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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: O-19065
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Sandy Spring Bancorp, Inc.
--------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1532952
------------------------ --------------------------------------
(State of incorporation) (I.R.S. Employer Identification Number)
17801 Georgia Avenue, Olney, Maryland 20832 301-774-6400
- ------------------------------------- ----- ------------
(Address of principal office) (Zip Code) (Telephone Number)
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
filing requirements for the past 90 days.
YES X NO
------- -------
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
YES X NO
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The number of shares of common stock outstanding as of October 20, 2004
is 14,500,361 shares.
SANDY SPRING BANCORP, INC.
INDEX
PAGE
- --------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at
September 30, 2004 and December 31, 2003...........................1
Consolidated Statements of Income for the Nine
Month Periods Ended September 30, 2004 and 2003....................2
Consolidated Statements of Cash Flows for the Nine
Month Periods Ended September 30, 2004 and 2003 ...................4
Consolidated Statements of Changes in Stockholders' Equity for
the Nine Month Periods Ended September 30, 2004 and 2003...........6
Notes to Consolidated Financial Statements.........................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....................10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK ................................................20
ITEM 4. CONTROLS AND PROCEDURES...........................................20
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND
ISSUER PURCHASES OF EQUITY SECURITIES.............................21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................................21
SIGNATURES................................................................22
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(Dollars in thousands, except per share data) 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 43,390 $ 38,397
Federal funds sold 27,086 10,670
Interest-bearing deposits with banks 512 724
Residential mortgage loans held for sale (at fair value) 8,849 12,209
Investments available-for-sale (at fair value) 598,886 639,460
Investments held-to-maturity -- fair value of $328,531 (2004) and
$344,814 (2003) 321,451 337,634
Other equity securities 19,852 21,111
Total loans and leases 1,365,483 1,153,428
Less: allowance for credit losses (14,792) (14,880)
--------------- ---------------
Net loans and leases 1,350,691 1,138,548
Premises and equipment, net 40,991 37,679
Accrued interest receivable 13,049 13,661
Goodwill 7,642 7,642
Other intangible assets 9,987 11,446
Other assets 63,916 65,243
--------------- ---------------
Total assets $ 2,506,302 $ 2,334,424
=============== ===============
LIABILITIES
Noninterest-bearing deposits $ 423,254 $ 368,319
Interest-bearing deposits 1,286,388 1,193,511
--------------- ---------------
Total deposits 1,709,642 1,561,830
Short-term borrowings 393,528 413,223
Subordinated debentures 70,000 35,000
Other long-term borrowings 114,696 115,158
Accrued interest payable and other liabilities 16,699 15,764
--------------- ---------------
Total liabilities 2,304,565 2,140,975
STOCKHOLDERS' EQUITY
Common stock -- par value $1.00; shares authorized 50,000,000; shares issued
and outstanding 14,493,104 (2004) and 14,495,613 (2003) 14,493 14,496
Additional paid in capital 18,473 18,970
Retained earnings 164,977 153,280
Accumulated other comprehensive income 3,794 6,703
--------------- ---------------
Total stockholders' equity 201,737 193,449
--------------- ---------------
Total liabilities and stockholders' equity $ 2,506,302 $ 2,334,424
=============== ===============
See Notes to Consolidated Financial Statements.
1
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
(In thousands, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income:
Interest and fees on loans and leases $ 18,233 $ 15,883 $ 51,608 $ 48,754
Interest on loans held for sale 172 422 522 993
Interest on deposits with banks 3 2 8 9
Interest and dividends on securities:
Taxable 5,472 7,998 17,537 24,610
Exempt from federal income taxes 3,678 3,558 10,780 10,509
Interest on federal funds sold 133 49 280 264
---------------------------------------------------------------
TOTAL INTEREST INCOME 27,691 27,912 80,735 85,139
Interest Expense:
Interest on deposits 3,412 3,230 9,136 10,891
Interest on short-term borrowings 4,717 4,389 12,167 13,516
Interest on long-term borrowings 1,193 1,518 4,575 4,547
---------------------------------------------------------------
TOTAL INTEREST EXPENSE 9,322 9,137 25,878 28,954
---------------------------------------------------------------
NET INTEREST INCOME 18,369 18,775 54,857 56,185
Provision for Credit Losses 0 0 0 0
---------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 18,369 18,775 54,857 56,185
Noninterest Income:
Securities gains 138 106 475 657
Service charges on deposit accounts 1,886 2,027 5,635 6,048
Gains on sales of mortgage loans 714 1,906 2,511 5,084
Fees on sales of investment products 475 512 1,770 1,699
Trust department income 813 756 2,551 2,234
Insurance agency commissions 944 924 3,095 2,865
Income from bank owned life insurance 614 866 1,857 2,185
Income from an early termination of a sublease 0 0 0 1,077
Visa check fees 498 434 1,419 1,353
Other income 1,338 1,220 3,907 3,356
---------------------------------------------------------------
TOTAL NONINTEREST INCOME 7,420 8,751 23,220 26,558
Noninterest Expenses:
Salaries and employee benefits 10,353 9,932 30,571 28,896
Occupancy expense of premises 1,861 1,839 5,304 4,956
Equipment expenses 1,380 1,101 3,894 3,241
Marketing 385 477 1,380 1,440
Outside data services 697 643 2,184 1,948
Amortization of intangible assets 486 665 1,459 1,994
Other expenses 2,779 2,247 8,074 7,009
---------------------------------------------------------------
TOTAL NONINTEREST EXPENSES 17,941 16,904 52,866 49,484
---------------------------------------------------------------
Income Before Income Taxes 7,848 10,622 25,211 33,259
Income Tax Expense 1,431 2,404 5,100 7,977
---------------------------------------------------------------
NET INCOME $ 6,417 $ 8,218 $ 20,111 $ 25,282
===============================================================
See Notes to Consolidated Financial Statements.
2
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (Continued)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
(In thousands, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Basic Net Income Per Share $0.44 $0.57 $1.39 $1.75
Diluted Net Income Per Share 0.44 0.56 1.37 1.72
Dividends Declared Per Share 0.20 0.19 0.58 0.55
See Notes to Consolidated Financial Statements.
3
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Nine Months Ended
September 30,
-----------------------------
2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 20,111 $ 25,282
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 5,609 4,795
Provision for credit losses 0 0
Deferred Income Taxes (benefits) (555) 380
Origination of loans held for sale (211,426) (356,944)
Proceeds from sales of loans held for sale 217,297 391,073
Gains on sales of loans held for sale (2,511) (5,084)
Securities gains (475) (657)
Income from early termination of a sublease 0 (1,077)
Net (increase) decrease in accrued interest receivable 612 (335)
Net (increase) decrease in other assets 3,224 (8,520)
Net increase (decrease) in accrued expenses and other liabilities 546 (8,529)
Other - net 1,177 4,324
------------ ------------
Net cash provided by operating activities 33,609 44,708
Cash flows from investing activities:
Net decrease (increase) in interest-bearing deposits with banks 212 (114)
Purchases of investments held-to-maturity (25,035) (102,429)
Purchases of other equity securities 0 (1,556)
Proceeds from sales of other equity securities 1,259 0
Purchases of investments available-for-sale (397,218) (1,131,486)
Proceeds from sales of investments available-for-sale 217,988 150,726
Proceeds from the sales of other real estate owned 153 78
Proceeds from maturities, calls and principal payments of investments held-to-maturity 40,977 95,174
Proceeds from maturities, calls and principal payments of investments available-for-sale 214,639 924,733
Net increase in loans and leases (212,055) (35,875)
Proceeds from an early termination of a sublease 0 750
Expenditures for premises and equipment (6,861) (3,592)
------------ ------------
Net cash used in investing activities (165,941) (103,591)
Cash flows from financing activities:
Net increase in deposits 147,812 66,008
Net decrease in short-term borrowings (20,157) (23,317)
Proceeds from long-term borrowings 35,000 28,500
Common stock purchased and retired (1,448) (3,326)
Proceeds from issuance of common stock 948 840
Dividends paid (8,414) (7,972)
------------ ------------
Net cash provided by financing activities 153,741 60,733
------------ ------------
Net increase in cash and cash equivalents 21,409 1,850
Cash and cash equivalents at beginning of period 49,067 48,133
------------ ------------
Cash and cash equivalents at end of period $ 70,476 $ 49,983
============ ============
4
Sandy Spring Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Nine Months Ended
September 30,
-----------------------------
2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
Supplemental Disclosures:
Interest payments $ 25,543 $ 29,125
Income tax payments 4,303 10,671
Noncash Financing Activities:
Transfers from loans to other real estate owned 0 187
Increase in premises and equipment from an early termination of a sublease 0 1,168
Reclassification of borrowings from long-term to short-term 35,462 30,654
See Notes to Consolidated Financial Statements.
5
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accum-
ulated
Other
Compre- Total
Additional hensive Stock-
Common Paid-in Retained Income holders'
(Dollars in thousands, except per share data) Stock Capital Earnings (loss) Equity
- --------------------------------------------------------------------------------------------------------------------------------
Balances at January 1, 2004 $ 14,496 $ 18,970 $ 153,280 $ 6,703 $ 193,449
Comprehensive income:
Net income 20,111 20,111
Other comprehensive loss, net of tax effects and
reclassification adjustment (2,909) (2,909)
----------
Total comprehensive income 17,202
Cash dividends - $0.58 per share (8,414) (8,414)
Common stock issued pursuant to:
Director stock purchase plan- 1,120 shares 1 39 40
Stock option plan - 28,266 shares 28 458 486
Employee stock purchase plan - 14,417 shares 14 408 422
Stock repurchases - 46,312 shares (46) (1,402) (1,448)
---------- ----------- ----------- ------------ ----------
Balances at September 30, 2004 $ 14,493 $ 18,473 $ 164,977 $ 3,794 $ 201,737
========== =========== =========== ============ ==========
Balances at January 1, 2003 $ 14,536 $ 21,128 $ 131,939 $ 10,421 $ 178,024
Comprehensive income:
Net income 25,282 25,282
Other comprehensive income, net of tax effects
and reclassification adjustment (3,225) (3,225)
----------
Total comprehensive income 22,057
Cash dividends - $0.55 per share (7,972) (7,972)
Common stock issued pursuant to:
Stock option plan - 30,814 shares 31 453 484
Employee stock purchase plan - 12,926 shares 13 343 356
Stock repurchases - 105,460 shares (106) (3,220) (3,326)
---------- ----------- ----------- ----------- ----------
Balances at September 30, 2003 $ 14,474 $ 18,704 $ 149,249 $ 7,196 $ 189,623
========== =========== =========== =========== ===========
See Notes to Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - General
The foregoing financial statements are unaudited. In the opinion of
Management, all adjustments (comprising only normal recurring accruals)
necessary for a fair presentation of the results of the interim periods have
been included. These statements should be read in conjunction with the financial
statements and accompanying notes included in Sandy Spring Bancorp's 2003 Annual
Report to Shareholders. There have been no significant changes to the Company's
Accounting Policies as disclosed in the 2003 Annual Report. The results shown in
this interim report are not necessarily indicative of results to be expected for
the full year 2004.
The accounting and reporting policies of Sandy Spring Bancorp (the
"Company") conform to accounting principles generally accepted in the United
States of America and to general practices within the banking industry. Certain
reclassifications have been made to amounts previously reported to conform to
current classifications.
Consolidation has resulted in the elimination of all significant
intercompany accounts and transactions.
Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks and federal funds sold (which have original maturities
of three months or less).
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, "Consolidation of Variable Interest Entities"
("FIN 46"), which explains identification of variable interest entities and the
assessment of whether to consolidate these entities. FIN 46 requires existing
unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among the
involved parties. The potential de-consolidation of subsidiary trusts of bank
holding companies formed in connection with the issuance of trust preferred
securities appears to be an unintended consequence of FIN 46. On December 17,
2003, the FASB revised FIN 46 (FIN 46R) and deferred the effective date of FIN
46 to no later than the end of the first reporting period that ends after March
15, 2004. Accordingly, the Company chose to postpone de-consolidation of the
trust preferred securities until March 31, 2004. Prior periods have been
restated. The overall effect on the Company's financial position as a result of
this deconsolidation was not material. The Company has no significant variable
interests in any entities which would require disclosure or consolidation.
Note 2 - Stock Option Plan
At September 30, 2004, the Company had options outstanding under two
stock-based employee compensation plans, the 1992 stock option plan (expired but
having outstanding options that may still be exercised) and the 1999 stock
option plan. 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
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effects 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 periods indicated.
7
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------
(In thousands, except per share data) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 6,417 $ 8,218 $ 20,111 $ 25,282
Less pro forma stock-based employee
compensation expense determined
under fair value based method, net
of related tax effects (310) (248) (930) (745)
----------------------------------------------------------------------
Pro forma net income $ 6,107 $ 7,970 $ 19,181 $ 24,537
======================================================================
Net income per share:
Basic - as reported $ 0.44 $ 0.57 $ 1.39 $ 1.75
Basic - pro forma $ 0.42 $ 0.55 $ 1.32 $ 1.69
Diluted - as reported $ 0.44 $ 0.56 $ 1.37 $ 1.72
Diluted - pro forma $ 0.42 $ 0.54 $ 1.30 $ 1.67
Note 3 - Per Share Data
The calculations of net income per common share for the three month and
nine month periods ended September 30 are as shown in the following table. Basic
net income per share is computed 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 calculation method is derived by
dividing net income available to common stockholders by the weighted average
number of common shares outstanding adjusted for the dilutive effect of
outstanding stock options.
(Dollars and amounts in thousands, except Three Months Ended Nine Months Ended
Per share data) September 30, September 30,
- ----------------------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Basic:
Net income available to common stockholders $ 6,417 $ 8,218 $ 20,111 $ 25,282
Average common shares outstanding 14,499 14,472 14,506 14,496
Basic net income per share $ 0.44 $ 0.57 $ 1.39 $ 1.75
=========================== =============================
Diluted:
Net income available to common stockholders $ 6,417 $ 8,218 $ 20,111 $ 25,282
Average common shares outstanding 14,499 14,472 14,506 14,496
Stock option adjustment 175 205 199 202
--------------------------- -----------------------------
Average common shares outstanding-diluted 14,674 14,677 14,705 14,698
Diluted net income per share $ 0.44 $ 0.56 $ 1.37 $ 1.72
=========================== =============================
Options for 187,907 shares of common stock were not included in
computing diluted net income per share for the three and nine months ended
September 30, 2004 because their effects are antidilutive. There was no such
effect for the three and nine months ended September 30, 2003.
Note 4-Pension, Profit Sharing, and Other Employee Benefit Plans
Defined Benefit Pension Plan
The Company has a qualified, noncontributory, defined benefit pension
plan covering substantially all employees. Benefits equal the sum of two parts:
(a) the benefit accrued as of December 31, 2000, based on the formula of 1.5% of
the highest five year average salary as of that date times years of service as
of that date, plus (b) 1.75% of each year's earnings after December 31, 2000
(1.75% of career average earnings). In addition, if the participant's age plus
years of service as of January 1, 2001, equal at least 60 and the participant
had at least 15 years of service at that date, he or she will receive an
additional benefit of 1% of year 2000 earnings for each of the first 10 years of
service completed after December 31, 2000. Early retirement is also permitted by
the Plan at age 55 after 10 years of service. The Company's funding policy is to
contribute at least the minimum amount necessary to keep the plan fully funded.
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 Company, with input from its actuaries, estimates that the 2004
contribution will be approximately $1.5 million which will maintain the pension
plan's fully funded status.
8
Net periodic benefit cost for the three and nine month periods ended
September 30 includes the following components:
Three months Ended Nine months Ended
- ---------------------------------------------------------------------------------------------------------------------
September 30, September 30,
- ---------------------------------------------------------------------------------------------------------------------
(In thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------
Service cost for benefits earned $ 395 $ 285 $ 1,184 $ 855
Interest cost on projected benefit obligation 232 183 697 548
Expected return on plan assets (259) (197) (778) (590)
Amortization of prior service cost (16) (15) (47) (47)
Recognized net actuarial loss 82 73 246 220
------------ ------------ ------------ ------------
Net periodic benefit cost $ 434 $ 329 $ 1,302 $ 986
============ ============ ============ ============
Cash and Deferred Profit Sharing Plan
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 under the 401(k) provision receive a
matching contribution up to the first 4% of compensation based on years of
service and subject to employee contribution limitations. 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. The
Company had expenses related to the qualified Cash and Deferred Profit Sharing
Plan of $539,000 and $594,000 for the nine month period ended September 30, 2003
and 2004, respectively and $167,000 and $201,000 for the three month period
ended September 30, 2003 and 2004, respectively.
The Company also has a performance based compensation benefit which is
integrated with the Cash and Deferred Profit Sharing Plan and which provides
incentives to employees based on the Company's financial results as measured
against key performance indicator goals set by management. The Company had
expenses related to the performance based compensation benefit of $744,000 and
$14,000 for the nine months ended September 30, 2003 and 2004, respectively and
$257,000 and $0 for the three months ended September 30, 2003 and 2004,
respectively.
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 SERAs, if any,
are integrated with other pension plan and Social Security retirement benefits
expected to be received by the executives. The Company is accruing the present
value of these benefits over the remaining years to the executives' retirement
dates. The Company had expenses related to the SERAs of $444,000 and $233,000
for the nine months ended September 30, 2003 and 2004, respectively and $152,000
and $118,000 for the three months ended September 30, 2003 and 2004,
respectively.
The Company has an Executive Health Insurance Plan that provides for
payment of defined medical and dental insurance cost and out of pocket expenses
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. The Company had expenses related to the Executive Health Insurance
Plan of $160,000 and $193,000 for the nine months ended September 30, 2003 and
2004, respectively and $64,000 and $65,000 for the three months ended September
30, 2003 and 2004.
9
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Sandy Spring Bancorp makes forward-looking statements in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations that are subject to risks and uncertainties. These forward-looking
statements include: statements of goals, intentions, earnings expectations and
other expectations; estimates of risks and future costs and benefits;
assessments of probable loan and lease losses; assessments of 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, market behavior, 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.
THE COMPANY
The Company is the registered bank holding company for Sandy Spring
Bank (the "Bank"), headquartered in Olney, Maryland. The Bank operates thirty
community offices in Anne Arundel, Frederick, Howard, Montgomery, and Prince
George's Counties in Maryland, together with an insurance subsidiary and an
equipment leasing company.
The Company offers a broad range of financial services to consumers and
businesses in this market area. Through September 30, 2004, year-to-date average
commercial loans and leases and commercial real estate loans accounted for
approximately 42% of the Company's loan and lease portfolio, and year-to-date
average consumer and residential real estate loans accounted for approximately
58%. Based upon the most recent data available, consumer deposits account for
approximately 75% of total average deposits, while approximately 60% of the
Company's revenues are derived from consumer loans, consumer deposits and other
retail services. The Company has established a strategy of independence, and
intends to establish or acquire additional offices, banking organizations, and
nonbanking organizations as appropriate opportunities may arise.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America 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. The estimates used in management's assessment of the adequacy of
the allowance for credit losses require that management make assumptions about
matters that are uncertain at the time of estimation. Differences in these
assumptions and differences between the estimated and actual losses could have a
material effect.
NON-GAAP FINANCIAL MEASURE
The Company has for many years used a traditional efficiency ratio that
is a non-GAAP financial measure as defined in Commission Regulation G and Item
10 of U.S. Securities and Exchange Commission Regulation S-K. This traditional
efficiency ratio is used as a 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 that it 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 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.
10
In general, the efficiency ratio measures noninterest expenses as a
percentage of net interest income plus total noninterest income. This is a GAAP
financial measure. Noninterest expenses used in the calculation of the
traditional, non-GAAP efficiency ratio exclude intangible asset amortization.
Income for the traditional ratio is increased for the favorable effect of
tax-exempt income, and excludes securities gains and losses, which can vary
widely from period to period without appreciably affecting operating expenses.
The traditional measure is different from the GAAP-based efficiency ratio. 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 presented and reconciled in Table 1.
Table 1 - GAAP based and traditional efficiency ratios
Three Months Ended Nine Months Ended
- --------------------------------------------------------------------------------------------------------------------------------
September 30, September 30,
- --------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Noninterest expenses-GAAP based $ 17,941 $ 16,904 $ 52,866 $ 49,484
Net interest income plus noninterest income-
GAAP based 25,789 27,526 78,077 82,743
Efficiency ratio-GAAP based 69.57% 61.41% 67.71% 59.80%
============ ============ ============ ============
Noninterest expenses-GAAP based $ 17,941 $ 16,904 $ 52,866 $ 49,484
Less non-GAAP adjustment:
Amortization of intangible assets 486 665 1,459 1,994
---------------------------- -------------------------------
Noninterest expenses-traditional ratio 17,455 16,239 51,407 47,490
Net interest income plus noninterest income-
GAAP based 25,789 27,526 78,077 82,743
Plus non-GAAP adjustment:
Tax-equivalency 2,175 2,148 6,059 6,003
Less non-GAAP adjustments:
Securities gains (losses) 138 106 475 657
Income from an early termination of
a sublease 0 0 0 1,077
---------------------------- -------------------------------
Net interest income plus noninterest
Income - traditional ratio 27,826 29,568 83,661 87,012
Efficiency ratio - traditional 62.73% 54.92% 61.45% 54.58%
============ ============ ============ ============
A. FINANCIAL CONDITION
The Company's total assets were $2,506,302,000 at September 30, 2004,
compared to $2,334,424,000 at December 31, 2003, increasing $171,878,000 or 7%
during the first nine months of 2004. Earning assets increased by 8%, to
$2,342,119,000 at September 30, 2004, from $2,175,236,000 at December 31, 2003.
Total loans and leases, excluding loans held for sale, increased 18% or
$212,055,000 during the first nine months of 2004, to $1,365,483,000. During
this period, all three major loan categories showed increases. These increases
occurred in residential real estate loans, which increased by $72,061,000 or
17%, attributable in large part to residential construction loan growth,
consumer loans which increased by $56,966,000 or 23%, primarily reflecting
higher home equity lines and commercial loans and leases which increased by
$83,028,000 or 17%, due predominantly to growth in commercial loans secured by
real estate. Residential mortgage loans held for sale decreased by $3,360,000
from December 31, 2003, to $8,849,000 at September 30, 2004.
Table 2 - Analysis of Loans and Leases
The following table presents the trends in the composition of the loan and lease
portfolio at the dates indicated:
(In thousands) September 30, 2004 % December 31, 2003 %
- -------------------------------------------------------------------------------------------------------------------------------
Residential real estate $ 491,690 36% $ 419,629 36%
Commercial loans and leases 573,967 42 490,939 43
Consumer 299,826 22 242,860 21
----------------------------------------------------------------------------------
Total Loans and Leases 1,365,483 100% 1,153,428 100%
=========== =========
Less: Allowance for credit losses (14,792) (14,880)
----------------------------- -----------------------------
Net loans and leases $1,350,691 $1,138,548
============================= =============================
11
The total investment portfolio decreased by 6% or $58,016,000 from
December 31, 2003, to $940,189,000 at September 30, 2004, as management
decreased the amount of leverage on the balance sheet to mitigate interest rate
risk in the event of rising rates. The decrease was driven primarily by a
decline of $40,574,000 or 6% of available-for-sale securities. The aggregate of
federal funds sold and interest-bearing deposits with banks increased by
$16,204,000 during the first nine months of 2004, reaching $27,598,000 at
September 30, 2004.
Table 3 - Analysis of Deposits
The following table presents the trends in the composition of deposits at the
dates indicated:
(In thousands) September 30, 2004 % December 31, 2003 %
- -------------------------------------------------------------------------------------------------------------------------------
Noninterest-bearing deposits $ 423,254 25% $ 368,319 24%
Interest-bearing deposits:
Demand 232,892 14 224,272 14
Money market savings 365,164 21 376,722 24
Regular savings 225,456 13 187,510 12
Time deposits less than $100,000 271,912 16 269,938 17
Time deposits $100,000 or more 190,964 11 135,069 9
----------------------------- --------- ---------------------------- ---------
Total interest-bearing 1,286,388 75 1,193,511 76
----------------------------- --------- ---------------------------- ---------
Total deposits $1,709,642 100% $1,561,830 100%
============================= ========= ============================ =========
Total deposits were $1,709,642,000 at September 30, 2004, increasing
$147,812,000 or 9% from $1,561,830,000 at December 31, 2003. For the first
nine-months of 2004 growth rates of 15% were achieved for noninterest-bearing
demand deposits (up $54,935,000), 20% for interest-bearing regular savings (up
$37,946,000), 41% for time deposits of $100,000 or more (up $55,895,000), 4% for
interest-bearing demand deposits (up $8,620,000) and 1% for time deposits of
less than $100,000 (up $1,974,000). Over the same period, decreases of 3% were
recorded for money market savings (down $11,558,000).
Total borrowings were $578,224,000 at September 30, 2004, which
represented an increase of $14,843,000 or 3% from December 31, 2003, primarily
reflecting an increase in subordinated debentures. In August, the Company issued
$35 million in 6.35% subordinated debentures. The proceeds will be used later
this year to redeem the $35 million in 9.375% debentures issued in 1999.
MARKET RISK AND INTEREST RATE SENSITIVITY
OVERVIEW
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 Board of Directors has established a comprehensive
interest rate risk management policy, which is administered by Management's
Asset Liability Management Committee ("ALCO"). The policy establishes limits of
risk, which are quantitative measures of the percentage change in net interest
income (a measure of net interest income at risk) and the fair value of equity
capital (a measure of economic value of equity ("EVE") at risk) resulting from a
hypothetical change in U.S. Treasury interest rates for maturities from one day
to thirty years. The Company measures the potential adverse impacts that
changing interest rates may have on its short-term earnings, long-term value,
and liquidity by employing simulation analysis through the use of computer
modeling. The simulation model captures optionality factors such as call
features and interest rate caps and floors imbedded in investment and loan
portfolio contracts. 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.
12
The Company prepares a current base case and eight alternative
simulations, at least once a quarter, and reports the analysis to the Board of
Directors. In addition, more frequent forecasts are produced when interest rates
are particularly uncertain or when other business conditions so dictate.
If a measure of risk produced by the alternative simulations of the
entire balance sheet or of the Company's leverage program violates policy
guidelines, ALCO is required to develop a plan to restore the measure of risk to
a level that complies with policy limits within two quarters.
The Company's interest rate risk management goals are (1) to increase
net interest income at a growth rate consistent with the growth rate of total
assets and, (2) to minimize fluctuations in net interest margin as a percentage
of earning assets. Management attempts to achieve these goals by balancing,
within policy limits, the volume of floating-rate liabilities with a similar
volume of floating-rate assets; by keeping the average maturity of fixed-rate
asset and liability contracts reasonably matched; by maintaining a pool of
administered core deposits; and by adjusting pricing rates to market conditions
on a continuing basis.
The balance sheet is subject to quarterly testing for eight alternative
interest rate shock possibilities to indicate the inherent interest rate risk.
Average interest rates are shocked by +/- 100, 200, 300, and 400 basis points
("bp"), although the Company may elect not to use particular scenarios that it
determines are impractical in a current rate environment. It is management's
goal to structure the balance sheet so that net interest earnings at risk over a
twelve-month period and the economic value of equity at risk do not exceed
policy guidelines at the various interest rate shock levels.
The Company augments its quarterly interest rate shock analysis with
alternative external interest rate scenarios on a monthly basis. These
alternative interest rate scenarios may include non-parallel rate ramps and
non-parallel yield curve twists.
ANALYSIS OF POSSIBLE OUTCOMES
Measures of net interest income at risk produced by simulation analysis
are indicators of an institution's short-term performance in alternative rate
environments. These measures are typically based upon a relatively brief period,
usually one year. They do not necessarily indicate the long-term prospects or
economic value of the institution.
ESTIMATED CHANGES IN NET INTEREST INCOME
-------------------------------------- ------------- -------------- ------------- ------------- ------------
CHANGE IN NET INTEREST INCOME: + 400 BP + 300 BP + 200 BP + 100 BP - 100 BP
-------------------------------------- ------------- -------------- ------------- ------------- ------------
POLICY LIMIT 30% 25% 20% 15% 15%
September 2004 +0.76 +0.38 +0.47 +1.37 -3.67
December 2003 -6.61 -3.80 -2.30 -0.62 -9.17
As shown above, measures of net interest income at risk improved from
December 31, 2003 at all interest rate shock levels. Specifically, at the +200bp
shock level, the measure moved from -2.30% to +0.47%, well within the policy
limit of 20%. Although assumed to be unlikely, our largest exposure is at the
- -100bp level, with a measure of -3.67% compared to -9.17% at December 31, 2003.
This is also well within our prescribed policy limit of 15%. The reduction in
the net interest income sensitivity is consistent with management's decision to
reduce the duration and size of the investment portfolio during the first nine
months of 2004 in anticipation of rising interest rates in the future.
The measures of equity value at risk indicate the ongoing economic
value of the Company by considering the effects of changes in interest rates on
all of the Company's cash flows, and discounting the cash flows to estimate the
present value of assets and liabilities. The difference between these discounted
values of the assets and liabilities is the economic value of equity, which, in
theory, approximates the fair value of the Company's net assets.
ESTIMATED CHANGES IN ECONOMIC VALUE OF EQUITY (EVE)
---------------------------------------- -------------- ------------- ------------- ------------- ----------
DECREASE IN ECONOMIC VALUE OF EQUITY: + 400 BP + 300 BP + 200 BP + 100 BP - 100 BP
---------------------------------------- -------------- ------------- ------------- ------------- ----------
POLICY LIMIT 60% 40% 22.5% 10.0% 12.5%
September 2004 -28.25 -21.25 -12.56 -2.14 -4.09
December 2003 -47.83 -34.66 -20.41 -3.98 -10.17
13
Measures of the economic value of equity (EVE) at risk also improved
over year-end 2003 at all interest rate shock levels. A reduced duration in the
investment portfolio is the key contributor to the improved risk position as
well as core deposit balance growth and an increase in core deposit estimated
lives. The economic value of equity exposure at +200bp is now -12.56% compared
to -20.41% at year-end 2003, and is well within the policy limit of 22.5%, as
are measures at all other shock levels.
The Company's leverage program consists primarily of investments in
available-for-sale securities funded by Federal Home Loan Bank of Atlanta
advances. This program increased the Company's return on equity and earnings per
share in prior years. The Company reduced its leverage program during 2003 and
2004, however, in the face of higher interest rates and net interest margin
compression. The net interest margin was approximately break-even through the
first nine months of 2004. The average balance in the leverage program was
$281,173,000 for the nine months ended September 30, 2004. The Company continues
to evaluate the potential effects of its remaining leverage program in
connection with its interest rate risk management policies, discussed above.
LIQUIDITY
Liquidity is measured using an approach designed to take into account
loan and lease payments, maturities, calls and pay -downs of securities,
earnings, growth, mortgage banking activities, leverage programs, investment
portfolio liquidity, and other factors. Through this approach, implemented by
the funds management subcommittee 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 September 30, 2004 showed short-term
investments exceeding short-term borrowings over the subsequent 90 days by
$45,048,000, which decreased from $69,038,000 at December 31, 2003. This excess
of liquidity over projected requirements for funds indicates that the Company
can 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 a line of credit for
$725,816,000 from the Federal Home Loan Bank of Atlanta, of which approximately
$360,246,000 was outstanding at September 30, 2004. 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 $262,643,000
at September 30, 2004, against which there were outstandings of approximately
$25,000,000. Based upon its liquidity analysis, including external sources of
liquidity available, management believes the liquidity position is appropriate
at September 30, 2004.
The following is a schedule of significant commitments at September 30,
2004:
(In thousands)
Commitments to extend credit:
Unused lines of credit (home equity and business) $404,122
Other commitments to extend credit $182,877
Standby letters of credit $ 33,570
---------
$620,569
CAPITAL MANAGEMENT
The Company recorded a total risk-based capital ratio of 15.99% at
September 30, 2004, compared to 15.51% at December 31, 2003; a tier 1 risk-based
capital ratio of 15.06%, compared to 14.34%; and a capital leverage ratio of
9.84%, compared to 8.67%. These increases in capital ratios were mainly the
result of the Company issuing $35 million in 6.35% subordinated debentures
during the third quarter of 2004. These proceeds will be used later this year to
redeem the $35 million in 9.375% subordinated debentures which will result in a
reduction in the Company's capital ratios. Capital adequacy, as measured by
these ratios, was well above regulatory requirements. Management believes the
level of capital at September 30, 2004, is appropriate.
Stockholders' equity for September 30, 2004, totaled $201,737,000,
representing an increase of $8,288,000 or 4% from $193,449,000 at December 31,
2003. Accumulated other comprehensive income, a component of stockholders'
equity comprised of unrealized gains and losses on available-for-sale
securities, net of taxes, decreased by 43% or $2,909,000 from December 31, 2003
to $3,794,000 at September 30, 2004.
Internal capital generation (net income less dividends) added
$11,697,000 to total stockholders' equity during the first nine months of 2004.
When internally formed capital is annualized and expressed as a percentage of
average total stockholders' equity, the resulting rate was 8% compared to 12%
reported for the full-year 2003.
External capital formation (equity created through the issuance of
stock under the employee stock purchase plan, stock option plan and the director
stock purchase plan) totaled $948,000 during the nine month period ended
September 30, 2004. However, share repurchases amounted to $1,448,000 from
December 31, 2003 through September 30, 2004, for a net decrease in
stockholders' equity from these sources of $500,000.
14
Dividends for the first nine months of the year were $0.58 per share in
2004, compared to $0.55 per share in 2003, for respective dividend payout ratios
(dividends declared per share to diluted net income per share) of 42% versus
32%.
B. RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2004, AND 2003
Net income for the first nine months of the year decreased $5,171,000
or 20% to $20,111,000 in 2004 from $25,282,000 in 2003, representing annualized
returns on average equity of 13.65% and 18.32%, respectively. Diluted earnings
per share (EPS) for the first nine months were $1.37 in 2004, compared to $1.72
in 2003.
The net interest margin decreased by 15 basis points to 3.65% for the
nine months ended September 30, 2004, from 3.80% for the same period of 2003.
The net interest spread decreased by 14 basis points as the yields on earning
assets decreased more than the rates on interest bearing liabilities.
TABLE 4 - CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES
(Dollars in thousands and tax equivalent)
For the nine months ended September 30,
2004 2003
------------------------------------------------------------------------------
Average Average
Average Annualized Yield/Rate Average Annualized Yield/Rate
Balance Interest (1) Balance Interest (1)
------------------------------------------------------------------------------
Assets
Total loans and leases (2) $1,253,243 $69,595 5.55% $1,095,085 $66,454 6.07%
Total securities 942,167 45,656 4.85 1,060,939 54,979 5.18
Other earning assets 34,211 384 1.12 32,772 364 1.11
-------------------------- ------------------------
TOTAL EARNING ASSETS 2,229,621 115,635 5.19% 2,188,796 121,797 5.56%
Nonearning assets 164,014 152,622
------------- ----------
Total assets $2,393,635 $2,341,418
============= ==========
Liabilities and Stockholders' Equity
Interest-bearing demand deposits $ 230,598 $671 0.29% $ 197,284 $483 0.24%
Money market savings deposits 368,261 2,143 0.58 404,196 2,626 0.65
Regular savings deposits 211,241 762 0.36 168,708 517 0.31
Time deposits 430,664 8,628 2.00 439,947 10,934 2.49
-------------------------- ------------------------
Total interest-bearing deposits 1,240,764 12,204 0.98 1,210,135 14,560 1.20
Short-term borrowings 405,277 16,013 3.95 472,100 18,029 3.82
Long-term borrowings 144,825 6,049 4.18 122,208 6,062 4.96
-------------------------- ------------------------
Total interest-bearing liabilities 1,790,866 34,266 1.91 1,804,443 38,651 2.14
----------- -----------
Noninterest-bearing demand deposits 386,194 325,933
Other noninterest-bearing liabilities 19,724 26,537
Stockholders' equity 196,851 184,505
------------- ----------
Total liabilities and stockholders' equity $2,393,635 $2,341,418
============= ==========
Net interest spread 3.28% 3.42%
=========== =============
Net interest margin (3) 3.65% 3.80%
=========== =============
Ratio of average earning assets to
Average interest-bearing liabilities 124.50% 121.30%
============= ==========
(1) Interest income includes the effects of taxable-equivalent adjustments
(reduced by the nondeductible portion of interest expense) using the
appropriate federal income tax rate of 35% 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 net taxable-equivalent adjustment amounts
utilized in the above table (on an annual basis) to compute yields were
$8,093,000 and $8,026,000 for the nine months ended September 30, 2004 and
2003, respectively.
(2) Non-accrual loans are included in the average balances.
(3) Net interest margin = annualized net interest income on a tax-equivalent
basis divided by total interest-earning assets.
15
NET INTEREST INCOME
Net interest income for the first nine months of the year was
$54,857,000 in 2004, a decrease of 2% from $56,185,000 in 2003, due to lower
interest rates on loans and investment securities and lower investment
securities balances, offset in part by the effects of loan growth, reduced
interest rates on deposits and borrowings, and lower borrowing balances.
Non-GAAP tax-equivalent net interest income, which takes into account the
benefit of tax advantaged investment securities, also decreased by 2%, to
$60,916,000 in 2004 from $62,188,000 in 2003. The average balances, yields and
rates are presented in table 4.
For the first nine months, total interest income decreased by
$4,404,000 or 5% in 2004, compared to 2003. On a non-GAAP tax-equivalent basis,
interest income also decreased by 5%. Average earning assets rose by 2% over the
prior period, to $2,229,621,000 from $2,188,796,000, while the average yield
earned on those assets decreased by 37 basis points to 5.19%. Comparing the
first nine months of 2004 versus 2003, average total loans and leases grew by
14% to $1,253,243,000 (56% of average earning assets, versus 50% a year ago),
while recording a 52 basis point decline in average yield to 5.55%. Average
residential real estate loans increased by 19% (reflecting increases in both
mortgage and construction lending); average consumer loans increased by 17%
(attributable primarily to home equity line growth); and average commercial
loans and leases grew by 10% (due to increases in commercial mortgages and other
commercial loans and leases, partially offset by a decline in construction
loans). Over the same period, average total securities decreased by 11% to
$942,167,000 (42% of average earning assets, versus 48% a year ago), while the
average yield earned on those assets also decreased, by 33 basis points to
4.85%.
Interest expense for the first nine months of the year decreased by
$3,076,000 or 11% in 2004, compared to 2003. Average total interest-bearing
liabilities decreased by 1% over the prior year period, while the average rate
paid on these funds also decreased, by 23 basis points to 1.91%. As shown in
Table 4, money market savings deposits, time deposits and long-term borrowings
recorded declines in average rate. These declines were partially offset by
increases in the rates paid on interest-bearing demand deposits, regular savings
deposits and short-term borrowings.
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 allowance represents an estimation made
pursuant to 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
consideration 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
and leases 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 the allowance. 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, as adjusted, by credit category and (2) the specific
allowance for risk-rated credits on an individual or portfolio basis.
The formula allowance that is based upon historical loss factors, as
adjusted, establishes allowances for the major loan and lease categories based
upon adjusted historical loss experience over the prior eight quarters, weighted
so that losses in the most recent quarters have the greatest effect. The factors
used to adjust the historical loss experience address various risk
characteristics of the Company's loan and lease portfolio including (1) trends
in delinquencies and other non-performing loans, (2) changes in the risk profile
related to large loans in the portfolio, (3) changes in the categories of loans
comprising the loan portfolio, (4) concentrations of loans to specific industry
segments, (5) changes in economic conditions on both a local and national level,
(6) changes in the Company's credit administration and loan and lease portfolio
management processes and (7) quality of the Company's credit risk identification
processes.
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 be imminent. 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 potential loss embedded in the individual loan.
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 nonaccrual 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 application of the risk factor alone.
16
The amount of the allowance is reviewed monthly by the senior loan
committee, and reviewed and approved by the Board of Directors quarterly.
There were no provisions for credit losses in the first nine months of
2004 or 2003. The Company experienced net charge-offs (recoveries) during the
first nine months of 2004 and 2003 of $88,000 and ($13,000), respectively.
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 Sandy Spring
Bank, periodically review the credit portfolio and the allowance. Such review
may result in additional provisions based on these third-party judgments of
information available at the time of each examination. During the first nine
months of 2004, there were no changes in estimation methods or assumptions that
affected the allowance methodology. The allowance for credit losses was 1.08% of
total loans and leases at September 30, 2004 and 1.29% at December 31, 2003. The
allowance decreased during the first nine months of 2004 by $88,000 (the amount
of net charge-offs for the period), from $14,880,000 at December 31, 2003, to
$14,792,000 at September 30, 2004. The stability of the allowance reflects the
required reserve computed by the allowance methodology at September 30, 2004,
compared to December 31, 2003. In spite of loan growth, the required reserve
declined due to management's analysis of improving economic trends.
Nonperforming loans and leases decreased by $667,000 to $2,188,000 from
December 31, 2003 to September 30, 2004, while nonperforming assets decreased by
$744,000 to $2,188,000. Expressed as a percentage of total assets, nonperforming
assets decreased to 0.09% at September 30, 2004 from 0.13% at December 31, 2003.
The allowance for credit losses represented 676% of nonperforming loans and
leases at September 30, 2004, compared to coverage of 521% at December 31, 2003.
Significant variation in this coverage ratio may occur from period to period
because the amount of nonperforming 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. Other real estate owned was $0 at September 30,
2004, and $77,000 at December 31, 2003. The balance of impaired loans and leases
was $758,000 at September 30, 2004, with specific reserves against those loans
of $309,000, compared to $336,000 at December 31, 2003, with specific reserves
of $120,000.
17
Table 5 -- Analysis of Credit Risk
(Dollars in thousands)
Activity in the allowance for credit losses is shown below:
Nine Months Ended Twelve Months Ended
September 30, 2004 December 31, 2003
- -------------------------------------------------------------------------------------------------------------------------
Balance, January 1 $14,880 $15,036
Provision for credit losses 0 0
Loan charge-offs:
Residential real estate (34) (148)
Commercial loans and leases (109) (122)
Consumer (152) (87)
------------------------ -------------------------
Total charge-offs (295) (357)
Loan recoveries:
Residential real estate 58 126
Commercial loans and leases 141 63
Consumer 8 12
------------------------ -------------------------
Total recoveries 207 201
------------------------ -------------------------
Net charge-offs (88) (156)
------------------------ -------------------------
Balance, period end $14,792 $14,880
======================== =========================
Net charge-offs to average loans and
leases (annual basis) (0.01)% (0.01)%
Allowance to total loans and leases 1.08% 1.29%
The following table presents nonperforming assets at the dates indicated:
September 30, December 31,
2004 2003
- -------------------------------------------------------------------------------------------------------------------------
Non-accrual loans and leases $ 848 $ 522
Loans and leases 90 days past due 1,340 2,333
------------------------- --------------------------
Total nonperforming loans and leases* 2,188 2,855
Other real estate owned 0 77
------------------------- --------------------------
Total nonperforming assets $2,188 $2,932
========================= ==========================
Nonperforming assets to total assets 0.09% 0.13%
- --------------------------------------------------------------------------------
* Those performing credits considered potential problem credits (which the
Company classifies as substandard), as defined and identified by management,
amounted to approximately $8,521,000 at September 30, 2004, compared to
$16,793,000 at December 31, 2003. Although these are credits where known
information about the borrowers' possible credit problems causes management to
have doubts as to their ability to comply with the present repayment terms,
which could result in their reclassification as nonperforming credits in the
future, most are well collateralized and are not believed to present significant
risk of loss.
18
NONINTEREST INCOME AND EXPENSES
Total noninterest income was $23,220,000 for the nine-month period
ended September 30, 2004, a 13% or $3,338,000 decrease from the same period of
2003. This decline was mainly the result of decreases in gains on sales of
mortgage loans (down $2,573,000 or 51%), reflecting lower levels of mortgage
banking activity, securities gains (down $182,000 or 28%), service charges on
deposit accounts (down $413,000 or 7%) and nonrecurring income of $1,077,000
recorded in 2003 from the early termination of a sublease. Partially offsetting
these decreases were increases in trust department income (up $317,000 or 14%),
insurance agency commissions (up $230,000 or 8%) and fees on sales of investment
products (up $71,000 or 4%), reflecting management's desire to both increase and
diversify its sources of noninterest income. Also, other income increased
$551,000 or 16%, due primarily to increases in gains on sales of other real
estate owned and gains on sales of SBA loans.
Total noninterest expenses were $52,866,000 for the nine-month period
ended September 30, 2004, a 7% or $3,382,000 increase from the first nine-months
of 2003. The Company incurs additional costs in order to enter new markets,
provide new services, and support the growth of the Company. Management controls
its operating expenses, however, with the goal of maximizing profitability over
time. Most of the rise in noninterest expenses during the first nine months of
2004 occurred in salaries and employee benefits (up $1,675,000 or 6%),
attributable to a larger staff and merit increases, occupancy expenses (up
$348,000 or 7%) which increased due to an expanded branch network and the
opening of a new operations center, equipment expenses (up $653,000 or 20%) and
other expenses (up $1,065,000 or 15%) which increased mainly as the result of
the accelerated write-off of capitalized underwriting costs associated with the
$35 million in 9.375% subordinated debentures that will be redeemed later this
year. The Company opened a new branch in June 2003 and another in August 2003.
Average full-time equivalent employees increased to 585 during the first nine
months of 2004, from 564 during the like period in 2003, a 4% increase. The
ratio of net income per average full-time-equivalent employee after completion
of the first nine months of the year was $34,000 in 2004 and $45,000 in 2003
(which includes after-tax income from an early termination of a sublease).
INCOME TAXES
The effective tax rate decreased to 20.2% for the nine-month period
ended September 30, 2004, from 24.0% for the prior year period. This decline was
primarily due to an increase in tax-advantaged investment interest income as a
percentage of total income before taxes.
C. RESULTS OF OPERATIONS - THIRD QUARTER 2004 AND 2003
Third quarter net income of $6,417,000 ($0.44 per share-diluted) in
2004 was $1,801,000 or 22% below net income of $8,218,000 ($0.56 per
share-diluted) shown for the same quarter of 2003. Annualized returns on average
equity for these periods were 12.89% in 2004 versus 17.35% in 2003.
Third quarter net interest income was $18,369,000 in 2004, a decrease
of 2% from $18,775,000 in 2003, reflecting a 16 basis point decline in net
interest margin partially offset by a 2% higher volume of average earning
assets. Non-GAAP tax-equivalent net interest income, which takes into account
the benefit of tax advantaged investment securities, decreased by 2%.
There were no third quarter provisions for credit losses in 2004 or
2003. Net recoveries of $48,000 were recorded for the three-month period ended
September 30, 2004, compared to net recoveries of $16,000 for the three-month
period ended September 30, 2003.
Third quarter noninterest income was $7,420,000 in 2004, representing a
15% or $1,331,000 decrease from the same period of 2003. This decrease was
mainly the result of decreases in gains on sales of mortgage loans (down
$1,192,000 or 63%), income from bank owned life insurance (down $252,000 or 29%)
and service charges on deposit accounts (down $141,000 or 7%). Partially
offsetting this decrease, were increases in visa check fees (up $64,000 or 15%),
trust department income (up $57,000 or 8%) and other income (up $118,000 or
10%).
Third quarter noninterest expenses increased 6% or $1,037,000 to
$17,941,000 in 2004 from $16,904,000 in 2003. This increase was mainly the
result of increases in salaries and employee benefits (up $421,000 or 4%),
equipment expenses (up $279,000 or 25%) and other expenses (up $532,000 or 24%).
The third quarter effective tax rate decreased to 18.2%, from the 22.6%
recorded in the third quarter of 2003. This decrease was primarily due to an
increase in tax-advantaged investment interest income as a percentage of total
income before taxes.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Financial Condition - Market Risk and Interest Rate Sensitivity"
in Management's Discussion and Analysis of Financial Condition and Results of
Operations, above, which is incorporated herein by reference. Management has
determined that no additional disclosures are necessary to assess changes in
information about market risk that have occurred since December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, evaluated as of the last day of the period covered by this report, the
effectiveness of the design and operation of the Company's disclosure controls
and procedures, as defined in Rule 13a-15 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 in the Company's internal controls
over financial reporting (as defined in Rule 13a-15 under the Securities Act of
1934) during the quarter ended September 30, 2004, that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
20
PART II - OTHER INFORMATION
Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF
EQUITY SECURITIES
The following table provides information on the Company's purchases of its
common stock during the nine months ended September 30, 2004.
Issuer Purchases of Equity Securities (1)
- -----------------------------------------------------------------------------------------------------------------------------
(c) Total Number of (d) Maximum Number
Shares Purchased as that May Yet Be
Part of Publicly Purchased Under the
(a) Total Number of (b) Average Price Paid Announced Plans or Plans or Programs
Period Shares Purchased per Share Programs (2)(3)
- -----------------------------------------------------------------------------------------------------------------------------
January 2004 0 NA 0 670,904
- -----------------------------------------------------------------------------------------------------------------------------
February 2004 0 NA 0 670,904
- -----------------------------------------------------------------------------------------------------------------------------
March 2004 550 $36.05 550 670,354
- -----------------------------------------------------------------------------------------------------------------------------
April 2004 0 NA 0 670,354
- -----------------------------------------------------------------------------------------------------------------------------
May 2004 0 NA 0 670,354
- -----------------------------------------------------------------------------------------------------------------------------
June 2004 0 NA 0 670,354
- -----------------------------------------------------------------------------------------------------------------------------
July 2004 45,762 $31.29 45,762 624,592
- -----------------------------------------------------------------------------------------------------------------------------
August 2004 0 NA 0 624,592
- -----------------------------------------------------------------------------------------------------------------------------
September 2004 0 NA 0 624,592
- -----------------------------------------------------------------------------------------------------------------------------
(1) Includes purchases of the Company's stock made by or on behalf of the
Company or any affiliated purchasers of the Company as defined in Securities and
Exchange Commission Rule 10b-18.
(2) On March 26, 2003, the Company publicly announced a stock repurchase program
that permits the repurchase of up to 5%, or 726,804 shares, of its outstanding
common stock. The current program replaced a similar plan that expired on March
31, 2003. Repurchases under the program may be made on the open market and in
privately negotiated transactions from time to time until March 31, 2005, or
earlier termination of the program by the Board. The repurchases are made in
connection with shares expected to be issued under the Company's stock option
and benefit plans, as well as for other corporate purposes. In 2003, a total of
55,900 shares were repurchased under the current program and 49,560 shares were
purchased under the previous program.
(3) Indicates the number of shares remaining under the plan at the end of the
indicated month.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit 10(a)* Form of Employment Agreement by and among
Sandy Spring Bancorp, Inc., Sandy Spring
Bank, and R. Louis Caceres
Exhibit10(b)* Form of Employment Agreement by and among
Sandy Spring Bancorp, Inc., Sandy Spring
Bank, and Daniel J. Schrider
Exhibit 31(a) and (b) Rule 13a-14(a) / 15d-14(a) Certifications
Exhibit 32 (a) and (b) 18 U.S.C. Section 1350 Certifications
* Management Contract or Compensatory Plan or Arrangement
(b) Reports on Form 8-K.
On July 15, 2004, the Company furnished, under Item 9 and Item 12,
its news release including results of operations and financial
condition and related information concerning non-GAAP
financial measures for June 30, 2004, and the quarter then
ended.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this quarterly 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
Date: November 5, 2004
By: /S/ PHILIP J. MANTUA
----------------------
Philip J. Mantua
Executive Vice President and Chief Financial Officer
Date: November 5, 2004
22