOTAL INTEREST EARNING ASSETS 132,367,127 $ 10,789,158 8.15% Cash and due from banks 3,431,939 Other assets 4,984,475 Allowance for loan and lease losses (1,470,381) - ----------------------------------------------------------------------------- TOTAL ASSETS $139,313,160 ============================================================================= LIABILITIES Interest-bearing liabilities Super NOW accounts $ 14,763,485 $ 458,095 3.10% Money market deposit account 20,708,692 704,005 3.40 Time, $100,000 or more 13,801,000 650,745 4.72 Other time deposits 26,826,207 1,370,902 5.11 IRA deposits 14,038,374 804,030 5.73 Savings deposits 13,868,563 456,851 3.29 Other borrowed funds 817,945 52,236 6.39 - ----------------------------------------------------------------------------- TOTAL INTEREST BEARING LIABILITIES 104,824,266 4,496,864 4.29% Demand deposits 13,400,204 Other liabilities 770,078 - ----------------------------------------------------------------------------- Total liabilities 118,994,548 Stockholders' equity 20,318,612 - ----------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $139,313,160 ============================================================================= Net interest income and interest rate spread $ 6,292,294 3.86% Net interest income as a percent of earning assets 4.75%
============================================================================= 1. All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate exclusinve of the alternative minimum tax rate of 34% and nondeductible interest expense. 2. Loan fee income is included in interest income for each loan category and yields are stated to include all. 3. Balances of nonaccrual loans and related income have been included for computational purposes. 34 RATE AND VOLUME VARIANCE ANALYSIS (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- 1997 COMPARED TO 1996 1996 compared to 1995 - ----------------------------------------------------------------------------------------------------------------------------- CHANGE DUE TO Change due to INCREASE Increase INTEREST INCOME (DECREASE) RATE(2) VOLUME (Decrease) Rate(2) Volume - ----------------------------------------------------------------------------------------------------------------------------- Federal funds sold $ (23,915) $ 8,144 $ (32,059) $ 240,512 $(36,741) $ 277,253 - ----------------------------------------------------------------------------------------------------------------------------- Total money market investments (23,915) 8,144 (32,059) 240,512 (36,741) 277,253 - ----------------------------------------------------------------------------------------------------------------------------- U.S. Treasury securities and obligations of U.S. government agencies 398,729 68,618 330,111 (360,221) 47,282 (407,503) Tax-exempt obligations of State and political subdivisions(1) (9,554) (6,595) (2,959) (139,738) (47,128) (92,610) All other investment securities 52,483 (13,766) 66,249 (1,797) (8,920) 7,123 - ----------------------------------------------------------------------------------------------------------------------------- Total investment securities 441,658 48,257 393,401 (501,756) (8,766) (492,990) - ----------------------------------------------------------------------------------------------------------------------------- Commercial loans (92,170) 9,323 (101,493) (82,193) (1,587) (80,606) Installment loans 24,223 7,380 16,843 74,992 (16,239) 91,231 Mortgage loans 1,310,595 (89,962) 1,400,557 439,224 51,821 387,403 - ----------------------------------------------------------------------------------------------------------------------------- Total loans(3) 1,242,648 (73,259) 1,315,907 432,023 33,995 398,028 - ----------------------------------------------------------------------------------------------------------------------------- Total interest income $1,660,391 $(16,858) $1,677,249 $ 170,779 $(11,512) $ 182,291 ============================================================================================================================= INTEREST EXPENSE Super NOW accounts $ 20,381 $(16,064) $ 36,445 $ 31,733 $ (7,331) $ 39,064 Money market deposit accounts 62,607 (1,504) 64,111 (64,351) (10,077) (54,274) Time deposits of $100,000 or more 70,830 (19,883) 90,713 (17,285) 84,981 (102,266) Other time deposits 553,441 (20,746) 574,187 211,179 43,907 167,272 IRA deposits 58,138 43,778 14,360 (65,408) (89,075) 23,667 Savings deposits 128,681 (8,573) 137,254 (64,517) (13,653) (50,864) Other borrowed funds 77,825 -- 77,825 (52,236) -- (52,236) - ----------------------------------------------------------------------------------------------------------------------------- Total interest expense $ 971,903 $(22,992) $ 994,895 $ (20,885) $ 8,752 $ (29,637) ============================================================================================================================= Net interest margin/income $ 688,488 $ 6,134 $ 682,354 $ 191,664 $(20,264) $ 211,928 =============================================================================================================================
1. Income and yields are computed on a tax equivalent basis using the statutory federal income tax rate of 34%, exclusive of the alternative minimum tax and nondeductible interest expense. 2. Variances caused by the change in yield/rate times the average balance are allocated to rate. 3. Balances of nonaccrual loans and related income have been included for computational purposes. 35 MARKET PRICE OF AND DIVIDENDS ON REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION There is no established public trading market for the Company's Shares. Accordingly, there is no comprehensive record of trades of the prices of any such trades. The following table reflects stock prices for Company Shares (and shares of common stock prior to the Company's formation and acquisition of the Bank in July, 1996), to the extent such information is available to management of the Company.
- ----------------------------------------------------------------------------------- 1997 - ----------------------------------------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER - ----------------------------------------------------------------------------------- HIGH LOW HIGH LOW HIGH LOW HIGH LOW $35.50 $33.00 $36.50 $35.00 $40.00 $33.00 $44.00 $40.50 =================================================================================== - ----------------------------------------------------------------------------------- 1996 - ----------------------------------------------------------------------------------- 1st Quarter* 2nd Quarter* 3rd Quarter 4th Quarter - ----------------------------------------------------------------------------------- High Low High Low High Low High Low $22.00 $20.50 $26.00 $22.00 $29.00 $26.00 $30.00 $27.50 ===================================================================================
* Prices adjusted for 2 for 1 conversion to Shore Bancshares, Inc. July 1, 1996. HOLDERS As of March 7, 1998, a total of 1,007,424 shares of Shore Bancshares, Inc. common stock was held by approximately 963 registered and beneficial owners. DIVIDENDS The Company declared and paid a cash dividend per Share totaling $.97 per share or $977,201 for the year 1997 and $.92 per share or $926,832 for 1996. On March 11, 1997, the Board of Directors declared a dividend to be paid March 20, 1997, at the rate of $0.23 per share to stockholders of record as of March 10, 1997. In the second quarter, a $0.23 per share dividend was declared on June 10, 1997 for holders of record as of June 10, 1997 and the dividend was paid June 20, 1997. On September 2, 1997, a $0.23 per share dividend was announced to be paid on September 19, 1997 to stockholders of record September 10, 1997. Shareholders of record on December 10, 1997 were paid a $0.28 per share dividend on December 19, 1997 as declared by the Board of Directors of the Company on December 2, 1997. The Board of Directors of Shore Bancshares, Inc. declared a dividend on March 5, 1996 of $.35 per share to be paid on March 20, 1996 to holders of record March 11, 1996. On June 11, 1996 a dividend of $0.35 per share was approved to be paid on June 20, 1996, to stockholders of record as of June 11, 1996. In the third quarter, an $.18 per share dividend was announced on September 3, 1996, to be paid September 20, 1996 to stockholders of record September 10, 1996. The final dividend in 1996 of $.39 per share was declared December 10, 1996 for holders of record December 10, 1996 and was paid on December 20, 1996. There are no contractual restrictions that currently limit the Company's ability to pay dividends or that the Company reasonably believes are likely to limit materially the future payment of dividends on the Company's Shares. 36 DIRECTORS Shore Bancshares, Inc. - -------------------------------------------------------------------------------- Sydney G. Ashley Mark M. Freestate ASSOCIATE, ASHLEY BROTHERS REAL ESTATE COMPANY AND PRESIDENT, W.M. FREESTATE & SON, INC. GENERAL PARTNER, HUNT-RAY FARMS Neil R. LeCompte J. Robert Barton CERTIFIED PUBLIC ACCOUNTANT, OFFICE OF NEIL R. RETIRED PRESIDENT AND CEO, THE CENTREVILLE NATIONAL LECOMPTE BANK OF MARYLAND Jerry F. Pierson David C. Bryan PRESIDENT, JERRY F. PIERSON, INC. MEMBER, LAW OFFICES OF FOUNTAIN, BRYAN AND RITTER, LLC Wm. Maurice Sanger Daniel T. Cannon PRESIDENT, F.W., INC. PRESIDENT, SHORE BANCSHARES, INC. PRESIDENT, CLOVERBAY DEVELOPMENT CORPORATION PRESIDENT AND CEO, THE CENTREVILLE NATIONAL BANK OF MARYLAND Walter E. Schmidt VICE PRESIDENT, SCHMIDT VENTURES, INC. B. Vance Carmean, Jr. PRESIDENT, CARMEAN GRAIN, INC. The Centreville National Bank of Maryland - ----------------------------------------------------------------------------------------------------------------------- Sydney G. Ashley Mark M. Freestate ASSOCIATE, ASHLEY BROTHERS REAL ESTATE COMPANY PRESIDENT, W.M. FREESTATE & SON, INC. AND GENERAL PARTNER, HUNT-RAY FARMS Neil R. LeCompte J. Robert Barton CERTIFIED PUBLIC ACCOUNTANT, ACCOUNTING OFFICE OF NEIL RETIRED PRESIDENT AND CEO, THE CENTREVILLE NATIONAL R. LECOMPTE BANK OF MARYLAND Susanne K. Nuttle Paul M. Bowman RETIRED VICE PRESIDENT, THE CENTREVILLE NATIONAL BANK ATTORNEY, LAW OFFICE OF PAUL M. BOWMAN OF MARYLAND David C. Bryan Jerry F. Pierson MEMBER, LAW OFFICES OF FOUNTAIN, BRYAN AND RITTER, LLC PRESIDENT, JERRY F. PIERSON, INC. Daniel T. Cannon Wm. Maurice Sanger PRESIDENT, SHORE BANCSHARES, INC. PRESIDENT, F.W., INC. PRESIDENT AND CEO, THE CENTREVILLE NATIONAL BANK OF PRESIDENT, CLOVERBAY DEVELOPMENT CORPORATION MARYLAND Walter E. Schmidt B. Vance Carmean, Jr. VICE PRESIDENT, SCHMIDT VENTURES, INC. PRESIDENT, CARMEAN GRAIN, INC.
DIRECTORS EMERITI The Centreville National Bank of Maryland - -------------------------------------------------------------------------------- Madison B. Bordley, Jr. William H. Harris James O. Pippin, Jr. Royden N. Powell, Jr. William E. Sylvester William E. Thompson Howard Wood 37 OFFICERS (as of March 1, 1998) SHORE BANCSHARES, INC. Walter E. Schmidt..........................................Chairman of the Board Sydney G. Ashley.....................................Vice President of the Board Daniel T. Cannon.......................................................President Carol I. Brownawell....................................................Treasurer Mary C. Quimby.........................................................Secretary THE CENTREVILLE NATIONAL BANK OF MARYLAND Daniel T. Cannon...................................................President/CEO Carol I. Brownawell.................................Executive Vice President/CFO Timothy J. Berrigan...............................................Vice President Thomas E. Beery...................................................Vice President Rita B. Mielke............................................Vice President/Cashier Pamela C. Satchell................................................Vice President Carolyn D. Spicher................................................Vice President David E. Thompson.................................................Vice President Ralph F. Twilley..................................................Vice President Katharine M. Crook......................................Assistant Vice President William E. Stoops.......................................Assistant Vice President Kathryn C. Walls........................................Assistant Vice President Brenda M. Beaver...............................................Assistant Cashier Elizabeth T. Clough............................................Assistant Cashier Lorrie S. Greenwood............................................Assistant Cashier Florance R. Walls..............................................Assistant Cashier 38 THE CENTREVILLE NATIONAL BANK OF MARYLAND EMPLOYEES (as of March 1, 1998) - -------------------------------------------------------------------------------- Maryanne C. Alderson Barri G. Horney Janice S. Barkley Josephine C. Hutchins Joyce D. Bradley Constance M. Lee Laura C. Bradley Edith P. Legg Gertrude E. Brown Cortney L. Moore Phyllis B. Carroll Joyce S. Moore Lois F. Carter Laura E. Nier Mary Ann Cheezum Gina A. Paul Susan C. Childress Renee W. Perkins Vonda K. Collier Kelli C. Phillips Rochelle L. Corkell Wade L. Pinder Connie L. Crossman Howard S. Pinder, Sr. Carrie E. Darling Mary C. Quimby Alicia E. Dodd Katherine S. Riddel Robert D. El Shartinese D. Rochester J. Carol Elliott Robin J. Rust Lisa S. Fleetwood Donna M. Schaeffer Virginia Lynn Foster Marquita D. Singleterry Bonnie J. Freburger Phyllis S. Skinner Margaret A. Fuller Karen A. Stanavich Goldie J. Garner Donna J. Stevens W. Allen Greiner Barbara B. Stoops R. Sheldon Gunther Deborah H. Thomas Cassandra A. Guy James W. Thompson, III Ann M. Haddaway Katherine A. Thompson Lisa R. Handy Ronald J. Walters Glorious D. Heath Diane B. Whitby Gail F. Hickman THE CENTREVILLE NATIONAL BANK OF MARYLAND OFFICES - -------------------------------------------------------------------------------- MAIN OFFICE STEVENSVILLE OFFICE - ------------------------------------------- -------------------------------------------------- 109 N. Commerce St. -- PO Box 400 408 Thompson Creek Road -- PO Box 279 Centreville, MD 21617 Stevensville, MD 21666 Phone (410) 758-1600 Phone (410) 643-2233 Fax (410) 758-2364 Fax (410) 643-4215 ROUTE 213 SOUTH OFFICE HILLSBORO OFFICE - ------------------------------------------- -------------------------------------------------- 2609 Centreville Road -- PO Box 400 21913 Shore Highway -- PO Box 118 Centreville, MD 21617 Hillsboro, MD 21641 Phone (410) 758-2414 Phone (410) 820-2121 Fax (410) 758-3867 Fax (410) 820-1341
KENT BRANCH ------------------------------------------ 305 East High Street -- PO Box 388 Chestertown, MD 21620 Phone (410) 778-1299 Fax (410) 778-6084 39 NOTES EX-27 3 FINANCIAL DATA SCHEDULE
9 12-MOS DEC-31-1997 DEC-31-1997 5,092 128,086 3,504 0 9,444 32,298 39,498 109,167 1,404 175,115 145,813 0 787 5,000 0 0 10 23,505 175,115 9,347 2,704 354 12,405 5,370 5,448 6,957 0 9 4,366 3,500 3,500 0 0 2,370 2.35 2.35 4.64 199 251 209 3,300 1,503 159 44 1,403 1,403 0 0
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