[SANDY SPRING LOGO]
SANDY SPRING BANCORP, INC.
2002 ANNUAL REPORT
ON FORM 10-K/A
FORM 10-K/A
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 2002
Commission File Number 0-19065
SANDY SPRING BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Maryland 52-1532952
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
17801 Georgia Avenue, Olney, Maryland 20832
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 301-774-6400.
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by a check mark if the registrant is an accelerated filer.
YES X NO
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The registrant's Common Stock is traded on the NASDAQ National Market under the
symbol SASR. The aggregate market value of approximately 14,087,000 shares of
Common Stock of the registrant issued and outstanding held by nonaffiliates on
June 30, 2002, the last day of the registrant's most recently completed second
fiscal quarter, was approximately $453 million based on the closing sales price
of $32.15 per share of the registrant's Common Stock on that date. For purposes
of this calculation, the term "affiliate" refers to all directors and executive
officers of the registrant.
As of the close of business on February 11, 2003, approximately 14,542,000
shares of the registrant's Common Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Portions of the definitive proxy statement for the Annual Meeting of
Shareholders to be held on April 15, 2003 (the "Proxy Statement").
EXPLANATORY NOTE TO AMENDED REPORT ON FORM-10-K/A
On March 12, 2003, Sandy Spring Bancorp, Inc. (the "Company") filed its
annual report on Form 10-K for the year ended December 31, 2002. In November
2003, the Company discovered that accrued interest expense on certain Federal
Home Loan Bank ("FHLB") advances had been understated, beginning in the first
quarter of 1997. This accrual error was the result of a mistake in the interest
calculation formula for certain specific types of FHLB advances, and was
discovered as part of the Company's auditing process. The total amount of the
under-accrual for the year ended December 31, 2002, and prior periods is
$929,000 or $668,000 after applicable income taxes. The maximum effect on
diluted earnings per share in any affected year is less than one cent. Please
refer to footnote 23 to the audited financial statements for a summary of the
effects resulting from the restatement.
This amended Annual Report on Form 10-K/A corrects and restates the
Company's consolidated financial statements and other financial information for
all periods shown to properly reflect the effects of the under-accrual. The
financial statement items affected by the correction are accrued interest
payable and other liabilities, retained earnings, interest on short-term
borrowings, income tax expense, net income, basic and diluted earnings per
share, totals and other amounts that are calculated using those items, and the
related footnotes, including, without limitation, Note 22-Quarterly Financial
Results (unaudited). Related corrections also have been made to the Five Year
Summary of Selected Financial Data, and Management's Discussion and Analysis of
Financial Condition and Results of Operations.
3
SANDY SPRING BANCORP, INC.
INDEX
Forward-Looking Statements.........................................................................4
Form 10-K Cross Reference Sheet....................................................................5
Sandy Spring Bancorp, Inc..........................................................................6
About this Report..................................................................................6
Five Year Summary of Selected Financial Data.......................................................7
Securities Listing, Prices and Dividends...........................................................8
Management's Discussion and Analysis of Financial Condition and Results of Operations.............10
Consolidated Financial Statements.................................................................29
Notes to the Consolidated Financial Statements....................................................34
Management's Statement of Responsibility..........................................................58
Report of Independent Auditors....................................................................59
Other Material Required by Form 10-K:
Description of Business......................................................................60
Executive Officers..........................................................................69
Controls and Procedures.....................................................................70
Properties...................................................................................71
Exhibits, Financial Statements, and Reports on Form 8-K......................................73
Signatures...................................................................................75
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FORWARD-LOOKING STATEMENTS
Sandy Spring Bancorp makes forward-looking statements in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other portions of this Annual Report on Form 10-K that are
subject to risks and uncertainties. These forward-looking statements include:
statements of goals, intentions, and expectations; estimates of risks and of
future costs and benefits; assessments of probable loan and lease losses and
market risk; and statements of the ability to achieve financial and other goals.
These forward-looking statements are subject to significant uncertainties
because they are based upon or are affected by: management's estimates and
projections of future interest rates and other economic conditions; future laws
and regulations; and a variety of other matters which, by their nature, are
subject to significant uncertainties. Because of these uncertainties, Sandy
Spring Bancorp's actual future results may differ materially from those
indicated. In addition, the Company's past results of operations do not
necessarily indicate its future results.
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4
SANDY SPRINT BANCORP, INC.
FORM 10-K CROSS REFERENCE SHEET OF MATERIAL INCORPORATED BY REFERENCE
The following table shows the location in this Annual Report on Form 10-K or the
accompanying Proxy Statement of the information required to be disclosed by
United States Securities and Exchange Commission ("SEC") Form 10-K. Where
indicated below, information has been incorporated by reference in this Report
from the Proxy Statement that accompanies it. Other portions of the Proxy
Statement are not included in this Report. This Report is not part of the Proxy
Statement. References are to pages in this report unless otherwise indicated.
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ITEM OF FORM 10-K LOCATION
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PART I
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Item 1. Business "Forward-Looking Statements" on page 4, "Sandy Spring
Bancorp, Inc." and "About this Report" on page 6,
and "Business" on pages 53 through 62.
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Item 2. Properties "Properties" on pages 63 and 64.
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Item 3. Legal Proceedings Note 18 "Litigation" on page 46.
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Item 4. Submission of Matters to a Vote of Security Not applicable. No matter was submitted to a vote of
Holders security holders during the fourth quarter of 2002.
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PART II
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Item 5. Market for Registrant's Common Equity and "Securities Listing, Prices, and Dividends" on pages 8
Related Stockholder Matters and 9.
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Item 6. Selected Financial Data "Five Year Summary of Selected Financial Data" on
page 7.
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Item 7. Management's Discussion and Analysis of "Forward-Looking Statements" on page 4 and
Financial Condition and Results of Operations "Management's Discussion and Analysis of Financial
Condition and Results of Operations" on pages 10
through 26.
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Item 7A. Quantitative and Qualitative Disclosures about "Forward-Looking Statements" on page 4 and "Market
Market Risk Risk Management" on pages 24 through 26.
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Item 8. Financial Statements and Supplementary Data Pages 27 through 53.
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Item 9. Changes in and Disagreements with Not applicable. During the past two years or any
Accountants on Accounting and Financial subsequent period there has been no change in or
Disclosure reportable disagreement with the certifying accountants
for Sandy Spring Bancorp or any of its subsidiaries.
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PART III
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Item 10. Directors and Executive Officers of the The material labeled "Election of
Registrant Directors--Information as to Nominees and Continuing
Directors" and "Compliance with Section 16(a) of the
Securities Exchange Act of 1934" in the Proxy Statement
is incorporated in this Report by reference.
Information regarding executive officers is included
under the caption "Executive Officers" on pages 61 and
62 of this Report.
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Item 11. Executive Compensation The material labeled "Corporate Governance and Other
Matters," "Executive Compensation," "Report of the Human
Resources Committee," and "Stock Performance
Comparisons" in the Proxy Statement is incorporated in
this Report by reference.
-------------------------------------------------------------- -------------------------------------------------------
Item 12. Security Ownership of Certain Beneficial "Equity Compensation Plan Information" on page 8 and
Owners and Management and Related Stockholder the material labeled "Stock Ownership of Directors
Matters and Executive Officers" in the Proxy Statement is
incorporated in this Report by reference.
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Item 13. Certain Relationships and Related The material labeled "Transactions and Relationships
Transactions with Management" in the Proxy Statement is
incorporated in this Report by reference.
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5
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ITEM OF FORM 10-K LOCATION
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Item 14. Controls and Procedures "Controls and Procedures" on page 62.
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PART IV
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Item 15. Exhibits, Financial Statement Schedules, "Exhibits, Financial Statements, and Reports on
and Reports on Form 8-K on Form 8-K" pages 64 and 65.
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SIGNATURES "Signatures" on page 66.
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CERTIFICATIONS "Certifications" on pages 67 and 68.
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SANDY SPRING BANCORP, INC.
Sandy Spring Bancorp, Inc. is the holding company for Sandy Spring Bank and its
principal subsidiaries, Sandy Spring Insurance Corporation and The Equipment
Leasing Company. Sandy Spring Bancorp is the third largest publicly traded
banking company headquartered in Maryland. Sandy Spring is a community banking
organization that focuses its lending and other services on businesses and
consumers in the local market area. Independent and community-oriented, Sandy
Spring Bank traces its origin to 1868 and offers a broad range of commercial
banking, retail banking and trust services through 30 community offices and 45
ATMs located in Anne Arundel, Frederick, Howard, Montgomery, and Prince George's
counties in Maryland.
ABOUT THIS REPORT
This report comprises the entire 2002 Form 10-K, other than exhibits, as filed
with the SEC. The 2002 annual report to shareholders, including this report, and
the annual proxy materials for the 2003 annual meeting are being distributed
together to the shareholders. Please see page 65 or information regarding how to
obtain copies of exhibits and additional copies of the Form 10-K.
This report is provided along with the annual proxy statement for convenience of
use and to decrease costs, but is not part of the proxy materials.
THE SEC HAS NOT APPROVED OR DISAPPROVED THIS REPORT OR PASSED UPON ITS ACCURACY
OR ADEQUACY.
6
FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data) 2002 2001 2000 1999 1998
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RESULTS OF OPERATIONS:
Interest income $ 122,722 $ 127,870 $ 118,680 $ 94,387 $ 84,272
Interest expense 44,113 61,262 61,486 42,227 38,849
Net interest income 78,609 66,608 57,194 52,160 45,423
Provision for credit losses 2,865 2,470 2,690 1,216 552
Net interest income after provision for credit
losses 75,744 64,138 54,504 50,944 44,871
Noninterest income, excluding securities gains 27,713 21,490 17,251 12,230 11,270
Securities gains 2,016 346 277 101 853
Noninterest expenses 63,961 54,618 47,601 39,528 34,053
Income before taxes 41,512 31,356 24,431 23,747 22,941
Income tax expense 10,927 8,342 5,798 6,330 6,936
Net income 30,585 23,014 18,633 17,417 16,005
PER SHARE DATA:
Net income - basic $ 2.11 $ 1.60 $ 1.30 $ 1.21 $ 1.11
Net income - diluted 2.08 1.58 1.30 1.20 1.10
Dividends declared 0.69 0.61 0.54 0.50 0.42
Book value (at year end) 12.25 10.37 8.87 7.49 7.70
Tangible book value (at year end) (1) 10.76 8.69 7.22 6.08 7.62
FINANCIAL CONDITION (AT YEAR END):
Assets $2,307,404 $2,081,834 $1,773,001 $1,591,281 $1,343,471
Deposits 1,492,212 1,387,459 1,242,927 1,165,372 954,571
Loans and leases 1,063,853 995,919 967,817 826,125 624,412
Securities 1,046,258 914,479 666,927 630,039 613,579
Borrowings 613,714 525,248 392,368 312,096 271,392
Stockholders' equity 178,024 150,133 127,150 108,449 110,765
PERFORMANCE RATIOS (FOR THE YEAR):
Return on average equity 18.89% 16.32% 16.72% 15.85% 14.94%
Return on average assets 1.42 1.18 1.11 1.25 1.35
Net interest margin 4.23 3.96 4.01 4.34 4.39
Efficiency ratio - GAAP based (2) 59.04 61.75 63.70 61.29 59.18
Efficiency ratio - traditional (2) 54.13 55.28 56.64 56.15 56.05
Dividends declared per share to diluted net
income per share 33.17 38.36 41.22 41.32 37.84
CAPITAL AND CREDIT QUALITY RATIOS:
Average equity to average assets 7.49% 7.24% 6.66% 7.90% 9.01%
Allowance for credit losses to loans and leases 1.41 1.27 1.19 1.00 1.18
Non-performing assets to total assets 0.12 0.38 0.16 0.13 0.13
Net charge-offs to average loans and leases 0.05 0.14 0.08 0.05 0.04
(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) See the discussion of the efficiency ratio in the section of Management's
Discussion and Analysis of Financial Condition and Results of Operations
entitled "Operating Expense Performance".
7
SECURITIES LISTING, PRICES AND DIVIDENDS
STOCK LISTING
Common shares of Sandy Spring Bancorp, Inc. are traded on the National
Association of Security Dealers (NASDAQ) National Market under the symbol SASR.
Trust preferred securities of Sandy Spring Capital Trust I are traded on the
NASDAQ National Market under the symbol SASRP.
TRANSFER AGENT AND REGISTRAR
American Stock Transfer and Trust Company
59 Maiden Lane
New York, New York 10038
RECENT STOCK PRICES AND DIVIDENDS
Shareholders received quarterly cash dividends totaling $10,012,000 in 2002 and
$8,881,000 in 2001. Regular dividends have been declared for one hundred and two
consecutive years. Sandy Spring Bancorp, Inc. (the "Company") has increased its
dividends per share each year for the past twenty-two years. Since 1997,
dividends per share have risen at a compound annual growth rate of 17%. The
increase in dividends per share was 13% in 2002.
The ratio of dividends per share to diluted net income per share was 33% in
2002, compared to 38% for 2001. The dividend amount is established by the Board
of Directors each quarter. In making its decision on dividends, the Board
considers operating results, financial condition, capital adequacy, regulatory
requirements, shareholder returns and other factors.
Shares issued under the employee stock purchase plan, which commenced on July 1,
2001, totaled 14,841 in 2002 and 5,931 in 2001, while issuances pursuant to the
stock option plan were 39,529 and 79,521 in the respective years. The following
table presents disclosure regarding equity compensation plans in existence at
December 31, 2002, consisting only of the 1992 stock option plan (expired but
having outstanding options that may still be exercised) and the 1999 stock
option plan, both of which were approved by the shareholders (described further
in Note 12 to the consolidated financial statements).
Equity Compensation Plan Information
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Plan category Number of securities to be Weighted average exercise Number of securities
issued upon exercise of price of outstanding remaining available for
outstanding options, options, warrants and future issuance under
warrants and rights rights equity compensation plans
(a) (b) excluding securities
reflected in column (a)
(c)
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Equity compensation plans
approved by security holders 675,126 $22.41 1,000,599
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Equity compensation plans not
approved by security holders 0 0 0
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Total 675,126 $22.41 1,000,599
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8
The Company has a stock repurchase program that permits the repurchase of up to
5% (approximately 718,000 shares) of its outstanding common stock. Repurchases
are made in connection with shares expected to be reissued under the Company's
stock option and benefit plans, as well as for other corporate purposes. A total
of 952,409 shares have been repurchased since 1997, when stock repurchases
began, through December 31, 2002. No shares were repurchased in either 2002 or
2001.
The number of common shareholders of record was approximately 2,300 as of
February 11, 2003.
QUARTERLY STOCK INFORMATION
2002 2001
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STOCK PRICE RANGE PER SHARE Stock Price Range Per Share
Quarter LOW HIGH DIVIDEND Low High Dividend
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1st $ 27.90 $ 32.45 $ 0.17 $ 15.17 $ 21.67 $ 0.14
2nd 30.70 35.19 0.17 19.50 21.83 0.15
3rd 29.20 35.00 0.17 20.80 26.46 0.15
4th 28.24 32.88 0.18 25.24 32.82 0.17
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Total $ 0.69 $ 0.61
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9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Sandy Spring Bancorp, Inc. and subsidiaries (the "Company") achieved record
earnings in both the fourth quarter and for the year ended December 31, 2002. In
addition, according to the latest Bank Holding Company Performance Report from
the Federal Reserve, the Company's return on average equity for the nine months
ended September 30, 2002, was in the 85th percentile of all U.S. bank holding
companies with assets between $1-3 billion.
Net income for the year ended December 31, 2002, was $30.6 million ($2.08 per
diluted share), as compared to $23.0 million ($1.58 per diluted share) for the
prior year, an increase of 33%.
The Company's results in 2002, versus 2001, reflected significant growth in
average earning assets and an increase in the net interest margin, resulting in
higher net interest income, the largest revenue category. Noninterest income
continued to increase and diversify, reflecting a 36% increase over the prior
year. This increase was primarily due to increases in securities gains, mortgage
banking income and commissions from the Bank's insurance agency, Chesapeake
Insurance Group, which was acquired at the end of 2001. Expressed as a
percentage of net interest income and noninterest income, noninterest income
increased to 27% from 18% five years ago. With respect to operating cost
management, the Company's efficiency ratio - GAAP based improved to 59.04% in
2002 from 61.75% in 2001 and 63.70% in 2000, while the efficiency ratio -
traditional also improved over the three year period, to 54.13% (2002) from
55.28% (2001) and 56.64% (2000). For an explanation of the efficiency ratio -
GAAP based, as compared to the efficiency ratio - traditional, see the section
of this report entitled "Operating Expense Performance". The return on average
equity was 18.89% in 2002, as compared to 16.32% in 2001 and 16.72% in 2000.
Comparing December 31, 2002, balances to December 31, 2001, total assets were
$2.3 billion versus $2.1 billion, an 11% increase. Total deposits increased 8%
to $1.5 billion, while total loans and leases grew to $1.1 billion from $996
million, a 7% increase. During the same period, stockholders' equity increased
to $178 million or 7.7% of total assets.
Asset quality, as measured by the following ratios, continued to be favorable.
Non-performing assets represented 0.12% of total assets at year-end 2002, versus
0.38% at year-end 2001. This decrease was due substantially to a lower level of
non-performing loans and leases in the fourth quarter of 2002, reflecting the
payment in full of a single credit that had been classified as non-performing.
The ratio of net charge-offs to average loans and leases was 0.05% in 2002, as
compared to 0.14% for the prior year.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") and follow general practices within the industry 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.
10
The allowance for credit losses is an estimate of the losses that may be
sustained in the loan and lease portfolio. The allowance is based on two basic
principles of accounting: (1) Statement of Financial Accounting Standards
("SFAS") No. 5, "Accounting for Contingencies", which requires that losses be
accrued when they are probable of occurring and estimable, and (2) SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan", which requires that losses
be accrued when it is probable that the Company will not collect all principal
and interest payments according to the loan's or lease's contractual terms.
Management believes that the allowance is adequate. However, its determination
requires significant judgment, and estimates of probable losses inherent in the
credit portfolio can vary significantly from the amounts actually observed.
While management uses available information to recognize probable losses, future
additions to the allowance may be necessary based on changes in the credits
comprising the portfolio and changes in the financial condition of borrowers,
such as may result from changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process, and
independent consultants engaged by the Company, periodically review the credit
portfolio and the allowance. Such review may result in additional provisions
based on their judgments of information available at the time of each
examination.
The Company's allowance for credit losses has three basic components: the
formula allowance reflecting historical losses by credit category, specific
allowances, and a nonspecific allowance resulting from evaluation of other
factors relating to the portfolio. Each of these components, and the systematic
allowance methodology used to establish them, are described in detail in Note 1
of the Notes to the Consolidated Financial Statements. The amount of the
allowance is reviewed monthly by the Senior Loan Committee, and reviewed and
approved quarterly by the Board of Directors.
The portion of the allowance that is based upon historical losses establishes
allowances for the major loan categories based upon their respective historical
loss experience over the prior eight quarters, weighted so that losses realized
in the most recent quarters have the greatest effect. This component comprised
4% of the total allowance at December 31, 2002. The Company has historically had
low levels of realized losses on its loan and lease portfolio. The formula
allowance is the most objective component since the factors used in the
methodology are related to actual losses in the past. It is, therefore, intended
to narrow differences between estimated and realized losses.
The specific allowance is used primarily to establish allowances for risk rated
credits on an individual or portfolio basis, and accounted for 24% of the total
allowance at December 31, 2002. The Company has historically had favorable
credit quality. The actual occurrence and severity of losses involving risk
rated credits can differ substantially from estimates, and some risk rated
credits may not be identified. A 10% decrease in risk rated credits not
specifically reserved would have resulted in a corresponding decrease of
approximately $95,000 in the recommended reserve computed by the allowance
methodology for December 31, 2002. If the 2002 provision for credit losses had
then been reduced by this amount, net income would have been approximately
$57,000 higher than reported.
A nonspecific allowance establishes allowances based upon evaluations of a
number of factors whose effects are not directly measured in determining the
other two components. The evaluation of the inherent loss resulting from these
factors involves a higher degree of uncertainty because they are not identified
with either historical results or specific problem credits or portfolio
segments. The required analysis is regularly and carefully undertaken by
management, and the risk factors are revised as conditions indicate. This
component was responsible for 69% of the total allowance at December 31, 2002. A
10% decrease in values assigned to judgmentally-derived risk factors utilized in
establishing the nonspecific allowance would have resulted in a corresponding
decrease of approximately $609,000 in the recommended reserve computed by the
allowance methodology for December 31, 2002. If the 2002 provision for credit
losses had then been reduced by this amount, net income would have been
approximately $368,000 higher than reported.
11
TABLE 1 - CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES (1)
(DOLLARS IN THOUSANDS AND TAX EQUIVALENT)
2002 2001 2000
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AVERAGE YIELD/ Average Yield/ Average Yield/
BALANCE INTEREST RATE Balance Interest Rate Balance Interest Rate
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ASSETS
Loans and leases (2)
Residential real estate(3) $ 366,472 $ 24,145 6.59% $ 332,693 $ 25,183 7.57 $ 290,225 $ 23,260 8.01
Consumer 231,831 13,781 5.94 213,163 15,923 7.47 203,066 17,231 8.49
Commercial loans and
leases 458,535 35,760 7.80 451,801 39,457 8.73 389,936 35,553 9.12
---------------------- ---------------------- -----------------------
Total loans and leases 1,056,838 73,686 6.97 997,657 80,563 8.08 883,227 76,044 8.61
Securities:
Taxable 698,351 38,643 5.53 615,249 39,193 6.37 486,775 33,261 6.83%
Nontaxable 232,841 16,746 7.19 167,234 12,068 7.22 157,552 12,765 8.10
---------------------- ---------------------- -----------------------
Total securities 931,192 55,389 5.95 782,483 51,261 6.55 644,327 46,026 7.14
Interest-bearing
deposits with banks 1,546 21 1.36 2,665 88 3.30 1,872 112 5.98
Federal funds sold 33,872 546 1.61 29,811 1,172 3.93 25,608 1,649 6.44
---------------------- ---------------------- -----------------------
TOTAL EARNING ASSETS $2,023,448 $ 129,642 6.41% $1,812,616 $ 133,084 7.34% $1,555,034 $ 123,831 7.96%
Less: allowances for credit
losses (14,429) (11,874) (9,044)
Cash and due from banks 34,993 40,784 35,847
Premises and equipment, net 34,347 31,947 31,813
Other assets 82,248 73,385 58,969
---------- ---------- ----------
Total assets $2,160,607 $1,946,858 $1,672,619
========== ========== ==========
LIABILITIES AND
STOCKHOLDERS' EQUITY:
Interest-bearing demand
deposits $ 173,935 $ 550 0.32% $ 151,873 $ 1,191 0.78% $ 153,035 $ 1,664 1.09%
Regular savings deposits 143,357 1,163 0.81 104,496 1,568 1.50 105,221 2,112 2.01
Money market savings
deposits 386,571 4,582 1.19 366,759 10,894 2.97 304,501 12,816 4.21
Time deposits 427,943 13,538 3.16 426,464 21,944 5.15 427,627 23,163 5.42
---------------------- ---------------------- -----------------------
Total interest-bearing
deposits 1,131,806 19,833 1.75 1,049,592 35,597 3.39 990,384 39,755 4.01
Short-term borrowings 453,769 16,351 3.60 384,400 17,543 4.56 274,444 15,873 5.78
Long-term borrowings 117,252 7,929 6.76 113,415 8,122 7.16 74,659 5,858 7.85
---------------------- ---------------------- -----------------------
TOTAL INTEREST-BEARING
LIABILITIES 1,702,827 44,113 2.59 1,547,407 61,262 3.96 1,339,487 61,486 4.59
---------- ---------- ----------
Net interest income and
spread $ 85,529 3.82% $ 71,822 3.38% $ 62,345 3.37%
---------- ---------- ----------
Noninterest-bearing demand
deposits 280,839 245,408 215,111
Other liabilities 15,038 13,039 6,562
Stockholders' equity 161,903 141,004 111,459
---------- ---------- ----------
Total liabilities and
stockholders' equity $2,160,607 $1,946,858 $1,672,619
========== ========== ==========
Interest income/
earning assets 6.41% 7.34% 7.96%
Interest expense/
earning assets 2.18 3.38 3.95
------ ------ ------
Net interest margin 4.23% 3.96% 4.01%
====== ====== ======
(1) Interest income includes the effects of taxable-equivalent adjustments
(reduced by the nondeductible portion of interest expense) using the appropriate
marginal federal income tax rate of 35.00% and, where applicable, the marginal
state income tax rate of 7.00% (or a combined marginal federal and state rate of
39.55%), to increase tax-exempt interest income to a taxable-equivalent basis.
The taxable-equivalent adjustment amounts utilized in the above table to compute
yields aggregated to $6,920,000 in 2002, $5,214,000 in 2001, and $5,151,000 in
2000.
(2) Non-accrual loans are included in the average balances.
(3) Includes residential mortgage loans held for sale. Home equity loans and
lines are classified as consumer loans.
12
NET INTEREST INCOME
The largest source of operating revenue is net interest income, which is the
difference between the interest earned on earning assets and the interest paid
on interest-bearing liabilities.
Net interest income for 2002 was $78,609,000, representing an increase of
$12,001,000 or 18% from 2001. A 16% increase was achieved in 2001, compared to
2000, resulting in net interest income of $66,608,000.
For purposes of this discussion and analysis, the interest earned on tax-exempt
investment securities has been adjusted to an amount comparable to interest
subject to normal income taxes. The result is referred to as tax-equivalent
interest income and tax-equivalent net interest income.
The tabular analysis of net interest income performance (entitled "Table 1 -
Consolidated Average Balances, Yields and Rates") shows an increase in net
interest margin for 2002 of 27 basis points (representing a percentage change of
7% when compared to 2001). This increase reversed a two-year decline in net
interest margin from 1999 to 2001. Over the three-year period shown in Table 1,
average-earning assets increased each year, but at a declining rate of increase.
Table 2 shows the extent to which volume and rate increases each contributed to
the rise in tax-equivalent net interest income during 2002, compared to 2001,
while higher volume drove the increase in 2001, compared to 2000. The combined
effects of volume and rate increases during 2002 resulted in 19% higher
tax-equivalent net interest income (to $85,529,000 in 2002 from $71,822,000 in
2001), while the increase in volume produced a 15% annual increase in 2001 (from
$62,345,000 in 2000). Pressure on the net interest margin in recent years has
been an industry-wide trend and a significant challenge for management. It has
lead to greater sophistication in margin management and heightened emphasis on
growing noninterest revenues. During 2002, the Company was able to manage its
deposit rates such that it overcame the effect of calls of higher yielding
securities in the lower rate environment. Thus, there was margin improvement in
the second and third quarters. However, by the fourth quarter, the margin was
being compressed once more as deposit rates had been lowered close to their
practical floor.
TABLE 2 - EFFECT OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
2002 VS. 2001 2001 vs. 2000
--------------------------------------------------------------------------------------------------------------
INCREASE DUE TO CHANGE Increase Due to Change
OR IN AVERAGE:* or In Average:*
(In thousands and tax equivalent) (DECREASE) VOLUME RATE (Decrease) Volume Rate
--------------------------------------------------------------------------------------------------------------
Interest income from earning assets:
Loans and leases $ (6,877) $ 4,581 $(11,458) $ 4,520 $ 9,442 $ (4,922)
Taxable securities (550) 4,942 (5,492) 5,932 8,306 (2,374)
Nontaxable securities 4,678 4,718 (40) (697) 753 (1,450)
Other investments (693) 105 (798) (502) 280 (782)
-------- --------
Total interest income (3,442) 14,537 (17,979) 9,253 19,422 (10,169)
Interest expense on funding of earning
assets:
Interest-bearing demand deposits (641) 153 (794) (473) (13) (460)
Regular savings deposits (405) 463 (868) (544) (14) (530)
Money market savings deposits (6,312) 559 (6,871) (1,922) 2,305 (4,227)
Time deposits (8,406) 76 (8,482) (1,219) (63) (1,156)
Total borrowings (1,385) 3,443 (4,828) 3,934 8,046 (4,112)
-------- --------
Total interest expense (17,149) 5,654 (22,803) (224) 8,813 (9,037)
-------- -------- -------- -------- -------- --------
Net interest income $ 13,707 $ 8,883 $ 4,824 $ 9,477 $ 10,609 $ (1,132)
======== ======== ======== ======== ======== ========
*Variances are computed line-by-line and do not add to the totals shown. Where
volume and rate have a combined effect that cannot be separately identified
with either, the variance is allocated to volume and rate based on the
relative size of the variance that can be separately identified with each.
13
INTEREST INCOME
The Company's interest income decreased by $5,148,000 or 4.0% in 2002, compared
to 2001, preceded by an increase of $9,190,000 or 8% the prior year. On a
tax-equivalent basis, the respective changes were a 3% decline in 2002, as
contrasted with a 7% increase in 2001. Table 2 shows that, in 2002, the negative
effect of the significant decline in average earning asset yields overwhelmed
the positive effect of the higher volume of average earning assets. During 2001,
however, significantly higher average earning assets produced an increase in
interest income despite the decline in average rate.
During 2002, average loans and leases, yielding 6.97% versus 8.08% a year
earlier (representing a 14% decline), rose 6% to $1,056,838,000, with all three
major categories exhibiting growth. Average residential real estate loans rose
10% (attributable to both mortgage and construction lending), consumer loans
increased 9% (due to home equity products), and average commercial loans and
leases were up 1% (primarily reflecting a rise in commercial credits not secured
by real estate). In 2002, average loans and leases comprised 52% of average
earning assets, compared to ratios of 55% in 2001 and 57% in 2000. Average total
securities, yielding 5.95% in 2002 versus 6.55% last year, rose 19% to
$931,192,000. The smaller category of nontaxable securities rose by a much
greater percentage than taxable securities. Average total securities grew to
represent 46% of average earning assets in 2002, up from 43% in 2001 and 41% in
2000. The Company expanded its leverage activities during 2002, through which
growth in securities is funded by Federal Home Loan Bank of Atlanta borrowing
advances. The leveraging programs earned similar margins in 2002 and 2001, while
benefiting the return on average equity by 115 basis points and 105 basis points
in the respective years.
INTEREST EXPENSE
Interest expense decreased significantly by 28% or $17,149,000 in 2002, compared
to 2001, as a 137 basis point decline in the average rate paid on
interest-bearing liabilities (decreasing 35% to 2.59% from 3.96%) offset the
effects of 10% or $155,420,000 higher average interest-bearing liabilities. In
2001, compared to 2000, interest expense decreased slightly as the offsetting
effects of lower rates and higher volume were nearly equal.
During 2002, all major categories of interest-bearing deposits increased and
reported declines in average rate. While average time deposits grew the least,
by only 0.3%, they had the greatest effect on the overall decline in interest
expense (see Table 2). This was due to a 199 basis point decrease in average
rate, the largest decline of any category. Average money market savings, which
increased by 5%, also had a large impact, attributable to a 178 basis point
decrease in average rate. As market interest rates declined during 2002, the
Company was able to achieve growth in its deposit base, while significantly
lowering interest rates on deposit funding. This was a major factor in the
improvement in net interest margin for 2002 versus 2001. By contrast, while
declines in average rate paid for interest-bearing deposits were also achieved
in 2001, compared to 2000, growth in these deposits was essentially flat except
for an increase in average money market savings. Average short-term and
long-term borrowings, generally the most expensive funding sources, increased in
2002 by 18% and 3%, respectively, while showing declines in average rate paid.
INTEREST RATE PERFORMANCE
Net interest margin, the profit margin achieved on the Company's earning asset
base, increased by 27 basis points in 2002, as compared to an increase in net
interest spread of 44 basis points. The differential between these two
indicators of interest rate performance was attributable primarily to a decrease
in the benefit of funding average earning assets from interest-free sources,
which is reflected in the net interest margin. During periods of low interest
rates, as in 2002, the relative benefit of interest-free, versus
interest-bearing, funding sources on the net interest margin is diminished.
However, while contributing less to margin improvement, interest-free funding of
average earning assets, primarily through noninterest-bearing demand deposits
and stockholders' equity, increased as a percentage of average earning assets in
2002, compared to 2001, after remaining approximately the same in 2001, compared
to 2000. During 2002, the Company benefited from a greater relative decline in
the funding rate compared to the decline in the yield on earning assets,
resulting in an increase in the net interest margin and spread.
14
By comparison, in 2001 versus 2000, also in the face of a general decline in
interest rates, the Company reported a decrease in funding rates that only
matched the decline in earning asset yields, so that overall interest rate
performance declined slightly.
NONINTEREST INCOME
Total noninterest income was $29,729,000 in 2002, a 36% or $7,893,000 rise from
2001. An increase of 25% or $4,308,000 was recorded for 2001 versus 2000. The
Company has made it an organizational priority to grow and diversify its sources
of noninterest income and, as a result, has reported significant increases in
revenue from these sources. The major reason for the rise in noninterest income
for 2002, as compared to 2001 (comprising 38% of the overall increase) was
$3,038,000 of additional noninterest revenue generated by an insurance agency
(Chesapeake Insurance Group) acquired in December 2001. Other significant
contributors included gains of sales of mortgage loans (up $1,332,000), service
charges on deposit accounts (up $532,000), income from trust operations (up
$502,000) and items of other noninterest income such as loan prepayment fees (up
$534,000), in addition to higher securities gains (up $1,670,000). In the
comparison of total noninterest income for 2001 versus 2000, the increase
primarily reflected higher mortgage banking revenues, growth in service charges
on deposit accounts, and increases in various types of other noninterest income,
including those recorded for transaction-based service fees, bank owned life
insurance investments, and certain revenues of the Equipment Leasing Company
acquired in December 2000.
Securities gains were $2,016,000 in 2002, an increase of $1,670,000 from
$346,000 for 2001. Securities gains of $277,000 were recorded in 2000. During
2002, the sale of available-for-sale debt securities generated net gains of
$547,000, while gains of $1,469,000 were realized on sales of equity securities.
During 2001, sales of available-for-sale debt securities generated $142,000 in
net gains, compared to $204,000 in gains on sales of equity securities.
Service charges on deposit accounts increased 7% in 2002 and 22% in 2001. A
large part of the change in both years was attributable to growth in return
check charges and in commercial and small business account fees.
Gains on mortgage sales increased significantly by 51% or $1,332,000 in 2002,
compared to 2001, after more than doubling in 2001, compared to 2000.
Historically low mortgage interest rates prevailing during the two-year period
led to increased fixed-rate loan production, both from new loans and refinancing
business. Most of these loans were sold in the secondary market, resulting in
increased gains on sales. The Company achieved gains of $3,940,000 on sales of
$313,512,000 in 2002, compared to gains of $2,608,000 on sales of $222,303,000
in 2001 and gains of $1,058,000 on sales of $64,166,000 in 2000.
Fees on sales of investment products decreased by $92,000 or 4% in 2002,
compared to 2001, reflecting a decline in fees from sales of mutual funds.
However, commissions from annuity sales increased by a small percentage during
2002, and contributed much of the 32% rise in fees on sales of investment
products during 2001, compared to 2000.
Trust income amounted to $2,497,000 in 2002, an increase of $502,000 or 25% over
2001, reflecting increased assets under management and higher estate and trust
settlement administration fees. During 2002, trust assets under management rose
by 11% to $313,000,000 despite adverse investment markets, aided by strong sales
and better-than-market investment performance in managed accounts. Revenues of
$1,995,000 for 2001 represented an increase of $342,000 or 21% over 2000.
The Chesapeake Insurance Group, acquired in December 2001, contributed
significantly to the overall rise in noninterest revenues during 2002, its first
year of operation with the Company, as discussed previously. Income from bank
owned life insurance rose $243,000 during 2002, preceded by an increase of
$1,205,000 during 2001.
Other noninterest income increased $668,000 or 12% to $6,202,000 for 2002,
compared to $5,534,000 for 2001, primarily reflecting higher pre-payment charges
associated with commercial credits. The rise in other noninterest income was 10%
in 2001 over 2000, due in large part to noninterest revenues generated by the
Equipment Leasing Company acquired at the end of 2000 and a $256,000 gain on the
sale of the credit card portfolio.
15
NONINTEREST EXPENSES
Noninterest expenses increased $9,343,000 or 17% in 2002, compared to 2001, and
$7,017,000 or 15% in 2001, compared to 2000. The Company incurs additional costs
in order to enter new markets, provide new services, and support growth.
Management controls its operating expenses with the goal of maximizing
profitability over time.
The major categories of noninterest expenses include salaries and employee
benefits, occupancy and equipment expenses, marketing expenses, outside data
services costs, intangible asset amortization, and other noninterest expenses
generally associated with the day-to-day operations of the Company. Prior to
2002, goodwill amortization was also included in noninterest expenses.
Salaries and employee benefits, the largest component of noninterest expenses,
rose $8,976,000 or 30% in 2002, and $4,695,000 or 19% in 2001. The increase in
this category comprised 96% of the total increase reported for noninterest
expenses for 2002, compared to 2001. The higher compensation and benefit costs
shown for the three-year period from 2000 to 2002 resulted in large part from
incentive compensation, merit raises, modest branch expansion, and acquisitions
of the Equipment Leasing Company in December 2000 and the Chesapeake Insurance
Group in December 2001. Efficient staffing is a goal of management and staff
additions are made carefully with a view toward achieving gains in financial
performance. Average full-time equivalent employees reached 539 in 2002,
representing an increase of 13% from 475 in 2001, which was 5% above 452 for
2000. The ratio of net income per average full-time equivalent employee
increased to $57,000 in 2002, up from $49,000 in 2001 and $42,000 in 2000.
In 2002, occupancy expense rose 10% or $519,000, primarily reflecting higher
rental expenses, net of rental income, and increased depreciation and
amortization charges. The rate of increase was 7% or $311,000 in 2001,
attributable in large part to increased depreciation and amortization charges.
Equipment expenses rose 11% in 2002, preceded by an increase of 7% in 2001,
compared to each prior year, due largely to higher depreciation charges and
software costs (2002 versus 2001), and to increased software and equipment
servicing costs (2001 versus 2000). Marketing expense increased by $433,000 in
2002, representing a rate of 29%, following an increase of $192,000 or 15% the
prior year. Most of the rise in 2002 occurred in advertising costs. Outside data
services increased by only 3% in 2002, after decreasing in 2001 due to a
re-negotiation of the major provider contract.
Goodwill amortization ceased with the year ended 2001 due to adoption of the
non-amortization provisions of Statement of Financial Accounting Standards No.
142 (effective January 1, 2002). This new accounting standard resulted in a
reduction in noninterest expense in this category from $666,000 in 2001 to no
such expense in 2002. No intangible assets were acquired in 2002. In each year
over the three-year period from 2000 to 2002, goodwill and intangible asset
amortization comprised less than 6% of total noninterest expenses. The Company's
intangible assets are being amortized over relatively short amortization periods
averaging ten years at December 31, 2002. Intangible assets arising from branch
acquisitions were not classified as goodwill and continue to be amortized since
the acquisitions did not meet the definition for business combinations.
Other noninterest expenses of $9,000,000 were $516,000 or 5% below $9,516,000
recorded for 2001, due largely to a decline in consulting fees. The level of
consulting fees, primarily reflecting an efficiency study, was the single
largest contributor to the 15% or $1,268,000 rise in other noninterest expenses
in 2001, compared to 2000.
OPERATING EXPENSE PERFORMANCE
Management views the efficiency ratio as an important measure of expense
performance and cost management. The ratio expresses the level of noninterest
expenses as a percentage of total revenue (net interest income plus total
noninterest income). This is a GAAP financial measure. Lower ratios indicate
improved productivity.
NON-GAAP FINANCIAL MEASURE
The Company has for many years used a traditional efficiency ratio that is a
non-GAAP financial measure of operating expense control and efficiency of
operations. Management believes that its traditional ratio better focuses
attention on the operating performance of the Company over time than does a GAAP
based ratio, and is highly useful in comparing period-to-period operating
performance of the Company's core business operations. It is used by management
as part of its assessment of its performance in managing noninterest expenses.
However, this
16
measure is supplemental, and is not a substitute for an analysis of performance
based on GAAP measures. The reader is cautioned that the traditional efficiency
ratio used by the Company may not be comparable to GAAP or non-GAAP efficiency
ratios reported by other financial institutions.
In general, the efficiency ratio is noninterest expenses as a percentage of net
interest income plus noninterest income. Noninterest expenses used in the
calculation of the traditional, non-GAAP efficiency ratio exclude amortization
of goodwill and intangibles and non-recurring expenses. Income for the
traditional ratio is increased for the favorable effect of tax-exempt income
(see Table 1), and excludes securities gains and losses, which vary widely from
period to period without appreciably affecting operating expenses, and
non-recurring gains. The measure is different from the GAAP based efficiency
ratio, which also is presented in this report. The GAAP based measure is
calculated using noninterest expense and income amounts as shown on the face of
the Consolidated Statements of Income. The traditional and GAAP based efficiency
ratios are reconciled in Table 3. As shown in Table 3, both efficiency ratios,
GAAP based and traditional, improved in each of the last two years.
TABLE 3 - GAAP BASED AND TRADITIONAL EFFICIENCY RATIOS
(Dollars in thousands) 2002 2001 2000 1999 1998
-----------------------------------------------------------------------------------------------------------
Noninterest expenses - GAAP based $ 63,961 $ 54,618 $ 47,601 $ 39,528 $ 34,053
Net interest income plus noninterest income -
GAAP based 108,338 88,444 74,722 64,491 57,546
Efficiency ratio - GAAP based 59.04% 61.75% 63.70% 61.29% 59.18%
=========================================================
Noninterest expenses - GAAP based $ 63,961 $ 54,618 $ 47,601 $ 39,528 $ 34,053
Less non-GAAP adjustments:
Goodwill amortization 0 666 65 65 65
Amortization of intangible assets 2,659 2,512 2,759 919 306
Early retirement window option 0 0 744 0 0
---------------------------------------------------------
Noninterest expenses - traditional ratio 61,302 51,440 44,033 38,544 33,682
Net interest income plus noninterest income -
GAAP based 108,338 88,444 74,722 64,491 57,546
Plus non-GAAP adjustment:
Tax-equivalency 6,920 5,214 5,151 4,259 3,404
Less non-GAAP adjustments:
Securities gains 2,016 346 277 101 853
Gains on sales of assets 0 256 1,854 0 0
---------------------------------------------------------
Netinterest income plus noninterest
income - traditional ratio 113,242 93,056 77,742 68,649 60,097
Efficiency ratio - traditional 54.13% 55.28% 56.64% 56.15% 56.05%
=========================================================
PROVISION FOR INCOME TAXES
Income tax expense amounted to $10,927,000 in 2002, compared with $8,342,000 in
2001 and $5,798,000 in 2000. The resulting effective tax rates were 26% for
2002, 27% for 2001, and 24% for 2000.
BALANCE SHEET ANALYSIS
The Company's total assets reached $2,307,404,000 at December 31, 2002, an
increase of 11% or $225,570,000 from $2,081,834,000 at December 31, 2001.
Earning assets increased 11% or $219,800,000 in 2002, to $2,158,494,000 at
December 31, 2002, from $1,938,694,000 at the prior year-end.
17
LOANS AND LEASES
Residential real estate loans, comprised of residential construction and
residential mortgage categories, rose $14,876,000 or 4% during 2002, to
$354,673,000 at December 31, 2002. Residential construction loans, a specialty
of the Company for many years, declined in 2002 (down 13% or $11,956,000, to
$73,585,000 at December 31, 2002), largely reflecting market conditions and a
reduced wholesale lending initiative. Residential mortgages, most of which are
1-4 family, increased by $25,832,000 or 10%, to $281,088,000, largely due to
competitive pricing in the Bank's five-year adjustable rate mortgage product
which increased $56,286,000 or 47%.
The Company devotes significant resources and attention to seeking and then
serving commercial clients. Commercial loans and leases increased by $34,474,000
or 8% during 2002, to $476,014,000 at December 31, 2002. Included in this
category are commercial real estate loans, commercial construction loans, leases
and other commercial loans.
Over the years, the Company's commercial loan clients have come to represent a
diverse cross-section of small to mid-size local businesses, whose owners and
employees are often established Bank customers. Such banking relationships are a
natural business for the Company, with its long-standing community roots and
extensive experience in serving and lending to this market segment. In 2002, the
marketplace continued to be characterized by lower rates and significant
refinancing. Despite these market conditions, other commercial loans increased
by $24,908,000 or 21% during 2002 to $144,328,000 at year-end.
In general, the Company's commercial real estate loans consist of owner occupied
properties where an established banking relationship exists or, to a lesser
extent, involve investment properties for warehouse, retail, and office space
with a history of occupancy and cash flow. Commercial mortgages increased
$16,821,000 or 7% during 2002, to $257,118,000 at year-end. Commercial
construction credits declined $2,531,000 or 5% during the year, to $51,947,000
at December 31, 2002. The Company lends for commercial construction in markets
it knows and understands, works selectively with local, top-quality builders and
developers, and requires substantial equity from its borrowers.
The Company' equipment leasing business is, for the most part, technology based,
consisting of a portfolio of leases for items such as computers,
telecommunications systems and equipment, medical equipment, and point-of-sale
systems for retail businesses. Equipment leasing is conducted through vendors
located primarily in east coast states from New Jersey to Florida and in
Illinois. The typical lease is "small ticket" by industry standards, averaging
less than $30,000, with individual leases generally not exceeding $250,000. The
Company's equipment leasing business continued to suffer from clients' reduction
in capital spending throughout the most recent year. As a result, the leasing
portfolio declined $4,724,000 or 17% in 2002, to $22,621,000 at year-end.
Consumer lending continues to be very important to the Company's full-service,
community banking business. This category of loans includes primarily home
equity loans and lines, installment loans, personal lines of credit, and student
loans. The consumer loan portfolio rose 9% or $18,584,000 in 2002, to
$233,166,000 at December 31, 2002. This increase was driven largely by an
increase of $26,048,000 or 37% in home equity lines during 2002 to $95,818,000
at year-end. This growth was primarily a result of the Company's increased sales
culture emphasis and the continuing low rate environment.
18
TABLE 4 - ANALYSIS OF LOANS AND LEASES
This table presents the trends in the composition of the loan and lease
portfolio over the previous five years.
December 31,
---------------------------------------------------------------------------------------------
(In thousands) 2002 2001 2000 1999 1998
---------------------------------------------------------------------------------------------
Residential real estate:
Residential mortgages $ 281,088 $ 255,256 $ 266,511 $ 235,153 $ 152,764
Residential construction 73,585 84,541 44,078 34,721 38,856
Commercial loans and leases:
Commercial real estate 257,118 240,297 232,640 237,924 210,079
Commercial construction 51,947 54,478 60,312 42,256 33,092
Leases 22,621 27,345 31,304 0 0
Other commercial 144,328 119,420 119,130 92,674 79,259
Consumer 233,166 214,582 213,841 183,397 110,362
---------- ---------- ---------- ---------- ----------
Total loans and leases $1,063,853 $ 995,919 $ 967,817 $ 826,125 $ 624,412
========== ========== ========== ========== ==========
TABLE 5 - LOAN AND LEASE MATURITIES AND INTEREST RATE SENSITIVITY
At December 31, 2002
Remaining Maturities of Selected Credits in Years
---------------------------------------------------------------------------------------------
(In thousands) 1 or less Over 1-5 Over 5 Total
---------------------------------------------------------------------------------------------
Residential construction loans $ 73,294 $ 291 $ 0 $ 73,585
Commercial construction loans 51,947 0 0 51,947
Commercial loans not secured by real estate 85,905 46,294 12,129 144,328
-----------------------------------------
Total $211,146 $ 46,585 $ 12,129 $269,860
=========================================
Rate Terms:
Fixed $ 17,932 $ 45,632 $ 12,077 $ 75,641
Variable or adjustable 193,214 953 52 194,219
-----------------------------------------
Total $211,146 $ 46,585 $ 12,129 $269,860
=========================================
SECURITIES
The investment portfolio, consisting of available-for-sale, held-to-maturity and
other equity securities, increased 14% or $131,779,000 to $1,046,258,000 at
December 31, 2002, from $914,479,000 at December 31, 2001. This increase was due
to slower growth in outstanding loans, an increase in deposits, an increase in
leverage, and changes in interest rates. In 2002, the shape of the yield curve
changed with a significant decline in intermediate to long-term treasury rates.
The Company's overall policy is to maximize earnings and maintain liquidity
through an investment portfolio bearing low credit risk.
The asset mix within the investment portfolio shifted with increases in the
purchases of U.S. Agency and state and municipal obligations. This was
accomplished primarily to capture higher tax-equivalent yields. At December 31,
2002, mortgage backed securities declined to 2% of total investments, compared
to 14% at December 31, 2001, while the percentage for U. S. Agencies increased
to 63% from 58%. The Company's portfolio had approximately $299,177,000 in
municipal securities at year-end 2002, or 29% of the total portfolio, up from
21% in 2001. These are high-grade obligations held for their tax-exempt income.
19
The Company does not hedge through derivatives. The only derivatives are covered
call option contracts, held from time to time, incident to an established plan
to enhance the yield on certain of the Company's equity securities. These
derivatives do not expose the Company to credit risk, or to significant market
risk. The Company had no derivatives at December 31, 2002 or at December 31,
2001.
The Company's leverage programs, primarily investing in available-for-sale
securities, and funded either by Federal Home Loan Bank of Atlanta advances or
repurchase agreements with U. S. Government security dealers, are managed to
better utilize available capital to achieve higher returns on equity and
earnings per share. The percentage of the investment portfolio funded in this
manner increased to 33% at December 31, 2002, from 31% at December 31, 2001.
TABLE 6 - ANALYSIS OF SECURITIES
The composition of securities at December 31 for each of the latest three years
was:
(Dollars in thousands) 2002 2001 2000
------------------------------------------------------------------------------
Available-for-Sale: (1)
U.S. Agency $ 571,688 $ 522,308 $ 418,460
State and municipal 46,031 39,157 44,317
Mortgage-backed (2) 18,708 124,197 22,921
Corporate debt 16,757 11,878 3,148
Trust preferred 24,743 27,273 23,817
Marketable equity securities 7,659 7,816 5,198
---------- ---------- ----------
Total 685,586 732,629 517,861
Held-to-Maturity and Other Equity
U.S. Agency 87,714 9,995 22,020
State and municipal 253,146 154,926 112,859
Other equity securities 19,812 16,929 14,187
---------- ---------- ----------
Total 360,672 181,850 149,066
---------- ---------- ----------
Total securities (3) $1,046,258 $ 914,479 $ 666,927
========== ========== ==========
(1) At estimated fair value.
(2) Issued by a U. S. Government Agency or secured by U.S. Government Agency
collateral.
(3) The outstanding balance of no single issuer, except for U.S. Government and
U.S. Government Agency securities, exceeded ten percent of stockholders'
equity at December 31, 2002, 2001 or 2000.
20
Maturities and weighted average yields for debt securities available-for-sale
and held-to-maturity at December 31, 2002 are presented in Table 7. Amounts
appear in the table at amortized cost, without market value adjustments, by
stated maturity adjusted for estimated calls.
TABLE 7 - MATURITY TABLE FOR DEBT SECURITIES
Years to Maturity
-----------------------------------------------------------------------------------------------------------------------
Within Over 1 Over 5 Over
1 Through 5 Through 10 10
-----------------------------------------------------------------------------------------------------------------------
(In thousands) Amount Yield Amount Yield Amount Yield Amount Yield Total Yield
-----------------------------------------------------------------------------------------------------------------------
Debt Securities
Available-for-Sale
U. S. Agency $ 420,345 4.17% $ 141,057 4.84% $ 394 6.00% $ 0 0% $ 561,796 4.34%
State and
municipal 2,081 7.09 23,356 6.89 16,492 7.13 2,419 7.15 44,348 7.00
Mortgage-backed 5,184 7.29 10,640 5.88 456 4.51 1,798 6.18 18,078 6.28
Corporate debt 3,108 8.20 9,725 6.57 3,146 7.42 0 0 15,979 6.00
Trust preferred 1,512 6.24 13,864 9.72 6,237 9.29 1,650 8.23 23,263 9.27
---------- ---------- ---------- ---------- ----------
Total $ 432,230 4.26% $ 198,642 5.56% $ 26,725 7.61% $ 5,867 7.15% $ 663,464 4.81%
========== ========== ========== ========== ==========
Debt Securities
Held-to-Maturity
U. S. Agency $ 87,714 5.50% $ 0 0% $ 0 0% $ 0 0% $ 87,714 5.50%
State and
municipal 14,463 7.41 86,071 6.72 148,243 7.04 4,369 7.11 253,146 6.95
---------- ---------- ---------- ---------- ----------
Total $ 102,177 5.77% $ 86,071 6.72% $ 148,243 7.04% $ 4,369 7.11% $ 340,860 6.58%
========== ========== ========== ========== ==========
* Yields on state and municipal securities have been calculated on a
tax-equivalent basis using the applicable federal income tax rate.
OTHER EARNING ASSETS
Residential mortgage loans held for sale increased $21,753,000 in 2002.
Originations and sales of these loans, and the resulting gains on sales,
increased substantially during 2002 under favorable interest rate conditions.
The aggregate of federal funds sold and interest-bearing deposits with banks
decreased 14% or $1,666,000 in 2002.
DEPOSITS AND BORROWINGS
Total deposits were $1,492,212 at December 31, 2002, increasing $104,753,000 or
8% from $1,387,459,000 at December 31, 2001. Growth was achieved for
noninterest-bearing demand deposits, up $42,991,000 or 16%, with increases
recorded for both personal and business accounts. Interest-bearing deposits
increased $61,762,000 or 6%, attributable in large part to regular savings and
interest checking deposits, which increased by 41% (up $44,959,000) and 11% (up
$18,778,000), respectively.
Total borrowings increased $88,466,000 or 17% during 2002, to $613,714,000 at
December 31, 2002, primarily reflective of $58,111,000 in higher levels of
short-term and long-term advances from the Federal Home Loan Bank of Atlanta,
along with a $20,000,000 increase in federal funds purchased.
21
CAPITAL MANAGEMENT
Management monitors historical and projected earnings, dividends and asset
growth, as well as risks associated with the various types of on- and
off-balance sheet assets and liabilities, in order to determine appropriate
capital levels. During 2002, total stockholders' equity increased 19% or
$27,891,000 to $178,024,000 at December 31, 2002, from $150,133,000 at December
31, 2001. Internal capital generation (net income less dividends) was
responsible for most of this increase in total stockholders' equity. Internal
capital generation added $20,573,000 to equity during 2002, representing a rate,
when considered as a percentage of average total stockholders' equity, of 13%
for 2002, up from 10% recorded in 2001. Year-end accumulated other comprehensive
income (comprised of net unrealized gains and losses on available-for-sale
securities) increased in 2002, compared to 2001, contributing $6,485,000 of the
overall increase in stockholders' equity.
External capital formation, resulting from exercises of stock options and from
stock purchases under the employee stock purchase plan, totaled $833,000 during
2002. The ratio of average equity to average assets was 7.49% for 2002, as
compared to 7.24% for 2001 and 6.66% for 2000.
Bank holding companies and banks are required to maintain capital ratios in
accordance with guidelines adopted by the federal bank regulators. These
guidelines are commonly known as Risk-Based Capital Guidelines. On December 31,
2002, the Company exceeded all applicable capital requirements, with a total
risk-based capital ratio of 14.95%, a tier 1 risk-based capital ratio of 13.72%,
and a leverage ratio of 8.08%. Tier 1 capital of $181,034,000 and total
qualifying capital of $197,202,000 each included $35,000,000 in trust preferred
debt issuance as permitted under Federal Reserve Guidelines (see "Note
10--Long-Term Borrowings" of the Notes to the Consolidated Financial
Statements). As of December 31, 2002, the Bank met the criteria for
classification as a "well-capitalized" institution under the prompt corrective
action rules of the Federal Deposit Insurance Act. Designation as a
well-capitalized institution under these regulations is not a recommendation or
endorsement of the Company or the Bank by federal bank regulators. Additional
information regarding regulatory capital ratios is included in "Note
21--Regulatory Matters" of the Notes to the Consolidated Financial Statements.
CREDIT RISK MANAGEMENT
The Company's loan and lease portfolio (the "credit portfolio") is subject to
varying degrees of credit risk. Credit risk is mitigated through portfolio
diversification, limiting exposure to any single customer, industry or
collateral type. The Company maintains an allowance for credit losses (the
"allowance") to absorb losses inherent in the loan and lease portfolio. The
allowance is based on careful, continuous review and evaluation of the loan and
lease portfolio, along with ongoing, quarterly assessments of the probable
losses inherent in that portfolio, and, to a lesser extent, in unused
commitments to provide financing. The methodology for assessing the
appropriateness of the allowance includes: (1) the formula allowance reflecting
historical losses by credit category, (2) the specific allowance for risk rated
credits on an individual or portfolio basis, and (3) the nonspecific allowance
which considers risk factors not evaluated by the other two components of the
methodology. This systematic allowance methodology is further described in the
section entitled "Critical Accounting Policies" and in "Note 1 - Significant
Accounting Policies" of the Notes to the Consolidated Financial Statements. The
amount of the allowance is reviewed monthly by the Senior Loan Committee, and
reviewed and approved quarterly by the Board of Directors.
The allowance is increased by provisions for credit losses, which are charged to
expense. Charge-offs of loan amounts determined by management to be
uncollectible or impaired decrease the allowance, while recoveries of previous
charge-offs are added back to the allowance. The Company makes provisions for
credit losses in amounts necessary to maintain the allowance at an appropriate
level, as established by use of the allowance methodology. Resulting provisions
were $2,865,000 in 2002 and $2,470,000 in 2001, representing an increase of
$395,000 over the period. Net charge-offs of $482,000, $1,347,000 and $691,000,
were recorded in 2002, 2001 and 2000, respectively. Given the current state of
the economy, management does not expect the low dollar level of net charge-offs
reported in 2002 to continue, since it is below recent historical levels. The
ratio of net charge-offs to average loans and leases was 0.05% in 2002, compared
to 0.14% in 2001. At December 31, 2002, the allowance for credit losses was
$15,036,000, or 1.41% of total loans and leases, versus $12,653,000, or 1.27% of
total loans and leases, at December 31, 2001.
22
Management believes that the allowance is adequate. However, its determination
requires significant judgment, and estimates of probable losses inherent in the
credit portfolio can vary significantly from the amounts actually observed.
While management uses available information to recognize probable losses, future
additions to the allowance may be necessary based on changes in the credits
comprising the portfolio and changes in the financial condition of borrowers,
such as may result from changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process, and
independent consultants engaged by the Bank, periodically review the credit
portfolio and the allowance. Such review may result in additional provisions
based upon their judgments of information available at the time of each
examination.
Table 8 presents a five-year history for the allocation of the allowance,
reflecting use of the methodology outlined above, along with the credit mix
(year-end credit balances by category as a percent of total loans and leases).
The entire balances of the formula allowance, the specific allowance and the
nonspecific allowance are allocated to the related loan and lease categories.
Amounts not allocated to loan and lease categories relate to the entire
portfolio, and are shown as "unallocated" below. The loan and lease categories
have been expanded for 2002 to mirror the loan and lease breakout in Table 4 -
Analysis of Loans and Leases. Such expansion of categories in the detail shown
for 2002 is not practicable for prior years.
TABLE 8 - ALLOWANCE FOR CREDIT LOSSES
December 31,
----------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------------------------------------------------------------------------------------------------------
CREDIT Credit Credit Credit Credit
(Dollars in thousands) AMOUNT MIX Amount Mix Amount Mix Amount Mix Amount Mix
---------------------------------------------------------------------------------------------------------------
Amount applicable to:
Residential real estate:
Residential mortgages $ 2,338 26% $ 1,301 26% $ 1,969 28% $ 1,744 28% $ 432 24%
Residential construction 937 7 1,240 8 467 4 301 5 332 7
-------------- -------------- -------------- -------------- --------------
Total 3,275 33 2,541 34 2,436 32 2,045 33 764 31
Commercial loans and
leases:
Commercial real estate 3,637 24
Commercial construction 1,966 5
Other commercial 2,191 14
--------
Total 7,794 43 5,271 41 5,547 46 4,361 45 4,056 51
Leases 566 2 814 3 0 0 0 0 0 0
-------------- -------------- -------------- -------------- --------------
Total 8,360 45 6,085 44 5,547 46 4,361 45 4,056 51
Consumer 2,912 22 2,309 22 2,363 22 2,025 22 1,226 18
Unallocated 489 1,718 1,184 (200) 1,304
-------- -------- -------- -------- --------
Total allowance $ 15,036 $ 12,653 $ 11,530 $ 8,231 $ 7,350
======== ======== ======== ======== ========
During 2002, there were no changes in estimation methods or assumptions that
affected the allowance methodology. Significant variation can occur over time in
the methodology's assessment of the adequacy of the allowance as a result of the
credit performance of a small number of borrowers. The unallocated allowance at
year-end 2002, when measured against the total allowance, was 3% versus 14% a
year earlier. The total allowance at December 31, 2002, including the
unallocated portion, was within the desirable range under the Company's policy
guidelines derived from the allowance methodology.
23
The allowance increased by $2,383,000 or 19% during 2002, from $12,653,000 at
December 31, 2001 to $15,036,000 at December 31, 2002. Most of this change was
attributable to higher reserves for commercial loans, (commercial real estate,
commercial construction, and other commercial loans). The commercial loan
portfolio grew by 9% over the period. The allowance for this category increased
by 48% or $2,523,000. The increase was attributable primarily to the growth in
commercial loans, an increase in the specific allowance, and higher nonspecific
reserves for other factors relating to the portfolio. The specific allowance for
commercial loans nearly doubled, increasing by $1,597,000, due primarily to a
specific reserve for a single borrower. The Company does not have significant
exposure to other borrowers in that borrower's classification. A number of other
factors also contributed to higher reserves for commercial loans, none of which
was especially significant by itself, including trends in delinquencies and
non-accrual loans, and evaluation of portfolio concentrations, economic
conditions, and credit administration and risk identification systems.
The allowance pertaining to residential mortgage loans rose by 80% and was
responsible for $1,037,000 of the overall increase in the allowance for credit
losses from December 31, 2001 to December 31, 2002. Residential mortgage loans
increased by 10% during 2002. The increase in the related allowance was due
primarily to the effect of an increased historical loan volume trend.
The 26% or $603,000 rise in the allowance for consumer loans during 2002 was
also significant. The consumer portfolio grew by 9%. The change in this category
of allowance reflected an increase in the specific allowance on an existing
portfolio of manufactured housing credits (comprising 0.6% of total outstanding
loans) affected adversely by economic conditions, as well as higher risk factors
related to evaluation of portfolio concentrations and economic conditions.
At December 31, 2002, total non-performing loans and leases were $2,745,000, or
0.26% of total loans and leases, compared to $7,807,000, or 0.78% of total loans
and leases, at December 31, 2001. The allowance represented 548% of
non-performing loans and leases at December 31, 2002, versus coverage of 162% a
year earlier. Significant variation in the coverage ratio may occur from year to
year because the amount of non-performing loans and leases depends largely on
the condition of a small number of individual credits and borrowers relative to
the total loan and lease portfolio. There was no other real estate owned on the
balance sheet at December 31, 2002, compared to $50,000 at December 31, 2001.
The balance of impaired loans was $170,000 at December 31, 2002, with no
reserves against those loans, compared to $5,589,000 at December 31, 2001, with
reserves of $91,000. Non-performing and impaired loans and leases at December
31, 2001 included a problem credit of a single borrower in the amount of
approximately $5,125,000. The property securing this credit was sold in October
2002, and all principal, interest, and fees due to the Company were paid in
full. The Company does not have any significant exposure to borrowers in the
business involved with this credit.
The Company's borrowers are concentrated in five counties of the state of
Maryland. Commercial and residential mortgages, including home equity loans and
lines, represented 64% of total loans and leases at December 31, 2002, compared
to 61% at December 31, 2001. Historically, the Company has experienced low loss
levels with respect to such loans through various economic cycles and
conditions. Risk inherent in this loan concentration is mitigated by the nature
of real estate collateral, the Company's substantial experience in most of the
markets served, and its lending practices.
24
TABLE 9 - SUMMARY OF CREDIT LOSS EXPERIENCE
Years Ended December 31,
(Dollars in thousands) 2002 2001 2000 1999 1998
----------------------------------------------------------------------------------------------------------------------
Balance of credit loss allowance, January 1 $ 12,653 $ 11,530 $ 8,231 $ 7,350 $ 7,016
Provision for credit losses 2,865 2,470 2,690 1,216 552
Allowance acquired 0 0 1,300 0 0
Loan and lease charge-offs:
Residential real estate (165) (23) (220) (67) (3)
Commercial loans and leases (467) (1,180) (246) (123) (136)
Consumer (158) (225) (303) (225) (196)
-------- -------- -------- -------- --------
Total charge-offs (790) (1,428) (769) (415) (335)
Loan and lease recoveries:
Residential real estate 0 0 0 0 0
Commercial loans and leases 284 54 36 32 82
Consumer 24 27 42 48 35
-------- -------- -------- -------- --------
Total recoveries 308 81 78 80 117
-------- -------- -------- -------- --------
Net charge-offs (482) (1,347) (691) (335) (218)
-------- -------- -------- -------- --------
Balance of credit loss allowance, December 31 $ 15,036 $ 12,653 $ 11,530 $ 8,231 $ 7,350
======== ======== ======== ======== ========
Net charge-offs to average loans and leases 0.05% 0.14% 0.08% 0.05% 0.04%
Allowance to total loans and leases 1.41% 1.27% 1.19% 1.00% 1.18%
TABLE 10 - ANALYSIS OF CREDIT RISK
Years Ended December 31,
(Dollars in thousands) 2002 2001 2000 1999 1998
---------------------------------------------------------------------------------------------------------------------
Non-accrual loans and leases (1) $ 588 $ 5,904 $ 684 $ 275 $ 832
Loans and leases 90 days past due 2,157 1,903 1,809 110 965
Restructured loans and leases 0 0 0 0 4
-------- -------- -------- -------- --------
Total non-performing loans and leases (2) 2,745 7,807 2,493 1,985 1,801
Other real estate owned, net 0 50 380 163 0
-------- -------- -------- -------- --------
Total non-performing assets $ 2,745 $ 7,857 $ 2,873 $ 2,148 $ 1,801
======== ======== ======== ======== ========
Non-performing loans and leases to total
loans and leases 0.26% 0.78% 0.26% 0.24% 0.29%
Allowance for credit loss to non-performing
loans and leases 548% 162% 462% 415% 408%
Non-performing assets to total assets 0.12% 0.38% 0.16% 0.13% 0.13%
(1) Gross interest income that would have been recorded in 2002 if non-accrual
loans and leases shown above had been current and in accordance with their
original terms was $57,000, while interest actually recorded on such loans
was $38,000.
(2) Performing loans considered potential problem loans, as defined and
identified by management, amounted to $5,962,000 at December 31, 2002.
Although these are loans where known information about the borrowers'
possible credit problems causes management to have doubts as to the
borrowers' ability to comply with the present loan repayment terms, most
are well collateralized and are not believed to present significant risk of
loss. Loans classified for regulatory purposes not included in
non-performing or potential problem loans consist only of "other loans
especially mentioned" and do not, in management's opinion, represent or
result from trends or uncertainties reasonably expected to materially
impact future operating results, liquidity or capital resources, or
represent material credits where known information about the borrowers'
possible credit problems causes management to have doubts as to the
borrowers' ability to comply with the loan repayment terms.
25
MARKET RISK MANAGEMENT
The Company's net income is largely dependent on its net interest income. Net
interest income is susceptible to interest rate risk to the degree that
interest-bearing liabilities mature or reprice on a different basis than
interest-earning assets. When interest-bearing liabilities mature or reprice
more quickly than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest income.
Similarly, when interest-earning assets mature or reprice more quickly than
interest-bearing liabilities, falling interest rates could result in a decrease
in net interest income. Net interest income is also affected by changes in the
portion of interest-earning assets that are funded by interest-bearing
liabilities rather than by other sources of funds, such as noninterest-bearing
deposits and stockholders' equity.
The Company's interest rate sensitivity, as measured by the repricing of its
interest sensitive assets and liabilities at December 31, 2002 is presented in
Table 11. As indicated in the note to the table, the data was based in part on
assumptions that are regularly reviewed for propriety. The accompanying analysis
indicates an asset sensitive one-year cumulative GAP position of 14% of total
assets, with approximately 48% of rate sensitive assets and approximately 40% of
rate sensitive liabilities subject to maturity or repricing within a one-year
period from December 31, 2002. The one-year cumulative GAP continues in an asset
sensitive position, but reflects a smaller positive GAP position than at the end
of 2001. This was due to the maturity and subsequent replacement of a
significant percentage of the investment portfolio throughout the year into
longer average life investments. The investment portfolio is composed of various
securities that contain imbedded call options or prepayments that are more
likely to occur as interest rates move in a downward direction. While senior
management, through its Asset Liability Management Committee (ALCO), has a
preference for maintaining a moderate level of interest rate risk as measured by
the repricing GAP, the Company's interest rate risk policies are guided by
results of simulation analysis, which takes into account more factors than does
GAP analysis. Simulation results presented in the following discussion show that
the Company's exposure to changing interest rates is well within policy limits
for acceptable levels of risks. The ALCO analyzes balance sheet, income
statement, and margin trends monthly. A detailed interest rate risk profile is
prepared for ALCO quarterly and is reviewed with the Board of Directors. The
following GAP analysis schedule sets out the time frames from December 31, 2002,
in which the Company's assets and liabilities are subject to repricing.
26
TABLE 11 - INTEREST RATE SENSITIVITY ANALYSIS
0-90 91-365 Over 1-3 Over 3-5 Over 5
(Dollars in thousands) Days Days Years Years Years
--------------------------------------------------------------------------------------------------------
Rate Sensitive Assets (RSA):
Loans and leases $394,917 $112,067 $148,299 $267,053 $141,516
Taxable securities 264,866 186,703 158,150 55,823 81,538
Nontaxable securities 5,673 12,531 33,217 77,826 169,930
Other investments 48,383 0 0 0 0
-------- -------- -------- -------- --------
Total 713,839 311,301 339,666 400,702 392,984
Rate Sensitive Liabilities (RSL):
Interest-bearing demand deposits 4,966 14,897 39,724 39,724 86,069
Regular savings deposits 4,892 14,677 39,139 39,139 55,447
Money market savings deposits 22,811 68,433 182,488 96,527 28,281
Time deposits 107,934 215,735 76,825 33,782 138
Short-term borrowings and other
RSL 205,432 54,047 205 30,100 310,000
-------- -------- -------- -------- --------
Total 346,035 367,789 338,381 239,272 479,935
-------- -------- -------- -------- --------
Cumulative GAP* $367,804 $311,315 $312,601 $474,031 $387,080
======== ======== ======== ======== ========
As a percent of total assets 16.04% 13.57% 13.63% 20.67% 16.88%
Cumulative RSA to RSL 2.06 1.44 1.30 1.37 1.22
* This analysis is based upon a number of significant assumptions including the
following items. Loans and leases are repaid/rescheduled by contractual maturity
and repricings. Securities, except mortgage-backed securities, are repaid
according to contractual maturity adjusted for call features. Mortgage-backed
security repricing is adjusted for estimated early paydowns. Interest-bearing
demand, regular savings, and money market savings deposits are estimated to
exhibit some rate sensitivity based on management's analysis of deposit
withdrawals. Time deposits are shown in the table based on contractual maturity.
The Company's Board of Directors has established a comprehensive interest rate
risk management policy, which is administered by ALCO. The policy establishes
limits of risk, which are quantitative measures of the percentage change in net
interest income and the fair value of equity capital resulting from a
hypothetical change of plus or minus 200 basis points in U.S. Treasury interest
rates for maturities from one day to thirty years. By employing simulation
analysis through use of a computer model, the Company intends to effectively
manage the potential adverse impacts that changing interest rates can have on
its short-term earnings, long-term value, and liquidity. The simulation model
captures optionality factors such as call features and interest rate caps and
floors imbedded in investment and loan portfolio contracts. During 2002, as
general market interest rates reached historically low levels, management
adjusted the simulation model to consider interest rate floors on the Company's
core deposit portfolio. This recognizes that at certain low levels of market
interest rates, the Company's core deposit products would not reprice below
specific rates. For evaluating interest rate risk at the end of 2002, the
simulation of a hypothetical, parallel change of plus and minus 200 basis points
in U.S. Treasury interest rates was not practical. Therefore, the Company chose
to apply a plus 200 basis point change and a minus 100 basis point change when
evaluating the December 31, 2002, interest rate risk position. Measured from
December 31, 2002, the simulation analysis indicates that net interest income
would decline by 4% over a twelve-month period given a decrease in interest
rates of 100 basis points, against a policy limit of 15%. In terms of equity
capital on a fair value basis, a 100 basis point decrease in interest rates is
estimated to reduce the fair value of capital (as computed) by 13%, as compared
to a policy limit of 25%.
27
As with any method of gauging interest rate risk, there are certain shortcomings
inherent in the interest rate modeling methodology used by the Company. When
interest rates change, actual movements in different categories of
interest-earning assets and interest-bearing liabilities, loan prepayments, and
withdrawals of time and other deposits, may deviate significantly from
assumptions used in the model. Finally, the methodology does not measure or
reflect the impact that higher rates may have on adjustable-rate loan customers'
ability to service their debts, or the impact of rate changes on demand for
loan, lease and deposit products.
In addition to the potential adverse effect that changing interest rates may
have on the Company's net interest margin and operating results, potential
adverse effects on liquidity can occur as a result of changes in the estimated
cash flows from investment, loan, and deposit portfolios. The Company manages
this inherent risk by maintaining a large portfolio of available-for-sale
investments as well as secondary sources of liquidity from Federal Home Loan
Bank of Atlanta advances and other bank borrowing arrangements.
LIQUIDITY
Liquidity is measured by a financial institution's ability to raise funds
through loan and lease repayments, maturing investments, deposit growth,
borrowed funds, capital, or the sale of highly marketable assets such as
residential mortgage loans. The Company's liquidity position, considering both
internal and external sources available, exceeded anticipated short-term and
long-term needs at December 31, 2002. All deposits, except time deposits of
$100,000 or more, considered a stable funding source by management, equaled 63%
of total earning assets at December 31, 2002. In addition, loan and lease
payments, maturities, calls and paydowns of securities, deposit growth and
earnings contribute a flow of funds available to meet liquidity requirements. In
assessing liquidity, management considers operating requirements, the
seasonality of deposit flows, investment, loan, lease and deposit maturities and
calls, expected funding of loans and leases and deposit withdrawals, and the
market values of available-for-sale investments, so that sufficient funds are
available on short notice to meet obligations as they arise and to ensure that
the Company is able to pursue new business opportunities.
Liquidity is measured using an approach designed to take into account, in
addition to factors already discussed above, the Company's growth, mortgage
banking activities and leverage programs. Also considered are the greater
sophistication of investment activities and changes in the liquidity of the
investment portfolio due to fluctuations in interest rates. Under this approach,
implemented by the Funds Management Committee under formal policy guidelines,
the Company's liquidity position is measured weekly, looking forward thirty,
sixty and ninety days. The measurement is based upon the Asset-liability
Management Model's projection of a funds sold or purchased position, along with
ratios and trends developed to measure dependence on purchased funds, leverage
limitations and core growth. Resulting projections as of December 31, 2002, show
short-term investments exceeding short-term borrowings by $21,542,000 over the
subsequent 90 days. This excess of liquidity over projected requirements for
funds indicates that the Company can continue to increase its loans and other
earning assets without incurring additional borrowing.
The Company also has external sources of funds, which can be drawn upon when
required. The main source of external liquidity is an available line of credit
for $689,660,000 with the Federal Home Loan Bank of Atlanta, of which
$359,427,000 was outstanding at December 31, 2002. Other external sources of
liquidity available to the Company in the form of lines of credit granted by the
Federal Reserve, correspondent banks and other institutions totaled $259,039,000
at December 31, 2002, against which there were outstandings of $70,000,000.
Based upon its liquidity analysis, including external sources of liquidity
available, management believes the liquidity position is appropriate at December
31, 2002.
The Company's time deposits of $100,000 or more represented 8.5% of total
deposits at December 31, 2002, and are shown by maturity in the table below.
Months to Maturity
-----------------------------------------------------------------------------------------------------
3 or Over 3 Over 6 Over
(Dollars in thousands) Less to 6 to 12 12 TOTAL
-----------------------------------------------------------------------------------------------------
Time deposits--$100 thousand or more $ 30,769 $ 19,570 $ 35,850 $ 40,058 $126,247
28
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS (AS RESTATED)
(Dollars in thousands, except per share data)
December 31,
2002 2001
-----------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 38,998 $ 45,609
Federal funds sold 9,135 10,774
Interest-bearing deposits with banks 813 840
Residential mortgage loans held for sale 38,435 16,682
Investments available-for-sale (at fair value) 685,586 732,629
Investments held-to-maturity - fair value of $346,862 (2002)
and $165,015 (2001) 340,860 164,921
Other equity securities 19,812 16,929
Total loans and leases 1,063,853 995,919
Less: allowance for credit losses (15,036) (12,653)
----------- -----------
Net loans and leases 1,048,817 983,266
Premises and equipment, net 36,007 32,584
Accrued interest receivable 14,957 15,163
Goodwill 7,642 7,642
Other intangible assets, net 13,927 16,584
Other assets 52,415 38,211
----------- -----------
Total assets $ 2,307,404 $ 2,081,834
=========== ===========
Liabilities
Noninterest-bearing deposits $ 320,583 $ 277,592
Interest-bearing deposits 1,171,629 1,109,867
----------- -----------
Total deposits 1,492,212 1,387,459
Short-term borrowings 488,214 411,132
Guaranteed preferred beneficial interests in
the Company's subordinated debentures 35,000 35,000
Other long-term borrowings 90,500 79,116
Accrued interest payable and other liabilities 23,454 18,994
----------- -----------
Total liabilities 2,129,380 1,931,701
Stockholders' Equity
Common stock-par value $1.00; shares authorized 50,000,000;
shares issued and outstanding 14,536,094 (2002) and 14,483,564 (2001) 14,536 14,484
Additional paid in capital 21,128 20,347
Retained earnings 131,939 111,366
Accumulated other comprehensive income 10,421 3,936
----------- -----------
Total stockholders' equity 178,024 150,133
----------- -----------
Total liabilities and stockholders' equity $ 2,307,404 $ 2,081,834
=========== ===========
See Notes to Consolidated Financial Statements.
29
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (AS RESTATED)
(In thousands, except per share data)
Years Ended December 31,
2002 2001 2000
--------------------------------------------------------------------------------
Interest income:
Interest and fees on loans and leases $ 72,710 $ 79,783 $ 75,746
Interest on loans held for sale 976 780 298
Interest on deposits with banks 21 88 112
Interest and dividends on securities:
Taxable 37,239 37,873 33,261
Exempt from federal income taxes 11,230 8,174 7,614
Interest on federal funds sold 546 1,172 1,649
-------- -------- --------
Total interest income 122,722 127,870 118,680
Interest expense:
Interest on deposits 19,833 35,597 39,755
Interest on short-term borrowings 16,351 17,543 15,873
Interest on long-term borrowings 7,929 8,122 5,858
-------- -------- --------
Total interest expense 44,113 61,262 61,486
-------- -------- --------
Net interest income 78,609 66,608 57,194
Provision for credit losses 2,865 2,470 2,690
-------- -------- --------
Net interest income after
provision for credit losses 75,744 64,138 54,504
Noninterest income:
Securities gains 2,016 346 277
Service charges on deposit accounts 7,839 7,307 5,975
Gains on sales of mortgage loans 3,940 2,608 1,058
Fees on sales of investment products 2,078 2,170 1,640
Trust department income 2,497 1,995 1,653
Insurance agency commissions 3,281 243 0
Income from bank owned life insurance 1,876 1,633 428
Gain on sale of premises 0 0 1,470
Other income 6,202 5,534 5,027
-------- -------- --------
Total noninterest income 29,729 21,836 17,528
Noninterest expenses:
Salaries and employee benefits 38,571 29,595 24,900
Occupancy expense of premises 5,599 5,080 4,769
Equipment expenses 3,810 3,433 3,204
Marketing 1,907 1,474 1,282
Outside data services 2,415 2,342 2,374
Goodwill amortization 0 666 65
Amortization of intangible assets 2,659 2,512 2,759
Other expenses 9,000 9,516 8,248
-------- -------- --------
Total noninterest expenses 63,961 54,618 47,601
-------- -------- --------
Income before income taxes 41,512 31,356 24,431
Income tax expense 10,927 8,342 5,798
-------- -------- --------
Net income $ 30,585 $ 23,014 $ 18,633
======== ======== ========
Basic net income per share $ 2.11 $ 1.60 $ 1.30
Diluted net income per share $ 2.08 $ 1.58 $ 1.30
See Notes to Consolidated Financials Statements
30
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (AS RESTATED)
Years Ended December 31,
(In thousands) 2002 2001 2000
--------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 30,585 $ 23,014 $ 18,633
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 6,052 6,225 5,699
Provision for credit losses 2,865 2,470 2,690
Deferred income taxes (433) 1,565 1,344
Origination of loans held for sale (331,325) (230,006) (67,657)
Proceeds from sales of loans held for sale 313,512 222,303 64,166
Gains on sales of loans held for sale (3,940) (2,608) (1,058)
Securities gains (2,016) (346) (277)
Gain on sale of premises 0 0 (1,470)
Net increase in accrued interest receivable 206 (39) (2,359)
Net increase in other assets (15,505) (11,819) (7,504)
Net increase in accrued expenses 3,541 4,337 3,839
Other-net (375) (4,272) (4,945)
----------- ----------- -----------
Net cash provided by operating activities 3,167 10,824 11,101
Cash flows from investing activities:
Net decrease (increase) in interest-bearing deposits with banks 27 (333) 3,194
Purchases of investments held-to-maturity (219,319) (79,656) (29,774)
Purchases of other equity securities (2,883) (2,742) (10,063)
Purchases of investments available-for-sale (1,122,816) (984,951) (120,279)
Proceeds from sales of investments available-for-sale 316,295 142,658 68,538
Proceeds from maturities, calls and principal payments of
investments held-to-maturity 43,338 49,235 0
Proceeds from maturities, calls and principal payments of
investments available-for-sale 865,460 638,389 59,068
Proceeds from sales of other equity securities 0 0 12,083
Proceeds from sales of other real estate owned 81 459 531
Net increase in loans and leases receivable (67,963) (28,184) (113,311)
Acquisitions, net of cash acquired 0 (1,231) (32,460)
Proceeds from sale of premises 0 0 2,965
Expenditures for premises and equipment (7,366) (4,712) (3,501)
----------- ----------- -----------
Net Cash Used by Investing Activities (195,146) (271,068) (163,009)
Cash flows from financing activities:
Net increase in deposits 104,753 143,532 77,555
Net increase in short-term borrowings 48,155 102,618 69,138
Proceeds from long-term borrowings 40,000 30,262 46,134
Retirement of long-term borrowings 0 0 (35,000)
Common stock purchased and retired 0 0 (4,158)
Proceeds from issuance of common stock 833 2,767 2,098
Dividends paid (10,012) (8,881) (7,749)
----------- ----------- -----------
Net cash provided by financing activities 183,729 270,298 148,018
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents (8,250) 10,054 (3,890)
Cash and cash equivalents at beginning of year 56,383 46,329 50,219
----------- ----------- -----------
Cash and cash equivalents at end of year $ 48,133 $ 56,383 $ 46,329
=========== =========== ===========
31
Supplemental Disclosures:
Interest payments $ 22,794 $ 60,766 $ 61,172
Income tax payments 9,291 9,236 6,631
Non-cash Investing Activities:
Transfers from loans to other real estate owned $ 29 $ 82 $ 686
Reclassification of borrowings from long-term to short-term 28,855 200 200
Details of acquisitions:
Fair value of assets acquired $ 0 $ 2,605 $ 29,156
Fair value of liabilities assumed 0 (2,503) (2,689)
Cash to be paid for acquisition 0 (2,227) 0
Purchase price in excess of net assets acquired 0 3,725 5,993
----------- ----------- -----------
Cash paid 0 1,600 32,460
Less cash acquired 0 (369) 0
----------- ----------- -----------
Net cash paid for acquisition $ 0 $ 1,231 $ 32,460
=========== =========== ===========
See Notes to Consolidated Financial Statements.
32
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (AS RESTATED)
(Dollars in thousands, except per share data)
Accumulated
Additional Other Total
Common paid in Retained Comprehensive Stockholders'
Stock Capital Earnings Income (Loss) Equity
Balances at January 1, 2000, as previously $ 9,648 $ 24,476 $ 86,620 $(12,024) $108,720
reported
Less adjustments for the cumulative effect on
prior years of the understatement of accrued
interest on borrowings from the Federal Home
Loan Bank (271) (271)
-------- --------
Balances at January 1, 2000, as adjusted 9,648 24,476 86,349 (12,024) 108,449
Comprehensive Income:
Net income 18,633 18,633
Other comprehensive income, net of tax
(unrealized gains on securities of
$9,994, net of reclassification
adjustment for gains of $117) 9,877 9,877
Total comprehensive income 28,510
Cash dividends-$0.54 per share (7,749) (7,749)
Common stock issued pursuant to dividend
reinvestment and stock purchase plan-97,927
shares 98 2,000 2,098
Stock repurchases-193,234 shares (193) (3,965) (4,158)
Balances at December 31, 2000 9,553 22,511 97,233 (2,147) 127,150
Increase in beginning shares as a result
of 3-for-2 stock split in the form of
a stock dividend 4,777 (4,777)
Comprehensive Income:
Net income 23,014 23,014
Other comprehensive income, net of tax
(unrealized gains on securities of
$6,394, net of reclassification
adjustment for gains of $311) 6,083 6,083
Total comprehensive income 29,097
Cash dividends-$0.61 per share (8,881) (8,881)
Common stock issued pursuant to:
Stock option plan-79,521 shares 80 1,045 1,125
Dividend reinvestment and stock purchase
plan-67,947 shares 68 1,447 1,515
Employee stock purchase plan-5,931 shares 6 121 127
Balances at December 31, 2001 14,484 20,347 111,366 3,936 150,133
Comprehensive Income:
Net income 30,585 30,585
Other comprehensive income, net of tax
(unrealized gains on securities of
$7,336, net of reclassification
adjustment for gains of $851) 6,485 6,485
Total comprehensive income 37,070
Cash dividends-$0.69 per share (10,012) (10,012)
Common stock issued pursuant to:
Stock option plan-39,529 shares 38 392 430
Employee stock purchase plan-14,841 shares 14 389 403
Balances at December 31, 2002 $ 14,536 $ 21,128 $131,939 $ 10,421 $178,024
See Notes to Consolidated Financial Statements.
33
Sandy Spring Bancorp, Inc. and Subsidiaries
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company, which include Sandy Spring
Bancorp, Inc. and its wholly owned subsidiary, Sandy Spring Bank (the "Bank"),
together with its subsidiaries, Sandy Spring Insurance Corporation and The
Equipment Leasing Company, conform to accounting principles generally accepted
in the United States and to general practice within the financial services
industry.
Certain reclassifications have been made to amounts previously reported to
conform to the classifications made in 2002. The following is a summary of the
more significant accounting policies:
NATURE OF OPERATIONS
Through its subsidiary bank, the Company conducts a full-service commercial
banking, mortgage banking and trust business. Services to individuals and
businesses include accepting deposits, extending real estate, consumer and
commercial loans and lines of credit, equipment leasing, general insurance, and
personal trust services. The Company operates in the five Maryland counties of
Anne Arundel, Frederick, Howard, Montgomery, and Prince George's, and has a
concentration in residential and commercial mortgage loans.
POLICY FOR CONSOLIDATION
The consolidated financial statements include the accounts of Sandy Spring
Bancorp, Inc. and its subsidiaries. Consolidation has resulted in the
elimination of all significant intercompany balances and transactions. The
financial statements of Sandy Spring Bancorp (Parent Only) include its
investment in the Bank under the equity method of accounting.
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 reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks and federal funds sold (items with an original maturity of three
months or less).
RESIDENTIAL MORTGAGE LOANS HELD FOR SALE
The Company engages in sales of residential mortgage loans originated by the
Bank. Loans held for sale are carried at the lower of aggregate cost or fair
value. Fair value is derived from secondary market quotations for similar
instruments. Gains and losses on sales of these loans are recorded as a
component of noninterest income in the Consolidated Statements of Income.
When the Company retains the servicing rights to collect and remit principal and
interest payments, manage escrow account matters and handle borrower
relationships on mortgage loans sold, resulting service fee income is included
in noninterest income. The Company's current practice is to sell loans on a
servicing released basis, and, therefore, it has no intangible asset recorded
for the value of such servicing at either December 31, 2002 or December 31,
2001.
34
INVESTMENTS AVAILABLE-FOR-SALE
Marketable equity securities and debt securities not classified as
held-to-maturity or trading are classified as available-for-sale. Securities
available-for-sale are acquired as part of the Company's asset/liability
management strategy and may be sold in response to changes in interest rates,
loan demand, changes in prepayment risk and other factors. Securities
available-for-sale are carried at fair value, with unrealized gains or losses
based on the difference between amortized cost and fair value reported as
accumulated other comprehensive income, a separate component of stockholders'
equity, net of deferred tax. Realized gains and losses, using the specific
identification method, are included as a separate component of noninterest
income. Related interest and dividends are included in interest income.
INVESTMENTS HELD-TO-MATURITY AND OTHER EQUITY SECURITIES
Investments held-to-maturity are those securities which the Company has the
ability and positive intent to hold until maturity. Securities so classified at
time of purchase are recorded at cost. The carrying values of securities
held-to-maturity are adjusted for premium amortization and discount accretion.
Other equity securities represent Federal Reserve Bank and Federal Home Loan
Bank of Atlanta stock, which are considered restricted as to marketability.
LOANS AND LEASES
Loans are stated at their principal balance outstanding net of any deferred fees
and costs. Interest income on loans is accrued at the contractual rate based on
the principal outstanding. Lease financing assets, all of which are direct
financing leases, include aggregate lease rentals, net of related unearned
income. Leasing income is recognized on a basis that achieves a constant
periodic rate of return on the outstanding lease financing balances over the
lease terms. The Company generally places loans and leases, except for consumer
loans, on non-accrual when any portion of the principal or interest is ninety
days past due and collateral is insufficient to discharge the debt in full.
Interest accrual may also be discontinued earlier if, in management's opinion,
collection is unlikely. Generally, consumer installment loans are not placed on
non-accrual, but are charged off when they are five months past due.
Loans are considered impaired when, based on current information, it is probable
that the Company will not collect all principal and interest payments according
to contractual terms. Generally, loans are considered impaired once principal or
interest payments become ninety days or more past due and they are placed on
non-accrual. Management also considers the financial condition of the borrower,
cash flows of the loan and the value of the related collateral. Impaired loans
do not include large groups of smaller balance homogeneous credits such as
residential real estate, consumer installment loans, and commercial leases,
which are evaluated collectively for impairment. Loans specifically reviewed for
impairment are not considered impaired during periods of "minimal delay" in
payment (usually ninety days or less) provided eventual collection of all
amounts due is expected. The impairment of a loan is measured based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, or the fair value of the collateral if repayment is expected to
be provided by the collateral. Generally, the Company's impairment on such loans
is measured by reference to the fair value of the collateral. Income on impaired
loans is recognized on a cash basis, and is first applied against the principal
balance outstanding.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses ("allowance") represents an amount which, in
management's judgment, will be adequate to absorb probable losses on outstanding
loans and leases, as well as other extensions of credit, that may become
uncollectible. The allowance represents an estimation made 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 adequacy of the allowance is determined through careful and
continuous evaluation of the credit portfolio, and involves the balancing of a
number of factors, as outlined below, to establish a prudent level.
Determination of the allowance is inherently subjective and requires significant
estimates, including estimated losses on pools of homogeneous loans based on
historical loss experience and consideration of current economic trends, which
may be susceptible to significant change. Loans and leases deemed uncollectible
are charged against the allowance, while recoveries are credited to it.
Management adjusts the level of the allowance through the provision for credit
losses, which is recorded as a current period operating expense. The Company's
systematic methodology for assessing the appropriateness of the allowance
includes: (1) the formula allowance reflecting historical losses by credit
35
category, (2) specific allowances, and (3) a nonspecific allowance based upon
evaluation of other factors relating to the portfolio.
The historical loss allowance establishes allowances for the major loan and
lease categories based upon their respective historical loss experience over the
prior eight quarters and is weighted so as to give more recent quarters the
greatest effect. The use of these factors in the methodology, because of their
relationship to actual results, is intended to narrow differences between
estimated and realized losses.
The specific allowance is used to allocate an allowance for internally risk
rated commercial loans where significant conditions or circumstances indicate
that a loss may have been incurred. Analysis resulting in specific allowances,
including those on loans identified for evaluation of impairment, includes
consideration of the borrower's overall financial condition, resources and
payment record, support available from financial guarantors and the sufficiency
of collateral. These factors are combined to estimate the probability and
severity of inherent losses. Then a specific allowance is established based on
the Company's calculation of the loss embedded in the individual loan. Formula
allowances are also established by application of credit risk factors to other
internally risk rated loans, individual consumer and residential loans and
commercial leases having reached non-accrual or 90-day past due status, and
unfunded commitments. Each risk rating category is assigned a credit risk factor
based on management's estimate of the associated risk, complexity, and size of
the individual loans within the category. Additional allowances may also be
established in special circumstances involving a particular group of credits or
portfolio within a risk category when management becomes aware that losses
incurred may exceed those determined by use of the risk factor for that general
credit category.
A nonspecific allowance is primarily based upon management's regular evaluation
of the following factors (which are included in federal bank regulatory
guidelines): trends in delinquencies and non-accruals, size of credits relative
to the allowance, volume trends, concentrations, economic conditions, credit
administration and management, and the quality of the risk identification
system. Additional factors which may also be considered include changes in
underwriting standards, such as acceptance of higher loan to value ratios.
Evaluation of the potential effects of these factors on estimated losses
involves a high degree of uncertainty including the strength and timing of
economic cycles and concerns over the effects of a prolonged economic downturn
in the current cycle. The required analysis is regularly and carefully
undertaken by management, and the risk factors are revised as conditions
indicate.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization computed using the straight-line method. Premises and equipment are
depreciated over the useful lives of the assets, which generally range from 3 to
10 years for furniture, fixtures and equipment, 3 to 5 years for computer
software and hardware, and 10 to 40 years for buildings and building
improvements. Leasehold improvements are amortized over the terms of the
respective leases or the estimated useful lives of the improvements, whichever
is shorter. The costs of major renewals and betterments are capitalized, while
the costs of ordinary maintenance and repairs are expensed as incurred.
OTHER REAL ESTATE OWNED (OREO)
OREO, which is included in other assets, comprises properties acquired in
partial or total satisfaction of problem loans. The properties are recorded at
the lower of cost or fair value at the date acquired. Losses arising at the time
of acquisition of such properties are charged against the allowance for credit
losses. Subsequent write-downs that may be required are added to a valuation
reserve. Gains and losses realized from the sale of OREO, as well as valuation
adjustments, are included in noninterest income. Expenses of operation are
included in noninterest expense.
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. On January 1, 2002, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets". Under the provisions of SFAS No. 142,
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.
36
All of the Company's other intangible assets have finite lives and are amortized
on a straight-line basis over varying periods not exceeding 15 years. Prior to
adoption of SFAS No. 142, the Company's goodwill was amortized on a
straight-line basis over varying periods not exceeding 10 years. Note 7 includes
a summary of the Company's goodwill and other intangible assets as well as
further detail about the impact of the adoption of SFAS No. 142.
ADVERTISING COSTS
Advertising costs are generally expensed as incurred.
INCOME TAXES
Income tax expense is based on the results of operations, adjusted for permanent
differences between items of income or expense reported in the financial
statements and those reported for tax purposes. Under the liability method,
deferred income taxes are determined based on the differences between the
financial statement carrying amounts and the income tax bases of assets and
liabilities and are measured at the enacted tax rates that will be in effect
when these differences reverse.
NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", which addresses the accounting and reporting for acquired
goodwill and other intangible assets and supersedes Accounting Principles Board
("APB") Opinion 17, Intangible Assets. Notes 1 and 7 provide further detail on
the accounting for goodwill and intangible assets under the standard and the
impact of the adoption on the financial statements. The standard's adoption had
no impact on liquidity.
In October 2002, the Financial Accounting Standards Board issued SFAS No. 147,
"Acquisitions of Certain Financial Institutions". SFAS No. 147 amends SFAS No.
72 "Accounting for Certain Acquisitions of Banking and Thrift Institutions".
SFAS No. 147 addresses unidentifiable intangible assets resulting from
acquisitions of entire or less-than-whole financial institutions where the fair
value of liabilities assumed exceeds the fair value of tangible and identifiable
intangible assets acquired. The Statement allows for the recognition of goodwill
where the transaction in which an unidentifiable intangible asset arose was a
business combination. The transitional provisions of SFAS No. 147 allow for the
reclassification of unidentifiable intangible assets that meet certain criteria
to goodwill and the restatement of earnings for any amortization of the
reclassified goodwill that occurred since SFAS No. 142 was adopted. Transitional
provisions were effective on October 1, 2002, with earlier application
permitted. Recent acquisitions of bank branches by the Company did not meet the
criteria of a business combination and therefore the adoption of SFAS No. 147
had no effect on the financial position or results of operations of the Company.
In December 2002, the Financial Accounting Standards Board issued SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure" which
amends SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No. 148
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require additional and more frequent disclosures in financial statements about
the effects of stock-based compensation. Adoption of SFAS No. 148 had no effect
on the financial position or results of operations of the Company. Additional
disclosures required by SFAS No. 148 appear in Note 12.
NOTE 2 - CASH AND DUE FROM BANKS
Regulation D of the Federal Reserve Act requires that banks maintain reserve
balances with the Federal Reserve Bank based principally on the type and amount
of their deposits. At its option, the Company maintains additional balances to
compensate for clearing and safekeeping services. The average balance maintained
in 2002 was $2,188,000 and in 2001 was $3,042,000.
37
NOTE 3 - INVESTMENTS AVAILABLE-FOR-SALE
The amortized cost and estimated fair values of investments available-for-sale
at December 31 are as follows:
2002 2001
-------------------------------------------------------------------------------------------------------------------
GROSS GROSS ESTIMATED Gross Gross Estimated
AMORTIZED UNREALIZED UNREALIZED FAIR Amortized Unrealized Unrealized Fair
(In thousands) COST GAINS LOSSES VALUE Cost Gains Losses Value
-------------------------------------------------------------------------------------------------------------------
U.S. Agency $ 561,796 $ 10,001 $ (109) $ 571,688 $ 517,916 $ 5,495 $ (1,103) $ 522,308
State and municipal 44,348 1,726 (43) 46,031 38,750 409 (2) 39,157
Mortgage-backed 18,078 636 (6) 18,708 124,646 277 (726) 124,197
Corporate debt 15,979 794 (16) 16,757 11,874 4 0 11,878
Trust preferred 23,263 1,480 0 24,743 27,415 789 (931) 27,273
------------------------------------------------------------------------------------------
Total debt securities 663,464 14,637 (174) 677,927 720,601 6,974 (2,762) 724,813
Marketable equity
securities 5,144 2,515 0 7,659 5,612 2,204 0 7,816
------------------------------------------------------------------------------------------
Total investments
available-for-sale $ 668,608 $ 17,152 $ (174) $ 685,586 $ 726,213 $ 9,178 $ (2,762) $ 732,629
==========================================================================================
The amortized cost and estimated fair values of debt securities
available-for-sale at December 31 by contractual maturity, except
mortgage-backed securities for which an average life is used, are shown below.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
2002 2001
------------------------------------------------------------------------------------------------
ESTIMATED Estimated
AMORTIZED FAIR Amortized Fair
(In thousands) COST VALUE Cost Value
------------------------------------------------------------------------------------------------
Due in one year or less $432,230 $436,141 $471,518 $473,775
Due after one year through five years 198,642 207,094 187,535 189,031
Due after five years through ten years 26,725 28,585 49,283 49,629
Due after ten years 5,867 6,107 12,265 12,378
-----------------------------------------------
Total debt securities available-for-sale $663,464 $677,927 $720,601 $724,813
===============================================
Sale of investments available-for-sale during 2002, 2001 and 2000 resulted in
the following:
(In thousands) 2002 2001 2000
-------------------------------------------------------------------------------------
Proceeds $ 316,242 $ 142,471 $ 68,538
Gross gains 3,472 708 457
Gross losses 1,434 566 180
At December 31, 2002 and 2001, investments available-for-sale with a carrying
value of $479,573,000 and $408,530,000, respectively, were pledged as collateral
for certain government deposits and for other purposes as required or permitted
by law. The outstanding balance of no single issuer, except for U.S. Government
and U.S. Government Agency securities, exceeded ten percent of stockholders'
equity at December 31, 2002 and 2001.
38
NOTE 4 - INVESTMENTS HELD-TO-MATURITY AND OTHER EQUITY SECURITIES
The amortized cost and estimated fair values of investments held-to-maturity at
December 31 are as follows:
2002 2001
------------------------------------------------------------------------------------------------------------------
GROSS GROSS ESTIMATED Gross Gross Estimated
AMORTIZED UNREALIZED UNREALIZED FAIR Amortized Unrealized Unrealized Fair
(In thousands) COST GAINS LOSSES VALUE Cost Gains Losses Value
------------------------------------------------------------------------------------------------------------------
U.S. Agency $ 87,714 $ 1,049 $ 0 $ 88,763 $ 9,995 $ 171 $ 0 $ 10,166
State and municipal 253,146 6,343 (1,390) 258,099 154,926 0 (77) 154,849
----------------------------------------------------------------------------------------------
Total investments
held-to-maturity $ 340,860 $ 7,392 $ (1,390) $ 346,862 $ 164,921 $ 171 $ (77) $ 165,015
==============================================================================================
The amortized cost and estimated fair values of debt securities held-to-maturity
at December 31 by contractual maturity, except mortgage-backed securities for
which an average life is used, are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
2002 2001
-----------------------------------------------------------------------------------------------------------------
ESTIMATED Estimated
AMORTIZED FAIR Amortized Fair
(In thousands) COST VALUE Cost Value
-----------------------------------------------------------------------------------------------------------------
Due in one year or less $ 102,177 $ 103,480 $ 13,620 $ 13,806
Due after one year through five years 86,071 87,645 50,818 51,210
Due after five years through ten years 148,243 151,289 94,397 93,998
Due after ten years 4,369 4,448 6,086 6,001
---------- --------- --------- --------
Total debt securities held-to-maturity $ 340,860 $ 346,862 $ 164,921 $ 165,015
========== ========= ========= =========
At December 31, 2002 and 2001, investments held-to-maturity with a book value
of $101,484,000 and $58,274,000, respectively, were pledged as collateral for
certain government deposits and for other purposes as required or permitted by
law. The outstanding balance of no single issuer, except for U.S. Government and
U.S. Government Agency securities, exceeded ten percent of stockholders' equity
at December 31, 2002 or 2001.
Other equity securities at December 31 are as follows:
(In thousands) 2002 2001
----------------------------------------------------------------------
Federal Reserve Bank stock $ 1,826 $ 1,826
Federal Home Loan Bank stock 17,986 15,103
-------- --------
Total $ 19,812 $ 16,929
======== ========
NOTE 5 - LOANS AND LEASES
Major categories at December 31 are presented below:
(In thousands) 2002 2001
-------------------------------------------------------------------------
Residential real estate $ 354,673 $ 339,797
Commercial loans and leases 476,014 441,540
Consumer 233,166 214,582
----------- -----------
Total loans and leases 1,063,853 995,919
Less: allowance for credit losses (15,036) (12,653)
----------- -----------
Net loans and leases $ 1,048,817 $ 983,266
=========== ===========
39
In the table, home equity loans are classified as consumer; commercial real
estate and commercial construction loans are classified as commercial loans and
leases; and, residential construction credits are classified as residential real
estate.
Activity in the allowance for credit losses for the preceding three years ended
December 31 is shown below:
(In thousands) 2002 2001 2000
----------------------------------------------------------------------------------------------------------
Balance at beginning of year $ 12,653 $ 11,530 $ 8,231
Provision for credit losses 2,865 2,470 2,690
Allowance acquired 0 0 1,300
Loan charge-offs (790) (1,428) (769)
Loan recoveries 308 81 78
-------- -------- --------
Net charge-offs (482) (1,347) (691)
-------- -------- --------
Balance at end of year $ 15,036 $ 12,653 $ 11,530
======== ======== ========
Information regarding impaired loans at December 31, and for the respective
years, is as follows:
(In thousands) 2002 2001 2000
----------------------------------------------------------------------------------------------------------
Impaired loans with a valuation allowance $ 0 $ 91 $ 113
Impaired loans without a valuation allowance 170 5,498 500
------------------------------------
Total impaired loans $ 170 $ 5,589 $ 613
====================================
Allowance for credit losses related to impaired loans $ 0 $ 91 $ 100
Allowance for credit losses related to other than impaired loans 15,036 12,562 11,430
------------------------------------
Total allowance for credit losses $ 15,036 $ 12,653 $ 11,530
====================================
Average impaired loans for the year $ 4,135 $ 1,625 $ 303
Interest income on impaired loans recognized on a cash basis $ 672 $ 0 $ 10
NOTE 6 - PREMISES AND EQUIPMENT Premises and equipment at December 31 consist
of:
(In thousands) 2002 2001
----------------------------------------------------------------------------------------------------------
Land $ 8,505 $ 8,505
Buildings and leasehold improvements 29,926 28,494
Equipment 19,789 16,732
----------------------
Total premises and equipment 58,220 53,731
Less: accumulated depreciation and amortization (22,213) (21,147)
----------------------
Net premises and equipment $ 36,007 $ 32,584
========================
Depreciation and amortization expense for premises and equipment amounted to
$3,286,000 for 2002, $2,967,000 for 2001 and $2,816,000 for 2000.
40
Total rental expense (net of rental income) of premises and equipment for the
three years ended December 31 was $2,787,000 (2002), $2,465,000 (2001) and
$2,315,000 (2000). Lease commitments entered into by the Company bear initial
terms varying from 3 to 15 years, or they are 20-year ground leases, and are
associated with premises. Future minimum lease payments as of December 31, 2002
for all non-cancelable operating leases are:
Operating
(In thousands) Leases
--------------------------------------------------------------------------------
2003 $ 2,714
2004 2,752
2005 2,624
2006 2,467
2007 2,164
Thereafter 13,954
--------
Total minimum lease payments $ 26,675
========
NOTE 7 - GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, goodwill is no longer being amortized but rather is
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:
2002 2001
---------------------------------------------------------------------------------------------------------------------
WEIGHTED Weighted
GROSS NET AVERAGE Gross Net Average
CARRYING ACCUMULATED CARRYING REMAINING Carrying Accumulated Carrying Remaining
(In thousands) AMOUNT AMORTIZATION AMOUNT LIFE Amount Amortization Amount Life
---------------------------------------------------------------------------------------------------------------------
Goodwill $ 8,751 $ 1,109 $ 7,642 -- $ 8,751 $ 1,109 $ 7,642 --
Unidentifiable intangible
assets resulting from
branch acquisitions 17,854 5,926 11,928 6.7 17,854 4,143 13,711 7.7
Core deposit intangible
assets 3,895 3,360 535 3,895 2,646 1,249
0.8 1.8
Other identifiable assets 1,637 173 1,464 10.8 1,637 13 1,624 11.7
-------------------------------- -------------------------------------------
Total $ 32,137 $ 10,568 $ 21,569 8.2 $ 32,137 $ 7,911 $ 24,226 8.6
================================ ===========================================
Future estimated annual amortization expense, excluding goodwill, is presented
below:
(In thousands)
Year Amount
--------------------------------------------------------
2003 $ 2,480
2004 1,945
2005 1,945
2006 1,945
2007 1,900
Under the provisions of SFAS No. 142, goodwill was subjected to an initial
assessment for impairment as of January 1, 2002. The Company also performed an
annual test for impairment as of October 1, 2002. As a result of both the
initial and annual assessment reviews, the Company determined that there was no
impairment of goodwill at either date. The Company will continue to review
41
goodwill on an annual basis for impairment and as events occur or circumstances
change.
The Company adopted SFAS No. 142 effective January 1, 2002. The following
presents the pro forma effects of applying SFAS No. 142 to years ended December
31, 2001 and 2000.
Years ended December 31,
(Dollars in thousands except per share data) 2002 2001 2000
------------------------------------------------------------------------------------------------
Goodwill amortization:
Pre-tax $ 0 $ 666 $ 65
After-tax 0 428 65
Net income:
Reported $ 30,585 $ 23,014 $ 18,633
Add back: goodwill amortization, net of tax effect 0 428 65
------------------------------------
Adjusted net income $ 30,585 $ 23,442 $ 18,698
====================================
Basic net income per share:
Reported $ 2.11 $ 1.60 $ 1.30
Goodwill amortization 0.00 0.00 0.03
------------------------------------
Adjusted net income per share $ 2.11 $ 1.63 $ 1.30
====================================
Diluted net income per share:
Reported $ 2.08 $ 1.58 $ 1.30
Goodwill amortization 0.00 0.03 0.00
------------------------------------
Adjusted net income per share $ 2.08 $ 1.61 $ 1.30
====================================
NOTE 8 - DEPOSITS
Deposits outstanding at December 31 consist of:
(In thousands) 2002 2001
-------------------------------------------------------------------------------
Noninterest-bearing deposits $ 320,583 $ 277,592
Interest-bearing deposits:
Demand 185,380 166,603
Money market savings 398,539 396,295
Regular savings 153,294 109,409
Time deposits of less than $100,000 308,169 316,786
Time deposits of $100,000 or more 126,247 120,774
---------- ----------
Total interest-bearing deposits 1,171,629 1,109,867
---------- ----------
Total deposits $1,492,212 $1,387,459
========== ==========
Interest expense on time deposits of $100,000 or more amounted to $3,728,800,
$5,650,000 and $5,491,000 for 2002, 2001, and 2000, respectively.
42
NOTE 9 - SHORT-TERM BORROWINGS
Information relating to short-term borrowings is as follows for the years ended
December 31:
2002 2001
------------------------------------------------------------------------------------
(Dollars in thousands) AMOUNT RATE Amount Rate
------------------------------------------------------------------------------------
At Year End:
Federal Home Loan Bank advances $ 268,927 5.21% $ 222,200 5.25%
Retail repurchase agreements 149,287 0.75 138,932 1.20
Other short-term borrowings 70,000 2.94 50,000 3.20
--------- ---------
Total $ 488,214 3.52% $ 411,132 3.64%
========= =========
Average for the Year:
Federal Home Loan Bank advances $ 240,043 5.29% $ 219,612 5.44%
Retail repurchase agreements 150,775 1.12 133,832 3.25
Other short-term borrowings 62,951 3.11 30,956 4.01
Maximum Month-end Balance:
Federal Home Loan Bank advances $ 268,927 $ 222,200
Retail repurchase agreements 169,128 157,520
Other short-term borrowings 75,000 50,000
The Company pledges U.S. Government Agency Securities, based upon their market
values, as collateral for 102% of the principal and accrued interest of its
repurchase agreements.
The Company has a line of credit arrangement with the Federal Home Loan Bank of
Atlanta (the "FHLB") under which it may borrow up to $689,660,000 at interest
rates based upon current market conditions, of which $359,427,000 was
outstanding at December 31, 2002. The Company also had lines of credit available
from the Federal Reserve, correspondent banks, and other institutions of
$259,039,000 at December 31, 2002, against which there were outstandings of
$70,000,000.
NOTE 10 - LONG-TERM BORROWINGS
On November 29, 1999, the Company issued $35,000,000 of trust preferred
securities at a rate of 9.375%. These long-term borrowings bear a maturity date
of November 30, 2029, which may be shortened, subject to conditions, to a date
no earlier than November 30, 2004. The trust preferred securities qualify as
tier 1 capital, subject to regulatory guidelines that limit the amount included
to an aggregate of 25% of tier 1 capital.
The Company had other long-term borrowings at December 31 as follows:
(Dollars in thousands) 2002 2001
-------------------------------------------------------------------------------
FHLB 6.12% Advance called in 2002 $ 0 $ 2,020
FHLB 6.37% Advance called in 2002 0 26,396
FHLB 6.45% Advance due 2006 250 350
FHLB 6.68% Advance due 2006 250 350
FHLB 5.26% Advance due 2006 30,000 30,000
FHLB 2.35% Advance due 2009 10,000 10,000
FHLB 6.25% Advance due 2010 10,000 10,000
FHLB 2.51% Advance due 2012 40,000 0
--------- ---------
Total other long-term borrowings $ 90,500 $ 79,116
========= =========
The 6.45% and 6.68% advances due in 2006 are principal reducing with payments of
$50,000 semi-annually. Interest on these instruments is generally paid monthly.
FHLB advances are fully collateralized by pledges of loans and U.S.
43
Agency securities. The Company has pledged, under a blanket lien, all qualifying
residential mortgage loans amounting to $191,386,000 at December 31, 2002 as
collateral under the borrowing agreement with the FHLB.
NOTE 11 - STOCKHOLDERS' EQUITY
The Company's Articles of Incorporation authorize 50,000,000 shares of capital
stock (par value $1.00 per share). Issued shares have been classified as common
stock. The Articles of Incorporation provide that remaining unissued shares may
later be designated as either common or preferred stock.
The Company has an employee stock purchase plan (the "Purchase Plan") which
commenced on July 1, 2001, with consecutive monthly offering periods thereafter.
The shareholders have reserved 450,000 authorized but unissued shares of common
stock for purchase upon the exercise of options granted under the plan. Shares
are placed under option to employees, to be purchased at 85% of the fair market
value on the exercise date through monthly payroll deductions of not less than
1% or more than 10% of cash compensation paid in the month. The Purchase Plan is
administered by a committee of at least three directors appointed by the Board
of Directors.
In 2001, the Company's Board of Directors renewed a Stock Repurchase Plan by
authorizing the repurchase of up to 5%, or approximately 718,000 shares of the
Company's outstanding common stock, par value $1.00 per share, in connection
with shares expected to be issued pursuant to the Company's dividend
reinvestment and stock purchase plan, stock option plan, and employee benefit
plans, and for other corporate purposes. The share repurchases would be made on
the open market and in privately negotiated transactions, from time to time
until March 31, 2003, or earlier termination of the program by the Board.
The Company has an Investors Choice Plan (the "Plan"), which is sponsored and
administered by the American Stock Transfer & Trust Company ("AST") as
independent agent, which enables current shareholders as well as first-time
buyers to purchase and sell common stock of Sandy Spring Bancorp, Inc. directly
through AST at low commissions. Participants may reinvest cash dividends and
make periodic supplemental cash payments to purchase additional shares. Share
purchases pursuant to the Plan are made in the open market. The Plan also allows
participants to deposit their stock certificates with AST for safekeeping or
sale.
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Bank, as well as restricting extensions
of credit and transfers of assets between the Bank and the Company. At December
31, 2002, the Bank could have paid additional dividends of $43,840,000 to its
parent company without regulatory approval. In conjunction with the Company's
trust preferred securities, the Bank issued a subordinated note to Bancorp for
$33,565,000 which was outstanding at December 31, 2002 and 2001. There were no
other loans outstanding between the Bank and the Company at either year-end.
NOTE 12 - STOCK OPTION PLAN
The Company's 1999 Stock Option Plan ("Option Plan") provides for the granting
of incentive and non-qualifying stock options to the Company's directors and to
selected key employees on a periodic basis at the discretion of the Board. The
Option Plan authorizes the issuance of up to 1,600,000 shares of common stock,
has a term of ten years, and is administered by a committee of at least three
directors appointed by the Board of Directors. In general, the options have an
exercise price which may not be less than 100% of the fair market value of the
common stock on the date of grant, must be exercised within ten years and vest
over a period of two years. The exercise price of stock options must be paid for
in full in cash or shares of common stock, or a combination of both. The Stock
Option Committee has the discretion when making a grant of stock options to
impose restrictions on the shares to be purchased in exercise of such options.
Outstanding options granted under the expired 1992 Stock Option Plan will
continue until exercise or expiration
44
The following is a summary of changes in shares under option for the years ended
December 31:
2002 2001 2000
-------------------------------------------------------------------------------------------------------------
WEIGHTED Weighted Weighted
NUMBER AVERAGE Number Average Number Average
OF EXERCISE Of Exercise Of Exercise
SHARES PRICE Shares Price Shares Price
-------------------------------------------------------------------------------------------------------------
Balance, beginning of year 557,068 $ 19.12 509,262 $ 14.53 319,275 $14.74
Granted 168,814 31.25 143,394 32.25 212,487 14.55
Cancelled (11,227) 27.63 (16,067) 16.77 (22,500) 17.74
Exercised (39,529) 12.33 (79,521) 13.86 0 0
------- ------- -------
Balance, end of year 675,126 $ 22.41 557,068 $ 19.12 509,262 $14.53
======= ======= =======
Weighted average fair value of options
granted during the year $ 9.05 $ 10.42 $ 4.11
The following table summarizes information about options outstanding at December
31, 2002:
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------------------------
Weighted Average
Remaining Weighted Weighted
Range of Contracted Life Average Average
Exercise Price Number (in years) Exercise Price Number Exercise Price
--------------------------------------------------------------------------------------------------
$7.67-$8.17 33,000 1.6 $ 7.97 33,000 $ 7.97
$11.09-$12.33 33,750 3.4 11.74 33,750 11.74
$14.54-$14.54 162,809 7.8 14.54 162,809 14.54
$16.24-$20.33 143,072 6.0 17.57 143,072 17.57
$31.25-$32.25 302,495 9.4 31.70 147,306 31.87
------- -------
675,126 7.6 22.41 519,937 19.68
======= =======
The fair value of each option grant is estimated on the date of grant using the
extended binomial option-pricing model with the following weighted-average
assumptions used for grants during the three years ended December 31:
2002 2001 2000
-------------------------------------------------------------------------------
Dividend yield 2.12% 2.10% 3.71%
Expected volatility 29.94% 30.87% 35.90%
Risk-free interest rate 3.73% 4.70% 5.05%
Expected lives (in years) 8 9 10
At December 31, 2002, the Company had two stock-based employee compensation
plans in existence, the 1992 stock option plan (expired but having outstanding
options that may still be exercised) and the 1999 stock option plan as described
more fully above. The Company accounts for those plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
45
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", to
stock-based employee compensation for the three years ended December 31.
(In thousands, except per share data) 2002 2001 2000
---------------------------------------------------------------------------------------------------------
Net income, as reported $ 30,585 $ 23,014 $ 18,633
Less pro forma stock-based employee compensation expense determined
under fair value based method, net of related tax effects (1,215) (1,041) (750)
--------------------------------
Pro forma net income $ 29,370 $ 21,973 $ 17,883
================================
Net income per share:
Basic - as reported $ 2.11 $ 1.60 $ 1.30
Basic - pro forma $ 2.02 $ 1.53 $ 1.25
Diluted - as reported $ 2.08 $ 1.58 $ 1.30
Diluted - pro forma $ 1.99 $ 1.51 $ 1.24
NOTE 13 - PENSION, PROFIT SHARING, AND OTHER EMPLOYEE BENEFIT PLANS
The Company has a qualified, noncontributory, defined benefit pension plan
covering substantially all employees. Benefits after January 1, 2002, are based
on the benefit earned as of December 31, 2001, plus benefits earned in future
years of service based on the employee's compensation during each such year. The
Company's funding policy is to contribute the maximum amount deductible for
federal income tax purposes. The Plan invests primarily in a diversified
portfolio of managed fixed income and equity funds. Contributions provide not
only for benefits attributed to service to date, but also for the benefit
expected to be earned in the coming year.
The Plan's funded status as of December 31 is as follows:
(Dollars in thousands) 2002 2001
--------------------------------------------------------------------------------
Reconciliation of Projected Benefit Obligation:
Projected obligation at January 1 $ 8,189 $ 6,479
Service cost 830 671
Interest cost 581 512
Actuarial loss 290 709
Projected benefit payments (243) (182)
------- -------
Projected obligation at December 31 9,647 8,189
------- -------
Accumulated Benefit Obligation at December 31 8,061 6,825
Reconciliation of Fair Value of Plan Assets:
Fair value of plan assets at January 1 7,423 8,029
Actual return on plan assets (565) (424)
Employer contributions 2,500 0
Benefit payments (243) (182)
------- -------
Fair value of plan assets at December 31 9,115 7,423
------- -------
Funded Status:
Funded status at December 31 (532) (766)
Unrecognized prior service cost (1,344) (1,407)
Unrecognized net loss 4,590 3,270
------- -------
Prepaid pension cost included in other assets $ 2,714 $ 1,097
======= =======
46
Weighted Average Assumptions as of December 31:
2002 2001 2000
--------------------------------------------------------------------------------
Discount rate 7.00% 7.25% 7.50%
Expected return on plan assets 8.00% 8.50% 8.50%
Rate of compensation increase 4.50% 4.50% 4.50%
Net pension expense for the previous three years includes the following
components:
(In thousands) 2002 2001 2000
--------------------------------------------------------------------------------
Service cost for benefits earned $ 830 $ 671 $ 754
Interest cost on projected benefit obligation 581 512 532
Expected return on plan assets (622) (677) (859)
Amortization of prior service cost (63) (63) (27)
Amortization of transition asset 0 0 (1)
Recognized net actuarial loss 157 44 0
----- ----- -----
Pension expense for the year $ 883 $ 487 $ 399
===== ===== =====
The Company has a qualified Cash and Deferred Profit Sharing Plan that includes
a 401(k) provision with a Company match. The profit sharing component is
non-contributory and covers all employees after ninety days of service. The
401(k) plan provision is voluntary and also covers all employees after ninety
days of service. Employees contributing to the 401(k) provision receive a
matching contribution up to the first 4% of compensation based on years of
service. The Company match includes a vesting schedule with employees becoming
100% vested after four years of service. The Plan permits employees to purchase
shares of Sandy Spring Bancorp common stock with their profit sharing
allocations, 401(k) contributions, Company match, and other contributions under
the Plan. Profit sharing contributions and Company match by the Company, which
are included in operating expenses, totaled $2,843,000 in 2002, $1,828,000 in
2001, and $707,000 in 2000.
The Company also has a performance based compensation benefit which provides
incentives to employees based on the Company's financial results as measured
against key performance indicator goals set by management. Payments are made
annually and total expense under the plan amounted to $2,028,000 in 2002,
$1,704,000 in 2001, and $797,000 in 2000.
The Company has Supplemental Executive Retirement Agreements (SERAs) with its
executive officers providing for retirement income benefits as well as
pre-retirement death benefits. Retirement benefits payable under the SERAs, if
any, are integrated with other pension plan and Social Security retirement
benefits expected to be received by the executive. The Company is accruing the
present value of these benefits over the remaining number of years to the
executives' retirement dates. Benefit accruals included in operating expenses
for 2002, 2001 and 2000 were $384,000, $232,000, and $127,000, respectively.
The Company has an Executive Health Plan that provides for payment of defined
medical and dental expenses not otherwise covered by insurance for selected
executives and their families. Benefits, which are paid during both employment
and retirement, are subject to a $6,500 limitation for each executive per year.
Expenses under the plan, covering insurance premium and out-of-pocket expense
reimbursement benefits, totaled $115,000 in 2002, $66,000 in 2001, and $65,000
in 2000.
47
NOTE 14 - INCOME TAXES
Income tax expense for the years ended December 31 consists of:
(In thousands) 2002 2001 2000
--------------------------------------------------------------------------------
Current Income Taxes:
Federal $ 8,637 $ 8,157 $ 7,119
State 1,857 1,750 23
------- ------- -------
Total current 10,494 9,907 7,142
Deferred Income Taxes (Benefit):
Federal 356 (1,289) (1,344)
State 77 (276) 0
------- ------- -------
Total deferred 433 (1,565) (1,344)
------- ------- -------
Total income tax expense $10,927 $ 8,342 $ 5,798
======= ======= =======
Temporary differences between the amounts reported in the financial statements
and the tax bases of assets and liabilities result in deferred taxes. Deferred
tax assets and liabilities, shown as the sum of the appropriate tax effect for
each significant type of temporary difference, are presented below for the years
ended December 31:
(Dollars in thousands) 2002 2001
--------------------------------------------------------------------------------
Deferred Tax Assets:
Allowance for credit losses $ 4,776 $ 4,179
Intangible assets 1,829 1,262
Net operating loss carryforward 207 248
Other 478 614
-------- --------
Gross deferred tax assets 7,290 6,303
Deferred Tax Liabilities:
Depreciation (1,353) (951)
Unrealized gains on investments available-for-sale (6,557) (2,482)
Pension plan costs (1,234) (594)
Deferred loan fees and costs (1,016) (722)
Other (495) (411)
-------- --------
Gross deferred tax liabilities (10,655) (5,160)
-------- --------
Net deferred tax (liabilities) assets $ (3,365) $ 1,143
======== ========
No valuation allowance exists with respect to deferred tax items. The Company
has a net operating loss carryforward (NOL) of $511,000, which expires in 2008.
The NOL is a result of an acquisition in 1993 and is subject to annual
limitations under IRS Code Section 382.
A three-year reconcilement of the difference between the statutory federal
income tax rate and the effective tax rate for the Company is as follows:
2002 2001 2000
-------------------------------------------------------------------------------------------
Federal income tax rate 35.0% 35.0% 35.0%
Increase (decrease) resulting from:
Tax-exempt interest income (10.2) (10.1) (10.7)
State income taxes, net of federal income tax benefits 1.3 2.0 0.1
Other .3 (0.2) (0.5)
----- ----- -----
Effective tax rate 26.4% 26.7% 23.9%
===== ===== =====
NOTE 15 - NET INCOME PER COMMON SHARE
In the following table, 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 impact of any potentially dilutive
common stock equivalents. The 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.
48
The calculation of net income per common share for the years ended December 31
was as follows:
(In thousands, except per share data) 2002 2001 2000
----------------------------------------------------------------------------------
Basic:
Net income available to common stockholders $30,585 $23,014 $18,663
Average common shares outstanding 14,508 14,389 14,361
Basic net income per share $ 2.11 $ 1.60 $ 1.30
======= ======= =======
Diluted:
Net income available to common stockholders $30,585 $23,014 $18,633
Average common shares outstanding 14,508 14,389 14,361
Stock option adjustment 214 169 42
------- ------- -------
Average common shares outstanding-diluted 14,722 14,558 14,403
Diluted net income per share $ 2.08 $ 1.58 $ 1.30
======= ======= =======
As of December 31, 2002 options for 135,480 shares of common stock were not
included in computing diluted net income per share because their effects were
antidilutive.
NOTE 16 - RELATED PARTY TRANSACTIONS
Certain directors and executive officers have loan transactions with the
Company. Such loans were made in the ordinary course of business on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with outsiders. The following
schedule summarizes changes in amounts of loans outstanding, both direct and
indirect, to these persons during the years indicated.
(In thousands) 2002 2001
--------------------------------------------------------------------------------
Balance at January 1 $ 16,726 $ 10,557
Additions 13,533 8,046
Repayments (1,373) (1,877)
-------- --------
Balance at December 31 $ 28,886 $ 16,726
======== ========
NOTE 17 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, the Company has various outstanding credit
commitments that are properly not reflected in the financial statements. These
commitments are made to satisfy the financing needs of the Company's clients.
The associated credit risk is controlled by subjecting such activity to the same
credit and quality controls as exist for the Company's lending and investing
activities. The commitments involve diverse business and consumer customers and
are generally well collateralized. Management does not anticipate that losses,
if any, which may occur as a result of these commitments would materially affect
the stockholders' equity of the Company. Since a portion of the commitments have
some likelihood of not being exercised, the amounts do not necessarily represent
future cash requirements.
Loan and credit line commitments, excluding unused portions of home equity lines
of credit, totaled $203,371,000 at December 31, 2002, and $205,869,000 at
December 31, 2001. These commitments are contingent upon continuing customer
compliance with the terms of the agreement.
Unused portions of equity lines at year-end amounted to $165,410,000 in 2002 and
$120,261,000 in 2001. The Company's home equity line accounts are secured by the
borrower's residence.
Irrevocable letters of credit, totaling $22,004,000 at December 31, 2002, and
$24,530,000 at December 31, 2001, are obligations to make payments under certain
conditions to meet contingencies related to customers' contractual agreements.
They are primarily used to guarantee a customer's contractual and/or financial
performance, and are seldom exercised.
49
NOTE 18 - LITIGATION
In the normal course of business, the Company may become involved in litigation
arising from the banking, financial, and other activities it conducts.
Management, after consultation with legal counsel, does not anticipate that the
ultimate liability, if any, arising out of these matters will have a material
effect on the Company's financial condition, operating results or liquidity.
NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company discloses fair value information about financial instruments for
which it is practicable to estimate the value, whether or not such financial
instruments are recognized on the balance sheet. Financial instruments have been
defined broadly to encompass 97.2% of the Company's assets and 99.1% of its
liabilities. Fair value is the amount at which a financial instrument could be
exchanged in a current transaction between willing parties, other than in a
forced sale or liquidation, and is best evidenced by a quoted market price, if
one exists.
Quoted market prices, where available, are shown as estimates of fair market
values. Because no quoted market prices are available for a significant part of
the Company's financial instruments, the fair values of such instruments have
been derived based on the amount and timing of future cash flows and estimated
discount rates.
Present value techniques used in estimating the fair value of many of the
Company's financial instruments are significantly affected by the assumptions
used. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate cash settlement of the instrument. Additionally, the accompanying
estimates of fair values are only representative of the fair values of the
individual financial assets and liabilities, and should not be considered an
indication of the fair value of the Company.
The estimated fair values of the Company's financial instruments at December 31
are as follows:
2002 2001
---------------------------------------------------------------------------------------------------------------------
ESTIMATED Estimated
CARRYING FAIR Carrying Fair
(In thousands) AMOUNT VALUE Amount Value
-------------------------------------------------------------------------------------------------------------------
Financial Assets
Cash and temporary investments (1) $ 87,381 $ 87,942 $ 73,904 $ 74,119
Investments available-for-sale 685,586 685,586 732,629 732,629
Investments held-to-maturity and other equity
securities 360,672 366,674 181,850 181,944
Loans, net of allowances 1,048,817 1,079,129 983,266 966,544
Accrued interest receivable and other assets (2) 59,379 59,379 46,451 46,451
Financial Liabilities
Deposits $ 1,492,212 $ 1,497,733 $ 1,387,459 $ 1,391,443
Short-term borrowings 488,214 490,601 411,132 412,075
Long-term borrowings 125,500 135,085 114,116 120,301
Accrued interest payable and other liabilities (2) 3,692 3,692 2,727 2,727
ESTIMATED ESTIMATED Estimated Estimated
(In thousands) AMOUNT FAIR VALUE Amount Fair Value
---------------------------------------------------------------------------------------------------------------------
Off-Balance Sheet Financial Assets
Commitments to extended credit (3) $ 368,781 $ (163) $ 326,130 $ (181)
Irrevocable letters of credit 22,004 (110) 24,530 (123)
(1) Temporary investments include interest-bearing deposits with banks, federal
funds sold and residential mortgage loans held for sale.
(2) Only financial instruments as defined in Statement of Financial Accounting
Standards No. 107, "Disclosure About Fair Value of Financial Instruments",
are included in other assets and other liabilities.
(3) Includes loan and credit line commitments and unused portions of equity
lines.
50
The following methods and assumptions were used to estimate the fair value of
each category of financial instruments for which it is practicable to estimate
that value:
CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD. The carrying amount approximated
the fair value.
INTEREST-BEARING DEPOSITS WITH BANKS. The fair value was estimated by computing
the discounted value of contractual cash flows using a current interest rate for
similar instruments.
RESIDENTIAL MORTGAGE LOANS HELD FOR SALE. The fair value of residential mortgage
loans held for sale was derived from secondary market quotations for similar
instruments.
SECURITIES. The fair value for U.S. Agency, state and municipal, and corporate
debt securities was based upon quoted market bids; for mortgage-backed
securities upon bid prices for similar pools of fixed and variable rate assets,
considering current market spreads and prepayment speeds; and, for equity
securities upon quoted market prices.
LOANS. The fair value was estimated by computing the discounted value of
estimated cash flows, adjusted for potential credit losses, for pools of loans
having similar characteristics. The discount rate was based upon the current
loan origination rate for a similar loan. Non-performing loans have an assumed
interest rate of 0%.
ACCRUED INTEREST RECEIVABLE. The carrying amount approximated the fair value of
accrued interest, considering the short-term nature of the receivable and its
expected collection.
OTHER ASSETS. The carrying amount approximated the fair value of certain accrued
commissions in other assets, considering the short-term nature of the receivable
and its expected collection.
DEPOSIT LIABILITIES. The fair value of demand, money market savings and regular
savings deposits, which have no stated maturity, were considered equal to their
carrying amount, representing the amount payable on demand. These estimated fair
values do not include the intangible value of core deposit relationships, which
comprise a significant portion of the Bank's deposit base. Management believes
that the Bank's core deposit relationships provide a relatively stable, low-cost
funding source that has a substantial intangible value separate from the value
of the deposit balances.
The fair value of time deposits was based upon the discounted value of
contractual cash flows at current rates for deposits of similar remaining
maturity.
SHORT-TERM BORROWINGS. The carrying amount approximated the fair value of
repurchase agreements due to their variable interest rates. The fair value of
Federal Home Loan Bank advances was estimated by computing the discounted value
of contractual cash flows payable at current interest rates for obligations with
similar remaining terms.
LONG-TERM BORROWINGS. The fair value of these mortgage and Federal Home Loan
Bank advances was estimated by computing the discounted value of contractual
cash flows payable at current interest rates for obligations with similar
remaining terms.
OTHER LIABILITIES. The carrying amount approximated the fair value of accrued
interest payable, accrued dividends and premiums payable, considering their
short-term nature and expected payment.
OFF-BALANCE SHEET INSTRUMENTS. The fair value of unused lines and letters of
credit was estimated based upon the amount of unamortized fees collected or paid
incident to granting or receiving the commitment.
51
NOTE 20 - PARENT COMPANY FINANCIAL INFORMATION
The condensed financial statements for Sandy Spring Bancorp, Inc. (Parent Only)
pertaining to the periods covered by the Company's consolidated financial
statements are presented below:
BALANCE SHEETS
December 31,
--------------------------------------------------------------------------------------------------------
(In thousands) 2002 2001
--------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 6,259 $ 3,956
Investments available-for-sale (at fair value) 8,621 8,520
Investment in subsidiary 156,594 136,493
Loan from subsidiary 33,565 33,565
Other assets 1,366 1,429
-------- --------
Total assets $206,405 $183,963
======== ========
Liabilities
Long-term borrowings $ 35,000 $ 35,000
Other liabilities 2,343 1,656
-------- --------
Total liabilities 37,343 36,656
Stockholders' Equity
Common stock 14,536 14,484
Additional paid in capital 21,128 20,347
Retained earnings 131,939 111,366
Accumulated other comprehensive income 1,459 1,110
-------- --------
Total stockholders' equity 169,062 147,307
-------- --------
Total liabilities and stockholders' equity $206,405 $183,963
======== ========
STATEMENTS OF INCOME
Years Ended December 31,
--------------------------------------------------------------------------------------------------------
(In thousands) 2002 2001 2000
--------------------------------------------------------------------------------------------------------
Income:
Cash dividends from subsidiary $ 10,012 $ 8,881 $ 9,254
Securities gains 1,151 0 209
Other income, principally interest 3,567 3,634 3,418
-------- -------- --------
Total income 14,730 12,515 12,881
Expenses:
Interest 3,281 3,281 3,281
Other expenses 707 610 506
-------- -------- --------
Total expenses 3,988 3,891 3,787
Income before income taxes and equity in undistributed income
of subsidiary 10,742 8,624 9,094
Income tax expense (benefit) 259 (90) (101)
-------- -------- --------
Income before equity in undistributed income of subsidiary 10,483 8,714 9,195
Equity in undistributed income of subsidiary 20,102 14,300 9,438
-------- -------- --------
Net income $ 30,585 $ 23,014 $ 18,633
======== ======== ========
52
STATEMENTS OF CASH FLOWS
Years Ended December 31,
-------------------------------------------------------------------------------------------------------------
(In thousands) 2002 2001 2000
-------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $ 30,585 $ 23,014 $ 18,633
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed income-subsidiary (20,102) (14,300) (9,438)
Securities gains (1,151) 0 (209)
Net change in other liabilities 467 (30) 65
Other-net 63 114 (31)
-------- -------- --------
Net cash provided by operating activities 9,862 8,798 9,020
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (682) (333) (1,100)
Proceeds from sales of investments available-for-sale 2,302 36 460
-------- -------- --------
Net cash provided (used) by investing activities 1,620 (297) (640)
Cash Flows from Financing Activities:
Common stock purchased and retired 0 0 (4,158)
Proceeds from issuance of common stock 833 2,767 2,098
Dividends paid (10,012) (8,881) (7,749)
-------- -------- --------
Net cash used by financing activities (9,179) (6,114) (9,809)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 2,303 2,387 (1,429)
Cash and cash equivalents at beginning of year 3,956 1,569 2,998
-------- -------- --------
Cash and cash equivalents at end of year $ 6,259 $ 3,956 $ 1,569
======== ======== ========
NOTE 21 - REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's and the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain amounts and ratios (set forth in
the table below) of total and tier 1 capital (as defined in the regulations) to
Risk weighted assets (as defined), and of tier 1 capital (as defined) to average
assets (as defined). As of December 31, 2002 and 2001, the capital levels of the
Company and the Bank substantially exceeded all capital adequacy requirements to
which they are subject.
As of December 31, 2002, the most recent notification from the Bank's primary
regulator categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Bank must maintain minimum total risk-based, tier 1 risk-based, and tier 1
leverage ratios as set forth in the table below. There are no conditions or
events since that notification that management believes have changed the
Company's or the Bank's category.
53
The Company's and the Bank's actual capital amounts and ratios are also
presented in the table:
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-----------------------------------------------------------------------------------------------------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------------------------------------------
As of December 31, 2002:
Total Capital (to risk weighted assets):
Company $197,202 14.95% $105,529 8.00%
Sandy Spring Bank 182,603 13.93 104,850 8.00 $131,063 10.00%
Tier 1 Capital (to risk weighted assets):
Company 181,034 13.72 52,765 4.00
Sandy Spring Bank 133,943 10.22 52,425 4.00 78,638 6.00
Tier 1 Capital (to average assets):
Company 181,034 8.08 67,225 3.00
Sandy Spring Bank 133,943 6.00 66,948 3.00 111,580 5.00
As of December 31, 2001:
Total Capital (to risk weighted assets):
Company $170,615 14.06% $ 97,095 8.00%
Sandy Spring Bank 157,577 13.07 96,453 8.00 $120,566 10.00%
Tier 1 Capital (to risk weighted assets):
Company 156,971 12.93 48,548 4.00
Sandy Spring Bank 111,184 9.22 48,226 4.00 72,339 6.00
Tier 1 Capital (to average assets):
Company 156,971 7.70 36,411 3.00
Sandy Spring Bank 111,184 5.48 36,170 3.00 60,283 5.00
NOTE 22 - QUARTERLY FINANCIAL RESULTS (UNAUDITED)
A summary of selected consolidated quarterly financial data for the two years
ended December 31, 2002 is reported in the following table.
First Second Third Fourth
(In thousands, except per share data) Quarter Quarter Quarter Quarter
--------------------------------------------------------------------------------------------------
2002
Interest income $29,694 $31,032 $30,968 $31,028
Net interest income 18,581 20,043 19,846 20,139
Provision for credit losses 1,185 985 395 300
Income before income taxes 8,896 9,625 11,219 11,772
Net income 6,560 7,134 8,204 8,687
Basic net income per share $ 0.45 $ 0.50 $ 0.56 $ 0.60
Diluted net income per share 0.45 0.48 0.56 0.59
2001
Interest income $32,119 $32,272 $32,725 $30,754
Net interest income 15,550 16,227 17,340 17,491
Provision for credit losses 492 492 742 744
Income before income taxes 7,108 7,993 8,052 8,203
Net income 5,310 5,844 5,902 5,958
Basic net income per share $ 0.37 $ 0.41 $ 0.41 $ 0.41
Diluted net income per share 0.37 0.40 0.40 0.41
54
NOTE 23 - RESTATEMENT
In November 2003, the Company discovered that accrued interest expense on
certain Federal Home Loan Bank ("FHLB") advances had been understated, beginning
in the first quarter of 1997. This accrual error was the result of a mistake in
the interest calculation formula for certain specific types of FHLB advances.
The total amount of the under-accrual for the year ended December 31, 2002, and
prior periods is $929,000 or $668,000 after applicable income taxes. The maximum
effect on diluted earnings per share in any affected year is less than one cent.
The financial statement items affected by the correction are accrued interest
payable and other liabilities, retained earnings, interest on short-term
borrowings, income tax expense, net income, basic and diluted earnings per
share, totals and other amounts that are calculated using those items, and the
related footnotes.
The following table shows the effect of the restatement on the Consolidated
Balance Sheets as previously reported:
December 31,
2002 2001
--------------------------------------------------------------------------------------------------------------------
As As Previously As As Previously
Restated Reported Restated Reported
Accrued interest payable and other liabilities $23,454 $22,786 $18,994 $18,454
Total liabilities 2,139,380 2,128,712 1,931,701 1,931,161
Retained earnings 131,939 132,607 111,366 111,906
Total stockholders' equity 178,024 178,692 150,133 150,673
55
The following table shows the effect of the restatement on the Consolidated
Statements of Income as previously reported:
Years Ended December 31,
2002 2001
------------------------------------------------------------------------------------------------------------------------------
As As Previously As As Previously
Restated Reported Restated Reported
Interest expense:
Interest on short-term borrowings $16,351 $16,138 $17,543 $17,324
Total interest expense 44,113 43,900 61,262 61,043
Net interest income 78,609 78,822 66,608 66,827
Net interest income after
provision for credit losses 75,744 75,957 64,138 64,357
Income before income taxes 41,512 41,725 31,356 31,575
Income tax expense 10,927 11,012 8,342 8,429
Net Income $30,585 $30,713 $23,014 $23,146
Basic net income per share $2.11 $2.12 $1.60 $1.61
Diluted net income per share $2.08 $2.08 $1.58 $1.59
2000
---------------------------------------------------------------------------------
As As Previously
Restated Reported
Interest expense:
Interest on short-term borrowings $15,873 $15,647
Total interest expense 61,486 61,260
Net interest income 57,194 57,420
Net interest income after
provision for credit losses 54,504 54,730
Income before income taxes 24,431 24,657
Income tax expense 5,798 5,887
Net Income $18,633 $18,770
Basic net income per share $1.30 $1.31
Diluted net income per share $1.30 $1.31
The following table shows the effect of the restatement on the Consolidated
Statements of Cash Flows as previously reported:
Years Ended December 31,
2002 2001
---------------------------------------------------------------------------------------------------------------------------
As As Previously As As Previously
Restated Reported Restated Reported
Cash Flows from operating activities
Net income $30,585 $30,713 $23,014 $23,146
Adjustments to reconcile net income to net
cash provided by operating activities:
Net increase in accrued expenses 3,541 3,413 4,337 4,205
2000
----------------------------------------------------------------------------------
As As Previously
Restated Reported
Cash Flows from operating activities
Net income $18,633 $18,770
Adjustments to reconcile net income to net
cash provided by operating activities:
Net increase in accrued expenses 3,839 3,702
56
The following table shows the effect of the restatement on the Consolidated
Statements of Changes in Stockholders' Equity as previously reported:
December 31,
2002 2001
-----------------------------------------------------------------------------------------------------------------------------
As As Previously As As Previously
Restated Reported Restated Reported
Beginning stockholders' equity $150,133 $150,673 $127,150 $127,558
Beginning retained earnings 111,366 111,906 97,233 97,641
Net income 30,585 30,713 23,014 23,146
Other comprehensive income 37,070 37,198 29,097 29,229
Ending retained earnings 131,939 132,607 111,366 111,906
Ending stockholders' equity 178,024 178,692 150,133 150,673
2000
-----------------------------------------------------------------------------------
As As Previously
Restated Reported
Beginning stockholders' equity $108,449 $108,720
Beginning retained earnings 86,349 86,620
Net income 18,633 18,770
Other comprehensive income 28,510 28,647
Ending retained earnings 97,233 97,641
Ending stockholders' equity 127,150 127,558
57
Sandy Spring Bancorp, Inc. and Subsidiaries
MANAGEMENT'S STATEMENT OF RESPONSIBILITY
Management acknowledges its responsibility for financial reporting (both audited
and unaudited) which provides a fair representation of the Company's operations
and is reliable and relevant to a meaningful appraisal of the Company.
Management has prepared the financial statements in accordance with generally
accepted accounting principles, making appropriate use of estimates and
judgment, and considering materiality. Except for tax equivalency adjustments
made to enhance comparative analysis, all financial information is consistent
with the audited financial statements.
In addition, management is responsible for establishing and maintaining
effective internal control over financial reporting, presented in conformity
with generally accepted accounting principles and the applicable requirements of
the Federal Reserve System. The internal control system contains monitoring
mechanisms, and actions are taken to correct deficiencies identified. There are
inherent limitations in the effectiveness of any internal control system,
including the possibility of human error and the circumvention or overriding of
controls. Accordingly, even effective internal control systems can provide only
reasonable assurance with respect to financial statement preparation. Further,
because of changes in conditions, the effectiveness of internal control systems
may vary over time.
Management assessed Sandy Spring Bancorp, Inc.'s internal control over financial
reporting, presented in conformity with generally accepted accounting principles
and applicable Federal Reserve requirements as of December 31, 2002. This
assessment was based on criteria for effective internal control over financial
reporting described in "Internal Control - Integrated Framework" issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, management believes that Sandy Spring Bancorp, Inc. maintained
effective internal control over financial reporting, presented in conformity
with generally accepted accounting principles and applicable Federal Reserve
requirements as of December 31, 2002.
Management is also responsible for compliance with the federal and state laws
and regulations concerning dividend restrictions and federal laws and
regulations concerning loans to insiders, designated by the Federal Deposit
Insurance Corporation or the Federal Reserve as safety and soundness laws and
regulations.
Management has assessed compliance by Sandy Spring Bancorp, Inc. subsidiary
Sandy Spring Bank with the designated laws and regulations relating to safety
and soundness. Based on this assessment, management believes that the subsidiary
insured depository institution complied, in all significant respects, with the
designated laws and regulations related to safety and soundness for the year
ended December 31, 2002.
Oversight of the financial reporting process is provided by the Audit Committee
of the Board of Directors, which consists solely of outside directors. This
Committee meets on a regular basis, in private, with the internal auditor, who
reports directly to the Audit Committee, to approve the audit schedule and
scope, discuss the adequacy of the internal control systems and the quality of
financial reporting, review audit reports and address problems. The Committee
also reviews the Company's annual report on Form 10-K to shareholders and filed
with the Securities and Exchange Commission, and its quarterly reports on Form
10-Q. The Audit Committee controls the hiring and compensation of the external
auditors, and meets at least quarterly with the external auditors, and has
direct and private access to them at any time.
The independent public accounting firm of Stegman & Company has examined the
Company's financial records. The resulting opinion statement which follows is
based upon knowledge of the Company's accounting systems, as well as on tests
and other audit procedures performed in accordance with generally accepted
auditing standards.
/s/ Hunter R. Hollar /s/ James H. Langmead
Hunter R. Hollar James H. Langmead
President and Chief Executive Officer Executive Vice President and
Chief Financial Officer
58
REPORT OF INDEPENDENT AUDITORS
Audit Committee of the
Board of Directors and Shareholders of
Sandy Spring Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Sandy Spring
Bancorp, Inc. and Subsidiaries as of December 31, 2002 and 2001, 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, 2002. These
financial statements are the responsibility of the management of Sandy Spring
Bancorp, Inc. and Subsidiaries. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Sandy Spring
Bancorp, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the results
of their operations and cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 23, the accompanying consolidated financial statements have
been restated.
/s/ Stegman & Company
Baltimore, Maryland
January 31, 2003 (December 12, 2003 as to Note 23)
59
OTHER MATERIAL REQUIRED BY FORM 10-K
BUSINESS
GENERAL
Sandy Spring Bancorp, Inc. ("the Company") is the one-bank holding company for
Sandy Spring Bank (the "Bank"). The Company is registered as a bank holding
company pursuant to the Bank Holding Company Act of 1956, as amended (the
"Holding Company Act"). As such, the Company is subject to supervision and
regulation by the Board of Governors of the Federal Reserve System (the "Federal
Reserve"). The Company began operating in 1988. The Bank traces its origin to
1868, and is the oldest banking business based in Montgomery County, Maryland.
The Bank is independent, community oriented, and conducts a full-service
commercial banking business through 30 community offices located in Anne
Arundel, Frederick, Howard, Montgomery and Prince George's counties in Maryland.
The Bank is a state chartered bank subject to supervision and regulation by the
Federal Reserve and the state of Maryland. The Bank's deposit accounts are
insured by the Bank Insurance Fund ("BIF") administered by the Federal Deposit
Insurance Corporation (the "FDIC") to the maximum permitted by law. The Bank is
a member of the Federal Reserve System and is an Equal Housing Lender. The
Company, the Bank, and its other subsidiaries are Affirmative Action/Equal
Opportunity Employers.
The Bank experiences substantial competition both in attracting and retaining
deposits and in making loans. Direct competition for deposits comes from other
commercial banks, savings associations, and credit unions located in the Bank's
primary market area of Anne Arundel, Frederick, Howard, Montgomery and Prince
George's counties in Maryland. Additional significant competition for deposits
comes from mutual funds and corporate and government debt securities. Sandy
Spring Insurance Corporation (SSIC), a wholly owned subsidiary of the Bank,
offers annuities as an alternative to traditional deposit accounts. Since
December 2001, SSIC also operates the Chesapeake Insurance Group, a general
insurance agency located in Annapolis, Maryland, which faces competition
primarily from other insurance agencies and insurance companies. The primary
factors in competing for loans are interest rates, loan origination fees, and
the range of services offered by lenders. Competitors for loan originations
include other commercial banks, mortgage bankers, mortgage brokers, savings
associations, and insurance companies. Equipment leasing through the equipment
leasing subsidiary basically involves the same competitive factors as lending,
with competition from other equipment leasing companies. Management believes the
Bank is able to compete effectively in its primary market area.
The Company's and the Bank's principal executive office is at 17801
Georgia Avenue, Olney, Maryland 20832, and its telephone number is 301-774-6400.
The Company's Website is located at www.sandyspringbank.com.
LOAN AND LEASE PRODUCTS
Residential Real Estate Loans. The residential real estate category contains
loans principally to consumers secured by residential real estate. The Company's
residential real estate lending policy requires each loan to have viable
repayment sources. Residential real estate loans are evaluated for the adequacy
of these repayment sources at the time of approval, based upon measures
including credit scores, debt-to-income ratios, and collateral values. Credit
risk for residential real estate loans arises from borrowers lacking the ability
or willingness to repay the loan, and by a shortfall in the value of the
residential real estate in relation to the outstanding loan balance in the event
of a default and subsequent liquidation of the real estate collateral. The
residential real estate portfolio includes both conforming and nonconforming
mortgage loans. Conforming mortgage loans represent loans originated in
accordance with underwriting standards set forth by the government-sponsored
entities (GSEs), including the Federal National Mortgage Association (FNMA), the
Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government
National Mortgage Association (GNMA), which serve as the primary purchasers of
loans sold in the secondary mortgage market by mortgage lenders. These loans are
generally collateralized by one-to-four-family residential real estate, have
loan-to-collateral value ratios of 80% or less or have mortgage insurance to
insure down to 80%, and are made to borrowers in good credit standing.
Substantially all fixed-rate conforming loans originated are sold in the
secondary mortgage market. For any loans retained by the Company, title
insurance insuring the priority of its mortgage lien, as well as fire and
extended coverage casualty insurance protecting the properties securing the
loans are required. Borrowers may be required to advance funds, with each
monthly payment of principal and interest, to a loan escrow account from which
the Company makes disbursements for items such as real estate taxes, hazard
60
insurance premiums and mortgage insurance premiums. Appraisers approved by the
Company appraise the properties securing substantially all of the Company's
residential mortgage loans.
Nonconforming mortgage loans represent loans that generally are not saleable in
the secondary market to the GSEs for inclusion in conventional mortgage-backed
securities due to the credit characteristics of the borrower, the underlying
documentation, the loan-to-value ratio, or the size of the loan, among other
factors. The Company originates nonconforming loans for its own portfolio and
for sale to third-party investors, usually large mortgage companies, under
commitments by them to purchase subject to compliance with pre-established
investor criteria. These nonconforming loans generated for sale include some
residential mortgage credits that may be categorized as sub-prime under federal
banking regulations. Such sub-prime credits typically remain on the Company's
consolidated books after funding for thirty days or less, and are included in
residential mortgages held for sale on the face of the balance sheet. The
Company also holds occasional, isolated credits that inadvertently failed to
meet GSE or other third-party investor criteria, or that were originated and
managed in the ordinary course of business (rather than in any sub-prime lending
program) and may have characteristics that could cause them to be categorized as
sub-prime. The Company's current practice is to sell all such sub-prime loans to
third party investors. The Company believes that the sub-prime credits it
originates or holds and the risks they entail are not significant to its
financial condition, results of operations, liquidity, or capital resources.
The Company engages in sales of residential mortgage loans originated by the
Bank. The Company's current practice is to sell loans on a servicing released
basis. In 2001, the Company sold substantially all of its servicing rights,
which related to loans originated and sold with servicing retained in years
prior to 1995.
The Company makes residential real estate development and construction loans
generally to provide interim financing on property during the development and
construction period. Borrowers include builders, developers and persons who will
ultimately occupy the single-family dwelling. Residential real estate
development and construction loan funds are disbursed periodically as
pre-specified stages of completion are attained based upon site inspections.
Interest rates on these loans are usually adjustable. Loans to individuals for
the construction of primary personal residences are typically secured by the
property under construction, frequently include additional collateral (such as a
second mortgage on the borrower's present home), and commonly have maturities of
six to twelve months. The Company attempts to obtain the permanent mortgage loan
under terms, conditions and documentation standards that permit the sale of the
mortgage loan in the secondary mortgage loan market. The Company's practice is
to immediately sell substantially all fixed-rate residential mortgage loans in
the secondary market with servicing released.
Commercial Loans and Leases. The Company devotes significant resources and
attention to seeking and then serving commercial clients. Included in this
category are commercial real estate loans, commercial construction loans, leases
and other commercial loans. Over the years, the Company's commercial loan
clients have come to represent a diverse cross-section of small to mid-size
local businesses, whose owners and employees are often established Bank
customers. Such banking relationships are a natural business for the Company,
with its long-standing community roots and extensive experience in serving and
lending to this market segment.
The Company's commercial lending policy requires each loan, regardless of
whether it is directly originated or is purchased through participation from
another lending institution, to have viable repayment sources. Commercial loans
are evaluated for the adequacy of repayment sources at the time of approval and
are regularly reviewed for any possible deterioration in the ability of the
borrower to repay the loan. Collateral generally is required to provide the
Company with an additional source of repayment in the event of default by a
commercial borrower. The structure of the collateral package, including the type
and amount of the collateral, varies from loan to loan depending on the
financial strength of the borrower, the amount and terms of the loan, and the
collateral available to be pledged by the borrower, but generally may include
real estate, accounts receivable, inventory, equipment or other assets. Loans
also may be supported by personal guarantees from the principals of the
commercial loan borrowers. The financial condition and cash flow of commercial
borrowers are closely monitored by the submission of corporate financial
statements, personal financial statements and income tax returns. The frequency
of submissions of required information depends upon the size and complexity of
the credit and the collateral that secures the loan. Credit risk for commercial
loans arises from borrowers lacking the ability or willingness to repay the
loan, and in the case of secured loans, by a shortfall in the collateral value
in relation to the outstanding loan balance in the event of a default and
subsequent liquidation of collateral. The Company has no commercial loans to
borrowers in similar industries that exceed 10% of total loans.
61
Included in commercial loans are credits directly originated by the Company and
syndicated transactions or loan participations that are originated by other
lenders. The Corporation's commercial lending policy requires each loan,
regardless of whether it is directly originated or is purchased, to have viable
repayment sources. The risks associated with syndicated loans or purchased
participations are similar to those of directly originated commercial loans,
although additional risk may arise from the limited ability to control actions
of the primary lender. Shared National Credits, as defined by the banking
regulatory agencies, represent syndicated lending arrangements with three or
more participating financial institutions and credit exceeding $20 million in
the aggregate. As of December 31, 2002, the Company had $21.3 million in Shared
National Credits outstanding. The Company also sells participations in loans it
originates to other financial institutions in order to build long-term customer
relationships or limit loan concentration. Strict policies are in place
governing the degree of risk assumed and volume of loans held. At December 31,
2002, other financial institutions had $3.1 million in outstanding commercial
and commercial real estate loan participations sold by the Company, and the
Company had $472,000 in outstanding commercial and commercial real estate loan
participations purchased from other lenders, excluding Shared National Credits..
In general, the Company's commercial real estate loans consist of loans secured
by owner occupied properties where an established banking relationship exists
or, to a lesser extent, involve investment properties for warehouse, retail, and
office space with a history of occupancy and cash flow. The commercial real
estate category contains mortgage loans to developers and owners of commercial
real estate. Commercial real estate loans are governed by the same lending
policies and subject to credit risk as previously described for commercial
loans. Although terms and amortization periods vary, the Company's commercial
mortgages generally have maturities or repricing opportunities of five years or
less. The Company seeks to reduce the risks associated with commercial mortgage
lending by generally lending in its market area, using conservative
loan-to-value ratios and obtaining periodic financial statements and tax returns
from borrowers to perform annual loan reviews. It is also the Company's general
policy to obtain personal guarantees from the principals of the borrowers and to
underwrite the business entity from a cash flow perspective.
Commercial real estates loans secured by owner occupied properties are based
upon on the borrower's financial health and the ability of the borrower and the
business to repay. Whenever appropriate and available, the Bank seeks
governmental loan guarantees, such as the Small Business Administration loan
programs, to reduce risks. All borrowers are required to forward annual
corporate, partnership and personal financial statements. Interest rate risks
are mitigated by using either floating interest rates or by fixing rates for a
short period of time, generally less than three years. While loan amortizations
may be approved for up to 240 months, each loan has a call provision (maturity
date) of five years or less. A risk rating system is used to determine loss
exposure.
The Company lends for commercial construction in markets it knows and
understands, works selectively with local, top-quality builders and developers,
and requires substantial equity from its borrowers. The underwriting process is
designed to confirm that the project will be economically feasible and
financially viable; it is generally evaluated as though the Company will provide
permanent financing. The Company's portfolio growth objectives do not include
speculative commercial construction projects or projects lacking reasonable
proportionate sharing of risk. The Company has limited loan losses in this area
of lending through monitoring of development and construction loans with on-site
inspections and control of disbursements on loans in process. Development and
construction loans are secured by the properties under development or
construction and personal guarantees are typically obtained. Further, to assure
that reliance is not placed solely upon the value of the underlying collateral,
the Company considers the financial condition and reputation of the borrower and
any guarantors, the amount of the borrower's equity in the project, independent
appraisals, cost estimates and pre-construction sales information.
Residential construction loans to residential builders are generally made for
the construction of residential homes for which a binding sales contract exists
and the prospective buyers had been pre-qualified for permanent mortgage
financing by either third-party lenders (mortgage companies or other financial
institutions) or the Company. Loans for the development of residential land are
extended when evidence is provided that the lots under development will be or
have been sold to builders satisfactory to the Company. These loans are
generally extended for a period of time sufficient to allow for the clearing and
grading of the land and the installation of water, sewer and roads, typically a
minimum of eighteen months to three years. In addition, residential land
development loans generally carry a loan-to-value ratio not to exceed 75% of the
value of the project as completed.
The Company' equipment leasing business is, for the most part, technology based,
consisting of a portfolio of leases for items such as computers,
telecommunications systems and equipment, medical equipment, and point-of-sale
systems for retail businesses. Equipment leasing is conducted through vendors
and end users located primarily in east coast states from New Jersey to Florida
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and in Illinois. The typical lease is "small ticket" by industry standards,
averaging less than $30,000, with individual leases generally not exceeding
$250,000. Terms generally are fixed payment for up to 5 years. Leases are
extended based primarily upon the ability of the borrower to pay rather than the
value of the leased property.
The Company makes other commercial loans. Commercial term loans are made to
provide funds for equipment and general corporate needs. This loan category is
designed to support borrowers who have a proven ability to service debt over a
term generally not to exceed 84 months. The Company generally requires a first
lien position on all collateral and requires guarantees from owners having at
least a 20% interest in the involved business. Interest rates on commercial term
loans are generally floating or fixed for a term not to exceed three years.
Management carefully monitors industry and collateral concentrations to avoid
loan exposures to a large group of similar industries or similar collateral.
Commercial loans are evaluated for historical and projected cash flow
attributes, balance sheet strength, and primary and alternate resources of
personal guarantors. Commercial term loan documents require borrowers to forward
regular financial information on both the business and personal guarantors. Loan
covenants require at least annual submission of complete financial information
and in certain cases this information is required monthly, quarterly or
semi-annually depending on the degree to which lenders desire information
resources for monitoring a borrower's financial condition and compliance with
loan covenants. Examples of properly margined collateral for loans, as required
by bank policy, would be a 75% advance on the lesser of appraisal or recent
sales price on commercial property, 80% or less advance on eligible receivables,
50% or less advance on eligible inventory and an 80% advance on appraised
residential property. Collateral borrowing certificates may be required to
monitor certain collateral categories on a monthly or quarterly basis. Loans may
require personal guarantees. Key person life insurance may be required as
appropriate and as necessary to mitigate the risk of loss of a primary owner or
manager.
Commercial lines of credit are granted to finance a business borrower's
short-term credit needs and/or to finance a percentage of eligible receivables
and inventory. In addition to the risks inherent in term loan facilities, line
of credit borrowers typically require additional monitoring to protect the
lender against increasing loan volumes and diminishing collateral values.
Commercial lines of credit are generally revolving in nature and require close
scrutiny. The Company generally requires at least an annual out of debt period
(for seasonal borrowers) or regular financial information (monthly or quarterly
financial statements, borrowing base certificates, etc.) for borrowers with more
growth and greater permanent working capital financing needs. Advances against
collateral value are limited. Lines of credit and term loans to the same
borrowers generally are cross-defaulted and cross-collateralized. Interest rate
charges on this group of loans generally float at a factor at or above the prime
lending rate.
Consumer Lending. Consumer lending continues to be very important to the
Company's full-service, community banking business. This category of loans
includes primarily home equity loans and lines, installment loans, personal
lines of credit, marine loans and student loans.
The home equity category consists mainly of revolving lines of credit to
consumers which are secured by residential real estate. Home equity lines of
credit and other home equity loans are originated by the Company for typically
up to 90% of the appraised value, less the amount of any existing prior liens on
the property. While home equity loans have maximum terms of up to fifteen years
and interest rates are generally fixed, home equity lines of credit have maximum
terms of up to fifteen years and interest rates are generally adjustable. The
Company secures these loans with mortgages on the homes (typically a second
mortgage). Purchase money second mortgage loans originated by the Company have
maximum terms ranging from ten to thirty years. These loans generally carry a
fixed rate of interest for the entire term or a fixed rate of interest for the
first five years, repricing every five years thereafter at a predetermined
spread to the prime rate of interest. Home equity lines are generally governed
by the same lending policies and subject to credit risk as described above for
residential real estate loans.
Other consumer loans includes installment loans used by customers to purchase
automobiles, boats, and recreational vehicles, manufactured housing, and student
loans. These consumer loans are generally governed by the same overall lending
policies as described for residential real estate. Credit risk for consumer
loans arises from borrowers lacking the ability or willingness to repay the
loan, and in the case of secured loans, by a shortfall in the value of the
collateral in relation to the outstanding loan balance in the event of a default
and subsequent liquidation of collateral.
Consumer installment loans are generally offered for terms of up to five years
at fixed interest rates. The Company makes loans for automobiles, recreational
vehicles, and marine craft, both new and used, directly to the borrowers. The
Company also makes indirect marine loans at fixed rates for terms of up to 20
years. Automobile loans can be for up to 100% of the purchase price or the
retail value listed by the National Automobile Dealers Association. The terms of
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the loans are determined by the age and condition of the collateral. Collision
insurance policies are required on all these loans, unless the borrower has
substantial other assets and income. The Company's student loans are made in
amounts of up to $18,500 per year. The Company offers a variety of graduate and
undergraduate loan programs under the Federal Family Education Loan Program.
Interest is capitalized annually until the student leaves school and
amortization over a ten-year period then begins. It is the Company's practice to
sell all such loans in the secondary market when the student leaves school. The
Company also makes other consumer loans, which may or may not be secured. The
term of the loans usually depends on the collateral. Unsecured loans usually do
not exceed $100,000 and have a term of no longer than 12 months.
AVAILABILITY OF FILINGS THROUGH THE COMPANY'S WEBSITE
The Company provides internet access to annual reports on form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to those
reports, through the Investor Relations area of the Bank's Website, at
www.sandyspringbank.com. Access to these reports is provided by means of a link
to a third-party vendor that maintains a database of such filings. In general,
the Company intends that these reports be available as soon as reasonably
practicable after they are filed with or furnished to the SEC. However,
technical and other operational obstacles or delays caused by the vendor may
delay their availability. The SEC maintains a Website (www.sec.gov) where these
filings also are available through the SEC's EDGAR system. There is no charge
for access to these filings through either the Company's site or the SEC's site,
although users should understand that there may be costs associated with
electronic access, such as usage charges from Internet access providers and
telephone companies, that they may bear.
REGULATION, SUPERVISION, AND GOVERNMENTAL POLICY
Following is a brief summary of certain statutes and regulations that
significantly affect the Company and the Bank. A number of other statutes and
regulations affect the Company and the Bank but are not summarized below.
Bank Holding Company Regulation. The Company is registered as a bank holding
company under the Holding Company Act and, as such, is subject to supervision
and regulation by the Federal Reserve. As a bank holding company, the Company is
required to furnish to the Federal Reserve annual and quarterly reports of its
operations and additional information and reports. The Company is also subject
to regular examination by the Federal Reserve.
Under the Holding Company Act, a bank holding company must obtain the prior
approval of the Federal Reserve before (1) acquiring direct or indirect
ownership or control of any class of voting securities of any bank or bank
holding company if, after the acquisition, the bank holding company would
directly or indirectly own or control more than 5% of the class; (2) acquiring
all or substantially all of the assets of another bank or bank holding company;
or (3) merging or consolidating with another bank holding company.
Under the Holding Company Act, any company must obtain approval of the Federal
Reserve prior to acquiring control of the Company or the Bank. For purposes of
the Holding Company Act, "control" is defined as ownership of 25% or more of any
class of voting securities of the Company or the Bank, the ability to control
the election of a majority of the directors, or the exercise of a controlling
influence over management or policies of the Company or the Bank.
The Change in Bank Control Act and the related regulations of the Federal
Reserve require any person or persons acting in concert (except for companies
required to make application under the Holding Company Act), to file a written
notice with the Federal Reserve before the person or persons acquire control of
the Company or the Bank. The Change in Bank Control Act defines "control" as the
direct or indirect power to vote 25% or more of any class of voting securities
or to direct the management or policies of a bank holding company or an insured
bank.
The Holding Company Act also limits the investments and activities of bank
holding companies. In general, a bank holding company is prohibited from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of a company that is not a bank or a bank holding company or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, providing services for its subsidiaries, non-bank
activities that are closely related to banking, and other financially related
activities. The activities of the Company are subject to these legal and
regulatory limitations under the Holding Company Act and Federal Reserve
regulations.
64
In general, bank holding companies that qualify as financial holding companies
under federal banking law may engage in an expanded list of non-bank activities.
Non-bank and financially related activities of bank holding companies, including
companies that become financial holding companies, also may be subject to
regulation and oversight by regulators other than the Federal Reserve.
The Federal Reserve has the power to order a holding company or its subsidiaries
to terminate any activity, or to terminate its ownership or control of any
subsidiary, when it has reasonable cause to believe that the continuation of
such activity or such ownership or control constitutes a serious risk to the
financial safety, soundness, or stability of any bank subsidiary of that holding
company.
The Federal Reserve has adopted guidelines regarding the capital adequacy of
bank holding companies, which require bank holding companies to maintain
specified minimum ratios of capital to total assets and capital to risk-weighted
assets. See "Regulatory Capital Requirements."
The Federal Reserve has the power to prohibit dividends by bank holding
companies if their actions constitute unsafe or unsound practices. The Federal
Reserve has issued a policy statement on the payment of cash dividends by bank
holding companies, which expresses the Federal Reserve's view that a bank
holding company should pay cash dividends only to the extent that the company's
net income for the past year is sufficient to cover both the cash dividends and
a rate of earnings retention that is consistent with the company's capital
needs, asset quality, and overall financial condition.
Bank Regulation. On September 21, 2001, the Bank's application to the Maryland
State Commissioner of Financial Regulation to become a state chartered bank and
trust company was approved and the Bank began operations as such. The Bank is a
member of the Federal Reserve System and is subject to supervision by Federal
Reserve and the State of Maryland. Deposits of the Bank are insured by the FDIC
to the legal maximum of $100,000 for each insured depositor. Deposits, reserves,
investments, loans, consumer law compliance, issuance of securities, payment of
dividends, establishment of branches, mergers and acquisitions, corporate
activities, changes in control, electronic funds transfers, responsiveness to
community needs, management practices, compensation policies, and other aspects
of operations are subject to regulation by the appropriate federal and state
supervisory authorities. In addition, the Bank is subject to numerous federal,
state and local laws and regulations which set forth specific restrictions and
procedural requirements with respect to extensions of credit (including to
insiders), credit practices, disclosure of credit terms and discrimination in
credit transactions.
The Federal Reserve regularly examines the operations and condition of the Bank,
including, but not limited to, its capital adequacy, reserves, loans,
investments, and management practices. These examinations are for the protection
of the Bank's depositors and the BIF. In addition, the Bank is required to
furnish quarterly and annual reports to the Federal Reserve. The Federal
Reserve's enforcement authority includes the power to remove officers and
directors and the authority to issue cease-and-desist orders to prevent a bank
from engaging in unsafe or unsound practices or violating laws or regulations
governing its business.
The Federal Reserve has adopted regulations regarding the capital adequacy,
which require member banks to maintain specified minimum ratios of capital to
total assets and capital to risk-weighted assets. See "Regulatory Capital
Requirements." Federal Reserve and State regulations limit the amount of
dividends that the Bank may pay to the Company. See "Note 11 - Stockholders'
Equity" of the Notes to the Consolidated Financial Statements.
The Bank is subject to restrictions under federal law which limit the transfer
of funds by the Bank to Bancorp and its non-banking subsidiaries, whether in the
form of loans, extensions of credit, investments, asset purchases, or otherwise.
Such transfers by the Bank to Bancorp or any of Bancorp's non-banking
subsidiaries are limited in amount to 10% of the Bank's capital and surplus and,
with respect to Bancorp and all such non-banking subsidiaries, to an aggregate
of 20% of the Bank's capital and surplus. Furthermore, such loans and extensions
of credit are required to be secured in specified amounts.
The Bank is subject to restrictions imposed by federal law on extensions of
credit to, and certain other transactions with, the Company and other
affiliates, and on investments in their stock or other securities. These
restrictions prevent the Company and the Bank's other affiliates from borrowing
from the Bank unless the loans are secured by specified collateral, and require
those transactions to have terms comparable to terms of arms-length transactions
with third persons. In addition, secured loans and other transactions and
65
investments by the Bank are generally limited in amount as to the Company and as
to any other affiliate to 10% of the Bank's capital and surplus and as to the
Company and all other affiliates together to an aggregate of 20% of the Bank's
capital and surplus. Certain exemptions to these limitations apply to extensions
of credit and other transactions between the Bank and its subsidiaries. These
regulations and restrictions may limit the Company's ability to obtain funds
from the Bank for its cash needs, including funds for acquisitions and for
payment of dividends, interest, and operating expenses.
Under Federal Reserve regulations, banks must adopt and maintain written
policies that establish appropriate limits and standards for extensions of
credit secured by liens or interests in real estate or are made for the purpose
of financing permanent improvements to real estate. These policies must
establish loan portfolio diversification standards; prudent underwriting
standards, including loan-to-value limits, that are clear and measurable; loan
administration procedures; and documentation, approval, and reporting
requirements. A bank's real estate lending policy must reflect consideration of
the Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") adopted by the federal bank regulators. The Interagency Guidelines,
among other things, call for internal loan-to-value limits for real estate loans
that are not in excess of the limits specified in the Guidelines. The
Interagency Guidelines state, however, that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits.
The FDIC has established a risk-based deposit insurance premium assessment
system for insured depository institutions. Under the system, the assessment
rate for an insured depository institution depends on the assessment risk
classification assigned to the institution by the FDIC, based upon the
institution's capital level and supervisory evaluations. Institutions are
assigned to one of three capital groups -- well-capitalized, adequately
capitalized, or undercapitalized -- based on the data reported to regulators.
Well-capitalized institutions are institutions satisfying the following capital
ratio standards: (i) total risk-based capital ratio of 10% or greater; (ii) Tier
1 risk-based capital ratio of 6% or greater; and (iii) Tier 1 leverage ratio of
5% or greater. Adequately capitalized institutions are institutions that do not
meet the standards for well-capitalized institutions but that satisfy the
following capital ratio standards: (i) total risk-based capital ratio of 8% or
greater; (ii) Tier 1 risk-based capital ratio of 4% or greater; and (iii) Tier 1
leverage ratio of 4% or greater. Institutions that do not qualify as either
well-capitalized or adequately capitalized are deemed to be undercapitalized.
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk it poses to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions with demonstrated
weaknesses that, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken. The
Bank has been informed that it is in the least costly assessment category for
the first assessment period of 2003. Deposit insurance rates may be increased
during 2003 or later years.
Regulatory Capital Requirements. The Federal Reserve has established guidelines
for maintenance of appropriate levels of capital by bank holding companies and
member banks. The regulations impose two sets of capital adequacy requirements:
minimum leverage rules, which require bank holding companies and banks to
maintain a specified minimum ratio of capital to total assets, and risk-based
capital rules, which require the maintenance of specified minimum ratios of
capital to "risk-weighted" assets.
The regulations of the Federal Reserve require bank holding companies and member
banks to maintain a minimum leverage ratio of "Tier 1 capital" (as defined in
the risk-based capital guidelines discussed in the following paragraphs) to
total assets of 3.0%. The capital regulations state, however, that only the
strongest bank holding companies and banks, with composite examination ratings
of 1 under the rating system used by the federal bank regulators, would be
permitted to operate at or near this minimum level of capital. All other bank
holding companies and banks are expected to maintain a leverage ratio of at
least 1% to 2% above the minimum ratio, depending on the assessment of an
individual organization's capital adequacy by its primary regulator. A bank or
bank holding company experiencing or anticipating significant growth is expected
to maintain capital well above the minimum levels. In addition, the Federal
Reserve has indicated that it also may consider the level of an organization's
ratio of tangible Tier 1 capital (after deducting all intangibles) to total
assets in making an overall assessment of capital.
66
The risk-based capital rules of the Federal Reserve requires bank holding
companies and member banks to maintain minimum regulatory capital levels based
upon a weighting of their assets and off-balance sheet obligations according to
risk. The risk-based capital rules have two basic components: a core capital
(Tier 1) requirement and a supplementary capital (Tier 2) requirement. Core
capital consists primarily of common stockholders' equity, certain perpetual
preferred stock (noncumulative perpetual preferred stock with respect to banks),
and minority interests in the equity accounts of consolidated subsidiaries; less
all intangible assets, except for certain mortgage servicing rights and
purchased credit card relationships. Supplementary capital elements include,
subject to certain limitations, the allowance for losses on loans and leases;
perpetual preferred stock that does not qualify as Tier 1 capital; long-term
preferred stock with an original maturity of at least 20 years from issuance;
hybrid capital instruments, including perpetual debt and mandatory convertible
securities; subordinated debt, intermediate-term preferred stock, and up to 45%
of pre-tax net unrealized gains on available for sale equity securities.
In November 1999, Sandy Spring Capital Trust I, a statutory business trust and
consolidated subsidiary of the Company, sold 1.4 million trust preferred
securities having a liquidation price of $25 each for a total price of $35
million. These trust preferred securities meet the Federal Reserve's regulatory
criteria for Tier 1 capital, subject to Federal Reserve guidelines that limit
the amount of trust preferred securities (and any cumulative perpetual preferred
stock) that may be included in Tier 1 capital to an aggregate of 25% of Tier 1
capital. Any excess may be included as supplementary capital. Funds from the
issuance of the trust preferred securities were used for general corporate
purposes, including investment in subordinated debt of the Bank.
The risk-based capital regulations assign balance sheet assets and credit
equivalent amounts of off-balance sheet obligations to one of four broad risk
categories based principally on the degree of credit risk associated with the
obligor. The assets and off-balance sheet items in the four risk categories are
weighted at 0%, 20%, 50% and 100%. These computations result in the total
risk-weighted assets.
The risk-based capital regulations require all commercial banks and bank holding
companies to maintain a minimum ratio of total capital to total risk-weighted
assets of 8%, with at least 4% as core capital. For the purpose of calculating
these ratios: (i) supplementary capital is limited to no more than 100% of core
capital; and (ii) the aggregate amount of certain types of supplementary capital
is limited. In addition, the risk-based capital regulations limit the allowance
for credit losses that may be included in capital to 1.25% of total
risk-weighted assets.
The federal bank regulatory agencies have established a joint policy regarding
the evaluation of commercial banks' capital adequacy for interest rate risk.
Under the policy, the Federal Reserve's assessment of a bank's capital adequacy
includes an assessment of the bank's exposure to adverse changes in interest
rates. The Federal Reserve has determined to rely on its examination process for
such evaluations rather than on standardized measurement systems or formulas.
The Federal Reserve may require banks that are found to have a high level of
interest rate risk exposure or weak interest rate risk management systems to
take corrective actions. Management believes its interest rate risk management
systems and its capital relative to its interest rate risk are adequate.
Federal banking regulations also require banks with significant trading assets
or liabilities to maintain supplemental risk-based capital based upon their
levels of market risk. The Bank did not have significant levels of trading
assets or liabilities during 2002, and was not required to maintain such
supplemental capital.
The Federal Reserve has established regulations that classify banks by capital
levels and provide for the Federal Reserve to take various "prompt corrective
actions" to resolve the problems of any bank that fails to satisfy the capital
standards. Under these regulations, a well-capitalized bank is one that is not
subject to any regulatory order or directive to meet any specific capital level
and that has a total risk-based capital ratio of 10% or more, a Tier 1
risk-based capital ratio of 6% or more, and a leverage ratio of 5% or more. An
adequately capitalized bank is one that does not qualify as well-capitalized but
meets or exceeds the following capital requirements: a total risk-based capital
ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of
either (i) 4% or (ii) 3% if the bank has the highest composite examination
rating. A bank that does not meet these standards is categorized as
undercapitalized, significantly undercapitalized, or critically
undercapitalized, depending on its capital levels. A bank that falls within any
of the three undercapitalized categories established by the prompt corrective
action regulation is subject to severe regulatory sanctions. As of December 31,
2002, the Bank was well-capitalized as defined in the Federal Reserve's
regulations.
67
For information regarding the Company's and the Bank's compliance with their
respective regulatory capital requirements, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Capital Management"
of this report and "Note 21 - Regulatory Matters" of the Notes to the
Consolidated Financial Statements of this Report.
SUPERVISION AND REGULATION OF MORTGAGE BANKING OPERATIONS
The Company's mortgage banking business is subject to the rules and regulations
of the U.S. Department of Housing and Urban Development ("HUD"), the Federal
Housing Administration ("FHA"), the Veterans' Administration ("VA"), and the
Federal National Mortgage Association ("FNMA") with respect to originating,
processing, selling and servicing mortgage loans. Those rules and regulations,
among other things, prohibit discrimination and establish underwriting
guidelines, which include provisions for inspections and appraisals, require
credit reports on prospective borrowers, and fix maximum loan amounts. Lenders
such as the Company are required annually to submit to FNMA, FHA and VA audited
financial statements, and each regulatory entity has its own financial
requirements. The Company's affairs are also subject to examination by the
Federal Reserve, FNMA, FHA and VA at all times to assure compliance with the
applicable regulations, policies and procedures. Mortgage origination activities
are subject to, among others, the Equal Credit Opportunity Act, Federal
Truth-in-Lending Act, Fair Housing Act, Fair Credit Reporting Act, the National
Flood Insurance Act and the Real Estate Settlement Procedures Act and related
regulations that prohibit discrimination and require the disclosure of certain
basic information to mortgagors concerning credit terms and settlement costs.
The Company's mortgage banking operations also are affected by various state and
local laws and regulations and the requirements of various private mortgage
investors.
COMPETITION
The Bank's principal competitors for deposits are other financial institutions,
including other banks, credit unions, and savings institutions. Competition
among these institutions is based primarily on interest rates and other terms
offered, service charges imposed on deposit accounts, the quality of services
rendered, and the convenience of banking facilities. Additional competition for
depositors' funds comes from U.S. Government securities, private issuers of debt
obligations and suppliers of other investment alternatives for depositors, such
as securities firms. Competition from credit unions has intensified in recent
years as historical federal limits on membership have been relaxed. Because
federal law subsidizes credit unions by giving them a general exemption from
federal income taxes, credit unions have a significant cost advantage over banks
and savings associations, which are fully subject to federal income taxes.
Credit unions may use this advantage to offer rates that are highly competitive
with those offered by banks and thrifts.
The banking business in Maryland generally, and the Bank's primary service areas
specifically, are highly competitive with respect to both loans and deposits. As
noted above, the Bank competes with many larger banking organizations that have
offices over a wide geographic area. These larger institutions have certain
inherent advantages, such as the ability to finance wide-ranging advertising
campaigns and promotions and to allocate their investment assets to regions
offering the highest yield and demand. They also offer services, such as
international banking, that are not offered directly by the Bank (but are
available indirectly through correspondent institutions), and, by virtue of
their larger total capitalization, such banks have substantially higher legal
lending limits, which are based on bank capital, than does the Bank. The Bank
can arrange loans in excess of its lending limit, or in excess of the level of
risk it desires to take, by arranging participations with other banks. Other
entities, both governmental and in private industry, raise capital through the
issuance and sale of debt and equity securities and indirectly compete with the
Bank in the acquisition of deposits.
In addition to competing with other commercial banks, credit unions and savings
associations, commercial banks such as the Bank compete with nonbank
institutions for funds. For instance, yields on corporate and government debt
and equity securities affect the ability of commercial banks to attract and hold
deposits. Commercial banks also compete for available funds with mutual funds.
These mutual funds have provided substantial competition to banks for deposits,
and it is anticipated they will continue to do so in the future.
The Holding Company Act permits the Federal Reserve to approve an application of
an adequately capitalized and adequately managed bank holding company to acquire
control of, or acquire all or substantially all of the assets of, a bank located
in a state other than that holding company's home state. The Federal Reserve may
not approve the acquisition of a bank that has not been in existence for the
minimum time period (not exceeding five years) specified by the statutory law of
the host state. The Holding Company Act also prohibits the Federal Reserve from
approving an application if the applicant (and its depository institution
68
affiliates) controls or would control more than 10% of the insured deposits in
the United States or 30% or more of the deposits in the target bank's home state
or in any state in which the target bank maintains a branch. The Holding Company
Act does not affect the authority of states to limit the percentage of total
insured deposits in the state which may be held or controlled by a bank or bank
holding company to the extent such limitation does not discriminate against
out-of-state banks or bank holding companies.
Federal banking laws also authorize the federal banking agencies to approve
interstate merger transactions without regard to whether such transactions are
prohibited by the law of any state, unless the home state of one of the banks
expressly prohibits merger transactions involving out-of-state banks. The State
of Maryland allows out-of-state financial institutions to merge with Maryland
banks and to establish branches in Maryland, subject to certain limitations.
Financial holding companies may engage in banking as well as types of
securities, insurance, and other financial activities that had been prohibited
for bank holding companies under prior law. Banks with or without holding
companies also may establish and operate financial subsidiaries that may engage
in most financial activities in which financial holding companies may engage.
Competition may increase as bank holding companies and other large financial
services companies take advantage of the new activities and provide a wider
array of products.
EMPLOYEES
As of February 3, 2003, the Company and the Bank employed 575 persons, including
executive officers, loan and other banking and trust officers, branch personnel,
and others. None of the Company's or the Bank's employees is represented by a
union or covered under a collective bargaining agreement. Management of the
Company and the Bank consider their employee relations to be excellent.
EXECUTIVE OFFICERS
The following listing sets forth the name, age (as of March 22, 2003) and
principal position regarding the executive officers of the Company and the Bank
who are not directors:
Frank L. Bentz, III, 44, Executive Vice President and Chief Information Officer
of the Bank
R. Louis Caceres, 40, Executive Vice President of the Bank
Ronald E. Kuykendall, 50, Executive Vice President, General Counsel and
Corporate Secretary of Bancorp and the Bank
James H. Langmead, 53, Executive Vice President and Chief Financial Officer of
Bancorp and the Bank
Lawrence T. Lewis, III, 54, Executive Vice President and Chief Investment
Officer of Bancorp and the Bank
Daniel J. Schrider, 38, Executive Vice President and Chief Credit Officer of the
Bank
Frank H. Small, 56, Executive Vice President and Chief Operating Officer of
Bancorp and the Bank
Sara E. Watkins, 46, Executive Vice President of the Bank
The principal occupation(s) and business experience of each executive officer
who is not a director for at least the last five years are set forth below.
Frank L. Bentz, III became Executive Vice President and Chief Information
Officer in 2002. Prior to that, Mr. Bentz was Senior Vice President of the Bank.
R. Louis Caceres became Executive Vice President in 2002. Prior to that, Mr.
Caceres was Senior Vice President of the Bank. Prior to joining the Bank, Mr.
Caceres was Vice President of First Union Corporation.
69
Ronald E. Kuykendall became Executive Vice President, General Counsel and
Corporate Secretary of Bancorp and the Bank in 2002. Prior to that, Mr.
Kuykendall was Vice President and Secretary of Bancorp and Senior Vice President
and General Counsel of the Bank. Before joining the Bank in 2000, Mr. Kuykendall
was Associate General Counsel, Crestar Financial Corporation.
James H. Langmead, CPA, became Executive Vice President and Chief Financial
Officer of Bancorp and the Bank in 2001. Prior to that, Mr. Langmead was Vice
President and Treasurer of Bancorp and Executive Vice President and Chief
Financial Officer of the Bank.
Lawrence T. Lewis, III became Executive Vice President of Bancorp and the Bank
in 2001 and Chief Investment Officer of Bancorp and the Bank in 2002. Prior to
that, Mr. Lewis was Executive Vice President of the Bank.
Daniel J. Schrider became Executive Vice President and Chief Credit Officer
effective January 1, 2003. Prior to that, Mr. Schrider served as Senior Vice
President of the Bank.
Frank H. Small became Executive Vice President of Bancorp and the Bank in 2001
and Chief Operating Officer of Bancorp and the Bank in 2002. Prior to that, Mr.
Small was Executive Vice President of the Bank.
Sara E. Watkins became Executive Vice President of the Bank in 2002. Prior to
that, Ms. Watkins was Senior Vice President of the Bank.
CONTROLS AND PROCEDURES
Within the ninety days prior to the filing of this report, the Company's
management, under the supervision and with the participation of the Company's
Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness
of the design and operation of the Company's disclosure controls and procedures,
as defined in Rule 13a-14 under the Securities Exchange Act of 1934. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were adequate.
There were no significant changes (including corrective actions with regard to
significant or material weaknesses) in the Company's internal controls or in
other factors subsequent to the date of the evaluation that could significantly
affect those controls.
70
PROPERTIES
The locations of Sandy Spring Bancorp, Inc. and its subsidiaries are shown
below.
COMMUNITY BANKING
OFFICES
Airpark* Damascus* Montgomery General Hospital*
7653 Lindbergh Drive 26250 Ridge Road 18101 Prince Philip Drive
Gaithersburg, MD 20879 Damascus, MD 20872 Olney, MD 20832
Annapolis West* East Gude Drive* Montgomery Village*
2051 West Street 1601 East Gude Drive 9921 Stedwick Road
Annapolis, MD 21401 Rockville, MD 20850 Montgomery Village, MD 20886
Ashton* Eastport* Olney*
1 Ashton Road 1013 Bay Ridge Avenue 17801 Georgia Avenue
Ashton, MD 20861 Annapolis, MD 21403 Olney, Maryland 20832
Asbury* Edgewater* Patrick Street*
409 Russell Avenue 116 Mitchells Chance Road 14 West Patrick Street
Gaithersburg MD 20877 Edgewater, MD 21037 Frederick, MD 21701
Aspenwood Gaithersburg Square* Potomac*
14400 Homecrest Road 596 A North Frederick Avenue 9822 Falls Road
Silver Spring, MD 20906 Gaithersburg, MD 20877 Potomac, MD 20854
Bedford Court Jennifer Road* Rockville
3701 International Drive 166 Jennifer Road 611 Rockville Pike
Silver Spring, MD 20906 Annapolis, MD 21401 Rockville, MD 20852
Bethesda* Laurel Lakes* Sandy Spring
7126 Wisconsin Avenue 14404 Baltimore Avenue 908 Olney-Sandy Spring Road
Bethesda, MD 20814 Laurel, MD 20707 Sandy Spring, MD 20860
Burtonsville* Layhill* Wildwood*
3535 Spencerville Road 14241 Layhill Road 10329 Old Georgetown Road
Burtonsville, MD 20866 Silver Spring, MD 20906 Bethesda, MD 20814
Clarksville* Leisurewood Plaza* * ATM available
12276 Clarksville Pike 3801 International Drive, Suite 100
Clarksville, MD 21029
Silver Spring, MD 20906
Colesville*
13300 New Hampshire Avenue Lisbon*
Silver Spring, MD 20904 704 Lisbon Centre Drive
Woodbine, MD 21797
Congressional*
1647 Rockville Pike Milestone Center*
Rockville, MD 20852 20930 Frederick Avenue
Germantown, MD 20876
71
OTHER PROPERTIES
SANDY SPRING BANK THE EQUIPMENT LEASING COMPANY SANDY SPRING MORTGAGE
FINANCIAL CENTER 53 Loveton Circle, Suite 100 9112 Guilford Road, Suite 2
148 Jennifer Road Sparks, MD 21152 Columbia, MD 21046
Annapolis, MD 21401 410-472-0011 301-680-0200
410-266-3000
ADMINISTRATIVE AND TRAINING CENTER SANDY SPRING INSURANCE CORPORATION
HUMAN RESOURCES 17735 Georgia Avenue T/A Chesapeake Insurance Group
8875 Centre Park Drive Olney, MD 20832 2661 Riva Road, Suite 1050
Columbia, MD 21045 301-774-6400 Annapolis, MD 21401
410-740-8005 410-841-5320
TRAINING CENTER
18120 Hillcrest Drive, Suite A
Olney, MD 20832
301-774-6400
72
EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K
The following financial statements are filed as a part of this report:
Consolidated Balance Sheets at December 31, 2002 and 2001
Consolidated Statements of Income for the years ended December 31, 2002,
2001, and 2000
Consolidated Statements of Cash Flows for the years ended December 31, 2002,
2001, and 2000
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 2002, 2001, and 2000
Notes to the Consolidated Financial Statements
Report of Independent Auditors
All financial statement schedules have been omitted, as the required information
is either inapplicable or included in the Consolidated Financial Statements or
related Notes.
The following exhibits are filed as a part of this report:
Exhibit No. Description Incorporated by Reference to:
------------------------------------------------------------------------------------------------------------------
3(a) Articles of Incorporation of Sandy Spring Exhibit 3.1 to Form 10-Q for the quarter
Bancorp, Inc., as Amended ended June 30, 1996, SEC File No. 0-19065.
3(b) Bylaws of Sandy Spring Bancorp, Inc. Exhibit 3.2 to Form 8-K dated May 13, 1992,
SEC File No. 0-19065.
10(a)* Amended and Restated Sandy Spring Bancorp, Exhibit 10(a) to Form 10-Q for the quarter
Inc., Cash and Deferred Profit Sharing Plan and ended September 30, 1997, SEC File No. 0-19065.
Trust
10(b)* Sandy Spring Bancorp, Inc. 1982 Incentive Stock Exhibit 10(c) to Form 10-Q for the quarter
Option Plan ended June 30, 1990, SEC File No. 0-19065.
10(c)* Sandy Spring Bancorp, Inc. 1992 Stock Option Exhibit 10(i) to Form 10-K for the year ended
Plan December 31, 1991, SEC File No. 0-19065.
10(d)* Sandy Spring Bancorp, Inc. Amended and Exhibit 4 to Registration Statement on Form
Restated Stock Option Plan for Employees of S-8, Registration Statement No. 333-11049.
Annapolis Bancshares, Inc.
10(e)* Sandy Spring Bancorp, Inc. 1999 Stock Option Exhibit 4 to Registration Statement on Form
Plan S-8, Registration Statement No. 333-81249.
10(f)* Sandy Spring National Bank of Maryland Exhibit 10 to Form 10-Q for the quarter ended
Executive Health Insurance Plan March 31, 2002, SEC File No. 0-19065.
10(g)* Sandy Spring National Bank of Maryland Exhibit 10(g) to Form 10-K for the year
Executive Health Expense Reimbursement Plan, ended December 31, 2001, SEC File No. 0-19065.
as amended
10(h)* Form of Director Fee Deferral Agreement, August Exhibit 10(b) to Form 10-Q for the quarter
26, 1997 ended September 30, 1997, SEC File No.
0-19065.
10(i)* Supplemental Executive Retirement Agreement Exhibit 10(c) to Form 10-Q for the quarter
by and between Sandy Spring National Bank of ended September 30, 1997, SEC File No.
Maryland and Hunter R. Hollar 0-19065.
73
10(j)* Form of Supplemental Executive Retirement **
Agreement by and between Sandy Spring Bank
and each of Frank L. Bentz, III; R. Louis Caceres;
Ronald E. Kuykendall; James H. Langmead,
Lawrence T. Lewis, III, Daniel J. Schrider;
Frank H. Small; and Sara E. Watkins
10(k)* Employment Agreement by and among Sandy Exhibit 10(e) to Form 10-Q for the quarter
Spring Bancorp, Inc., Sandy Spring Bank of ended September 30, 1997, SEC File No.
Maryland, and Hunter H. Hollar 0-19065.
10(l)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
James H. Langmead
10(m)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
Lawrence T. Lewis, III
10(n)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
Daniel J. Schrider
10(o)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
Frank H. Small
10(p)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
Sara E. Watkins
10(q)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
Ronald E. Kuykendall
10(r)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
Frank L. Bentz, III
10(s)* Employment Agreement by and among Sandy **
Spring Bancorp, Inc., Sandy Spring Bank, and
R. Louis Caceres
10(t) Form of Sandy Spring National Bank of Maryland Exhibit 10(r) to Form 10-K for the year ended
Officer Group Term Replacement Plan December 31, 2001, SEC File No. 0-19065.
21 Subsidiaries **
23 Consent of Independent Auditors
31 Rule 13a-14(a) /15d-14(a) Certifications
32 Certifications pursuant to 18 U.S.C. Section 1350
* Management Contract or Compensatory Plan or Arrangement filed pursuant to
Item 15(c) of this Report.
** Incorporated by reference to the exhibit of the same number to Form 10-K for
the year ended December 31, 2002, filed March 12, 2003.
74
The following Forms 8-K were filed during the fourth quarter of 2002:
(a) On October 16, 2002, the Company furnished information under Item 9 of Form
8-K reporting comfort with certain consensus earnings estimates.
(b) On October 18, 2002, the Company furnished information under Item 9 of Form
8-K reporting payment in full of the largest credit included in its total
non-performing loans at September 30, 2002.
(c) On December 20, 2002, the Company reported, under Item 5, the completion of
its analysis of the application of SFAS No. 147 to certain unidentified
intangible assets.
SHAREHOLDERS MAY OBTAIN, FREE OF CHARGE, A COPY OF THE EXHIBITS TO THIS REPORT
ON FORM 10-K BY WRITING RONALD E. KUYKENDALL, EXECUTIVE VICE PRESIDENT, GENERAL
COUNSEL AND CORPORATE SECRETARY, AT SANDY SPRING BANCORP, INC., 17801 GEORGIA
AVENUE, OLNEY, MARYLAND 20832. SHAREHOLDERS ALSO MAY ACCESS A COPY OF THE FORM
10-K INCLUDING EXHIBITS ON THE SEC WEBSITE AT www.sec.gov OR THROUGH THE
COMPANY'S INVESTOR RELATIONS WEBSITE MAINTAINED AT WWW.SANDYSPRINGBANK.COM
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
SANDY SPRING BANCORP, INC.
(Registrant)
By: /s/ Hunter R. Hollar
---------------------
Hunter R. Hollar
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated as of December 17, 2003.
Principal Executive Officer Principal Financial and
and Director: Accounting Officer:
/s/ Hunter R. Hollar /s/ James H. Langmead
-------------------- -----------------------------
Hunter R. Hollar James H. Langmead
President and Chief Executive Officer Executive Vice President
and Chief Financial Officer
Signature Title
--------- -----
/s/ John Chirtea Director
-----------------------------
John Chirtea
/s/ Susan D. Goff Director
-----------------------------
Susan D. Goff
/s/ Solomon Graham Director
-----------------------------
Solomon Graham
/s/ Gilbert L. Hardesty Director
-----------------------------
Gilbert L. Hardesty
/s/ Joyce R. Hawkins Director
-----------------------------
Joyce R. Hawkins
75
/s/ Charles F. Mess Director
-----------------------------
Charles F. Mess
/s/ Robert L. Mitchell Director
-----------------------------
Robert L. Mitchell
/s/ Robert L. Orndorff, Jr. Director
-----------------------------
Robert L. Orndorff, Jr.
/s/ David E. Rippeon Director
-----------------------------
David E. Rippeon
/s/ Craig A. Ruppert Director
-----------------------------
Craig A. Ruppert
/s/ Lewis R. Schumann Director
-----------------------------
Lewis R. Schumann
/s/ W. Drew Stabler Chairman of the Board,
----------------------------- Director
W. Drew Stabler
76