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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number: 0-22345
Shore Bancshares, Inc.
(Exact name of registrant as specified in its charter)
Maryland 52-1974638
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
109 North Commerce Street
Centreville, Maryland 21617
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including are code: (410) 758-1600
Securities registered under Section 12(b) of the Act: None
Securities registered
under Section 12(g) of the Act: Common Stock, Par Value $0.01
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes __x__ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _____
The aggregate market value of Shore Bancshares, Inc. voting stock held by
non-affiliates as of February 22, 1999 was $60,727,755, based on the sales price
as of that date.
As of February 22, 1999, Shore Bancshares, Inc. had 1,913,516 shares of Common
Stock $.01 Par Value outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts I, II and IV: Portions of the Annual Shareholders Report for the
year ended December 31, 1998 (the "Annual Report".)
Part III: Portions of the definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on April 20, 1999 (the
"Proxy Statement".)
1
PART I
ITEM I
BUSINESS
GENERAL
Shore Bancshares, Inc. (the "Company"), a Maryland corporation incorporated on
March 15, 1996, became a registered bank holding company on July 1, 1996 under
the Bank Holding Company Act of 1956, as amended. The Company engages in its
business through its sole subsidiary, The Centreville National Bank of Maryland
(the "Bank"), a national banking association. The Company acquired the Bank
through the merger of the Bank into an interim national banking association
formed as a Company subsidiary for the purpose of the merger, pursuant to a Plan
of Reorganization and Agreement to Merge (the "Plan") proposed by Bank
management and approved by the Bank's stockholders on April 16, 1996. Pursuant
to the Plan, each outstanding share of Bank common stock was exchanged for two
shares of the Company's common stock. The Bank's charter was not affected by the
merger. Currently, the Company has issued and outstanding 1,913,516 shares of
common stock, par value $0.01 per share ("Shares"), held by 1,102 holders of
record on February 22, 1999.
The Company's and the Bank's main office is located at 109 North Commerce
Street, Centreville, Queen Anne's County, Maryland. The Bank has five full
service branch offices located in Centreville, Chestertown, Stevensville and
Hillsboro, Maryland.
As of December 31, 1998, the Company had assets of approximately $181.1 million,
net loans of approximately $109.8 million, and deposits of $153.3 million.
Stockholders' equity has continued to grow over the last five years and has
increased $2.6 million (13.3%) over the preceding five years.
BANKING PRODUCTS AND SERVICES
The Bank has been doing business in Maryland since 1876 and is engaged in both
the commercial and consumer banking business. The Bank serves its customers
through a network of five banking offices. The Bank provides a wide range of
personal banking services designed to meet the needs of local consumers. Among
the services provided are checking accounts, savings and time accounts, safe
deposit boxes, and installment and other personal loans, especially residential
mortgages, as well as home equity loans, automobile and other consumer
financing. As a convenience to its customers, the Bank offers Saturday banking
hours, drive-thru teller windows, "Direct Dial," a telephone banking service,
debit cards, and 24-hour automated teller machines at all of its branch
locations.
The Bank is also engaged in the financing of commerce and industry by providing
credit and deposit services for small to medium sized businesses and for the
agricultural community in the Bank's market area. The Bank offers many forms of
commercial lending, including lines of credit, revolving credit, term loans,
accounts receivable financing, and commercial real estate mortgage lending and
other forms of secured financing. A full range of commercial banking services is
offered, including the acceptance of checking and savings deposits.
Additional types of real estate loans, discount brokerage services, credit
cards and related services are also offered through affiliates or correspondent
banks. The Bank does not offer trust services and does not engage in municipal
trading services.
BANK SERVICE CORPORATIONS
The Bank owns one-third of the outstanding common stock of two service
corporations: The Delmarva Bank Data Processing Center, Inc. and The Eastern
Shore Mortgage Corporation, both Maryland corporations. The Eastern Shore
Mortgage Corporation, located in Easton, Maryland, was engaged in mortgage
banking activities, including the origination of residential mortgage loans and
the subsequent sale of the loans to permanent investors but is currently in the
process of liquidation. Its primary customers were residents who live on
Maryland's Eastern Shore. The Delmarva Bank Data Processing Center, Inc., also
located in Easton, Maryland, provides data processing services to banks located
in Maryland, Delaware, Virginia and the District of Columbia.
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SEASONALITY
The management of the Bank does not believe that the deposits or the business
of the Bank in general are seasonal in nature. The deposits may, however,
vary with local and national economic conditions but not enough to have a
material effect on planning and policy making.
EMPLOYEES
As of December 31, 1998, the Company had no employees and the Bank employed 71
individuals, 11 of whom worked part-time.
DEPOSITS
No material portion of the Bank's deposits has been obtained from an individual
or a few individuals (including federal, state and local governments and
agencies) the loss of any one or more of which would have a materially adverse
effect on the Bank, nor is a material portion of the Bank's loans concentrated
within a single industry or group of related industries. On December 31, 1998,
the Bank had approximately 14,000 deposit customers representing $153.3 million
in deposits.
COMMITMENTS
As of the end of the last two fiscal years the Bank had the following
commitments to lend:
% of % of
12/31/98 Total 12/31/97 Total
-------- --------- -------- --------
(in thousands) (in thousands)
Standby Letters of Credit $1,377 7.33% $1,770 12.59%
Commitments to Grant Loans 17,402 92.67 12,293 87.41
------ ----- ------ ------
Total $18,779 100.00% $14,063 100.00%
------ ----- ------ ------
The above commitments are firm. The Bank expects approximately $6,000,000 of the
commitments to lend described above to be funded within the current year.
COMPETITION
The Bank offers many personalized services and attracts customers by being
responsive and sensitive to the needs of the community. The Bank relies on
goodwill and referrals from satisfied customers as well as traditional media
advertising to attract new customers. To enhance a positive image in the
community, the Bank supports and participates in many local events. Employees,
officers, and Directors represent the Bank on many boards and local civic and
charitable organizations.
The primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. Competition for deposits comes primarily from other
commercial banks, savings associations, credit unions, money market funds and
other investment alternatives. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services. Competition for loans comes primarily from other
commercial banks, savings associations, mortgage banking firms, credit unions
and other financial intermediaries.
3
Recent changes in federal banking laws facilitate interstate branching and
merger activity among banks. Since September 1995, certain bank holding
companies are authorized to acquire banks throughout the United States. In
addition, as of June 1, 1997, certain banks are permitted to merge with banks
organized under the laws of different states. These changes have resulted in an
even greater degree of competition in the banking industry and the Company and
the Bank will continue to be brought into competition with institutions with
which it does not presently compete.
Regional and local banks dominate the banking industry in Centreville,
Chestertown, Stevensville, and the Hillsboro areas where the Bank maintains
offices. The Bank competes for deposits and loans with these institutions and
with credit unions, savings institutions, insurance companies, and mortgage
companies, as well as other companies that offer financial services. To attract
new business and retain existing customers, the Bank offers a wide range of
banking products and services and relies on local promotional activity, personal
contact by its officers, staff, and Directors, referrals by current customers,
extended banking hours, and personalized service.
As of June 30, 1998, the most recent date for which comparative data is
available, bank deposits in Queen Anne's County (where the Bank's main office,
Centreville branch and Stevensville branch are located), Caroline County,
Maryland (where the Bank's Hillsboro branch is located), and Kent County (where
the Bank's Kent branch is located) ranked as follows:
% of
Queen Anne's County Deposits Total
-------- -----
(in thousands)
The Queenstown Bank of Maryland $131,464 35.39%
THE CENTREVILLE NATIONAL BANK OF MARYLAND 116,600 31.39
The Chestertown Bank of Maryland 36,528 9.83
NationsBank, N.A. 33,941 9.14
The First National Bank of Maryland 21,530 5.80
Farmers Bank of Maryland 17,692 4.76
Annapolis National Bank 13,712 3.69
------ ----
Total $371,467 100.00%
-------- -------
SOURCE: FDIC DATA BOOK
% of
Caroline County Deposits Total
-------- -----
(in thousands)
The Peoples Bank of Maryland $76,830 30.74%
Provident State Bank of Preston 62,440 24.98
The First National Bank of Maryland 38,709 15.49
Farmers Bank of Maryland 25,990 10.40
Atlantic Bank 17,320 6.93
NationsBank, N.A. 15,097 6.04
THE CENTREVILLE NATIONAL BANK OF MARYLAND 13,552 5.42
------ ----
Total $249,938 100.00%
-------- -------
SOURCE: FDIC DATA BOOK
4
% of
Kent County Deposits Total
-------- -----
(in thousands)
The Chestertown Bank of Maryland $103,222 32.60%
Peoples Bank of Kent County 100,078 31.60
The Chesapeake Bank and Trust Company 40,636 12.83
Farmers Bank of Maryland 32,704 10.33
Crestar Bank 21,331 6.74
THE CENTREVILLE NATIONAL BANK OF MARYLAND 18,683 5.90
------ ----
Total $316,654 100.00%
-------- -------
SOURCE: FDIC DATA BOOK
SUPERVISION AND REGULATION
GENERAL. The Company and the Bank are extensively regulated under federal and
state law. Generally, these laws and regulations are intended to protect
depositors, not stockholders. The following is a summary description of certain
provisions of certain laws which affect the regulation of bank holding companies
and banks. The discussion is qualified in its entirety by reference to
applicable laws and regulations. Changes in such laws and regulations may have a
material effect on the business and prospects of the Company and the Bank.
FEDERAL BANK HOLDING COMPANY REGULATION AND STRUCTURE. The Company is a bank
holding company within the meaning of the Bank Holding Company Act of 1956, as
amended, and as such, it is subject to regulation, supervision, and examination
by the Federal Reserve Board ("FRB"). The Company is required to file annual and
quarterly reports with the FRB and to provide the FRB with such additional
information as the FRB may require. The FRB may conduct examinations of the
Company and its subsidiaries.
With certain limited exceptions, the Company is required to obtain prior
approval from the FRB before acquiring direct or indirect ownership or control
of more than 5% of any voting securities or substantially all of the assets of a
bank or bank holding company, or before merging or consolidating with another
bank holding company. Additionally, with certain exceptions, any person
proposing to acquire control through direct or indirect ownership of 25% or more
of any voting securities of the Company is required to give 60 days' written
notice of the acquisition to the FRB, which may prohibit the transaction, and to
publish notice to the public.
Generally, a bank holding company may not engage in any activities other than
banking, managing or controlling its bank and other authorized subsidiaries, and
providing services to these subsidiaries. With prior approval of the FRB, the
Company may acquire more than 5% of the assets or outstanding shares of a
company engaging in non-bank activities determined by the FRB to be closely
related to the business of banking or of managing or controlling banks. The FRB
provides expedited procedures for expansion into approved categories of non-bank
activities.
Subsidiary banks of a bank holding company are subject to certain quantitative
and qualitative restrictions on extensions of credit to the bank holding company
or its subsidiaries, on investments in their securities and on the use of their
securities as collateral for loans to any borrower. These regulations and
restrictions may limit the Company's ability to obtain funds from the Bank for
its cash needs, including funds for the payment of dividends, interest and
operating expenses. Further, subject to certain exceptions, a bank holding
company and its subsidiaries are prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. For example, the Bank may not generally
require a customer to obtain other services from itself or the Company, and may
not require that a customer promise not to obtain other services from a
competitor as a condition to and extension of credit to the customer.
Under FRB policy, a bank holding company is expected to act as a source of
financial strength to its subsidiary banks and to make capital injections into a
troubled subsidiary bank, and the FRB may charge the bank holding company with
engaging in unsafe and unsound practices for failure to commit resources to a
subsidiary bank when required. A required capital injection may be called for at
a time when the holding company does not have the resources to provide it. In
addition,
5
depository institutions insured by the Federal Deposit Insurance Corporation
("FDIC") can be held liable for any losses incurred by, or reasonably
anticipated to be incurred by, the FDIC in connection with the default of, or
assistance provided to, a commonly controlled FDIC-insured depository
institution. Accordingly, in the event that any insured subsidiary of the
Company causes a loss to the FDIC, other insured subsidiaries of the Company
could be required to compensate the FDIC by reimbursing it for the estimated
amount of such loss. Such cross guaranty liabilities generally are superior in
priority to the obligations of the depository institution to its stockholders
due solely to their status as stockholders and obligations to other affiliates.
FEDERAL BANK REGULATION. The Company's banking subsidiary is a
federally-chartered national bank regulated by the Office of Comptroller of the
Currency ("OCC"). The OCC may prohibit the institutions over which it has
supervisory authority from engaging in activities or investments that the agency
believes constitutes unsafe or unsound banking practices. Federal banking
regulators have extensive enforcement authority over the institutions they
regulate to prohibit or correct activities which violate law, regulation or a
regulatory agreement or which are deemed to constitute unsafe or unsound
practices. Enforcement actions may include the appointment of a conservator or
receiver, the issuance of a cease and desist order, the termination of deposit
insurance, the imposition of civil money penalties on the institution, its
directors, officers, employees and institution-affiliated parties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the removal of or restrictions on directors, officers, employees and
institution-affiliated parties, and the enforcement of any such mechanisms
through restraining orders or other court actions.
The Bank is subject to certain restrictions on extensions of credit to executive
officers, directors, principal stockholders or any related interest of such
persons which generally require that such credit extensions be made on
substantially the same terms as are available to third persons dealing with the
Bank and not involve more than the normal risk of repayment. Other laws tie the
maximum amount which may be loaned to any one customer and its related interests
to capital levels.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), each federal banking agency is required to prescribe, by regulation,
non-capital safety and soundness standards for institutions under its authority.
The federal banking agencies, including the OCC, have adopted standards covering
internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, and
compensation, fees and benefits. An institution which fails to meet those
standards may be required by the agency to develop a plan acceptable to the
agency, specifying the steps that the institution will take to meet the
standards. Failure to submit or implement such a plan may subject the
institution to regulatory sanctions. The Company, on behalf of the Bank,
believes that it meets substantially all standards which have been adopted.
FDICIA also imposed new capital standards on insured depository institutions.
See "Capital Requirements."
Before establishing new branch offices, the Bank must meet certain minimum
capital stock and surplus requirements and the Bank must obtain OCC approval.
DEPOSIT INSURANCE. As a FDIC member institution, the Bank's deposits are insured
to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"),
administered by the FDIC, and each institution is required to pay semi-annual
deposit insurance premium assessments to the FDIC. The BIF assessment rates have
a range of 0 cents to 27 cents for every $100 in assessable deposits. The
federal Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"1996 Act"), included provisions that, among other things, recapitalized the
Savings Association Insurance Fund ("SAIF") through a special assessment on
savings association deposits and bank deposits that had been acquired from
savings associations. As a result of the April 1997 merger of Kent Savings and
Loan Association, F.A. into the Bank, approximately $21.8 million of the Bank's
deposits are assessed at SAIF rates. The SAIF assessment rates are determined
quarterly and the SAIF is also administered by the FDIC.
CAPITAL REQUIREMENTS. The federal banking regulators have adopted certain
risk-based capital guidelines to assist in the assessment of the capital
adequacy of a banking organization's operations for both transactions reported
on the balance sheet as assets and transactions, such as letters of credit, and
recourse arrangements, which are recorded as off balance sheet items. Under
these guidelines, nominal dollar amounts of assets and credit equivalent amounts
of off balance sheet items are multiplied by one of several risk adjustment
percentages, which range from 0% for assets with low credit risk, such as
certain U.S. Treasury securities, to 100% for assets with relatively high credit
risk, such as business loans.
6
A banking organization's risk-based capital ratios are obtained by dividing its
qualifying capital by its total risk adjusted assets. The regulators measure
risk-adjusted assets, which include off balance sheet items, against both total
qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2
capital) and Tier 1 capital. "Tier 1," or core capital, includes common equity,
perpetual preferred stock (excluding auction rate issues) and minority interest
in equity accounts of consolidated subsidiaries, less goodwill and other
intangibles, subject to certain exceptions. "Tier 2," or supplementary capital,
includes, among other things, limited-life preferred stock, hybrid capital
instruments, mandatory convertible securities, qualifying subordinated debt, and
the allowance for loan and lease losses, subject to certain limitations and less
required deductions. The inclusion of elements of Tier 2 capital is subject to
certain other requirements and limitations of the federal banking agencies.
Banks and bank holding companies subject to the risk-based capital guidelines
are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at
least 4% and a ratio of total capital to risk-weighted assets of at least 8%.
The appropriate regulatory authority may set higher capital requirements when
particular circumstances warrant. Institutions which meet or exceed a Tier 1
ratio of 6% and a total capital ratio of 10% are considered well capitalized. As
of December 31, 1998, the Bank's ratio of Tier 1 to risk-weighted assets stood
at 19.95% and its ratio of total capital to risk-weighted assets stood at
21.20%. In addition to risk-based capital, banks and bank holding companies are
required to maintain a minimum amount of Tier 1 capital to total assets,
referred to as the leverage capital ratio, of at least 3% or 5% to be considered
well capitalized. As of December 31, 1998, the Bank's leverage capital ratio was
11.04%.
In August, 1995 and May, 1996, the federal banking agencies adopted final
regulations specifying that the agencies will include, in their evaluations of a
bank's capital adequacy, an assessment of the Bank's interest rate risk ("IRR")
exposure. The standards for measuring the adequacy and effectiveness of a
banking organization's interest rate risk management includes a measurement of
board of director and senior management oversight, and a determination of
whether a banking organization's procedures for comprehensive risk management
are appropriate to the circumstances of the specific banking organization. The
Bank has internal IRR models that are used to measure and monitor IRR.
Additionally, the regulatory agencies have been assessing IRR on an informal
basis for several years. For these reasons, the Company does not expect the
addition of IRR evaluation to the agencies' capital guidelines to result in
significant changes in capital requirements for the Bank.
Failure to meet applicable capital guidelines could subject a banking
organization to a variety of enforcement actions, including limitations on its
ability to pay dividends, the issuance by the applicable regulatory authority of
a capital directive to increase capital and, in the case of depository
institutions, the termination of deposit insurance by the FDIC, as well as to
the measures described under "--Federal Deposit Insurance Corporation
Improvement Act of 1991" below, as applicable to undercapitalized institutions.
In addition, future changes in regulations or practices could further reduce the
amount of capital recognized for purposes of capital adequacy. Such a change
could affect the ability of the Bank to grow and could restrict the amount of
profits, if any, available for the payment of dividends to the Company.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. In December,
1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding
provisions of the Federal Deposit Insurance Act and made significant revisions
to several other federal banking statutes. FDICIA provides for, among other
things, (i) publicly available annual financial condition and management reports
for financial institutions, including audits by independent accountants, (ii)
the establishment of uniform accounting standards by federal banking agencies,
(iii) the establishment of a "prompt corrective action" system of regulatory
supervision and intervention, based on capitalization levels, with more scrutiny
and restrictions placed on depository institutions with lower levels of capital,
(iv) additional grounds for the appointment of a conservator or receiver, and
(v) restrictions or prohibitions on accepting brokered deposits, except for
institutions which significantly exceed minimum capital requirements. FDICIA
also provides for increased funding of the FDIC insurance funds and the
implementation of risked-based premiums. See "Deposit Insurance."
A central feature of FDICIA is the requirement that the federal banking agencies
take "prompt corrective action" with respect to depository institutions that do
not meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." The Bank is currently classified as
"well-capitalized." An institution may be deemed by the regulators to be in a
capitalization category that is lower than is indicated by its actual capital
position if, among other things, it receives an unsatisfactory examination
rating with respect to asset quality, management, earnings or liquidity.
7
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a cash dividend) or paying any management
fees to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to growth
limitations and are required to submit capital restoration plans. If a
depository institution fails to submit an acceptable plan, it is treated as if
it is significantly undercapitalized. Significantly undercapitalized depository
institutions may be subject to a number of other requirements and restrictions,
including orders to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets and stop accepting deposits
from correspondent banks. Critically undercapitalized institutions are subject
to the appointment of a receiver or conservator, generally within 90 days of the
date such institution is determined to be critically undercapitalized.
FDICIA provides the federal banking agencies with significantly expanded powers
to take enforcement action against institutions which fail to comply with
capital or other standards. Such action may include the termination of deposit
insurance by the FDIC or the appointment of a receiver or conservator for the
institution. FDICIA also limits the circumstances under which the FDIC is
permitted to provide financial assistance to an insured institution before
appointment of a conservator or receiver.
INTERSTATE BANKING LEGISLATION. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 was enacted into law on September 29, 1994. The law
provides that, among other things, substantially all state law barriers to the
acquisition of banks by out-of-state bank holding companies were eliminated
effective on September 29, 1995. The law also permits interstate branching by
banks effective as of June 1, 1997, subject to the ability of states to opt-out
completely or to set an earlier effective date. Maryland generally established
an earlier effective date of September 29, 1995.
MONETARY POLICY. The earnings of a bank holding company are affected by the
policies of regulatory authorities, including the FRB, in connection with the
FRB's regulation of the money supply. Various methods employed by the FRB are
open market operations in United States Government securities, changes in the
discount rate on member bank borrowing and changes in reserve requirements
against member bank deposits. These methods used in varying combinations to
influence overall growth and distribution of bank loans, investments and
deposits, and their use may also affect interest rates charged on loans or paid
on deposits. The money policies of the FRB have had a significant effect on the
operating results of commercial banks in the past and are expected to continue
to do so in the future.
RISK FACTORS
REGULATORY RISKS. The banking industry is subject to many laws and regulations.
Regulations protect depositors, not stockholders. The Office of the Comptroller
of the Currency and the Board of Governors of the Federal Reserve System
regulate the Company and the Bank. Regulations and laws increase the Company's
operating expenses, affect the Company's earnings, and may put the Company at a
disadvantage with less regulated competitors, such as finance companies,
mortgage banking companies, credit unions, and leasing companies.
EXPOSURE TO LOCAL ECONOMIC CONDITIONS. Most of the loans made by the Bank are
made to local borrowers. A decline in local economic conditions would affect
the Company's earnings.
CREDIT RISKS AND INADEQUACY OF LOAN LOSS RESERVE. When borrowers default and do
not repay the loans made to them by the Bank, the Company loses money.
Experience shows that some borrowers either will not pay on time or will not pay
at all. In these cases, the Bank will cancel, or "write off," the defaulted loan
or loans. A "write off" reduces the Company's assets and affects the Company's
earnings. The Company anticipates losses by reserving what it believes to be an
adequate cushion so that it does not have to take a large loss at any one time.
However, actual loan losses cannot be predicted, and the Company's loan loss
reserve may not be sufficient.
INTEREST RATE RISK. The Company's earnings depend greatly on its net interest
income, the difference between the interest earned on loans and investments and
the interest paid on deposits. If the interest rate paid on deposits is high and
the interest rate earned on loans and investments is low, net interest income is
small and the Company earns less. Because interest rates are influenced by
competition, the Company cannot completely control its net interest income.
RISKS ASSOCIATED WITH REAL ESTATE LENDING. The Bank makes real estate secured
loans. Real estate loans are in greater demand when interest rates are low and
economic conditions are good. Even when economic conditions are good and
interest rates are low, these conditions may not continue. The Company may lose
money if the borrower does not pay a real estate loan. If real estate values
decrease, then the Company may lose more money when borrowers default.
NO ASSURANCE OF GROWTH. The Company's ability to increase assets and earnings
depends upon many factors, including competition for deposits and loans, the
Company's branch and office locations, avoidance of credit losses, and hiring
and training of personnel. Some of these factors are beyond the Company's
control.
8
COMPETITION. Other banks and non-banks, including savings and loan associations,
credit unions, insurance companies, leasing companies, small loan companies,
finance companies, and mortgage companies, compete with the Company. Some of the
Company's competitors offer services and products that the Company does not
offer. Larger banks and non-bank lenders can make larger loans and service
larger customers. Law changes now permit interstate banks, which may increase
competition. Increased competition may decrease the Company's earnings.
NO ASSURANCE OF CASH OR STOCK DIVIDENDS. Whether dividends may be paid to
stockholders depends on the Company's earnings, its capital needs, law and
regulations, and other factors. The Company's payment of dividends in the past
does not mean that the Company will be able to pay dividends in the future.
STOCK NOT INSURED. Investments in the shares of the Company's common stock are
not deposits that are insured against loss by the government.
RISK INVOLVED IN ACQUISITIONS. Part of the Company's growth may come from buying
other banks and companies. A newly purchased bank or company may not be
profitable after the Company buys it and may lose money, particularly at first.
The new bank or company may bring with it unexpected liabilities or bad loans,
bad employee relations, or the new bank or company may lose customers.
RISK OF CLAIMS. Customers may sue the Company for losses due to the Company's
alleged breach of fiduciary duties, errors and omissions of employees, officers
and agents, incomplete documentation, the Company's failure to comply with
applicable laws and regulations, or many other reasons. Also, employees of the
Company conduct all of the Company's business. The employees may knowingly or
unknowingly violate laws and regulations. Company management may not be aware of
any violations until after their occurrence. This lack of knowledge will not
insulate the Company from liability. Claims and legal actions may result in
legal expenses and liabilities that may reduce the Company's profitability and
hurt its financial condition.
DEVELOPMENTS IN TECHNOLOGY. Financial services use technology, including
telecommunications, data processing, computers, automation, Internet-based
banking, debit cards, and "smart" cards. Technology changes rapidly. The
Company's ability to compete successfully with other banks and non-banks may
depend on whether it can exploit technological changes. The Company may not be
able to exploit technological changes and expensive new technology may not make
the Company more profitable.
YEAR 2000. The "Year 2000 Issue" describes the problems that may result from the
improper processing of dates and date-sensitive calculations beginning in the
Year 2000. Many existing computer programs use only two digits to identify the
year in the date field of a program. These programs could experience serious
malfunctions when the last two digits of the year change to "00" as a result of
identifying a year designated "00" as the Year 1900 rather than the Year 2000. A
system failure or other disruptions of operations could occur if the Company's
computer programs and other equipment identify a year designated "00" as the
Year 1900 rather than the Year 2000. The Company cannot be certain that its
computer programs and other equipment, and the computer programs and other
equipment of its customers, vendors, suppliers and even the government will be
Year 2000 compliant. Any systems failure, disruption, or other losses could
affect the Company's earnings.
MARKET FOR COMMON STOCK. The Company's shares of common stock are not listed on
any exchange, and there is currently no organized trading market. Prices for
the Company's common stock may not be the actual value or the trading price in a
liquid trading market.
ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS. The Company's
Articles of Incorporation and Bylaws divide the Company's Board of Directors
into three classes and each class serves for a staggered three-year term. No
director may be removed except for cause and then only by a vote of at least
two-thirds of the total eligible stockholder votes. In addition, Maryland law
contains anti-takeover provisions that apply to the Company. These provisions
may discourage or make it more difficult for another company to buy the Company
or may reduce the market price of the Company's common stock.
9
STATISTICAL INFORMATION:
The following supplementary information required under Guide 3 for the
respective periods and at the indicated respective dates is set forth on the
pages indicated below. The information should be read in conjunction with the
related Consolidated Financial Statements and Notes thereto for the year ended
December 31, 1998.
Table of Contents: Page
Investment Securities Portfolio Analysis 10
Summary of Loan Portfolio 11
Maturities of Loan Portfolio 11
Risk Elements of Loan Portfolio 11
Analysis of the Allowance for Credit Losses 12
Allocation of the Allowance for Credit Losses 12
Maturity of Time Certificates of Deposit $100,000 or More 13
Summary of Significant Ratios 13
Other statistical information required in this Item 1 is incorporated by
reference from the information appearing in the Company's Annual Report to
Stockholders as follows:
Disclosure Required by Guide 3 Reference to the 1998 Annual Report
- ------------------------------ -----------------------------------
(I) Distribution of Assets, Liabilities, and Stockholders' Average Balances, Yields and Rates (page 40)
Equity: Interest Rates and Interest Differential Rate and Volume Variance Analysis (page 41)
(II) Investment Portfolio Notes to Financial Statements - Investment Securities
(pages 23 and 24)
(III) Loan Portfolio Management's Discussion and Analysis of Financial
Condition and Results of Operations "Loan Portfolio"
(page 9)
(V) Deposits Average Balances, Yields and Rates (page 40)
Rate and Volume Variance Analysis (page 41)
(VI) Return on Equity and Assets Selected Financial Data (page 1)
Investment Securities Portfolio Analysis
December 31, 1998
(In Thousands)
AVAILABLE FOR SALE
================================================================================
U.S. Treasury U.S. Govt. Agencies
Amortized Avg.T.E. Amortized Avg.T.E.
Description & Term Cost Yield Cost Yield
- ------------------
====================================== ===============================
0 - 3 Months $1,000 6.35% $0 N/A
3 - 6 Months 500 7.05 0 N/A
6 - 12 Months 0 N/A 0 N/A
1 - 3 Years 3,485 6.55 4,524 6.04%
3 - 4 Years 0 N/A 5,000 6.33
4 - 5 Years 0 N/A 2,500 6.46
5 - 10 Years 0 N/A 4,076 6.86
10 - 30 Years 0 N/A 114 7.67
====================================== ===============================
Total $4,985 6.56% $16,214 7.38%
====================================== ===============================
HELD TO MATURITY
================================================================================
U.S. Govt. Agencies Municipals
Amortized Avg.T.E. Amortized Avg.T.E.
Description & Term Cost Yield Cost Yield
- ------------------
=========================================== ====================================
0 - 3 Months $0 N/A $765 6.78%
3 - 6 Months 0 N/A 290 9.73
6 - 12 Months 0 N/A 567 8.19
1 - 3 Years 2,496 6.28% 494 6.99
3 - 4 Years 4,497 6.62 0 N/A
4 - 5 Years 2,495 6.50 343 6.80
5 - 10 Years 5,014 7.38 3,914 7.11
10 - 30 Years 0 N/A 0 N/A
==================================== =====================================
Total $14,502 6.23% $6,373 7.26%
==================================== =====================================
========================
AVAILABLE FOR SALE ==============
=====================
Securities Mutual Fund Other Securities
Amortized Avg.T.E. Book Avg.T.E. Total
Description & Term Cost Yield Value Yield Value
- ------------------ ============ ========== ============================ ====================
0 - 3 Months $0 N/A $0 N/A $1,000
3 - 6 Months 0 N/A 0 N/A 500
6 - 12 Months 0 N/A 0 N/A 0
1 - 3 Years 0 N/A 0 N/A 8,009
3 - 4 Years 0 N/A 0 N/A 5,000
4 - 5 Years 0 N/A 0 N/A 2,500
5 - 10 Years 0 N/A 0 N/A 4,076
10 - 30 Years 1,010 6.79% 1,068 7.02% 2,192
========== ========== ============================ ====================
Total $1,010 6.79% $1,068 7.02% $23,277
========== ========== ============================ ====================
Municipals - In State
Amortized Avg.T.E.
HELD TO MATURITY Cost Yield Total
Description & Term Value
- ------------------ ============================================= ===========
$300 7.58% $1,065
0 - 3 Months 0 N/A 290
3 - 6 Months 0 N/A 567
6 - 12 Months 793 7.07 3,783
1 - 3 Years 917 7.66 5,414
3 - 4 Years 599 7.20 3,437
4 - 5 Years 270 9.78 9,198
5 - 10 Years 161 6.59 161
10 - 30 Years ============================================= ===========
Total $3,040 7.54% $23,915
============================================= ===========
The above yields have been adjusted to reflect a tax equivalent basis assuming a
federal tax rate of 34% and a state tax rate of 7%. Tax equivalent yields have
been weighted by settled par amount and are calculated using amortized cost.
10
Summary of Loan Portfolio
(In Thousands)
Loans Outstanding as of December 31,
------------------------------------
1998 1997
---- ----
Amount Amount
------ ------
Real Estate:
Construction and land development $4,488 $2,946
Commercial 14,459 12,973
Residential 76,483 78,273
Commercial 8,448 8,353
Consumer installment 7,318 6,622
----- -----
TOTAL $111,196 $109,167
======== ========
Maturities of Loan Portfolio
December 31, 1998
(In Thousands)
Maturing
Maturing After One Maturing
Within But Within After Five
One Year Five Years Years Total
------------------------------------------------------------
Real estate - Construction and land development $ 4,370 $ 118 $ - $ 4,488
Commercial 4,096 3,157 1,195 8,448
-----------------------------------------------------------
TOTAL $ 8,466 $ 3,275 $ 1,195 $ 12,936
============================================================
Classified by Sensitivities of Loans to Changes in Interest Rates
Real estate - Construction and land development
Fixed - Interest Rate Loans $ 2,555 $ 118 $ - $ 2,673
Adjustable - Interest Rate Loans 1,815 - - 1,815
====================================================================
TOTAL $ 4,370 $ 118 $ - $ 4,488
====================================================================
Commercial
Fixed - Interest Rate Loans $ 2,041 $ 2,432 $ 1,022 $ 5,495
Adjustable - Interest Rate Loans 2,055 725 173 2,953
====================================================================
TOTAL $ 4,096 $ 3,157 $ 1,195 $ 8,448
====================================================================
Risk Elements of Loan Portfolio
(In Thousands)
December 31,
1998 1997
---- ----
Non-accrual loans $55 $199
Accruing loans past due 90 Days or more 765 251
Restructured loans 872 209
Information with respect to non-accrual loans and restructured loans at December 31, 1998:
Interest income that would have been recorded under original terms 74
Interest income recorded during the period 72
At December 31, 1998 the Company had $2.8 million in loans on the watch list for
which payments were current, but the borrowers have the potential for
experiencing financial difficulties. These loans are subject to on going
management attention and their classifications are reviewed regularly.
11
Analysis of the Allowance for Credit Losses
(In Thousands)
For the Years Ended December 31,
1998 1997
---- ----
Balance at beginning of period $1,404 $1,503
Charge-offs:
Real Estate:
Construction and land development 0 0
Commercial 0 0
Residential 14 22
Commercial 0 37
Consumer installment 90 99
-- --
104 158
--- ---
Recoveries:
Real Estate:
Construction and land development 0 0
Commercial 0 0
Residential 0 0
Commercial 26 4
Consumer installment 23 40
-- --
49 44
-- --
Net charge-offs (recoveries) 55 114
Provision for credit losses 0 0
Allowance acquired 0 15
- --
Balance at end of period $1,349 $1,503
====== ======
Average daily balance of loans $108,180 $103,742
Ratio of net charge-offs to average loans outstanding 0.05% 0.11%
Allocation of the Allowance for Credit Losses
(In Thousands)
Percent of loans Percent of loans
December 31, in each category December 31, in each category
1998 to total loans 1997 to total loans
------------------------------------------------------------------------------------
Real Estate:
Construction and land development $56 4.04% $38 2.70%
Commercial 578 13.00% 518 11.88%
Residential 46 68.78% 47 71.70%
Commercial 180 7.60% 194 7.65%
Consumer 148 6.58% 112 6.07%
Unallocated 341 N/A 495 N/A
------------------------------------------------------------------------------------
TOTAL $1,349 100.00% $1,404 100.00%
====================================================================================
12
Maturity of Time Certificates of Deposit $100,000 or More
(In Thousands)
December 31, December 31,
1998 1997
---- ----
Three months or less $1,192 $2,360
Three months through six months 1,810 2,245
Six months through twelve months 3,839 3,368
Over twelve months 8,516 5,501
----- -----
TOTAL $15,357 $13,474
======= =======
Summary of Significant Ratios
1998 1997
---- ----
Return on average total assets 1.25% 1.43%
Return on average total equity 9.52% 10.40%
Dividend payout ratio 45.54% 41.28%
Total average equity to total average assets ratio 13.17% 13.75%
ITEM 2
PROPERTIES
The Bank owns real property at the location of its main office at 109 North
Commerce Street, Centreville, Maryland 21617, and at its four branch locations
at 2609 Centreville Road, Centreville, Maryland 21617 ("Route 213 South Branch
Office"), 408 Thompson Creek Road, Stevensville, Maryland 21666 ("Stevensville
Branch Office"), at 21913 Shore Highway, Hillsboro, Maryland 21614 ("Hillsboro
Branch Office") and 305 East High Street, Chestertown, Maryland ("Kent Branch
Office".) There are no encumbrances on any of these properties. The Company owns
no real property.
ITEM 3
LEGAL PROCEEDINGS
There are no material pending legal proceedings other than ordinary routine
litigation incidental to the business to which the Company, the Bank, or its
subsidiaries is a party or of which any of their properties is subject.
Management is not aware of any material proceedings to which any Director,
officer, or affiliate of the Company, any person holding beneficially in excess
of five (5) percent of the Company's shares of common stock, or any associate of
any such Director, officer, or securing holder is a party.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1998 to a vote of
security holders, through the solicitation of proxies.
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The sections entitled "Market Price of and Dividends on Registrant's Common
Equity and Related Stockholder Matters" and "Market Information" on page 39 of
the Annual Report is incorporated by reference herein.
For information regarding regulatory restrictions on the Bank's and, therefore,
the Company's payment of dividends, see Note 16 "Regulatory Matters" on page 35
of the Annual Report, which is incorporated by reference herein.
ITEM 6
SELECTED FINANCIAL DATA
The table entitled "Selected Financial Data" on page 1 of the Annual Report is
incorporated by reference herein. Reference is also made to the information
described in Part I, Item 1 of this Form 10K under the heading "Statistical
Information."
13
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Pages 5 through 15 of the Annual Report are incorporated by reference herein.
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the market risk of the Company's financial
instruments, see "Management Discussion and Analysis of Financial Condition and
Results of Operations - Market Risk Management" on page 11 of the Annual Report
and incorporated by reference herein. The Company's principal market risk
exposure is to interest rates.
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages 16 through 38 of the Annual Report are incorporated by reference herein.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Board of Directors of the Company, upon recommendation of the Bank's
Audit/Compliance Committee, proposed and recommended the election of Stegman &
Company as independent certified public accountants to make an examination of
the accounts of the Company and the Bank for the year ending December 31, 1998.
Stegman and Company served as the Company's and the Bank's independent public
auditor for 1996 and 1997.
There were no disagreements with Stegman and Company on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedures.
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference in the section entitled "Election of Directors" on
pages 2 - 4 and section entitled "Executive Officers" on page 7 in the Proxy
Statement as filed with the Securities and Exchange Commission March 24, 1999.
ITEM 11
EXECUTIVE COMPENSATION
Incorporated by reference in the sections entitled "Executive Compensation" on
pages 7-8, "Bank's Board of Directors' Executive Compensation Committee
Report" on pages 6-7, "Performance Graph" on page 8 and the discussion regarding
director compensation on pages 5-6, in the Proxy Statement as filed with the
Securities and Exchange Commission March 24, 1999.
14
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference in the section entitled "Beneficial Ownership of
Common Stock" on pages 1 and 2 in the Proxy Statement as filed with the
Securities and Exchange Commission March 24, 1999.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference in the section entitled "Election of Directors" on
page 2 in the Proxy Statement as filed with the Securities and Exchange
Commission March 24, 1999.
PART IV
ITEM 14
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1), (2) Financial Statements
The following consolidated financial statements included in the Annual Report to
Shareholders for the year ended December 31, 1998, are incorporated herein by
reference in Item 8 of this Report.
The following financial statements are filed as a part of this
report:
Consolidated Balance Sheets at December 31, 1998 and 1997
Consolidated Statements of Income for the years ended December 31,
1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December
31, 1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996
Notes to the Consolidated Financial Statements
Independent Auditors' Report
All financial statement schedules have been omitted as the required
information is either inapplicable or included in the consolidated
financial statements or related notes.
(a) (3) Exhibits required to be filed by Item 601 of Regulation S-K
EXHIBIT INDEX
(3) Charter and Bylaws
(3.1) Articles of Amendment and Restatement of the Company are
incorporated by reference from the Company's June 30, 1998 Form 10-Q, filed with
the Commission on August 13, 1998.
15
(3.2) Bylaws of the Company as amended and restated are incorporated by
reference from the Company's June 30, 1998 Form 10-Q, filed with the Commission
on August 13, 1998.
(10.1) 1998 Employee Stock Purchase Plan is incorporated by reference
from the Company's Registration Statement on Form S-8 filed with the Commission
on September 25, 1998 (Registration No. 333-64317).
(10.2) 1998 Stock Option Plan is incorporated by reference from the
Company's Registration Statement on Form S-8 filed with the Commission on
September 25, 1998 (Registration No. 333-64319).
(13) 1998 Annual Report filed herewith.
(21) List of Subsidiaries is incorporated by reference from the Company's
Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with
the Commission on May 30, 1997 (Registration No. 0-22523)
(23) Consent of Independent Auditors filed herewith.
(27) Financial Data Schedule is filed electronically herewith via EDGAR.
(b) Reports on Form 8-K
None
(c) Exhibits to Item 601 to Regulation S-K
See the Exhibits described in Item 14(a)(3) above.
16
SIGNATURES
Pursuant to the requirements in Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf on March 17, 1998 by the undersigned, thereunto duly authorized.
SHORE BANCSHARES, INC.
/s/ Daniel T. Cannon
____________________
Daniel T. Cannon
President
/s/ Carol I. Brownawell
_______________________
Carol I. Brownawell
Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on March 16, 1999.
/s/ J. Robert Barton Director
___________________________
J. Robert Barton
/s/ Paul M. Bowman Director
___________________________
Paul M. Bowman
/s/ David C. Bryan Director
___________________________
David C. Bryan
/s/ Daniel T. Cannon Director
___________________________
Daniel T. Cannon
Director
___________________________
B. Vance Carmean, Jr.
/s/ Mark M. Freestate Director
___________________________
Mark M. Freestate
/s/ Thomas K. Helfenbien Director
___________________________
Thomas K. Helfenbein
/s/ Neil R. LeCompte Director
___________________________
Neil R. LeCompte
Director
___________________________
Susanne K. Nuttle
/s/ Jerry F. Pierson Director
___________________________
Jerry F. Pierson
/s/ Wm. Maurice Sanger Director
___________________________
Wm. Maurice Sanger
Director
___________________________
Walter E. Schmidt
17