-----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, KxxprwwyWdl4zGYZmUuHKOoYXx0toPoJo9BKhsnEbk/xkr6hE/VN4GOmrIh1rPVg mDZBmkENXbEh1j/UMK/E0g== 0000928385-97-000498.txt : 19970327 0000928385-97-000498.hdr.sgml : 19970327 ACCESSION NUMBER: 0000928385-97-000498 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970326 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANDY SPRING BANCORP INC CENTRAL INDEX KEY: 0000824410 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 520312970 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-19065 FILM NUMBER: 97562968 BUSINESS ADDRESS: STREET 1: 17801 GEORGIA AVE CITY: OLNEY STATE: MD ZIP: 20832 BUSINESS PHONE: 3017746400 MAIL ADDRESS: STREET 1: 17801 GEORGIA AVENUE CITY: OLNEY STATE: MD ZIP: 20832 10-K 1 FORM 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Year Ended December 31, 1996 Commission File Number 0-19065 --------- SANDY SPRING BANCORP, INC. ------------------------------------------------- (Exact name of registrant as specified in its charter) Maryland 52-1532952 - -------------------------------- ------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) or No.) 17801 Georgia Avenue, Olney, Maryland 20832 - ----------------------------------------- -------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (301) 774-6400. Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1.00 per share --------------------------------------- (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 registrant's Common Stock is traded on the NASDAQ National Market under the symbol SASR. The aggregate market value of the 4,750,507 shares of Common Stock of the registrant issued and outstanding held by nonaffiliates on March 10, 1997, was approximately $165.1 million based on the closing sales price of $34.75 per share of the registrant's Common Stock on March 17, 1997. For purposes of this calculation, the term "affiliate" refers to all directors and executive officers of the registrant. As of the close of business on March 10, 1997, 4,911,461 shares of the registrant's Common Stock were outstanding. Documents Incorporated By Reference Parts I and II: Portions of the Annual Report to Shareholders for the year ended December 31, 1996 (the "Annual Report"). Part III: Portions of the definitive proxy statement for the Annual Meeting of Shareholders to be held on April 16, 1997 (the "Proxy Statement"). FORWARD-LOOKING STATEMENTS Part I and Part II of this Annual Report on Form 10-K contain forward- looking statements, including statements of goals, intentions, and expectations, regarding or based upon general economic conditions, interest rates, developments in national and local markets, and other matters, and which, by their nature, are subject to significant uncertainties. Because of these uncertainties and the assumptions on which statements in this report are based, the actual future results may differ materially from those indicated in this report. PART I ITEM 1. BUSINESS General Sandy Spring Bancorp, Inc. ("Bancorp") is the one-bank holding company for Sandy Spring National Bank of Maryland (the "Bank"). Bancorp is registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the "Holding Company Act"). As such, Bancorp is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). Bancorp began operating in 1988. The Bank traces its origin to 1868, and is the oldest banking business based in Montgomery County, Maryland. The Bank is independent, community oriented, and conducts a full- service commercial banking business through 19 community offices located in Montgomery, Howard, and Anne Arundel counties in Maryland. The Bank is a national bank subject to supervision and regulation by the Office of the Comptroller of the Currency (the "OCC"). The Bank's savings and deposit accounts are insured by the Bank Insurance Fund ("BIF") administered by the Federal Deposit Insurance Corporation (the "FDIC") to the maximum permitted by law. The Bank experiences substantial competition both in attracting and retaining deposits and in making loans. Direct competition for deposits comes from other commercial banks, savings associations, and credit unions located in the Bank's primary market area of Montgomery, Howard, and Anne Arundel Counties in Maryland. Additional significant competition for deposits comes from mutual funds and corporate and government debt securities. As an alternative to traditional deposit accounts, annuities are offered through Sandy Spring Insurance Corporation, a wholly owned subsidiary of the Bank. The primary factors in competing for loans are interest rates and loan origination fees and the range of services offered by lenders. Competitors for loan originations include other commercial banks, mortgage bankers, mortgage brokers, savings associations, and insurance companies. Management believes the Bank is able to compete effectively in its primary market area. Bancorp's and the Bank's principal executive office is at 17801 Georgia Avenue, Olney, Maryland 20832, and its telephone number is (301) 774-6400. Regulation, Supervision, and Governmental Policy Following is a brief summary of certain statutes and regulations that significantly affect Bancorp and the Bank. This summary does not purport to be complete and is qualified in its entirety by reference to these statutes and regulations. A number of other statutes and regulations affect Bancorp and the Bank but are not summarized below. Bank Holding Company Regulation. Bancorp is registered as a bank holding ------------------------------- company under the Holding Company Act and, as such, is subject to supervision and regulation by the Federal Reserve. As a bank holding company, Bancorp is required to furnish to the Federal Reserve annual and quarterly reports of its operations and additional information and reports. Bancorp is also subject to regular examination by the Federal Reserve. Under the Holding Company Act, a bank holding company must obtain the prior approval of the Federal Reserve before (i) acquiring direct or indirect ownership or control of any class of voting securities of any bank or 2 bank holding company if, after the acquisition, the bank holding company would directly or indirectly own or control more than 5% of the class; (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company. Under the Holding Company Act, any company must obtain approval of the Federal Reserve prior to acquiring control of Bancorp or the Bank. For purposes of the Holding Company Act, "control" is defined as ownership of more than 25% of any class of voting securities of Bancorp or the Bank, the ability to control the election of a majority of the directors, or the exercise of a controlling influence over management or policies of Bancorp or the Bank. The Change in Bank Control Act and the related regulations of the Federal Reserve require any person or persons acting in concert (except for companies required to make application under the Holding Company Act), to file a written notice with the Federal Reserve before the person or persons acquire control of Bancorp or the Bank. The Change in Bank Control Act defines "control" as the direct or indirect power to vote 25% or more of any class of voting securities or to direct the management or policies of a bank holding company or an insured bank. The Holding Company Act also prohibits, with certain exceptions, a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The activities of Bancorp are subject to these legal and regulatory limitations under the Holding Company Act and Federal Reserve regulations. The Federal Reserve also has the power to order a holding company or its subsidiaries to terminate any activity, or to terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that the continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness, or stability of any bank subsidiary of that holding company. The Federal Reserve has adopted guidelines regarding the capital adequacy of bank holding companies, which require bank holding companies to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See "Regulatory Capital Requirements." The Federal Reserve has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company's capital needs, asset quality, and overall financial condition. As a bank holding company, Bancorp is required to give the Federal Reserve notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of Bancorp's consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would violate any law, regulation, Federal Reserve order, directive, or any condition imposed by, or written agreement with, the Federal Reserve. Bank Regulation. As a national bank, the Bank is subject to the primary --------------- supervision of the OCC under the National Bank Act. The prior approval of the OCC is required for a national bank to establish or relocate an additional branch office or to engage in any merger, consolidation, or significant purchase or sale of assets. The OCC regularly examines the operations and condition of the Bank, including but not limited to its capital adequacy, reserves, loans, investments, and management practices. These examinations are for the protection 3 of the Bank's depositors and the BIF. In addition, the Bank is required to furnish quarterly and annual reports to the OCC. The OCC's enforcement authority includes the power to remove officers and directors and the authority to issue cease-and-desist orders to prevent a bank from engaging in unsafe or unsound practices or violating laws or regulations governing its business. The OCC has adopted regulations regarding the capital adequacy of national banks, which require national banks to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See "Regulatory Capital Requirements." No national bank may pay dividends from its paid-in capital. All dividends must be paid out of current or retained net profits, after deducting reserves for losses and bad debts. The National Bank Act further restricts the payment of dividends out of net profits by prohibiting a national bank from declaring a dividend on its shares of common stock until the surplus fund equals the amount of capital stock or, if the surplus fund does not equal the amount of capital stock, until one-tenth of a bank's net profits for the preceding half year in the case of quarterly or semi-annual dividends, or the preceding two half-year periods in the case of annual dividends, are transferred to the surplus fund. The approval of the OCC is required prior to the payment of a dividend if the total of all dividends declared by a national bank in any calendar year would exceed the total of its net profits for that year combined with its retained net profits for the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred stock. In addition, the Bank is prohibited by federal statute from paying dividends or making any other capital distribution that would cause the Bank to fail to meet its regulatory capital requirements. Further, the OCC also has authority to prohibit the payment of dividends by a national bank when it determines that their payment would be an unsafe and unsound banking practice. The Bank is a member of the Federal Reserve System and its deposits are insured by the FDIC to the legal maximum of $100,000 for each insured depositor. Some of the aspects of the lending and deposit business of the Bank that are subject to regulation by the Federal Reserve and the FDIC include reserve requirements and disclosure requirements in connection with personal and mortgage loans and deposit accounts. In addition, the Bank is subject to numerous federal and state laws and regulations that include specific restrictions and procedural requirements with respect to the establishment of branches, investments, interest rates on loans, credit practices, the disclosure of credit terms, and discrimination in credit transactions. The Bank is subject to restrictions imposed by federal law on extensions of credit to, and certain other transactions with, Bancorp and other affiliates, and on investments in their stock or other securities. These restrictions prevent Bancorp and the Bank's other affiliates from borrowing from the Bank unless the loans are secured by specified collateral, and require those transactions to have terms comparable to terms of arms-length transactions with third persons. In addition, secured loans and other transactions and investments by the Bank are generally limited in amount as to Bancorp and as to any other affiliate to 10% of the Bank's capital and surplus and as to Bancorp and all other affiliates together to an aggregate of 20% of the Bank's capital and surplus. Certain exemptions to these limitations apply to extensions of credit by, and other transactions between, the Bank to its subsidiaries. These regulations and restrictions may limit Bancorp's ability to obtain funds from the Bank for its cash needs, including funds for acquisitions and for payment of dividends, interest, and operating expenses. Under OCC regulations, national banks must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards; prudent underwriting standards, including loan-to-value limits, that are clear and measurable; loan administration procedures; and documentation, approval, and reporting requirements. A bank's real estate lending policy must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the "Interagency Guidelines") adopted by the federal bank regulators. The Interagency Guidelines, among other things, call for internal loan-to-value limits for real estate loans that are not in excess of the limits specified in the Guidelines. The 4 Interagency Guidelines state, however, that it may be appropriate in individual cases to originate or purchase loans with loan-to-value ratios in excess of the supervisory loan-to-value limits. The FDIC has established a risk-based deposit insurance premium assessment system for insured depository institutions. Under the system, the assessment rate for an insured depository institution depends on the assessment risk classification assigned to the institution by the FDIC, based upon the institution's capital level and supervisory evaluations. Institutions are assigned to one of three capital groups -- well-capitalized, adequately capitalized, or undercapitalized -- based on the data reported to regulators. Well-capitalized institutions are institutions satisfying the following capital ratio standards: (i) total risk-based capital ratio of 10.0% or greater; (ii) Tier 1 risk-based capital ratio of 6.0% or greater; and (iii) Tier 1 leverage ratio of 5.0% or greater. Adequately capitalized institutions are institutions that do not meet the standards for well-capitalized institutions but that satisfy the following capital ratio standards: (i) total risk-based capital ratio of 8.0% or greater; (ii) Tier 1 risk-based capital ratio of 4.0% or greater; and (iii) Tier 1 leverage ratio of 4.0% or greater. Institutions that do not qualify as either well-capitalized or adequately capitalized are deemed to be undercapitalized. Within each capital group, institutions are assigned to one of three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk it poses to the deposit insurance fund. Subgroup A consists of financially sound institutions with only a few minor weaknesses. Subgroup B consists of institutions with demonstrated weaknesses that, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the deposit insurance fund. Subgroup C consists of institutions that pose a substantial probability of loss to the deposit insurance fund unless effective corrective action is taken. For the semi-annual period beginning June 30, 1995, the assessment rate for institutions, such as the Bank, with deposits insured by the Bank Insurance Fund of the FDIC was lowered to between 0.04% and .31% of insured deposits from 0.23% to 0.31% of insured deposits and was subsequently reduced to the statutory minimum of $1,000 for the most highly rated banks for the semi-annual period beginning January 1, 1996. The Bank has been notified that its assessment rate for the first six months of 1997 is the $1,000 statutory minimum, which also applied to it during 1996. New Law. The operations of Bancorp and the Bank are affected by new ------- federal and state laws. The federal Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the "New Act"), enacted in September 1996, includes provisions that affect banks, bank holding companies, and savings associations. The New Act had, and is expected to have in the future, its most significant effect upon bank and savings associations that hold deposits assessed at Savings Deposit Insurance Fund ("SAIF") rates. The Bank does not have "SAIF" assessed deposits, and the direct impact on the Bank of the New Act was not material in 1996. Among other things, the New Act recapitalized the SAIF through a special assessment on savings association deposits and bank deposits that had been acquired from savings associations. The New Act may increase competition from savings associations by equalizing, over time, the amount of federal insurance premiums paid on savings association and bank deposits. The New Act also provides that, beginning in 1997, institutions with deposits insured by the BIF, as well as those with SAIF insured deposits, will be responsible for payment of certain bonds issued in connection with the resolution of failed savings associations. The result of these provisions will be somewhat higher federal deposit insurance premiums for the Bank. These higher insurance premiums are not expected to have a material adverse effect on the Bank or Bancorp. The New Act also simplifies the regulatory approval process for new activities of banks and bank holding companies, and reduces a number of other regulatory burdens. None of these changes is expected to have a significant effect on the Bancorp or the Bank. Bank Secrecy Act Compliance. In the fourth quarter of 1996, the Bank --------------------------- learned that it had not fully complied with certain requirements of the federal Bank Secrecy Act and related regulations, including obligations to monitor and file reports of certain types of currency transactions. Financial institutions that fail to comply with the requirements of the Bank Secrecy Act may be subject to penalties, including civil money penalties. It is not now known whether such penalties or any other action will be sought against the Bank in connection with its noncompliance, or, if they are, the amount or nature of such penalties. Management believes that the Bank is now 5 in compliance with its current reporting obligations under the Bank Secrecy Act, and is in discussion with appropriate federal regulatory authorities regarding the steps it has taken and plans to take to remedy its past noncompliance. See "Note 24 - Contingencies" of the Notes to the Consolidated Financial Statements on page 46 of the Annual Report. Regulatory Capital Requirements. The Federal Reserve and the OCC have ------------------------------- established guidelines for maintenance of appropriate levels of capital by bank holding companies and national banks, respectively. The regulations impose two sets of capital adequacy requirements: minimum leverage rules, which require bank holding companies and banks to maintain a specified minimum ratio of capital to total assets, and risk-based capital rules, which require the maintenance of specified minimum ratios of capital to "risk-weighted" assets. The regulations of the Federal Reserve and the OCC require bank holding companies and national banks, respectively, to maintain a minimum leverage ratio of "Tier 1 capital" (as defined in the risk-based capital guidelines discussed in the following paragraphs) to total assets of 3.0%. The capital regulations state, however, that only the strongest bank holding companies and banks, with composite examination ratings of 1 under the rating system used by the federal bank regulators, would be permitted to operate at or near this minimum level of capital. All other bank holding companies and banks are expected to maintain a leverage ratio of at least 1% to 2% above the minimum ratio, depending on the assessment of an individual organization's capital adequacy by its primary regulator. A bank or bank holding company experiencing or anticipating significant growth is expected to maintain capital well above the minimum levels. In addition, the Federal Reserve has indicated that it also may consider the level of an organization's ratio of tangible Tier 1 capital (after deducting all intangibles) to total assets in making an overall assessment of capital. The risk-based capital rules of the Federal Reserve and the OCC require bank holding companies and national banks to maintain minimum regulatory capital levels based upon a weighting of their assets and off-balance sheet obligations according to risk. The risk-based capital rules have two basic components: a core capital (Tier 1) requirement and a supplementary capital (Tier 2) requirement. Core capital consists primarily of common stockholders' equity, certain perpetual preferred stock (noncumulative perpetual preferred stock with respect to banks), and minority interests in the equity accounts of consolidated subsidiaries; less all intangible assets, except for certain mortgage servicing rights and purchased credit card relationships. Supplementary capital elements include, subject to certain limitations, the allowance for losses on loans and leases; perpetual preferred stock that does not qualify as Tier 1 capital; long-term preferred stock with an original maturity of at least 20 years from issuance; hybrid capital instruments, including perpetual debt and mandatory convertible securities; and subordinated debt and intermediate-term preferred stock. The risk-based capital regulations assign balance sheet assets and credit equivalent amounts of off-balance sheet obligations to one of four broad risk categories based principally on the degree of credit risk associated with the obligor. The assets and off-balance sheet items in the four risk categories are weighted at 0%, 20%, 50% and 100%. These computations result in the total risk- weighted assets. The risk-based capital regulations require all banks and bank holding companies to maintain a minimum ratio of total capital to total risk-weighted assets of 8%, with at least 4% as core capital. For the purpose of calculating these ratios: (i) supplementary capital is limited to no more than 100% of core capital; and (ii) the aggregate amount of certain types of supplementary capital is limited. In addition, the risk-based capital regulations limit the allowance for loan losses that may be included in capital to 1.25% of total risk-weighted assets. In July 1996, the federal bank regulatory agencies, including the OCC, issued a joint policy statement regarding the evaluation of commercial banks' capital adequacy for interest rate risk. Under the policy, the OCC's assessment of a bank's capital adequacy includes an assessment of the bank's exposure to adverse changes in interest rates. The OCC has determined to rely on its examination process for such evaluations rather than on standardized measurement systems or formulas. The OCC may require banks that are found to have a high level of interest rate 6 risk exposure or weak interest rate risk management systems to take corrective actions. Management believes its interest rate risk management systems and its capital relative to its interest rate risk are adequate. The OCC has established regulations that classify national banks by capital levels and provide for the OCC to take various "prompt corrective actions" to resolve the problems of any bank that fails to satisfy the capital standards. Under these regulations, a well-capitalized bank is one that is not subject to any regulatory order or directive to meet any specific capital level and that has a total risk-based capital ratio of 10% or more, a Tier 1 risk-based capital ratio of 6% or more, and a leverage ratio of 5% or more. An adequately capitalized bank is one that does not qualify as well-capitalized but meets or exceeds the following capital requirements: a total risk-based capital ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (i) 4% or (ii) 3% if the bank has the highest composite examination rating. A bank that does not meet these standards is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized, depending on its capital levels. A national bank that falls within any of the three undercapitalized categories established by the prompt corrective action regulation is subject to severe regulatory sanctions. As of December 31, 1996, the Bank was well-capitalized as defined in the OCC's regulations. For information regarding Bancorp's and the Bank's compliance with their respective regulatory capital requirements, see "Management's Discussion and Analysis -- Capital Management--Regulatory Capital Requirements" on page 26 of the Annual Report and "Note 22 - Regulatory Matters" of the Notes to the Consolidated Financial Statements on pages 45 and 46 of the Annual Report. Competition The Bank competes within its market area with numerous bank subsidiaries of larger bank holding companies, including the subsidiaries of regional and national bank holding companies with principal operations in states other than Maryland. It also competes with numerous independent banks, savings associations, credit unions, and various other nonbank financial companies. The banking business in Maryland generally, and the Bank's primary service areas specifically, are highly competitive with respect to both loans and deposits. As noted above, the Bank competes with many larger banking organizations that have offices over a wide geographic area. These larger institutions have certain inherent advantages, such as the ability to finance wide-ranging advertising campaigns and promotions and to allocate their investment assets to regions offering the highest yield and demand. They also offer services, such as international banking, that are not offered directly by the Bank (but are available indirectly through correspondent institutions), and, by virtue of their larger total capitalization, such banks have substantially higher legal lending limits, which are based on bank capital, than does the Bank. The Bank can arrange loans in excess of its lending limit, or in excess of the level of risk it desires to take, by arranging participations with other banks. Other entities, both governmental and in private industry, raise capital through the issuance and sale of debt and equity securities and indirectly compete with the Bank in the acquisition of deposits. In addition to competing with other commercial banks and savings associations, commercial banks such as the Bank compete with nonbank institutions for funds. For instance, yields on corporate and government debt and equity securities affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for available funds with mutual funds. These mutual funds have provided substantial competition to banks for deposits, and it is anticipated they will continue to do so in the future. The Holding Company Act permits the Federal Reserve to approve an application of an adequately capitalized and adequately managed bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than that holding company's home state. The Federal Reserve may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. The Holding Company Act also prohibits the Federal Reserve from approving an application if the applicant (and its depository institution affiliates) controls or would control more 7 than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. The Holding Company Act does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank or bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. The effect of these provisions of the Holding Company Act may be to increase competition within the State of Maryland among banking and savings associations located in Maryland and from banking companies located anywhere in the country. Federal banking laws also authorize the federal banking agencies, effective June 1, 1997, to approve interstate merger transactions without regard to whether such transactions are prohibited by the law of any state, unless the home state of one of the banks adopts a law after the date of enactment of such Act and prior to June 1, 1997 that applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. In 1995, however, the State of Maryland acted to authorize interstate mergers by enacting legislation that allows out-of-state financial institutions to merge with Maryland banks and to establish branches in Maryland, subject to certain limitations. Maryland previously had enacted reciprocal interstate banking statutes that authorized interstate bank and savings association acquisitions. The effect of the federal and Maryland law may be to increase competition within the State of Maryland among banking and thrift institutions located in Maryland and from the major regional and national bank holding companies that acquire institutions in Maryland, many of which are larger than the Bank. The New Act, described above, also may increase competition by reducing the deposit insurance cost advantage on BIF insured deposits, such as those of the Bank, over SAIF insured deposits, and by making acquisitions of savings associations more attractive by resolving uncertainties over the costs of SAIF recapitalization. Employees As of February 25, 1997, Bancorp and the Bank employed 388 persons, including executive officers, loan and other banking and trust officers, branch personnel, and others. None of Bancorp's or the Bank's employees is represented by a union or covered under a collective bargaining agreement. Management of Bancorp and the Bank consider their employee relations to be excellent. Executive Officers The following table sets forth information regarding the executive officers of Bancorp and the Bank who are not directors.
Name Age (1) Principal Position(s) - ---- ------- --------------------- James R. Farmer 45 Senior Vice President of the Bank James H. Langmead 47 Vice President and Treasurer of Bancorp and Senior Vice President and Chief Financial Officer of the Bank Lawrence T. Lewis 48 Senior Vice President of the Bank Stanley L. Merson 40 Senior Vice President of the Bank Frank H. Small 50 Senior Vice President of the Bank
________________ (1) At March 25, 1997 8 The principal occupation(s) and business experience of each executive officer who is not a director for the last five years are set forth below. James R. Farmer became a Senior Vice President of the Bank in 1994. Prior to that, Mr. Farmer was Vice President of the Bank. Mr. Farmer has been employed by the Bank since 1979. James H. Langmead, CPA, became Vice President and Treasurer of Bancorp and Senior Vice President and Chief Financial Officer of the Bank in 1995. Prior to that, Mr. Langmead was a Senior Vice President of the Bank (from January 1994), and Vice President and Controller of the Bank. Prior to joining the Bank in 1992, Mr. Langmead was Executive Vice President of the Bank of Baltimore. Lawrence T. Lewis began his employment with the Bank in 1996 as Senior Vice President. From January 1984 to December 1995, Mr. Lewis was a managing director of Clark Melvin Securities Corporation. Stanley L. Merson has been a Senior Vice President of the Bank since 1991 and was Vice President of the Commercial Loan Department prior to becoming Senior Vice President. Mr. Merson has been employed by the Bank since 1982. Frank H. Small became a Senior Vice President of the Bank in 1994. Prior to that, Mr. Small was Vice President of the Bank. Before joining the Bank in 1990, Mr. Small was Vice President in charge of branch operations at Equitable Bank, N.A. Tabular Financial Information Loan Maturity Table. The following table sets forth information as of December 31, 1996, regarding the loan maturities and interest rate sensitivity for real estate-construction, commercial, and tax exempt loans (dollars in thousands).
1 or Less Over 1-5 Over 5 Total --------- -------- ------ ----- Real Estate Construction..................... $47,503 $ 151 $ 0 $ 47,654 Commercial................................... 48,538 18,828 1,101 68,467 Tax Exempt................................... 2 10 15 27 ------- ------- -------- -------- Total .................................... $96,043 $18,989 $ 1,116 $116,148 ======= ======= ======== ======== Rate Terms: Fixed....................................... $13,774 $18,067 $ 1,101 $ 32,942 Variable or adjustable...................... 82,269 922 15 83,206 -------- ------- ------- -------- Total...................................... $96,043 $18,989 $ 1,116 $116,148 ======== ======= ======= ========
9 Credit Loss Allowance Table. The following table presents the allocation of the allowance for credit losses for the past five years, along with the percentage of total loans in each category (dollars in thousands).
December 31, ----------------------------------------------------------------------------- 1996 1995 1994 1993 1992 --------------- ------------- ------------- --------------- ------------- Loan Loan Loan Loan Loan Amount Mix Amount Mix Amount Mix Amount Mix Amount Mix ------ ------- ------ ----- ------ ----- ------ ------- ------ ----- Amount applicable to: Real estate--mortgage...... $ 425 72% $ 512 74% $1,581 76% $2,046 77% $1,756 81% Real estate--construction.. 745 9 10 8 41 7 34 6 78 6 Consumer................... 193 6 181 6 136 6 324 5 353 6 Commercial................. 1,015 13 907 12 832 11 1,998 12 61 7 Tax exempt................. 0 0 0 0 0 0 0 0 0 0 Unallocated................ 4,013 4,987 4,073 2,279 $1,965 ------ ------ ------ ------ ------ Total allowance for credit losses........ $6,391 $6,597 $6,663 $6,681 $4,213 ====== ====== ====== ====== ======
The Company's policies and practices regarding the allowance for credit losses, including factors regularly analyzed by management in evaluating the sufficiency of the allowance, are disclosed in the discussion of Credit Risk Management on pages 26 and 27 and in Notes 1 and 6 of the Notes to the Consolidated Financial Statements beginning on page 34 of the Annual Report. (See also the discussion of loan portfolio composition and trends on pages 23 and 24 of the Annual Report.) The amount of unallocated allowance for credit losses decreased to 62.8% of the total allowance at December 31, 1996, from 75.6% a year earlier. The percentage was 61.1% at December 31, 1994. The size of the unallocated reserve at December 31, 1996 reflects management's assessment of actual loss residing in the loan portfolio which has not been specifically attributed to any category of loans. The size of the unallocated allowance at December 31, 1996 was influenced by the merger with Annapolis Bancshares, Inc., consummated on August 29, 1996. The amount of potential loss identified in the due diligence process with particular categories of loans in the existing Annapolis portfolio is expected to increase, and the unallocated portion decrease, as Bancorp continues to evaluate and manage this new portfolio. In establishing the amount of the allowance for credit losses, and allocating the allowance to particular categories of loans, management also considered the increase in the amount and percentage to total loans attributable to commercial and commercial real estate loans, which are viewed as entailing greater risk than certain other categories of loans, and the resulting increase in large loans. The significance of these factors, which are believed to have contributed to the increase in both net charge-offs and nonperforming loans during 1996 compared to 1995, was mitigated by the Company's historical loss ratios and the continued concentration in types of credits considered to be of relatively low risk. Consideration of these and other factors, when balanced against each other, resulted in an unallocated allowance and in a total allowance which management deemed appropriate at December 31, 1996. The tabular financial information set forth on pages 18 through 29 of the Annual Report is incorporated herein by reference. ITEM 2. DESCRIPTION OF PROPERTY Airpark 7653 Lindbergh Drive Gaithersburg, Maryland 20879 (301) 774-8408 Annapolis 2024 West Street Annapolis, Maryland 21401 (410) 266-3000 Ashton 1 Ashton Road Ashton, Maryland 20861 (301) 774-8405 Aspenwood (Aspenwood Residents and Employees Only) 14400 Homecrest Road Silver Spring, Maryland 20906 (301) 774-8406 Bedford Court (Bedford Court Residents and Employees Only) 3701 International Drive Silver Spring, Maryland 20906 (301) 774-8407 Bethesda 7126 Wisconsin Avenue Bethesda, Maryland 20814 (301) 951-0800 Executive Offices 17801 Georgia Avenue Olney, Maryland 20832 (301) 774-6400 Burtonsville 3535 Spencerville Road Burtonsville, Maryland 20866 (301) 774-8404 Clarksville 12276 Clarksville Pike Clarksville, Maryland 21029 (410) 531-2650 Colesville 13300 New Hampshire Avenue Silver Spring, Maryland 20904 (301) 774-8403 Damascus 26250 Ridge Road Damascus, Maryland 20872 (301) 253-0133 East Gude Drive 1601 East Gude Drive Rockville, Maryland 20850 (301) 570-8330 Gaithersburg Square 596 A North Frederick Avenue Gaithersburg, Maryland 20877 (301) 963-3600 Layhill 14241 Layhill Road Silver Spring, Maryland 20906 (301) 774-8406 Leisureworld Plaza 3801 International Drive Silver Spring, Maryland 20906 (301) 774-8407 Lisbon 710-N Lisbon Centre Drive Woodbine, Maryland 21797 (410) 442-1878 Montgomery Village 9921 Stedwick Road Montgomery Village, Maryland 20879 (301) 990-3800 Olney 17801 Georgia Avenue Olney, Maryland 20832 (301) 774-8402 Rockville 611 Rockville Pike Rockville, Maryland 20852 (301) 217-0555 Sandy Spring 908 Olney-Sandy Spring Road Sandy Spring, Maryland 20860 (301) 774-8401 Customer Service Center (301) 774-8477 (800) 399-5919 10 ITEM 3. LEGAL PROCEEDINGS Note 18 on page 43 of the Annual Report ("Litigation") is hereby incorporated by reference. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of 1996, through solicitation of proxies or otherwise. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS RECENT STOCK PRICES AND DIVIDENDS (Dollars in thousands, except per share data) Shareholders received quarterly cash dividends totaling $3,620 in 1996 and $2,755 in 1995. Regular dividends have been declared for ninety-six consecutive years. The Company has increased its dividends per share each year for the past sixteen years. Since 1991, dividends per share have risen at an annual compound growth rate of 15.5%, with an increase of 21.9% in 1996. Per share dividends, expressed as a percentage of earnings per share, were 33.1% in 1996 and 30.6% in 1995. The amount of dividends is established by the Board of Directors in consideration of operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns and other factors. Shares issued under the dividend reinvestment plan totaled 35,273 in 1996 and 35,300 in 1995. The number of common shareholders of record was approximately 2,400 as of February 10, 1997 compared to approximately 2,000 a year earlier. Shares of Sandy Spring Bancorp commenced trading on The Nasdaq Stock Market's National Market on April 17, 1996 under the trading symbol SASR. Since that date, the price information provided below reflects actual high and low sales prices as quoted on The Nasdaq Stock Market. Prior to April 17, 1996, sales prices reported below were based upon reports of broker transactions published by third parties and any other transactions known to the Company to have occurred in each quarter.
QUARTERLY STOCK INFORMATION 1996 1995 ---------------------------------- ---------------------------------- Stock Price Range Per Share Stock Price Range Per Share ----------------- ----------------- Quarter Low High Dividend Low High Dividend - ---------------------------------------------------------------------------------------------------------------- 1st $35.00 $38.75 $0.18 $24.50 $26.25 $0.15 2nd 35.75 41.00 0.19 25.38 32.00 0.15 3rd 34.00 39.50 0.20 29.25 39.00 0.16 4th 31.25 34.75 0.21 35.00 39.00 0.18 - ---------------------------------------------------------------------------------------------------------------- Total $0.78 $0.64 ===== =====
For information regarding regulatory restrictions on the Bank's and, therefore, Bancorp's payment of dividends, see Note 11 -- "Stockholders' Equity" on page 40 of the Annual Report, which is hereby incorporated by reference. 11 ITEM 6. SELECTED FINANCIAL DATA HISTORICAL TRENDS IN FINANCIAL DATA 1992-1996(1) (Dollars in thousands, except per share data)
1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------ RESULTS OF OPERATIONS (for the year): Interest income $ 66,621 $ 62,115 $ 51,578 $ 46,189 $ 48,177 Interest expense 30,233 29,342 21,496 19,793 23,129 Net interest income 36,388 32,773 30,082 26,396 25,048 Provision for credit losses 308 180 212 1,056 1,880 Net interest income after provision for credit losses 36,080 32,593 29,870 25,340 23,168 Noninterest income 6,547 4,478 4,189 4,870 4,656 Noninterest expenses 25,344 22,424 21,462 18,340 16,243 Income before taxes and cumulative effect of accounting change 17,283 14,647 12,597 11,870 11,581 Income tax expense 5,789 4,653 3,694 3,261 3,252 Income before cumulative effect of accounting change 11,494 9,994 8,903 8,609 8,329 Cumulative effect of accounting change 0 0 0 0 744 Net income 11,494 9,994 8,903 8,609 9,073 PER SHARE DATA: Net income $ 2.36 $ 2.09 $ 1.90 $ 1.92 $ 2.01(2) Dividends declared 0.78 0.64 0.54 0.49 0.43 Book value 19.70 18.04 15.72 15.63 13.39 FINANCIAL CONDITION (at year end): Assets $978,595 $876,203 $830,834 $784,274 $675,418 Deposits 806,341 743,592 700,340 676,422 602,073 Loans 523,166 492,540 457,052 374,740 313,924 Securities 361,806 290,786 309,622 314,283 285,120 Stockholders' equity 96,581 86,941 73,766 72,420 59,205 MEASUREMENTS (for the year): Return on average assets 1.27% 1.18% 1.14% 1.23% 1.30%(2) Return of average equity 12.81 12.37 12.24 13.55 16.95(2) Average equity to average assets 9.90 9.57 9.28 9.10 7.65 Dividends declared to net income 33.05 30.62 28.42 25.52 21.39(2)
(1) Adjusted to give retroactive effect to a 2-for-1 stock split declared on March 29, 1995 and, except with respect to dividends declared per share, the acquisition of Annapolis Bancshares, Inc. on August 29, 1996, which was accounted for as a pooling of interests. (2) Excludes the cumulative benefit recorded in 1992 from the change in accounting for income taxes. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (Dollars in thousands, except per share data) OVERVIEW The Company's 1996 financial results and performance were favorable. During 1996, the Company recorded growth in core deposits, interest and noninterest revenues, and net income. Substantially all profitability measures showed improvement in 1996 when compared to 1995. At year-end 1996, capital remained well above minimum regulatory requirements. Also in 1996, Bancorp completed its second merger, when Annapolis Bancshares, Inc. was merged into Sandy Spring Bancorp and The Bank of Annapolis was merged into Sandy Spring National Bank. This transaction had little impact on consolidated earnings growth for 1996, after merger related expenses were recorded, but gives the Company opportunity for future growth in an attractive new market. This merger was accounted for as a pooling of interests. Accordingly, all financial data except dividend and stock price information have been retroactively restated to include the operations and position of Annapolis Bancshares. In December 1996, Sandy Spring National Bank completed the acquisition of an existing bank branch on Wisconsin Avenue in Bethesda from Bank of Maryland. This acquisition provides a new business base along the Route 355 corridor and is a natural extension of the Bank's branch system. For 1996, net earnings amounted to $11,494 ($2.36 per share) versus $9,994 ($2.09 per share) for 1995, a 15% increase. Return on average assets was 1.27% compared to 1.18% for 1995, and return on average equity was 12.81% versus 12.37% for 1995. Total deposits grew by 8.4% while loan growth amounted to 6.2%. Asset quality remains acceptable, as measured by net loans charged off and the level of problem assets continuing to indicate moderate levels of risk. The following more detailed discussion of our financial results is intended to give you the reader a clear and succinct view of the various significant components of our operating results and financial position. Please refer to the Selected Glossary and Abbreviations on page 29 for further definition of technical terms.
CHANGES IN NET INCOME PER COMMON SHARE 1995 to 1996 1994 to 1995 - --------------------------------------------------------------------------- Prior year net income per share $ 2.09 $ 1.90 Change attributed to: Net interest income 0.48 0.33 Provision for credit losses (0.02) 0.00 Noninterest income 0.28 0.04 Noninterest expenses (0.39) (0.13) Income taxes (0.04) (0.01) Increased shares outstanding (0.04) (0.04) ------ ------ Total 0.27 0.19 ------ ------ NET INCOME PER SHARE $ 2.36 $ 2.09 ====== ======
13 HISTORICAL TRENDS IN FINANCIAL DATA 1992-1996(1) (Dollars in thousands, except per share data)
1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------ RESULTS OF OPERATIONS (for the year): Interest income $ 66,621 $ 62,115 $ 51,578 $ 46,189 $ 48,177 Interest expense 30,233 29,342 21,496 19,793 23,129 Net interest income 36,388 32,773 30,082 26,396 25,048 Provision for credit losses 308 180 212 1,056 1,880 Net interest income after provision for credit losses 36,080 32,593 29,870 25,340 23,168 Noninterest income 6,547 4,478 4,189 4,870 4,656 Noninterest expenses 25,344 22,424 21,462 18,340 16,243 Income before taxes and cumulative effect of accounting change 17,283 14,647 12,597 11,870 11,581 Income tax expense 5,789 4,653 3,694 3,261 3,252 Income before cumulative effect of accounting change 11,494 9,994 8,903 8,609 8,329 Cumulative effect of accounting change 0 0 0 0 744 Net income 11,494 9,994 8,903 8,609 9,073 PER SHARE DATA: Net income $ 2.36 $ 2.09 $ 1.90 $ 1.92 $ 2.01(2) Dividends declared 0.78 0.64 0.54 0.49 0.43 Book value 19.70 18.04 15.72 15.63 13.39 FINANCIAL CONDITION (at year end): Assets $978,595 $876,203 $830,834 $784,274 $675,418 Deposits 806,341 743,592 700,340 676,422 602,073 Loans 523,166 492,540 457,052 374,740 313,924 Securities 361,806 290,786 309,622 314,283 285,120 Stockholders' equity 96,581 86,941 73,766 72,420 59,205 MEASUREMENTS (for the year): Return on average assets 1.27% 1.18% 1.14% 1.23% 1.30%(2) Return of average equity 12.81 12.37 12.24 13.55 16.95(2) Average equity to average assets 9.90 9.57 9.28 9.10 7.65 Dividends declared to net income 33.05 30.62 28.42 25.52 21.39(2)
(1) Adjusted to give retroactive effect to a 2-for-1 stock split declared on March 29, 1995 and, except with respect to dividends declared per share, the acquisition of Annapolis Bancshares, Inc. on August 29, 1996, which was accounted for as a pooling of interests. (2) Excludes the cumulative benefit recorded in 1992 from the change in accounting for income taxes. 14 Sandy Spring Bancorp and Subsidiaries CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES/(1)/ (Dollars in thousands and tax-equivalent)
1996 1995 ----------------------------------------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate - -------------------------------------------------------------------------------------------------------------------- ASSETS Loans:(2) Real estate(3) $417,161 $37,866 9.08% $400,176 $36,154 9.03% Consumer 28,600 2,682 9.38 26,710 2,437 9.12 Commercial 62,999 6,125 9.72 54,677 5,320 9.73 Tax exempt 169 16 9.65 479 63 13.15 -------- ------- -------- ------- Total loans 508,929 46,689 9.17 482,042 43,974 9.12 Securities: Taxable 250,763 15,062 6.01 234,354 13,769 5.88 Nontaxable 65,847 5,005 7.60 65,696 5,177 7.88 -------- ------- -------- ------- Total securities 316,610 20,067 6.34 300,050 18,946 6.31 Interest-bearing deposits with banks 3,585 187 5.22 740 39 5.27 Federal funds sold 25,319 1,342 5.30 15,252 872 5.72 -------- ------- -------- ------- TOTAL EARNING ASSETS 854,443 68,285 7.99 798,084 63,831 8.00 Less: allowance for credit losses (6,668) (6,647) Cash and due from banks 25,923 24,188 Premises and equipment, net 20,559 17,019 Other assets 12,305 11,174 -------- -------- Total Assets $906,562 $843,818 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing demand deposits $ 96,940 $ 2,529 2.61% $ 86,688 $ 2,263 2.61% Regular savings deposits 95,636 2,695 2.82 104,971 3,218 3.07 Money market savings deposits 149,358 4,935 3.30 154,644 5,646 3.65 Time deposits 324,842 17,730 5.46 277,804 15,578 5.61 -------- ------- -------- ------- Total interest-bearing deposits 666,776 27,889 4.18 624,107 26,705 4.28 Short-term borrowings 41,864 2,021 4.83 40,605 2,284 5.62 Long-term borrowings 4,854 323 6.65 6,097 353 5.79 -------- ------- -------- ------- TOTAL INTEREST- BEARING LIABILITIES 713,494 30,233 4.24 670,809 29,342 4.37 ------- ---- ------- ---- Net interest income and spread $ 38,052 3.75% $34,489 3.63% Noninterest-bearing demand deposits 100,127 90,260 Other liabilities 3,231 1,987 Stockholders' equity 89,710 80,762 -------- -------- Total liabilities and stockholders' equity $906,562 $843,818 -------- -------- Interest income/ earning assets 7.99% 8.00% Interest expense/ earning assets 3.54 3.68 ---- ---- Net interest margin 4.45% 4.32% ==== ==== 1994 ----------------------------------- Average Yield/ Balance Interest Rate - ---------------------------------------------------------------- ASSETS Loans:(2) Real estate(3) $327,485 $27,046 8.26% Consumer 20,357 1,765 8.67 Commercial 45,241 3,785 8.37 Tax exempt 611 77 12.60 -------- ------- Total loans 393,694 32,673 8.30 Securities: Taxable 258,102 14,299 5.54 Nontaxable 75,136 5,911 7.87 -------- ------- Total securities 333,238 20,210 6.06 Interest-bearing deposits with banks 1,028 38 3.70 Federal funds sold 13,948 549 3.94 -------- ------- TOTAL EARNING ASSETS 741,908 53,470 7.21 Less: allowance for credit losses (6,841) Cash and due from banks 22,730 Premises and equipment, net 16,239 Other assets 10,332 -------- Total Assets $784,368 -------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing demand deposits $ 87,591 $ 2,293 2.62% Regular savings deposits 115,839 3,525 3.04 Money market savings deposits 183,949 5,641 3.07 Time deposits 199,448 8,573 4.30 -------- ------- Total interest-bearing deposits 586,827 20,032 3.41 Short-term borrowings 28,973 1,175 4.06 Long-term borrowings 5,149 289 5.61 -------- ------- TOTAL INTEREST- BEARING LIABILITIES 620,949 21,496 3.46 ------- ----- Net interest income and spread Noninterest-bearing demand deposits 90,238 Other liabilities 427 Stockholders' equity 72,754 -------- Total liabilities and stockholders' equity $784,368 ======== Interest income/ earning assets 7.21% Interest expense/ earning assets 2.90 ----- Net interest margin 4.31% =====
(1) Income and yields are presented on a tax-equivalent basis using the maximum applicable federal income tax rate. (2) Nonaccrual loans are included in the average balances. (3) Includes residential mortgage loans held for sale. 15 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) NET INTEREST INCOME Net interest income for 1996 was $36,388, representing an increase of $3,615 or 11.0% from 1995. An 8.9% rise was achieved in 1995, compared to 1994, resulting in net interest income of $32,773, up from $30,082. On a tax-equivalent basis, net interest income amounted to $38,052 in 1996, representing a 10.3% annual rise, and $34,489 in 1995, representing a 7.9% annual rise, preceded by $31,974 in 1994. Since net interest income is the most important category of earnings, performance in this area is emphasized by management. The analysis of net interest income performance presented in the "Consolidated Average Balances, Yields and Rates" table shows a 1996 net interest margin of 4.45%, up 13 basis points, compared to 1995. The net interest margin for 1995 of 4.32% was essentially the same as for 1994. The table entitled "Effect of Volume and Rate Changes on Net Interest Income" shows that the increases in net interest income during 1996 and 1995, compared to each prior year, were primarily driven by increases in the volumes of earning assets.
EFFECT OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME 1996 vs. 1995 1995 vs. 1994 -------------------------------------------------------------------------------------- Increase or in Average: (1)(2) Increase or in Average: (1)(2) ---------------------- ---------------------- (Tax-equivalent basis) (Decrease) Volume Rate (Decrease) Volume Rate - ---------------------------------------------------------------------------------------------------------------------------------- Interest income from earnings assets: Loans $2,715 $2,464 $ 251 $11,301 $ 7,837 $3,464 Taxable securities 1,293 981 312 (530) (1,363) 833 Nontaxable securities (172) 12 (184) (734) (744) (10) Other investments 618 687 (69) 324 42 282 ------ ------- Total interest income 4,454 4,503 (49) 10,361 4,230 6,131 Interest expense on funding of earnings assets: Interest-bearing demand deposits 266 268 (2) (30) (24) (6) Regular savings deposits (523) (274) (249) (307) (333) 26 Money market savings deposits (711) (188) (523) 5 (976) 981 Time deposits 2,152 2,578 (426) 7,005 3,945 3,060 Borrowings (293) 1 (294) 1,173 632 541 ------ ------- Total interest expense............ 891 1,829 (938) 7,846 1,833 6,013 ------ ------ ----- ------- ------- ------ Net interest income............... $3,563 $2,674 $ 889 $ 2,515 $ 2,397 $ 118 ====== ====== ===== ======= ======= ======
(1) Variances are computed on a line-by-line basis and are non-additive. (2) Combined rate/volume variances, a third element of the calculation, are allocated to the volume and rate variances based on their relative size. Interest Income The Company's tax-equivalent interest income increased by 7.0% or $4,454 in 1996, compared to 1995, as a result of a 7.1% or $56,359 increase in average earning assets accompanied by a modest decline in average yield earned on those funds. During 1996, average loans, yielding 9.17%, rose $26,887 or 5.6%. Average commercial loans increased by 15.2% or $8,322 in 1996. Management has targeted commercial loans for growth, in part because they produce the highest rate (average yield of 9.72% for 1996) of any major category of earning assets. However, lower yielding average securities (yielding only 6.34%), increased $16,560 in 1996, representing virtually the same percentage rise as achieved for average loans. Less significantly, federal funds sold, which are short-term investments primarily benefitting liquidity, increased $10,067 or 66.0%, and earned an average yield of 5.30% for 1996. The Company generated a greater amount of interest income in 1996 in the face of stiff industrywide competition with banks and nonbanking entities for desirable lending opportunities. Tax-equivalent interest income increased 19.4% or $10,361 in 1995, compared to 1994, due to the combination of higher average earning assets, up 7.6%, and higher average yield earned, up 79 basis points. However, when higher funding costs are taken into consideration, the resulting interest rate spread achieved on those earning assets declined 12 basis points in 1995 versus 1994. Interest Expense Interest expense increased $891 or 3.0% in 1996 compared to 1995, attributable to the offsetting effects of 6.4% or $42,685 greater average interest-bearing liabilities and a 13 basis point decline in the average rate paid for those funds. Most of the rise in interest-bearing funds was generated by deposit growth of 6.8% or $42,669. By contrast, average interest free funding of earning assets increased 10.7% or $13,674 over the same period, primarily due to a rise in demand deposits attributable in part to the introduction of a new product around mid-year. By far, the largest increase in interest-bearing 16 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) deposits occurred in average time deposits, which were 16.9% or $47,038 above 1995, and comprised the most expensive deposit type, paying an average rate of 5.46% in 1996, compared to 4.18% for all interest-bearing deposits. In addition, the average rate paid on time deposits declined only 15 basis points in 1996, compared to 1995, much less than declines recorded by most other deposit and borrowing categories. In 1995, interest expense increased significantly more than interest income, rising 36.5% or $7,846, reflecting the effects of a 91 basis point rise in average rate on 8.0% higher average interest-bearing liabilities. Interest Rate Performance Interest rate performance has been relatively stable over the past three years. The same interest rate spread was achieved in 1996 and 1994, with a small decline in 1995. The net interest margin increased slightly in 1996, after remaining virtually the same the prior two years. The change in margin was due to the beneficial effects of the higher level of interest-free funding of earning assets in 1996 than in 1995 as well as to growth in interest-bearing deposits at favorable interest spreads. By maintaining, and then improving, its net interest margin from 1994 to 1996, the Company has been able to preserve, and then enhance, its net interest income performance during a period of significant growth. NONINTEREST INCOME Total noninterest income rose 46.2% or $2,069 to $6,547 in 1996 from $4,478 in 1995. An increase of 6.9% or $289 was posted for 1995 versus 1994. Securities gains totaled $30 in 1996 as compared with securities losses of $279 in 1995 and $84 in 1994. The sale of available-for-sale debt securities generated net losses of $66 for 1996 compared with $89 in net gains from sales of available-for-sale equity securities and $7 in net gains from securities calls, maturities and paydowns. During 1995, the sale of available-for-sale debt securities generated $277 in net losses, while calls, maturities and paydowns generated $2 in net losses. Service charges on deposit accounts increased 15.4% or $395 during 1996. In 1995, an increase of 9.4% or $221 was realized. Management continuously monitors the service fee structure and makes changes where appropriate. Mortgage banking operations generated $825 in gains on loan sales of $56,457 in 1996 as management placed great emphasis upon originations and sales of residential mortgage loans in the secondary market at a profit margin, versus building a mortgage portfolio on the Company's books. By comparison, gains of $244 were realized on loan sales of $19,246 during 1995, and $175 in gains were realized on loan sales of $15,476 in 1994. Other noninterest income rose 40.3% or $784 in 1996 over 1995, with fees from trust services, mutual funds and annuities increasing 44.2% or $385. Newer fee based businesses, credit cards and debit cards (new in 1996), generated another $118 in additional income during 1996, compared to 1995, and other fee income increased 23.8% or $143. Among nonrecurring items, sales of other real estate owned were responsible for $147 of the overall rise in other noninterest income, while asset dispositions during 1996 versus 1995 resulted in net losses of $47. Other noninterest income increased 11.1% or $194 in 1995 over 1994, attributable in large part to fees for trust services, which rose 20.8% or $131, and to gains on sales of student loans, which generated $131 in additional income. NONINTEREST EXPENSES Noninterest expenses increased 13.0% or $2,920 in 1996 over 1995 and 4.5% or $962 in 1995 over 1994. However, nonrecurring expenses significantly affected these changes, reducing the size of the core increase in noninterest expenses by $750 in 1996, compared to 1995, and by $342 in 1995, compared to 1994. Items of nonrecurring expenses included an industry-wide FDIC insurance premium reduction enacted in 1995, which effectively reduced noninterest expenses by $814 in 1996 and $692 in 1995, and merger related costs associated with the acquisition of Annapolis Bancshares, Inc., which increased noninterest expenses in 1996 by $724, along with costs of conversion to a new data processing center in 1995 and early retirement benefits extended to certain long-term employees in 1995 and 1994. Excluding nonrecurring items, increases in core noninterest expenses amounted to 17.5% or $3,670 in 1996 compared with an increase of 6.6% or $1,304 for 1995. Salaries and employee benefits increased 13.5% or $1,721 in 1996 and 6.4% or $767 in 1995. Excluding nonrecurring items, an increase of 14.8% or $1,842 was realized in 1996 compared with an increase of 6.6% or $766 for 1995. The increase for 1996 was, for the most part, due to growth in staff, including staffing for two new branches, and an expanded incentive program called "Stakeholder" which relates compensation throughout the business to the Company's performance as measured against key performance indicator goals. Quarterly "Stakeholder" payouts amounted to $479 in 1996. The increase in salary and benefit costs for 1995 was due significantly to merit increases. 17 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) The Company's net income, as measured on a per employee basis, continue to grow, which is favorable. The ratio of net income per average full-time- equivalent employee was $33 for 1996, $31 for 1995 and $29 for 1994. Average full-time equivalent employees increased in 1996 by 8.8% to 346, compared to 318 for 1995 and 310 for 1994. The increase in average full-time equivalent employees is largely a reflection of the Company's expansion over the period. All other noninterest expenses increased 12.4% or $1,199 in 1996 and increased 2.1% or $195 in 1995. Excluding nonrecurring expenses, an increase of 21.4% or $1,828 was realized in 1996 compared with an increase of 6.7% or $538 for 1995. The increase for 1996 included a 95.7% or $560 rise in marketing expenses due to intensified marketing associated with entry into new markets, 40.9% or $322 higher data services costs, reflecting growth and conversion to a new provider with expanded capabilities in late 1995, a 58.1% or $291 increase in building and grounds maintenance attributable to the merger, new branches and maintenance of existing facilities, and a 100.0% or $181 rise in attorneys' fees, in large part associated with merger activity, partially offset by a $370 increase in rental income which is netted against rental expenses. The increase for 1995 included increases in equipment expenses, primarily depreciation charges and software expenses, and in marketing expense, supply expenses, and data services costs. Operating Expense Performance Management believes that the net overhead ratio (lower ratios indicate improved productivity), which expresses the level of net operating expenses (noninterest expenses less noninterest income) as a percentage of tax-equivalent net interest income, is a good measure of overall operating expense performance and cost management. During 1996, the Company's net overhead ratio was 49.4%, compared to ratios of 52.0% achieved in 1995 and 54.0% in 1994. Ratios close to 50% are considered desirable. PROVISION FOR INCOME TAXES Income tax expense amounted to $5,789 in 1996, compared with $4,653 in 1995 and $3,694 in 1994. The Company's effective tax rate for 1996 was 33.5%, compared with 31.8% in 1995 and 29.3% in 1994. The increase in effective tax rate has been due primarily to a decline in the nontaxable component of income before taxes each year. During 1996, the Company's taxable income surpassed $10,000, triggering an increase in the applicable corporate tax rate from 34% to 35%. This increased rate resulted in additional income tax expense of $24 for 1996 on taxable earnings in excess of $10,000. BALANCE SHEET ANALYSIS During 1996, the Company's size, as measured by total assets, grew by $102,392 or 11.7%, to $978,595 at December 31, 1996 from $876,203 at December 31, 1995. Earning assets at year end increased $97,977 or 12.0%, to $917,096 from $819,119. The rise in loans, a core business for commercial banks, amounted to $30,626 or 6.2% compared to a $71,020 or 24.4% increase in securities. On an average basis, however, total loans increased $26,887 or 5.6% versus a $16,560 or 5.5% increase in average total securities. The types and characteristics of the growth in loans is discussed in detail below. LOANS Real estate mortgage loans rose 3.4% to $376,205 in 1996. Included in this category are commercial mortgages, which increased 12.5% during 1996 and totalled $178,639 at December 31, 1996. These mortgages mainly consist of owner occupied properties where an established banking relationship exists. Home equity lines and home equity loans, types of real estate mortgages that permit homeowning consumers to leverage their equity and possibly receive an income tax deduction on the interest, increased 7.7% during 1996 to $65,420 at year end. One to four family residential loans, down 11.5% in 1996, represented $116,444 of the real estate mortgage portfolio at December 31, 1996. This represents an increased emphasis by the Company on mortgage banking, where most residential mortgage loan production is sold in the secondary market rather than being maintained as a loan asset. In this type of business, the bank serves as the customer service and delivery channel for investors, while continuing to meet the needs of area residents for funds to finance their homes. Other real estate mortgages, including primarily residential lot loans, collectively rose 23.1% to $15,702. Real estate construction loans increased 14.2% to $47,654 from 1995, attributable to a substantial rise in residential construction activity. The Company conducts its commercial construction lending in the markets it knows and understands, works selectively with local, top-quality builders and developers, and requires substantial equity from its borrowers. The consumer loan portfolio rose 7.1% to $30,813 at December 31, 1996. In recent years, much of consumer lending has shifted from traditional installment credits into home equity lines and credit cards. During 1996, the Company achieved a 6.6% increase in home equity lines, which are included above in real estate mortgage loans. Credit cards, introduced in 1995, are showing growth, more than doubling in 1996 to an outstanding balance of $1,321 at year end. 18 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Consumer lending continues to be important to the full service community banking business conducted by the Company despite a smaller balance sheet presence in recent years. Commercial loans advanced the most among the major categories on a percentage basis, up 18.6% to $68,467 during 1996. For the most part, these are loans to a diverse cross-section of small to mid-size local businesses, many of whom are existing customers of the Company. These types of banking relationships are a natural fit for the Company, which is experienced in serving and lending to this market segment and has knowledge of the marketplace through its community roots and involvement. The Company continues to place special emphasis on this part of its loan portfolio in its business planning. Analysis of Loans The following table presents the trends in the composition of the loan portfolio over the previous five years.
December 31, ------------------------------------------------------------ 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------- Real estate -- mortgage(1) $376,205 $363,927 $345,547 $286,542 $252,706 Real estate -- construction(2) 47,654 41,725 31,853 21,770 18,592 Consumer 30,813 28,762 28,892 19,352 17,906 Commercial 68,467 57,718 50,224 46,405 23,477 Tax exempt 27 408 536 671 1,243 -------- -------- -------- -------- -------- TOTAL LOANS $523,166 $492,540 $457,052 $374,740 $313,924 ======== ======== ======== ======== ========
(1) Consists of fixed and adjustable rate first and second home mortgage loans, home equity lines of credit and commercial mortgage loans. (2) Includes both residential and commercial properties. Securities The investment portfolio, in the aggregate, increased 24.4% or $71,020 during 1996 to $361,806 at December 31, 1996 from $290,786 at December 31, 1995. Investments are managed to generate interest revenue, provide liquidity and achieve asset/liability management goals. During 1996, funds provided by the increase in deposits exceeded the increase in the loan portfolio, and the excess was invested primarily in securities. A significant portion of the rise in investments occurred toward the end of 1996, when funds were borrowed from the Federal Home Loan Bank of Atlanta and invested in securities at a favorable interest rate spread in order to leverage the balance sheet and enhance the return on shareholders' equity (see discussion on page 25 in "Deposits and Short-term Borrowings" section). On an average basis, aggregate investments rose 5.5% during 1996, compared to 1995. Analysis of Securities The composition of Securities at December 31 for each of the latest three fiscal years was:
1996 1995 1994 - ------------------------------------------------------------------------- AVAILABLE-FOR-SALE(1) U.S. Treasury $ 26,940 $ 15,991 $ 23,272 U.S. Agency 145,275 70,106 23,579 State and municipal 26,628 35,330 39,836 Corporate debt obligations 1,483 2,458 3,260 Mortgage-backed securities(2) 31,876 40,282 37,307 Marketable equity securities 2,221 1,786 518 -------- -------- -------- Total 234,423 165,953 127,772 HELD-TO-MATURITY AND OTHER EQUITY U.S. Treasury 0 500 1,499 U.S. Agency 42,932 40,185 79,816 State and municipal 37,152 30,522 29,717 Mortgage-backed securities(2) 42,188 48,579 65,902 Certificates of deposit 0 100 0 Other equity securities 5,111 4,947 4,916 -------- -------- -------- Total 127,383 124,833 181,850 -------- -------- -------- TOTAL SECURITIES(3) $361,806 $290,786 $309,622 ======== ======== ========
(1) At estimated fair value. (2) Mortgage-backed securities are either issued by a federal agency or are secured by U.S. Agency collateral and therefore are believed to be high- quality. (3) The outstanding balance of no single issuer, except for the U.S. Government and U.S. Government Agency securities, exceeded ten percent of stockholders' equity at December 31, 1996, 1995 or 1994. 19 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Maturities and weighted average yields for investments available-for-sale and held-to-maturity at December 31, 1996, are shown below:
Years to Maturity --------------------------------------------------------------------------------------- Within Over 1 Over 5 Over 1 through 5 through 10 10 --------------------------------------------------------------------------------------- Amount Yield Amount Yield Amount Yield Amount Yield - ----------------------------------------------------------------------------------------------------------------------- INVESTMENTS AVAILABLE-FOR-SALE(1) U.S. Treasury $12,996 5.61% $ 13,957 5.63% $ 0 0% $ 0 0% U.S. Agency 8,998 5.55 131,520 6.16 4,999 6.78 0 0 State and municipal(2) 4,374 8.18 19,639 7.68 2,264 6.61 0 0 Corporate debt obligations 0 0 500 5.76 1,000 5.65 0 0 Mortgage-backed securities 3,061 6.18 16,553 5.93 9,734 6.06 2,847 6.74 ------- -------- ------- ------- Total debt securities $29,429 6.03% $182,169 6.26% $17,997 6.31% $ 2,847 6.74% ======= ======== ======= ======= Marketable equity securities TOTAL INVESTMENTS AVAILABLE-FOR-SALE INVESTMENTS HELD- TO-MATURITY U.S. Agency $ 0 0% $20,090 5.86% $ 9,320 7.04% $13,522 7.93% State and municipal(2) 0 0 18,113 7.51 18,439 7.02 600 7.79 Mortgage-backed securities 12,926 6.32 29,262 6.89 0 0 0 0 ------- -------- ------- ------ TOTAL INVESTMENTS HELD-TO-MATURITY $12,926 6.32% $ 67,465 6.75% $27,759 7.03% $14,122 7.92% ======= ======== ======= ======= - ---------------------------------------------------- TOTAL YIELD - ---------------------------------------------------- INVESTMENTS AVAILABLE-FOR-SALE(1) U.S. Treasury $ 26,953 5.63% U.S. Agency 145,517 6.14 State and municipal(2) 26,277 7.68 Corporate debt obligations 1,500 5.69 Mortgage-backed securities 32,195 6.07 -------- Total debt securities 232,442 6.24% Marketable equity securities 470 -------- TOTAL INVESTMENTS AVAILABLE-FOR-SALE $232,912 ======== INVESTMENTS HELD- TO-MATURITY U.S. Agency $ 42,932 6.76% State and municipal(2) 37,152 7.28% Mortgage-backed securities 42,188 6.76% -------- TOTAL INVESTMENTS HELD-TO-MATURITY $122,272 6.92% ========
(1) Amounts shown at amortized cost without market value adjustments required by FASB 115 (see Notes 1 and 4 of Notes to the Consolidated Financial Statements). (2) The yields on state and municipal securities have been calculated on a tax- equivalent basis using the maximum applicable federal income tax rate. Other Earning Assets Residential mortgage loans held for sale increased 69.0% or $3,260 in 1996. Originations and sales of these loans, and the resulting gains on sales, increased substantially as presented on the Consolidated Statements of Cash Flows, reflecting the change to a mortgage banking philosophy of residential mortgage lending. The aggregate of federal funds sold and interest-bearing deposits with banks decreased 22.3% or $6,929 in 1996. Deposits and Short-term Borrowings Total deposits increased 8.4% or $62,749 during 1996 to $806,341 at December 31, 1996 from $743,592 at December 31, 1995. Noninterest-bearing deposits increased 22.0% or $21,077, attributable primarily to growth in commercial checking balances and the introduction of a "free" checking account product around mid- year. Interest-bearing deposits increased 6.4% or $41,672 in 1996, with the majority of the rise occurring in time deposits for amounts less than $100,000. Short-term borrowings increased 95.7% or $33,323 in 1996 to $68,127 at December 31, 1996 from $34,804 at December 31, 1995. Borrowings from the Federal Home Loan Bank of Atlanta increased $17,200, reflecting funds borrowed late in the year and invested in securities in order to leverage the balance sheet and enhance the shareholders' return on investment. Repurchase agreements, the other major category of short-term borrowings, increased 44.6% or $13,639, due primarily to an increase in sweep accounts associated with cash management services to commercial customers. CAPITAL MANAGEMENT During 1996, stockholders' equity increased 11.1% or $9,640 to $96,581 at December 31, 1996 from $86,941 at December 31, 1995. The increase for 1996 was, for the most part, due to internal capital generation, which represents net earnings less dividends as a percent of average equity. The resulting internal capital generation rate was 8.7% for 1996, compared with 8.8% for 1995 and 9.0% for 1994. The amount of the increase in stockholders' equity attributable to internal capital generation was $7,776 in 1996, $7,096 in 1995 and $6,528 in 1994. External capital formation from dividend reinvestment, the exercise of warrants, and employee stock purchases under the Company's stock option and profit sharing plans totaled $1,741 in 1996, $2,379 in 1995 and $1,063 in 1994. The ratio of average equity to average assets amounted to 9.90% for 1996, compared with 9.57% for 1995 and 9.28% for 1994. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Regulatory Capital Requirements The Company achieved a total risk-based capital ratio of 17.56% at December 31, 1996, compared to 17.67% at December 31, 1995, a Tier 1 risk-based capital ratio of 16.44% compared to 16.42%, and a capital leverage ratio of 10.38% compared to 10.09%. A discussion of these quantitative measures of capitalization and the regulatory capital requirements which pertain to them, along with a presentation of the Company's and the Bank's capital and ratios compared to the various regulatory standards, appears in Note 22 of the Notes to the Consolidated Financial Statements. At December 31, 1996, the Company and its banking subsidiary exceeded all capital requirements and were considered to be "well- capitalized" under regulatory definitions. Management monitors historical and projected earnings, dividends and asset growth, as well as risks associated with the various types of on- and off- balance sheet assets, in order to determine the appropriate capital levels and the action needed, if any, to preserve capital adequacy. CREDIT RISK MANAGEMENT The allowance for credit losses is a valuation reserve established by management in an amount it deems adequate to absorb losses on loans which may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level. Management records provisions for credit losses in order to increase the allowance to the level it deems adequate. Loan charge-offs decrease the allowance. Management believes that the allowance for credit losses is adequate. The level of nonperforming loans increased to $4,655 (.89% of year-end loans) at December 31, 1996 from $898 (.18% of year-end loans) at December 31, 1995, due to increases in nonaccrual loans and loans which are past due 90 days or more. The rise in nonaccruals involved loans to a single borrower which management believes will be collected in full during 1997. The increase in loans reported as 90 days or more past due was attributable primarily to the inclusion of credit line expirations at December 31, 1996, which were not included in prior years, and to Annapolis Bancshares credits, which became subject to the Company's more stringent loan review and classification practices subsequent to the merger. It is anticipated that many of the expired lines of credit, which are still current as to principal and interest payments, will be renewed or otherwise return to performing status. The Company also had an increase in loans 90 or more days past due associated with growth and diversification of the loan portfolio. The allowance for credit losses represented 137% of nonperforming loans at December 31, 1996, compared to coverage of 735% a year earlier, with the change attributable to an increase in the level of nonperforming loans. Significant variation in the coverage ratio may occur from period to period because the amount of nonperforming loans depends largely on the condition of a small number of individual loans and borrowers relative to the total loan portfolio. There were no real estate owned properties at December 31, 1996 as compared to a modest $47 at December 31, 1995. The balance of impaired loans was $1,280 at December 31, 1996 and the reserve on these loans was $127. There were no impaired loans at December 31, 1995. Although $590 of loans were classified as being in nonaccrual status at December 31, 1995, the insignificant delay of projected payments caused the loans not to be classified as impaired. The major concentrations of credit risk for the Company arise by customer location, because it operates only in three counties in the State of Maryland, and by loan portfolio composition. Real estate secured credits represented 81.0% of total loans at December 31, 1996, and 82.4% at December 31, 1995. In the past, the Company has experienced low loss levels, especially in real estate secured loans, through various economic cycles and conditions. The risk of the Company's real estate loan concentration is mitigated by the nature of real estate collateral, the Bank's substantial experience in most of its markets and its intention to maintain risk averse lending practices. The provision for credit losses charged against earnings was $308 in 1996 compared with $180 in 1995, an increase of 71.1%. The provision was $211 in 1994. In each year, net charge-offs exceeded the provision for credit losses. The ratio of net charge-offs to average loans was .10% in 1996, compared to .05% in 1995 and .06% in 1994. The allowance for credit losses was decreased to $6,391 (1.22% of year-end loans) at December 31, 1996 from $6,597 (1.34% of year-end loans) at December 31, 1995. The allowance has been maintained at levels believed consistent with the increased risk potential inherent in the increase in the amount and percentage to total loans attributable to commercial and commercial real estate loans (see the discussion of loan growth earlier in this report), which are viewed as entailing greater risk than certain other categories of loans, and the associated increase in large loans, as balanced against other factors, as described above. For additional discussion of the allowance for credit losses, see Note 1 of the Notes to the Consolidated Financial Statements. 21
Analysis of Credit Risk Activity in the allowance for credit losses for the preceding five years ended December 31 is shown below: 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------- Balance, January 1 $6,597 $6,663 $6,681 $4,213 $2,957 Provision for credit losses 308 180 211 1,057 1,880 Allowance from merger transaction 0 0 0 1,158 0 Loan charge-offs: Real estate - mortgage (3) (33) (135) 0 (506) Real estate - construction 0 0 0 0 0 Consumer (143) (209) (32) (104) (243) Commercial (469) (507) (342) (29) (76) ------ ------ ------ ------ ------ Total charge-offs (615) (749) (509) (133) (825) Loan recoveries: Real estate - mortgage 0 153 16 54 0 Real estate - construction 0 0 0 0 5 Consumer 37 30 40 79 61 Commercial 64 320 224 253 135 ------ ------ ------ ------ ------ Total recoveries 101 503 280 386 201 ------ ------ ------ ------ ------ Net recoveries (charge-offs) (514) (246) (229) 253 (624) ------ ------ ------ ------ ------ BALANCE, DECEMBER 31 $6,391 $6,597 $6,663 $6,681 $4,213 ====== ====== ====== ====== ====== Net charge-offs to average loans 0.10% 0.05% 0.06% * 0.19% Allowance to total loans 1.22% 1.34% 1.46% 1.78% 1.34%
* The Company had net recoveries in 1993. The following table presents nonperforming assets for a five year period:
December 31, ---------------------------------------------------------- 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------- Nonaccrual loans/(1)/ $1,291 $ 590 $ 866 $2,969 $ 508 Loans 90 days past due 3,337 272 832 517 953 Restructured loans 27 36 44 394 0 ------ ------ ------ ------ ------ Total nonperforming loans/(2)//(3)/ 4,655 898 1,742 3,880 1,461 Other real estate owned, net 0 47 277 1,387 999 ------ ------ ------ ------ ------ TOTAL NONPERFORMING ASSETS $4,655 $ 734 $2,019 $5,267 $2,460 ====== ====== ====== ====== ====== NONPERFORMING ASSETS TO TOTAL ASSETS 0.48% 0.11% 0.24% 0.67% 0.36%
/(1)/ Gross interest income that would have been recorded in 1996 if nonaccrual loans had been current and in accordance with their original terms was $192, while interest actually recorded on such loans was $89. /(2)/ Those performing loans considered potential problem loans, as defined and identified by management, amounted to $3,440 at December 31, 1996. Although these are loans where known information about the borrowers' possible credit problems causes management to have doubts as to the borrowers' ability to comply with the present loan repayment terms, most are well collateralized and are not believed to present significant risk of loss. Loans classified for regulatory purposes not included in nonperforming loans consist only of "other loans especially mentioned" and do not in management's opinion, represent or result from trends or uncertainties reasonably expected to materially impact further operating results, liquidity or capital resources or represent material credits where known information about the borrowers' possible credit problems causes management to have doubts as to the borrowers' ability to comply with the loan repayment terms. /(3)/ Installment loans past due by 90 days or more are included in the totals for the "loans 90 days past due" line in the table above and were immaterial at December 31, 1996 and 1995. LIQUIDITY AND INTEREST RATE SENSITIVITY Liquidity The Company's liquidity position, considering both internal and external sources available, exceeded anticipated short- and long-term funding needs at December 31, 1996. Core deposits, considered to be stable funds sources and defined to include all deposits except time deposits of $100,000 or more, equaled 81.7% of total earning assets at December 31, 1996. In addition, substantial amortizing residential mortgage loans, maturities, calls and paydowns of securities, deposit growth and earnings contribute a flow of funds available to meet liquidity requirements. In assessing liquidity, management considers operating requirements, the seasonality of deposit flows, investment, loan and deposit maturities, expected fundings of loans and deposit withdrawals, and the market values of available-for-sale investments, so that sufficient funds are available on short notice to meet obligations as they arise and to ensure that the Company is able to pursue new business opportunities. 22 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Internally generated funds on hand at December 31, 1996, consisting of cash and cash equivalents, interest-bearing deposits with banks, residential mortgage loans held for sale, maturities of investments held-to-maturity due within one year at fair value and investments available-for-sale, totalled $312,390 or 31.9% of total assets. The primary external source of liquidity available is a line of credit for $145,000 with the Federal Home Loan Bank of Atlanta of which $20,200 was outstanding at December 31, 1996. Core deposits increased by $56,862 during 1996, while loans grew by $30,626, so that borrowed funds were not required to support loan growth. As discussed previously in the section entitled "Deposits and Short-term Borrowings", Federal Home Loan Bank advances increased in 1996 due to management's desire to leverage the balance sheet at favorable interest spreads to enhance return on stockholder's equity. The Company's time deposits of $100,000 or more represented 7.1% of total deposits at December 31, 1996 and are shown by maturity in the table below.
Months to Maturity ------------------------------------------------ 3 or Over 3 Over 6 Over less to 6 to 12 12 TOTAL - ---------------------------------------------------------------------------------------- Time deposits--$100,000 or more $23,373 $9,735 $10,399 $13,667 $57,174 ======= ====== ======= ======= =======
Interest Rate Sensitivity The Bank's interest rate sensitivity, as measured by the repricing of its interest sensitive assets and liabilities at December 31, 1996 is presented in the following table. As indicated in the note to the table, the data is based in part on assumptions that are regularly reviewed for propriety. The accompanying analysis indicates a moderate level of interest rate risk based on the Bank's having about 51% of its rate sensitive assets versus about 49% of its rate sensitive liabilities subject to maturity or repricing within a one year period from December 31, 1996 (termed GAP analysis). By managing to approximately match the dollar amount of assets and liabilities whose interest rates are subject to change, the Bank seeks to control the risk that a net interest margin decline would have a pronounced adverse impact on its revenues (net interest income). While the Bank's senior management, through its Asset Liability Management Committee (ALCO), has a preference for maintaining a moderate level of interest rate risk as measured by the repricing GAP, the Company's interest rate risk policies are guided by results of simulation analysis which takes into account more factors than does simple GAP analysis. The ALCO analyzes balance sheet, income statement, and margin trends monthly. A detailed quarterly interest rate risk profile is performed for ALCO and is reviewed with the Board of Directors. The Bank's Board of Directors has established a comprehensive interest rate risk management policy, which is administered by ALCO. The policy establishes limits of risk, which are quantitative measures of percentage change in net interest income and equity capital resulting from a hypothetical plus or minus 200 basis point change in U.S. Treasury interest rates for maturities from one month to thirty years. By employing simulation analysis through use of a computer model, the Bank intends to effectively manage the potential adverse impacts that changing interest rates can have on the institution's short term earnings, long term value, and liquidity. Measured from December 31, 1996, the simulation analysis indicates that the Bank's net interest income would decline by 8.1% over a twelve month period given a decline in interest rates of 200 basis points, against a policy limit of 15%. In terms of equity capital on a fair value basis, a 200 basis point decline in interest rates, is estimated to reduce the fair value of capital (as computed) by 18.5% as compared to a policy limit of 25%. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. In addition to the potential adverse impact that changing interest rates may have on the Bank's interest margin and operating results, potential adverse impacts on liquidity can occur as a result of changes in the estimated cash flows from investment, loan and deposit portfolios. The Bank manages this inherent risk by maintaining a sizeable portfolio of available for sale investments as well as a secondary source of liquidity from Federal Home Loan Bank advances. 23 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) The following schedule sets out the time frames from December 31, 1996 in which the Bank's rate sensitive assets and liabilities are subject to repricing:
----------------------------------------------------------- 0-90 91-365 Over 1-3 Over 3-5 Over 5 Days Days Years Years Years - -------------------------------------------------------------------------------------------------------- RATE SENSITIVE ASSETS: Loans $180,441 $ 92,100 $162,500 $ 47,186 $ 40,939 Taxable securities 72,898 78,826 105,662 18,349 15,555 Nontaxable securities 1,980 3,935 17,110 19,395 21,009 Other investments 42,023 0 0 0 0 -------- -------- -------- -------- -------- TOTAL 297,342 174,861 285,272 84,930 77,503 RATE SENSITIVE LIABILITIES: Noninterest-bearing demand deposits 11,711 3,513 42,159 42,159 17,566 Interest-bearing demand deposits 5,936 17,808 47,487 27,701 0 Regular savings deposits 4,749 14,246 37,989 36,408 1,583 Money market savings deposits 13,974 41,922 111,794 0 0 Time deposits 107,022 146,882 67,733 16,235 28 Short-term borrowings and other rate sensitive liabilities 55,930 12,002 1,000 0 3,920 -------- -------- -------- -------- -------- TOTAL................................. 199,322 236,373 308,162 122,503 23,097 -------- -------- -------- -------- -------- CUMULATIVE GAP........................ $ 98,020 $ 36,508 $ 13,618 $(23,955) $ 30,451 ======== ======== ======== ======== ======== As a percent of total assets 10.02% 3.73% 1.39% (2.45)% 3.11% CUMULATIVE RATE SENSITIVE ASSETS TO RATE SENSITIVE LIABILITIES 1.49 1.08 1.02 0.97 1.03
NOTE: This analysis is based upon a number of significant assumptions including the following: Loans are repaid/rescheduled by contractual maturity and repricings. Securities, except mortgage-backed securities, are repaid according to contractual maturity adjusted for call features. Mortgage-backed security repricing is adjusted for estimated early paydowns. In order to reflect the temporary seasonal influx of noninterest-bearing demand deposits at year end, which inflates short-term rate sensitive assets, such deposits in excess of their average balance for the year are shown in 0-90 days. Interest-bearing demand, regular savings and money market savings deposits are estimated to exhibit some rate sensitivity based on management's analysis of deposit withdrawals. Time deposits are shown in the table based on contractual maturity. SELECTED GLOSSARY AND ABBREVIATIONS Basis Point: One hundredth of one percent. An increase in yield from 7.00% to 7.50% could be expressed as a change of 50 basis points. Book Value Per Share: Total stockholders' equity divided by the number of shares of common stock outstanding at year-end. Capital Leverage Ratio: Year-end core capital (stockholders' equity less intangibles and the net unrealized gain or loss on investments available-for- sale) as a percentage of average total assets for the fourth quarter. The Company: Sandy Spring Bancorp, Sandy Spring National Bank of Maryland and Sandy Spring Insurance Corporation. Internal Capital Generation Rate: The percent of return on average equity multiplied by the percent of earnings retained (net earnings less dividends). Net Interest Margin: Fully tax-equivalent net interest income as a percentage of average earning assets. Net Interest Spread: Fully tax-equivalent yield on earning assets less the average rate paid on interest-bearing liabilities. Net Overhead Ratio: A measure of cost management and productivity. Net overhead (noninterest expenses less non-interest income) divided by fully tax- equivalent net interest income. Nonperforming Assets: The sum of loans which are nonaccrual, 90 days past due or restructured and other real estate owned. Return on Average Assets: Net income as a percentage of average total assets. Return on Average Equity: Net income as a percentage of average total stockholders' equity. Total Risk-based Capital Ratio: Qualifying regulatory capital (stockholders' equity less intangibles and the net unrealized gain or loss on investments available-for-sale, plus a portion of the allowance for credit losses) as a percentage of risk-adjusted total assets. Tax-Equivalent Net Interest Income: Interest income, plus the addition of tax savings from nontaxable loans and investments, less interest expense. Tier 1 Risk-based Capital Ratio: Regulatory core capital (stockholders' equity less intangibles and the net unrealized gain or loss on investments available- for-sale) as a percentage of risk-adjusted total assets. 24 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Pages 30 through 47 of the Annual Report are hereby incorporated by reference. The remaining information appearing in the Annual Report to Shareholders is not deemed to be filed as part of this Report, except as expressly provided herein. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 25 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding directors and nominees for directors of Bancorp and compliance with Section 16(a) of the Securities Exchange Act of 1934 is included under the captions entitled "Election of Directors -- Information as to Nominees and Continuing Directors" on pages 3 through 5 of the Proxy Statement, and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" on pages 15 and 16 of the Proxy Statement, and is hereby incorporated by reference. Information concerning the executive officers of Bancorp is included under the caption entitled "Item 1. Business -- Executive Officers" of this report and is hereby incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION Information regarding the compensation of Bancorp's directors and executive officers is included under the captions "Executive Compensation," "Report of the Human Resources Committee," and "Stock Performance Graph" on pages 6 through 14 of the Proxy Statement, and is hereby incorporated by reference. 26 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding beneficial ownership of Bancorp's common stock by certain beneficial owners and directors and executive officers of Bancorp is included under the caption "Stock Ownership of Management" on page 2 of the Proxy Statement and is hereby incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and related transactions with management is included under the caption "Transactions and Relationships with Management" on page 15 of the Proxy Statement and is hereby incorporated by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following consolidated financial statements of Bancorp included in the Annual Report to Shareholders for the year ended December 31, 1996, are incorporated herein by reference in Item 8 of this Report. The remaining information appearing in the Annual Report to Shareholders is not deemed to be filed as part of this Report, except as expressly provided herein. The following financial statements are filed as a part of this report: Consolidated Balance Sheets at December 31, 1995 and 1996 Consolidated Statements of Income for the years ended December 31, 1994, 1995 and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1994, 1995 and 1996 Notes to the Consolidated Financial Statements Report of Independent Auditors All financial statement schedules have been omitted as the required information is either inapplicable or included in the consolidated financial statements or related notes. 27 The following exhibits are filed as a part of this report:
Exhibit No. Description Incorporated by Reference to: - ---------------------------------------------------------------------------------------------------------------- 3(a) Articles of Incorporation of Sandy Spring Exhibit 3.1 to Form 10-Q for the Quarter Bancorp, Inc., as Amended Ended June 30, 1996, SEC File No. 0- 19065. 3(b) Bylaws of Sandy Spring Bancorp, Inc. Exhibit 3.2 to Form 8-K dated May 13, 1992, SEC File No. 0-19065. 10(a)* Sandy Spring Bancorp, Inc., Cash and Deferred Exhibit 10(b) to Form 10-K for the year Profit Sharing Plan and Trust, as Amended ended December 31, 1989, SEC File No. 0- 19065, Exhibits 4.2, 4.3, 4.4, and 4.5 to Form S-8 and Post Effective Amendment No. 2 to Form S-8 Registration Statements No. 33-29316 and 33-48453, filed with the Securities and Exchange Commission on December 16, 1996. 10(b)* Sandy Spring Bancorp, Inc. 1982 Incentive Exhibit 10(c) to Form 10-Q for the quarter Stock Option Plan ended June 30, 1990, SEC File No. 0- 19065. 10(c)* Sandy Spring Bancorp, Inc. 1992 Stock Option Exhibit 10(i) to Form 10-K for the year Plan ended December 31, 1991, SEC File No. 0- 19065. 10(d)* Sandy Spring Bancorp, Inc. Amended and Exhibit 4 to Registration Statement on Restated Stock Option Plan for Employees of Form S-8, Registration Statement No. 333- Annapolis Bancshares, Inc. 11-049. 10(e)* Sandy Spring National Bank of Maryland Exhibit 10(g) to Form 10-K for the year Executive Health Insurance Plan ended December 31, 1991, SEC File No. 0- 19065. 10(f)* Sandy Spring National Bank of Maryland Exhibit 10(k) to Form 10-K for the year Executive Health Expense Reimbursement Plan ended December 31, 1991, SEC File No. 0- 19065. 10(g)* Employment Agreement with Hunter R. Hollar, Exhibit 10(e) to Form 10-K for the year as Amended ended December 31, 1990, SEC File No. 0- 19065, and Exhibit 10(f) to Form 10-K for the year ended December 31, 1991, SEC File No. 0-19065. 10(h)* Forms of Supplemental Executive Retirement Exhibit 10(g) to Form 10-K for the year Agreements with Willard H. Derrick, Hunter R. ended December 31, 1991, SEC File No. 0- Hollar, Thomas O. Keech and A. Hardy 19065. Pickett, with 1992 Amendments 10(i)* Forms of Executive Severance Agreements with Exhibit 10(h) to Form 10-K for the year Willard H. Derrick, Thomas O. Keech and A. ended December 31, 1991, SEC File No. 0- Hardy Pickett, with 1992 Amendments 19065.
28
Exhibit No. Description Incorporated by Reference to: - ---------------------------------------------------------------------------------------------------------------- 13 Specified Portions of the 1996 Annual Report to Shareholders 21 Subsidiaries 23 Consent of Independent Auditors 24 Power of Attorney 27 Financial Data Schedule
* Management Contract or Compensatory Plan or Arrangement filed pursuant to Item 14(c) of this Report. (b) No Current Reports on Form 8-K were filed during the three month period ended December 31, 1996. (c) Exhibits to this Form 10-K are attached or incorporated by reference as stated above. (d) None. 29 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SANDY SPRING BANCORP, INC. (Registrant) By: /s/ Hunter R. Hollar -------------------- Hunter R. Hollar President and Chief Executive Officer 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 as of March 20, 1997. Principal Executive Officer and Director: Principal Financial and Accounting Officer: /s/ Hunter R. Hollar /s/ James H. Langmead - -------------------- --------------------- Hunter R. Hollar James H. Langmead President and Chief Executive Officer Vice President and Treasurer A majority of the directors of Bancorp executed a power of attorney appointing Marjorie S. Holsinger as their attorney-in-fact, empowering her to sign this report on their behalf. This power of attorney has been filed with the Securities and Exchange Commission under Part IV, Exhibit 24 of this Form 10-K for the year ended December 31, 1996. This report has been signed below by such attorney-in-fact as of March 20, 1997. By: /s/ Marjorie S. Holsinger ------------------------- Marjorie S. Holsinger Attorney-in-Fact for Majority of the Directors of Bancorp INDEX TO EXHIBITS
Exhibit No. Description Incorporated by Reference to: - ---------------------------------------------------------------------------------------------------------------- 3(a) Articles of Incorporation of Sandy Spring Exhibit 3.1 to Form 10-Q for the Quarter Bancorp, Inc., as Amended Ended June 30, 1996, SEC File No. 0- 19065. 3(b) Bylaws of Sandy Spring Bancorp, Inc. Exhibit 3.2 to Form 8-K dated May 13, 1992, SEC File No. 0-19065. 10(a)* Sandy Spring Bancorp, Inc., Cash and Deferred Exhibit 10(b) to Form 10-K for the year Profit Sharing Plan and Trust, as Amended ended December 31, 1989, SEC File No. 0- 19065, Exhibits 4.2, 4.3, 4.4, and 4.5 to Form S-8 and Post Effective Amendment No. 2 to Form S-8 Registration Statements No. 33-29316 and 33-48453, filed with the Securities and Exchange Commission on December 16, 1996. 10(b)* Sandy Spring Bancorp, Inc. 1982 Incentive Exhibit 10(c) to Form 10-Q for the quarter Stock Option Plan ended June 30, 1990, SEC File No. 0- 19065. 10(c)* Sandy Spring Bancorp, Inc. 1992 Stock Option Exhibit 10(i) to Form 10-K for the year Plan ended December 31, 1991, SEC File No. 0- 19065. 10(d)* Sandy Spring Bancorp, Inc. Amended and Exhibit 4 to Registration Statement on Restated Stock Option Plan for Employees of Form S-8, Registration Statement No. 333- Annapolis Bancshares, Inc. 11-049. 10(e)* Sandy Spring National Bank of Maryland Exhibit 10(g) to Form 10-K for the year Executive Health Insurance Plan ended December 31, 1991, SEC File No. 0- 19065. 10(f)* Sandy Spring National Bank of Maryland Exhibit 10(k) to Form 10-K for the year Executive Health Expense Reimbursement Plan ended December 31, 1991, SEC File No. 0- 19065. 10(g)* Employment Agreement with Hunter R. Hollar, Exhibit 10(e) to Form 10-K for the year as Amended ended December 31, 1990, SEC File No. 0- 19065, and Exhibit 10(f) to Form 10-K for the year ended December 31, 1991, SEC File No. 0-19065. 10(h)* Forms of Supplemental Executive Retirement Exhibit 10(g) to Form 10-K for the year Agreements with Willard H. Derrick, Hunter R. ended December 31, 1991, SEC File No. 0- Hollar, Thomas O. Keech and A. Hardy 19065. Pickett, with 1992 Amendments 10(i)* Forms of Executive Severance Agreements with Exhibit 10(h) to Form 10-K for the year Willard H. Derrick, Thomas O. Keech and A. ended December 31, 1991, SEC File No. 0- Hardy Pickett, with 1992 Amendments 19065. 13 Specified Portions of the 1996 Annual Report to Shareholders
Exhibit No. Description Incorporated by Reference to: - ---------------------------------------------------------------------------------------------------------------- 21 Subsidiaries 23 Consent of Independent Auditors 24 Power of Attorney 27 Financial Data Schedule
* Management Contract or Compensatory Plan or Arrangement filed pursuant to Item 14(c) of this Report. EX-13 2 EXHIBIT 13 Exhibit 13 Sandy Spring Bancorp 1996 Annual Report [PHOTO APPEARS HERE] CONTENTS 2 Letter to Shareholders 6 Our Customers 16 Board of Directors 17 Financial Section FINANCIAL HIGHLIGHTS* (Dollars in thousands, except per share data)
1996 1995 % Change - ------------------------------------------------------------------------------------------------------------------------- PROFITABILITY FOR THE YEAR: Net Interest Income $ 36,388 $ 32,773 11.0% Income before Taxes 17,283 14,647 18.0 Net Income 11,494 9,994 15.0 Return on Average Assets 1.27% 1.18% Return on Average Equity 12.81% 12.37% Net Interest Margin 4.45% 4.32% PER SHARE DATA: Net Income $ 2.36 $ 2.09 12.9% Dividends Declared 0.78 0.64 21.9 Book Value 19.70 18.04 9.2 AT YEAR END: Assets $978,595 $876,203 11.7% Deposits 806,341 743,592 8.4 Loans 523,166 492,540 6.2 Securities 361,806 290,786 24.4 Stockholders' Equity 96,581 86,941 11.1 CAPITAL AND CREDIT QUALITY RATIOS: Average Equity to Average Assets 9.90% 9.57% Total Risk-based Capital Ratio 17.56% 17.67% Allowance for Credit Losses to Loans 1.22% 1.34% Nonperforming Assets to Total Assets 0.48% 0.11% Net Charge-Offs to Average Loans 0.10% 0.05%
* Adjusted to give retroactive effect to a 2-for-1 stock split declared on March 29, 1995 and, except with respect to dividends declared per share, the acquisition of Annapolis Bancshares, Inc., completed on August 29, 1996. Forward-looking Statements The following letter to shareholders and other portions of this Annual Report contain forward-looking statements, including statements of goals, intentions, and expectations, regarding or based upon general economic conditions, interest rates, developments in national and local markets, and other matters, and which, by their nature, are subject to significant uncertainties. Because of these uncertainties and the assumptions on which statements in this report are based, the actual future results may differ materially from those indicated in this report. Sandy Spring Bancorp SANDY SPRING BANCORP Sandy Spring Bancorp is the holding company for Sandy Spring National Bank of Maryland, the oldest banking business native to Montgomery County. Sandy Spring National Bank, independent and community-oriented, traces its origin to 1868 and conducts a full-service commercial banking business through nineteen community offices located in Montgomery, Howard and Anne Arundel Counties in Maryland. LETTER TO SHAREHOLDERS Dear Shareholders It is a pleasure to report to you Sandy Spring Bancorp results for 1996 and the vision for this successful community-oriented bank holding company. Our success has been due to consistent results, and 1996 continued our record of earnings growth and superior customer service. After our first bank acquisition in 1993, 1996 saw our second acquisition: Annapolis Bankshares, Inc., the holding company for Bank of Annapolis. This acquisition was completed on August 29, 1996 and represents a unique opportunity for us to fill a locally-owned, community bank niche in this vibrant market served by many out-of-state organizations. A healthy institution with a significant deposit and loan base, Bank of Annapolis was located only about 30 miles from our Clarksville office. All financial results in this Annual Report, unless otherwise noted, have been restated as if Bank of Annapolis had been part of our organization in all the prior periods mentioned. Financial Highlights Net income grew from $10.0 million in 1995 to $11.5 million in 1996, a 15.0% increase. Assets grew 11.7% (from $876.2 million to $978.6 million). Loans grew 6.2% (from $492.5 million to $523.2 million), while deposits grew 8.4% (from $743.6 million to $806.3 million). These figures demonstrate our desire to grow while putting significant emphasis on profitability gains as a way to enhance shareholder value. The major contributors to our earnings increase were an improved net interest margin and increases in noninterest income. After three straight years of modest changes in the net interest margin, the figure rose to 4.45% in 1996 from 4.32% in 1995. This improvement was due largely to our ability to grow noninterest-bearing deposits as well as interest-bearing deposits at favorable interest spreads, which permitted us to earn more than in previous years. Noninterest income grew in virtually all categories including service charges, fees on sales of annuities and mutual funds, trust fees, and gains on sales of residential mortgage loans and student loans. We believe our ability to grow noninterest income is a reflection of our ability to meet customer needs and provide excellent customer service at fair prices. While our net interest margin grew in 1996, we believe that over the long term, competitive pressure will compress margins and increase the importance of fee-based income. Our return on assets grew to 1.27% in 1996 from 1.18% in 1995, putting us approximately in the top one-third of our peers (as to total asset size) nationwide in this important measure of profitability. Return on equity grew from 12.37% in 1995 to 12.81% in 1996, reflecting better utilization of our total capital. Earnings per share grew 12.9% (from $2.09 to $2.36) and dividends increased 21.9% (from $0.64 per share to $0.78). While the dividends increased significantly, our stock price declined from $35.00 per share at year-end 1995 to $32.00 at year-end 1996. Considering dividends and the price decrease, the total return for the year was -6.3%. However, the similar calculation for the prior year gave a positive return of 45.5%. At year-end 1995 and into 1996, our stock was becoming widely traded and stock brokers took a more active interest, driving our price to record highs as a percentage of book value and earnings per share. By year end 1996, the euphoria had subsided and our stock began to trade closer to historic book and earnings multiples for Sandy Spring Bancorp, which are also similar to multiples for other financial institutions. Our goal is to continue to manage your company such that the fundamentals of earnings, loan and deposit growth, asset quality, noninterest income growth, and expense control are among the best in the industry. The Year in Review Due to the increased interest in Sandy Spring Bancorp in 1996, we decided to list our stock on the National Association of Securities Dealers (NASDAQ) National Market in April. This listing permits a more orderly market for those interested in buying or selling Sandy Spring Bancorp stock. Further, being on a recognized exchange provides better liquidity in our stock. In March of 1996, we opened a new office on East Gude Drive in Rockville. This office fits our strategy of better covering the Rockville area. In December, we acquired another financial institution's branch office, including deposits of $19 million, on Wisconsin Avenue in Bethesda. This location fits our intention of better serving the entire I-270/Route 355 corridor in Montgomery County. Bethesda is a thriving "city" in which we think Sandy Spring style banking will be welcomed. We will be offering a full range of services there including business and consumer loans, trust and investment services, and residential mortgages. Both of these new offices support 2 our strategy of making ourselves more accessible to potential customers. Our Asset and Trust Management Department continues to grow. At the end of 1996, we had $166 million in assets under management and we had earned $943 thousand in fees. One of our goals for 1996 was to significantly increase our noninterest- bearing checking accounts. These deposits are attractive because they are noninterest-bearing, but, more importantly, they are the primary means by which consumers are allied with a primary bank. In June, we launched an aggressive GO FOR THE GOLD campaign which offered the best checking account for consumers in our market. As a result, Sandy Spring Bank and our BONUS GOLD account were featured in a June 30th news story in The Baltimore Sun. In addition to no service charges until the year 2000, the account provided numerous other benefits. Partly as a result of this special limited-time offer of BONUS GOLD CHECKING, our noninterest deposits grew from $96.0 million at year-end 1995 to $117.1 million by December 31, 1996. In 1996, we continued to devote more resources to our residential mortgage lending. This market has become crowded with competitors and we have responded with many new mortgage products and with very competitive pricing. We continue to believe that the mortgage loan is a key component of the relationship with a family. We originated over $95 million in residential mortgage loans in 1996, almost double the figure for 1995. We want to distinguish ourselves from other competitors through our commitment to this segment of our business over time and through superior customer service. The comments we received from customers in 1996 indicate that we are succeeding. The View Forward One aspect of our view of the future doesn't change; we continue to believe that a community bank like Sandy Spring has a bright future. As long as we provide superior customer service and value to our shareholders through solid financial results, we will be a survivor on the competitive battlefield of financial services providers. Real people continue to look for personal service delivered in a caring way by people they know, like, and trust. Our goal is to provide such service. In addition to the personal touch, we believe that we must provide those products and services which people [PHOTO APPEARS HERE] Hunter R. Hollar President and Chief Executive Officer Willard H. Derrick Chairman of the Board 3 want in a way which is convenient and effective for the customer, not just for us as bankers. In the first quarter of 1997, we introduced BANKXPRESS, allowing our customers to bank with us using their personal computer or a screen telephone. In the not-too-distant future we may even be able to provide "cash" through the telephone lines by loading a smart card which can be used like cash. While the percentage of individuals using electronic/computer access is projected to increase dramatically, we believe that we must constantly search for the mix of access points which best serves our customers. For this reason, branches are very much in our future. Our office in Gaithersburg Square is opening in early April. In addition, we have recently reached an agreement to occupy a new branch in the Milestone area of Germantown, a fast-growing part of upper Montgomery County. In accordance with plans mentioned here last year, we will be offering more formal financial planning services during 1997. We continue to believe that our customers and others in our markets are looking for help and advice as they assess their future financial needs, particularly as these needs require investment decisions, estate planning, and insurance purchases. We want to become a trusted advisor for people in all of these areas. We believe such a direction fits well with our already strong Asset and Trust Management Department efforts. We are looking forward in 1997 to occupying the former Coles Furniture building adjacent to our headquarters in Olney. This will allow us to consolidate some administrative employees permitting more convenient communication and planning between departments. Our advertising and promotion emphasis will be on increasing the "top of mind awareness" of Sandy Spring Bank. In addition, we want to let non-customers know that our existing customers are very happy with us. We have all heard it said that the best advertising is word of mouth and we want to encourage that method with a campaign: You should hear what our customers say about us. We are proud of the great relationship we have with our customers and we want to tell others about it. At the same time, we know there is absolutely no substitute for continuing to take care of our existing and new customers very well. We are open to acquisitions of other financial institutions, but only in cases where we feel that earnings per share of the combined institution will be enhanced in a reasonably short period of time. As mentioned earlier, we plan to continue careful additions of new branches as well. Our desire is to concentrate our expansion efforts in 1) Annapolis and Anne Arundel County; 2) areas of Montgomery and Howard Counties we do not presently serve; and 3) the area between our existing markets and our new market in Annapolis/Anne Arundel County. Our strategy, as always, will be to approach any growth in a way that enhances profitability and maintains our ability to manage prudently and to provide high quality service. In Conclusion Under our age 70 retirement policy, two Directors, Andrew Adams and Willard Derrick, will leave the Board as of April 16. Please see additional comments on page 16. Their wisdom and perspective will be missed by those remaining on the Board. Further, we were saddened by the passing on July 27, 1996 of our Director Emeritus John F. Wilson. Mr. Wilson left the board in 1991 after 21 years of service. One of the few certainties in our lives and in the business world is change. Things will be different tomorrow than they are today. We must constantly adapt to remain strong, healthy, and independent. Technologies will change. New products and services will wax and wane in popularity. New buildings will be built and new locations occupied. One constant will remain: the importance of our people in providing the service level needed for us to be different. We sincerely appreciate the loyalty and dedication of our employees, who, we believe, continue to distinguish Sandy Spring National Bank as the best financial institution in our trade area. Thank you for your support and interest in Sandy Spring Bancorp. Respectfully, /s/ Willard H. Derrick Willard H. Derrick Chairman of the Board /s/ Hunter R. Hollar Hunter R. Hollar President and Chief Executive Officer 4 [PHOTO APPEARS HERE] You should hear what our customers say about us... "Annapolis is a special place to live or own a business and Sandy Spring Bank is a welcome addition. They're a Maryland bank with a long heritage." [PHOTO APPEARS HERE] Michael Swift, Owner Griffins Restaurant Annapolis, Maryland 6 [PHOTO APPEARS HERE] Michael Swift at his restaurant, Griffins, a landmark on the city dock in Annapolis. 7 [PHOTO APPEARS HERE] Kristine Mitchell (left), Vice President and John Corgan (right), President of Mitchell & Best Homebuilders, LLC, an award winning Maryland home builder, with Jeff Wood (center), Sandy Spring Bank Vice President of the Commercial Real Estate Group. 8 "When I call my Sandy Spring banker, I don't need to explain how the construction business works. He knows." [PHOTO APPEARS HERE] Kristine Mitchell, Vice President Mitchell & Best Homebuilders Rockville, Maryland 9 "I'd rather fly than do almost anything, so I own a 1939 Stearman bi-plane and a twin engine Beechcraft Baron. They're the best of the old and new. Just like Sandy Spring Bank. Sandy Spring combines old-fashioned service with modern technology." [PHOTO APPEARS HERE] Gustavus McLeod, President Lawson Surgical Gaithersburg, Maryland 10 [PHOTO APPEARS HERE] Gustavus McLeod (left), President of Lawson Surgical in Gaithersburg and Mike Penyak, Sandy Spring Bank Vice President of Community Lending. 11 [PHOTO APPEARS HERE] Le Cress, Controller of the quality furniture company, Mastercraft Interiors, Ltd., headquartered in Beltsville. 12 "Things get pretty busy around here, but Sandy Spring makes banking easy. When I need to look up company account infor- mation or to transfer funds, all I do is turn on my computer." [PHOTO APPEARS HERE] Le Cress, Controller Mastercraft Interiors, Ltd. Beltsville, Maryland 13 "Sandy Spring gets high marks for commu- nity service. Their in-school bank program helps our students in so many ways." [PHOTO APPEARS HERE] Laura Czankner, Teacher Sherwood Elementary School Sandy Spring, Maryland 14 [PHOTO APPEARS HERE] Laura Czankner (upper right), teacher at Sherwood Elementary School in Sandy Spring and Sandy Spring Bank mascot, Sandy Dog, assist at the in-school bank. 15 DIRECTORS RETIRE Board of Directors Willard H. Derrick Chairman of the Bank and Bancorp Andrew N. Adams, Jr. Retired President of Ten Oaks Nursery and Gardens, Inc. John Chirtea Retired from LCOR, a national real estate development company Susan D. Goff President of M.D.IPA, Inc. Solomon Graham President and Chief Executive Officer of Quality Biological, Inc. Joyce Riggs Hawkins Real Estate Agent Hunter R. Hollar President and Chief Executive Officer of the Bank and Bancorp Thomas O. Keech Retired Executive Vice President of the Bank and Bancorp Charles F. Mess, M.D. General Orthopaedic Practice Robert L. Mitchell President and Chief Executive Officer of C-I/Mitchell & Best Company Robert L. Orndorff, Jr. President of RLO Contractors, Inc. Lewis R. Schumann Partner in the law firm of Miller, Miller and Canby, Chtd. W. Drew Stabler Partner in Pleasant Valley Farm Directors Emeritus Daniel Ligon, Chairman Emeritus Samuel Riggs, IV, Chairman Emeritus Thomas A. Ladson Charles H. Ligon Louisa W. Riggs Francis Snowden Stanley P. Stabler Clyde W. Unglesbee Robert H. White In accordance with established board policy pertaining to age limitations, Chairman of the Board Willard H. Derrick and Director Andrew N. Adams will be retiring from the boards of the Bank and Bancorp on April 16, 1997. Mr. Derrick and Mr. Adams have consistently exhibited integrity and sound judgment as they have helped guide the Bank through many successful years. [PHOTO APPEARS HERE] Willard H. Derrick Willard Derrick began his career at the Bank in 1952. At that time he actually worked for two banks housed under the same roof, the Savings Institution of Sandy Spring and the First National Bank of Sandy Spring. He joined the boards of both banks in 1971. In 1972 he was named President when the two banks, due in large part to his efforts, were unified into Sandy Spring National Bank. During Mr. Derrick's 44 years of dedicated service, the Bank has grown from one office and $5 million in assets to 19 offices and almost $1 billion in assets. This tremendous growth and the Bank's enviable reputation are a tribute to Mr. Derrick's strong leadership. A native of Montgomery County, Mr. Derrick has participated in leadership positions in numerous organizations including Montgomery General Hospital, the Sandy Spring Lions Club, the Sandy Spring Museum, the Asbury Foundation, the Montgomery County Community Foundation and the Montgomery Mutual Insurance Company. He has earned the respect of those whose lives have been touched by his energy, devotion to others and his tireless support of worthwhile charitable causes. Mr. Derrick has been given innumerable awards in recognition of his outstanding leadership. The Board of Directors, management, the entire bank staff, shareholders and bank customers are indebted to him for the legacy he leaves. [PHOTO APPEARS HERE] Andrew N. Adams, Jr. Andrew (Andy) Adams joined the board in 1968. Since that time, he has served on several of the board's committees. In recent years, he was a member of the nominating committee and the audit committee. Mr. Adams is retired President of Ten Oaks Nursery, Inc., a family-owned business begun by his father in 1925. He has been widely recognized in the nursery trade for his development of new varieties of plants. Mr. Adams is a native of Howard County and has lived there his entire life. Active in the community, he was an organizer and charter member of the Columbia Rotary Club. The Bank's presence in the Howard County market area is due in large measure to his encouragement and support. He has done an outstanding job of representing the Bank to the people and businesses of Howard County. 16
INDEX TO FINANCIAL SECTION Recent Stock Prices and Dividends 17 Management's Discussion and Analysis of Operations and Financial Condition 18 Selected Glossary and Abbreviations 29 Financial Statements: At December 31, 1996 and 1995: Consolidated Balance Sheets 30 For the Years Ended December 31, 1996, 1995 and 1994: Consolidated Statements of Income 31 Consolidated Statements of Cash Flows 32 Consolidated Statements of Changes in Stockholders' Equity 33 Notes to the Consolidated Financial Statements 34 Management's Statement of Responsibility 47 Report of Independent Auditors 47
RECENT STOCK PRICES AND DIVIDENDS (Dollars in thousands, except per share data) Shareholders received quarterly cash dividends totaling $3,620 in 1996 and $2,755 in 1995. Regular dividends have been declared for ninety-six consecutive years. The Company has increased its dividends per share each year for the past sixteen years. Since 1991, dividends per share have risen at an annual compound growth rate of 15.5%, with an increase of 21.9% in 1996. Per share dividends, expressed as a percentage of earnings per share, were 33.1% in 1996 and 30.6% in 1995. The amount of dividends is established by the Board of Directors in consideration of operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns and other factors. Shares issued under the dividend reinvestment plan totaled 35,273 in 1996 and 35,300 in 1995. The number of common shareholders of record was approximately 2,400 as of February 10, 1997 compared to approximately 2,000 a year earlier. Shares of Sandy Spring Bancorp commenced trading on The Nasdaq Stock Market's National Market on April 17, 1996 under the trading symbol SASR. Since that date, the price information provided below reflects actual high and low sales prices as quoted on The Nasdaq Stock Market. Prior to April 17, 1996, sales prices reported below were based upon reports of broker transactions published by third parties and any other transactions known to the Company to have occurred in each quarter.
QUARTERLY STOCK INFORMATION 1996 1995 ---------------------------------- ---------------------------------- Stock Price Range Per Share Stock Price Range Per Share ----------------- ----------------- Quarter Low High Dividend Low High Dividend - ---------------------------------------------------------------------------------------------------------------- 1st $35.00 $38.75 $0.18 $24.50 $26.25 $0.15 2nd 35.75 41.00 0.19 25.38 32.00 0.15 3rd 34.00 39.50 0.20 29.25 39.00 0.16 4th 31.25 34.75 0.21 35.00 39.00 0.18 - ---------------------------------------------------------------------------------------------------------------- Total $0.78 $0.64 ===== =====
17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION (Dollars in thousands, except per share data) OVERVIEW The Company's 1996 financial results and performance were favorable. During 1996, the Company recorded growth in core deposits, interest and noninterest revenues, and net income. Substantially all profitability measures showed improvement in 1996 when compared to 1995. At year-end 1996, capital remained well above minimum regulatory requirements. Also in 1996, Bancorp completed its second merger, when Annapolis Bancshares, Inc. was merged into Sandy Spring Bancorp and The Bank of Annapolis was merged into Sandy Spring National Bank. This transaction had little impact on consolidated earnings growth for 1996, after merger related expenses were recorded, but gives the Company opportunity for future growth in an attractive new market. This merger was accounted for as a pooling of interests. Accordingly, all financial data except dividend and stock price information have been retroactively restated to include the operations and position of Annapolis Bancshares. In December 1996, Sandy Spring National Bank completed the acquisition of an existing bank branch on Wisconsin Avenue in Bethesda from Bank of Maryland. This acquisition provides a new business base along the Route 355 corridor and is a natural extension of the Bank's branch system. For 1996, net earnings amounted to $11,494 ($2.36 per share) versus $9,994 ($2.09 per share) for 1995, a 15% increase. Return on average assets was 1.27% compared to 1.18% for 1995, and return on average equity was 12.81% versus 12.37% for 1995. Total deposits grew by 8.4% while loan growth amounted to 6.2%. Asset quality remains acceptable, as measured by net loans charged off and the level of problem assets continuing to indicate moderate levels of risk. The following more detailed discussion of our financial results is intended to give you the reader a clear and succinct view of the various significant components of our operating results and financial position. Please refer to the Selected Glossary and Abbreviations on page 29 for further definition of technical terms.
CHANGES IN NET INCOME PER COMMON SHARE 1995 to 1996 1994 to 1995 - --------------------------------------------------------------------------- Prior year net income per share $ 2.09 $ 1.90 Change attributed to: Net interest income 0.48 0.33 Provision for credit losses (0.02) 0.00 Noninterest income 0.28 0.04 Noninterest expenses (0.39) (0.13) Income taxes (0.04) (0.01) Increased shares outstanding (0.04) (0.04) ------ ------ Total 0.27 0.19 ------ ------ NET INCOME PER SHARE $ 2.36 $ 2.09 ====== ======
18 HISTORICAL TRENDS IN FINANCIAL DATA 1992-1996(1) (Dollars in thousands, except per share data)
1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------ RESULTS OF OPERATIONS (for the year): Interest income $ 66,621 $ 62,115 $ 51,578 $ 46,189 $ 48,177 Interest expense 30,233 29,342 21,496 19,793 23,129 Net interest income 36,388 32,773 30,082 26,396 25,048 Provision for credit losses 308 180 212 1,056 1,880 Net interest income after provision for credit losses 36,080 32,593 29,870 25,340 23,168 Noninterest income 6,547 4,478 4,189 4,870 4,656 Noninterest expenses 25,344 22,424 21,462 18,340 16,243 Income before taxes and cumulative effect of accounting change 17,283 14,647 12,597 11,870 11,581 Income tax expense 5,789 4,653 3,694 3,261 3,252 Income before cumulative effect of accounting change 11,494 9,994 8,903 8,609 8,329 Cumulative effect of accounting change 0 0 0 0 744 Net income 11,494 9,994 8,903 8,609 9,073 PER SHARE DATA: Net income $ 2.36 $ 2.09 $ 1.90 $ 1.92 $ 2.01(2) Dividends declared 0.78 0.64 0.54 0.49 0.43 Book value 19.70 18.04 15.72 15.63 13.39 FINANCIAL CONDITION (at year end): Assets $978,595 $876,203 $830,834 $784,274 $675,418 Deposits 806,341 743,592 700,340 676,422 602,073 Loans 523,166 492,540 457,052 374,740 313,924 Securities 361,806 290,786 309,622 314,283 285,120 Stockholders' equity 96,581 86,941 73,766 72,420 59,205 MEASUREMENTS (for the year): Return on average assets 1.27% 1.18% 1.14% 1.23% 1.30%(2) Return of average equity 12.81 12.37 12.24 13.55 16.95(2) Average equity to average assets 9.90 9.57 9.28 9.10 7.65 Dividends declared to net income 33.05 30.62 28.42 25.52 21.39(2)
(1) Adjusted to give retroactive effect to a 2-for-1 stock split declared on March 29, 1995 and, except with respect to dividends declared per share, the acquisition of Annapolis Bancshares, Inc. on August 29, 1996, which was accounted for as a pooling of interests. (2) Excludes the cumulative benefit recorded in 1992 from the change in accounting for income taxes. 19 Sandy Spring Bancorp and Subsidiaries CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES/(1)/ (Dollars in thousands and tax-equivalent)
1996 1995 ----------------------------------------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate - -------------------------------------------------------------------------------------------------------------------- ASSETS Loans:(2) Real estate(3) $417,161 $37,866 9.08% $400,176 $36,154 9.03% Consumer 28,600 2,682 9.38 26,710 2,437 9.12 Commercial 62,999 6,125 9.72 54,677 5,320 9.73 Tax exempt 169 16 9.65 479 63 13.15 -------- ------- -------- ------- Total loans 508,929 46,689 9.17 482,042 43,974 9.12 Securities: Taxable 250,763 15,062 6.01 234,354 13,769 5.88 Nontaxable 65,847 5,005 7.60 65,696 5,177 7.88 -------- ------- -------- ------- Total securities 316,610 20,067 6.34 300,050 18,946 6.31 Interest-bearing deposits with banks 3,585 187 5.22 740 39 5.27 Federal funds sold 25,319 1,342 5.30 15,252 872 5.72 -------- ------- -------- ------- TOTAL EARNING ASSETS 854,443 68,285 7.99 798,084 63,831 8.00 Less: allowance for credit losses (6,668) (6,647) Cash and due from banks 25,923 24,188 Premises and equipment, net 20,559 17,019 Other assets 12,305 11,174 -------- -------- Total Assets $906,562 $843,818 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing demand deposits $ 96,940 $ 2,529 2.61% $ 86,688 $ 2,263 2.61% Regular savings deposits 95,636 2,695 2.82 104,971 3,218 3.07 Money market savings deposits 149,358 4,935 3.30 154,644 5,646 3.65 Time deposits 324,842 17,730 5.46 277,804 15,578 5.61 -------- ------- -------- ------- Total interest-bearing deposits 666,776 27,889 4.18 624,107 26,705 4.28 Short-term borrowings 41,864 2,021 4.83 40,605 2,284 5.62 Long-term borrowings 4,854 323 6.65 6,097 353 5.79 -------- ------- -------- ------- TOTAL INTEREST- BEARING LIABILITIES 713,494 30,233 4.24 670,809 29,342 4.37 ------- ---- ------- ---- Net interest income and spread $ 38,052 3.75% $34,489 3.63% Noninterest-bearing demand deposits 100,127 90,260 Other liabilities 3,231 1,987 Stockholders' equity 89,710 80,762 -------- -------- Total liabilities and stockholders' equity $906,562 $843,818 -------- -------- Interest income/ earning assets 7.99% 8.00% Interest expense/ earning assets 3.54 3.68 ---- ---- Net interest margin 4.45% 4.32% ==== ==== 1994 ----------------------------------- Average Yield/ Balance Interest Rate - ---------------------------------------------------------------- ASSETS Loans:(2) Real estate(3) $327,485 $27,046 8.26% Consumer 20,357 1,765 8.67 Commercial 45,241 3,785 8.37 Tax exempt 611 77 12.60 -------- ------- Total loans 393,694 32,673 8.30 Securities: Taxable 258,102 14,299 5.54 Nontaxable 75,136 5,911 7.87 -------- ------- Total securities 333,238 20,210 6.06 Interest-bearing deposits with banks 1,028 38 3.70 Federal funds sold 13,948 549 3.94 -------- ------- TOTAL EARNING ASSETS 741,908 53,470 7.21 Less: allowance for credit losses (6,841) Cash and due from banks 22,730 Premises and equipment, net 16,239 Other assets 10,332 -------- Total Assets $784,368 -------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing demand deposits $ 87,591 $ 2,293 2.62% Regular savings deposits 115,839 3,525 3.04 Money market savings deposits 183,949 5,641 3.07 Time deposits 199,448 8,573 4.30 -------- ------- Total interest-bearing deposits 586,827 20,032 3.41 Short-term borrowings 28,973 1,175 4.06 Long-term borrowings 5,149 289 5.61 -------- ------- TOTAL INTEREST- BEARING LIABILITIES 620,949 21,496 3.46 ------- ----- Net interest income and spread Noninterest-bearing demand deposits 90,238 Other liabilities 427 Stockholders' equity 72,754 -------- Total liabilities and stockholders' equity $784,368 ======== Interest income/ earning assets 7.21% Interest expense/ earning assets 2.90 ----- Net interest margin 4.31% =====
(1) Income and yields are presented on a tax-equivalent basis using the maximum applicable federal income tax rate. (2) Nonaccrual loans are included in the average balances. (3) Includes residential mortgage loans held for sale. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) NET INTEREST INCOME Net interest income for 1996 was $36,388, representing an increase of $3,615 or 11.0% from 1995. An 8.9% rise was achieved in 1995, compared to 1994, resulting in net interest income of $32,773, up from $30,082. On a tax-equivalent basis, net interest income amounted to $38,052 in 1996, representing a 10.3% annual rise, and $34,489 in 1995, representing a 7.9% annual rise, preceded by $31,974 in 1994. Since net interest income is the most important category of earnings, performance in this area is emphasized by management. The analysis of net interest income performance presented in the "Consolidated Average Balances, Yields and Rates" table shows a 1996 net interest margin of 4.45%, up 13 basis points, compared to 1995. The net interest margin for 1995 of 4.32% was essentially the same as for 1994. The table entitled "Effect of Volume and Rate Changes on Net Interest Income" shows that the increases in net interest income during 1996 and 1995, compared to each prior year, were primarily driven by increases in the volumes of earning assets.
EFFECT OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME 1996 vs. 1995 1995 vs. 1994 -------------------------------------------------------------------------------------- Increase or in Average: (1)(2) Increase or in Average: (1)(2) ---------------------- ---------------------- (Tax-equivalent basis) (Decrease) Volume Rate (Decrease) Volume Rate - ---------------------------------------------------------------------------------------------------------------------------------- Interest income from earnings assets: Loans $2,715 $2,464 $ 251 $11,301 $ 7,837 $3,464 Taxable securities 1,293 981 312 (530) (1,363) 833 Nontaxable securities (172) 12 (184) (734) (744) (10) Other investments 618 687 (69) 324 42 282 ------ ------- Total interest income 4,454 4,503 (49) 10,361 4,230 6,131 Interest expense on funding of earnings assets: Interest-bearing demand deposits 266 268 (2) (30) (24) (6) Regular savings deposits (523) (274) (249) (307) (333) 26 Money market savings deposits (711) (188) (523) 5 (976) 981 Time deposits 2,152 2,578 (426) 7,005 3,945 3,060 Borrowings (293) 1 (294) 1,173 632 541 ------ ------- Total interest expense............ 891 1,829 (938) 7,846 1,833 6,013 ------ ------ ----- ------- ------- ------ Net interest income............... $3,563 $2,674 $ 889 $ 2,515 $ 2,397 $ 118 ====== ====== ===== ======= ======= ======
(1) Variances are computed on a line-by-line basis and are non-additive. (2) Combined rate/volume variances, a third element of the calculation, are allocated to the volume and rate variances based on their relative size. Interest Income The Company's tax-equivalent interest income increased by 7.0% or $4,454 in 1996, compared to 1995, as a result of a 7.1% or $56,359 increase in average earning assets accompanied by a modest decline in average yield earned on those funds. During 1996, average loans, yielding 9.17%, rose $26,887 or 5.6%. Average commercial loans increased by 15.2% or $8,322 in 1996. Management has targeted commercial loans for growth, in part because they produce the highest rate (average yield of 9.72% for 1996) of any major category of earning assets. However, lower yielding average securities (yielding only 6.34%), increased $16,560 in 1996, representing virtually the same percentage rise as achieved for average loans. Less significantly, federal funds sold, which are short-term investments primarily benefitting liquidity, increased $10,067 or 66.0%, and earned an average yield of 5.30% for 1996. The Company generated a greater amount of interest income in 1996 in the face of stiff industrywide competition with banks and nonbanking entities for desirable lending opportunities. Tax-equivalent interest income increased 19.4% or $10,361 in 1995, compared to 1994, due to the combination of higher average earning assets, up 7.6%, and higher average yield earned, up 79 basis points. However, when higher funding costs are taken into consideration, the resulting interest rate spread achieved on those earning assets declined 12 basis points in 1995 versus 1994. Interest Expense Interest expense increased $891 or 3.0% in 1996 compared to 1995, attributable to the offsetting effects of 6.4% or $42,685 greater average interest-bearing liabilities and a 13 basis point decline in the average rate paid for those funds. Most of the rise in interest-bearing funds was generated by deposit growth of 6.8% or $42,669. By contrast, average interest free funding of earning assets increased 10.7% or $13,674 over the same period, primarily due to a rise in demand deposits attributable in part to the introduction of a new product around mid-year. By far, the largest increase in interest-bearing 21 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) deposits occurred in average time deposits, which were 16.9% or $47,038 above 1995, and comprised the most expensive deposit type, paying an average rate of 5.46% in 1996, compared to 4.18% for all interest-bearing deposits. In addition, the average rate paid on time deposits declined only 15 basis points in 1996, compared to 1995, much less than declines recorded by most other deposit and borrowing categories. In 1995, interest expense increased significantly more than interest income, rising 36.5% or $7,846, reflecting the effects of a 91 basis point rise in average rate on 8.0% higher average interest-bearing liabilities. Interest Rate Performance Interest rate performance has been relatively stable over the past three years. The same interest rate spread was achieved in 1996 and 1994, with a small decline in 1995. The net interest margin increased slightly in 1996, after remaining virtually the same the prior two years. The change in margin was due to the beneficial effects of the higher level of interest-free funding of earning assets in 1996 than in 1995 as well as to growth in interest-bearing deposits at favorable interest spreads. By maintaining, and then improving, its net interest margin from 1994 to 1996, the Company has been able to preserve, and then enhance, its net interest income performance during a period of significant growth. NONINTEREST INCOME Total noninterest income rose 46.2% or $2,069 to $6,547 in 1996 from $4,478 in 1995. An increase of 6.9% or $289 was posted for 1995 versus 1994. Securities gains totaled $30 in 1996 as compared with securities losses of $279 in 1995 and $84 in 1994. The sale of available-for-sale debt securities generated net losses of $66 for 1996 compared with $89 in net gains from sales of available-for-sale equity securities and $7 in net gains from securities calls, maturities and paydowns. During 1995, the sale of available-for-sale debt securities generated $277 in net losses, while calls, maturities and paydowns generated $2 in net losses. Service charges on deposit accounts increased 15.4% or $395 during 1996. In 1995, an increase of 9.4% or $221 was realized. Management continuously monitors the service fee structure and makes changes where appropriate. Mortgage banking operations generated $825 in gains on loan sales of $56,457 in 1996 as management placed great emphasis upon originations and sales of residential mortgage loans in the secondary market at a profit margin, versus building a mortgage portfolio on the Company's books. By comparison, gains of $244 were realized on loan sales of $19,246 during 1995, and $175 in gains were realized on loan sales of $15,476 in 1994. Other noninterest income rose 40.3% or $784 in 1996 over 1995, with fees from trust services, mutual funds and annuities increasing 44.2% or $385. Newer fee based businesses, credit cards and debit cards (new in 1996), generated another $118 in additional income during 1996, compared to 1995, and other fee income increased 23.8% or $143. Among nonrecurring items, sales of other real estate owned were responsible for $147 of the overall rise in other noninterest income, while asset dispositions during 1996 versus 1995 resulted in net losses of $47. Other noninterest income increased 11.1% or $194 in 1995 over 1994, attributable in large part to fees for trust services, which rose 20.8% or $131, and to gains on sales of student loans, which generated $131 in additional income. NONINTEREST EXPENSES Noninterest expenses increased 13.0% or $2,920 in 1996 over 1995 and 4.5% or $962 in 1995 over 1994. However, nonrecurring expenses significantly affected these changes, reducing the size of the core increase in noninterest expenses by $750 in 1996, compared to 1995, and by $342 in 1995, compared to 1994. Items of nonrecurring expenses included an industry-wide FDIC insurance premium reduction enacted in 1995, which effectively reduced noninterest expenses by $814 in 1996 and $692 in 1995, and merger related costs associated with the acquisition of Annapolis Bancshares, Inc., which increased noninterest expenses in 1996 by $724, along with costs of conversion to a new data processing center in 1995 and early retirement benefits extended to certain long-term employees in 1995 and 1994. Excluding nonrecurring items, increases in core noninterest expenses amounted to 17.5% or $3,670 in 1996 compared with an increase of 6.6% or $1,304 for 1995. Salaries and employee benefits increased 13.5% or $1,721 in 1996 and 6.4% or $767 in 1995. Excluding nonrecurring items, an increase of 14.8% or $1,842 was realized in 1996 compared with an increase of 6.6% or $766 for 1995. The increase for 1996 was, for the most part, due to growth in staff, including staffing for two new branches, and an expanded incentive program called "Stakeholder" which relates compensation throughout the business to the Company's performance as measured against key performance indicator goals. Quarterly "Stakeholder" payouts amounted to $479 in 1996. The increase in salary and benefit costs for 1995 was due significantly to merit increases. 22 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) The Company's net income, as measured on a per employee basis, continue to grow, which is favorable. The ratio of net income per average full-time- equivalent employee was $33 for 1996, $31 for 1995 and $29 for 1994. Average full-time equivalent employees increased in 1996 by 8.8% to 346, compared to 318 for 1995 and 310 for 1994. The increase in average full-time equivalent employees is largely a reflection of the Company's expansion over the period. All other noninterest expenses increased 12.4% or $1,199 in 1996 and increased 2.1% or $195 in 1995. Excluding nonrecurring expenses, an increase of 21.4% or $1,828 was realized in 1996 compared with an increase of 6.7% or $538 for 1995. The increase for 1996 included a 95.7% or $560 rise in marketing expenses due to intensified marketing associated with entry into new markets, 40.9% or $322 higher data services costs, reflecting growth and conversion to a new provider with expanded capabilities in late 1995, a 58.1% or $291 increase in building and grounds maintenance attributable to the merger, new branches and maintenance of existing facilities, and a 100.0% or $181 rise in attorneys' fees, in large part associated with merger activity, partially offset by a $370 increase in rental income which is netted against rental expenses. The increase for 1995 included increases in equipment expenses, primarily depreciation charges and software expenses, and in marketing expense, supply expenses, and data services costs. Operating Expense Performance Management believes that the net overhead ratio (lower ratios indicate improved productivity), which expresses the level of net operating expenses (noninterest expenses less noninterest income) as a percentage of tax-equivalent net interest income, is a good measure of overall operating expense performance and cost management. During 1996, the Company's net overhead ratio was 49.4%, compared to ratios of 52.0% achieved in 1995 and 54.0% in 1994. Ratios close to 50% are considered desirable. PROVISION FOR INCOME TAXES Income tax expense amounted to $5,789 in 1996, compared with $4,653 in 1995 and $3,694 in 1994. The Company's effective tax rate for 1996 was 33.5%, compared with 31.8% in 1995 and 29.3% in 1994. The increase in effective tax rate has been due primarily to a decline in the nontaxable component of income before taxes each year. During 1996, the Company's taxable income surpassed $10,000, triggering an increase in the applicable corporate tax rate from 34% to 35%. This increased rate resulted in additional income tax expense of $24 for 1996 on taxable earnings in excess of $10,000. BALANCE SHEET ANALYSIS During 1996, the Company's size, as measured by total assets, grew by $102,392 or 11.7%, to $978,595 at December 31, 1996 from $876,203 at December 31, 1995. Earning assets at year end increased $97,977 or 12.0%, to $917,096 from $819,119. The rise in loans, a core business for commercial banks, amounted to $30,626 or 6.2% compared to a $71,020 or 24.4% increase in securities. On an average basis, however, total loans increased $26,887 or 5.6% versus a $16,560 or 5.5% increase in average total securities. The types and characteristics of the growth in loans is discussed in detail below. LOANS Real estate mortgage loans rose 3.4% to $376,205 in 1996. Included in this category are commercial mortgages, which increased 12.5% during 1996 and totalled $178,639 at December 31, 1996. These mortgages mainly consist of owner occupied properties where an established banking relationship exists. Home equity lines and home equity loans, types of real estate mortgages that permit homeowning consumers to leverage their equity and possibly receive an income tax deduction on the interest, increased 7.7% during 1996 to $65,420 at year end. One to four family residential loans, down 11.5% in 1996, represented $116,444 of the real estate mortgage portfolio at December 31, 1996. This represents an increased emphasis by the Company on mortgage banking, where most residential mortgage loan production is sold in the secondary market rather than being maintained as a loan asset. In this type of business, the bank serves as the customer service and delivery channel for investors, while continuing to meet the needs of area residents for funds to finance their homes. Other real estate mortgages, including primarily residential lot loans, collectively rose 23.1% to $15,702. Real estate construction loans increased 14.2% to $47,654 from 1995, attributable to a substantial rise in residential construction activity. The Company conducts its commercial construction lending in the markets it knows and understands, works selectively with local, top-quality builders and developers, and requires substantial equity from its borrowers. The consumer loan portfolio rose 7.1% to $30,813 at December 31, 1996. In recent years, much of consumer lending has shifted from traditional installment credits into home equity lines and credit cards. During 1996, the Company achieved a 6.6% increase in home equity lines, which are included above in real estate mortgage loans. Credit cards, introduced in 1995, are showing growth, more than doubling in 1996 to an outstanding balance of $1,321 at year end. 23 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Consumer lending continues to be important to the full service community banking business conducted by the Company despite a smaller balance sheet presence in recent years. Commercial loans advanced the most among the major categories on a percentage basis, up 18.6% to $68,467 during 1996. For the most part, these are loans to a diverse cross-section of small to mid-size local businesses, many of whom are existing customers of the Company. These types of banking relationships are a natural fit for the Company, which is experienced in serving and lending to this market segment and has knowledge of the marketplace through its community roots and involvement. The Company continues to place special emphasis on this part of its loan portfolio in its business planning. Analysis of Loans The following table presents the trends in the composition of the loan portfolio over the previous five years.
December 31, ------------------------------------------------------------ 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------- Real estate -- mortgage(1) $376,205 $363,927 $345,547 $286,542 $252,706 Real estate -- construction(2) 47,654 41,725 31,853 21,770 18,592 Consumer 30,813 28,762 28,892 19,352 17,906 Commercial 68,467 57,718 50,224 46,405 23,477 Tax exempt 27 408 536 671 1,243 -------- -------- -------- -------- -------- TOTAL LOANS $523,166 $492,540 $457,052 $374,740 $313,924 ======== ======== ======== ======== ========
(1) Consists of fixed and adjustable rate first and second home mortgage loans, home equity lines of credit and commercial mortgage loans. (2) Includes both residential and commercial properties. Securities The investment portfolio, in the aggregate, increased 24.4% or $71,020 during 1996 to $361,806 at December 31, 1996 from $290,786 at December 31, 1995. Investments are managed to generate interest revenue, provide liquidity and achieve asset/liability management goals. During 1996, funds provided by the increase in deposits exceeded the increase in the loan portfolio, and the excess was invested primarily in securities. A significant portion of the rise in investments occurred toward the end of 1996, when funds were borrowed from the Federal Home Loan Bank of Atlanta and invested in securities at a favorable interest rate spread in order to leverage the balance sheet and enhance the return on shareholders' equity (see discussion on page 25 in "Deposits and Short-term Borrowings" section). On an average basis, aggregate investments rose 5.5% during 1996, compared to 1995. Analysis of Securities The composition of Securities at December 31 for each of the latest three fiscal years was:
1996 1995 1994 - ------------------------------------------------------------------------- AVAILABLE-FOR-SALE(1) U.S. Treasury $ 26,940 $ 15,991 $ 23,272 U.S. Agency 145,275 70,106 23,579 State and municipal 26,628 35,330 39,836 Corporate debt obligations 1,483 2,458 3,260 Mortgage-backed securities(2) 31,876 40,282 37,307 Marketable equity securities 2,221 1,786 518 -------- -------- -------- Total 234,423 165,953 127,772 HELD-TO-MATURITY AND OTHER EQUITY U.S. Treasury 0 500 1,499 U.S. Agency 42,932 40,185 79,816 State and municipal 37,152 30,522 29,717 Mortgage-backed securities(2) 42,188 48,579 65,902 Certificates of deposit 0 100 0 Other equity securities 5,111 4,947 4,916 -------- -------- -------- Total 127,383 124,833 181,850 -------- -------- -------- TOTAL SECURITIES(3) $361,806 $290,786 $309,622 ======== ======== ========
(1) At estimated fair value. (2) Mortgage-backed securities are either issued by a federal agency or are secured by U.S. Agency collateral and therefore are believed to be high- quality. (3) The outstanding balance of no single issuer, except for the U.S. Government and U.S. Government Agency securities, exceeded ten percent of stockholders' equity at December 31, 1996, 1995 or 1994. 24 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Maturities and weighted average yields for investments available-for-sale and held-to-maturity at December 31, 1996, are shown below:
Years to Maturity --------------------------------------------------------------------------------------- Within Over 1 Over 5 Over 1 through 5 through 10 10 --------------------------------------------------------------------------------------- Amount Yield Amount Yield Amount Yield Amount Yield - ----------------------------------------------------------------------------------------------------------------------- INVESTMENTS AVAILABLE-FOR-SALE(1) U.S. Treasury $12,996 5.61% $ 13,957 5.63% $ 0 0% $ 0 0% U.S. Agency 8,998 5.55 131,520 6.16 4,999 6.78 0 0 State and municipal(2) 4,374 8.18 19,639 7.68 2,264 6.61 0 0 Corporate debt obligations 0 0 500 5.76 1,000 5.65 0 0 Mortgage-backed securities 3,061 6.18 16,553 5.93 9,734 6.06 2,847 6.74 ------- -------- ------- ------- Total debt securities $29,429 6.03% $182,169 6.26% $17,997 6.31% $ 2,847 6.74% ======= ======== ======= ======= Marketable equity securities TOTAL INVESTMENTS AVAILABLE-FOR-SALE INVESTMENTS HELD- TO-MATURITY U.S. Agency $ 0 0% $20,090 5.86% $ 9,320 7.04% $13,522 7.93% State and municipal(2) 0 0 18,113 7.51 18,439 7.02 600 7.79 Mortgage-backed securities 12,926 6.32 29,262 6.89 0 0 0 0 ------- -------- ------- ------ TOTAL INVESTMENTS HELD-TO-MATURITY $12,926 6.32% $ 67,465 6.75% $27,759 7.03% $14,122 7.92% ======= ======== ======= ======= - ---------------------------------------------------- TOTAL YIELD - ---------------------------------------------------- INVESTMENTS AVAILABLE-FOR-SALE(1) U.S. Treasury $ 26,953 5.63% U.S. Agency 145,517 6.14 State and municipal(2) 26,277 7.68 Corporate debt obligations 1,500 5.69 Mortgage-backed securities 32,195 6.07 -------- Total debt securities 232,442 6.24% Marketable equity securities 470 -------- TOTAL INVESTMENTS AVAILABLE-FOR-SALE $232,912 ======== INVESTMENTS HELD- TO-MATURITY U.S. Agency $ 42,932 6.76% State and municipal(2) 37,152 7.28% Mortgage-backed securities 42,188 6.76% -------- TOTAL INVESTMENTS HELD-TO-MATURITY $122,272 6.92% ========
(1) Amounts shown at amortized cost without market value adjustments required by FASB 115 (see Notes 1 and 4 of Notes to the Consolidated Financial Statements). (2) The yields on state and municipal securities have been calculated on a tax- equivalent basis using the maximum applicable federal income tax rate. Other Earning Assets Residential mortgage loans held for sale increased 69.0% or $3,260 in 1996. Originations and sales of these loans, and the resulting gains on sales, increased substantially as presented on the Consolidated Statements of Cash Flows, reflecting the change to a mortgage banking philosophy of residential mortgage lending. The aggregate of federal funds sold and interest-bearing deposits with banks decreased 22.3% or $6,929 in 1996. Deposits and Short-term Borrowings Total deposits increased 8.4% or $62,749 during 1996 to $806,341 at December 31, 1996 from $743,592 at December 31, 1995. Noninterest-bearing deposits increased 22.0% or $21,077, attributable primarily to growth in commercial checking balances and the introduction of a "free" checking account product around mid- year. Interest-bearing deposits increased 6.4% or $41,672 in 1996, with the majority of the rise occurring in time deposits for amounts less than $100,000. Short-term borrowings increased 95.7% or $33,323 in 1996 to $68,127 at December 31, 1996 from $34,804 at December 31, 1995. Borrowings from the Federal Home Loan Bank of Atlanta increased $17,200, reflecting funds borrowed late in the year and invested in securities in order to leverage the balance sheet and enhance the shareholders' return on investment. Repurchase agreements, the other major category of short-term borrowings, increased 44.6% or $13,639, due primarily to an increase in sweep accounts associated with cash management services to commercial customers. CAPITAL MANAGEMENT During 1996, stockholders' equity increased 11.1% or $9,640 to $96,581 at December 31, 1996 from $86,941 at December 31, 1995. The increase for 1996 was, for the most part, due to internal capital generation, which represents net earnings less dividends as a percent of average equity. The resulting internal capital generation rate was 8.7% for 1996, compared with 8.8% for 1995 and 9.0% for 1994. The amount of the increase in stockholders' equity attributable to internal capital generation was $7,776 in 1996, $7,096 in 1995 and $6,528 in 1994. External capital formation from dividend reinvestment, the exercise of warrants, and employee stock purchases under the Company's stock option and profit sharing plans totaled $1,741 in 1996, $2,379 in 1995 and $1,063 in 1994. The ratio of average equity to average assets amounted to 9.90% for 1996, compared with 9.57% for 1995 and 9.28% for 1994. 25 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Regulatory Capital Requirements The Company achieved a total risk-based capital ratio of 17.56% at December 31, 1996, compared to 17.67% at December 31, 1995, a Tier 1 risk-based capital ratio of 16.44% compared to 16.42%, and a capital leverage ratio of 10.38% compared to 10.09%. A discussion of these quantitative measures of capitalization and the regulatory capital requirements which pertain to them, along with a presentation of the Company's and the Bank's capital and ratios compared to the various regulatory standards, appears in Note 22 of the Notes to the Consolidated Financial Statements. At December 31, 1996, the Company and its banking subsidiary exceeded all capital requirements and were considered to be "well- capitalized" under regulatory definitions. Management monitors historical and projected earnings, dividends and asset growth, as well as risks associated with the various types of on- and off- balance sheet assets, in order to determine the appropriate capital levels and the action needed, if any, to preserve capital adequacy. CREDIT RISK MANAGEMENT The allowance for credit losses is a valuation reserve established by management in an amount it deems adequate to absorb losses on loans which may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level. Management records provisions for credit losses in order to increase the allowance to the level it deems adequate. Loan charge-offs decrease the allowance. Management believes that the allowance for credit losses is adequate. The level of nonperforming loans increased to $4,655 (.89% of year-end loans) at December 31, 1996 from $898 (.18% of year-end loans) at December 31, 1995, due to increases in nonaccrual loans and loans which are past due 90 days or more. The rise in nonaccruals involved loans to a single borrower which management believes will be collected in full during 1997. The increase in loans reported as 90 days or more past due was attributable primarily to the inclusion of credit line expirations at December 31, 1996, which were not included in prior years, and to Annapolis Bancshares credits, which became subject to the Company's more stringent loan review and classification practices subsequent to the merger. It is anticipated that many of the expired lines of credit, which are still current as to principal and interest payments, will be renewed or otherwise return to performing status. The Company also had an increase in loans 90 or more days past due associated with growth and diversification of the loan portfolio. The allowance for credit losses represented 137% of nonperforming loans at December 31, 1996, compared to coverage of 735% a year earlier, with the change attributable to an increase in the level of nonperforming loans. Significant variation in the coverage ratio may occur from period to period because the amount of nonperforming loans depends largely on the condition of a small number of individual loans and borrowers relative to the total loan portfolio. There were no real estate owned properties at December 31, 1996 as compared to a modest $47 at December 31, 1995. The balance of impaired loans was $1,280 at December 31, 1996 and the reserve on these loans was $127. There were no impaired loans at December 31, 1995. Although $590 of loans were classified as being in nonaccrual status at December 31, 1995, the insignificant delay of projected payments caused the loans not to be classified as impaired. The major concentrations of credit risk for the Company arise by customer location, because it operates only in three counties in the State of Maryland, and by loan portfolio composition. Real estate secured credits represented 81.0% of total loans at December 31, 1996, and 82.4% at December 31, 1995. In the past, the Company has experienced low loss levels, especially in real estate secured loans, through various economic cycles and conditions. The risk of the Company's real estate loan concentration is mitigated by the nature of real estate collateral, the Bank's substantial experience in most of its markets and its intention to maintain risk averse lending practices. The provision for credit losses charged against earnings was $308 in 1996 compared with $180 in 1995, an increase of 71.1%. The provision was $211 in 1994. In each year, net charge-offs exceeded the provision for credit losses. The ratio of net charge-offs to average loans was .10% in 1996, compared to .05% in 1995 and .06% in 1994. The allowance for credit losses was decreased to $6,391 (1.22% of year-end loans) at December 31, 1996 from $6,597 (1.34% of year-end loans) at December 31, 1995. The allowance has been maintained at levels believed consistent with the increased risk potential inherent in the increase in the amount and percentage to total loans attributable to commercial and commercial real estate loans (see the discussion of loan growth earlier in this report), which are viewed as entailing greater risk than certain other categories of loans, and the associated increase in large loans, as balanced against other factors, as described above. For additional discussion of the allowance for credit losses, see Note 1 of the Notes to the Consolidated Financial Statements. 26
Analysis of Credit Risk Activity in the allowance for credit losses for the preceding five years ended December 31 is shown below: 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------- Balance, January 1 $6,597 $6,663 $6,681 $4,213 $2,957 Provision for credit losses 308 180 211 1,057 1,880 Allowance from merger transaction 0 0 0 1,158 0 Loan charge-offs: Real estate - mortgage (3) (33) (135) 0 (506) Real estate - construction 0 0 0 0 0 Consumer (143) (209) (32) (104) (243) Commercial (469) (507) (342) (29) (76) ------ ------ ------ ------ ------ Total charge-offs (615) (749) (509) (133) (825) Loan recoveries: Real estate - mortgage 0 153 16 54 0 Real estate - construction 0 0 0 0 5 Consumer 37 30 40 79 61 Commercial 64 320 224 253 135 ------ ------ ------ ------ ------ Total recoveries 101 503 280 386 201 ------ ------ ------ ------ ------ Net recoveries (charge-offs) (514) (246) (229) 253 (624) ------ ------ ------ ------ ------ BALANCE, DECEMBER 31 $6,391 $6,597 $6,663 $6,681 $4,213 ====== ====== ====== ====== ====== Net charge-offs to average loans 0.10% 0.05% 0.06% * 0.19% Allowance to total loans 1.22% 1.34% 1.46% 1.78% 1.34%
* The Company had net recoveries in 1993. The following table presents nonperforming assets for a five year period:
December 31, ---------------------------------------------------------- 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------- Nonaccrual loans/(1)/ $1,291 $ 590 $ 866 $2,969 $ 508 Loans 90 days past due 3,337 272 832 517 953 Restructured loans 27 36 44 394 0 ------ ------ ------ ------ ------ Total nonperforming loans/(2)(3)/ 4,655 898 1,742 3,880 1,461 Other real estate owned, net 0 47 277 1,387 999 ------ ------ ------ ------ ------ TOTAL NONPERFORMING ASSETS $4,655 $ 734 $2,019 $5,267 $2,460 ====== ====== ====== ====== ====== NONPERFORMING ASSETS TO TOTAL ASSETS 0.48% 0.11% 0.24% 0.67% 0.36%
/(1)/ Gross interest income that would have been recorded in 1996 if nonaccrual loans had been current and in accordance with their original terms was $192, while interest actually recorded on such loans was $89. /(2)/ Those performing loans considered potential problem loans, as defined and identified by management, amounted to $3,440 at December 31, 1996. Although these are loans where known information about the borrowers' possible credit problems causes management to have doubts as to the borrowers' ability to comply with the present loan repayment terms, most are well collateralized and are not believed to present significant risk of loss. Loans classified for regulatory purposes not included in nonperforming loans consist only of "other loans especially mentioned" and do not in management's opinion, represent or result from trends or uncertainties reasonably expected to materially impact further operating results, liquidity or capital resources or represent material credits where known information about the borrowers' possible credit problems causes management to have doubts as to the borrowers' ability to comply with the loan repayment terms. /(3)/ Installment loans past due by 90 days or more are included in the totals for the "loans 90 days past due" line in the table above and were immaterial at December 31, 1996 and 1995. LIQUIDITY AND INTEREST RATE SENSITIVITY Liquidity The Company's liquidity position, considering both internal and external sources available, exceeded anticipated short- and long-term funding needs at December 31, 1996. Core deposits, considered to be stable funds sources and defined to include all deposits except time deposits of $100,000 or more, equaled 81.7% of total earning assets at December 31, 1996. In addition, substantial amortizing residential mortgage loans, maturities, calls and paydowns of securities, deposit growth and earnings contribute a flow of funds available to meet liquidity requirements. In assessing liquidity, management considers operating requirements, the seasonality of deposit flows, investment, loan and deposit maturities, expected fundings of loans and deposit withdrawals, and the market values of available-for-sale investments, so that sufficient funds are available on short notice to meet obligations as they arise and to ensure that the Company is able to pursue new business opportunities. 27 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Internally generated funds on hand at December 31, 1996, consisting of cash and cash equivalents, interest-bearing deposits with banks, residential mortgage loans held for sale, maturities of investments held-to-maturity due within one year at fair value and investments available-for-sale, totalled $312,390 or 31.9% of total assets. The primary external source of liquidity available is a line of credit for $145,000 with the Federal Home Loan Bank of Atlanta of which $20,200 was outstanding at December 31, 1996. Core deposits increased by $56,862 during 1996, while loans grew by $30,626, so that borrowed funds were not required to support loan growth. As discussed previously in the section entitled "Deposits and Short-term Borrowings", Federal Home Loan Bank advances increased in 1996 due to management's desire to leverage the balance sheet at favorable interest spreads to enhance return on stockholder's equity. The Company's time deposits of $100,000 or more represented 7.1% of total deposits at December 31, 1996 and are shown by maturity in the table below.
Months to Maturity ------------------------------------------------ 3 or Over 3 Over 6 Over less to 6 to 12 12 TOTAL - ---------------------------------------------------------------------------------------- Time deposits--$100,000 or more $23,373 $9,735 $10,399 $13,667 $57,174 ======= ====== ======= ======= =======
Interest Rate Sensitivity The Bank's interest rate sensitivity, as measured by the repricing of its interest sensitive assets and liabilities at December 31, 1996 is presented in the following table. As indicated in the note to the table, the data is based in part on assumptions that are regularly reviewed for propriety. The accompanying analysis indicates a moderate level of interest rate risk based on the Bank's having about 51% of its rate sensitive assets versus about 49% of its rate sensitive liabilities subject to maturity or repricing within a one year period from December 31, 1996 (termed GAP analysis). By managing to approximately match the dollar amount of assets and liabilities whose interest rates are subject to change, the Bank seeks to control the risk that a net interest margin decline would have a pronounced adverse impact on its revenues (net interest income). While the Bank's senior management, through its Asset Liability Management Committee (ALCO), has a preference for maintaining a moderate level of interest rate risk as measured by the repricing GAP, the Company's interest rate risk policies are guided by results of simulation analysis which takes into account more factors than does simple GAP analysis. The ALCO analyzes balance sheet, income statement, and margin trends monthly. A detailed quarterly interest rate risk profile is performed for ALCO and is reviewed with the Board of Directors. The Bank's Board of Directors has established a comprehensive interest rate risk management policy, which is administered by ALCO. The policy establishes limits of risk, which are quantitative measures of percentage change in net interest income and equity capital resulting from a hypothetical plus or minus 200 basis point change in U.S. Treasury interest rates for maturities from one month to thirty years. By employing simulation analysis through use of a computer model, the Bank intends to effectively manage the potential adverse impacts that changing interest rates can have on the institution's short term earnings, long term value, and liquidity. Measured from December 31, 1996, the simulation analysis indicates that the Bank's net interest income would decline by 8.1% over a twelve month period given a decline in interest rates of 200 basis points, against a policy limit of 15%. In terms of equity capital on a fair value basis, a 200 basis point decline in interest rates, is estimated to reduce the fair value of capital (as computed) by 18.5% as compared to a policy limit of 25%. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. In addition to the potential adverse impact that changing interest rates may have on the Bank's interest margin and operating results, potential adverse impacts on liquidity can occur as a result of changes in the estimated cash flows from investment, loan and deposit portfolios. The Bank manages this inherent risk by maintaining a sizeable portfolio of available for sale investments as well as a secondary source of liquidity from Federal Home Loan Bank advances. 28 MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) The following schedule sets out the time frames from December 31, 1996 in which the Bank's rate sensitive assets and liabilities are subject to repricing:
----------------------------------------------------------- 0-90 91-365 Over 1-3 Over 3-5 Over 5 Days Days Years Years Years - -------------------------------------------------------------------------------------------------------- RATE SENSITIVE ASSETS: Loans $180,441 $ 92,100 $162,500 $ 47,186 $ 40,939 Taxable securities 72,898 78,826 105,662 18,349 15,555 Nontaxable securities 1,980 3,935 17,110 19,395 21,009 Other investments 42,023 0 0 0 0 -------- -------- -------- -------- -------- TOTAL 297,342 174,861 285,272 84,930 77,503 RATE SENSITIVE LIABILITIES: Noninterest-bearing demand deposits 11,711 3,513 42,159 42,159 17,566 Interest-bearing demand deposits 5,936 17,808 47,487 27,701 0 Regular savings deposits 4,749 14,246 37,989 36,408 1,583 Money market savings deposits 13,974 41,922 111,794 0 0 Time deposits 107,022 146,882 67,733 16,235 28 Short-term borrowings and other rate sensitive liabilities 55,930 12,002 1,000 0 3,920 -------- -------- -------- -------- -------- TOTAL................................. 199,322 236,373 308,162 122,503 23,097 -------- -------- -------- -------- -------- CUMULATIVE GAP........................ $ 98,020 $ 36,508 $ 13,618 $(23,955) $ 30,451 ======== ======== ======== ======== ======== As a percent of total assets 10.02% 3.73% 1.39% (2.45)% 3.11% CUMULATIVE RATE SENSITIVE ASSETS TO RATE SENSITIVE LIABILITIES 1.49 1.08 1.02 0.97 1.03
NOTE: This analysis is based upon a number of significant assumptions including the following: Loans are repaid/rescheduled by contractual maturity and repricings. Securities, except mortgage-backed securities, are repaid according to contractual maturity adjusted for call features. Mortgage-backed security repricing is adjusted for estimated early paydowns. In order to reflect the temporary seasonal influx of noninterest-bearing demand deposits at year end, which inflates short-term rate sensitive assets, such deposits in excess of their average balance for the year are shown in 0-90 days. Interest-bearing demand, regular savings and money market savings deposits are estimated to exhibit some rate sensitivity based on management's analysis of deposit withdrawals. Time deposits are shown in the table based on contractual maturity. SELECTED GLOSSARY AND ABBREVIATIONS Basis Point: One hundredth of one percent. An increase in yield from 7.00% to 7.50% could be expressed as a change of 50 basis points. Book Value Per Share: Total stockholders' equity divided by the number of shares of common stock outstanding at year-end. Capital Leverage Ratio: Year-end core capital (stockholders' equity less intangibles and the net unrealized gain or loss on investments available-for- sale) as a percentage of average total assets for the fourth quarter. The Company: Sandy Spring Bancorp, Sandy Spring National Bank of Maryland and Sandy Spring Insurance Corporation. Internal Capital Generation Rate: The percent of return on average equity multiplied by the percent of earnings retained (net earnings less dividends). Net Interest Margin: Fully tax-equivalent net interest income as a percentage of average earning assets. Net Interest Spread: Fully tax-equivalent yield on earning assets less the average rate paid on interest-bearing liabilities. Net Overhead Ratio: A measure of cost management and productivity. Net overhead (noninterest expenses less non-interest income) divided by fully tax- equivalent net interest income. Nonperforming Assets: The sum of loans which are nonaccrual, 90 days past due or restructured and other real estate owned. Return on Average Assets: Net income as a percentage of average total assets. Return on Average Equity: Net income as a percentage of average total stockholders' equity. Total Risk-based Capital Ratio: Qualifying regulatory capital (stockholders' equity less intangibles and the net unrealized gain or loss on investments available-for-sale, plus a portion of the allowance for credit losses) as a percentage of risk-adjusted total assets. Tax-Equivalent Net Interest Income: Interest income, plus the addition of tax savings from nontaxable loans and investments, less interest expense. Tier 1 Risk-based Capital Ratio: Regulatory core capital (stockholders' equity less intangibles and the net unrealized gain or loss on investments available- for-sale) as a percentage of risk-adjusted total assets. 29 Sandy Spring Bancorp and Subsidiaries CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share data)
December 31, --------------------- 1996 1995 - ------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 32,899 $ 30,215 Federal funds sold 23,278 30,220 Interest-bearing deposits with banks 861 848 Residential mortgage loans held for sale 7,985 4,725 Investments available-for-sale (at fair value) 234,423 165,953 Investments held-to-maturity - fair value of $123,067 (1996) and $121,177 (1995) 122,272 119,886 Other equity securities 5,111 4,947 Total loans (net of unearned income) 523,166 492,540 Less: Allowance for credit losses (6,391) (6,597) -------- -------- Net loans 516,775 485,943 Premises and equipment 20,211 19,897 Accrued interest receivable 7,917 6,494 Other real estate owned, net of allowance of $0 (1996) and $45 (1995) 0 47 Other assets 6,863 7,028 -------- -------- TOTAL ASSETS $978,595 $876,203 ======== ======== LIABILITIES Noninterest-bearing deposits $117,052 $ 95,975 Interest-bearing deposits 689,289 647,617 -------- -------- Total deposits 806,341 743,592 Short-term borrowings 68,127 34,804 Long-term borrowings 4,820 5,151 Accrued interest and other liabilities 2,726 5,715 -------- -------- TOTAL LIABILITIES 882,014 789,262 STOCKHOLDERS' EQUITY Common stock - par value $1.00; shares authorized 15,000,000 (1996) and 6,000,000 (1995); shares issued and outstanding 4,902,113 (1996) and 4,820,604 (1995) 4,902 4,821 Surplus 33,474 31,814 Retained earnings 57,669 49,893 Net unrealized gain on investments available-for-sale, net of taxes 536 413 -------- -------- TOTAL STOCKHOLDERS' EQUITY 96,581 86,941 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $978,595 $876,203 ======== ========
See Notes to Consolidated Financial Statements. 30 Sandy Spring Bancorp and Subsidiaries CONSOLIDATED STATEMENT OF INCOME (Dollar in thousands, except per share data)
Years Ended December 31, --------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------------------- Interest income: Interest and fees on loans $46,491 $43,926 $32,594 Interest on loans held for sale 196 55 57 Interest on deposits with banks 187 39 38 Interest and dividends on securities: Taxable 15,062 13,769 14,299 Nontaxable 3,343 3,454 4,041 Interest on federal funds sold 1,342 872 549 ------- ------- ------- TOTAL INTEREST INCOME 66,621 62,115 51,578 Interest expense: Interest on deposits 27,889 26,705 20,032 Interest on short-term borrowings 2,021 2,284 1,175 Interest on long-term borrowings 323 353 289 ------- ------- ------- TOTAL INTEREST EXPENSE 30,233 29,342 21,496 ------- ------- ------- NET INTEREST INCOME 36,388 32,773 30,082 Provision for credit losses 308 180 212 ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 36,080 32,593 29,870 Noninterest income: Securities gains (losses) 30 (279) (84) Service charges on deposit accounts 2,964 2,569 2,348 Gains on mortgage sales 825 244 175 Trust income 943 760 629 Other income 1,785 1,184 1,121 ------- ------- ------- TOTAL NONINTEREST INCOME 6,547 4,478 4,189 Noninterest expenses: Salaries and employee benefits 14,447 12,726 11,959 Occupancy expense of premises 2,082 1,814 1,905 Equipment expenses 2,165 1,943 1,617 Marketing 1,145 585 503 FDIC insurance expense 4 818 1,510 Outside data services 1,109 787 630 Other expenses 4,392 3,751 3,338 ------- ------- ------- TOTAL NONINTEREST EXPENSES 25,344 22,424 21,462 ------- ------- ------- Income before income taxes 17,283 14,647 12,597 Income tax expense 5,789 4,653 3,694 ------- ------- ------- NET INCOME $11,494 $ 9,994 $ 8,903 ======= ======= ======= NET INCOME PER COMMON SHARE $ 2.36 $ 2.09 $ 1.90
See Notes to Consolidated Financial Statements. 31 Sandy Spring Bancorp and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands, except per share data)
Years Ended December 31, ------------------------------------ 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 11,494 $ 9,994 $ 8,903 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,791 1,655 1,527 Provision for credit losses 308 180 212 Deferred income taxes 152 253 (178) Origination of loans held for sale (59,717) (23,971) (8,497) Proceeds from sales of loans held for sale 57,282 19,490 15,651 Gains on sales of loans held for sale (825) (244) (175) Securities (gains) losses (30) 278 84 Net change in: Accrued interest receivable (1,423) (300) (1,162) Accrued income taxes 202 477 (187) Other accrued expenses (1,457) 255 (246) Other - net 978 (2,553) 390 --------- -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 8,755 5,514 16,322 Cash flows from investing activities: Net (increase) decrease in interest-bearing deposits with banks (13) (588) 11,865 Purchases of investments held-to-maturity (36,941) (26,408) (56,828) Purchases of other equity securities (304) 0 0 Purchases of investments available-for-sale (159,085) (38,030) (65,782) Proceeds from sales of investments available-for-sale 19,392 13,140 33,879 Proceeds from maturities, calls and principal payments of investments held-to-maturity 28,815 39,902 15,572 Proceeds from maturities, calls and principal payments of investments available-for-sale 77,075 35,729 66,955 Proceeds from sales of loans 291 1,620 916 Proceeds from sales of other real estate owned 442 665 1,459 Net increase in loans receivable (31,127) (34,701) (72,700) Purchases of loans 0 (2,826) (10,851) Net funds received in branch purchase 17,181 0 0 Expenditures for premises and equipment (2,031) (5,281) (2,089) --------- -------- -------- NET CASH USED BY INVESTING ACTIVITIES (86,305) (16,778) (77,604) Cash flows from financing activities: Net increase (decrease) in demand and savings accounts 25,484 (45,164) 1,259 Net increase (decrease) in time and other deposits 18,571 88,417 22,658 Net increase (decrease) in short-term borrowings 31,223 (13,439) 19,936 Proceeds from long-term borrowings 1,800 0 3,000 Retirement of long-term borrowings (31) (29) (26) Net increase (decrease) in balance due to banks (1,733) 1,733 (248) Proceeds from issuance of common stock 1,741 2,379 1,063 Dividends paid (3,763) (2,881) (2,369) --------- -------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES 73,292 31,016 45,273 --------- -------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (4,258) 19,752 (16,009) Cash and cash equivalents at beginning of year 60,435 40,683 56,692 --------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR* $ 56,177 $ 60,435 $ 40,683 ========= ======== ======== Supplemental disclosures: Interest payments $ 31,157 $ 29,424 $ 20,536 Income tax payments 5,441 4,286 4,121 Noncash investing activities: Transfers from loans to other real estate owned 210 419 323 Reclassification of borrowings from long-term to short-term 2,100 0 0 Investment transfers from available-for-sale 0 0 66,925 Investment transfers from held-to-maturity 0 43,630 0 Unrealized gain (loss) on investments available-for-sale net of deferred tax effect of $77, $2,328 and $(3,929), respectively 123 3,700 (6,245)
/*/ Cash and cash equivalents include those amounts under the captions "Cash and due from banks" and "Federal funds sold" on the Consolidated Balance Sheets. See Notes to Consolidated Financial Statements. 32 Sandy Spring Bancorp and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands, except per share data)
Years Ended December 31, -------------------------------- 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------- Common stock: Balance at beginning of year $ 4,821 $ 2,484 $ 2,454 Increase in shares as a result of 2 for 1 stock split in the form of a stock dividend 0 2,140 0 Increase in shares as a result of a 20% stock dividend by pooled bank prior to acquisition 0 82 0 Employee stock purchases - shares issued 11,020 (1996), 8,592 (1995) and 4,950 (1994) 11 9 5 Exercise of stock options - shares issued 31,565 (1996), 9,404 (1995) and 8,356 (1994) 31 10 8 Dividend reinvestment plan stock purchases - shares issued 35,273 (1996), 35,300 (1995) and 16,613 (1994) 35 35 17 Exercise of warrants - shares issued 3,755 (1996), 61,404 (1995) and 63 (1994) 4 61 0 ------- ------- ------- COMMON STOCK AT END OF YEAR 4,902 4,821 2,484 Surplus: Balance at beginning of year 31,814 31,772 30,739 Transfer to common stock - for 2 for 1 stock split 0 (2,140) 0 Transfer to common stock - 20% stock dividend by pooled bank 0 (82) 0 Employee stock purchases 353 201 223 Exercise of stock options 67 80 42 Dividend reinvestment stock purchases 1,194 965 768 Exercise of warrants 46 1,018 0 ------- ------- ------- SURPLUS AT END OF YEAR 33,474 31,814 31,772 Retained earnings: Balance at beginning of year 49,893 42,797 36,269 Net income 11,494 9,994 8,903 Cash dividends - $0.78 (1996), $0.64 (1995) and $0.54 (1994) per share (3,620) (2,755) (2,273) Cash dividends by pooled bank prior to acquisition (98) (143) (102) ------- ------- ------- RETAINED EARNINGS AT END OF YEAR 57,669 49,893 42,797 Net unrealized gain (loss) on investments available-for-sale, net of taxes: Balance at beginning of year 413 (3,287) 2,958 Net change in unrealized gain (loss) on investments available-for-sale, net of taxes 123 3,700 (6,245) ------- ------- ------- NET UNREALIZED GAIN (LOSS), NET OF TAXES, AT END OF YEAR 536 413 (3,287) ------- ------- ------- TOTAL STOCKHOLDERS' EQUITY $96,581 $86,941 $73,766 ======= ======= =======
See Notes to Consolidated Financial Statements. 33 Sandy Spring Bancorp and Subsidiaries NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data) NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of the Company, which includes Sandy Spring Bancorp, its wholly owned subsidiary, Sandy Spring National Bank of Maryland (the Bank), and Sandy Spring Insurance Corporation, the Bank's subsidiary, conform to generally accepted accounting principles and to general practice within the banking industry. Certain reclassifications have been made to amounts previously reported to conform with the classifications made in 1996. The following is a summary of the more significant accounting policies: Nature of Operations Through its subsidiary, the Company conducts a full-service commercial banking and trust business. Services to individuals and businesses include accepting deposits; extending real estate, consumer and commercial loans and lines of credit; safe deposit boxes; and personal trust services. The Company operates in three Maryland counties, Montgomery, Howard and Anne Arundel, and continues to show a concentration in loans secured by residential and commercial real estate. The Company has a small presence, based on revenue, in the annuity business through an insurance agency subsidiary. Policy for Consolidation The consolidated financial statements include the accounts of Sandy Spring Bancorp and its subsidiaries. Consolidation has resulted in the elimination of all significant intercompany balances and transactions. The financial statements of Sandy Spring Bancorp (Parent Only) include the Bank under the equity method of accounting. 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Residential Mortgage Loans Held for Sale The Company engages in sales of residential mortgage loans originated by the Bank. Loans held for sale are carried at the lower of aggregate cost or fair value. Gains and losses on sales of these loans are recorded as a component of noninterest income in the Consolidated Statements of Income. When the Company retains the servicing rights to collect and remit principal and interest payments, manage escrow account matters and handle borrower relationships on mortgage loans sold, resulting service fee income is included in noninterest income. The Company's current practices are to sell all loans servicing released and, therefore, it has no intangible asset recorded for the value of such servicing. Investments Available-for-Sale Marketable equity securities and debt securities not classified as held-to- maturity are classified as available-for-sale. Securities available-for-sale are acquired as part of the Company's asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at fair value, with unrealized gains or losses based on the difference between amortized cost and fair value, reported as a separate component of stockholders' equity, net of deferred tax. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income. Related interest and dividends are included in interest income. Premiums on covered call options are deferred and included in noninterest income upon option expiration or included in the computation of realized gains upon option exercise. Investments Held-to-Maturity and Other Equity Securities Investments held-to-maturity are those securities which the Company has the ability and positive intent to hold until maturity. Securities so classified at time of purchase are recorded at cost. Securities transferred into held-to- maturity from the available-for-sale portfolio are recorded at fair value at time of transfer with unrealized gains or losses reflected in equity and amortized over the remaining life of the security. The carrying values of securities held-to-maturity are adjusted for premium amortization and discount accretion. Other equity securities represent Federal Reserve Bank and Federal Home Loan Bank stock, which are considered restricted as to marketability. 34 Loans Loans are stated at their principal balance outstanding net of any deferred fees and costs. Interest income on loans is accrued at the contractual rate based on the principal outstanding. The Company places loans, except for installment loans, on nonaccrual when any portion of the principal or interest is 90 days past due and collateral is insufficient to discharge the debt in full. Interest accrual may also be discontinued earlier if, in management's opinion, collection is unlikely. Generally, installment loans are not placed on nonaccrual, but are charged off when they are five months past due. Loans are considered impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal or interest payments become 90 days or more past due and they are placed on nonaccrual. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance homogeneous loans such as residential real estate and consumer installment loans which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of "minimal delay" in payment (90 days or less) provided eventual collection of all amounts due is expected. The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, the Company's impairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis. Allowance for Credit Losses The allowance for credit losses represents an amount which, in management's judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level. Among the factors considered are lending risks associated with growth and entry into new markets, loss allocations for specific nonperforming credits, the level of the allowance to nonperforming loans, historical loss experience, economic conditions, portfolio trends and credit concentrations, and changes in the size and character of the loan portfolio. Allowances for impaired loans are generally determined based on collateral values. Loans deemed uncollectible are charged against, while recoveries are credited to, the allowance. Management adjusts the level of the allowance through the provision for credit losses, which is recorded as a current period operating expense. Management believes that the allowance for credit losses is adequate. While management used available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank, periodically review the Bank's loan portfolio and allowance for credit losses. Such review may result in recognition of additions to the allowance based on their judgments of information available to them at the time of their examination. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method. Premises and equipment are depreciated over the useful lives of the assets, except for leasehold improvements which are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are expensed as incurred. Other Real Estate Owned (OREO) OREO comprises properties acquired in partial or total satisfaction of problem loans. The properties are recorded at the lower of cost or fair value at the date acquired. Losses arising at the time of acquisition of such properties are charged against the allowance for credit losses. Subsequent write-downs that may be required are added to a valuation reserve. Gains and losses realized from the sale of OREO, as well as valuation adjustments, are included in noninterest income. Expenses of operation are included in noninterest expense. 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 Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FASB 123), establishes a fair value based method of accounting for employee stock options and expands disclosure requirements, including a 35 description of the plan. FASB 123 permits a company to continue to measure compensation cost for its stock option plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." The Company adopted FASB 123 on January 1, 1996 as presented in Note 12. Two other newly issued accounting standards were adopted in the first quarter of 1996 and together with FASB 123 did not have a material effect on the financial position or results of operations of the Company. Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (FASB 121), requires that certain long-lived assets be reviewed for impairment when events or circumstances indicate that the carrying amounts of the assets may not be recoverable. If such review indicates that the carrying amount of an asset exceeds the sum of its expected future cash flows, the asset's carrying value is written down to fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights" (FASB 122), requires the recognition of an asset at the estimated present value of future servicing rights. Additionally, FASB 122 requires that capitalized rights to service mortgage loans be assessed for impairment by individual risk stratum by comparing each stratum's carrying amount with its fair value. To the extent that the carrying value of mortgage servicing rights exceeds fair value by individual stratum, the resulting impairment is recognized in earnings through a valuation allowance. As stated above in the policy note, the Company's current practices are to sell residential mortgage loans with servicing released. NOTE 2 - ACQUISITIONS On August 29, 1996, the Company and its wholly owned subsidiary, Sandy Spring National Bank of Maryland, merged with Annapolis Bancshares, Inc. (ABI) and its wholly owned subsidiary, Bank of Annapolis, Annapolis, Maryland, a state- chartered commercial bank. The acquisition was accounted for as a pooling of interests, and financial information for all prior periods presented has been restated to include the results of operations and financial position of ABI. Based on an exchange ratio of .62585 shares of the Company's common stock for each outstanding share of ABI common stock, the Company issued 495,940 shares of common stock. Pre-tax merger-related expenses of $724 are included in noninterest expenses ($558 after tax effect). Total assets and the results of operations of the separate entities prior to the combination are summarized as follows:
June 30, December 31, 1996 1995 - -------------------------------------------------------------------------------------------- (unaudited) Total assets: Company $835,292 $794,319 ABI 81,063 81,884 -------- -------- $916,355 $876,203 ======== ======== Years Ended December 31, Six Months Ended ----------------------------- June 30, 1996 1995 1994 - -------------------------------------------------------------------------------------------- (unaudited) Net interest income: Company $ 15,529 $ 29,243 $ 27,085 ABI 2,103 3,530 2,997 -------- -------- -------- $ 17,632 $ 32,773 $ 30,082 ======== ======== ======== Net income: Company $ 5,038 $ 8,923 $ 8,020 ABI 740 1,071 883 -------- -------- -------- $ 5,778 $ 9,994 $ 8,903 ======== ======== ========
On December 13, 1996, the Company completed its acquisition of the Bethesda, Maryland branch of Bank of Maryland, including approximately $19 million dollars of deposits and related overdraft protection accounts. The transaction has been accounted for under the purchase method of accounting, in accordance with Accounting Principles Board Opinion No. 16 (Accounting for Business Combinations) and accordingly, the branch's results of operations are included in the consolidated financial statements since December 13, 1996, only. The deposits were purchased at a premium of 7.82%, resulting in recognition of a deposit premium intangible of $1,008 to be amortized straight-line over four years. Goodwill of $453 also resulted from the transaction and will be amortized straight-line over ten years. The Company's intangible assets are included in other assets. NOTE 3 - CASH AND DUE FROM BANKS Regulation D of the Federal Reserve Act requires that banks maintain reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. At its option, the Bank maintains additional balances to compensate for clearing and safekeeping services. The average daily balance maintained in 1996 was $20,245 and in 1995 was $19,041. 36 NOTE 4 - INVESTMENTS AVAILABLE-FOR-SALE The amortized cost and estimated fair values of investments available-for-sale at December 31 are as follows:
1996 1995 --------------------------------------------------- ------------------------------------------------- Gross Gross Estimated Gross Gross Estimated Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gains Losses Value Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------------------- U.S. Treasury $ 26,953 $ 42 $ (55) $ 26,940 $ 15,972 $ 49 $ (30) $ 15,991 U.S. Agency 145,517 186 (428) 145,275 70,096 300 (290) 70,106 State and municipal 26,277 382 (31) 26,628 34,686 692 (48) 35,330 Corporate debt obligations 1,500 0 (17) 1,483 2,499 9 (50) 2,458 Mortgage-backed securities 32,195 149 (468) 31,876 40,558 159 (435) 40,282 -------- ------ ----- -------- -------- ------ ----- -------- Total debt securities 232,442 759 (999) 232,202 163,811 1,209 (853) 164,167 Marketable equity securities 470 1,751 0 2,221 470 1,316 0 1,786 -------- ------ ----- -------- -------- ------ ----- -------- Total investments available-for-sale $232,912 $2,510 $(999) $234,423 $164,281 $2,525 $(853) $165,953 ======== ====== ===== ======== ======== ====== ===== ========
The amortized cost and estimated fair values of investments available-for- sale at December 31, 1996 and 1995 by contractual maturity, except mortgage- backed securities for which an average life is used, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
1996 1995 ---------------------- ----------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value - ---------------------------------------------------------------------------------------------- Due in one year or less $ 29,429 $ 29,481 $ 31,754 $ 31,871 Due after one through five years 182,169 182,142 113,055 113,425 Due after five years through ten years 17,997 17,731 13,935 13,848 Due after ten years 2,847 2,848 5,067 5,023 -------- -------- -------- -------- Total debt securities $232,442 $232,202 $163,811 $165,953 ======== ======== ======== ========
Sales of investments available-for-sale during 1996, 1995 and 1994 resulted in the following:
1996 1995 1994 - ----------------------------------------------------------------------------------------- Proceeds $19,392 $13,140 $33,879 Gross gains 97 4 139 Gross losses 73 345 284
At December 31, 1996 and 1995, investments available-for-sale with a carrying value of $60,654 and $48,709, respectively, were pledged as collateral for certain government deposits and for other purposes as required or permitted by law. The outstanding balance of no single issuer, except for U.S. Government and U.S. Government Agency securities, exceeded ten percent of stockholders' equity at December 31, 1996 and 1995. At December 31, 1996, the Bank had outstanding Covered Call Option contracts for 2,000 shares of Sallie Mae common stock, with expiration dates of January 18, 1997 (1,000 shares) and April 19, 1997 (1,000 shares). Premiums received on these options amounted to $5. The contracts have an average option price of $97.50 per share and the underlying securities have a quoted market price of $93.13 per share. These options are incident to an established plan to enhance the yield on the Bank's equity securities in the available-for-sale portfolio. Excluding option premiums, these Sallie Mae holdings had an unrealized gain at December 31, 1996 of $1,385 ($92.83 per share). Generally, the option contracts have a term of approximately one to four months. During 1996, the Bank received total option premiums of $11. The amount of option premiums recorded as noninterest income (upon option expiration) was $2, and the amount of option premiums that were included in realized gains (where options were exercised) was $4. These covered call options are subject to disclosure as derivative financial instruments in accordance with Statement of Financial Accounting Standards No. 119. The option contracts do not exhibit any credit risk since the Bank is holder of the premiums paid. Market risk is mitigated by the fact that the option price is stated in the contract and that the underlying securities held have a significant unrealized gain position. NOTE 5 - INVESTMENTS HELD-TO-MATURITY AND OTHER EQUITY SECURITIES The amortized cost and estimated fair values of investments held-to-maturity at December 31 are as follows:
1996 1995 --------------------------------------------------- --------------------------------------------------- Gross Gross Estimated Gross Gross Estimated Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gains Losses Value Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------------------------------ U.S. Treasury $ 0 $ 0 $ 0 $ 0 $ 500 $ 0 $ (2) $ 498 U.S. Agency 42,932 103 (208) 42,827 40,185 90 (361) 39,914 State and municipal 37,152 697 (167) 37,682 30,522 855 (38) 31,339 Mortgage-backed securities 42,188 449 (79) 42,558 48,579 807 (60) 49,326 Certificates of deposit 0 0 0 0 100 0 0 100 -------- ------ ----- -------- -------- ------ ----- -------- Total investments held-to-maturity $122,272 $1,249 $(454) $123,067 $119,886 $1,752 $(461) $121,177 ======== ====== ===== ======== ======== ====== ===== ========
37 In accordance with a Financial Accounting Standards Board pronouncement in late 1995, permitting a one time transfer from investments held-to-maturity into investments available-for-sale, the Company transferred $43,630 from its held- to-maturity portfolio into the available-for-sale category with net unrealized gains of $279, net of taxes. The amortized cost and estimated fair values of debt securities at December 31 by contractual maturity, except mortgage-backed securities for which an average life is used, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
1996 1995 --------------------- --------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value - -------------------------------------------------------------------------------------------- Due in one year or less $ 12,926 $ 12,944 $ 5,687 $ 5,699 Due after one through five years 67,465 68,221 82,393 83,130 Due after five years through ten years 27,759 27,794 28,206 28,751 Due after ten years 14,122 14,108 3,600 3,597 -------- -------- -------- -------- Total investments held-to-maturity $122,272 $123,067 $119,886 $121,177 ======== ======== ======== ========
At December 31, 1996 and 1995, investments held-to-maturity with a book value of $21,726 and $24,987 for 1995, respectively, were pledged as collateral for certain government deposits and for other purposes as required or permitted by law. The outstanding balance of no single issuer, except for U.S. Government and U.S. Government Agency securities, exceeded ten percent of stockholders' equity at December 31, 1996 or 1995. Other equity securities at December 31, are as follows:
1996 1995 - -------------------------------------------------------------------------------- Federal Reserve Bank stock $1,340 $1,036 Federal Home Loan Bank stock 3,771 3,911 ------ ------ $5,111 $4,947 ====== ======
NOTE 6 - LOANS Book values for the two most recent years are presented below for the major loan categories at December 31:
1996 1995 - ------------------------------------------------------------------------------- Real estate-mortgage $376,205 $363,927 Real estate-construction 47,654 41,725 Consumer 30,813 28,762 Commercial 68,467 57,718 Tax exempt 27 408 -------- -------- Total loans 523,166 492,540 Less: Allowance for credit losses (6,391) (6,597) -------- -------- NET LOANS $516,775 $485,943 ======== ========
Loan fees amounting to $254 (1996), $270 (1995) and $247 (1994) were included in interest and fees on loans. The servicing portfolio of mortgage loans sold totalled $91,249 at December 31, 1996 and $108,324 at December 31, 1995. Escrow balances relating to the servicing portfolio amounted to $730 and $861 at December 31, 1996 and 1995, respectively. Activity in the allowance for credit losses for the preceding three years ended December 31 is shown below:
1996 1995 1994 - ------------------------------------------------------------------------------- Balance at beginning of year $6,597 $6,663 $6,681 Provision for credit losses 308 180 211 Loan charge-offs (615) (749) (509) Loan recoveries 101 503 280 ------ ------ ------ Net recoveries (charge-offs) (514) (246) (229) ------ ------ ------ BALANCE AT END OF YEAR $6,391 $6,597 $6,663 ====== ====== ======
Information with respect to impaired loans at December 31, 1996 and for the year ended is as follows: Impaired loans with a valuation allowance $ 127 Impaired loans without a valuation allowance 1,153 ------ Total impaired loans $1,280 ====== Allowance for credit losses related to impaired loans $ 127 Allowance for credit losses related to other than impaired loans 6,264 ------ Total allowance for credit losses $6,391 ====== Average impaired loans for the year $1,327 ====== Interest income on impaired loans recognized on the cash basis $ 0 ======
There were no impaired loans at December 31, 1995. Although $590 of loans were classified as being in nonaccrual status at December 31, 1995, the insignificant delay of payments caused the loans not to be classified as impaired. 38 NOTE 7 - PREMISES AND EQUIPMENT Premises and equipment at December 31 consist of:
1996 1995 - -------------------------------------------------------------------------------- Land $ 6,652 $ 7,354 Buildings and leasehold improvements 13,226 11,778 Equipment 11,154 10,865 -------- -------- 31,032 29,997 Less: Accumulated depreciation and amortization (10,821) (10,100) -------- -------- NET PREMISES AND EQUIPMENT $ 20,211 $ 19,897 ======== ========
Depreciation and amortization expense amounted to $1,726 for 1996, $1,572 for 1995 and $1,445 for 1994. Total rental expenses (net of rental income) for premises and equipment for the three years ended December 31 were $303 (1996), $447 (1995) and $601 (1994). Lease commitments bear initial terms varying from 3 to 10 years and are associated with premises. Future minimum payments as of December 31, 1995, for all noncancelable operating leases are:
Year Ending Premises and December 31, Equipment - ------------------------------------------------------------------------------ 1997 $ 949 1998 781 1999 727 2000 624 2001 638 Thereafter 4,155 ------ TOTAL $7,874 ======
NOTE 8 - DEPOSITS Deposits outstanding at December 31 consist of:
1996 1995 - -------------------------------------------------------------------------------- Noninterest-bearing demand $117,052 $ 95,975 Interest-bearing: Demand 98,932 90,686 Money market savings 157,484 149,442 Regular savings 94,974 99,173 Time deposits 280,725 257,029 Time deposits - $100,000 or more 57,174 51,287 -------- -------- Total Interest-bearing 689,289 647,617 -------- -------- TOTAL DEPOSITS $806,341 $743,592 ======== ========
Interest expense on time deposits of $100,000 or more amounted to $2,640, $2,576 and $1,531 for 1996, 1995 and 1994, respectively. NOTE 9 - SHORT-TERM BORROWINGS Short-term borrowings consist of securities sold under agreements to repurchase, a U.S. Treasury demand note, federal funds purchased and advances from the Federal Home Loan Bank of Atlanta (FHLB). The Company has a line of credit arrangement with the FHLB under which it may borrow up to $145,000 at interest rates based upon current market conditions. Short-term advances outstanding were $20,200 at December 31, 1996 and $3,000 at December 31, 1995. Information relating to short-term borrowings is as follows for the years ended December 31:
1996 1995 1994 --------------- --------------- ---------------- Amount Rate Amount Rate Amount Rate - ---------------------------------------------------------------------------------------------- At year end: Repurchase agreements $44,193 4.65% $30,554 5.03% $20,824 4.70% Other short-term borrowings 23,934 5.61 4,250 5.69 26,419 6.15 ------- ------- ------- Total $68,127 4.99% $34,804 5.11% $47,243 5.51% ======= ======= ======= Average for the year: Repurchase agreements $34,125 4.66% $23,843 5.15% $15,067 3.62% Other short-term borrowings 7,739 5.58 16,762 6.31 13,906 4.61 Maximum month-end balance: Repurchase agreements $44,193 $32,415 $20,824 Other short-term borrowings 23,934 42,359 35,730
39 NOTE 10 - LONG-TERM BORROWINGS The Company had outstanding mortgages with balances due of $100 at December 31, 1996 and $131 at December 31, 1995. Interest rates range up to 10% and the maximum maturity is July 2000. In addition, the Company had long-term advances from the Federal Home Loan Bank of Atlanta of $4,720 at December 31, 1996 and $5,020 at December 31, 1995 (see line of credit described in Note 9). Interest rates at December 31, 1995 range up to 8.21% and the maximum maturity is March 2006. NOTE 11 - STOCKHOLDERS' EQUITY As of December 31, 1996, Bancorp's Articles of Incorporation authorize 15,000,000 shares of capital stock, par value $1.00 per share, to be initially classified as common stock. However, as set out in the Articles of Incorporation, remaining unissued stock may in the future be designated as either common or preferred stock. Sandy Spring Bancorp has a Dividend Reinvestment Plan which provides shareholders with the opportunity to increase their equity ownership in Bancorp by electing to have cash dividends automatically reinvested in additional shares of common stock without payment of any brokerage commission or service charge. The Board has reserved 200,000 shares for issuance under the plan. Bank and holding company regulations, as well as Maryland law, impose certain restrictions on dividend payments by the Bank, as well as restricting extensions of credit and transfers of assets between the Bank and the holding company. At December 31, 1996, the Bank could have paid dividends to its parent company amounting to $18,719. There were no loans outstanding between the Bank and Bancorp at December 31, 1996 and 1995. On March 29, 1995, the Board of Directors approved a 2 for 1 stock split in the form of a stock dividend payable to shareholders of record at the close of business on April 12, 1995. Stock warrants were issued by the pooled bank prior to merger. The following share and price information related to those warrants was computed by applying the exchange ratio used in the merger. Nontransferrable warrants to acquire 3,755 shares of common stock at $13.31 per share, outstanding at December 31, 1995, were exercised in 1996. Transferrable warrants to acquire 61,404 shares at $17.58 per share were exercised in 1995. There were no warrants outstanding at December 31, 1996. NOTE 12 - INCENTIVE STOCK OPTION PLAN The Company's 1992 Stock Option Plan, which essentially replaced the expired 1982 Incentive Stock Option Plan, provides for the granting of incentive and non-incentive options to selected key employees on a periodic basis at the discretion of the Board. Share amounts and prices which follow have been adjusted to give retroactive effect to the 2-for-1 stock split declared March 29, 1995. The 1992 Plan authorizes the issuance of up to 270,000 shares of common stock, has a term of ten years, and is administered by the Human Resources Committee of the Board. Options are granted at market value at date of grant and must be exercised within ten years. Options granted prior to December, 1996, were immediately exercisable. Options granted in December, 1996 become exercisable over a period of three years. A total of 103,900 shares of common stock were granted under the 1982 Plan, of which 6,000 are outstanding, and the outstanding options will continue until exercise or expiration. The following is a summary of changes in shares under option for the years ended December 31:
1996 1995 -------------------------------------------------------------------- Number Weighted Number Weighted of Average of Average Shares Exercise Price Shares Exercise Price - ------------------------------------------------------------------------------------------------------------------------- Balance, beginning of year 76,936 $ 17.89 82,192 $ 15.63 Granted 6,000 33.66 5,250 37.00 Exercised (46,935) 14.19 (10,506) 9.75 ------ ------ BALANCE, END OF YEAR 36,001 $ 25.34 76,936 $ 17.89 ====== ====== Weighted average fair value of options granted during the year $ 7.68 $ 10.11
The following table summarizes information about options outstanding at December 31, 1996:
Options Outstanding ----------------------------------------------------- Weighted Average Options Exercisable Remaining ------------------------------- Range of Contractual Life Weighted Average Weighted Average Exercise Prices Number (in years) Exercise Price Number Exercise Price - ------------------------------------------------------------------------------------------------------------------------- $13.98 - $23.00 15,751 5.9 $ 18.76 15,751 $18.76 $24.50 - $37.00 20,250 8.8 30.45 16,750 29.87 ------ ------ 36,001 $ 25.34 32,501 $24.49 ====== ======
The fair value of each option grant is estimated on the date of grant using the Extended Binomial option-pricing model with the following weighted-average assumptions used for grants in the years ended December 31, 1996 and 1995: dividend yield of 2.67%; expected volatility of 25%; risk-free interest rate of 5.58%; and expected lives of 10 years. 40 The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FASB 123), and is continuing to apply Accounting Principles Board Opinion No. 25 (APB 25) and related interpretations in accounting for its stock option plan. Under APB 25, no compensation expense related to the plans was recorded during the two years ended December 31, 1996. If the Company had elected to recognize compensation cost based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by FASB 123, net income and earnings per share would have been changed to the pro forma amounts as follows for the years ended December 31:
1996 1995 - ----------------------------------------------------------------------- Net income $11,475 $9,961 Earnings per share $ 2.36 $ 2.09
The pro forma amounts are not representative of the effects on reported net income for future years. NOTE 13 - PENSION, PROFIT SHARING AND OTHER EMPLOYEE BENEFIT PLANS The Company has a qualified, noncontributory, defined benefit pension plan covering substantially all employees. Benefits are based on years of service and the employee's compensation during the last five years of employment. The Company's funding policy is to contribute the maximum amount deductible for federal income tax purposes. The Plan invests primarily in a diverse portfolio of managed fixed income and equity funds. Contributions provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Net pension cost for the previous three years include the following components:
1996 1995 1994 - -------------------------------------------------------------------------------- Service cost for benefits earned $ 377 $ 333 $ 316 Interest cost on projected benefit obligation 351 301 307 Actual (return) loss on plan assets (362) (721) 5 Net amortization and deferral (45) 479 (370) Early retirement window options 0 274 271 ----- ----- ----- PENSION EXPENSE FOR THE YEAR $ 321 $ 666 $ 529 ===== ===== =====
For 1996, 1995 and 1994, the weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.50% and 5.50%, respectively, while the expected long-term rate of return on assets was 8.50%.
The Plan's funded status as of December 31 is: 1996 1995 - --------------------------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $2,871 in 1996 and $3,169 in 1995 $3,205 $3,460 Additional liability based upon projected compensation 1,385 1,268 ------ ------ Projected benefit obligation for service rendered to date (PBO) 4,590 4,728 Plan assets at fair value 4,903 4,787 ------ ------ Plan assets greater than PBO 313 59 Unrecognized net gain 962 915 Prior service cost not yet recognized in net periodic pension expense 9 10 Unrecognized net asset, net of amortization (9) (11) ------ ------ PREPAID PENSION COST INCLUDED IN OTHER ASSETS $1,275 $ 973 ====== ======
The Company has a qualified, noncontributory profit sharing plan that covers all employees after 90 days of service. The Plan permits employees to purchase shares of Sandy Spring Bancorp's common stock with their profit sharing allocations and other contributions under the Plan. Profit sharing contributions by the Company, which are included in operating expenses, totaled $468 in 1996, $400 in 1995, and $346 in 1994. The Company utilizes a performance based compensation model which provides additional incentives to employees based on the Company's financial performance as measured against key performance indicator goals set by management. Payments are made quarterly and total expense under the plan amounted to $479 in 1996. The Company has a Supplemental Executive Retirement Plan (SERP) providing for retirement income benefits as well as pre-retirement death benefits for selected executives. Retirement benefits payable under the SERP, if any, are integrated with other pension plan and Social Security retirement benefits expected to be received by the SERP plan participants. The Company is accruing the present value of these benefits over the remaining number of years to the participants' retirement dates. Benefit accruals included in operating expenses for 1996, 1995 and 1994 were $25, $99, and $55, respectively. The Company has an Executive Health Plan effective January 1, 1991 that provides for payment of defined medical and dental expenses not otherwise covered for selected executives including their families. Benefits, which are paid during both employment and retirement, are subject to a $5 limitation for each executive per year. Expenses under the plan, covering insurance premium and out-of-pocket expense reimbursement benefits, totalled $7 in 1996, $18 in 1995 and $17 in 1994. 41 NOTE 14 - INCOME TAXES Income tax expense for the years ended December 31 consists of:
1996 1995 1994 - --------------------------------------------------------------- Current income taxes: Federal $4,692 $3,398 $2,943 State 1,249 983 929 ------ ------ ------ TOTAL CURRENT 5,941 4,381 3,872 Deferred income taxes: Federal (122) 223 (146) State (30) 49 (32) ------ ------ ------ TOTAL DEFERRED (152) 272 (178) ------ ------ ------ TOTAL INCOME TAX EXPENSE $5,789 $4,653 $3,694 ====== ====== ======
Temporary differences between the amounts reported in the financial statements and the tax bases of assets and liabilities result in deferred taxes. Deferred tax assets and liabilities, shown as the sum of the appropriate tax effect for each significant type of temporary difference, are presented below for the years ended December 31:
1996 1995 - -------------------------------------------------------------------------------- Deferred tax assets: Allowance for credit losses $ 2,021 $ 2,069 Deferred loan fees and costs 464 298 Net operating loss carry forward 434 473 Other 164 297 ------- ------- Gross deferred tax assets 3,083 3,137 Deferred tax liabilities: Depreciation (841) (907) Pension plan costs (424) (660) Unrealized gains on investments available-for-sale (337) (156) Other (331) (207) ------- ------- Gross deferred tax liabilities (1,933) (1,930) ------- ------- NET DEFERRED TAX ASSET $ 1,150 $ 1,207 ======= =======
No valuation allowance exists with respect to deferred tax items. Net deferred tax assets are included in other assets. A three year reconcilement of the difference between the statutory federal income tax rate and the effective tax rate for the Company is as follows:
1996 1995 1994 - -------------------------------------------------------------------------------------------- FEDERAL INCOME TAX RATE 35.0% 34.0% 34.0% Increase (decrease) resulting from: Tax-exempt interest income (5.8) (7.1) (10.9) State income taxes, net of federal income tax benefits 4.6 4.6 4.7 Other (0.3) 0.3 1.5 -------- -------- -------- EFFECTIVE TAX RATE 33.5% 31.8% 29.3%
NOTE 15 - NET INCOME PER COMMON SHARE Income per common share is based on weighted average number of shares outstanding of 4,868,206 in 1996, 4,771,867 in 1995 and 4,686,431 in 1994. All per share data have been adjusted to give retroactive effect to a 2 for 1 stock split in the form of a stock dividend declared on March 29, 1995. The potentially dilutive effect of stock options is not material for any of the three years. NOTE 16 - RELATED PARTY TRANSACTIONS Certain directors and senior officers have loan transactions with the Company. Such loans were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with outsiders. The following schedule summarizes changes in amounts of loans outstanding, both direct and indirect, to these persons during 1996. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Balance at January 1, 1996 $ 7,223 Additions 4,859 Repayments (4,681) ------- BALANCE AT DECEMBER 31, 1996 $ 7,401 =======
42 NOTE 17 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK In the normal course of business, the Company has various outstanding credit commitments which are properly not reflected in the financial statements. These commitments are made to satisfy the financing needs of the Company's clients. The associated credit risk is controlled by subjecting such activity to the same credit and quality controls as exist for the Company's lending and investment activities. The commitments involve diverse business and consumer customers and are generally well collateralized. Management does not anticipate that losses, if any, which may occur as a result of these commitments would materially affect the stockholders' equity of the Company. Since a portion of the commitments have some likelihood of not being exercised, the amounts do not necessarily represent future cash requirements. Loan and credit line commitments, excluding unused portions of home equity lines of credit, totaled $101,126 at December 31, 1996 and $84,944 at December 31, 1995. These commitments are contingent upon continuing customer compliance with the terms of the agreement. Unused portions of equity lines at year end amounted to $59,859 in 1996 and $51,937 in 1995. The Company's home equity line accounts, which are secured by the borrower's residence, are reviewed annually. Irrevocable letters of credit, totalling $4,082 at December 31, 1996 and $5,269 at December 31, 1995, are obligations to make payments under certain conditions to meet contingencies related to customers' contractual agreements. They are primarily used to guarantee a customer's contractual and/or financial performance, and are seldom exercised. NOTE 18 - LITIGATION In the normal course of business, the Company may become involved in litigation arising from banking, financial, and other activities of the Company. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Company's financial condition, operating results or liquidity. NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosure About Fair Value of Financial Instruments" (FASB 107), as amended by Statement of Financial Accounting Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments," requires the disclosure in statement form of estimated fair values of financial instruments. Financial instruments have been defined broadly to encompass 97.4% of the Company's assets and 99.8% of its liabilities. Quoted market prices, where available, are shown as estimates of fair market values. Because no quoted market prices are available for a significant part of the Company's financial instruments, the fair values of such instruments have been derived based on the amount and timing of future cash flows and estimated discount rates. Present value techniques used in estimating the fair value of many of the Company's financial instruments are significantly affected by the assumptions used. 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 cash settlement of the instrument. Additionally, the accompanying estimates of fair values are only representative of the fair values of the individual financial assets and liabilities and should not be considered an indication of the fair value of the Company. The estimated fair values of the Company's financial instruments at December 31, are as follows:
1996 1995 ---------------------- ---------------------- Book Estimated Book Estimated Value Fair Value Value Fair Value - ------------------------------------------------------------------------------------------------------------ FINANCIAL ASSETS Cash and temporary investments/(1)/ $ 65,023 $ 65,050 $ 66,008 $ 66,068 Investments available-for-sale 234,423 234,423 165,953 165,953 Investments held-to-maturity and other equity securities 127,383 128,178 124,833 126,124 Loans, net of allowance 516,775 522,945 485,943 491,195 Accrued interest receivable and other assets/(2)/ 9,404 9,404 9,954 9,954 FINANCIAL LIABILITIES Deposits $806,341 $806,602 $743,592 $744,538 Short-term borrowings 68,127 68,320 34,804 34,804 Long-term borrowings 4,820 4,886 5,151 5,158 Accrued interest payable and other liabilities/(2)/ 695 695 3,386 3,386 Estimated Estimated Amount Fair Value Amount Fair Value - ------------------------------------------------------------------------------------------------------------ OFF-BALANCE SHEET FINANCIAL ASSETS Commitments to extend credit/(3)/ $160,985 $ (684) $136,881 $ (314) Irrevocable letters of credit 4,082 (20) 5,269 (25) Servicing rights on mortgages sold 91,249 940 108,324 986
/(1)/ Temporary investments include interest-bearing deposits with banks, federal funds sold and residential mortgage loans held for sale. /(2)/ Only financial instruments as defined in FASB 107 are included in other assets and other liabilities. /(3)/ Includes loan and credit line commitments and unused portions of equity lines. 43 The following methods and assumptions were used to estimate the fair value of each category of financial instruments for which it is practicable to estimate that value: Cash and due from banks and federal funds sold. Carrying amount approximated fair value. Interest-bearing deposits with banks. The fair value was estimated by computing the discounted value of contractual cash flows using a current interest rate for similar instruments. Residential mortgage loans held for sale. The fair value of mortgage loans held for sale was derived from secondary market quotations for similar instruments. Securities. The fair value for U.S. Treasury and Agency, state and municipal, and corporate debt securities is based upon quoted market bids; for mortgage-backed securities upon bid prices for similar pools of fixed and variable rate assets, considering current market spreads and prepayment speeds; and for equity securities upon quoted market prices. Loans. Fair value was estimated by computing the discounted value of estimated cash flows, adjusted for potential credit losses, for pools of loans having similar characteristics. The discount rate was based on the current loan origination rate for a similar loan. Nonperforming loans have an assumed interest rate of 0%. Accrued interest receivable. Carrying amount approximated the fair value of accrued interest, considering the short-term nature of the receivable and its expected collection. Other assets. Carrying amount approximated fair value of certain accrued commissions in other assets, considering the short-term nature of the receivable and its expected collection. Deposit liabilities. Under FASB 107, the fair value of demand, money market savings and regular savings deposits, which have no stated maturity, must be considered equal to their book value, representing the amount payable on demand, regardless of any value which may be derived from retaining those deposits for an expected future period of time (the deposit base intangible). The fair value of time deposits was based upon the discounted value of contractual cash flows at current rates for deposits of similar remaining maturity. Short-term borrowings. Carrying amount approximated fair value of repurchase agreements and the Treasury demand note due to their variable interest rates. The fair value of Federal Home Loan Bank advances was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. Long-term borrowings. The fair value of these mortgage and Federal Home Loan Bank advances was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. Other liabilities. Carrying amount approximated fair value of accrued interest payable, accrued dividends and premiums payable, considering their short-term nature and expected payment. Off-balance sheet instruments. The fair value of unused lines of credit, letters of credit, and commitments to fund and deliver loans was estimated based upon the amount of unamortized fees collected or paid incident to granting or receiving the commitment. The fair value of the Bank's serviced mortgage loan portfolio was estimated utilizing an independent appraisal which considered fees receivable, number of loans, average loan size, delinquency data, escrow balances, prepayment risks, and current market supply and demand factors. NOTE 20 - PARENT COMPANY FINANCIAL INFORMATION The condensed financial statements for Sandy Spring Bancorp (Parent Only) pertaining to the periods covered by the Company's consolidated financial statements are presented below:
December 31, ------------------- BALANCE SHEETS 1996 1995 - ------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $10,264 $ 8,881 Investments available-for-sale (at fair value) 831 735 Investment in subsidiary 85,136 77,043 Other assets 261 308 ------- ------- Total assets $96,492 $86,967 ======= ======= LIABILITIES Other liabilities $ 223 $ 273 ------- ------- Total liabilities 223 273 STOCKHOLDERS' EQUITY Common stock 4,902 4,821 Surplus 33,474 31,814 Retained earnings 57,669 49,893 Unrealized gain on investments available-for-sale, net of taxes 224 166 ------- ------- Total stockholders' equity 96,269 86,694 ------- ------- Total liabilities and stockholders' equity $96,492 $86,967 ======= =======
44
Years Ended December 31, -------------------------------- STATEMENTS OF INCOME 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------- Income: Cash dividends from subsidiary $ 3,620 $ 2,826 $ 1,806 Interest income 366 358 250 ------- ------- ------- Total income 3,986 3,184 2,056 Interest and other expenses 647 337 261 ------- ------- ------- Income before income taxes and equity in undistributed income of subsidiary 3,339 2,847 1,795 Income tax expense (benefit) (14) 8 (4) ------- ------- ------- Income before equity in undistributed income of subsidiary 3,353 2,839 1,799 Equity in undistributed income of subsidiary 8,141 7,155 7,104 ------- ------- ------- NET INCOME $11,494 $ 9,994 $ 8,903 ======= ======= ======= Years Ended December 31, -------------------------------- STATEMENTS OF CASH FLOWS 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $11,494 $ 9,994 $ 8,903 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income - subsidiary (8,141) (7,155) (7,104) Other - net 73 (11) (6) ------- ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES 3,426 2,828 1,793 Cash flows from investing activities: Purchase of investments available-for-sale 0 (465) 0 Capital contributed to subsidiary 0 (1,070) 0 ------- ------- ------- NET CASH USED BY INVESTING ACTIVITIES 0 (1,535) 0 Cash flows from financing activities: Retirement of long-term debt (21) (17) (17) Proceeds from issuance of common stock 1,741 2,379 1,063 Dividends paid (3,763) (2,881) (2,369) ------- ------- ------- NET CASH USED BY FINANCING ACTIVITIES (2,043) (519) (1,323) ------- ------- ------- NET INCREASE IN CASH AND CASH EQUIVALENTS 1,383 774 470 Cash and cash equivalents at beginning of year 8,881 8,107 7,637 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF YEAR $10,264 $ 8,881 $ 8,107 ======= ======= =======
NOTE 21 - PROSPECTIVE ACCOUNTING CHANGES On January 1, 1997, the Company adopted the provisions of Statement of Financial Accounting Standards No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. Management does not believe that adoption of this pronouncement will have a material impact on the financial position and results of operations of the Company. NOTE 22 - REGULATORY MATTERS 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 quantitative 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. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain amounts and ratios (set forth in the table on page 46) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As of December 31, 1996, the capital levels of the Company and the Bank substantially exceed all capital adequacy requirements to which they are subject. As of December 31, 1996, 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 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company's or the Bank's category. 45
The Company's and the Bank's actual capital amounts and ratios are also presented in the table. To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ----------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------------------------------------- As of December 31, 1996: Total capital (to risk weighted assets): Company $100,520 17.56% $45,794 8.00% $57,242 10.00% Sandy Spring National Bank of Maryland 89,611 15.68 45,718 8.00 57,147 10.00 Tier 1 capital (to risk weighted assets): Company 94,129 16.44 22,897 4.00 34,345 6.00 Sandy Spring National Bank of Maryland 83,220 14.56 22,859 4.00 34,288 6.00 Tier 1 capital (to average assets): Company 94,129 10.38 36,257 4.00 45,321 5.00 Sandy Spring National Bank of Maryland 83,220 9.19 36,227 4.00 45,284 5.00 As of December 31, 1995: Total capital (to risk weighted assets): Company 92,555 17.67 41,894 8.00 52,367 10.00 Sandy Spring National Bank of Maryland 83,059 15.89 41,820 8.00 52,276 10.00 Tier 1 capital (to risk weighted assets): Company 86,008 16.42 20,947 4.00 31,420 6.00 Sandy Spring National Bank of Maryland 76,524 14.64 20,910 4.00 31,366 6.00 Tier 1 capital (to average assets): Company 86,008 10.09 34,109 4.00 42,637 5.00 Sandy Spring National Bank of Maryland 76,524 8.98 34,080 4.00 42,600 5.00
NOTE 23 - QUARTERLY FINANCIAL RESULTS (UNAUDITED) A summary of selected consolidated quarterly financial data for the year ended December 31, 1996 is as follows:
First Second Third Fourth Quarter Quarter Quarter Quarter - ------------------------------------------------------------------------------------------------------------ (Dollars in thousands, except per share data) Interest income $ 16,163 $16,379 $16,773 $17,306 Net interest income 8,704 8,929 9,193 9,562 Provisions for loan losses 183 25 0 100 Income before income taxes 4,274 4,332 3,845 4,832 Net income $ 2,876 $ 2,903 $ 2,473 $ 3,242 Net income per share $ 0.60 $ 0.60 $ 0.51 $ 0.65
Amounts shown above for the first and second quarters of 1996 have been retroactively restated to reflect the acquisition of ABI on August 29, 1996, and, accordingly, differ from amounts originally reported as shown below:
First Quarter Second Quarter ------------------------------------------------------------------------------ Originally Effect As Originally Effect As Reported of Pooling Restated Reported of Pooling Restated - ---------------------------------------------------------------------------------------------------------------- Interest income $14,217 $1,946 $16,163 $14,397 $1,982 $16,379 Net interest income 7,664 1,040 8,704 7,865 1,064 8,929 Provision for loan losses 150 33 183 0 25 25 Income before income taxes 3,687 587 4,274 3,711 621 4,332 Net income $ 2,516 $ 360 $ 2,876 $ 2,522 $ 381 $ 2,903 Net income per share $ 0.58 $ 0.02 $ 0.60 $ 0.58 $ 0.02 $ 0.60
NOTE 24--CONTINGENCIES In the fourth quarter of 1996, the Bank learned that it had not fully complied with certain requirements of the federal Bank Secrecy Act and related regulations, including obligations to monitor and file reports of certain types of currency transactions. Financial institutions that fail to comply with the requirements of the Bank Secrecy Act may be subject to penalties, including civil money penalties. It is not now known whether such penalties or any other action will be sought against the Bank in connection with its noncompliance, or, if they are, the amount or nature of such penalties. 46 Sandy Spring Bancorp and Subsidiaries MANAGEMENT'S STATEMENT OF RESPONSIBILITY Management acknowledges its responsibility for financial reporting (both audited and unaudited) which provides a fair representation of the Company's operations and is reliable and relevant to a meaningful appraisal of the Company. Management has prepared the financial statements in accordance with generally accepted accounting principles, making appropriate use of estimates and judgment, and considering materiality. Except for tax equivalency adjustments made to enhance comparative analysis, all financial information is consistent with the audited financial statements. Oversight of the financial reporting process is provided by the Audit Committee of the Board of Directors, which consists of outside directors. This committee meets on a regular basis, in private, with the internal auditor to approve the audit schedule and scope, discuss the adequacy of the internal control system and the quality of financial reporting, review audit reports and address problems. The committee also reviews the Company's annual report to shareholders and the annual report to the Securities and Exchange Commission on form 10-K. The Audit Committee meets at least annually with the external auditors, and has direct and private access to them at any time. The independent public accounting firm of Stegman & Company has examined the Company's financial records. The resulting opinion statement which follows is based upon knowledge of the Company's accounting systems, as well as on tests and other audit procedures performed in accordance with generally accepted auditing standards. /s/ Hunter R. Hollar /s/ James H. Langmead Hunter R. Hollar James H. Langmead President and Chief Executive Officer Vice President and Treasurer REPORT OF INDEPENDENT AUDITORS STEGMAN & COMPANY Certified Public Accountants BOARD OF DIRECTORS AND SHAREHOLDERS SANDY SPRING BANCORP OLNEY, MARYLAND We have audited the accompanying consolidated balance sheets of Sandy Spring Bancorp and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the management of Sandy Spring Bancorp and Subsidiaries. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger of Sandy Spring Bancorp and Annapolis Bancshares, Inc., which has been accounted for using the pooling of interests accounting method as described in Note 2 to the consolidated financial statements. We did not audit the 1995 and 1994 consolidated financial statements of Annapolis Bancshares, Inc., which statements reflect total assets constituting 9.3% for 1995 and net income constituting 10.7% for 1995 and 9.9% for 1994 of the related consolidated financial statement totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Annapolis Bancshares, Inc., is based solely on the report of the other auditors. 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 misstatements. 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, based on our audits, and for 1995 and 1994 the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sandy Spring Bancorp and Subsidiaries as of December 31, 1996 and 1995, and the results of its operations and cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. /s/ Stegman & Company Towson, Maryland January 31, 1997 47 Sandy Spring Bancorp and Sandy Spring National Bank of Maryland OFFICERS (as of March 1, 1997) Sandy Spring Bancorp OFFICERS Executive Officers Hunter R. Hollar President and Chief Executive Officer James H. Langmead Vice President and Treasurer CORPORATE SECRETARY Marjorie S. Holsinger AUDITOR Mark G. Shullenbarger Sandy Spring National Bank of Maryland OFFICERS Executive Officers Hunter R. Hollar President and Chief Executive Officer James H. Langmead Senior Vice President and Chief Financial Officer James R. Farmer Senior Vice President Lawrence T. Lewis, III Senior Vice President Stanley L. Merson Senior Vice President Frank H. Small Senior Vice President CORPORATE SECRETARY Marjorie S. Holsinger AUDITOR Mark G. Shullenbarger VICE PRESIDENTS Steven E. Anderson Frank L. Bentz James A. Berkey Janice L. Biennas Patricia M. Green Roy J. Green Susan N. Haybyrne Steven B. Haynes Peter L. Hickling Brian J. Hiley Marjorie S. Holsinger Richard G. Knapp, Jr. Thomas H. McDowell David S. Miller James P. Morison, Jr. Dennis P. Neville Richard M. Owens Michael R. Penyak Kathleen E. Pieper Pamela M. Roberts Daniel J. Schrider William M. Slade Russell R. Till William A. Walker, II Sara E. Watkins William C. Watkins Jeffrey A. Wood ASSISTANT VICE PRESIDENTS Richard A. Adamson Harriet B. Argentiere C. Louise Basore Joseph F. Brown Mary Jo Clark Shirley A. Connelly Carole A. Corrigan Dominick A. Del Grosso Donald S. Emel Lynn M. Gallagher Victoria L. Gillespie Chrystina M. Giorgio Edward W. Kinsella Donna L. Lampe Susan D. Lemmon A. Elizabeth Lipscomb Debra L.C. Liverpool Marsha E. Maloney Nahid E. Moghadam Richard S. Prin Roberto D. Ramos Marsha K. Ritter Eric J. Schrider Sally A. Shelton Thomas E. Spilman Carla S. Taylor Janet M. Van Albert Debra A. Whelan S. Lynne White OTHER OFFICERS Frederick T. Billig Lee E. Briggs Barbara R. Brown Sheila L. Butler M. Denise Canard Wendy J. Collins Julie A. Hayne Eileen F. Heiss Christine L. Hill Joyce C. Howes Laura E. C. Johnson Brita M. Jones Mark A. Kruhm Kenneth G. Kubu Walter J. Laderer Ronda M. Long Mary C. Matthews Yvonne D. Minor Nicol M. Morris Douglas A. Parker Sharon L. Rhodes Cheryl A. Spell Sandra B. Stocksdale Melanie N. Stranix Lois D. Tringali Daniel R. West Kenneth V. Wilhelm Marilyn P. Wyscarver Sandra S. Wright Gretchen F. Ziegler Cathryn D. Zinkgraf 48 CORPORATE INFORMATION ANNUAL MEETING The Annual Meeting of shareholders will be held at: Indian Spring Country Club 13501 Layhill Road Silver Spring, Maryland on Wednesday, April 16, 1997 at 3 p.m. FORM 10-K The Company's Form 10-K may be obtained free of charge by writing: Marjorie S. Holsinger Corporate Secretary Sandy Spring Bancorp 17801 Georgia Avenue Olney, Maryland 20832 Member Federal Deposit Insurance Corporation Member Federal Reserve System Equal Housing Lender Affirmative Action/Equal Opportunity Employer STOCK LISTING Shares of Sandy Spring Bancorp are traded on the National Association of Security Dealers (NASDAQ) National Market under the symbol SASR. Airpark 7653 Lindbergh Drive Gaithersburg, Maryland 20879 (301) 774-8408 Annapolis 2024 West Street Annapolis, Maryland 21401 (410) 266-3000 Ashton 1 Ashton Road Ashton, Maryland 20861 (301) 774-8405 Aspenwood (Aspenwood Residents and Employees Only) 14400 Homecrest Road Silver Spring, Maryland 20906 (301) 774-8406 Bedford Court (Bedford Court Residents and Employees Only) 3701 International Drive Silver Spring, Maryland 20906 (301) 774-8407 Bethesda 7126 Wisconsin Avenue Bethesda, Maryland 20814 (301) 951-0800 Executive Offices 17801 Georgia Avenue Olney, Maryland 20832 (301) 774-6400 Burtonsville 3535 Spencerville Road Burtonsville, Maryland 20866 (301) 774-8404 Clarksville 12276 Clarksville Pike Clarksville, Maryland 21029 (410) 531-2650 Colesville 13300 New Hampshire Avenue Silver Spring, Maryland 20904 (301) 774-8403 Damascus 26250 Ridge Road Damascus, Maryland 20872 (301) 253-0133 East Gude Drive 1601 East Gude Drive Rockville, Maryland 20850 (301) 570-8330 Gaithersburg Square 596 A North Frederick Avenue Gaithersburg, Maryland 20877 (301) 963-3600 Layhill 14241 Layhill Road Silver Spring, Maryland 20906 (301) 774-8406 Leisureworld Plaza 3801 International Drive Silver Spring, Maryland 20906 (301) 774-8407 Lisbon 710-N Lisbon Centre Drive Woodbine, Maryland 21797 (410) 442-1878 Montgomery Village 9921 Stedwick Road Montgomery Village, Maryland 20879 (301) 990-3800 Olney 17801 Georgia Avenue Olney, Maryland 20832 (301) 774-8402 Rockville 611 Rockville Pike Rockville, Maryland 20852 (301) 217-0555 Sandy Spring 908 Olney-Sandy Spring Road Sandy Spring, Maryland 20860 (301) 774-8401 Customer Service Center (301) 774-8477 (800) 399-5919 Internet Address http://www.ssnb.com [LOGO OF SANDY SPRING BANCORP APPEARS HERE] EX-21 3 EXHIBIT 21 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT
Percentage State Subsidiaries Owned of Incorporation - ------------ ----------- ---------------- Sandy Spring National Bank of Maryland 100% United States Sandy Spring Insurance Corporation (1) 100% Maryland Sandy Spring Mortgage Corporation (1) 100% Maryland
- ---------------- (1) 100% owned by Sandy Spring National Bank of Maryland. EX-23 4 EXHIBIT 23 EXHIBIT 23 Stegman & Company Certified Public Accountants Suite 200 405 East Joppa Road Towson, Maryland 21286 (410) 823-8000 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Sandy Spring Bancorp, Inc. We hereby consent to the incorporation by reference in the prospectuses included in Registration Statements No. 33-29316, 33-48453 (including Registration Statement on Form S-8 and Post Effective Amendment No. 2 to Form S- 8 with respect to Registration Statements No. 33-29316 and 33-48453 ),33-35319, 33-56692, 333-11049, each on Form S-8, and Registration Statement No. 33-57182 on Form S-3, and in the Annual Report on Form 10-K of Sandy Spring Bancorp, Inc. for the year ended December 31, 1996, of our report dated January 31, 1997, relating to the consolidated financial statements of Sandy Spring Bancorp, Inc. and Subsidiaries. /s/ Stegman & Company Stegman & Company Towson, Maryland March 21, 1997 EX-24 5 EXHIBIT 24 EXHIBIT 24 POWER OF ATTORNEY We, the undersigned directors of the Registrant, hereby severally constitute and appoint Marjorie S. Holsinger our true and lawful attorney and agent, to do any and all things in our names in the capacities indicated below which said person may deem necessary or advisable to enable the Registrant to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with the annual report on Form 10-K for the year ended December 31, 1996, including specifically, but not limited to, power and authority to sign for us in our names in the capacities indicated below the annual report and any amendments thereto; and we hereby approve, ratify and confirm all that said person shall do or cause to be done by virtue thereof.
Signature Title Date /s/ Andrew N. Adams, Jr. Director February 26, 1997 - ----------------------------------- Andrew N. Adams, Jr. /s/ John Chirtea Director February 26, 1997 - ----------------------------------- John Chirtea /s/ Willard H. Derrick Chairman of the Board and Director February 26, 1997 - ----------------------------------- Willard H. Derrick /s/ Susan D. Goff Director February 26, 1997 - ----------------------------------- Susan D. Goff /s/ Solomon Graham Director February 26, 1997 - ----------------------------------- Solomon Graham /s/ Joyce R. Hawkins Director February 26, 1997 - ----------------------------------- Joyce R. Hawkins /s/ Thomas O. Keech Director February 26, 1997 - ----------------------------------- Thomas O. Keech /s/ Charles F. Mess Director February 26, 1997 - ----------------------------------- Charles F. Mess - ----------------------------------- Director Robert L. Mitchell /s/ Robert L. Orndorff, Jr. Director February 26, 1997 - ----------------------------------- Robert L. Orndorff, Jr. /s/ Lewis R. Schumann Director February 26, 1997 - ----------------------------------- Lewis R. Schumann /s/ W. Drew Stabler Director February 26, 1997 - ----------------------------------- W. Drew Stabler
EX-27 6 EXHIBIT 27
9 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 32,899 861 23,278 0 234,423 122,272 123,067 524,760 (6,391) 978,595 806,341 68,127 2,726 4,820 0 0 4,902 91,679 978,595 46,491 18,405 1,725 66,621 27,889 30,233 36,388 308 30 25,344 17,283 17,283 0 0 11,494 2.36 2.36 3.75 1,291 3,337 27 3,440 6,597 (615) 101 6,391 2,378 0 4,013
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