SHORE BANCSHARES INC - Annual Report: 2005 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
Year Ended December 31, 2005
Commission
File No. 0-22345
SHORE
BANCSHARES, INC.
(Exact
name of registrant as specified in its charter)
|
Maryland
|
52-1974638
|
|
(State
or Other Jurisdiction of Incorporation or Organization)
|
(I.R.S.
Employer Identification No.)
|
|
18
East Dover Street, Easton, Maryland
|
21601
|
|
(Address
of Principal Executive Offices)
|
(Zip
Code)
|
(410)
822-1400
Registrant’s
Telephone Number, Including Area Code
Securities
Registered pursuant to Section 12(b) of the Act: None.
Securities
Registered pursuant to Section 12(g) of the Act: Common
Stock, par value $.01 per share.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. o
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 16(d) of the Act. o
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
o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this
Form 10-K o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (check one):
Large
accelerated filer o Accelerated
filer x Non-accelerated
filer o
State
the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity
was
last sold, or the average bid and asked price of such common equity, as of
the
last business day of the registrant’s most recently completed second fiscal
quarter: $133,451,892.
The
number of shares outstanding of the registrant’s common stock as of the latest
practicable date: 5,559,850
as of March 1, 2006.
Documents
Incorporated by Reference
Certain
information required by Part III of this annual report is incorporated herein
by
reference to the definitive proxy statement for the 2006 Annual Meeting of
Stockholders to be held on April 26, 2006.
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2
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10
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13
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14
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15
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15
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15
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17
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18
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32
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33
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61
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61
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64
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64
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64
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64
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64
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64
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65
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66
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67
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This
Annual Report of Shore Bancshares, Inc. on Form 10-K may contain forward-looking
statements within the meaning of The Private Securities Litigation Reform Act
of
1995. Readers of this report should be aware of the speculative nature of
“forward-looking statements.” Statements that are not historical in nature,
including the words “anticipate,” “estimate,” “should,” “expect,” “believe,”
“intend,” and similar expressions, are based on current expectations, estimates
and projections about (among other things) the industry and the markets in
which
the Company and its subsidiaries operate; they are not guarantees of future
performance. Whether actual results will conform to expectations and predictions
is subject to known and unknown risks and uncertainties, including risks and
uncertainties discussed in this Form 10-K, general economic, market or business
conditions; changes in interest rates, deposit flow, the cost of funds, and
demand for loan products and financial services; changes in our competitive
position or competitive actions by other companies; changes in the quality
or
composition of loan and investment portfolios; the ability to mange growth;
changes in laws or regulations or policies of federal and state regulators
and
agencies; and other circumstances beyond the Company’s control. Consequently,
all of the forward-looking statements made in this document are qualified by
these cautionary statements, and there can be no assurance that the actual
results anticipated will be realized, or if substantially realized, will have
the expected consequences on the Company’s business or operations. Except as
required by applicable laws, the Company does not intend to publish updates
or
revisions of any forward-looking statements it makes to reflect new information,
future events or otherwise.
Except
as
expressly provided otherwise, the term “Company” as used in this report refers
to Shore Bancshares, Inc. and the terms “we”, “us” and “our” refer collectively
to Shore Bancshares, Inc. and its consolidated subsidiaries.
BUSINESS
General
The
Company was incorporated under the laws of Maryland on March 15, 1996 and is
registered as a financial holding company registered under the Bank Holding
Company Act of 1956, as amended (the “BHC Act”). The Company’s primary business
is acting as the parent company to three bank subsidiaries, The Centreville
National Bank of Maryland (“Centreville National Bank”), The Talbot Bank of
Easton, Maryland (“Talbot Bank”), and The Felton Bank (“Felton Bank”)
(collectively, the “Banks”), two insurance producer firms, The Avon-Dixon
Agency, LLC and Elliott Wilson Insurance, LLC, one insurance premium finance
company, Mubell Finance, LLC (together with The Avon-Dixon Agency, LLC and
Elliot Wilson Insurance, LLC, the “Insurance Subsidiaries”), and an investment
adviser firm, Wye Financial Services, LLC (“Wye Financial”). The Company also
has an inactive subsidiary, Shore Pension Services, LLC.
Talbot
Bank owns all of the issued and outstanding securities of Dover Street Realty,
Inc., a Maryland corporation that engages in the business of holding and
managing real property acquired by Talbot Bank as a result of loan foreclosures.
Centreville
National Bank owns 20% of the issued and outstanding common stock of Delmarva
Data Bank Processing Center, Inc. (“Delmarva Data”), a Maryland corporation that
provides data processing services to banks located in Maryland, Delaware,
Virginia and the District of Columbia, including Centreville National Bank
and
Talbot Bank.
We
operate in two business segments: community banking and insurance products
and
services. Financial information
related to our operations in these segments for each of the three years ended
December 31, 2005 is provided in Note 24 to the Company’s Consolidated Financial
Statements included in Item 8 of Part II of this report.
Banking
Products and Services
Centreville
National Bank is a national banking association that commenced operations in
1876. Talbot Bank is a Maryland commercial bank that commenced operations in
1885 and was acquired by the Company in its December 2000 merger with Talbot
Bancshares, Inc. (“Talbot Bancshares”). Felton Bank is a Delaware commercial
bank that commenced operations in 1908 and was acquired by the Company in April
2004 when it merged with Midstate Bancorp, Inc. The Banks operate 16 full
service branches and 20 ATMs and provide a full range of commercial and consumer
banking products and services to individuals, businesses, and other
organizations in the Maryland counties of Kent, Queen Anne’s, Caroline, Talbot
and Dorchester and in Kent County, Delaware. The Banks’ deposits are insured by
the Federal Deposit Insurance Corporation (the “FDIC”).
The
Banks
are independent community banks and serve businesses and individuals in their
respective market areas. Services offered are essentially the same as those
offered by larger regional institutions that compete with the Banks. Services
provided to businesses include commercial checking, savings, certificate of
deposit and overnight investment sweep accounts. The Banks offer all forms
of
commercial lending, including secured and unsecured loans, working capital
loans, lines of credit, term loans, accounts receivable financing, real estate
acquisition development, construction loans and letters of credit. Merchant
credit card clearing services are available as well as direct deposit of
payroll, internet banking and telephone banking services.
Services
to individuals include checking accounts, various savings programs, mortgage
loans, home improvement loans, installment and other personal loans, credit
cards, personal lines of credit, automobile and other consumer financing, safe
deposit boxes, debit cards, 24 hour telephone banking, PC and internet banking,
and 24-hour automatic teller machine services. The Banks also offer nondeposit
products, such as mutual funds and annuities, and discount brokerage services
to
their customers. Additionally, the Banks have Saturday hours and extended hours
on certain evenings during the week for added customer convenience.
Lending
Activities
The
Banks
originate secured and unsecured loans for business purposes. Commercial loans
are typically secured by real estate, accounts receivable, inventory equipment
and/or other assets of the business. Commercial loans generally involve a
greater degree of credit risk than one to four family residential mortgage
loans. Repayment is often dependent on the successful operation of the business
and may be affected by adverse conditions in the local economy or real estate
market. The financial condition and cash flow of commercial borrowers is
therefore carefully analyzed during the loan approval process, and continues
to
be monitored by obtaining business financial statements, personal financial
statements and income tax returns. The frequency of this ongoing analysis
depends upon the size and complexity of the credit and collateral that secures
the loan. It is also the Company’s general policy to obtain personal guarantees
from the principals of the commercial loan borrowers.
The
Bank’s provide residential real estate construction loans to builders and
individuals for single family dwellings. Residential construction loans are
usually granted based upon “as completed” appraisals and are secured by the
property under construction. Additional collateral may be taken if loan to
value
ratios exceed 80%. Site inspections are performed to determine pre-specified
stages of completion before loan proceeds are disbursed. These loans typically
have maturities of six to 12 months and may have fixed or variable rate
features. Permanent financing options for individuals include fixed and variable
rate loans with three- and five-year balloon features and one-, three- and
five-year adjustable rate mortgage loans. The risk of loss associated with
real
estate construction lending is controlled through conservative underwriting
procedures such as loan to value ratios of 80% or less, obtaining additional
collateral when prudent, and closely monitoring construction projects to control
disbursement of funds on loans.
The
Banks
originate fixed and variable rate residential mortgage loans. As with any
consumer loan, repayment is dependent on the borrower’s continuing financial
stability, which can be adversely impacted by job loss, divorce, illness, or
personal bankruptcy. Underwriting standards recommend loan to value ratios
not
to exceed 80% based on appraisals performed by approved appraisers. The Banks
rely on title insurance to protect their lien priorities and protect the
property securing the loans by requiring fire and casualty
insurance.
The
Banks
also originate and sell long-term fixed rate residential mortgage loans on
the
secondary market. The Banks do not typically fund these loans, but they do
receive commissions upon settlement.
Commercial
real estate loans are primarily those secured by office condominiums, retail
buildings, warehouses and general purpose business space. Low loan to value
ratio standards, as well as the thorough financial analysis performed and the
Banks’ knowledge of the local economy in which they lend are employed to help
reduce the risk associated with these loans.
A
variety
of consumer loans are offered to customers, including home equity loans, credit
cards and other secured and unsecured lines of credit and term loans. Careful
analysis of an applicant’s creditworthiness is performed before granting credit,
and on going monitoring of loans outstanding is performed in an effort to
minimize risk of loss by identifying problem loans early.
Deposit
Activities
The
Banks
offer a full array of deposit products including checking, savings and money
market accounts, regular and IRA certificates of deposit, and Christmas Savings
accounts. The Banks also offers the CDARS program, providing up to $20 million
of FDIC insurance to our customers. In addition, we offer our commercial
customers packages which include Cash Management services and various checking
opportunities.
Trust
Services
Centreville
National Bank established a trust department during the second quarter of 2005
and markets trust, asset management and financial planning services to customers
within our market areas.
Insurance
Activities
The
Insurance Subsidiaries were formed as a result of the Company’s acquisition of
the assets of The Avon-Dixon Agency, Inc., Elliott Wilson Insurance, Inc.,
Avon-Dixon Financial Services, Inc., Joseph M. George & Son, Inc. and 59th
Street Finance Company on May 1, 2002. In November 2002, The Avon-Dixon Agency,
LLC acquired certain assets of W. M. Freestate & Son, Inc., a full-service
insurance producer firm located in Centreville, Maryland. The Insurance
Subsidiaries offer a full range of insurance products and services to customers,
including insurance premium financing.
Seasonality
Management
does not believe that our business activities are seasonal in nature. Deposits
may vary depending on local and national economic conditions, but management
believes that any variation will not have a material impact on our planning
or
policy-making strategies.
Employees
At
February 11, 2006, we employed 308 persons, of which 272 were employed on a
full-time basis.
COMPETITION
The
banking business, in all of its phases, is highly competitive. Within our market
areas, we compete with commercial banks (including local banks and branches
or
affiliates of other larger banks), savings and loan associations and credit
unions for loans and deposits, with money market and mutual funds and other
investment alternatives for deposits, with consumer finance companies for loans,
with insurance companies, agents and brokers for insurance products, and with
other financial institutions for various types of products and services. There
is also competition for commercial and retail banking business from banks and
financial institutions located outside our market areas.
The
primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services. The primary factors in competing for insurance
customers are competitive rates, the quality and range of insurance products
offered, and quality, personalized service.
To
compete with other financial services providers, we rely principally upon local
promotional activities, including advertisements in local newspapers, trade
journals and other publications and on the radio, personal relationships
established by officers, directors and employees with customers, and specialized
services tailored to meet its customers’ needs. In those instances in which we
are unable to accommodate the needs of a customer, we will arrange for those
services to be provided by other financial services providers with which we
have
a relationship. We additionally rely on referrals from satisfied
customers.
The
following tables set forth deposit data for Kent, Queen Anne’s, Caroline, Talbot
and Dorchester Counties in Maryland and for Kent County in Delaware as of June
30, 2005, the most recent date for which comparative information is
available.
|
%
of
|
|||||||
|
Kent
County, Maryland
|
Deposits
|
Total
|
|||||
|
(in
thousands)
|
|||||||
|
Peoples
Bank of Kent County, Maryland
|
$
|
162,921
|
36.91
|
%
|
|||
|
Mercantile
Shore Bank
|
138,682
|
31.42
|
|||||
|
Chesapeake
Bank and Trust Co.
|
63,159
|
14.31
|
|||||
|
Branch
Banking & Trust
|
33,231
|
7.53
|
|||||
|
The
Centreville National Bank of Maryland
|
21,748
|
4.93
|
|||||
|
SunTrust
Bank
|
21,646
|
4.90
|
|||||
|
Total
|
$
|
441,387
|
100.00
|
%
|
|||
Source:
FDIC DataBook
|
%
of
|
|||||||
|
Queen
Anne’s County, Maryand
|
Deposits
|
Total
|
|||||
|
(in
thousands)
|
|||||||
|
The
Queenstown Bank of Maryland
|
$
|
260,791
|
40.25
|
%
|
|||
|
The
Centreville National Bank of Maryland
|
182,068
|
28.10
|
|||||
|
Bank
of America, National Association
|
66,535
|
10.27
|
|||||
|
Mercantile
Shore Bank
|
49,981
|
7.71
|
|||||
|
M&T
|
39,882
|
6.16
|
|||||
|
BankAnnapolis
|
32,647
|
5.04
|
|||||
|
Branch
Banking & Trust
|
16,042
|
2.47
|
|||||
|
Total
|
$
|
647,946
|
100.00
|
%
|
|||
Source:
FDIC DataBook
|
%
of
|
|||||||
|
Caroline
County, Maryland
|
Deposits
|
Total
|
|||||
|
(in
thousands)
|
|||||||
|
Provident
State Bank of Preston, Maryland
|
$
|
118,298
|
33.17
|
%
|
|||
|
Mercantile
Shore Bank
|
92,387
|
25.90
|
|||||
|
Branch
Banking & Trust
|
44,197
|
12.39
|
|||||
|
The
Centreville National Bank of Maryland
|
42,651
|
11.96
|
|||||
|
M&
T
|
31,578
|
8.85
|
|||||
|
Bank
of America, National Association
|
17,922
|
5.03
|
|||||
|
Easton
Bank & Trust
|
9,621
|
2.70
|
|||||
|
Total
|
$
|
356,654
|
100.00
|
%
|
|||
Source:
FDIC DataBook
|
|
%
of
|
||||||
|
Talbot
County, Maryland
|
Deposits
|
Total
|
|||||
|
|
(in
thousands)
|
||||||
|
The
Talbot Bank of Easton, Maryland
|
$
|
363,607
|
42.47
|
%
|
|||
|
Mercantile
Shore Bank
|
157,513
|
18.40
|
|||||
|
Bank
of America, National Association
|
90,542
|
10.58
|
|||||
|
Easton
Bank & Trust
|
86,841
|
10.14
|
|||||
|
SunTrust
Bank
|
45,684
|
5.34
|
|||||
|
The
Queenstown Bank of Maryland
|
30,278
|
3.54
|
|||||
|
Branch
Banking & Trust
|
28,859
|
3.37
|
|||||
|
M&T
|
27,605
|
3.22
|
|||||
|
First
Mariner Bank
|
18,704
|
2.18
|
|||||
|
Chevy
Chase Bank
|
6,551
|
0.76
|
|||||
|
Total
|
$
|
856,184
|
100.00
|
%
|
|||
Source:
FDIC DataBook
|
%
of
|
|||||||
|
Dorchester
County, Maryland
|
Deposits
|
Total
|
|||||
|
(in
thousands)
|
|||||||
|
The
National Bank of Cambridge
|
$
|
166,305
|
31.42
|
%
|
|||
|
Bank
of the Eastern Shore
|
157,879
|
29.83
|
|||||
|
Hebron
Savings Bank
|
51,337
|
9.70
|
|||||
|
Provident
State Bank of Preston, Maryland
|
38,083
|
7.19
|
|||||
|
Branch
Banking & Trust
|
30,237
|
5.71
|
|||||
|
Bank
of America, National Association
|
29,913
|
5.65
|
|||||
|
M&T
|
22,579
|
4.27
|
|||||
|
SunTrust
Bank
|
17,548
|
3.31
|
|||||
|
The
Talbot Bank of Easton, Maryland
|
15,460
|
2.92
|
|||||
|
Total
|
$
|
529,341
|
100.00
|
%
|
|||
Source:
FDIC DataBook
|
Kent
County, Delaware
|
Deposits
|
Total
|
|||||
|
(in
thousands)
|
|||||||
|
Wilmington
Trust
|
$
|
386,150
|
27.50
|
%
|
|||
|
Citizens
Bank
|
247,271
|
17.61
|
|||||
|
PNC
Bank Delaware
|
244,629
|
17.42
|
|||||
|
First
NB of Wyoming
|
196,125
|
13.97
|
|||||
|
Wachovia
Bank of Delaware
|
129,689
|
9.24
|
|||||
|
Artisans
Bank
|
62,204
|
4.43
|
|||||
|
The
Felton Bank
|
60,134
|
4.28
|
|||||
|
County
Bank
|
35,203
|
2.51
|
|||||
|
Wilmington
Savings Fund Society
|
22,939
|
1.64
|
|||||
|
Commerce
Bank National Assn
|
13,206
|
0.94
|
|||||
|
Fort
Sill National Bank
|
6,500
|
0.46
|
|||||
|
Total
|
$
|
1,404,050
|
100.00
|
%
|
|||
Source:
FDIC DataBook
SUPERVISION
AND REGULATION
The
following is a summary of the material regulations and policies applicable
to us
and is not intended to be a comprehensive discussion. Changes in applicable
laws
and regulations may have a material effect on our business, financial condition
and results of operation.
General
The
Company is a financial holding company registered with the Board of Governors
of
the Federal Reserve System (the “FRB”) under the BHC Act and, as such, is
subject to the supervision, examination and reporting requirements of the BHC
Act and the regulations of the FRB.
Talbot
Bank is a Maryland commercial bank subject to the banking laws of Maryland
and
to regulation by the Commissioner of Financial Regulation of Maryland, who
is
required by statute to make at least one examination in each calendar year.
Centreville National Bank is a national banking association subject to federal
banking laws and regulations enforced and/or promulgated by the Office of the
Comptroller of the Currency (the “OCC”), which is required by statute to make at
least one examination in each calendar year. Felton Bank is a Delaware
commercial bank subject to the banking laws of Delaware and to regulation by
the
Delaware Office of the State Bank Commissioner (the “Delaware Commissioner”),
who is entitled by statute to make examinations of Felton Bank as and when
deemed necessary or expedient. The primary federal regulator of both Talbot
Bank
and Felton Bank is the FDIC, which is also entitled to conduct regular
examinations. The deposits of the Banks are insured by the FDIC, so certain
laws
and regulations administered by the FDIC also govern their deposit taking
operations. In addition to the foregoing, the Banks are subject to numerous
state and federal statutes and regulations that affect the business of banking
generally.
Nonbank
affiliates of the Company are subject to examination by the FRB, and, as
affiliates of the Banks, may be subject to examination by the Banks’ regulators
from time to time. In addition, the Insurance Subsidiaries are each subject
to
licensing and regulation by the insurance authorities of the states in which
they do business. Retail sales of insurance products by the Insurance
Subsidiaries to customers of the Banks are also subject to the requirements
of
the Interagency Statement on Retail Sales of Nondeposit Investment Products
promulgated in 1994, as amended, by the FDIC, the FRB, the OCC, and the Office
of Thrift Supervision. Wye Financial Services, LLC is subject to the
registration and examination requirements of federal and state laws governing
investment advisers.
Regulation
of Financial Holding Companies
In
November 1999, the federal Gramm-Leach-Bliley Act (the “GLBA”) was signed into
law. Effective in pertinent part on March 11, 2000, GLBA revises the BHC Act
and
repeals the affiliation provisions of the Glass-Steagall Act of 1933, which,
taken together, limited the securities, insurance and other non-banking
activities of any company that controls an FDIC insured financial institution.
Under GLBA, a bank holding company can elect, subject to certain qualifications,
to become a “financial holding company.” GLBA provides that a financial holding
company may engage in a full range of financial activities, including insurance
and securities sales and underwriting activities, and real estate development,
with new expedited notice procedures.
Under
FRB
policy, the Company is expected to act as a source of strength to its subsidiary
banks, and the FRB may charge the Company with engaging in unsafe and unsound
practices for failure to commit resources to a subsidiary bank when required.
In
addition, under the Financial Institutions Reform, Recovery and Enforcement
Act
of 1989 (“FIRREA”), depository institutions insured by the FDIC can be held
liable for any losses incurred by, or reasonably anticipated to be incurred
by,
the FDIC in connection with (i) the default of a commonly controlled
FDIC-insured depository institution or (ii) any assistance provided by the
FDIC
to a commonly controlled FDIC-insured depository institution in danger of
default. Accordingly, in the event that any insured subsidiary of the Company
causes a loss to the FDIC, other insured subsidiaries of the Company could
be
required to compensate the FDIC by reimbursing it for the estimated amount
of
such loss. Such cross guaranty liabilities generally are superior in priority
to
obligations of a financial institution to its stockholders and obligations
to
other affiliates.
Regulation
of Banks
Federal
and state banking regulators may prohibit the institutions over which they
have
supervisory authority from engaging in activities or investments that the
agencies believes are unsafe or unsound banking practices. These banking
regulators have extensive enforcement authority over the institutions they
regulate to prohibit or correct activities that violate law, regulation or
a
regulatory agreement or which are deemed to be unsafe or unsound practices.
Enforcement actions may include the appointment of a conservator or receiver,
the issuance of a cease and desist order, the termination of deposit insurance,
the imposition of civil money penalties on the institution, its directors,
officers, employees and institution-affiliated parties, the issuance of
directives to increase capital, the issuance of formal and informal agreements,
the removal of or restrictions on directors, officers, employees and
institution-affiliated parties, and the enforcement of any such mechanisms
through restraining orders or other court actions.
The
Company and its affiliates are subject to the provisions of Section 23A and
Section 23B of the Federal Reserve Act. Section 23A limits the amount of loans
or extensions of credit to, and investments in, the Company and its nonbank
affiliates by the Banks. Section 23B requires that transactions between any
of
the Banks and the Company and its nonbank affiliates be on terms and under
circumstances that are substantially the same as with non-affiliates.
The
Banks
are also subject to certain restrictions on extensions of credit to executive
officers, directors, and principal stockholders or any related interest of
such
persons, which generally require that such credit extensions be made on
substantially the same terms as are available to third parties dealing with
the
Banks and not involve more than the normal risk of repayment. Other laws tie
the
maximum amount that may be loaned to any one customer and its related interests
to capital levels.
As
part
of the Federal Deposit Insurance Company Improvement Act of 1991 (“FDICIA”),
each federal banking regulator adopted non-capital safety and soundness
standards for institutions under its authority. These standards include internal
controls, information systems and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. An institution that fails to meet those standards may be
required by the agency to develop a plan acceptable to meet the standards.
Failure to submit or implement such a plan may subject the institution to
regulatory sanctions. The Company, on behalf of the Banks, believes that the
Banks meet substantially all standards that have been adopted. FDICIA also
imposes new capital standards on insured depository institutions.
The
Community Reinvestment Act (“CRA”) requires that, in connection with the
examination of financial institutions within their jurisdictions, the federal
banking regulators evaluate the record of the financial institution in meeting
the credit needs of their communities including low and moderate income
neighborhoods, consistent with the safe and sound operation of those banks.
These factors are also considered by all regulatory agencies in evaluating
mergers, acquisitions and applications to open a branch or facility. As of
the
date of its most recent examination report, each of the Banks has a CRA rating
of “Satisfactory.”
Capital
Requirements
FDICIA
established a system of prompt corrective action to resolve the problems of
undercapitalized institutions. Under this system, federal banking regulators
are
required to rate supervised institutions on the basis of five capital
categories: “well -capitalized,” “adequately capitalized,” “undercapitalized,”
“significantly undercapitalized,” and “critically undercapitalized;” and to take
certain mandatory actions, and are authorized to take other discretionary
actions, with respect to institutions in the three undercapitalized categories.
The severity of the actions will depend upon the category in which the
institution is placed. A depository institution is “well capitalized” if it has
a total risk based capital ratio of 10% or greater, a Tier 1 risk based capital
ratio of 6% or greater, and a leverage ratio of 5% or greater and is not subject
to any order, regulatory agreement, or written directive to meet and maintain
a
specific capital level for any capital measure. An “adequately capitalized”
institution is defined as one that has a total risk based capital ratio of
8% or
greater, a Tier 1 risk based capital ratio of 4% or greater and a leverage
ratio
of 4% or greater (or 3% or greater in the case of a bank with a composite CAMELS
rating of 1).
FDICIA
generally prohibits a depository institution from making any capital
distribution, including the payment of cash dividends, or paying a management
fee to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to growth
limitations and are required to submit capital restoration plans. For a capital
restoration plan to be acceptable, the depository institution’s parent holding
company must guarantee (subject to certain limitations) that the institution
will comply with such capital restoration plan.
Significantly
undercapitalized depository institutions may be subject to a number of other
requirements and restrictions, including orders to sell sufficient voting stock
to become adequately capitalized and requirements to reduce total assets and
stop accepting deposits from correspondent banks. Critically undercapitalized
depository institutions are subject to the appointment of a receiver or
conservator, generally within 90 days of the date such institution is determined
to be critically undercapitalized.
As
of
December 31, 2005, the Banks were each deemed to be “well capitalized.” For more
information regarding the capital condition of the Company, see Note 17 of
Consolidated Financial Statements appearing in Item 8 of Part II of this
report.
Deposit
Insurance
As
FDIC
member institutions, the Banks’ deposits are insured to a maximum of $100,000
per depositor through the Bank Insurance Fund (“BIF”), administered by the FDIC,
and each institution is required to pay semi-annual deposit insurance premium
assessments to the FDIC. The BIF assessment rates have a range of 0 to 27 cents
for every $100 in assessable deposits. In addition, as a result of the April
1997 merger of Kent Savings and Loan Association, F.A. into Centreville National
Bank, approximately $37 million of the Centreville National Bank’s deposits are
insured through the Savings Association Insurance Fund (“SAIF”), also
administered by the FDIC, which are determined quarterly. The federal Economic
Growth and Regulatory Paperwork Reduction Act of 1996 included provisions that,
among other things, recapitalized the SAIF through a special assessment on
savings association deposits and bank deposits that had been acquired from
savings associations.
Under
the
Federal
Deposit Insurance Reform Act of 2005,
which was signed into law on February 8, 2006: (i) the BIF and the SAIF will
be
merged into a new combined fund, to be called the Deposit Insurance Fund
effective July 1, 2006, (ii) the current $100,000 deposit insurance coverage
will be indexed for inflation (with adjustments every five years, commencing
January 1, 2011); and (iii) deposit insurance coverage for retirement accounts
will be increased to $250,000 per participant subject to adjustment for
inflation. The FDIC will be given greater latitude in setting the assessment
rates for insured depository institutions which could be used to impose minimum
assessments.
USA
PATRIOT Act
Congress
adopted the USA PATRIOT Act (the “Patriot Act”) on October 26, 2001 in response
to the terrorist attacks that occurred on September 11, 2001. Under the Patriot
Act, certain financial institutions, including banks, are required to maintain
and prepare additional records and reports that are designed to assist the
government’s efforts to combat terrorism. The Patriot Act includes sweeping
anti-money laundering and financial transparency laws and required additional
regulations, including, among other things, standards for verifying client
identification when opening an account and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
Federal
Securities Laws
Shares
of
the Company’s common stock are registered with the SEC under Section 12(g) of
the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and are
listed on the Nasdaq Capital Market (formerly designated by Nasdaq as the
“SmallCap Market”). The Company is subject to information reporting and proxy
solicitation requirements, insider trading restrictions and other requirements
of the Exchange Act. The federal Sarbanes-Oxley Act of 2002 and its implementing
regulations made several changes to the Exchange Act and to the listing
standards of The Nasdaq Stock Market, Inc. to which the Company is subject.
These changes impose additional requirements and restrictions on the Company,
including, among other things, restrictions on loans to and other transactions
with insiders, additional disclosure requirements in the reports and other
documents that the Company files with the SEC, new director independence
requirements, certain Board of Director committee requirements, and other
corporate governance requirements.
Governmental
Monetary and Credit Policies and Economic Controls
The
earnings and growth of the banking industry and ultimately of the Bank are
affected by the monetary and credit policies of governmental authorities,
including the FRB. An important function of the FRB is to regulate the national
supply of bank credit in order to control recessionary and inflationary
pressures. Among the instruments of monetary policy used by the FRB to implement
these objectives are open market operations in U.S. Government securities,
changes in the federal funds rate, changes in the discount rate of member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth of
bank
loans, investments and deposits and may also affect interest rates charged
on
loans or paid for deposits. The monetary policies of the FRB authorities have
had a significant effect on the operating results of commercial banks in the
past and are expected to continue to have such an effect in the future. In
view
of changing conditions in the national economy and in the money markets, as
well
as the effect of actions by monetary and fiscal authorities, including the
FRB,
no prediction can be made as to possible future changes in interest rates,
deposit levels, loan demand or their effect on the business and earnings of
the
Company and its subsidiaries.
AVAILABLE
INFORMATION
The
Company maintains an Internet site at www.shbi.net
on which
it makes available, free of charge, its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the
foregoing as soon as reasonably practicable after these reports are
electronically filed with, or furnished to, the SEC. In addition, stockholders
may access these reports and documents on the SEC’s web site at www.sec.gov.
The
following factors may impact our business, financial condition and results
of
operations and should be considered carefully in evaluating an investment in
shares of common stock of the Company.
The
Company’s future depends on the successful growth of its
subsidiaries
The
Company’s primary business activity for the foreseeable future will be to act as
the holding company of Talbot Bank, Centreville National Bank, Felton Bank,
and
its other subsidiaries. Therefore, the Company’s future profitability will
depend on the success and growth of these subsidiaries. In the future, part
of
the Company’s growth may come from buying other banks and buying or establishing
other companies. Such entities may not be profitable after they are purchased
or
established, and they may lose money, particularly at first. A new bank or
company may bring with it unexpected liabilities, bad loans, or bad employee
relations, or the new bank or company may lose customers.
A
majority of our business is concentrated in Maryland and Delaware; a significant
amount of our business is concentrated in real estate
lending
A
majority of our customers reside in Maryland and Delaware. Therefore, a decline
in local economic conditions may have a greater impact on our earnings and
capital than on the earnings and capital of larger financial institutions whose
customer bases are geographically diverse. Further, the Banks make many real
estate secured loans, which are in greater demand when interest rates are low
and economic conditions are good. There can be no guarantee that good economic
conditions or low interest rates will continue to exist. Additionally, the
market values of the real estate securing the Banks’ loans may deteriorate due
to a number of unpredictable factors, which could cause us to lose money in
the
event a borrower failed to repay a loan and we were forced to foreclose on
the
property.
Interest
rates and other economic conditions will impact our results of
operation
Our
results of operations may be materially and adversely affected by changes in
prevailing economic conditions, including declines in real estate values, rapid
changes in interest rates and the monetary and fiscal policies of the federal
government. Our profitability is in part a function of the spread between the
interest rates earned on assets and the interest rates paid on deposits and
other interest-bearing liabilities (i.e.,
net
interest income), including advances from the Federal Home Loan Bank of Atlanta.
Interest rate risk arises from mismatches (i.e.,
the
interest sensitivity gap) between the dollar amount of repricing or maturing
assets and liabilities and is measured in terms of the ratio of the interest
rate sensitivity gap to total assets. More assets repricing or maturing than
liabilities over a given time period is considered asset-sensitive and is
reflected as a positive gap, and more liabilities repricing or maturing than
assets over a given time period is considered liability-sensitive and is
reflected as negative gap. An asset-sensitive position (i.e.,
a
positive gap) could enhance earnings in a rising interest rate environment
and
could negatively impact earnings in a falling interest rate environment, while
a
liability-sensitive position (i.e.,
a
negative gap) could enhance earnings in a falling interest rate environment
and
negatively impact earnings in a rising interest rate environment. Fluctuations
in interest rates are not predictable or controllable. We have attempted to
structure our asset and liability management strategies to mitigate the impact
on net interest income of changes in market interest rates, but there can be
no
assurance that these attempts will be successful in the event of such changes.
The
Banks may experience loan losses in excess of their
allowances
The
risk
of credit losses on loans varies with, among other things, general economic
conditions, the type of loan being made, the creditworthiness of the borrower
over the term of the loan and, in the case of a collateralized loan, the value
and marketability of the collateral for the loan. Management of each of the
Banks bases that Bank’s allowance for loan losses upon, among other things,
historical experience, an evaluation of economic conditions and regular reviews
of delinquencies and loan portfolio quality. Based upon such factors, management
makes various assumptions and judgments about the ultimate collectability of
the
loan portfolio and provides an allowance for loan losses based upon a percentage
of the outstanding balances and for specific loans when their ultimate
collectability is considered questionable. If management’s assumptions and
judgments prove to be incorrect and the allowance for loan losses is inadequate
to absorb future losses, or if the bank regulatory authorities, as a part of
their examination process, require our bank subsidiaries to increase their
respective allowance for loan losses, our earnings and capital could be
significantly and adversely affected. Although management uses the best
information available to make determinations with respect to the allowance
for
loan losses, future adjustments may be necessary if economic conditions differ
substantially from the assumptions used or adverse developments arise with
respect to the Banks’ non-performing or performing loans. Material additions to
the allowance for loan losses of one of the Banks would result in a decrease
in
that Bank’s net income and capital and could have a material adverse effect on
our financial condition.
The
market value of our investments might decline
As
of
December 31, 2005, we had classified 88% of our investment securities as
available-for-sale pursuant to Statement of Financial Accounting Standards
No.
115 (“SFAS 115”) relating to accounting for investments. SFAS 115 requires that
unrealized gains and losses in the estimated value of the available-for-sale
portfolio be “marked to market” and reflected as a separate item in
stockholders’ equity (net of tax) as accumulated other comprehensive income. The
remaining investment securities are classified as held-to-maturity in accordance
with SFAS 115 and are stated at amortized cost.
In
the
past, gains on sales of investment securities have not been a significant source
of income for us. There can be no assurance that future market performance
of
our investment portfolio will enable us to realize income from sales of
securities. Stockholders’ equity will continue to reflect the unrealized gains
and losses (net of tax) of these investments. There can be no assurance that
the
market value of our investment portfolio will not decline, causing a
corresponding decline in stockholders’ equity.
Management
believes that several factors will affect the market values of our investment
portfolio. These include, but are not limited to, changes in interest rates
or
expectations of changes, the degree of volatility in the securities markets,
inflation rates or expectations of inflation and the slope of the interest
rate
yield curve (the yield curve refers to the differences between shorter-term
and
longer-term interest rates; a positively sloped yield curve means shorter-term
rates are lower than longer-term rates). Also, the passage of time will affect
the market values of our investment securities, in that the closer they are
to
maturing, the closer the market price should be to par value. These and other
factors may impact specific categories of the portfolio differently, and
management cannot predict the effect these factors may have on any specific
category.
The
banking industry is heavily regulated; significant regulatory changes could
adversely affect our operations
Our
operations are and will be affected by current and future legislation and by
the
policies established from time to time by various federal and state regulatory
authorities. The Company is subject to supervision by the FRB; Talbot Bank
is
subject to supervision and periodic examination by the Maryland Commissioner
and
the FDIC; Centreville National Bank is subject to supervision and periodic
examination by the OCC and the FDIC; and Felton Bank is subject to supervision
and periodic examination by the Delaware Commissioner and the FDIC. Banking
regulations, designed primarily for the safety of depositors, may limit a
financial institution’s growth and the return to its investors by restricting
such activities as the payment of dividends, mergers with or acquisitions by
other institutions, investments, loans and interest rates, interest rates paid
on deposits, expansion of branch offices, and the offering of securities or
trust services. The Company and the Banks are also subject to capitalization
guidelines established by federal law and could be subject to enforcement
actions to the extent that those institutions are found by regulatory examiners
to be undercapitalized. It is not possible to predict what changes, if any,
will
be made to existing federal and state legislation and regulations or the effect
that such changes may have on our future business and earnings prospects.
Management also cannot predict the nature or the extent of the effect on our
business and earnings of future fiscal or monetary policies, economic controls,
or new federal or state legislation. Further, the cost of compliance with
regulatory requirements may adversely affect our ability to operate
profitably.
We
operation in a highly competitive market
We
operate in a competitive environment, competing for loans, deposits, insurance
products and customers with commercial banks, savings associations and other
financial entities. Competition for deposits comes primarily from other
commercial banks, savings associations, credit unions, money market and mutual
funds and other investment alternatives. Competition for loans comes primarily
from other commercial banks, savings associations, mortgage banking firms,
credit unions and other financial intermediaries. Competition for other
products, such as insurance and securities products, comes from other banks,
securities and brokerage companies, insurance companies, insurance agents and
brokers, and other nonbank financial service providers in our market areas.
Many
of these competitors are much larger in terms of total assets and
capitalization, have greater access to capital markets, and/or offer a broader
range of financial services than those offered by us. In addition, banks with
a
larger capitalization and financial intermediaries not subject to bank
regulatory restrictions have larger lending limits and are thereby able to
serve
the needs of larger customers. Our growth and profitability will depend upon
our
ability to attract and retain skilled managerial, marketing and technical
personnel. Competition for qualified personnel in the financial services
industry is intense, and there can be no assurance that we will be successful
in
attracting and retaining such personnel.
In
addition, current banking laws facilitate interstate branching, merger activity
among banks, and expanded activities. Since September 1995, certain bank holding
companies are authorized to acquire banks throughout the United States. Since
June 1, 1997, certain banks are permitted to merge with banks organized under
the laws of different states. As a result, interstate banking is now an accepted
element of competition in the banking industry and the Corporation may be
brought into competition with institutions with which it does not presently
compete. Moreover, as discussed above, the GLBA revised the BHC Act in 2000
and
repealed the affiliation provisions of the Glass-Steagall Act of 1933, which,
taken together, limited the securities, insurance and other non-banking
activities of any company that controls an FDIC insured financial institution.
These laws will likely increase the competition we face in our market areas
in
the future, although management cannot predict the degree to which such
competition will impact our financial conditions or results of
operations.
The
Company’s Ability to Pay Dividends is Limited
The
Company’s stockholders are entitled to dividends on their shares of common stock
if, when, and as declared by the Company’s Board of Directors out of funds
legally available for that purpose. The Company’s current ability to pay
dividends to stockholders is largely dependent upon the receipt of dividends
from the Banks. Both federal and state laws impose restrictions on the ability
of the Banks to pay dividends. Federal law prohibits the payment of a dividend
by an insured depository institution if the depository institution is considered
“undercapitalized” or if the payment of the dividend would make the institution
“undercapitalized”. For a Maryland state-chartered bank, dividends may be paid
out of undivided profits or, with the prior approval of the Maryland
Commissioner, from surplus in excess of 100% of required capital stock. If,
however, the surplus of a Maryland bank is less than 100% of its required
capital stock, then cash dividends may not be paid in excess of 90% of net
earnings. National banking associations are generally limited, subject to
certain exceptions, to paying dividends out of undivided profits. For a Delaware
state-chartered bank, dividends may be paid out of net profits, but only if
its
surplus fund is equal to or greater than 50% of its required capital stock.
If a
Delaware bank’s surplus is less than 100% of capital stock when it declares a
dividend, then it must carry 25% of its net profits of the preceding period
for
which the dividend is paid to its surplus fund until the surplus amounts to
100%
of its capital stock. In addition to these specific restrictions, bank
regulatory agencies also have the ability to prohibit proposed dividends by
a
financial institution that would otherwise be permitted under applicable
regulations if the regulatory body determines that such distribution would
constitute an unsafe or unsound practice. Because of these limitations, there
can be no guarantee that the Company’s Board will declare dividends in any
fiscal quarter.
The
loss of key personnel could disrupt our operations and result in reduced
earnings
Our
growth and profitability will depend upon our ability to attract and retain
skilled managerial, marketing and technical personnel. Competition for qualified
personnel in the financial services industry is intense, and there can be no
assurance that we will be successful in attracting and retaining such personnel.
Our current executive officers provide valuable services based on their many
years of experience and in-depth knowledge of the banking industry. Due to
the
intense competition for financial professionals, these key personnel would
be
difficult to replace and an unexpected loss of their services could result
in a
disruption to the continuity of operations and a possible reduction in earnings.
We
may be subject to claims
We
may
from time to time be subject to claims from customers for losses due to alleged
breaches of fiduciary duties, errors and omissions of employees, officers and
agents, incomplete documentation, the failure to comply with applicable laws
and
regulations, or many other reasons. Also, our employees may knowingly or
unknowingly violate laws and regulations. Management may not be aware of any
violations until after their occurrence. This lack of knowledge may not insulate
the Company or our subsidiaries from liability. Claims and legal actions may
result in legal expenses and liabilities that may reduce our profitability
and
hurt our financial condition.
The
shares of the Company’s common stock are not heavily
traded
The
shares of common stock of the Company are listed on the Nasdaq Capital Market
and are not heavily traded. Stock that is not heavily traded can be more
volatile than stock trading in an active public market. Factors such as our
financial results, the introduction of new products and services by us or our
competitors, and various factors affecting the banking industry generally may
have a significant impact on the market price of the shares our common stock.
Management cannot predict the extent to which an active public market for our
common stock will develop or be sustained in the future. In recent years, the
stock market has experienced a high level of price and volume volatility, and
market prices for the stock of many companies have experienced wide price
fluctuations that have not necessarily been related to their operating
performance. Therefore, the Company’s stockholders may not be able to sell their
shares at the volumes, prices, or times that they desire.
The
Shares of the Company’s common stock are not insured
Investments
in the shares of the common stock of the Company are not deposits and are not
insured against loss by the government.
We
may be adversely affected by recent legislation
As
discussed above, the GLBA repeals restrictions on banks affiliating with
securities firms and permits bank holding companies that become financial
holding companies to engage in additional financial activities, including
insurance and securities underwriting and agency activities, merchant banking,
and insurance company portfolio investment activities that are currently not
permitted for bank holding companies. Although the Company is a financial
holding company, this law may increase the competition we face from larger
banks
and other companies. It is not possible to predict the full effect that this
law
will have on us.
The
Sarbanes-Oxley Act of 2002 requires management of publicly traded companies
to
perform an annual assessment of their internal controls over financial reporting
and to report on whether the system is effective as of the end of the Company’s
fiscal year. Disclosure of significant deficiencies or material weaknesses
in
internal controls could cause an unfavorable impact to shareholder value by
affecting the market value of our stock.
The
Patriot Act reinforced the importance of implementing and following procedures
required by the Bank Secrecy Act and money laundering issues. Non-compliance
with this act or failure to file timely and accurate documentation could expose
the company to adverse publicity as well as fines and penalties assessed by
regulatory agencies.
We
may not be able to keep pace with developments in
technology
We
use
various technologies in our business, including telecommunication, data
processing, computers, automation, internet-based banking, and debit cards.
Technology changes rapidly. Our ability to compete successfully with other
banks
and non-bank entities may depend on whether we can exploit technological
changes. We may not be able to exploit technological changes, and any investment
we do make may not make us more profitable.
The
Company’s Articles of Incorporation and Bylaws and Maryland law may discourage a
corporate takeover
The
Company’s Amended and Restated Articles of Incorporation and Amended and
Restated Bylaws contain certain provisions designed to enhance the ability
of
the Board of Directors to deal with attempts to acquire control of the Company.
These provisions provide for the classification of the Board into three classes;
directors of each class generally serve for staggered three-year periods. No
director may be removed except for cause and then only by a vote of at least
two-thirds of the total eligible stockholder votes. In addition, Maryland law
contains anti-takeover provisions that apply to the Company. Although these
provisions do not preclude a takeover, they may have the effect of discouraging
a future takeover attempt which would not be approved by the board of directors,
but pursuant to which stockholders might receive a substantial premium for
their
shares over then-current market prices. As a result, stockholders who might
desire to participate in such a transaction might not have the opportunity
to do
so. Such provisions will also render the removal of the Board of Directors
and
of management more difficult and, therefore, may serve to perpetuate current
management. As a result of the foregoing, such provisions could potentially
adversely affect the market price of the shares of common stock of the
Company.
None.
Our
offices are listed in the tables below. The Company’s main office is the same as
Talbot Bank’s main office. The Company owns real property at 28969 Information
Lane in Easton, Maryland, which houses the Operations, Information Technology
and Finance departments of the Company and its subsidiaries, and certain
operations of The Avon-Dixon Agency, LLC. A portion of the facility is leased
to
an unaffiliated third party.
|
The
Talbot Bank of Easton, Maryland
|
||
|
Main
Office
18
East Dover Street
Easton,
Maryland 21601
|
Tred
Avon Square Branch
210
Marlboro Road
Easton,
Maryland 21601
|
St.
Michaels Branch
1013
South Talbot Street
St.
Michaels, Maryland 21663
|
|
Elliott
Road Branch
8275
Elliott Road
Easton,
Maryland 21601
|
Cambridge
Branch
2745
Dorchester Square
Cambridge,
Maryland 21613
|
Sunburst
Branch
424
Dorchester Avenue
Cambridge,
Maryland 21613
|
|
ATMs
|
||
|
Memorial
Hospital at Easton
219
South Washington Street
Easton,
Maryland 21601
|
Sailwinds
Amoco
511
Maryland Avenue
Cambridge,
Maryland 21613
|
Talbottown
218
North Washington Street
Easton,
Maryland 21601
|
|
The
Centreville National Bank of Maryland
|
||
|
Main
Office
109
North Commerce Street
Centreville,
Maryland 21617
|
Route
213 South Office
2609
Centreville Road
Centreville,
Maryland 21617
|
Stevensville
Office
408
Thompson Creek Road
Stevensville,
Maryland 21666
|
|
Kent
Office
305
East High Street
Chestertown,
Maryland 21620
|
Hillsboro
Office
21913
Shore Highway
Hillsboro,
Maryland 21641
|
Denton
Office
850
South 5th
Street
Denton,
Maryland 21629
|
|
Chester
Office
300
Castle Marina Road
Chester,
Maryland 21619
|
Grasonville
Office
202
Pullman Crossing
Grasonville,
Maryland 21638
|
ATM
Queenstown
Harbor Golf Links
Queenstown,
Maryland 21658
|
|
The
Felton Bank
|
||
|
Main
Office
120
West Main Street
Felton,
Delaware 19943
|
Milford
Office
698
A North Dupont Highway
Milford,
Delaware 19963
|
|
|
The
Avon-Dixon Agency, LLC
|
||
|
Easton
Office
28969
Information Lane
Easton,
Maryland 21601
|
Grasonville
Office
202
Pullman Crossing
Grasonville,
Maryland 21638
|
Centreville
Office
195
Lawyers Row
Centreville,
Maryland 21617
|
|
Elliott-Wilson
Insurance, LLC
|
Mubell
Finance, LLC
|
Wye
Financial Services, LLC
|
|
106
North Harrison Street
Easton,
Maryland 21601
|
106
North Harrison Street
Easton,
Maryland 21601
|
17
East Dover Street, Suite 101
Easton,
Maryland 21601
|
Talbot
Bank owns the real property on which all of its offices are located, except
that
it operates under leases at its Saint Michaels Branch and its Cambridge Branch.
Centreville National Bank owns the real property on which all of its offices
are
located, and also owns real property in Chestertown, Maryland the site of a
future branch location. Felton Bank leases the real property on which its main
office is located and owns its Milford branch location subject to a land lease.
The Insurance Subsidiaries do not own any real property, but operate under
leases. Wye Financial occupies space in Talbot Bank’s main office. For
information about rent expense for all leased premises, see Note 6 to
Consolidated Financial Statements appearing in Item 8 of Part II of this
report.
We
are at
times, in the ordinary course of business, subject to legal actions. Management,
upon the advice of counsel, believes that losses, if any, resulting from current
legal actions will not have a material adverse effect on our financial condition
or results of operation.
None.
MARKET
PRICE, HOLDERS AND CASH DIVIDENDS
The
shares of the common stock of the Company are listed on the Nasdaq Capital
Market under the symbol “SHBI”. As of March 1, 2006, the Company had
approximately 1,661 holders of record. The high and low sales prices for the
shares of common stock of the Company, as reported on the Nasdaq Capital Market,
and the cash dividends declared on those shares for each quarterly period of
2005 and 2004 are set forth in the table below.
|
2005
|
2004
|
||||||||||||||||||
|
Price
Range
|
Dividends
|
Price
Range
|
Dividends
|
||||||||||||||||
|
High
|
Low
|
Paid
|
High
|
Low
|
Paid
|
||||||||||||||
|
First
Quarter
|
$
|
35.81
|
$
|
31.10
|
$
|
.19
|
$
|
39.45
|
$
|
30.37
|
$
|
.18
|
|||||||
|
Second
Quarter
|
31.80
|
26.28
|
.19
|
32.72
|
25.15
|
.18
|
|||||||||||||
|
Third
Quarter
|
33.00
|
28.50
|
.21
|
29.70
|
25.25
|
.18
|
|||||||||||||
|
Fourth
Quarter
|
33.08
|
30.53
|
.21
|
37.01
|
29.05
|
.18
|
|||||||||||||
|
$
|
.80
|
$
|
.72
|
||||||||||||||||
Stockholders
received cash dividends totaling $4,428,335 in 2005 and $3,948,218 in 2004.
The
ratio of dividends per share to net income per share was 34.33% in 2005 compared
to 38.71% in 2004. Cash dividends are typically declared on a quarterly basis
and are at the discretion of the Board of Directors, based upon such factors
as
operating results, financial condition, capital adequacy, regulatory
requirements, and stockholder return. The Company’s ability to pay dividends is
limited by federal and Maryland law and is generally dependent on the ability
of
the Company’s subsidiaries, particularly the Banks, to declare dividends to the
Company. For more information regarding these limitations, see Item 1A of Part
I
of this report under the heading “The Company’s ability to pay dividends is
limited”.
The
transfer agent for the Company’s common stock is:
Registrar
& Transfer Company
10
Commerce Drive
Cranford,
New Jersey 07016
Investor
Relations: 1-800-368-5948
E-mail
for investor inquiries: info@rtco.com.
ISSUER
REPURCHASES
The
Company did not repurchase any shares of its common stock during the fourth
quarter of 2005. On February 2, 2006, the Company’s Board of Directors
authorized the Company to repurchase up to 165,000 shares of its common stock
over a period not to exceed 60 months. Shares may be repurchased in the open
market or in privately negotiated transactions at such times and in such amounts
per transaction as the President of the Company determines to be appropriate,
subject to Board oversight. The Company intends to use the repurchased shares
to
fund the Company’s employee benefit plans and for other general corporate
purposes.
EQUITY
COMPENSATION PLAN INFORMATION
The
Company has three equity compensation plans under which it may issue shares
of
the common stock of the Company to employees, officers, and/or directors of
the
Company and its subsidiaries. These plans are: (i) the Shore Bancshares, Inc.
1998 Stock Option Plan (the “1998 Stock Option Plan”); the (ii) the Shore
Bancshares, Inc. 1998 Employee Stock Purchase Plan (the “1998 Stock Purchase
Plan”); and (iii) the Talbot Bancshares, Inc. Employee Stock Option Plan (the
“Talbot Plan”).
The
1998
Stock Option Plan and the 1998 Employee Stock Purchase Plan were approved by
the
Company’s Board of Directors and its stockholders. In
connection with the merger of Talbot Bancshares, Inc. (“Talbot Bancshares”) into
the Company in December 2000, the Company assumed options previously granted
under, and subject to all terms of, the Talbot Plan. The Company subsequently
registered the Talbot Plan with the SEC, and this plan authorizes the grant
of
options to purchase up to 114,000 shares of the Company’s Common Stock (subject
to adjustment for capital adjustments, stock dividends, and similar changes
in
the Common Stock). The Talbot Plan was previously approved by both the Board
of
Directors and the stockholders of Talbot Bancshares, but was not approved by
the
stockholders of the combined companies. Thus, only non-qualified stock options
may be granted under the Talbot Plan.
The
Talbot Plan is administered by the Personnel Committee of the Company’s Board of
Directors and will expire on April 9, 2007 unless sooner terminated. Generally,
key management employees of the Company and its subsidiaries are eligible to
receive option grants. An option granted under the plan vests according to
the
terms of the related stock option agreements and can generally be exercised
for
10 years after grant, unless the Board provides otherwise. The option exercise
price will generally be the fair market value of the shares on the date the
option is granted. Upon exercise of options granted under the plan, the plan
obligates the Company to pay the optionee a tax benefit payment in an amount
of
U.S. dollars equal to the number of shares as to which the option is being
exercised, multiplied by (i) the “tax rate” and (ii) the difference between the
per share fair market value at the time of exercise and the per share option
price. The tax rate shall be a percentage designated by the Company to result
in
compensating the optionee for the federal, state and local income tax liability
incurred by the optionee by virtue of his exercise of the option and the payment
to him of the tax benefit payment. Options are not transferable other than
by
will or the laws of descent and distribution. All unexercised options will
lapse
upon termination of employment other than because of death, disability or
approved retirement. If employment is terminated because of disability or
approved retirement, the options will lapse one year or three months after
termination, respectively. Upon a “change in control” as defined in the plan,
all unexercised options will immediately vest and become exercisable. No options
have been granted under the Talbot Plan since the merger with Talbot.
The
following table contains information about these equity compensation plans
as of
December 31, 2005:
|
Plan
Category
|
Number
of securities to be issued upon exercise of outstanding options,
warrants,
and rights
(a)
|
Weighted-average
exercise price of outstanding options, warrants, and
rights
(b)
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected
in
column
(a))
(c)
|
|||||||
|
Equity
compensation plans approved by security holders
(1)(2)
|
51,600
|
$
|
16.03
|
75,619
|
||||||
|
Equity
compensation plans not approved by security holders
(3)
|
0
|
$
|
0
|
3,491
|
||||||
|
Total
|
51,600
|
$
|
16.03
|
79,110
|
||||||
| (1) |
Includes
information for the 1998 Stock Option Plan and the 1998 Employee
Stock
Purchase Plan.
|
| (2) |
Columns
(a) and (b) of this item also include options assumed by the Company
under
the Talbot Plan in the 2000 merger of Talbot Bancshares into the
Company.
As of December 31, 2005, outstanding options assumed in the merger
represent 24,495 shares of the Company’s Common Stock, with a
weighted-average exercise price of $8.78.
|
| (3) |
This
item covers options under the Talbot Plan other than those assumed
by the
Company in the 2000 merger of Talbot Bancshares into the
Company.
|
The
following table sets forth certain selected financial data for the five years
ended December 31, 2005 and is qualified in its entirety by the detailed
statistical and other information contained in this report, including
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” appearing in Item 7 of Part II of this report and the financial
statements and notes thereto appearing in Item 8 of Part II of this report.
|
Years
Ended December 31,
|
||||||||||||||||
|
(Dollars
in thousands, except per shares data)
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
RESULTS
OF OPERATIONS:
|
||||||||||||||||
|
Interest
income
|
$
|
47,384
|
$
|
38,291
|
$
|
34,339
|
$
|
36,306
|
$
|
38,938
|
||||||
|
Interest
expense
|
11,899
|
9,010
|
9,743
|
12,438
|
17,061
|
|||||||||||
|
Net
interest income
|
35,485
|
29,281
|
24,596
|
23,868
|
21,877
|
|||||||||||
|
Provision
for credit losses
|
810
|
931
|
335
|
356
|
226
|
|||||||||||
|
Net
interest income after provision for credit losses
|
34,675
|
28,350
|
24,261
|
23,512
|
21,651
|
|||||||||||
|
Noninterest
income
|
11,498
|
10,224
|
9,845
|
5,968
|
2,646
|
|||||||||||
|
Noninterest
expenses
|
25,431
|
22,535
|
19,344
|
15,960
|
12,026
|
|||||||||||
|
Income
before taxes
|
20,742
|
16,039
|
14,762
|
13,520
|
12,271
|
|||||||||||
|
Income
taxes
|
7,854
|
5,841
|
5,266
|
4,730
|
4,277
|
|||||||||||
|
NET
INCOME
|
$
|
12,888
|
$
|
10,198
|
$
|
9,496
|
$
|
8,790
|
$
|
7,994
|
||||||
|
PER
SHARE DATA:
|
||||||||||||||||
|
Net
income - basic
|
$
|
2.33
|
$
|
1.86
|
$
|
1.77
|
$
|
1.64
|
$
|
1.50
|
||||||
|
Net
income - diluted
|
2.32
|
1.84
|
1.74
|
1.62
|
1.49
|
|||||||||||
|
Dividends
paid
|
.80
|
.72
|
.66
|
.60
|
.60
|
|||||||||||
|
Book
value (at year end)
|
18.26
|
16.86
|
15.47
|
14.52
|
13.31
|
|||||||||||
|
Tangible
book value (at year end) (1)
|
15.76
|
14.29
|
14.06
|
13.08
|
13.03
|
|||||||||||
|
|
||||||||||||||||
|
FINANCIAL
CONDITION (at year end):
|
||||||||||||||||
|
Assets
|
$
|
851,638
|
$
|
790,598
|
$
|
705,379
|
$
|
654,066
|
$
|
582,403
|
||||||
|
Deposits
|
704,958
|
658,672
|
592,409
|
545,192
|
487,470
|
|||||||||||
|
Total
loans, net of unearned income and allowance for credit
losses
|
622,227
|
590,766
|
470,895
|
435,422
|
388,516
|
|||||||||||
|
Stockholders’
equity
|
101,448
|
92,976
|
83,527
|
78,028
|
70,971
|
|||||||||||
|
PERFORMANCE
RATIOS (for the year):
|
||||||||||||||||
|
Return
on average assets
|
1.51
|
%
|
1.32
|
%
|
1.40
|
%
|
1.42
|
%
|
1.42
|
%
|
||||||
|
Return
on average stockholders’ equity
|
13.20
|
%
|
11.17
|
%
|
11.70
|
%
|
11.79
|
%
|
11.70
|
%
|
||||||
|
Net
interest margin
|
4.69
|
%
|
4.10
|
%
|
3.91
|
%
|
4.12
|
%
|
4.15
|
%
|
||||||
|
Efficiency
ratio(2)
|
54.13
|
%
|
57.04
|
%
|
56.17
|
%
|
53.49
|
%
|
49.04
|
%
|
||||||
|
Dividend
payout ratio
|
34.33
|
%
|
38.71
|
%
|
37.29
|
%
|
36.59
|
%
|
40.00
|
%
|
||||||
|
Average
stockholders’ equity to average total assets
|
11.86
|
%
|
11.79
|
%
|
11.96
|
%
|
12.00
|
%
|
12.16
|
%
|
||||||
| (1) |
Total
stockholders’ equity, net of goodwill and other intangible assets, divided
by the number of shares of common stock outstanding at
year-end.
|
|
(2)
|
Noninterest
expenses as a percentage of total revenue (net interest income
plus total
noninterest income). Lower ratios indicate improved productivity.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS
OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The
following discussion compares the financial condition of the Company at December
31, 2005 to the financial condition at December 31, 2004 and the results of
operations for the years ended December 31, 2005, 2004, and 2003. This
discussion should be read in conjunction with the Consolidated Financial
Statements and the Notes thereto appearing in Item 8 of Part II of this report.
As used in this Item 7, the term “Company” refers to Shore Bancshares, Inc. and,
as the context requires, its consolidated subsidiaries.
PERFORMANCE
OVERVIEW
The
Company recorded a 26.1% increase in net income for 2005 over 2004. Net income
for the year ended December 31, 2005 was $12,888,000, compared to $10,198,000
and $9,496,000 for the years ended December 31, 2004 and 2003, respectively.
Basic net income per share for 2005 was $2.33, an increase of 25.3% over 2004.
Basic net income per share was $1.86 and $1.77 for 2004 and 2003, respectively.
Diluted net income per share for 2005 was $2.32, an increase of 26.1% over
2004.
Diluted net income per share was $1.84 and $1.74 for 2004 and 2003,
respectively.
Return
on
average assets was 1.51% for 2005, compared to 1.32% for 2004 and 1.40% for
2003. Return on stockholders’ equity for 2005 was 13.20%, compared to 11.17% for
2004 and 11.70% for 2003. When compared to 2004, average assets increased 6.3%
to $823,320,000, average loans increased 9.3% to $607,017,000, average deposits
increased 6.2% to $688,064,000, and average stockholders’ equity increased 6.9%
to $97,657,000 for the year ended December 31, 2005.
CRITICAL
ACCOUNTING POLICIES
The
Company’s consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the industries in which it operates. Application
of these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, the financial statements could reflect different
estimates, assumptions, and judgments. Certain policies inherently have a
greater reliance on the use of estimates, assumptions, and judgments and as
such
have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent
upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information
used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
The
most
significant accounting policies followed by the Company are presented in Note
1
to Consolidated Financial Statements. These policies, along with the disclosures
presented in the other financial statement notes and in this discussion, provide
information on how significant assets and liabilities are valued in the
financial statements and how those values are determined. Based on the valuation
techniques used and the sensitivity of financial statement amounts to the
methods, assumptions, and estimates underlying those amounts, management has
determined that the accounting policy with respect to the allowance for credit
losses to be the accounting area that requires the most subjective or complex
judgments, and, as such, could be most subject to revision as new information
becomes available. Accordingly, the allowance for credit losses is considered
to
be a critical accounting policy, as discussed below.
The
allowance for credit losses represents management’s estimate of probable credit
losses inherent in the loan portfolio as of the balance sheet date. Determining
the amount of the allowance for credit losses is considered a critical
accounting estimate because it requires significant judgment and the use of
estimates related to the amount and timing of expected future cash flows on
impaired loans, estimated losses on pools of homogeneous loans based on
historical loss experience, and consideration of current economic trends and
conditions, all of which may be susceptible to significant change. The loan
portfolio also represents the largest asset type on the consolidated balance
sheets. Note 1 to Consolidated Financial Statements describes the methodology
used to determine the allowance for credit losses and a discussion of the
factors driving changes in the amount of the allowance for credit losses is
included in the Credit Risk Management section of this discussion.
RECENT
ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
Note
1 to
the Consolidated Financial Statements discusses new accounting policies adopted
by the Company during 2005 and the expected impact of accounting policies
recently issued or proposed but not yet required to be adopted. To the extent
the adoption of new accounting standards materially affects the Company’s
financial condition, results of operations, or liquidity, the impacts are
discussed in the applicable section(s) of this discussion and notes to the
consolidated financial statements.
RESULTS
OF OPERATIONS
Net
Interest Income and Net Interest Margin
Net
interest income remains the most significant component of the Company’s
earnings. It is the excess of interest and fees earned on loans, federal funds
sold, and investment securities over interest paid on deposits and borrowings.
Tax equivalent net interest income for 2005 was $35,812,000, representing a
20.9% increase over 2004. Tax equivalent net interest income for 2004 was
$29,624,000, a 18.6% increase over 2003. An increase in the volume and overall
yield on earning assets were the reasons for the 2005 growth. Increased interest
income, primarily from increased loan volume, and a reduction in interest
expense resulted in the increase in net interest income in 2004 over 2003.
The
tax equivalent yield on earning assets was 6.25% for 2005, compared to 5.35%
and
5.44% for 2004 and 2003, respectively. The average balance of earning assets
increased during 2005, totaling $763,187,000, compared to $722,490,000 and
$638,271,000 for 2004 and 2003, respectively.
The
FRB
raised short-term interest rates throughout 2005. The Federal Funds rate
increased 200 basis points from 2.25% to 4.25%. This increase had a direct
impact on the Company’s yield on interest bearing deposits and federal funds
sold. The New York Prime rate, the primary index used for variable rate loans,
also increased 200 basis points to 7.25% at December 31, 2005. This increase
had
a direct impact on
the
Company’s overall loan yield. Although the FRB increased short-term rates in
2004, they were not enough to have a significant impact on overall yields for
the year.
The
rate
paid for interest bearing liabilities was 1.94% for the year ended December
31,
2005, representing an increase of 39 basis points over the 1.55% for the year
ended December 31, 2004. In 2004, the overall rate paid for interest bearing
liabilities declined 33 basis points when compared to the rate paid for the
year
ended December 31, 2003.
The
following table sets forth the major components of net interest income, on
a tax
equivalent basis, for the years ended December 31, 2005, 2004 and
2003.
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||||||||||||||||||||||||
|
Average
|
Interest
|
Yield/
|
Average
|
Interest
|
Yield/
|
Average
|
Interest
|
Yield/
|
||||||||||||||||||||
|
Balance
|
(1)
|
Rate
|
Balance
|
(1)
|
Rate
|
Balance
|
(1)
|
Rate
|
||||||||||||||||||||
|
Earning
Assets:
|
||||||||||||||||||||||||||||
|
Investment
securities:
|
||||||||||||||||||||||||||||
|
Taxable
|
$
|
106,523
|
$
|
3,796
|
3.56
|
%
|
$
|
126,835
|
$
|
4,359
|
3.44
|
%
|
118,104
|
$
|
4,332
|
3.67
|
%
|
|||||||||||
|
Non-taxable
|
15,074
|
879
|
5.83
|
15,593
|
909
|
5.83
|
14,739
|
914
|
6.20
|
|||||||||||||||||||
|
Loans
(2)(3)
|
607,017
|
41,866
|
6.90
|
555,259
|
33,065
|
5.95
|
457,491
|
28,981
|
6.33
|
|||||||||||||||||||
|
Interest
bearing deposits
|
3,002
|
111
|
3.69
|
4,737
|
46
|
.98
|
19,602
|
202
|
1.03
|
|||||||||||||||||||
|
Federal
funds sold
|
31,571
|
1,058
|
3.35
|
20,066
|
255
|
1.27
|
28,335
|
301
|
1.06
|
|||||||||||||||||||
|
Total
earning assets
|
763,187
|
47,710
|
6.25
|
%
|
722,490
|
38,634
|
5.35
|
%
|
638,271
|
34,730
|
5.44
|
%
|
||||||||||||||||
|
Cash
and due from banks
|
25,231
|
23,190
|
18,436
|
|||||||||||||||||||||||||
|
Other
assets
|
39,821
|
33,685
|
26,130
|
|||||||||||||||||||||||||
|
Allowance
for credit losses
|
(4,919
|
)
|
(4,485
|
)
|
(4,190
|
)
|
||||||||||||||||||||||
|
Total
assets
|
$
|
823,320
|
$
|
774,880
|
$
|
678,647
|
||||||||||||||||||||||
|
Interest
bearing liabilities:
|
||||||||||||||||||||||||||||
|
Demand
|
$
|
110,977
|
552
|
.50
|
%
|
$
|
110,614
|
409
|
.37
|
%
|
$
|
101,227
|
504
|
.50
|
%
|
|||||||||||||
|
Savings
|
200,980
|
1,760
|
.88
|
195,842
|
1,394
|
.71
|
153,721
|
1,388
|
.90
|
|||||||||||||||||||
|
Certificates
of deposit $100,000 or more
|
96,077
|
3,444
|
3.59
|
86,450
|
2,346
|
2.71
|
91,194
|
2,503
|
2.74
|
|||||||||||||||||||
|
Other
time
|
172,724
|
5,346
|
3.10
|
159,612
|
4,393
|
2.75
|
145,035
|
4,918
|
3.39
|
|||||||||||||||||||
|
Interest
bearing deposits
|
580,758
|
11,102
|
1.91
|
552,518
|
8,542
|
1.55
|
491,177
|
9,313
|
1.90
|
|||||||||||||||||||
|
Short-term
borrowings
|
28,794
|
692
|
2.40
|
25,590
|
215
|
0.84
|
23,071
|
178
|
.77
|
|||||||||||||||||||
|
Long-term
debt
|
2,207
|
104
|
4.71
|
5,000
|
253
|
5.05
|
5,000
|
252
|
5.04
|
|||||||||||||||||||
|
Total
interest bearing liabilities
|
611,759
|
11,898
|
1.94
|
%
|
583,108
|
9,010
|
1.55
|
%
|
519,248
|
9,743
|
1.88
|
%
|
||||||||||||||||
|
Noninterest
bearing deposits
|
107,306
|
95,627
|
73,910
|
|||||||||||||||||||||||||
|
Other
liabilities
|
6,598
|
4,819
|
4,308
|
|||||||||||||||||||||||||
|
Stockholders’
equity
|
97,657
|
91,326
|
81,181
|
|||||||||||||||||||||||||
|
Total
liabilities and stockholders’ equity
|
$
|
823,320
|
$
|
774,880
|
$
|
678,647
|
||||||||||||||||||||||
|
Net
interest spread
|
$
|
35,812
|
4.31
|
%
|
$
|
29,624
|
3.80
|
%
|
$
|
24,987
|
3.56
|
%
|
||||||||||||||||
|
Net
interest margin
|
4.69
|
%
|
4.10
|
%
|
3.91
|
%
|
||||||||||||||||||||||
| (1) |
All
amounts are reported on a tax equivalent basis computed using the
statutory federal income tax rate of 35% exclusive of the alternative
minimum tax rate and nondeductible interest expense. The taxable
equivalent adjustment amounts utilized in the above table to compute
yields aggregated $326 in 2005, $343 in 2004, and $392 in
2003.
|
| (2) |
Average
loan balances include nonaccrual
loans.
|
| (3) |
Interest
income on loans includes amortized loan fees, net of costs, for each
category and yields are stated to include
all.
|
The
Company’s tax equivalent yield on loans increased to 6.90% for 2005, compared to
5.95% for 2004. In 2004, the tax equivalent yield on loans declined as new
loans
and loans refinanced with the Company were recorded at lower rates than the
year
before. On a tax equivalent basis, interest income totaled $47,710,000 for
2005,
compared to $38,634,000 for 2004. An increase in both the volume and yield
on
loans was the primary reason for the increase in 2005. An increased volume
of
loans during 2004 resulted in an increase in interest income for that year
when
compared to 2003. The effect of declining rates in 2003 on interest income
was
much greater than the effect of loan volume in that year. In 2005, the increase
in yields on earning assets generated $6,215,000 in additional interest income.
Of that amount, $5,376,000 was attributable to loans. The increased volume
of
loans generated an additional $3,425,000 in interest income.
Interest
expense for 2005 increased $2,888,000 when compared to 2004. Higher rates paid
for interest bearing liabilities, primarily deposits, resulted in a $2,178,000
increase in interest expense for 2005. The increased volume of deposits and
other interest bearing liabilities in 2005 also resulted in additional interest
expense of $710,000. The average rate paid for certificates of deposit of
$100,000 or more increased 88 basis points to 3.59% for 2005 from 2.71% for
2004. The rate paid for all other time deposits also increased to 3.10% for
2005, compared to 2.75% for 2004. In 2004, the average rate paid for
certificates of deposit $100,000 or more remained relatively unchanged over
2003, while the average rate paid for all other time deposits decreased by
64
basis points. The rate paid for short-term borrowings, which consist primarily
of securities sold under agreements to repurchase, was 2.40% for 2005, compared
to.84% and .77% in 2004 and 2003, respectively.
Growth
in
the average balance of earning assets was $40,697,000 or 5.6% for the year
ended
December 31, 2005. Average loans increased $51,758,000 or 9.3%, totaling
$607,017,000 for the year ended December 31, 2005, compared to an increase
of
$97,768,000 or 21.4% for 2004. For the year ended December 31, 2005, the average
balance of investment securities decreased $20,831,000 and federal funds sold
and interest bearing deposits in other banks increased $9,770,000 when compared
to 2004. In 2004, the average balance of earning assets increased $84,219,000
or
13.2% when compared to 2003, driven primarily by growth in loans. As a
percentage of total average earning assets, loans and investment securities
totaled 79.5% and 15.9%, respectively, for 2005, compared to 76.9% and 19.7%,
respectively, for 2004.
The
following Rate/Volume Variance Analysis identifies the portion of the changes
in
tax equivalent net interest income attributable to changes in volume of average
balances or to changes in the yield on earning assets and rates paid on interest
bearing liabilities.
|
2005
over (under) 2004
|
2004
over (under) 2003
|
||||||||||||||||||
|
Total
|
Caused
By
|
Total
|
Caused
By
|
||||||||||||||||
|
(Dollars
in thousands)
|
Variance
|
Rate
|
Volume
|
Variance
|
Rate
|
Volume
|
|||||||||||||
|
Interest
income from earning assets:
|
|||||||||||||||||||
|
Interest
Bearing Deposits
|
$
|
65
|
$
|
87
|
$
|
(22
|
)
|
$
|
(156
|
)
|
$
|
(15
|
)
|
$
|
(141
|
)
|
|||
|
Federal
funds sold
|
803
|
595
|
208
|
(46
|
)
|
63
|
(109
|
)
|
|||||||||||
|
Taxable
investment securities
|
(563
|
)
|
157
|
(720
|
)
|
27
|
(281
|
)
|
308
|
||||||||||
|
Non-taxable
investment securities
|
(30
|
)
|
—
|
(30
|
)
|
(5
|
)
|
(55
|
)
|
50
|
|||||||||
|
Loans
|
8,801
|
5,376
|
3,425
|
4,084
|
(1,782
|
)
|
5,866
|
||||||||||||
|
Total
interest income
|
9,076
|
6,215
|
2,861
|
3,904
|
(2,070
|
)
|
5,974
|
||||||||||||
|
Interest
expense on deposits and borrowed funds:
|
|||||||||||||||||||
|
Interest
bearing demand
|
143
|
141
|
2
|
(95
|
)
|
(131
|
)
|
36
|
|||||||||||
|
Savings
deposits
|
366
|
332
|
34
|
6
|
(321
|
)
|
327
|
||||||||||||
|
Time
deposits
|
2,051
|
1,390
|
661
|
(682
|
)
|
(962
|
)
|
280
|
|||||||||||
|
Short-term
borrowings
|
477
|
332
|
145
|
37
|
14
|
23
|
|||||||||||||
|
Long
term debt
|
(149
|
)
|
(17
|
)
|
(132
|
)
|
1
|
—
|
1
|
||||||||||
|
Total
interest expense
|
2,888
|
2,178
|
710
|
(733
|
)
|
(1,400
|
)
|
667
|
|||||||||||
|
Net
interest income
|
$
|
6,188
|
$
|
4,037
|
$
|
2,151
|
$
|
4,637
|
$
|
(670
|
)
|
$
|
5,307
|
||||||
The
rate and volume variance for each category has been allocated on a consistent
basis between rate and volume variances, based on a percentage of rate, or
volume, variance to the sum of the absolute two variances.
The
Company’s net interest margin (i.e.,
tax
equivalent net interest income divided by average earning assets) represents
the
net yield on earning assets. The net interest margin is managed through loan
and
deposit pricing and assets/liability strategies. The Company’s net interest
margin increased 59 basis points to 4.69% for 2005 from 4.10% for 2004. This
compares to a 19 basis point increase for 2004 over 2003. The Company’s net
interest spread, which is the difference between the average yield on earning
assets and the rate paid for interest bearing liabilities, increased from 3.80%
for 2004 to 4.31% for 2005.
Noninterest
Income
Noninterest
income increased $1,274,000 or 12.5% in 2005, compared to an increase of
$379,000 or 3.8% in 2004. Service charges on deposit accounts increased 16.5%
or
$408,000 in 2005, compared to an increase of 28.1% or $541,000 in 2004. These
increases resulted primarily from new and enhanced overdraft products offered
to
customers, which generated additional income of $400,000 and $330,000 in 2005
and 2004, respectively. Felton Bank, which was acquired in 2004, contributed
$139,000 toward the increase for that year. Other service charges and fees
increased $23,000 in 2005 following an increase of $522,000 in 2004. The 2004
increase was the result of increased letter of credit fees ($94,000), increases
in interchange income relating to bank debit and ATM cards ($232,000), an agency
management fee received by one of the Company’s insurance subsidiaries ($67,000)
and fee income generated by the Felton Bank ($79,000). The Insurance
Subsidiaries generated income of $6,384,000 for 2005, compared to $6,383,000
and
$6,037,000 for 2004 and 2003, respectively. The Company recognized $4,000 in
gains on sales of securities in 2005, compared to $41,000 in 2004 and $448,000
in 2003. The Company recognized losses on securities relating to other-than
temporary impairment of $658,000 and $132,000 in 2004 and 2003, respectively.
These losses related to certain Freddie Mac preferred stocks and a U.S.
Government bond fund owned by the Company in 2004 and 2003, respectively. The
Company did not recognize any loss in 2005 that was other than temporary. Other
noninterest income increased $198,000 or 25% in 2005, following a decline of
$87,000 in 2004. The 2005 increase and 2004 declines were both attributable
to
fluctuations in income generated from the sale of loans on the secondary market,
which totaled $494,000, $310,000, and $465,000, for 2005, 2004 and 2003,
respectively.
The
following table summarizes noninterest income of the Company for the years
ended
December 31:
|
Years
Ended
|
Change
from Prior Year
|
|||||||||||||||||||||
|
2005/04
|
2004/03
|
|||||||||||||||||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
Amount
|
Percent
|
Amount
|
Percent
|
|||||||||||||||
|
Service
charges on deposit accounts
|
$
|
2,878
|
$
|
2,470
|
$
|
1,929
|
$
|
408
|
16.5
|
%
|
$
|
541
|
28.1
|
%
|
||||||||
|
Other
service charges and fees
|
1,193
|
1,170
|
648
|
23
|
2.0
|
522
|
80.4
|
|||||||||||||||
|
Gain
on sale of securities
|
4
|
41
|
448
|
(37
|
)
|
(90.2
|
)
|
(407
|
)
|
(90.8
|
)
|
|||||||||||
|
Other
than temporary impairment of securities
|
—
|
(657
|
)
|
(132
|
)
|
657
|
(100.0
|
)
|
(525
|
)
|
398.1
|
|||||||||||
|
Earnings
from unconsolidated subsidiaries
|
50
|
26
|
37
|
24
|
92.3
|
(11
|
)
|
(29.2
|
)
|
|||||||||||||
|
Insurance
agency commissions
|
6,384
|
6,383
|
6,037
|
1
|
—
|
346
|
5.7
|
|||||||||||||||
|
Other
noninterest income
|
989
|
791
|
878
|
198
|
25.0
|
(87
|
)
|
(9.9
|
)
|
|||||||||||||
|
Total
|
$
|
11,498
|
$
|
10,224
|
$
|
9,845
|
$
|
1,274
|
12.5
|
%
|
$
|
379
|
3.8
|
%
|
||||||||
Noninterest
Expense
Total
noninterest expense increased $2,897,000 or 12.9% in 2005, compared to an
increase of $3,190,000 or 16.5% in 2004. The majority of the noninterest expense
increase in 2005 is related to salaries and employee benefits expense. In 2005
the Company felt the effects of two additional bank branches, one opened in
late
2004 and the other opened in 2005, as well as the full year impact of the Felton
Bank, which was acquired in the second quarter of 2004. A portion of the
increase relates to incentive compensation paid during the year. Increases
in
occupancy and equipment expense, data processing and other noninterest expenses
in 2005 and 2004 were attributable to overall growth of the Company. A
significant portion of the overall increase in 2004 over 2003 was attributable
to the Felton Bank. In 2004, expenses relating to the Felton Bank were: $805,000
in salaries and employee benefits; $171,000 in occupancy and equipment; $85,000
in data processing; $6,000 in directors’ fees; $91,000 in amortization of
intangibles; and $270,000 in other noninterest expense. A significant portion
of
the 2005, 2004 and 2003 salaries attributable to the Insurance Subsidiaries
is
based on commissions, which fluctuate with premium revenues. Amortization of
other intangible assets relate to Felton Bank and the operation of the Insurance
Subsidiaries. See Note 8 to Consolidated Financial Statements for further
information regarding the impact of goodwill and other intangible assets on
the
financial statements. The Company had 276 full-time equivalent employees at
December 31, 2005, compared to 268 and 231 at December 31, 2004 and 2003,
respectively.
The
following table summarizes noninterest expense of the Company for the years
ended December 31:
|
Years
Ended
|
Change
from Prior Year
|
|||||||||||||||||||||
|
2005/04
|
2004/03
|
|||||||||||||||||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
Amount
|
Percent
|
Amount
|
Percent
|
|||||||||||||||
|
Salaries
and employee benefits
|
$
|
15,755
|
$
|
13,760
|
$
|
12,243
|
$
|
1,995
|
14.5
|
%
|
$
|
1,517
|
12.4
|
%
|
||||||||
|
Occupancy
and equipment
|
2,652
|
2,427
|
2,034
|
225
|
9.3
|
393
|
19.3
|
|||||||||||||||
|
Data
processing
|
1,414
|
1,310
|
955
|
104
|
8.0
|
355
|
37.1
|
|||||||||||||||
|
Directors’
fees
|
590
|
553
|
569
|
37
|
6.6
|
(16
|
)
|
(2.8
|
)
|
|||||||||||||
|
Amortization
of other intangible assets
|
337
|
306
|
216
|
31
|
10.1
|
90
|
42.1
|
|||||||||||||||
|
Other
operating expenses
|
4,683
|
4,178
|
3,327
|
505
|
12.1
|
851
|
25.6
|
|||||||||||||||
|
Total
|
$
|
25,431
|
$
|
22,534
|
$
|
19,344
|
$
|
2,897
|
12.9
|
%
|
$
|
3,190
|
16.5
|
%
|
||||||||
Income
Taxes
Income
tax expense was $7,854,000 for 2005, compared to $5,841,000 for 2004 and
$5,266,000 for 2003. The effective tax rates on earnings were 37.9%, 36.4%
and
35.7%, respectively.
REVIEW
OF FINANCIAL CONDITION
Asset
and
liability composition, asset quality, capital resources, liquidity, market
risk
and interest sensitivity are all factors that affect the Company’s financial
condition.
Assets
Total
assets increased 7.7% to $851,638,000 at December 31, 2005, compared to an
increase of 12.1% for 2004. Average total assets at December 31, 2005 were
$823,320,000, an increase of 6.3% over 2004. Average total assets increased
14.2% in 2004, totaling $774,880,000 for the year. The loan portfolio is the
primary source of income for the Company and it represented 79.5% and 76.85%
of
average earning assets at December 31, 2005 and 2004, respectively.
Funding
for loans is provided primarily by core deposits and short-term borrowings.
Total deposits increased 7.0% to $704,958,000 at December 31, 2005, compared
to
an 11.2% increase for 2004.
The
following table sets forth the average balance of the components of average
earning assets as a percentage of total average earning assets as of December
31.
|
2005
|
2004
|
2003
|
2002
|
2001
|
||||||||||||
|
Investment
securities
|
15.93
|
%
|
19.71
|
%
|
20.81
|
%
|
21.47
|
%
|
21.42
|
%
|
||||||
|
Loans
|
79.54
|
76.85
|
71.68
|
72.18
|
72.28
|
|||||||||||
|
Interest
bearing deposits with other banks
|
0.39
|
0.66
|
3.07
|
1.68
|
2.00
|
|||||||||||
|
Federal
funds sold
|
4.14
|
2.78
|
4.44
|
4.67
|
4.30
|
|||||||||||
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
|||||||
Interest
Bearing Deposits With Other Banks and Federal Funds Sold
The
Company invests excess cash balances in interest bearing accounts and federal
funds sold offered by its correspondent banks. These liquid investments are
maintained at a level necessary to meet the immediate liquidity needs of the
Company. The average balance of interest bearing deposits with other banks
and
federal funds sold increased $9,770,000 to $34,573,000 at December 31, 2005,
compared to a $23,134,000 decline in 2004 as a result of liquidity needs to
fund
loan growth.
Investment
Securities
The
investment portfolio is structured to provide liquidity for the Company and
also
plays an important role in the overall management of interest rate risk.
Investment securities in the held to maturity category are stated at cost
adjusted for amortization of premiums and accretion of discounts. The Company
has the intent and current ability to hold such securities until maturity.
Investment securities available for sale are stated at estimated fair value
based on quoted market prices. They represent securities which may be sold
as
part of the Company’s asset/liability strategy or which may be sold in response
to changing interest rates. Net unrealized holding gains and losses on these
securities are reported net of related income taxes as accumulated other
comprehensive income, a separate component of stockholders’ equity. During 2004,
the Company recognized losses on securities in the amount of $658,000 due to
declines that were determined to be other than temporary. There were no
impairment losses recognized during 2005. At December 31, 2005, the Company
had
classified 88% of the portfolio as available for sale and 12% as held to
maturity, compared to 89% and 13%, respectively, at December 31, 2004. The
percentage of securities designated as available for sale reflects the amount
needed to support the anticipated growth and liquidity needs of the Company.
With the exception of municipal securities, it is the general practice of the
Company to classify all newly purchased securities as available for
sale.
Investment
securities available for sale increased $2,726,000 or 2.6% in 2005, totaling
$106,160,000 at December 31, 2005, compared to $103,434,000 at December 31,
2004. In 2004, investment securities available for sale declined $40,934,000
or
28.4% due primarily to maturities in the portfolio which were used to fund
loan
growth.
Investment
securities held to maturity, consisting primarily of tax-exempt municipal bonds,
totaled $14,911,000 at December 31, 2005, compared to $15,662,000 at December
31, 2004. The Company does not typically invest in structured notes or other
derivative securities.
The
following table sets forth the maturities and weighted average yields of the
investment portfolio as of December
31, 2005.
|
1
Year or Less
|
1-5
Years
|
5-10
Years
|
Over
10 Years
|
||||||||||||||||||||||
|
Carrying
|
Average
|
Carrying
|
Average
|
Carrying
|
Average
|
Carrying
|
Average
|
||||||||||||||||||
|
(Dollars
in thousand)
|
Amount
|
Yield
|
Amount
|
Yield
|
Amount
|
Yield
|
Amount
|
Yield
|
|||||||||||||||||
|
Held
to Maturity:
|
|||||||||||||||||||||||||
|
Obligations
of states and
|
|||||||||||||||||||||||||
|
political
subdivisions (1)
|
$
|
—
|
—
|
%
|
$
|
5,862
|
5.64
|
%
|
$
|
6,094
|
5.41
|
%
|
$
|
2,952
|
6.39
|
%
|
|||||||||
|
Mortgage
backed securities
|
3
|
7.89
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||||
|
Total
Held to Maturity
|
$
|
3
|
7.89
|
%
|
$
|
5,862
|
5.64
|
%
|
$
|
6,094
|
5.41
|
%
|
$
|
2,952
|
6.39
|
%
|
|||||||||
|
Available
for Sale:
|
|||||||||||||||||||||||||
|
U.S.
government agencies
|
$
|
20,425
|
2.94
|
%
|
$
|
66,356
|
3.81
|
%
|
$
|
2,451
|
4.04
|
%
|
$
|
—
|
—
|
%
|
|||||||||
|
Mortgage
backed securities
|
576
|
9.44
|
8,126
|
4.14
|
609
|
4.95
|
4,780
|
4.14
|
|||||||||||||||||
|
Equity
securities
|
—
|
—
|
—
|
—
|
—
|
—
|
2,837
|
3.48
|
|||||||||||||||||
|
Total
Available for Sale
|
$
|
21,001
|
3.11
|
%
|
$
|
74,482
|
3.84
|
%
|
$
|
3,060
|
4.22
|
%
|
$
|
7,617
|
3.90
|
%
|
|||||||||
| (1) |
Yields
adjusted to reflect a tax equivalent basis assuming a federal tax
rate of
35%.
|
Loans
During
2005, the Company continued to experience strong growth trends in real estate
lending. The markets in which the Company operate have experienced a significant
amount of construction and land development activity over the last several
years, which has been a significant factor behind overall loan growth Loans
increased 5.4% in 2005, compared to 25.4% in 2004. Real estate construction
loans increased $37,359,000 or 38.5% in 2005, compared to an increase of
$60,381,000 or 16.8% in 2004. Other real estate secured mortgage loans declined
slightly to $400,629,000 at December 31, 2005, compared to $406,053,000 at
December 31, 2004. Increases in short-term interest rates in 2005 contributed
to
the decline of the real estate mortgage portfolio. Many residential real estate
customers obtained longer term fixed rate financing from the secondary market
in
both 2005 and 2004. Commercial, financial and agricultural loans increased
$1,770,000 or 2.4% in 2005 compared to a $9,338,000 or 14.5% increase in 2004.
Consumer loans remain a small percentage of the overall loan portfolio and
declined $1,700,000 in 2005, compared to an increase of $1,612,000 or 9.5%
in
2004 . Loans, net of unearned income, totaled $627,463,000 at December 31,
2005,
an increase of $32,005,000 when compared to 2004. Loans increased $120,503,000
in 2004 in part due to the acquisition of Felton Bank, which represented
approximately $50,364,000 of this growth. The Company has brokered long-term
fixed rate residential mortgage loans for sale on the secondary market since
2002.
The
table
below sets forth trends in the composition of the loan portfolio over the past
five years (including net deferred loan fees/costs).
|
December
31,
|
||||||||||||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
Commercial,
financial and agricultural
|
$
|
75,527
|
$
|
73,757
|
$
|
64,419
|
$
|
61,962
|
$
|
58,953
|
||||||
|
Real
estate - construction
|
134,380
|
97,021
|
36,640
|
25,354
|
20,255
|
|||||||||||
|
Real
estate - mortgage
|
400,629
|
406,053
|
356,881
|
335,037
|
293,921
|
|||||||||||
|
Consumer
|
16,927
|
18,627
|
17,015
|
17,186
|
19,577
|
|||||||||||
|
Total
Loans
|
$
|
627,463
|
$
|
595,458
|
$
|
474,955
|
$
|
439,539
|
$
|
392,706
|
||||||
The
table
below sets forth the maturities and interest rate sensitivity of the loan
portfolio at December 31, 2005.
|
Maturing
|
|||||||||||||
|
Maturing
|
After
one
|
Maturing
|
|||||||||||
|
Within
|
But
Within
|
After
Five
|
|||||||||||
|
One
Year
|
Five
Years
|
Years
|
Total
|
||||||||||
|
|
|||||||||||||
|
Commercial,
financial and agricultural
|
$
|
39,683
|
$
|
27,862
|
$
|
7,982
|
$
|
75,527
|
|||||
|
Real
estate - construction
|
77,210
|
53,518
|
3,652
|
134,380
|
|||||||||
|
Real
estate - mortgage
|
84,271
|
203,852
|
112,506
|
400,629
|
|||||||||
|
Consumer
|
7,149
|
7,914
|
1,864
|
16,927
|
|||||||||
|
Total
|
$
|
208,313
|
$
|
293,146
|
$
|
126,004
|
$
|
627,463
|
|||||
|
Rate
Terms:
|
|||||||||||||
|
Fixed-Interest
Rate Loans
|
$
|
77,529
|
$
|
198,128
|
$
|
49,427
|
$
|
325,084
|
|||||
|
Adjustable-Interest
Rate Loans
|
130,784
|
95,018
|
76,577
|
302,379
|
|||||||||
|
Total
|
$
|
208,313
|
$
|
293,146
|
$
|
126,004
|
$
|
627,463
|
|||||
Deposits
The
Company primarily uses core deposits primarily to fund loans and to purchase
investment securities. At both December 31, 2005 and 2004, deposits provided
funding for approximately 90% of average earning assets. Average deposits
increased $39,919,000 or 6.2% in 2005, compared to a 14.7% increase in 2004.
The
Company experienced the majority of its deposit growth in certificates of
deposit during 2005. Certificates of deposit less than $100,00 increased
$13,112,000 or 8.2% and certificates of deposit $100,000 or more increased
$9,627,000 or 11.1% when compared to 2004. The average balance of other time
deposits increased $14,577,000 or 10.1% during 2004. The average balance of
noninterest bearing demand deposits increased $11,679,000 or 12.2% in 2005,
compared to an increase of $21,717,000 or 29.4% in 2004. NOW and SuperNOW
accounts increased $363,000 in 2005, compared to an increase of $9,387,000
in
2004. In 2004 the most significant growth occurred in the average balance of
money management account and other savings accounts, which increased $42,121,000
or 27.4%. Low interest rates kept depositors from utilizing long-term deposit
products for much of the year, but the Company began to offer higher rates
paid
for time deposits during the third and fourth quarters of 2004 due to increased
competition. Certificates of deposit over $100,000 declined on average in 2004
as a result of a municipal depositor who sought competitive bids and moved
money
to other financial institutions.
The
Company has not historically relied on brokered deposits or purchased deposits
as funding sources for loans.
The
following table sets forth the average balances of deposits and the percentage
of each category to total deposits for the years ended December 31.
|
(Dollars
in thousands)
|
Average
Balances
|
||||||||||||||||||
|
2005
|
2004
|
2003
|
|||||||||||||||||
|
Noninterest-bearing
demand
|
$
|
107,306
|
15.60
|
%
|
$
|
95,627
|
14.75
|
%
|
$
|
73,910
|
13.08
|
%
|
|||||||
|
Interest
bearing deposits
|
|||||||||||||||||||
|
NOW
and Super NOW
|
110,977
|
16.13
|
110,614
|
17.07
|
101,227
|
17.91
|
|||||||||||||
|
Savings
|
51,528
|
7.49
|
48,875
|
7.54
|
40,726
|
7.21
|
|||||||||||||
|
Money
management
|
149,452
|
21.72
|
146,967
|
22.68
|
112,995
|
20.00
|
|||||||||||||
|
Certificates
of Deposit and other time deposits less than $100,000
|
172,724
|
25.10
|
159,612
|
24.62
|
145,035
|
25.66
|
|||||||||||||
|
Certificates
of Deposit $100,000 or more
|
96,077
|
13.96
|
86,450
|
13.34
|
91,194
|
16.14
|
|||||||||||||
|
$
|
688,064
|
100.00
|
%
|
$
|
648,145
|
100.00
|
%
|
$
|
565,087
|
100.00
|
%
|
||||||||
The
following table sets forth the maturity ranges of certificates of deposit with
balances of $100,000 or more on December 31, 2005 (in
thousands).
|
Three
months or less
|
$
|
14,407
|
||
|
Over
three through twelve month
|
31,784
|
|||
|
Over
twelve months
|
60,350
|
|||
|
$
|
106,541
|
Short-Term
Borrowings
Short-term
borrowings consist primarily of securities sold under agreement to repurchase.
These short-term obligations are issued in conjunction with cash management
services for deposit customers. The Company occasionally borrows from the
Federal Home Loan Bank or from a correspondent bank under a federal funds line
of credit arrangement to meet short-term liquidity needs.
The
average balance of short-term borrowings increased $3,204,000 or 12.5% in 2005,
compared to an increase of $2,519,000 or 10.9% in 2004.
The
following table sets forth the Company’s position with respect to short-term
borrowings.
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
||||||||||||||||
|
Interest
|
Interest
|
Interest
|
|||||||||||||||||
|
Balance
|
Rate
|
Balance
|
Rate
|
Balance
|
Rate
|
||||||||||||||
|
Federal
funds purchased and securities sold
|
|||||||||||||||||||
|
under
agreements to repurchase:
|
|||||||||||||||||||
|
Average
outstanding for the year
|
$
|
28,794
|
2.40
|
%
|
$
|
25,590
|
0.84
|
%
|
$
|
23,071
|
0.77
|
%
|
|||||||
|
Outstanding
at year end
|
35,848
|
3.05
|
%
|
27,106
|
0.80
|
%
|
20,957
|
0.63
|
|||||||||||
|
Maximum
outstanding at any month end
|
35,848
|
—
|
30,845
|
—
|
29,781
|
—
|
|||||||||||||
Capital
Management
The
Company and the Banks continue to maintain capital at levels in excess of the
risk based capital guidelines adopted by the federal banking agencies. Total
stockholders’ equity for the Company was $101,448,000 at December 31, 2005, 9.1%
higher than the previous year. Stockholders’ equity at December 31, 2004
increased 11.3% over December 31, 2003. The increase in stockholders’ equity in
2005 and 2004 was due primarily to increases in earnings for those years,
reduced by dividends paid on shares of the common stock of the Company.
The
Company records unrealized holding gains (losses), net of tax, on investment
securities available for sale as accumulated other comprehensive income (loss),
a separate component of stockholder’s equity. As of December 31, 2005, the
portion of the Company’s investment portfolio designated as “available for sale”
had net unrealized holding losses, net of tax, of $1,263,000, compared to
unrealized holding gains, net of tax, of $278,000 at December 31,
2004.
The
following table compares the Company’s capital ratios as of December 31 to the
regulatory requirements.
|
Regulatory
|
||||||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
Requirements
|
|||||||
|
Tier
1 capital
|
$
|
89,104
|
$
|
82,385
|
||||||
|
Tier
2 capital
|
5,527
|
4,844
|
||||||||
|
Total
capital, less deductions
|
$
|
94,631
|
$
|
87,229
|
||||||
|
Risk-adjusted
assets
|
$
|
683,422
|
$
|
629,225
|
||||||
|
Risk-based
capital ratios:
|
||||||||||
|
Tier
1
|
13.04
|
%
|
13.04
|
%
|
4.0
|
%
|
||||
|
Total
capital
|
13.85
|
%
|
13.86
|
%
|
8.0
|
%
|
||||
|
Total
Capital
|
$
|
89,104
|
$
|
82,385
|
||||||
|
Total
adjusted assets
|
$
|
834,041
|
$
|
772,140
|
||||||
|
Leverage
capital ratio
|
10.68
|
%
|
10.67
|
%
|
3.0
|
%
|
||||
Management
knows of no trends or demands, commitments, events or uncertainties that are
likely to have a material adverse impact on capital. See Note 17 to the
Consolidated Financial Statements for further information about the regulatory
capital positions of the Company and the Banks.
Provision
for Credit Losses and Risk Management
Originating
loans involves a degree of risk that credit losses will occur in varying amounts
according to, among other factors, the types of loans being made, the
credit-worthiness of the borrowers over the term of the loans, the quality
of
the collateral for the loan, if any, as well as general economic conditions.
The
Company’s Board of Directors demands accountability of management, keeping the
interests of stockholders’ in focus. Through its Asset/Liability and Audit
Committee, the Board actively reviews critical risk positions, including market,
credit, liquidity and operational risk. The Company’s goal in managing risk is
to reduce earnings volatility, control exposure to unnecessary risk, and ensure
appropriate returns for risk assumed. Senior members of management actively
manage risk at the product level, supplemented with corporate level oversight
through the Asset/Liability Committee and internal audit function. The risk
management structure is designed to identify risk issues through a systematic
process, enabling timely and appropriate action to avoid and mitigate
risk.
Credit
risk is mitigated through portfolio diversification, limiting exposure to any
single industry or customer, collateral protection and standard lending policies
and underwriting criteria. The following discussion provides information and
statistics on the overall quality of the Company’s loan portfolio. Note 1 to
Consolidated Financial Statements describes the accounting policies related
to
nonperforming loans and charge-offs and describes the methodologies used to
develop the allowance for credit losses, including both the specific and
nonspecific components. Management believes the policies governing nonperforming
loans and charge-offs are consistent with regulatory standards. The amount
of
the allowance for credit losses and the resulting provision are reviewed monthly
by senior members of management and approved quarterly by the Board of
Directors.
The
allowance is increased by provisions for credit losses charged to expense and
recoveries of loans previously charged-off. It is decreased by loans charged-off
in the current period. Provisions for credit losses are made to bring the
allowance for credit losses within the range of balances that are considered
appropriate based upon the allowance methodology and to reflect losses within
the loan portfolio as of the balance sheet date.
The
adequacy of the allowance for credit losses is determined based upon
management’s estimate of the inherent risks associated with lending activities,
estimated fair value of collateral, past experience and present indicators
such
as loan delinquency trends, nonaccrual loans and current market conditions.
Management believes the allowance is adequate; however, future changes in the
composition of the loan portfolio and financial condition of borrowers may
result in additions to the allowance. Examination of the portfolio and allowance
by various regulatory agencies and consultants engaged by the Company may result
in the need for additional provisions based upon information available at the
time of the examination.
Each
of
the Banks maintains a separate allowance for credit losses, which is only
available to absorb losses from their respective loan portfolios. The allowance
set by each of the Banks is subject to regulatory examination and determination
as to its adequacy.
The
allowance for credit losses is comprised of two parts: the specific allowance
and the formula allowance. The specific allowance is the portion of the
allowance that results from management’s evaluation of specific loss allocations
for identified problem loans and pooled reserves based on historical loss
experience for each loan category. The formula allowance is determined based
on
management’s assessment of industry trends and economic factors in the markets
in which the Company operates. The determination of the formula allowance
involves a higher risk of uncertainty and considers current risk factors that
may not have yet manifested themselves in the Company’s historical loss factors.
The
specific allowance is based on each the Banks’ quarterly analysis of its loan
portfolio and is determined based upon the analysis of collateral values, cash
flows and guarantor’s financial capacity, whichever are applicable. In addition,
allowance factors are applied to internally classified loans for which specific
allowances have not been determined and historical loss factors are applied
to
homogenous pools of unclassified loans. Historical loss factors may be adjusted
by management in situations where no historical losses have occurred or where
current conditions are not reflective of the specific history of the
Company.
The
formula allowance is based upon management’s evaluation of external conditions,
the effects of which are not directly measured in the determination of the
specific allowance. The conditions evaluated in connection with the formula
allowance include: general economic and business conditions affecting the
Company’s primary lending area; credit quality trends; collateral values; loan
values; loan volumes and concentrations; seasoning of the loan portfolio;
specific industry conditions within the portfolio segments; recent loss
experience; duration of the current business cycle; bank regulatory examination
results; and findings of internal loan review personnel. Management reviews
the
conditions which impact the formula allowance quarterly and to the extent any
of
these conditions relate to specifically identifiable loans may reflect the
adjustment in the specific allowance. Where any of these conditions is not
related to a specific loan or loan category, management’s evaluation of the
probable loss related to the condition is reflected in the formula
allowance.
Although
the local economy does not appear to show the same signs of weakness that exist
in other parts of the nation, management acknowledges that the effects of
continued weakness in the national economy and/or a weakness in the local
economy could result in higher loss levels for the Company in the future.
The
ratio
of net charge-offs to average loans was .04% in 2005, compared to .13% in 2004.
At December 31, 2005, the allowance for credit losses was $5,236,000, or .86%
of
average outstanding loans, and 619% of total nonaccrual loans. This compares
to
an allowance of $4,692,000, or .85% of average outstanding loans and 319% of
nonaccrual loans, at December 31, 2004, and an allowance for credit losses
of
$4,060,000, or .89% of outstanding loans and 406% of nonaccrual loans, at
December 31, 2003.
Management’s
decision regarding the amount of the provision is influenced in part by growth
in commercial and real estate loan balances. Loan charge-offs totaled $449,000
for 2005, a significant decline when compared to $887,000 in loan charge-offs
for 2004. In 2004, the Company experienced a significant loss related to a
single commercial customer. Charge-offs were $530,000, $538,000 and $335,000
in
2003, 2002 and 2001, respectively.
The
following table sets forth a summary of the Company's loan loss experience
for
the years ended December 31.
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
Balance,
beginning of year
|
$
|
4,692
|
$
|
4,060
|
$
|
4,117
|
$
|
4,189
|
$
|
4,199
|
||||||
|
Loans
charged off:
|
||||||||||||||||
|
Real
estate loans
|
—
|
(131
|
)
|
(7
|
)
|
(86
|
)
|
(5
|
)
|
|||||||
|
Installment
loans
|
(183
|
)
|
(94
|
)
|
(114
|
)
|
(170
|
)
|
(155
|
)
|
||||||
|
Commercial
and other
|
(266
|
)
|
(662
|
)
|
(409
|
)
|
(282
|
)
|
(175
|
)
|
||||||
|
(449
|
)
|
(887
|
)
|
(530
|
)
|
(538
|
)
|
(335
|
)
|
|||||||
|
Recoveries:
|
||||||||||||||||
|
Real
estate loans
|
2
|
20
|
35
|
16
|
2
|
|||||||||||
|
Installment
loans
|
71
|
63
|
56
|
76
|
60
|
|||||||||||
|
Commercial
and other
|
110
|
79
|
47
|
18
|
37
|
|||||||||||
|
183
|
162
|
138
|
110
|
99
|
||||||||||||
|
Net
losses charged off
|
(266
|
)
|
(725
|
)
|
(392
|
)
|
(428
|
)
|
(236
|
)
|
||||||
|
Allowance
of acquired institution
|
—
|
426
|
—
|
—
|
||||||||||||
|
Provision
for credit losses
|
810
|
931
|
335
|
356
|
226
|
|||||||||||
|
Balance,
end of year
|
$
|
5,236
|
$
|
4,692
|
$
|
4,060
|
$
|
4,117
|
$
|
4,189
|
||||||
|
Average
loans outstanding
|
$
|
607,017
|
$
|
555,259
|
$
|
457,491
|
$
|
423,771
|
$
|
386,161
|
||||||
|
Percentage
of net charge-offs to average loans outstanding during the
year
|
.04
|
%
|
.13
|
%
|
.09
|
%
|
.10
|
%
|
.06
|
%
|
||||||
|
Percentage
of allowance for loan losses at year-end to average loans
|
0.86
|
%
|
0.85
|
%
|
0.89
|
%
|
0.97
|
%
|
1.08
|
%
|
||||||
Total
non-accrual loans declined to.13% of total loans, net of unearned income, at
December 31, 2005, compared to .25% at December 31, 2004. Specific valuation
allowances totaling $555,000 have been established for to address current
nonaccrual loans. Loans 90 days past due declined from $2,969,000 for 2004
to
$818,000 for 2005. In 2004, $2,881,000 or 97% of loans 90 days past due were
real estate secured and present limited loss exposure to the Company.
The
following table summarizes the past due and non-performing assets of the Company
as of December 31.
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||
|
Non-performing
assets:
|
|
|||||||||||||||
|
Non-accrual
loans
|
$
|
846
|
$
|
1,469
|
$
|
1,002
|
$
|
771
|
$
|
943
|
||||||
|
Other
real estate and other assets owned
|
302
|
391
|
—
|
54
|
56
|
|||||||||||
|
Total
non-performing assets
|
1,148
|
1,860
|
1,002
|
825
|
999
|
|||||||||||
|
Loans
90 days past due
|
818
|
2,969
|
1,128
|
374
|
1,532
|
|||||||||||
|
Total
non-performing assets and past due loans
|
$
|
1,966
|
$
|
4,829
|
$
|
2,130
|
$
|
1,199
|
$
|
2,531
|
||||||
|
Non-accrual
loans to total loans at period end
|
.13
|
%
|
.25
|
%
|
.21
|
%
|
.18
|
%
|
.24
|
%
|
||||||
|
Non-accrual
loans and past due loans, to total loans at period end
|
.27
|
%
|
.75
|
%
|
.45
|
%
|
.26
|
%
|
.64
|
%
|
||||||
During
2005, there was no change in the methods or assumptions affecting the allowance
methodology. The provision for credit losses was $810,000 for the year, compared
to $931,000 for 2004. The amount of the provision is determined based upon
management’s analysis of the portfolio, growth and changes in the condition of
credits and their resultant specific loss allocations. Historically, the Company
has experienced the majority of its losses in the commercial loan portfolio,
which are typically not secured by real estate. Because the majority of loan
growth is in loans secured by real estate, which have experienced minimal losses
over the past five years, the required allowance for those type of loans is
minimal compared to the amount required for non real estate secured commercial
loans.
Net
charge-offs during 2005 were $266,000, compared to $725,000 and $392,000 for
2004 and 2003, respectively. The increase in 2004 was primarily related to
losses of a single commercial loan customer. The allowance increased $544,000
or
11.6% in 2005 as a result of the provision for credit losses less net
charge-offs. In 2004, the allowance increased $632,000, of which $426,000 was
due to the acquisition of Felton Bank.
The
overall quality of the loan portfolio was strong at December 31, 2005, as
nonaccrual loans and delinquencies were within acceptable levels for the
industry. There was no unallocated portion of the allowance at December 31,
2005
and 2004, compared to 1.3% of the total allowance at December 31, 2003. The
majority of loans made by the Company are real estate secured. At December
31,
2005, 63.9% and 21.4% of the Company’s total loans were real estate mortgage
loans and real estate construction and land development loans, respectively,
compared to 68.3% and 16.3% at December 31, 2004.
The
following table sets forth the allocation of the allowance for credit losses
and
the percentage of loans in each category to total loans for the years ended
December 31,
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||||||||||||||||||
|
%
of
|
%
of
|
%
of
|
%
of
|
%
of
|
|||||||||||||||||||||||||||
|
(Dollars
in thousands)
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
|||||||||||||||||||||
|
Commercial,
Financial and
|
|||||||||||||||||||||||||||||||
|
Agricultural
|
$
|
1,780
|
12.0
|
%
|
$
|
1,863
|
12.3
|
%
|
$
|
1,362
|
13.6
|
%
|
$
|
1,869
|
14.1
|
%
|
$
|
1,563
|
15.0
|
%
|
|||||||||||
|
Real
Estate-Construction
|
945
|
21.4
|
429
|
16.3
|
253
|
7.7
|
172
|
5.8
|
135
|
5.2
|
|||||||||||||||||||||
|
Real
Estate-Mortgage
|
2,299
|
63.9
|
2,262
|
68.3
|
2,231
|
75.2
|
1,825
|
76.2
|
1,918
|
74.8
|
|||||||||||||||||||||
|
Consumer
|
212
|
2.7
|
138
|
3.1
|
160
|
3.5
|
169
|
3.9
|
387
|
5.0
|
|||||||||||||||||||||
|
Unallocated
|
—
|
—
|
—
|
—
|
54
|
—
|
82
|
—
|
186
|
—
|
|||||||||||||||||||||
|
$
|
5,236
|
100
|
%
|
$
|
4,692
|
100
|
%
|
$
|
4,060
|
100
|
%
|
$
|
4,117
|
100
|
%
|
$
|
4,189
|
100
|
%
|
||||||||||||
Market
Risk Management
Market
risk is the risk of loss arising from adverse changes in the fair value of
financial instruments due to changes in interest rates, exchange rates or equity
pricing. The Company’s principal market risk is interest rate risk that arises
from its lending, investing and deposit taking activities. The Company’s
profitability is dependent on the Banks’ net interest income. Interest rate risk
can significantly affect net interest income to the degree that interest bearing
liabilities mature or reprice at different intervals than interest earning
assets. The Banks’ Asset/Liability Committees oversee the management of interest
rate risk. The primary purpose of these committees is to manage the exposure
of
net interest margins to unexpected changes due to interest rate fluctuations.
These efforts affect the loan pricing and deposit rate policies of the Company
as well as the asset mix, volume guidelines, and liquidity and capital
planning.
The
Company does not utilize derivative financial or commodity instruments or
hedging strategies in its management of interest rate risk. Because the Company
is not exposed to market risk from trading activities and does not utilize
hedging strategies or off-balance sheet management strategies, the
Asset/Liability Committees of the Banks rely on “gap” analysis as its primary
tool in managing interest rate risk. Gap analysis summarizes the amount of
interest sensitive assets and liabilities, which will reprice over various
time
intervals. The difference between the volume of assets and liabilities repricing
in each interval is the interest sensitivity “gap”. “Positive gap” occurs when
more assets reprice in a given time interval, while “negative gap” occurs when
more liabilities reprice. As of December 31, 2005, the Company had a negative
gap position within the one-year repricing interval because the interest
sensitive liabilities exceeded the interest sensitive assets within the one-year
repricing interval by $41.8 million, or 4.9% of total assets. This was
essentially unchanged from the negative gap position within the one-year
interval at December 31, 2004, which totaled $41.8 million, or 5.29% of total
assets.
The
following table summarizes the Company’s interest sensitivity at December 31,
2005. Loans, federal funds sold, time deposits and short-term borrowings are
classified based upon contractual maturities if fixed-rate or earliest repricing
date if variable rate. Investment securities are classified by contractual
maturities or, if they have call provisions, by the most likely repricing
date.
|
3
Months
|
1
Year
|
3
Years
|
Non-
|
|||||||||||||||||||
|
Within
|
through
|
through
|
through
|
After
|
Sensitive
|
|||||||||||||||||
|
December
31, 2005
|
3
Months
|
12
Months
|
3
Years
|
5
Years
|
5
Years
|
Funds
|
Total
|
|||||||||||||||
|
(Dollars
in Thousands)
|
||||||||||||||||||||||
|
ASSETS:
|
||||||||||||||||||||||
|
Loans
|
$
|
279,216
|
$
|
69,199
|
$
|
178,574
|
$
|
59,847
|
$
|
40,627
|
$
|
(5,236
|
)
|
$
|
622,227
|
|||||||
|
Investment
securities
|
—
|
21,004
|
61,531
|
18,812
|
19,724
|
—
|
121,071
|
|||||||||||||||
|
Interest
bearing deposits with other banks
|
13,068
|
—
|
—
|
—
|
—
|
—
|
13,068
|
|||||||||||||||
|
Federal
funds sold
|
25,401
|
—
|
—
|
—
|
—
|
—
|
25,401
|
|||||||||||||||
|
Other
assets
|
—
|
—
|
—
|
—
|
—
|
69,871
|
69,871
|
|||||||||||||||
|
Total
Assets
|
$
|
317,685
|
$
|
90,203
|
$
|
240,105
|
$
|
78,659
|
$
|
60,351
|
$
|
64,635
|
$
|
851,638
|
||||||||
|
LIABILITIES:
|
||||||||||||||||||||||
|
Certificates
of deposit $100,000 and over
|
$
|
14,407
|
$
|
31,784
|
$
|
29,454
|
$
|
30,896
|
$
|
—
|
$
|
—
|
$
|
106,541
|
||||||||
|
Other
time deposits
|
20,994
|
39,023
|
76,077
|
41,398
|
—
|
—
|
177,492
|
|||||||||||||||
|
Savings
and money market
|
195,883
|
—
|
—
|
—
|
—
|
—
|
195,883
|
|||||||||||||||
|
NOW
and SuperNOW
|
111,798
|
—
|
—
|
—
|
—
|
—
|
111,798
|
|||||||||||||||
|
Noninterest
bearing demand
|
—
|
—
|
—
|
—
|
—
|
113,244
|
113,244
|
|||||||||||||||
|
Short-term
borrowings
|
35,848
|
—
|
—
|
—
|
—
|
—
|
35,848
|
|||||||||||||||
|
Long-term
debt
|
—
|
—
|
4,000
|
—
|
—
|
—
|
4,000
|
|||||||||||||||
|
Other
liabilities
|
—
|
—
|
—
|
—
|
—
|
5,384
|
5,384
|
|||||||||||||||
|
STOCKHOLDERS’
EQUITY
|
—
|
—
|
—
|
—
|
—
|
101,448
|
101,448
|
|||||||||||||||
|
Total
Liabilities and Stockholders’ Equity
|
$
|
378,930
|
$
|
70,807
|
$
|
109,531
|
$
|
72,294
|
$
|
—
|
$
|
220,076
|
$
|
851,638
|
||||||||
|
Excess
|
$
|
(61,245
|
)
|
$
|
19,396
|
$
|
130,574
|
$
|
6,365
|
$
|
60,351
|
$
|
(155,441
|
)
|
$
|
—
|
||||||
|
Cumulative
Excess
|
$
|
(61,245
|
)
|
$
|
(41,849
|
)
|
$
|
88,725
|
$
|
95,090
|
$
|
155,441
|
$ |
—
|
$
|
—
|
||||||
|
Cumulative
Excess as percent of total assets
|
(7.19
|
)%
|
(4.91
|
)%
|
10.42
|
%
|
11.17
|
%
|
18.25
|
%
|
—
|
—
|
||||||||||
In
addition to gap analysis, the Banks utilize simulation models to quantify the
effect a hypothetical immediate plus or minus 200 basis point change in rates
would have on their net interest income and the fair value of capital. The
model
takes into consideration the effect of call features of investments as well
as
prepayments of loans in periods of declining rates. When actual changes in
interest rates occur, the changes in interest earning assets and interest
bearing liabilities may differ from the assumptions used in the model. As of
December 31, 2005 and 2004, the models produced similar sensitivity profiles
for
net interest income and the fair value of capital, which are provided
below.
|
Immediate
Change in Rates
|
||||||||||||||||
|
+200
|
+100
|
-100
|
-200
|
Policy
|
||||||||||||
|
Basis
Points
|
Basis
Points
|
Basis
Points
|
Basis
Points
|
Limit
|
||||||||||||
|
2005
|
||||||||||||||||
|
%
Change in Net Interest Income
|
9.04
|
%
|
5.11
|
%
|
(5.34
|
)%
|
(11.83
|
)%
|
±25
|
%
|
||||||
|
%
Change in Fair Value of Capital
|
3.78
|
%
|
2.51
|
%
|
(3.21
|
)%
|
(8.24
|
)%
|
±15
|
%
|
||||||
|
2004
|
||||||||||||||||
|
%
Change in Net Interest Income
|
8.90
|
%
|
5.19
|
%
|
(6.41
|
)%
|
(14.09
|
)%
|
±25
|
%
|
||||||
|
%
Change in Fair Value of Capital
|
2.49
|
%
|
1.90
|
%
|
(4.08
|
)%
|
(10.31
|
)%
|
±15
|
%
|
||||||
Off-Balance
Sheet Arrangements
In
the
normal course of business, to meet the financing needs of its customers, the
Banks are parties to financial instruments with off-balance sheet risk. These
financial instruments include commitments to extend credit and standby letters
of credit. The Banks’ exposure to credit loss in the event of nonperformance by
the other party to these financial instruments is represented by the contractual
amount of the instruments. The Banks use the same credit policies in making
commitments and conditional obligations as they use for on-balance sheet
instruments. The Banks generally require collateral or other security to support
the financial instruments with credit risk. The amount of collateral or other
security is determined based on management’s credit evaluation of the
counterparty. The Banks evaluate each customer’s creditworthiness on a
case-by-case basis.
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Letters of credit are
conditional commitments issued by the Banks to guarantee the performance of
a
customer to a third party. Letters of credit and other commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Because many of the letters of credit and commitments are expected
to
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. Further information about these
arrangements is provided in Note 20 to Consolidated Financial Statements.
Management
does not believe that any of the foregoing arrangements have or are reasonably
likely to have a current or future effect on the Company’s financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures
or
capital resources that is material to investors.
Liquidity
Management
Liquidity
describes the ability of the Company to meet financial obligations that arise
during the normal course of business. Liquidity is primarily needed to meet
the
borrowing and deposit withdrawal requirements of customers and to fund current
and planned expenditures. Liquidity is derived through increased customer
deposits, maturities in the investment portfolio, loan repayments and income
from earning assets. To the extent that deposits are not adequate to fund
customer loan demand, liquidity needs can be met in the short-term funds
markets. The Company has arrangements with correspondent banks whereby it has
$20,500,000 available in federal funds lines of credit and a reverse repurchase
agreement available to meet any short-term needs which may not otherwise be
funded by its portfolio of readily marketable investments that can be converted
to cash. The Banks are also members of the Federal Home Loan Bank, which
provides another source of liquidity. At December 31, 2005 the Federal Home
Loan
Bank had issued a letter of credit in the amount of $20,000,000 on behalf of
the
Talbot Bank to a local government entity as collateral for its
deposits.
At
December 31, 2005, the Company’s loan to deposit ratio was 89% approximately the
same as one year ago. Investment securities available for sale totaling
$106,160,000 were available for the management of liquidity and interest rate
risk. Cash and cash equivalents were $67,459,000 at December 31, 2005,
$23,908,000 higher than one year ago. Management is not aware of any demands,
commitments, events or uncertainties that will materially affect the Company’s
ability to maintain liquidity at satisfactory levels.
The
Company has various financial obligations, including contractual obligations
and
commitments that may require future cash payments.
The
following table presents, as of December 31, 2005, significant fixed and
determinable contractual obligations to third parties by payment date (dollars
in thousands):
|
Within
|
One
to
|
Three
to
|
Over
five
|
||||||||||
|
Contractual
Obligations
|
one
year
|
three
years
|
five
years
|
years
|
|||||||||
|
Deposits
without a stated maturity(a)
|
$
|
420,870
|
$
|
—
|
$
|
—
|
$
|
—
|
|||||
|
Certificates
of Deposit(a)
|
107,477
|
105,530
|
72,294
|
—
|
|||||||||
|
Short-term
borrowings
|
35,848
|
—
|
—
|
—
|
|||||||||
|
Long-term
debt
|
—
|
4,000
|
—
|
—
|
|||||||||
|
Operating
Leases
|
284
|
296
|
175
|
1,411
|
|||||||||
|
Purchase
obligations
|
2,563
|
—
|
—
|
—
|
|||||||||
|
$
|
567,042
|
$
|
109,826
|
$
|
72,469
|
$
|
1,411
|
||||||
| (a) |
Includes
accrued interest payable
|
The
information required by this item may be found in Item 7 of Part II of this
report under the caption “Market Risk Management”, which is incorporated herein
by reference.
|
34
|
|
|
35
|
|
|
36
|
|
|
37
|
|
|
38
|
|
|
40
|
The
Board
of Directors and Stockholders
Shore
Bancshares, Inc.
We
have
audited the accompanying consolidated balance sheets of Shore Bancshares, Inc.
(the “Company”) as of December 31, 2005 and 2004, 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, 2005. These consolidated
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of December
31, 2005 and 2004, and the results of its operations and cash flows for each
of
the three years in the period ended December 31, 2005, in conformity with
accounting principles generally accepted in the United States of
America.
We
have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2005, based on the criteria
established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO),
and our
report dated March 7, 2006 expressed an unqualified opinion on management’s
assessment of internal control over financial reporting and an unqualified
opinion on the effectiveness of internal control over financial
reporting.
/s/
Stegman and Company
Baltimore,
Maryland
March
7,
2006
December
31, 2005 and 2004
|
2005
|
2004
|
||||||
|
ASSETS
|
|||||||
|
Cash
and due from banks
|
$
|
28,989,716
|
$
|
22,050,846
|
|||
|
Interest
bearing deposits with other banks
|
13,068,316
|
960,812
|
|||||
|
Federal
funds sold
|
25,400,992
|
20,539,412
|
|||||
|
Investment
securities:
|
|||||||
|
Available
for sale - at fair value
|
106,159,559
|
103,433,819
|
|||||
|
Held
to maturity - at amortized cost - fair value of (2005) $14,826,249
and
(2004) $15,802,385
|
14,910,580
|
15,662,077
|
|||||
|
Loans,
less allowance for credit losses (2005) $5,235,670 and (2004)
$4,692,202
|
622,227,459
|
590,765,937
|
|||||
|
Insurance
premiums receivable
|
1,089,982
|
385,923
|
|||||
|
Premises
and equipment, net
|
15,186,866
|
13,069,835
|
|||||
|
Accrued
interest receivable on loans and investment securities
|
3,897,182
|
3,275,042
|
|||||
|
Investment
in unconsolidated subsidiary
|
909,133
|
859,133
|
|||||
|
Goodwill
|
11,938,714
|
11,938,714
|
|||||
|
Other
intangible assets
|
1,905,585
|
2,242,367
|
|||||
|
Deferred
income taxes
|
1,991,114
|
1,542,544
|
|||||
|
Other
real estate
|
301,525
|
390,825
|
|||||
|
Other
assets
|
3,661,423
|
3,480,229
|
|||||
|
Total
assets
|
$
|
851,638,146
|
$
|
790,597,515
|
|||
|
LIABILITIES
|
|||||||
|
Deposits:
|
|||||||
|
Noninterest
bearing demand
|
$
|
113,244,399
|
$
|
102,671,672
|
|||
|
NOW
and Super NOW
|
111,798,486
|
112,326,736
|
|||||
|
Certificates
of deposit, $100,000 or more
|
106,541,050
|
91,315,421
|
|||||
|
Other
time and savings
|
373,374,451
|
352,358,525
|
|||||
|
704,958,386
|
658,672,354
|
||||||
|
Accrued
interest payable
|
1,213,500
|
630,062
|
|||||
|
Short-term
borrowings
|
35,847,600
|
27,106,241
|
|||||
|
Long
term debt
|
4,000,000
|
5,000,000
|
|||||
|
Contingent
earn-out payments payable
|
—
|
3,312,500
|
|||||
|
Other
liabilities
|
4,170,486
|
2,900,705
|
|||||
|
Total
liabilities
|
750,189,972
|
697,621,862
|
|||||
|
STOCKHOLDERS’
EQUITY
|
|||||||
|
Common
stock, par value $.01, authorized 35,000,000 shares; issued and
outstanding (2005) 5,556,985 shares; (2004) 5,515,198
shares
|
55,570
|
55,152
|
|||||
|
Additional
paid in capital
|
29,013,841
|
28,016,571
|
|||||
|
Retained
earnings
|
73,641,882
|
65,182,004
|
|||||
|
Accumulated
other comprehensive loss
|
(1,263,119
|
)
|
(278,074
|
)
|
|||
|
Total
stockholders’ equity
|
101,448,174
|
92,975,653
|
|||||
|
Total
liabilities and stockholders’ equity
|
$
|
851,638,146
|
$
|
790,597,515
|
|||
The
notes
to consolidated financial statements are an integral part of these
statements.
For
the
Years Ended December 31, 2005, 2004 and 2003
|
2005
|
2004
|
2003
|
||||||||
|
INTEREST
INCOME
|
||||||||||
|
Loans,
including fees
|
$
|
41,848,475
|
$
|
33,034,103
|
$
|
28,916,967
|
||||
|
Interest
and dividends on investment securities:
|
||||||||||
|
Taxable
|
3,789,797
|
4,353,701
|
4,314,727
|
|||||||
|
Tax-exempt
|
576,522
|
601,803
|
603,421
|
|||||||
|
Federal
funds sold
|
1,058,190
|
254,618
|
301,316
|
|||||||
|
Other
interest
|
110,878
|
46,568
|
202,025
|
|||||||
|
Total
interest income
|
47,383,862
|
38,290,793
|
34,338,456
|
|||||||
|
INTEREST
EXPENSE
|
||||||||||
|
NOW
and Super NOW accounts
|
552,088
|
409,441
|
503,993
|
|||||||
|
Certificates
of deposit, $100,000 or more
|
3,444,424
|
2,345,737
|
2,503,373
|
|||||||
|
Other
time and savings
|
7,106,616
|
5,787,514
|
6,305,204
|
|||||||
|
Interest
on short-term borrowings
|
691,723
|
214,504
|
178,052
|
|||||||
|
Interest
on long term debt
|
103,807
|
252,642
|
251,951
|
|||||||
|
Total
interest expense
|
11,898,658
|
9,009,838
|
9,742,573
|
|||||||
|
NET
INTEREST INCOME
|
35,485,204
|
29,280,955
|
24,595,883
|
|||||||
|
PROVISION
FOR CREDIT LOSSES
|
810,000
|
931,345
|
335,000
|
|||||||
|
NET
INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
|
34,675,204
|
28,349,610
|
24,260,883
|
|||||||
|
|
||||||||||
|
NONINTEREST
INCOME
|
||||||||||
|
Service
charges on deposit accounts
|
2,878,120
|
2,470,350
|
1,928,521
|
|||||||
|
Other
service charges and fees
|
1,192,931
|
1,169,648
|
648,251
|
|||||||
|
Gain
on sale of securities
|
4,071
|
41,440
|
447,713
|
|||||||
|
Recognized
loss on impairment of securities
|
—
|
(657,500
|
)
|
(131,394
|
)
|
|||||
|
Insurance
agency commissions
|
6,384,315
|
6,383,212
|
6,036,792
|
|||||||
|
Other
operating income
|
1,038,750
|
816,450
|
914,839
|
|||||||
|
11,498,187
|
10,223,600
|
9,844,722
|
||||||||
|
NONINTEREST
EXPENSE
|
||||||||||
|
Salaries
and wages
|
12,578,602
|
10,658,637
|
9,372,409
|
|||||||
|
Employee
benefits
|
3,176,005
|
3,101,617
|
2,871,206
|
|||||||
|
Occupancy
expense
|
1,542,186
|
1,448,320
|
1,225,476
|
|||||||
|
Furniture
and equipment expense
|
1,110,117
|
978,635
|
808,143
|
|||||||
|
Data
processing
|
1,414,478
|
1,309,746
|
955,108
|
|||||||
|
Directors’
fees
|
589,794
|
553,249
|
569,039
|
|||||||
|
Amortization
of other intangible assets
|
336,782
|
306,533
|
215,786
|
|||||||
|
Other
operating expenses
|
4,682,904
|
4,177,648
|
3,327,042
|
|||||||
|
25,430,868
|
22,534,385
|
19,344,209
|
||||||||
|
INCOME
BEFORE INCOME TAXES
|
20,742,523
|
16,038,825
|
14,761,396
|
|||||||
|
Federal
and state income taxes
|
7,854,310
|
5,840,624
|
5,265,701
|
|||||||
|
NET
INCOME
|
$
|
12,888,213
|
$
|
10,198,201
|
$
|
9,495,695
|
||||
|
Basic
earnings per common share
|
$
|
2.33
|
$
|
1.86
|
$
|
1.77
|
||||
|
Diluted
earnings per common share
|
$
|
2.32
|
$
|
1.84
|
$
|
1.74
|
||||
|
Cash
dividends paid per common share
|
$
|
.80
|
$
|
.72
|
$
|
.66
|
||||
The
notes
to consolidated financial statements are an integral part of these
statements.
For
the
Years Ended December 31, 2005, 2004 and 2003
|
Accumulated
|
||||||||||||||||
|
|
Additional
|
Other
|
Total
|
|||||||||||||
|
Common
|
Paid
in
|
Retained
|
Comprehensive
|
Stockholders’
|
||||||||||||
|
Stock
|
Capital
|
Earnings
|
Income
(Loss)
|
Equity
|
||||||||||||
|
Balances,
January 1, 2003
|
$
|
53,721
|
$
|
23,837,608
|
$
|
52,984,735
|
$
|
1,151,836
|
$
|
78,027,900
|
||||||
|
Comprehensive
income:
|
||||||||||||||||
|
Net
income
|
—
|
—
|
9,495,695
|
—
|
9,495,695
|
|||||||||||
|
Other
comprehensive income, net of tax:
|
||||||||||||||||
|
Unrealized
gain on available for sale securities, net of reclassification adjustment
of ($104,509)
|
—
|
—
|
—
|
(841,598
|
)
|
(841,598
|
)
|
|||||||||
|
Total
comprehensive income
|
8,654,097
|
|||||||||||||||
|
Shares
issued for employee stock based awards and related tax
effects
|
287
|
393,605
|
—
|
—
|
393,892
|
|||||||||||
|
Cash
dividends paid $.66 per share
|
—
|
—
|
(3,548,409
|
)
|
—
|
(3,548,409
|
)
|
|||||||||
|
Balances,
December 31, 2003
|
54,008
|
24,231,213
|
58,932,021
|
310,238
|
83,527,480
|
|||||||||||
|
Comprehensive
income:
|
||||||||||||||||
|
Net
income
|
—
|
—
|
10,198,201
|
—
|
10,198,201
|
|||||||||||
|
Other
comprehensive income, net of tax:
|
||||||||||||||||
|
Unrealized
loss on available for sale securities, net of reclassification adjustment
of $225,865
|
—
|
—
|
—
|
(588,312
|
)
|
(588,312
|
)
|
|||||||||
|
Total
comprehensive income
|
9,609,889
|
|||||||||||||||
|
Shares
issued for employee stock based awards and related tax
effects
|
316
|
577,805
|
—
|
—
|
578,121
|
|||||||||||
|
Shares
issued for purchase accounting acquisition
|
828
|
3,207,553
|
—
|
—
|
3,208,381
|
|||||||||||
|
Cash
dividends paid $.72 per share
|
—
|
—
|
(3,948,218
|
)
|
—
|
(3,948,218
|
)
|
|||||||||
|
Balances,
December 31, 2004
|
55,152
|
28,016,571
|
65,182,004
|
(278,074
|
)
|
92,975,653
|
||||||||||
|
Comprehensive
income:
|
||||||||||||||||
|
Net
income
|
—
|
—
|
12,888,213
|
—
|
12,888,213
|
|||||||||||
|
Other
comprehensive income, net of tax:
|
||||||||||||||||
|
Unrealized
loss on available for sale securities, net of reclassification adjustment
of ($105,344)
|
—
|
—
|
—
|
(985,045
|
)
|
(985,045
|
)
|
|||||||||
|
Total
comprehensive income
|
—
|
—
|
—
|
—
|
11,903,168
|
|||||||||||
|
Shares
issued for employee stock based awards and related tax
effects
|
304
|
597,384
|
—
|
—
|
597,688
|
|||||||||||
|
Shares
issued for contingent earn out
|
114
|
399,886
|
—
|
—
|
400,000
|
|||||||||||
|
Cash
dividends paid $.80 per share
|
—
|
—
|
(4,428,335
|
)
|
—
|
(4,428,335
|
)
|
|||||||||
|
Balances,
December 31, 2005
|
$
|
55,570
|
$
|
29,013,841
|
$
|
73,641,882
|
$
|
(1,263,119
|
)
|
$
|
101,448,174
|
|||||
The
notes
to consolidated financial statements are an integral part of these
statements.
For
the
Years Ended December 31, 2005, 2004 and 2003
|
2005
|
2004
|
2003
|
||||||||
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||||
|
Net
income
|
$
|
12,888,213
|
$
|
10,198,201
|
$
|
9,495,695
|
||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||
|
Depreciation
and amortization
|
1,410,369
|
1,474,954
|
1,521,160
|
|||||||
|
Discount
accretion on debt securities
|
(136,394
|
)
|
(116,838
|
)
|
(60,236
|
)
|
||||
|
Gain
on sale of securities
|
(4,071
|
)
|
(41,440
|
)
|
(579,107
|
)
|
||||
|
Recognized
loss on impairment of securities
|
—
|
657,500
|
131,394
|
|||||||
|
Provision
for credit losses, net
|
810,000
|
931,345
|
335,000
|
|||||||
|
Deferred
income taxes
|
168,583
|
(273,569
|
)
|
75,412
|
||||||
|
Deferred
gain on sale of premises
|
(175,993
|
)
|
—
|
—
|
||||||
|
Loss
on disposal of premises and equipment
|
16,729
|
37,789
|
—
|
|||||||
|
Loss
on other real estate owned
|
89,300
|
—
|
2,143
|
|||||||
|
Net
changes in:
|
||||||||||
|
Insurance
premiums receivable
|
(704,059
|
)
|
458,653
|
774,582
|
||||||
|
Accrued
interest receivable
|
(622,140
|
)
|
(877
|
)
|
(83,542
|
)
|
||||
|
Other
assets
|
(231,196
|
)
|
75,538
|
(387,710
|
)
|
|||||
|
Accrued
interest payable
|
583,438
|
46,269
|
(221,558
|
)
|
||||||
|
Other
liabilities
|
1,269,782
|
(314,669
|
)
|
(132,195
|
)
|
|||||
|
Net
cash provided by operating activities
|
15,362,561
|
13,132,856
|
10,871,038
|
|||||||
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||||
|
Proceeds
from sales of securities available for sale
|
9,743,709
|
16,955,388
|
8,770,500
|
|||||||
|
Proceeds
from maturities and principal payments of securities available for
sale
|
21,284,766
|
63,612,769
|
112,185,011
|
|||||||
|
Purchases
of securities available for sale
|
(35,350,170
|
)
|
(31,222,203
|
)
|
(156,031,628
|
)
|
||||
|
Proceeds
from maturities and principal payments of securities held to
maturity
|
1,062,202
|
2,155,368
|
2,836,613
|
|||||||
|
Purchases
of securities held to maturity
|
(332,864
|
)
|
(2,533,504
|
)
|
(5,051,827
|
)
|
||||
|
Net
increase in loans
|
(32,271,521
|
)
|
(83,345,923
|
)
|
(35,807,512
|
)
|
||||
|
Purchase
of premises and equipment
|
(3,787,108
|
)
|
(1,827,159
|
)
|
(3,469,743
|
)
|
||||
|
Proceeds
from sale of other real estate owned
|
—
|
—
|
51,973
|
|||||||
|
Proceeds
from sale of investment in unconsolidated subsidiary
|
—
|
379,490
|
—
|
|||||||
|
Proceeds
from sale of premises and equipment
|
912,135
|
—
|
—
|
|||||||
|
Deferred
earn out payment, net of stock issued
|
(2,912,500
|
)
|
(234,845
|
)
|
—
|
|||||
|
Net
cash used in investing activities
|
(41,651,351
|
)
|
(36,060,619
|
)
|
(76,516,613
|
)
|
||||
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||||
|
Net
increase in demand, NOW, money market, and savings
deposits
|
9,175,445
|
6,901,851
|
76,290,829
|
|||||||
|
Net
increase (decrease) in certificates of deposit
|
37,110,587
|
10,365,672
|
(29,073,330
|
)
|
||||||
|
Net
increase (decrease)
in
short-term borrowings
|
8,741,359
|
6,148,947
|
(1,050,823
|
)
|
||||||
|
Net
decrease in long term debt
|
(1,000,000
|
)
|
—
|
—
|
||||||
|
Proceeds
from issuance of common stock
|
597,688
|
279,275
|
290,308
|
|||||||
|
Dividends
paid
|
(4,428,335
|
)
|
(3,948,218
|
)
|
(3,548,410
|
)
|
||||
|
Net
cash provided by financing activities
|
50,196,744
|
19,747,527
|
42,908,574
|
|||||||
CONSOLIDATED
STATEMENTS OF CASH FLOWS (CONTINUED)
For
the
Years Ended December 31, 2005, 2004 and 2003
|
2005
|
2004
|
2003
|
||||||||
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
23,907,954
|
(3,180,236
|
)
|
(22,737,001
|
)
|
|||||
|
CASH
AND CASH EQUIVALENTS AT BEGINNING OF YEAR
|
43,551,070
|
46,731,306
|
69,468,307
|
|||||||
|
CASH
AND CASH EQUIVALENTS AT END OF YEAR
|
$
|
67,459,024
|
$
|
43,551,070
|
$
|
46,731,306
|
||||
|
Supplemental
cash flows information:
|
||||||||||
|
Interest
paid
|
$
|
11,315,220
|
$
|
8,794,961
|
$
|
9,964,131
|
||||
|
Income
taxes paid
|
$
|
7,426,775
|
$
|
5,832,108
|
$
|
5,559,256
|
||||
|
Transfers
from loans to other real estate
|
$
|
—
|
$
|
390,825
|
$
|
—
|
||||
|
Details
of acquisitions:
|
||||||||||
|
Fair
value of assets acquired
|
$
|
—
|
$
|
49,538,073
|
$
|
—
|
||||
|
Fair
value of liabilities acquired
|
—
|
(49,309,778
|
)
|
—
|
||||||
|
Stock
issued for acquisition
|
—
|
(3,208,381
|
)
|
—
|
||||||
|
Purchase
price in excess of net assets acquired
|
—
|
3,214,931
|
—
|
|||||||
|
Net
cash paid for acquisition
|
$
|
—
|
$
|
234,845
|
$
|
—
|
||||
The
notes
to consolidated financial statements are an integral part of these
statements.
For
the
Years Ended December 31, 2005, 2004 and 2003
NOTE
1. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
The
consolidated financial statements include the accounts of Shore Bancshares,
Inc.
and its subsidiaries (collectively referred to in these Notes as the “Company”),
with all significant intercompany transactions eliminated. The investments
in
subsidiaries are recorded on the Company’s books (Parent only) on the basis of
its equity in the net assets of the subsidiaries. The accounting and reporting
policies of the Company conform to accounting principles generally accepted
in
the United States of America and to prevailing practices within the industries
in which it operates. For purposes of comparability, certain reclassifications
have been made to amounts previously reported to conform with the current period
presentation.
Nature
of Operations
The
Company provides commercial banking services from its locations in the Maryland
Counties of Talbot, Queen Anne’s, Kent, Caroline, and Dorchester and in Kent
County, Delaware. Its primary source of revenue is interest earned on
commercial, real estate and consumer loans made to customers located on the
Delmarva Peninsula. A full range of insurance and investment services are
offered through the Company’s nonbank subsidiaries.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
The
allowance for credit losses is a material estimate that is particularly
susceptible to significant changes in the near-term. Management believes that
the allowance for credit losses is sufficient to address the probable losses
in
the current portfolio. While management uses available information to recognize
losses on loans, future additions to the allowance may be necessary based on
changes in economic conditions. In addition, various regulatory agencies, as
an
integral part of their examination processes, periodically review the Company’s
allowance for credit losses. Such agencies may require the Company to recognize
additions to the allowance based on their judgments about information available
to them at the time of their examination.
Investment
Securities Available for Sale
Investment
securities available for sale are stated at estimated fair value based on quoted
market prices. They represent those securities which management may sell as
part
of its asset/liability strategy or which may be sold in response to changing
interest rates, changes in prepayment risk or other similar factors. The cost
of
securities sold is determined by the specific identification method. Purchase
premiums and discounts are recognized in interest income using the interest
method over the terms of the securities. Net unrealized holding gains and losses
on these securities are reported as accumulated other comprehensive income,
a
separate component of stockholders’ equity, net of related income taxes.
Declines in the fair value of individual available-for-sale securities below
their cost that are other than temporary result in write-downs of the individual
securities to their fair value and are reflected in earnings as realized losses.
Factors affecting the determination of whether an other-than-temporary
impairment has occurred include a downgrading of the security by a rating
agency, a significant deterioration in the financial condition of the issuer,
or
that management would not have the intent and ability to hold a security for
a
period of time sufficient to allow for any anticipated recovery in fair
value.
Investment
Securities Held to Maturity
Investment
securities held to maturity are stated at cost adjusted for amortization of
premiums and accretion of discounts. Purchase premiums and discounts are
recognized in interest income using the interest method over the terms of the
securities. The Company intends and has the ability to hold such securities
until maturity. Declines in the fair value of individual held-to-maturity
securities below their cost that are other than temporary result in write-downs
of the individual securities to their fair value. Factors affecting the
determination of whether an other-than-temporary impairment has occurred include
a downgrading of the security by the rating agency, a significant deterioration
in the financial condition of the issuer, or that management would not have
the
ability to hold a security for a period of time sufficient to allow for any
anticipated recovery in fair value.
Loans
Loans
are
stated at their principal amount outstanding net of any deferred fees and costs.
Interest income on loans is accrued at the contractual rate based on the
principal amount outstanding. Fees charged and costs capitalized for originating
loans are being amortized substantially on the interest method over the term
of
the loan. A loan is placed on nonaccrual when it is specifically determined
to
be impaired or when principal or interest is delinquent for 90 days or more.
Any
unpaid interest previously accrued on those loans is reversed from income.
Interest income generally is not recognized on specific impaired loans unless
the likelihood of further loss is remote. Interest payments received on such
loans are applied as a reduction of the loan principal balance. Interest income
on other nonaccrual loans is recognized only to the extent of interest payments
received. Loans are returned to accrual status when all principal and interest
amounts contractually due are brought current and future payments are reasonably
assured.
Loans
are
considered impaired when it is probable that the Company will not collect all
principal and interest payments according to the loan’s contractual terms. The
impairment of a loan is measured at the present value of expected future cash
flows using the loan’s effective interest rate, or at the loan’s observable
market price or the fair value of the collateral if the loan is collateral
dependent. Generally, the Company measures impairment on such loans by reference
to the fair value of the collateral. Income on impaired loans is recognized
on a
cash basis, and payments are first applied against the principal balance
outstanding. Impaired loans do not include groups of smaller balance homogeneous
loans such as residential mortgage and consumer installment loans that are
evaluated collectively for impairment. Reserves for probable credit losses
related to these loans are based upon historical loss ratios and are included
in
the allowance for credit losses.
Allowance
for Credit Losses
The
allowance for credit losses is maintained at a level believed adequate by
management to absorb probable losses inherent in the loan portfolio as of the
balance sheet date and is based on the size and current risk characteristics
of
the loan portfolio, an assessment of individual problem loans and actual loss
experience, current economic events in specific industries and geographical
areas, including unemployment levels, and other pertinent factors, including
regulatory guidance and general economic conditions and other observable data.
Determination of the allowance is inherently subjective as it requires
significant estimates, including the amounts and timing of expected future
cash
flows or collateral value of impaired loans, estimated losses on pools of
homogeneous loans that are based on historical loss experience, and
consideration of current economic trends, all of which may be susceptible to
significant change. Loan losses are charged off against the allowance, while
recoveries of amounts previously charged off are credited to the allowance.
A
provision for credit losses is charged to operations based on management’s
periodic evaluation of the factors previously mentioned, as well as other
pertinent factors. Evaluations are conducted at least quarterly and more often
if deemed necessary.
The
Company’s systematic methodology for assessing the appropriateness of the
allowance includes the two following components: (1) the formula allowance
component reflecting historical losses, as adjusted, by credit category; and
(2)
the specific allowance component for risk rated credits on an individual or
portfolio basis. The components of the allowance for credit losses represent
an
estimation done pursuant to either Statement of Financial Accounting Standards
(“SFAS”) No. 5, “Accounting for Contingencies,” or SFAS No. 114 “Accounting by
Creditors for Impairment of a Loan.” The specific component of the allowance for
credit losses reflects expected losses resulting from analysis developed through
credit allocations for individual loans and historical loss experience for
each
loan category. The specific credit allocations are based on a regular analysis
of all loans over a fixed-dollar amount where the internal credit rating is
at
or below a predetermined classification. The historical loan loss element is
determined statistically using a loss migration analysis that examines loss
experience and the related internal grading of loans charged off. The loss
migration analysis is performed quarterly and loss factors are updated regularly
based on actual experience. The specific component of the allowance for credit
losses also includes consideration of concentrations and changes in portfolio
mix and volume.
The
formula portion of the allowance reflects management’s estimate of probable
inherent but undetected losses within the portfolio due to uncertainties in
economic conditions, delays in obtaining information, including unfavorable
information about a borrower’s financial condition, the difficulty in
identifying triggering events that correlate perfectly to subsequent loss rates,
and risk factors that have not yet manifested themselves in loss allocation
factors. In addition, the formula allowance includes a component that explicitly
accounts for the inherent imprecision in loan loss migration models. Historical
loss experience data used to establish allocation estimates may not precisely
correspond to the current portfolio. The uncertainty surrounding the strength
and timing of economic cycles, including management’s concerns over the effects
of the prolonged economic downturn in the current cycle, also affects the
allocation model’s estimates of loss. The historical losses used in the
migration analysis may not be representative of actual losses inherent in the
portfolio that have not yet been realized.
Premises
and Equipment
Premises
and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation and amortization are calculated using the straight-line method
over
the estimated useful lives of the assets. Useful lives range from three to
ten
years for furniture, fixtures and equipment; three to five years for computer
hardware and data handling equipment; and ten to forty years for buildings
and
building improvements. Land improvements are amortized over a period of fifteen
years; and leasehold improvements are amortized over the term of the respective
lease. Maintenance and repairs are charged to expense as incurred, while
improvements which extend the useful life of an asset are capitalized and
depreciated over the estimated remaining life of the asset.
Long-lived
assets are evaluated periodically for impairment when events or changes in
circumstances indicate the carrying amount may not be recoverable. Impairment
exists when the expected undiscounted future cash flows of a long-lived asset
are less than its carrying value. In that event, the Company recognizes a loss
for the difference between the carrying amount and the estimated fair value
of
the asset.
Goodwill
and Other Intangible Assets
Goodwill
represents the excess of the cost of an acquisition over the fair value of
the
net assets acquired. Other intangible assets represent purchased assets that
also lack physical substance but can be distinguished from goodwill because
of
contractual or other legal rights or because the asset is capable of being
sold
or exchanged either on its own or in combination with a related contract, asset
or liability. Under the provisions of SFAS No. 142 “Goodwill and Other
Intangible Assets”, goodwill is no longer ratably amortized into the income
statement over an estimated life, but rather is tested at least annually for
impairment. Intangible assets that have finite lives continue to be amortized
over their estimated useful lives and also continue to be subject to impairment
testing. All of the Company’s other intangible assets have finite lives and are
amortized on a straight-line basis over varying periods not exceeding fifteen
years. Prior to adoption of SFAS No. 142, the Company’s goodwill was amortized
on a straight-line basis over fifteen years. Note 8 includes a summary of the
Company’s goodwill and other intangible assets as well as further detail about
the effect of the adoption of SFAS No. 142.
Other
Real Estate
Other
real estate represents assets acquired in satisfaction of loans either by
foreclosure or deeds taken in lieu of foreclosure. Properties acquired are
recorded at the lower of cost or fair value less estimated selling costs at
the
time of acquisition with any deficiency charged to the allowance for credit
losses. Thereafter, costs incurred to operate or carry the properties as well
as
reductions in value as determined by periodic appraisals are charged to
operating expense. Gains and losses resulting from the final disposition of
the properties are included in noninterest expense.
Short-Term
Borrowings
Short-term
borrowing are comprised primarily of repurchase agreements which are securities
sold to the Company’s customers, at the customers’ request, under a continuing
“roll-over” contract that matures in one business day. The underlying securities
sold are U.S. Treasury notes or Government Agency bonds, which are segregated
from the Company’s other investment securities by its safekeeping
agents.
Income
Taxes
The
Company and its subsidiaries file a consolidated federal income tax return.
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 income tax purposes.
Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to
taxable income in the years in which those temporary differences are expected
to
be recovered or settled. The effect on deferred tax assets and liabilities
of a
change in tax rates is recognized in the period that includes the enactment
date.
Transfers
of Financial Assets
Transfers
of financial assets are accounted for as sales, when control over the assets
has
been surrendered. Control over transferred assets is deemed to be surrendered
when (1) the assets have been isolated from the Company, (2) the transferee
obtains the right (free of conditions that constrain it from taking advantage
of
that right) to pledge or exchange the transferred assets, and (3) the Company
does not maintain effective control over the transferred assets through an
agreement to repurchase them before their maturity.
Statement
of Cash Flows
Cash
and
demand balances due from banks, interest bearing deposits with other banks
and
federal funds sold are considered “cash and cash equivalents” for financial
reporting purposes.
Stock-Based
Compensation
The
Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting
for Stock-based Compensation” and SFAS No. 148 “Accounting for Stock-Based
Compensation - Transition and Disclosure”, and applies APB Opinion No. 25 and
related interpretations in accounting for its plans. No compensation expense
related to the plans was recorded during the years ended December 31, 2005,
2004, and 2003. If the Company had elected to recognize compensation cost based
on fair value of the award on date of grant and recognized cost based upon
the
vesting dates under the plans consistent with the method prescribed by SFAS
No.
123, net income and earnings per share would have been changed to the pro forma
amounts as follows for the years ended December 31:
|
2005
|
2004
|
2003
|
||||||||
|
Net
income:
|
||||||||||
|
As
reported
|
$
|
12,888,213
|
$
|
10,198,201
|
$
|
9,495,695
|
||||
|
Less
pro forma stock-based compensation expense determined under the fair
value
method, net of related tax effects
|
(49,850
|
)
|
(49,407
|
)
|
(32,328
|
)
|
||||
|
Pro
forma net income
|
$
|
12,838,363
|
$
|
10,148,794
|
$
|
9,463,367
|
||||
|
Basic
net income per share:
|
||||||||||
|
As
reported
|
$
|
2.33
|
$
|
1.86
|
$
|
1.77
|
||||
|
Pro
forma
|
2.32
|
1.85
|
1.76
|
|||||||
|
Diluted
earnings per share
|
||||||||||
|
As
reported
|
$
|
2.32
|
$
|
1.84
|
$
|
1.74
|
||||
|
Pro
forma
|
2.31
|
1.83
|
1.74
|
|||||||
The
pro
forma amounts are not representative of the effects on reported net income
for
future years.
Advertising
Costs
Advertising
costs are generally expensed as incurred. The Company incurred advertising
costs
of approximately $385,000, $217,000, and $169,000 for the years ended December
31, 2005, 2004 and 2003, respectively.
New
Accounting Pronouncements
In
January 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R, “Share Based Payment (Revised 2004)”, which establishes standards for
accounting for transaction in which an entity (i) exchanges its equity
instruments for goods and services, or (ii) incurs liabilities in exchange
for
goods and services that are based on ant entity’s equity instruments or that may
be settled by the issuance of equity instruments. SFAS 123R eliminates the
ability to account for stock-based compensation using Accounting Principles
Board (“APB”) No. 25 and requires that such transactions be recognized as
compensation cost in the income statement based on their fair values on the
date
of grant. SFAS 123R is effective for fiscal periods beginning after December
15,
2005. The Company will transition to fair value-based compensation using a
modified version of the prospective application, which means the fair
value-based method prescribed under SFAS 123R will apply to new awards,
modification of previous awards, repurchases and cancellations after January
1,
2006. Additionally, compensation cost for awards for which requisite service
has
not been rendered (non-vested options and stock grants) that are outstanding
as
of December 31, 2005 must be recognized as the remaining requisite service
is
rendered during the period of and/or the periods after the adoption of SFAS
123R. The determination of compensation cost for awards granted prior to January
1, 2006 will be based on the same methods an on the same fair values previously
determined for the pro forma disclosures required for companies that did not
previously adopt the fair value accounting method for stock-based compensation.
Based on the stock-based compensation awards outstanding as of December 31,
2005
for which the requisite service has not been fully rendered, the Company expects
to record an additional compensation expense of approximately $33,430 for each
of the years ended December 31, 2006 and 2007 as a result of adopting SFAS
123R.
Future levels of compensation expense related to stock-based compensation may
be
impacted by new awards, or modifications, repurchases, or cancellations of
existing awards, both before and after the adoption of this
standard.
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29,
Accounting for Nonmonetary Transactions”. This statement amends the principle
that exchanges of nonmonetary assets should be measured based on the fair value
of the assets exchanged and more broadly provides for exceptions regarding
exchanges of nonmonetary assets that do not have commercial substance. This
Statement is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this standard did not
have a material impact on financial condition, results of operations, or
liquidity.
In
March
2004, FASB Emerging Issues Task Force (EITF) released Issue 03-01, “Meaning of
Other Than Temporary Impairment and Its Application to Certain Investments”.
EITF 03-1 provides guidance for determining whether impairment for certain
debt
and equity investments is other-than-temporary and the measurement of the
impaired loss. Certain disclosure requirements of EITF 03-1 were adopted in
2003
and the Company complied with the new disclosure requirements in its
consolidated financial statements. The recognition and measurement requirements
of EITF 03-01 were initially effective for periods beginning after June 15,
2004. In September 2004, however, the FASB staff issued FASB Staff Position
(“FSP”) EITF 03-1-1, which delayed the effective date for certain measurement
and recognition guidance contained in Issue 03-1. The FSP requires the
application of pre-existing other-than-temporary guidance during the period
of
delay until a final consensus is reached. Management does not anticipate the
issuance of the final consensus will have a material impact on financial
condition, the results of operations, or liquidity. During 2004, the Company
recorded a $657,500 write-down relating to its investment in FHLMC preferred
stock whose decline in value was determined to be
other-than-temporary.
In
December 2003, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 03-3, “Accounting for Certain Loans or Debt
Securities Acquired in a Transfer”. SOP 03-3 requires acquired loans, including
debt securities, to be recorded at the amount of the purchase’s initial
investment and prohibits carrying over valuation allowances from the seller
for
those-individually-evaluated loans that have evidence of deterioration in credit
quality since origination, and it is probable all contractual cash flows on
the
loan will be unable to be collected. SOP 03-3 also requires the excess of all
undiscounted cash flows expected to be collected at acquisition over the
purchase’s initial investment to be recognized as interest income on a
level-yield basis over the life of the loan. Subsequent increases in cash flows
expected to be collected are recognized prospectively through an adjustment
of
the loan’s yield over its remaining life, while subsequent decreases are
recognized as impairment. Loans carried at fair value, loans held for sale,
and
loans to borrowers in good standing under revolving credit agreements are
excluded from the scope of SOP 03-3. The guidance is effective for loans
acquired in fiscal years beginning after December 15, 2004 and did not have
a
material impact on the Company’s financial condition, result of operations, or
liquidity.
Reclassifications
Certain
amounts in the prior year statements have been reclassified to conform to the
current year’s presentation.
NOTE
2. ACQUISITIONS
On
April
1, 2004, the Company completed its merger with Midstate Bancorp, Inc., a
Delaware bank holding company (“Midstate Bancorp”). Pursuant to the merger
agreement, each outstanding share of common stock of Midstate Bancorp was
converted into the right to receive (i) $31.00 in cash, plus (ii) 0.8732 shares
of the common stock of the Company, with cash being paid in lieu of fractional
shares at the rate of $33.83 per share. The Company paid $2,953,710 in cash
and
issued 82,786 shares of common stock to stockholders of Midstate Bancorp in
connection with the merger. The Company recorded approximately $2,636,000 of
goodwill and $968,000 of other intangible assets as a result of the
acquisition.
On
May 1,
2002, the Company acquired certain assets of The Avon-Dixon Agency, Inc., a
full
service insurance agency, and its subsidiaries, all located in Easton, Maryland.
The acquisition agreement called for a deferred payment (earn-out) to be made
on
or before February 15, 2005, the exact amount of which would depend upon the
acquired business meeting certain performance criteria through December 31,
2004. The Company recorded a deferred payment of $2,800,000 on December 31,
2004
as additional goodwill. In February 2005, the Company paid $2,400,000 in cash
and $400,000 in stock to liquidate the obligation.
On
November 1, 2002, The Avon-Dixon Agency, LLC acquired certain assets of W.
M.
Freestate & Son, Inc., a full service insurance agency located in
Centreville, Maryland. The acquisition agreement called for a deferred payment
(earn-out) to be made on or before December 16, 2005, the exact amount of which
would depend upon the acquired business meeting certain performance criteria
through December 31, 2004. The Company recorded a deferred payment of $512,500
on December 31, 2004 as additional goodwill and made the payment during
2005.
NOTE
3. CASH
AND DUE FROM BANKS
The
Board
of Governors of the Federal Reserve System (the “FRB”) requires the banks to
maintain certain minimum cash balances consisting of vault cash and deposits
in
the appropriate Federal Reserve Bank or in other commercial banks. Such balances
for the Company’s bank subsidiaries averaged approximately $13,141,000 and
$11,877,000 during 2005 and 2004, respectively.
NOTE
4. INVESTMENT SECURITIES
The
amortized cost and estimated fair values of investment securities are as
follows:
|
Gross
|
Gross
|
Estimated
|
|||||||||||
|
Amortized
|
Unrealized
|
Unrealized
|
Fair
|
||||||||||
|
Available
for sale securities:
|
Cost
|
Gains
|
Losses
|
Value
|
|||||||||
|
December
31, 2005:
|
|||||||||||||
|
Obligations
of U.S. Government agencies and corporations
|
$
|
90,872,189
|
$
|
1,043
|
$
|
1,640,342
|
$
|
89,232,890
|
|||||
|
Other
securities:
|
|||||||||||||
|
Mortgage
backed securities
|
14,517,990
|
677
|
428,980
|
14,089,687
|
|||||||||
|
Federal
Home Loan Bank stock
|
2,088,300
|
—
|
—
|
2,088,300
|
|||||||||
|
Federal
Reserve Bank stock
|
302,250
|
—
|
—
|
302,250
|
|||||||||
|
Federal
Home Loan Mortgage Corporation Cumulative preferred stock
|
388,500
|
21,500
|
—
|
410,000
|
|||||||||
|
Equity
securities
|
35,000
|
1,432
|
—
|
36,432
|
|||||||||
|
$
|
108,204,229
|
$
|
24,652
|
$
|
2,069,322
|
$
|
106,159,559
|
||||||
|
December
31, 2004:
|
|||||||||||||
|
Obligations
of U.S. Government agencies and corporations
|
$
|
74,961,442
|
$
|
46,913
|
$
|
539,525
|
$
|
74,468,830
|
|||||
|
Other
securities:
|
|||||||||||||
|
Mortgage
backed securities
|
24,379,611
|
199,610
|
165,979
|
24,413,242
|
|||||||||
|
Federal
Home Loan Bank stock
|
1,614,100
|
—
|
—
|
1,614,100
|
|||||||||
|
Federal
Reserve Bank stock
|
302,250
|
—
|
—
|
302,250
|
|||||||||
|
Federal
Home Loan Mortgage Corporation Cumulative preferred stock
|
2,342,500
|
—
|
—
|
2,342,500
|
|||||||||
|
Equity
securities
|
284,180
|
8,717
|
—
|
292,897
|
|||||||||
|
$
|
103,884,083
|
$
|
255,240
|
$
|
705,504
|
$
|
103,433,819
|
||||||
|
Held
to Maturity securities:
|
|||||||||||||
|
December
31, 2005
|
|||||||||||||
|
Obligations
of states and political subdivisions
|
$
|
14,908,105
|
$
|
93,895
|
$
|
178,365
|
$
|
14,823,635
|
|||||
|
Mortgage
backed securities
|
2,475
|
139
|
—
|
2,614
|
|||||||||
|
$
|
14,910,580
|
$
|
94,034
|
$
|
178,365
|
$
|
14,826,249
|
||||||
|
December
31, 2004
|
|||||||||||||
|
Obligations
of states and political subdivisions
|
$
|
15,658,414
|
$
|
219,019
|
$
|
79,047
|
$
|
15,798,386
|
|||||
|
Mortgage
backed securities
|
3,663
|
336
|
—
|
3,999
|
|||||||||
|
$
|
15,662,077
|
$
|
219,355
|
$
|
79,047
|
$
|
15,802,385
|
||||||
Gross
unrealized losses and fair value by length of time that the individual
available-for-sale securities have been in a continuous unrealized loss position
at December 31, 2005 are as follows:
|
Continuous
unrealized losses existing for:
|
|||||||||||||
|
Less
than 12
|
More
than 12
|
Total
Unrealized
|
|||||||||||
|
Available
for sale securities:
|
Fair
Value
|
Months
|
Months
|
Losses
|
|||||||||
|
Obligations
of U.S. Government Agencies
and Corporations
|
$
|
88,230,373
|
$
|
483,824
|
$
|
1,156,519
|
$
|
1,640,343
|
|||||
|
Mortgage-backed
securities
|
13,760,201
|
198,262
|
230,717
|
428,979
|
|||||||||
|
$
|
101,990,574
|
$
|
682,086
|
$
|
1,387,236
|
$
|
2,069,322
|
||||||
The
available-for-sale investment portfolio has a fair value of approximately $106
million, of which approximately $102 million have unrealized losses from their
purchase price. Of these securities, $88 million or 86% are government agency
bonds, and $14 million or 14% are mortgage-backed securities. The securities
representing the unrealized losses in the available-for-sale portfolio all
have
modest duration risk, low credit risk, and minimal loss (approximately 1.95%)
when compared to book value. The unrealized losses that exist are the result
of
market changes in interest rates since the original purchase. These factors,
coupled with the fact the Company has both the intent and ability to hold these
investments for a period of time sufficient to allow for any anticipated
recovery in fair value, substantiates that the unrealized losses in the
available-for-sale portfolio are temporary. During 2004, the Company recorded
impairment losses in the amount of $657,500 for losses on Freddie Mac Preferred
Stock investments that were determined to be other than temporary.
Gross
unrealized losses and fair value by length of time that the individual
held-to-maturity securities have been in a continuous unrealized loss position
at December 31, 2005 are as follows:
|
Continuous
unrealized losses existing for:
|
|||||||||||||
|
Less
than 12
|
More
than 12
|
Total
Unrealized
|
|||||||||||
|
Held-to-Maturity
|
Fair
Value
|
Months
|
Months
|
Losses
|
|||||||||
|
Obligations
of states and political subdivisions
|
$
|
7,591,313
|
$
|
77,893
|
$
|
100,472
|
$
|
178,365
|
|||||
The
held-to-maturity investment portfolio has a fair value of approximately $15
million, of which approximately $8 million have some unrealized losses from
their purchase price. The securities representing the unrealized losses in
the
held-to-maturity portfolio are all municipal securities with modest duration
risk, low credit risk, and minimal losses (approximately 1.20%) when compared
to
book value. The unrealized losses that exist are the result of market changes
in
interest rates since the original purchase. These factors coupled with the
Company’s intent and ability to hold these investments for a period of time
sufficient to allow for any anticipated recovery in fair value substantiates
that the unrealized losses in the held-to-maturity portfolio are
temporary.
The
amortized cost and estimated fair values of investment securities by maturity
date at December 31, 2005 are as follows:
|
Available
for Sale
|
Held
to Maturity
|
||||||||||||
|
Amortized
|
Estimated
|
Amortized
|
Estimated
|
||||||||||
|
Cost
|
Fair
Value
|
Cost
|
Fair
Value
|
||||||||||
|
Due
in one year or less
|
$
|
21,237,642
|
$
|
21,000,910
|
$
|
2,475
|
$
|
2,614
|
|||||
|
Due
after one year through five years
|
76,048,038
|
74,481,451
|
5,861,526
|
5,861,123
|
|||||||||
|
Due
after five years through ten years
|
3,154,317
|
3,060,562
|
6,094,358
|
5,978,834
|
|||||||||
|
Due
after ten years
|
4,950,182
|
4,779,654
|
2,952,221
|
2,983,678
|
|||||||||
|
105,390,179
|
103,322,577
|
14,910,580
|
14,826,249
|
||||||||||
|
Equity
securities
|
2,814,050
|
2,836,982
|
—
|
—
|
|||||||||
|
$
|
108,204,229
|
$
|
106,159,559
|
$
|
14,910,580
|
$
|
14,826,249
|
||||||
The
maturity date for mortgage-backed securities is determined by its expected
maturity. The maturity date for the remaining debt securities is determined
using its contractual maturity date.
The
following table sets forth the amortized cost and estimated fair values of
securities which have been pledged as collateral for obligations to federal,
state and local government agencies, and other purposes as required or permitted
by law, or sold under agreements to repurchase. All pledged securities are
in
the available for sale investment portfolio.
|
December
31, 2005
|
December
31,2004
|
||||||||||||
|
Amortized
|
Estimated
|
Amortized
|
Estimated
|
||||||||||
|
Cost
|
Fair
Value
|
Cost
|
Fair
Value
|
||||||||||
|
Available
for sale
|
$
|
87,321,908
|
$
|
85,612,506
|
$
|
77,185,632
|
$
|
76,863,198
|
|||||
There
were no obligations of states or political subdivisions whose carrying value,
as
to any issuer, exceeded 10% of stockholders’ equity at December 31, 2005 or
2004.
Proceeds
from sales of investment securities were $9,744,000, $16,955,000, and $8,771,000
for the years ended December 31, 2005, 2004, and 2003, respectively. Gross
gains
from sales of investment securities were $118,000, $129,000, and $580,000 for
the years ended December 31, 2005, 2004, and 2003, respectively. Gross losses
were $114,000, $88,000 and $1,000 for the years ended December 31, 2005, 2004
and 2003, respectively.
NOTE
5. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The
Company grants residential mortgage, consumer and commercial loans to customers
primarily in the Maryland counties of Talbot, Queen Anne’s, Kent, Caroline and
Dorchester and in Kent County, Delaware. The principal categories of the loan
portfolio at December 31 are summarized as follows:
|
2005
|
2004
|
||||||
|
Real
estate loans:
|
|||||||
|
Construction
and land development
|
$
|
134,379,796
|
$
|
97,010,075
|
|||
|
Secured
by farmland
|
16,835,853
|
18,740,634
|
|||||
|
Secured
by residential properties
|
212,856,978
|
240,594,157
|
|||||
|
Secured
by non-farm, nonresidential properties
|
171,747,457
|
147,207,463
|
|||||
|
Loans
to farmers (loans to finance agricultural production and other
loans)
|
4,058,520
|
4,495,116
|
|||||
|
Commercial
and industrial loans
|
66,856,135
|
68,163,985
|
|||||
|
Loans
to individuals for household, family, and other personal
expenditures
|
15,396,741
|
18,485,816
|
|||||
|
Obligations
of states and political subdivisions in the United States,
tax-exempt
|
2,003,815
|
1,082,824
|
|||||
|
All
other loans
|
4,038,723
|
133,156
|
|||||
|
628,174,018
|
595,913,226
|
||||||
|
Net
deferred loan fees/costs
|
(710,889
|
)
|
(455,087
|
)
|
|||
|
627,463,129
|
595,458,139
|
||||||
|
Allowance
for credit losses
|
(5,235,670
|
)
|
(4,692,202
|
)
|
|||
|
$
|
622,227,459
|
$
|
590,765,937
|
||||
In
the
normal course of banking business, loans are made to officers and directors
and
their affiliated interests. These loans are made on substantially the same
terms
and conditions as those prevailing at the time for comparable transactions
with
outsiders and are not considered to involve more than the normal risk of
collectibility. As of December 31, 2005 and 2004, such loans outstanding,
both direct and indirect (including guarantees), to directors, their associates
and policy-making officers, totaled approximately $13,106,000, and $16,384,000,
respectively. During 2005 and 2004, loan additions were approximately $4,482,000
and $10,031,000 and loan repayments were approximately $7,760,000 and
$5,661,000, respectively.
Activity
in the allowance for credit losses is summarized as follows:
|
2005
|
2004
|
2003
|
||||||||
|
Balance,
beginning of year
|
$
|
4,692,202
|
$
|
4,059,964
|
$
|
4,116,598
|
||||
|
Loans
charged off:
|
||||||||||
|
Real
estate loans
|
—
|
(130,624
|
)
|
(7,369
|
)
|
|||||
|
Installment
loans
|
(182,712
|
)
|
(94,052
|
)
|
(113,717
|
)
|
||||
|
Commercial
and other
|
(266,434
|
)
|
(662,246
|
)
|
(409,329
|
)
|
||||
|
(449,146
|
)
|
(886,922
|
)
|
(530,415
|
)
|
|||||
|
Recoveries:
|
||||||||||
|
Real
estate loans
|
1,437
|
19,681
|
35,060
|
|||||||
|
Installment
loans
|
71,295
|
62,896
|
56,592
|
|||||||
|
Commercial
and other
|
109,882
|
79,093
|
47,129
|
|||||||
|
182,614
|
161,670
|
138,781
|
||||||||
|
Net
loans charged off
|
(266,532
|
)
|
(725,252
|
)
|
(391,634
|
)
|
||||
|
Allowance
of acquired institution
|
—
|
426,145
|
—
|
|||||||
|
Provision
|
810,000
|
931,345
|
335,000
|
|||||||
|
Balance,
end of year
|
$
|
5,235,670
|
$
|
4,692,202
|
$
|
4,059,964
|
||||
Information
with respect to impaired loans and the related valuation allowance as of
December 31 is as follows:
|
2005
|
2004
|
2003
|
||||||||
|
Impaired
loans with valuation allowance
|
$
|
604,471
|
$
|
1,245,881
|
$
|
729,340
|
||||
|
Impaired
loans with no valuation allowance
|
241,726
|
222,784
|
272,348
|
|||||||
|
Total
impaired loans
|
$
|
846,197
|
$
|
1,468,665
|
$
|
1,001,688
|
||||
|
Allowance
for loan losses related to impaired loans
|
$
|
554,992
|
$
|
441,930
|
$
|
349,268
|
||||
|
Allowance
for loan losses related to other than impaired loans
|
4,680,678
|
4,250,272
|
3,710,696
|
|||||||
|
Total
allowance for loan losses
|
$
|
5,235,670
|
$
|
4,692,202
|
$
|
4,059,964
|
||||
|
Interest
income on impaired loans recorded on the cash basis
|
$
|
90
|
$
|
11,177
|
$
|
26,464
|
||||
|
Average
recorded investment in impaired loans for the year
|
$
|
1,156,261
|
$
|
1,174,632
|
$
|
826,098
|
||||
NOTE
6. PREMISES
AND EQUIPMENT
A
summary
of premises and equipment at December 31 is as follows:
|
2005
|
2004
|
||||||
|
Land
|
$
|
4,228,249
|
$
|
3,313,344
|
|||
|
Buildings
and land improvements
|
11,330,891
|
10,628,881
|
|||||
|
Furniture
and equipment
|
6,708,379
|
6,013,936
|
|||||
|
22,267,519
|
19,956,161
|
||||||
|
Accumulated
depreciation
|
(7,080,653
|
)
|
(6,886,326
|
)
|
|||
|
$
|
15,186,866
|
$
|
13,069,835
|
||||
Depreciation
expense totaled $919,550, $846,359 and $702,042 for the years ended December
31,
2005, 2004 and 2003, respectively.
On
June
14, 2005, the Company entered into a sale-leaseback agreement with First Oxford
Corporation. Under the agreement, the Company conveyed title to the land,
including buildings, structures and other improvements of its banking facility
in Felton, Delaware on September 23, 2005. The Company has leased back the
facility for a period of 20 years under an operating lease arrangement. Rental
expense under the agreement was $30,253 for 2005.
The
Company leases facilities under operating leases. Rental expense for the years
ended December 31, 2005, 2004 and 2003 was $327,059, $314,015 and $330,927,
respectively. Future minimum annual rental payments are approximately as
follows:
|
2006
|
$
|
283,846
|
||
|
2007
|
173,455
|
|||
|
2008
|
122,873
|
|||
|
2009
|
85,931
|
|||
|
2010
|
88,742
|
|||
|
Thereafter
|
1,411,630
|
|||
|
Total
minimum lease payments
|
$
|
2,166,477
|
NOTE 7. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY
At
December 31, 2005, the Company owned, through The Centreville National Bank
of
Maryland (“Centreville National Bank”), 20.00% of the outstanding common stock
of the Delmarva Data Bank Processing Center, Inc. (“Delmarva Data”). This
investment is carried at cost, adjusted for the Company’s equity in Delmarva
Data’s undistributed income. During 2004, Centreville National Bank sold shares
of Delmarva Data to another institution.
|
December
31
|
||||||||||
|
2005
|
2004
|
2003
|
||||||||
|
Balance,
beginning of year
|
$
|
859,133
|
$
|
1,202,786
|
$
|
1,165,567
|
||||
|
Sale
of stock
|
—
|
(379,490
|
)
|
—
|
||||||
|
Equity
in net income
|
50,000
|
35,837
|
37,219
|
|||||||
|
Balance,
end of year
|
$
|
909,133
|
$
|
859,133
|
$
|
1,202,786
|
||||
Data
processing and other expenses paid to Delmarva Data totaled approximately
$1,722,000, $1,554,000, and $1,277,000 for the years ended December 31, 2005,
2004 and 2003, respectively.
NOTE
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective
January 1, 2002, goodwill is no longer being amortized but rather tested for
impairment under the provisions of SFAS No. 142. The acquired intangible assets
apart from goodwill will continue to be amortized over their remaining estimated
lives.
The
significant components of goodwill and acquired intangible assets are as
follows:
|
2005
|
2004
|
||||||||||||||||||||||||
|
Weighted
|
Weighted
|
||||||||||||||||||||||||
|
Gross
|
Net
|
Average
|
Gross
|
Net
|
Average
|
||||||||||||||||||||
|
Carrying
|
Accumulated
|
Carrying
|
Remaining
|
Carrying
|
Accumulated
|
Carrying
|
Remaining
|
||||||||||||||||||
|
Amount
|
Amortization
|
Amount
|
Life
|
Amount
|
Amortization
|
Amount
|
Life
|
||||||||||||||||||
|
Goodwill
|
$
|
12,605,832
|
$
|
667,118
|
$
|
11,938,714
|
—
|
$
|
12,605,832
|
$
|
667,118
|
$
|
11,938,714
|
—
|
|||||||||||
|
Core
Deposit Intangible
|
968,000
|
211,744
|
756,256
|
6.3
|
968,000
|
90,748
|
877,252
|
7.3
|
|||||||||||||||||
|
Unidentifiable
intangible resulting from branch acquisitions
|
104,144
|
96,628
|
7,516
|
1.1
|
104,144
|
89,685
|
14,459
|
2.1
|
|||||||||||||||||
|
Insurance
expirations
|
1,270,000
|
301,445
|
968,555
|
11.4
|
1,270,000
|
216,778
|
1,053,222
|
12.4
|
|||||||||||||||||
|
Other
identifiable intangibles
|
620,883
|
447,625
|
173,258
|
1.4
|
620,883
|
323,449
|
297,434
|
2.4
|
|||||||||||||||||
|
Total
|
$
|
15,568,859
|
$
|
1,724,560
|
$
|
13,844,299
|
$
|
15,568,859
|
$
|
1,387,778
|
$
|
14,181,081
|
|||||||||||||
Future
annual estimated annual amortization expense is as follows:
|
2006
|
$
|
336,786
|
||
|
2007
|
247,632
|
|||
|
2008
|
205,667
|
|||
|
2009
|
205,667
|
|||
|
2010
|
205,667
|
Under
the
provisions of SFAS No. 142, goodwill was subjected to an annual assessment
for
impairment during 2005. As a result of annual assessment reviews, the Company
determined that there was no impairment of goodwill. The Company will continue
to review goodwill on an annual basis for impairment and as events occur or
circumstances change.
NOTE
9. DEPOSITS
The
approximate amount of certificates of deposit of $100,000 or more at December
31, 2005 and 2004 was $106,541,000 and $91,315,000, respectively.
The
approximate maturities of time deposits at December 31, are as
follows:
|
2005
|
2004
|
||||||
|
Due
in one year or less
|
$
|
106,209,000
|
$
|
108,037,000
|
|||
|
Due
in one to three years
|
105,534,000
|
87,305,000
|
|||||
|
Due
in three to five years
|
72,290,000
|
51,580,000
|
|||||
|
$
|
284,033,000
|
$
|
246,922,000
|
||||
NOTE 10. SHORT-TERM BORROWINGS
The
following table summarizes certain information for short-term borrowings for
the
years ended December 31:
|
2005
|
2004
|
||||||||||||
|
Amount
|
Rate
|
Amount
|
Rate
|
||||||||||
|
At
Year End:
|
|||||||||||||
|
Federal
Home Loan Bank advances
|
$
|
8,725,000
|
4.71
|
%
|
$
|
—
|
|||||||
|
Retail
repurchase agreements
|
27,122,600
|
2.51
|
27,106,241
|
.80
|
%
|
||||||||
|
Total
|
$
|
35,847,600
|
3.05
|
%
|
$
|
27,106,241
|
.80
|
%
|
|||||
|
Average
for the Year:
|
|||||||||||||
|
Federal
Home Loan Bank advances
|
$
|
3,990,474
|
4.92
|
%
|
$
|
—
|
—
|
||||||
|
Retail
repurchase agreements
|
24,803,383
|
2.00
|
%
|
25,107,183
|
0.82
|
%
|
|||||||
|
Other
short-term borrowings
|
—
|
—
|
483,000
|
1.62
|
%
|
||||||||
|
Maximum
Month-end Balance:
|
|||||||||||||
|
Federal
Home Loan Bank advances
|
$
|
8,725,000
|
$
|
—
|
|||||||||
|
Retail
repurchase agreements
|
27,122,600
|
30,845,388
|
|||||||||||
|
Other
short-term borrowings
|
—
|
—
|
|||||||||||
Securities
sold under agreements to repurchase are securities sold to customers, at the
customers’ request, under a “roll-over” contract that matures in one business
day. The underlying securities sold are Government agency securities, which
are
segregated in the Company’s custodial accounts from other investment securities.
The
Company may periodically borrow from a correspondent federal funds line of
credit arrangement, under a secured reverse repurchase agreement, or from the
Federal Home Loan Bank to meet short-term liquidity needs.
NOTE
11. LONG-TERM DEBT
As
of
December 31, the Company had long-term borrowings from the Federal Home Loan
Bank as follows:
|
2005
|
2004
|
||||||
|
FHLB
4.67% Advance due in 2007
|
$
|
4,000,000
|
$
|
—
|
|||
|
FHLB
4.97% Advance due in 2006
|
—
|
5,000,000
|
|||||
The
Company has pledged its wholly-owned residential real estate mortgage loan
portfolio under a blanket floating lien as collateral for these
advances.
NOTE
12. BENEFIT
PLANS
401(k)
and Profit Sharing Plan
The
Company has a 401(k) and profit sharing plan covering substantially all
full-time employees. The plan calls for matching contributions by the Company,
and the Company makes discretionary contributions based on profits. Company
contributions to this plan included in expense totaled $968,914 (2005), $750,260
(2004), and $728,812 (2003).
The
Felton Bank 401(k) plan, covering substantially all full-time employees, was
merged into the Company’s 401(k) and profit sharing plan during 2005. No
contributions were made to the Felton Bank 401(k) plan in 2005; matching
contributions in 2004 totaled $10,244.
NOTE
13. STOCK OPTION PLANS
The
Company has two stock option plans whereby incentive and nonqualified stock
options may be granted periodically to directors, executive officers, and key
employees at the discretion of the Company’s Personnel Committee. The plans
provide for both immediate and graduated vesting schedules and originally
reserved 194,000 shares of common stock for grant. At December 31, 2005, a
total
of 53,966 shares remained available for grant under the plans. The plans were
adopted in 1998 and 1997 and the options granted have a life not to exceed
ten
years.
The
Company also has an Employee Stock Purchase Plan that was adopted in 1998 and
amended in 2003 that allows employees to receive options to purchase common
stock at an amount equivalent to 85% of the fair market value of the common
stock. As amended, the plan reserved 45,000 shares of common stock for issuance
under the plan. There were 25,144 shares available for grant under the plan
at
December 31, 2005.
Following
is a summary of changes in shares under option for all plans for the years
indicated:
|
Year
Ended December 31,
|
|||||||||||||
|
2005
|
2004
|
||||||||||||
|
Number
|
Weighted
Average
|
Number
|
Weighted
Average
|
||||||||||
|
of
Shares
|
Exercise
Price
|
of
Shares
|
Exercise
Price
|
||||||||||
|
Outstanding
at beginning of year
|
85,225
|
$
|
14.05
|
113,084
|
$
|
12.25
|
|||||||
|
Granted
|
—
|
—
|
5,979
|
24.98
|
|||||||||
|
Exercised
|
(30,339
|
)
|
10.14
|
(32,826
|
)
|
9.64
|
|||||||
|
Expired/Cancelled
|
(3,286
|
)
|
18.87
|
(1,012
|
)
|
20.49
|
|||||||
|
Outstanding
at end of year
|
51,600
|
$
|
16.03
|
85,225
|
$
|
14.05
|
|||||||
|
Weighted
average fair value of options granted during the year
|
|
|
$
|
—
|
$
|
8.26
|
|||||||
The
following summarizes information about options outstanding at December 31,
2005:
|
Options
Outstanding and Exercisable
|
||||||||||
|
Weighted
Average
|
||||||||||
|
Options
Outstanding
|
Remaining
|
|||||||||
|
Exercise
Price
|
Number
|
Number
|
Contract
Life
|
|||||||
|
$
8.78
|
24,495
|
24,495
|
.95
|
|||||||
|
32.00
|
4,000
|
4,000
|
3.05
|
|||||||
|
21.00
|
3,470
|
3,470
|
4.05
|
|||||||
|
19.75
|
15,110
|
7,360
|
6.42
|
|||||||
|
24.98
|
4,525
|
4,525
|
.68
|
|||||||
|
51,600
|
43,850
|
|||||||||
The
fair
value of stock options issued is measured on the date of grant and recognized
over the vesting period. The Company estimates the fair value of stock options
using the Black-Scholes option-pricing model with the following weighted average
assumptions for options granted during 2004 and 2003, there were no options
granted in 2005:
|
2004
|
2003
|
||||||
|
Dividend
yield
|
2.29
|
%
|
1.70
|
%
|
|||
|
Expected
volatility
|
27.60
|
%
|
20.00
|
%
|
|||
|
Risk
free interest
|
4.0
|
%
|
4.23
|
%
|
|||
|
Expected
lives (in years)
|
2.25
|
2.17
|
|||||
The
weighted average fair value of options granted was $8.26 per share in 2004
and
$7.12 per share in 2003.
NOTE
14. DEFERRED COMPENSATION
The
Company has a supplemental deferred compensation plan to provide retirement
benefits to its President and Chief Executive Officer. The plan calls for fixed
annual payments of $20,000 to be credited to the participant’s account. The
participant is 100% vested in amounts credited to his account. Contributions
to
the plan were $20,000 in 2005, 2004, and 2003.
Centreville
National Bank has agreements with certain of its directors under which they
have
deferred part of their fees and compensation. The amounts deferred are invested
in insurance policies, owned by the Company, on the lives of the respective
individuals. Amounts available under the policies are to be paid to the
individuals as retirement benefits over future years. Cash surrender values
and
the accrued benefit obligation included in other assets and other liabilities
at
December 31 are as follows:
|
2005
|
2004
|
||||||
|
Cash
surrender value
|
$
|
2,142,006
|
$
|
2,046,706
|
|||
|
Accrued
benefit obligations
|
895,021
|
820,719
|
|||||
NOTE
15. INCOME TAXES
Income
taxes included in the balance sheets as of December 31 are as
follows:
|
2005
|
2004
|
||||||
|
Federal
income taxes currently (receivable) payable
|
$
|
(105,328
|
)
|
$
|
263,652
|
||
|
State
income taxes currently payable
|
144,155
|
86,100
|
|||||
|
Deferred
income tax benefits
|
1,991,114
|
1,542,544
|
|||||
Components
of income tax expense for each of the three years ended December 31 are as
follows:
|
2005
|
2004
|
2003
|
||||||||
|
Currently
payable:
|
||||||||||
|
Federal
|
$
|
6,331,379
|
$
|
4,913,929
|
$
|
4,500,099
|
||||
|
State
|
1,158,737
|
918,988
|
826,384
|
|||||||
|
|
7,490,116
|
5,832,917
|
5,326,483
|
|||||||
|
Deferred
income tax benefits:
|
||||||||||
|
Federal
|
286,945
|
5,399
|
(50,635
|
)
|
||||||
|
State
|
77,249
|
2,308
|
(10,147
|
)
|
||||||
|
364,194
|
7,707
|
(60,782
|
)
|
|||||||
|
$
|
7,854,310
|
$
|
5,840,624
|
$
|
5,265,701
|
|||||
A
reconciliation of tax computed at the statutory federal tax rates of 35% to
the
actual tax expense for the three years ended December 31 follows:
|
2005
|
2004
|
2003
|
||||||||
|
Tax
at federal statutory rate
|
35.0
|
%
|
35.0
|
%
|
35.0
|
%
|
||||
|
Tax
effect of:
|
||||||||||
|
Tax-exempt
income
|
(1.0
|
)
|
(1.5
|
)
|
(2.0
|
)
|
||||
|
Non-deductible
expenses
|
.1
|
.2
|
.1
|
|||||||
|
State
income taxes, net of federal benefit
|
3.8
|
3.7
|
3.6
|
|||||||
|
Other
|
—
|
(1.0
|
)
|
(1.0
|
)
|
|||||
|
Income
tax expense
|
37.9
|
%
|
36.4
|
%
|
35.7
|
%
|
||||
Significant
components of the Company’s deferred tax assets and liabilities as of December
31 are as follows:
|
2005
|
2004
|
||||||
|
Deferred
tax assets:
|
|||||||
|
Allowance
for credit losses
|
$
|
2,001,691
|
$
|
1,735,196
|
|||
|
Provision
for off balance sheet commitments
|
108,063
|
57,850
|
|||||
|
Net
operating loss carryforward
|
92,315
|
303,137
|
|||||
|
Deferred
gain on sale leaseback
|
60,741
|
-
|
|||||
|
Unrealized
losses on available for sale securities
|
781,534
|
172,169
|
|||||
|
Recognized
loss on impaired securities
|
44,043
|
304,671
|
|||||
|
Recognized
loss on other real estate owned
|
37,249
|
-
|
|||||
|
Loan
fees
|
155,187
|
75,182
|
|||||
|
Deferred
compensation
|
349,607
|
313,528
|
|||||
|
Total
deferred tax assets
|
3,630,430
|
2,961,733
|
|||||
|
Deferred
tax liabilities:
|
|||||||
|
Depreciation
|
423,488
|
363,979
|
|||||
|
Purchase
accounting adjustments
|
584,097
|
635,149
|
|||||
|
Federal
Home Loan Bank stock dividend
|
28,243
|
27,613
|
|||||
|
Undistributed
income of unconsolidated subsidiary
|
74,875
|
69,345
|
|||||
|
Loan
origination fees and costs
|
464,264
|
288,934
|
|||||
|
Other
|
64,349
|
34,169
|
|||||
|
Total
deferred tax liabilities
|
1,639,316
|
1,419,189
|
|||||
|
Net
deferred tax assets
|
$
|
1,991,114
|
$
|
1,542,544
|
|||
The
Company had unused net operating loss carryforward of approximately $264,134
and
$816,000 at December 31, 2005 and 2004, respectively, that resulted from the
acquisition of The Felton Bank in 2004. In accordance with current tax laws,
the
Company is allowed to utilize the loss carryforward over a 20-year period
beginning in 2004. The Company expects to utilize the entire loss
carryforward.
NOTE
16. EARNINGS PER COMMON SHARE
Basic
earnings per share is derived by dividing net income available to common
stockholders by the weighted-average number of common shares outstanding and
does not include the effect of any potentially dilutive common stock
equivalents. Diluted earnings per share is derived by dividing net income by
the
weighted-average number of shares outstanding, adjusted for the dilutive effect
of outstanding stock options and warrants. For the years ended December 31,
2005
and 2004, options to purchase 4,000 shares of common stock were excluded from
computing diluted earnings per share because their effects were
antidilutive.
|
2005
|
2004
|
2003
|
||||||||
|
Basic:
|
||||||||||
|
Net
income (applicable to common stock)
|
$
|
12,888,213
|
$
|
10,198,201
|
$
|
9,495,695
|
||||
|
Average
common shares outstanding
|
5,536,401
|
5,482,928
|
5,376,618
|
|||||||
|
Basic
earnings per share
|
$
|
2.33
|
$
|
1.86
|
$
|
1.77
|
||||
|
Diluted:
|
||||||||||
|
Net
income (applicable to common stock)
|
$
|
12,888,213
|
$
|
10,198,201
|
$
|
9,495,695
|
||||
|
Average
common shares outstanding
|
5,536,401
|
5,482,928
|
5,376,618
|
|||||||
|
Diluted
effect of stock options
|
25,355
|
47,230
|
72,303
|
|||||||
|
Average
common shares outstanding - diluted
|
5,561,756
|
5,530,158
|
5,448,921
|
|||||||
|
Diluted
earnings per share
|
$
|
2.32
|
$
|
1.84
|
$
|
1.74
|
||||
NOTE
17. REGULATORY
CAPITAL REQUIREMENTS
The
Company and each of The Talbot Bank of Easton, Maryland (“Talbot Bank”),
Centreville National Bank, and The Felton Bank (Talbot Bank, Centreville
National Bank and The Felton Bank are collectively referred to in this Note
as
the “Banks”) are subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory - and possibly additional discretionary - actions
by regulators, that, if undertaken, could have a direct material effect on
the
Company’s financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Banks must meet specific
capital guidelines that involve quantitative measures of the Banks’ assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Banks’ capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative
measures established by regulation to ensure capital adequacy require the Banks
to maintain amounts and ratios (set forth in the table below) of total and
Tier
1 capital (as defined in the regulations) to risk-weighted assets (as defined),
and of Tier 1 capital (as defined) to average assets. Management believes as
of
December 31, 2005 that the Company and the Banks met all capital adequacy
requirements to which they are subject.
As
of
December 31, 2005, the most recent notification from the Federal Deposit
Insurance Corporation and the Office of the Comptroller of the Currency
categorized the Banks as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Banks
must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. At December 31, 2004, The Felton Bank did not meet
the minimum total risk-based ratio to be categorized as well capitalized under
the framework for prompt corrective action. The Company has made additional
capital contributions to The Felton Bank to achieve the minimum required total
risk based capital ratio. Management knows of no trends or demands, commitments,
events or uncertainties that are likely to have a material adverse impact on
the
ability of the Company or any of the Banks to remain in the well capitalized
category.
Capital
levels and ratios for Shore Bancshares, Inc., Talbot Bank, Centreville National
Bank and The Felton Bank as of December 31, 2005 and 2004, compared with the
minimum requirements, are presented below:
|
To
Be Well
|
|||||||||||||||||||
|
For
Capital
|
Capitalized
Under
|
||||||||||||||||||
|
Adequacy
|
Prompt
Corrective
|
||||||||||||||||||
|
Actual
|
Purposes
|
Action
Provisions
|
|||||||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||||||
|
As
of December 31, 2005:
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
|||||||||||||||||||
|
Company
|
$
|
94,631,000
|
13.85
|
%
|
$
|
54,675,360
|
8.00
|
%
|
$
|
68,344,200
|
10.00
|
%
|
|||||||
|
Talbot
Bank
|
$
|
53,659,000
|
12.92
|
%
|
$
|
33,231,280
|
8.00
|
%
|
$
|
41,539,100
|
10.00
|
%
|
|||||||
|
The
Centreville National Bank
|
$
|
29,653,000
|
14.49
|
%
|
$
|
16,366,400
|
8.00
|
%
|
$
|
20,458,000
|
10.00
|
%
|
|||||||
|
The
Felton Bank
|
$
|
6,067,000
|
10.02
|
%
|
$
|
4,846,000
|
8.00
|
%
|
$
|
6,057,500
|
10.00
|
%
|
|||||||
|
Tier
1 Capital (to Risk Weighted Assets):
|
|||||||||||||||||||
|
Company
|
$
|
89,104,000
|
13.04
|
%
|
$
|
27,336,680
|
4.00
|
%
|
|||||||||||
|
Talbot
Bank
|
$
|
50,374,000
|
12.13
|
%
|
$
|
16,615,640
|
4.00
|
%
|
$
|
24,923,460
|
6.00
|
%
|
|||||||
|
Centreville
National Bank
|
$
|
27,988,000
|
13.68
|
%
|
$
|
8,183,200
|
4.00
|
%
|
$
|
12,274,800
|
6.00
|
%
|
|||||||
|
The
Felton Bank
|
$
|
5,490,000
|
9.06
|
%
|
$
|
2,423,000
|
4.00
|
%
|
$
|
3,634,500
|
6.00
|
%
|
|||||||
|
Tier
1 Capital (to Average Assets):
|
|||||||||||||||||||
|
Company
|
$
|
89,104,000
|
10.68
|
%
|
$
|
33,361,640
|
3.00
|
%
|
|||||||||||
|
Talbot
Bank
|
$
|
50,374,000
|
10.85
|
%
|
$
|
18,575,360
|
3.00
|
%
|
$
|
23,219,200
|
5.00
|
%
|
|||||||
|
Centreville
National Bank
|
$
|
27,988,000
|
9.56
|
%
|
$
|
11,707,160
|
3.00
|
%
|
$
|
14,633,950
|
5.00
|
%
|
|||||||
|
The
Felton Bank
|
$
|
5,490,000
|
7.67
|
%
|
$
|
2,861,400
|
4.00
|
%
|
$
|
3,576,750
|
5.00
|
%
|
|||||||
|
As
of December 31, 2004:
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
|||||||||||||||||||
|
Company
|
$
|
87,229,000
|
13.86
|
%
|
$
|
50,338,000
|
8.00
|
%
|
$
|
62,922,500
|
10.00
|
%
|
|||||||
|
Talbot
Bank
|
$
|
49,620,000
|
12.65
|
%
|
$
|
31,383,040
|
8.00
|
%
|
$
|
39,228,800
|
10.00
|
%
|
|||||||
|
Centreville
National Bank
|
$
|
27,691,000
|
14.69
|
%
|
$
|
15,085,280
|
8.00
|
%
|
$
|
18,856,600
|
10.00
|
%
|
|||||||
|
The
Felton Bank
|
$
|
4,478,000
|
9.68
|
%
|
$
|
3,700,240
|
8.00
|
%
|
$
|
4,625,300
|
10.00
|
%
|
|||||||
|
Tier
1 Capital (to Risk Weighted Assets):
|
|||||||||||||||||||
|
Company
|
$
|
82,385,000
|
13.04
|
%
|
$
|
25,169,000
|
4.00
|
%
|
|||||||||||
|
Talbot
Bank
|
$
|
46,857,000
|
11.94
|
%
|
$
|
15,691,520
|
4.00
|
%
|
$
|
23,537,280
|
6.00
|
%
|
|||||||
|
Centreville
National Bank
|
$
|
26,121,000
|
13.85
|
%
|
$
|
7,542,640
|
4.00
|
%
|
$
|
11,313,960
|
6.00
|
%
|
|||||||
|
The
Felton Bank
|
$
|
3,967,000
|
8.09
|
%
|
$
|
1,850,000
|
4.00
|
%
|
$
|
2,775,180
|
6.00
|
%
|
|||||||
|
Tier
1 Capital (to Average Assets):
|
|||||||||||||||||||
|
Company
|
$
|
82,385,000
|
10.67
|
%
|
$
|
30,885,600
|
3.00
|
%
|
|||||||||||
|
Talbot
Bank
|
$
|
46,857,000
|
10.76
|
%
|
$
|
17,411,920
|
3.00
|
%
|
$
|
21,764,900
|
5.00
|
%
|
|||||||
|
Centreville
National Bank
|
$
|
26,121,000
|
9.61
|
%
|
$
|
10,871,480
|
3.00
|
%
|
$
|
13,589,350
|
5.00
|
%
|
|||||||
|
The
Felton Bank
|
$
|
3,967,000
|
6.58
|
%
|
$
|
2,410,200
|
4.00
|
%
|
$
|
3,012,750
|
5.00
|
%
|
|||||||
Federal
and state laws and regulations applicable to banks and their holding companies
impose certain restrictions on dividend payments by the Banks, as well as
restricting extensions of credit and transfers of assets between the Banks
and
the Company. At December 31, 2005, the Banks could have paid dividends to the
Company of approximately $10,978,000 without the prior consent and approval
of
the regulatory agencies. The Company had no outstanding receivables from
subsidiaries at December 31, 2005 or 2004.
NOTE
18. LINES OF CREDIT
The
Banks
had $20,500,000 in unsecured federal funds lines of credit and a reverse
repurchase agreement available on a short-term basis from correspondent banks
at
December 31, 2005. In addition, the Banks have credit availability of
approximately $128,907,000 from the Federal Home Loan Bank. The Banks have
pledged as collateral, under blanket lien, all qualifying residential loans
under borrowing agreements with the Federal Home Loan Bank. At December 31,
2005
and 2004, the Federal Home Loan Bank had issued a letter of credit in the
amounts of $20,000,000 on behalf of the Talbot Bank to a local government entity
as collateral for its deposits. The Banks had short-term borrowings from the
Federal Home Loan Bank of $8,725,000 at December 31, 2005. There were no
short-term advances outstanding from the Federal Home Loan Bank at December
31,
2004.
NOTE
19.
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The
following methods and assumptions were used to estimate the fair value of each
class of financial instruments for which it is practicable to estimate that
value:
Cash
and Cash Equivalents
For
short-term instruments, the carrying amount is a reasonable estimate of fair
value.
Investment
Securities
For
all
investments in debt securities, fair values are based on quoted market prices.
If a quoted market price is not available, fair value is estimated using quoted
market prices for similar securities.
Loan
Receivables
The
fair
value of categories of fixed rate loans, such as commercial loans, residential
mortgage, and other consumer loans is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same remaining maturities. Other loans,
including variable rates loans, are adjusted for differences in loan
characteristics.
Financial
Liabilities
The
fair
value of demand deposits, savings accounts, and certain money market deposits
is
the amount payable on demand at the reporting date. The fair value of
fixed-maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities. These estimates do not
take into consideration the value of core deposit intangibles. The fair value
of
securities sold under agreements to repurchase and long-term debt is estimated
using the rates offered for similar borrowings.
Commitments
to Extend Credit and Standby Letters of Credit
The
majority of the Company’s commitments to grant loans and standby letters of
credit are written to carry current market interest rates if converted to loans.
Because commitments to extend credit and letters of credit are generally
unassignable by the Company or the borrower, they only have value to the Company
and the borrower and therefore it is impractical to assign any value to these
commitments.
The
estimated fair values of the Company’s financial instruments, excluding
goodwill, as of December 31 are as follows:
|
2005
|
2004
|
||||||||||||
|
Estimated
|
Estimated
|
||||||||||||
|
Carrying
|
Fair
|
Carrying
|
Fair
|
||||||||||
|
Amount
|
Value
|
Amount
|
Value
|
||||||||||
|
Financial
assets:
|
|||||||||||||
|
Cash
and cash equivalents
|
$
|
67,459,024
|
$
|
67,459,000
|
$
|
43,551,070
|
$
|
43,551,000
|
|||||
|
Investment
securities
|
121,070,139
|
120,986,000
|
119,095,896
|
119,236,000
|
|||||||||
|
Loans
|
627,463,129
|
627,493,000
|
594,458,139
|
599,331,000
|
|||||||||
|
Less:
allowance for loan losses
|
(5,235,670
|
)
|
(5,236,000
|
)
|
(4,692,202
|
)
|
(4,692,000
|
)
|
|||||
|
$
|
810,756,622
|
$
|
810,702,000
|
$
|
752,412,903
|
$
|
757,426,000
|
||||||
|
Financial
liabilities:
|
|||||||||||||
|
Deposits
|
$
|
704,958,386
|
$
|
694,600,000
|
$
|
658,672,354
|
$
|
653,693,000
|
|||||
|
Short-term
borrowings
|
35,847,600
|
35,855,000
|
27,106,241
|
27,106,000
|
|||||||||
|
Long-term
debt
|
4,000,000
|
3,970,000
|
5,000,000
|
5,114,000
|
|||||||||
|
$
|
744,805,986
|
$
|
734,425,000
|
$
|
690,778,595
|
$
|
685,913,000
|
||||||
|
Unrecognized
financial instruments:
|
|||||||||||||
|
Commitments
to extend credit
|
$
|
199,569,000
|
$
|
—
|
$
|
181,067,000
|
$
|
—
|
|||||
|
Standby
letters of credit
|
14,594,000
|
—
|
22,021,000
|
—
|
|||||||||
|
|
$
|
214,163,000
|
$
|
—
|
$
|
203,088,000
|
$
|
—
|
|||||
NOTE
20. FINANCIAL
INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In
the
normal course of business, to meet the financing needs of its customers, the
Banks are parties to financial instruments with off-balance sheet risk. These
financial instruments include commitments to extend credit and standby letters
of credit. The Banks’ exposure to credit loss in the event of nonperformance by
the other party to these financial instruments is represented by the contractual
amount of the instruments. The Banks use the same credit policies in making
commitments and conditional obligations as they do for on-balance sheet
instruments. The Banks generally require collateral or other security to support
the financial instruments with credit risk. The amount of collateral or other
security is determined based on management’s credit evaluation of the
counterparty. The Banks evaluate each customer’s creditworthiness on a
case-by-case basis.
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Letters of credit are
conditional commitments issued by the Company to guarantee the performance
of a
customer to a third party. Letters of credit and other commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Because many of the letters of credit and commitments are expected
to
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements.
Commitments
outstanding as of December 31 are as follows:
|
2005
|
2004
|
||||||
|
Commitments
to extend credit
|
$
|
199,569,000
|
$
|
181,067,000
|
|||
|
Letters
of credit
|
14,594,000
|
22,021,000
|
|||||
|
$
|
214,163,000
|
$
|
203,088,000
|
||||
NOTE
21. CONTINGENCIES
In
the
normal course of business, the Company and its subsidiaries may become involved
in litigation arising from banking, financial, and other activities. Management,
after consultation with legal counsel, does not anticipate that the future
liability, if any, arising out of current proceedings will have a material
effect on the Company’s financial condition, operating results, or
liquidity.
NOTE
22. PARENT
COMPANY FINANCIAL INFORMATION
Condensed
financial information for Shore Bancshares, Inc. (Parent Company Only) is as
follows:
Condensed
Balance Sheets
December
31, 2005 and 2004
|
2005
|
2004
|
||||||
|
Assets:
|
|
||||||
|
Cash
|
$
|
813,274
|
$
|
790,710
|
|||
|
Investment
in subsidiaries
|
97,817,595
|
91,967,166
|
|||||
|
Income
taxes receivable
|
516,989
|
451,254
|
|||||
|
Premises
and equipment, net
|
2,873,795
|
2,882,676
|
|||||
|
Other
assets
|
149,421
|
83,865
|
|||||
|
Total
assets
|
$
|
102,171,074
|
$
|
96,175,671
|
|||
|
Liabilities:
|
|||||||
|
Accounts
payable
|
$
|
335,147
|
$
|
112,883
|
|||
|
Deferred
tax liability
|
387,752
|
287,135
|
|||||
|
Earn-out
payment payable
|
—
|
2,800,000
|
|||||
|
722,899
|
3,200,018
|
||||||
|
Stockholders’
equity:
|
|||||||
|
Common
stock
|
55,570
|
55,152
|
|||||
|
Additional
paid in capital
|
29,013,842
|
28,016,571
|
|||||
|
Retained
earnings
|
73,641,882
|
65,182,004
|
|||||
|
Accumulated
other comprehensive loss
|
(1,263,119
|
)
|
(278,074
|
)
|
|||
|
Total
stockholders’ equity
|
101,448,175
|
92,975,653
|
|||||
|
Total
liabilities and stockholders’ equity
|
$
|
102,171,074
|
$
|
96,175,671
|
|||
Condensed
Statements of Income
For
the
years ended December 31, 2005, 2004 and 2003
|
2005
|
2004
|
2003
|
||||||||
|
Dividends
from subsidiaries
|
$
|
6,928,207
|
$
|
7,665,535
|
$
|
6,773,560
|
||||
|
Management
and other fees from subsidiaries
|
2,577,344
|
2,174,187
|
1,315,960
|
|||||||
|
Gain
on sales of securities
|
—
|
—
|
80,000
|
|||||||
|
Rental
Income
|
124,530
|
97,771
|
33,333
|
|||||||
|
Other
investment income
|
—
|
—
|
11,000
|
|||||||
|
Interest
income
|
4,471
|
5,754
|
3,033
|
|||||||
|
9,634,552
|
9,943,247
|
8,216,886
|
||||||||
|
Salaries
and employee benefits
|
2,033,298
|
1,572,973
|
770,933
|
|||||||
|
Occupancy
expense
|
223,322
|
202,256
|
143,164
|
|||||||
|
Other
operating expenses
|
797,786
|
513,232
|
403,089
|
|||||||
|
3,054,406
|
2,288,461
|
1,317,186
|
||||||||
|
Income
before income tax benefit and
|
||||||||||
|
equity
in undistributed income of subsidiary
|
6,580,146
|
7,654,786
|
6,899,700
|
|||||||
|
Income
tax expense
|
177,407
|
396,717
|
489,819
|
|||||||
|
Income
before equity in undistributed income of subsidiary
|
6,402,739
|
7,258,069
|
6,409,881
|
|||||||
|
Equity
in undistributed income of subsidiary
|
6,485,474
|
2,940,132
|
3,085,814
|
|||||||
|
Net
income
|
$
|
12,888,213
|
$
|
10,198,201
|
$
|
9,495,695
|
||||
Condensed
Statements of Cash Flows
For
the
years ended December 31, 2005, 2004 and 2003
|
2005
|
2004
|
2003
|
||||||||
|
Cash
flows from operating activities:
|
||||||||||
|
Net
income
|
$
|
12,888,213
|
$
|
10,198,201
|
$
|
9,495,695
|
||||
|
Adjustments
to reconcile net income to cash provided by operating
activities:
|
||||||||||
|
Equity
in undistributed (income)\loss of subsidiaries
|
(6,485,474
|
)
|
(2,940,132
|
)
|
(3,085,815
|
)
|
||||
|
Gain
on sale of investment securities
|
—
|
—
|
(80,000
|
)
|
||||||
|
Depreciation
|
91,348
|
75,098
|
34,716
|
|||||||
|
Net
(increase) decrease in other assets
|
(131,291
|
)
|
155,059
|
(30,231
|
)
|
|||||
|
Net
increase (decrease) in other liabilities
|
222,881
|
112,479
|
180,871
|
|||||||
|
Net
cash provided by operating activities
|
6,585,677
|
7,600,705
|
6,515,236
|
|||||||
|
Cash
flows from investing activities:
|
||||||||||
|
Proceeds
from sale of investment securities
|
—
|
—
|
360,000
|
|||||||
|
Acquisition,
net of stock issued
|
—
|
(3,724,645
|
)
|
—
|
||||||
|
Purchase
of premises and equipment
|
(82,466
|
)
|
(150,019
|
)
|
(2,877,543
|
)
|
||||
|
Deferred
earn out payment, net of stock issued
|
(2,400,000
|
)
|
—
|
—
|
||||||
|
Investment
in subsidiaries
|
(250,000
|
)
|
—
|
(53,711
|
)
|
|||||
|
Net
cash used by investing activities
|
(2,732,466
|
)
|
(3,874,664
|
)
|
(2,571,254
|
)
|
||||
|
Cash
flows from financing activities:
|
||||||||||
|
Proceeds
from issuance of common stock
|
597,688
|
279,275
|
290,308
|
|||||||
|
Dividends
paid
|
(4,428,335
|
)
|
(3,948,218
|
)
|
(3,548,410
|
)
|
||||
|
Net
cash used by financing activities
|
(3,830,647
|
)
|
(3,668,943
|
)
|
(3,258,102
|
)
|
||||
|
Net
increase in cash and cash equivalents
|
22,564
|
57,098
|
685,880
|
|||||||
|
Cash
and cash equivalents at beginning of year
|
790,710
|
733,612
|
47,732
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
813,274
|
$
|
790,710
|
$
|
733,612
|
||||
NOTE
23. QUARTERLY FINANCIAL RESULTS (unaudited)
A
summary
of selected consolidated quarterly financial data for the two years ended
December 31, 2005 is reported as follows:
|
First
|
Second
|
Third
|
Fourth
|
||||||||||
|
(In
thousands, except per share data)
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
|||||||||
|
2005
|
|||||||||||||
|
Interest
income
|
$
|
10,807
|
$
|
11,490
|
$
|
12,236
|
$
|
12,851
|
|||||
|
Net
interest income
|
8,277
|
8,730
|
9,065
|
9,413
|
|||||||||
|
Provision
for credit losses
|
180
|
180
|
220
|
230
|
|||||||||
|
Income
before income taxes
|
4,966
|
5,509
|
5,010
|
5,258
|
|||||||||
|
Net
Income
|
$
|
3,106
|
$
|
3,501
|
$
|
3,142
|
$
|
3,139
|
|||||
|
Basic
earnings per common share
|
$
|
0.56
|
$
|
0.63
|
$
|
0.57
|
$
|
0.57
|
|||||
|
Diluted
earnings per common share
|
$
|
0.56
|
$
|
0.63
|
$
|
0.56
|
$
|
0.57
|
|||||
|
2004
|
|||||||||||||
|
Interest
income
|
$
|
8,550
|
$
|
9,345
|
$
|
9,981
|
$
|
10,415
|
|||||
|
Net
interest income
|
6,422
|
7,087
|
7,704
|
8,068
|
|||||||||
|
Provision
for credit losses
|
105
|
100
|
165
|
561
|
|||||||||
|
Income
before income taxes
|
3,982
|
4,053
|
4,569
|
3,435
|
|||||||||
|
Net
Income
|
$
|
2,516
|
$
|
2,600
|
$
|
2,935
|
$
|
2,147
|
|||||
|
Basic
earnings per common share
|
$
|
0.47
|
$
|
0.47
|
$
|
0.53
|
$
|
0.39
|
|||||
|
Diluted
earnings per common share
|
$
|
0.46
|
$
|
0.47
|
$
|
0.53
|
$
|
0.39
|
|||||
Earnings
per share are based upon quarterly results and may not be additive to the annual
earnings per share amounts.
NOTE
24. LINE OF BUSINESS RESULTS
The
Company operates two primary businesses: Community Banking and Insurance
Products and Services. The Community Banking business provides services to
consumers and small businesses on the Eastern Shore of Maryland through its
fifteen branch network. Community banking activities include small business
services, retail brokerage, trust services and consumer banking products and
services. Loan products available to consumers include mortgage, home equity,
automobile, marine, and installment loans, credit cards and other secured and
unsecured personal lines of credit. Small business lending includes commercial
mortgages, real estate development loans, equipment and operating loans, as
well
as secured and unsecured lines of credit, credit cards, accounts receivable
financing arrangements, and merchant card services.
A
full
range of insurance products and services are available to businesses and
consumers in the Company’s market. Products include property and casualty, life,
marine, individual health and long term care insurance. Pension and profit
sharing plans and retirement plans for executives and employees are available
to
suit the needs of individual businesses.
Selected
financial information by line of business is included in the following
table:
|
Community
|
Insurance
products
|
Parent
|
Intercompany
|
Consolidated
|
||||||||||||
|
(In
thousands)
|
banking
|
and
services
|
Company
|
Transactions
|
Total
|
|||||||||||
|
2005
|
||||||||||||||||
|
Net
Interest income
|
$
|
35,481
|
$
|
—
|
$
|
4
|
$
|
—
|
$
|
35,485
|
||||||
|
Provision
for credit losses
|
810
|
—
|
—
|
—
|
810
|
|||||||||||
|
Net
interest income after provision
|
34,671
|
—
|
4
|
—
|
34,675
|
|||||||||||
|
Noninterest
income
|
5,011
|
6,620
|
2,702
|
(2,835
|
)
|
11,498
|
||||||||||
|
Noninterest
expense
|
19,386
|
5,826
|
3,054
|
(2,835
|
)
|
25,431
|
||||||||||
|
Income
before taxes
|
20,296
|
794
|
(348
|
)
|
—
|
20,742
|
||||||||||
|
Income
tax expense(benefit)
|
7,678
|
314
|
(138
|
)
|
—
|
7,854
|
||||||||||
|
Net
income
|
$
|
12,618
|
$
|
480
|
$
|
(210
|
)
|
$
|
—
|
$
|
12,888
|
|||||
|
Average
assets
|
$
|
809,987
|
$
|
9,857
|
$
|
3,476
|
$
|
—
|
$
|
823,320
|
||||||
|
2004
|
||||||||||||||||
|
Net
Interest income
|
$
|
29,275
|
$
|
—
|
$
|
5
|
$
|
—
|
$
|
29,280
|
||||||
|
Provision
for credit losses
|
931
|
—
|
—
|
—
|
931
|
|||||||||||
|
Net
interest income after provision
|
28,344
|
—
|
5
|
—
|
28,349
|
|||||||||||
|
Noninterest
income
|
3,586
|
6,617
|
2,272
|
(2,251
|
)
|
10,224
|
||||||||||
|
Noninterest
expense
|
16,875
|
5,622
|
2,288
|
(2,251
|
)
|
22,534
|
||||||||||
|
Income
before taxes
|
15,055
|
995
|
(11
|
)
|
—
|
16,039
|
||||||||||
|
Income
tax expense
|
5,452
|
393
|
(4
|
)
|
—
|
5,841
|
||||||||||
|
Net
income
|
$
|
9,603
|
$
|
602
|
$
|
(7
|
)
|
—
|
$
|
10,198
|
||||||
|
Average
assets
|
$
|
764,000
|
$
|
7,610
|
$
|
3,270
|
—
|
$
|
774,880
|
|||||||
None.
The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the Company’s reports filed under
the Exchange Act with the SEC, such as this annual report, is recorded,
processed, summarized and reported within the time periods specified in those
rules and forms, and that such information is accumulated and communicated
to
the Company’s management, including the President and Chief Executive Officer
(“CEO”) and the Principal Accounting Officer (“PAO”), as appropriate, to allow
for timely decisions regarding required disclosure. A control system, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. These
inherent limitations include the realities that judgments in decision-making
can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions; over time, control may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures
may
deteriorate.
An
evaluation of the effectiveness of these disclosure controls, as of December
31,
2005, was carried out under the supervision and with the participation of the
Company’s management, including the CEO and the PAO. Based on that evaluation,
the Company’s management, including the CEO and the PAO, has concluded that the
Company’s disclosure controls and procedures are effective.
During
the fourth quarter of 2005, there was no change in the Company’s internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, the Company’s internal control over financial
reporting.
As
required by Section 404 of the Sarbanes-Oxley Act of 2002, management has
performed an evaluation
and
testing of the Corporation’s internal control over financial reporting as of
December 31, 2005. Management’s report on the Company’s internal control over
financial reporting and the related attestation report of the Company’s
independent registered public accounting firm are included on the following
pages.
MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The
Company’s management is responsible for the preparation, integrity and fair
presentation of the consolidated financial statements included in this annual
report. The Company’s consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
of
America and, as such, include some amounts that are based on the best estimates
and judgments of management.
The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting. This internal control system is
designed to provide reasonable assurance to management and the Board of
Directors regarding the reliability of the Company’s financial reporting and the
preparation and presentation of financial statements for external reporting
purposes in conformity with accounting principles generally accepted in the
United States of America, as well as to safeguard assets from unauthorized
use
or disposition. The system of internal control over financial reporting is
evaluated for effectiveness by management and tested for reliability through
a
program of internal audit with actions taken to correct potential deficiencies
as they are identified. Because of inherent limitations in any internal control
system, no matter how well designed, misstatement due to error or fraud may
occur and not be detected, including the possibility of the circumvention or
overriding of controls. Accordingly, even an effective internal control system
can provide only reasonable assurance with respect to financial statement
preparation. Further, because of changes in conditions, internal control
effectiveness may vary over time.
Management
assessed the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2005 based upon criteria set
forth in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
Based
on
this assessment and on the foregoing criteria, management has concluded that,
as
of December 31, 2005, the Company’s internal control over financial reporting is
effective. Stegman
and Company, the Company’s independent registered public accounting firm that
audited the financial statements included in this annual report, has issued
an
attestation report on management’s assessment of the Company’s internal control
over financial reporting, which
appears on the following page.
March
7,
2006
|
/s/
W. Moorhead Vermilye
|
/s/Susan
E. Leaverton
|
|
|
W.
Moorhead Vermilye
|
Susan
E. Leaverton
|
|
|
President
and Chief Executive Officer
|
Principal
Accounting Officer
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The
Board
of Directors and Stockholders
Shore
Bancshares, Inc.
We
have
audited management's assessment, included in the preceding Management's Report
on Internal Control Over Financial Reporting, that Shore Bancshares, Inc. (the
"Company") maintained effective internal control over financial reporting as
of
December 31, 2005, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
The
Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion
on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing
such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that: (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, management's assessment that the Company maintained effective internal
control over financial reporting as of December 31, 2005, is fairly stated,
in
all material respects, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
Also,
in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2005, based on
criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
We
have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company’s consolidated balance sheets as of
December 31, 2005 and 2004 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, 2005 and our report dated March 7, 2006 expressed
an unqualified opinion on those consolidated financial statements.
/s/
Stegman and Company
Baltimore,
Maryland
March
7,
2006
None.
The
Company has adopted a Code of Ethics that applies to all of its directors,
officers, and employees, including its principal executive officer, principal
financial officer, principal accounting officer, or controller, or persons
performing similar functions. A written copy of the Company’s Code of Ethics
will be provided to stockholders, free of charge, upon request to: Carol I.
Brownawell, Secretary, Shore Bancshares, Inc., 18 E. Dover Street, Easton,
Maryland 21601 or (410) 822-1400.
All
other
information required by this item is incorporated herein by reference to the
Company’s definitive proxy statement to be filed in connection with the 2006
Annual Meeting of Stockholders.
The
information required by this item is incorporated herein by reference to the
Company’s definitive proxy statement to be filed in connection with the 2006
Annual Meeting of Stockholders.
The
information provided in Item 5 of Part II of this report under the heading
“EQUITY COMPENSATION PLAN INFORMATION” is incorporated herein by reference. All
other information required by this item is incorporated herein by reference
to
the Company’s definitive proxy statement to be filed in connection with the 2006
Annual Meeting of Stockholders.
The
information required by this item is incorporated herein by reference to the
Company’s definitive proxy statement to be filed in connection with the 2006
Annual Meeting of Stockholders.
The
information required by this item is incorporated herein by reference to the
Company’s definitive proxy statement to be filed in connection with the 2006
Annual Meeting of Stockholders.
(a)(1),(2)
Financial statements and schedules:
(3)
Exhibits required to be filed by Item 601 of Regulation S-K:
|
3.1
|
Amended
and Restated Articles of Incorporation (incorporated by reference
to
Exhibit 3.1 of the Company’s Form 8-K filed on December 14,
2000).
|
|
|
3.2
|
Amended
and Restated By-Laws (incorporated by reference to Exhibit 3.2 of
the
Company’s Form 8-K filed on November 9, 2005).
|
|
|
10.1
|
Form
of Employment Agreement with W. Moorhead Vermilye (incorporated by
reference to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed
on July 31, 2000).
|
|
|
10.2
|
Form
of Employment Agreement with Daniel T. Cannon (incorporated by reference
to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed on July
31, 2000).
|
|
|
10.3
|
Form
of Employment Agreement with Thomas H. Evans, as amended on November
3,
2005 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K
filed on November 9, 2005).
|
|
|
10.4
|
Separation
Agreement and General Release between The Avon-Dixon Agency, LLC
and
Steven Fulwood (incorporated by reference to exhibit 10.11 of the
Company’s Quarterly Report on Form 10-Q for the period ended March 31,
2005).
|
|
|
10.5
|
Form
of Executive Supplemental Retirement Plan Agreement between The
Centreville National Bank of Maryland and Daniel T. Cannon (incorporated
by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form
10-Q for the period ended June 30, 2003).
|
|
|
10.6
|
Form
of Life Insurance Endorsement Method Split Dollar Plan Agreement
between
The Centreville National Bank of Maryland and Daniel T. Cannon
(incorporated by reference to Exhibit 10.5 of the Company's Quarterly
Report on Form 10-Q for the period ended June 30,
2003).
|
|
|
10.7
|
Talbot
Bank of Easton, Maryland Supplemental Deferred Compensation Plan
(incorporated by reference to Exhibit 10.7 of the Company’s Quarterly
Report on Form 10-Q for the period ended September 30,
2005).
|
|
|
10.8
|
Talbot
Bank of Easton, Maryland Supplemental Deferred Compensation Plan
Trust
Agreement (incorporated by reference to Exhibit 10.7 of the Company’s
Quarterly Report on Form 10-Q for the period ended September 30,
2005).
|
|
|
10.9
|
1998
Employee Stock Purchase Plan, as amended (incorporated
by reference to Appendix A of the Company’s definitive Proxy Statement on
Schedule 14A for the 2003 Annual Meeting of Stockholders filed on
March
31, 2003).
|
|
|
10.10
|
1998
Stock Option Plan (incorporated by reference to Exhibit 10 of the
Company’s Registration Statement on Form S-8 filed with the SEC on
September 25, 1998 (Registration No. 333-64319)).
|
|
|
10.11
|
Talbot
Bancshares, Inc. Employee Stock Option Plan (incorporated by reference
to
Exhibit 10 of the Company’s Registration Statement on Form S-8 filed May
4, 2001 (Registration No. 333-60214)).
|
|
|
21
|
Subsidiaries
of the Company (incorporated by reference to the “BUSINESS—General”
section of Item 1 of Part I of this report).
|
|
|
Consent
of Stegman & Company (filed herewith).
|
||
|
Certifications
of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith).
|
||
|
Certifications
of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith).
|
||
|
Certification
of the CEO pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
herewith).
|
||
|
Certification
of the PAO pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
herewith).
|
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
| SHORE BANCSHARES, INC. | ||
| |
|
|
| Date: March 15, 2006 | By: | /s/ W. MOORHEAD VERMILYE |
|
|
||
|
Name:
W. Moorhead Vermilye
Title:
President and CEO
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
|
/s/
Herbert L. Andrew, III
|
Director
|
March
15, 2006
|
||
|
Herbert
L. Andrew, III
|
||||
|
/s/
Blenda W. Armistead
|
Director
|
March
15, 2006
|
||
|
Blenda
W. Armistead
|
||||
|
/s/
Lloyd L. Beatty, Jr.
|
Director
|
March
15, 2006
|
||
|
Lloyd
L. Beatty, Jr.
|
||||
|
/s/
Paul M. Bowman
|
Director
|
March
15, 2006
|
||
|
Paul
M. Bowman
|
||||
|
/s/
Daniel T. Cannon
|
Director
|
March
15, 2006
|
||
|
Daniel
T. Cannon
|
||||
|
/s/
Thomas H. Evans
|
Director
|
March
15, 2006
|
||
|
Thomas
H. Evans
|
||||
|
/s/
Mark Freestate
|
Director
|
March
15, 2006
|
||
|
Mark
Freestate
|
||||
|
/s/
Richard C. Granville
|
Director
|
March
15, 2006
|
||
|
Richard
C. Granville
|
||||
|
/s/
W. Edwin Kee, Jr.
|
Director
|
March
15, 2006
|
||
|
W.
Edwin Kee
|
||||
|
/s/
Neil R. LeCompte
|
Director
|
March
15, 2006
|
||
|
Neil
R. Le Compte
|
||||
|
/s/
Jerry F. Pierson
|
Director
|
March
15, 2006
|
||
|
Jerry
F. Pierson
|
||||
|
/s/
Christopher F. Spurry
|
Director
|
March
15, 2006
|
||
|
Christopher
F. Spurry
|
||||
|
/s/
W. Moorhead Vermilye
|
Director
|
March
15, 2006
|
||
|
W.
Moorhead Vermilye
|
President/CEO
|
|||
|
/s/
Susan E. Leaverton
|
Treasurer/Principal
Accounting Officer
|
March
15, 2006
|
||
|
Susan
E. Leaverton
|
|
Exhibit
No.
|
Description
|
|
|
Exhibit
3.1
|
Amended
and Restated Articles of Incorporation (incorporated by reference
to
Exhibit 3.1 of the Company’s Form 8-K filed on December 14,
2000).
|
|
|
Exhibit
3.2
|
Amended
and Restated By-Laws (incorporated by reference to Exhibit 3.2 of
the
Company’s Form 8-K filed on November 9, 2005).
|
|
|
Exhibit
10.1
|
Form
of Employment Agreement with W. Moorhead Vermilye (incorporated by
reference to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed
on July 31, 2000).
|
|
|
Exhibit
10.2
|
Form
of Employment Agreement with Daniel T. Cannon (incorporated by reference
to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed on July
31, 2000).
|
|
|
Exhibit
10.3
|
Form
of Employment Agreement with Thomas H. Evans, as amended on November
3,
2005 (incorporated
by reference to Exhibit 10.1 of the Company’s Form 8-K filed on November
9, 2005).
|
|
|
Exhibit
10.4
|
Separation
Agreement and General Release between The Avon-Dixon Agency, LLC
and
Steven Fulwood (incorporated by reference to exhibit 10.11 of the
Company’s Quarterly Report on Form 10-Q for the period ended March 31,
2005).
|
|
|
Exhibit
10.5
|
Form
of Executive Supplemental Retirement Plan Agreement between The
Centreville National Bank of Maryland and Daniel T. Cannon (incorporated
by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form
10-Q for the period ended June 30, 2003).
|
|
|
Exhibit
10.6
|
Form
of Life Insurance Endorsement Method Split Dollar Plan Agreement
between
The Centreville National Bank of Maryland and Daniel T. Cannon
(incorporated by reference to Exhibit 10.5 of the Company's Quarterly
Report on Form 10-Q for the period ended June 30,
2003).
|
|
|
Exhibit
10.7
|
Talbot
Bank of Easton, Maryland Supplemental Deferred Compensation Plan
(incorporated by reference to Exhibit 10.7 of the Company’s Quarterly
Report on Form 10-Q for the period ended September 30,
2005).
|
|
|
Exhibit
10.8
|
Talbot
Bank of Easton, Maryland Supplemental Deferred Compensation Plan
Trust
Agreement ((incorporated by reference to Exhibit 10.7 of the Company’s
Quarterly Report on Form 10-Q for the period ended September 30,
2005).
|
|
|
Exhibit
10.9
|
1998
Employee Stock Purchase Plan, as amended (incorporated
by reference to Appendix A of the Company’s definitive Proxy Statement on
Schedule 14A for the 2003 Annual Meeting of Stockholders filed on
March
31, 2003).
|
|
|
Exhibit
10.10
|
1998
Stock Option Plan (incorporated by reference to Exhibit 10 of the
Company’s Registration Statement on Form S-8 filed with the SEC on
September 25, 1998 (Registration No. 333-64319)).
|
|
|
Exhibit
10.11
|
Talbot
Bancshares, Inc. Employee Stock Option Plan (incorporated by reference
to
Exhibit 10 of the Company’s Registration Statement on Form S-8 filed May
4, 2001 (Registration No. 333-60214)).
|
|
|
Exhibit
21
|
Subsidiaries
of the Company ((incorporated by reference to the “BUSINESS—General”
section of Item 1 of Part I of this report).
|
|
|
Consent
of Stegman & Company (filed herewith).
|
||
|
Certifications
of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith).
|
||
|
Certifications
of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith).
|
||
|
Certification
of the CEO pursuant to Section
906 of the Sarbanes-Oxley Act (furnished
herewith).
|
||
|
Certification
of the PAO pursuant to Section
906 of the Sarbanes-Oxley Act (furnished
herewith).
|
-67-