-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Uy38+WpMwtioU5Yf/JPXnotxqD6G6FdTAxxq0bjJYnIdQ9SXCFEbdKBR0Zq11c0F h6/VoL3LU1oP6Q32cKGutw== 0000891554-99-000629.txt : 19990402 0000891554-99-000629.hdr.sgml : 19990402 ACCESSION NUMBER: 0000891554-99-000629 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MASON DIXON BANCSHARES INC/MD CENTRAL INDEX KEY: 0000879558 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 521764929 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-20516 FILM NUMBER: 99580366 BUSINESS ADDRESS: STREET 1: 45 WEST MAIN ST CITY: WESTMINSTER STATE: MD ZIP: 21157 BUSINESS PHONE: 4108573401 MAIL ADDRESS: STREET 1: 45 WEST MAIN STREET CITY: WESTMINSTER STATE: MD ZIP: 21157 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K 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: 0-20516 MASON-DIXON BANCSHARES, INC. (Exact name of Registrant as specified in its charter) Maryland 52-1764929 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Registrant's telephone number including area code: 410-857-3401 Securities registered pursuant to section 12(b) of the Act: None Securities registered pursuant to section 12(g) of the Act: Common Stock, Par Value $1.00 per share (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No __ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. |X| The aggregate market value of the voting stock held by non-affiliates of the Registrant as of March 1, 1999 was $222,126,935. As of March 1, 1999 Mason-Dixon Bancshares, Inc. had 5,075,721 shares of common stock outstanding with a par value of $1.00. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Mason-Dixon Bancshares, Inc. Annual Report to Stockholders for the year ended December 31, 1998 are incorporated by reference into Parts II and IV. Table of Contents: Page - ------------------ ---- Part I - Business 3-8 Distribution of Assets, Liabilities and Stockholders' Equity 9 Interest Rates and Interest Differential 10 Investment Portfolio 11 Loan Portfolio 12 Non-Performing Loans 13 Summary of Loss Experience 13 Allocation of Allowance for Credit Losses 14 Rate Sensitivity Analysis 15 Deposits 16 Short-Term Borrowings 17 Return on Equity and Assets 18 Properties 19-21 Legal Proceedings 22 Submission of Matters to Vote of Securities Holders 22 Executive Officers 22 Part II 23 Part III -Directors and Executive Officers 24-25 Executive Compensation 26-32 Security Ownership of Certain Beneficial Owners and Management 33-35 Certain Relationships and Related Transactions 35 Part IV and Index of Exhibits 36-37 Signatures 38 2 Part I Item 1. Business General Mason-Dixon Bancshares, Inc. ("Mason-Dixon") is a registered bank holding company which was incorporated in 1991 in the State of Maryland. Mason-Dixon is a legal entity, separate and distinct from its principal operating subsidiaries, Carroll County Bank and Trust Company ("Carroll County Bank"), Bank of Maryland, Rose Shanis Financial Services, LLC ("Rose Shanis") and Bay Insurance, LLC. Mason-Dixon's major activity since its inception has been to provide advisory services and coordinate the general policies of its subsidiaries. Rose Shanis and Bay Insurance, LLC were acquired in February 1998 in an all cash acquisition for $15.4 million. The acquisition was accounted for using the purchase method of accounting; therefore, the results of operations were included in the consolidated statement of income from the date of the acquisition. Assets and liabilities of Rose Shanis and Bay Insurance, LLC were adjusted to market value as of the date of acquisition and included in the consolidated balance sheet subsequent to the acquisition. Carroll County Bank and Trust Company The parent company's principal subsidiary is Carroll County Bank, which accounts for approximately 70% of Mason-Dixon's consolidated assets at December 31, 1998. Carroll County Bank, a Maryland state-chartered bank since 1962, is a commercial bank and trust company with eleven (11) offices in Carroll County, Maryland, and one banking office in Howard County, Maryland. Carroll County Bank operates two wholly-owned subsidiaries; Carrollco Insurance, Inc. and Skylight Investment Corporation. Carrollco Insurance, Inc., headquartered in Manchester, Maryland, is an insurance agency primarily engaged in the sale of annuities. At December 31, 1998, Carrollco Insurance, Inc. had total assets of $255 thousand. Skylight Investment Corporation, headquartered in Wilmington, Delaware, is an investment company whose sole activity is to manage and maintain the passive investments of its parent. Skylight Investment Corporation had total assets of $107 million at December 31, 1998. At December 31, 1998, Carroll County Bank employed 323 individuals. Full-time equivalent employees were 296 as of year end. Bank of Maryland Bank of Maryland, acquired in 1995, accounts for approximately 26% of Mason-Dixon's consolidated assets at December 31, 1998. Bank of Maryland was chartered as a Maryland state bank in 1990. It is a commercial bank with nine (9) offices located throughout central Maryland. In June 1998, Bank of Maryland sold five of its branches located on Maryland's Eastern Shore as part of a strategy to concentrate on deeper penetration into its core market, Central Maryland. The sale of the branches included $87 million of deposits and $58 million in loans. To further the strategy of Central Maryland market penetration, Bank of Maryland opened two branches in the fourth quarter of 1998 in Baltimore City and Reisterstown (Baltimore County). Additionally, through the acquisition of Sterling Bank and Trust Co. (see recent developments), branches in Timonium (Baltimore County) and Annapolis (Anne Arundel County) were added. At December 31, 1998, Bank of Maryland employed 87 individuals. Full-time equivalent employees were 86 as of year end. Rose Shanis and Bay Insurance The business conducted by Rose Shanis was established 66 years ago in Baltimore by Rose Shanis Glick; the business was family owned and managed until acquired by Mason-Dixon. Rose Shanis established a reputation as a successful and dependable personal lender servicing second and even third generations of borrowers. Rose Shanis' business is conducted through twelve (12) branches located in the greater Baltimore area and in Annapolis, Bel Air, and Easton, Maryland. Bay Insurance, LLC is engaged in the business of selling insurance products that are directly 3 related to extensions of credit by Rose Shanis. The acquisition of the Rose Shanis business furthered Mason-Dixon's strategy to expand its business by acquiring banks and other financial service providers in its market area and to provide a range of financial services offering the opportunity for larger net interest margins and a broader customer base. Rose Shanis and Bay Insurance, LLC comprise approximately 4% of Mason-Dixon's consolidated total assets at December 31, 1998, and employed 87 employees, 84 on a full-time equivalent basis. Services Offered Through its bank subsidiaries, Mason-Dixon engages in commercial and consumer lending, depository business, and trust business, including the receiving of demand and time deposits and the making of loans to individuals, associations, partnerships, and corporations. Real estate financing comprises residential first and second mortgages, construction and land development, home equity lines of credit, and commercial mortgages. Consumer lending is direct to individuals on both a secured and unsecured basis. Commercial loans include lines of credit and term and demand loans for the purchase of equipment, inventory, and accounts receivable financing. Mason-Dixon offers traditional demand deposit accounts for individuals, associations, partnerships, governments, and corporations. Also offered are NOW, savings, and money market accounts, as well as certificates of deposit and Individual Retirement Accounts. Deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). Carroll County Bank provides 24-hour access to customer information through its XpressLine automated voice response system, and both bank subsidiaries currently operate 24-hour automated teller machines. Safe deposit facilities are available at most locations, as are after hour depository services. Customers may also obtain travelers checks, money orders, and cashier's and treasurer's checks at all locations. Additionally, bank subsidiaries provide a full range of trust services to individuals, corporations, and non-profit organizations under the name of Mason-Dixon Trust Company, which is a division of Carroll County Bank. Services to individuals include investment management, living and testamentary trusts, estate management, and custody of securities. Corporate financial services and employee benefit plans are provided to businesses. Services provided to non-profit organizations include management of endowment trusts. Bank subsidiaries also originate and service real estate mortgage and construction loans as a principal and as an agent under the name of Mason-Dixon Bancshares Mortgage Company (also a division of Carroll County Bank). The bank subsidiaries are not dependent upon a single customer or small group of customers, the loss of which would have a material adverse effect on Mason-Dixon. Carroll County Bank and Bank of Maryland are not dependent on a single product or small number of products, and do not experience any significant fluctuations in loan or deposit activity which are seasonal in nature. Rose Shanis offers consumer loans, sales finance, second mortgage loans, and various related products through two main lines of business: the purchase of credit sales contracts, and lending cash to consumers directly through its branches. The credit sale contracts represent financed sales of a range of products including health club memberships, household furniture and appliances, used automobiles and boats. These contracts are purchased through a wide variety of consumer dealers, both national and local, with which Rose Shanis has relationships. Sales from furniture and automobile dealers are the primary sources of the Rose Shanis installment sales portfolio. Credit sale contracts have a maximum term of 60 months, and in some cases, a dealer reserve is held to cover potentially doubtful accounts. The contracts either include pre-computed finance charges or are interest-bearing. Rose Shanis and Bay Insurance, LLC also offer credit related insurance products. Bay Insurance, LLC sells single and joint credit life insurance, single accident and health insurance, involuntary unemployment insurance, and Vendors Single Interest Automobile insurance. Each Rose Shanis branch has at least one licensed employee to sell insurance products. 4 Rose Shanis and Bay Insurance, LLC are not dependent upon a single customer or small group of customers, the loss of which would have a material adverse effect on Mason-Dixon. Rose Shanis and Bay Insurance are not dependent on a single product or small number of products, and do not experience any significant fluctuations in loan or deposit activity which are seasonal in nature. Competition and Other Market Factors The banking and financial service businesses are intensely competitive. Mason-Dixon competes with other commercial banks, savings banks, thrift institutions, credit unions, finance companies, mutual funds, insurance companies, mortgage companies, and brokerage and investment banking firms located in Maryland and elsewhere. Carroll County Bank's primary market is Carroll County, Maryland, which is served by all of the various financial service companies listed above. Its predominant commercial banking competitors are locally owned community banks, followed by regional banks. Through its eleven (11) offices in Carroll County, Carroll County Bank services the financial needs of communities throughout its market. It serves primarily small to medium size businesses and the financial needs of individuals. Carroll County Bank's market share (as measured by the percentage of insured deposits held in its primary market) has consistently approximated 25% for the last several years. It is by far the market leader, having nearly twice the market share of its nearest competitor. In order to maintain this market share, Carroll County Bank relies on a high level of responsible, personalized service, and affordable technology enhancements to keep up with customer needs for information and services around the clock. Advertising consists of television, radio, print media, and direct mail solicitations which emphasize specific product promotions, community orientation, and convenience. Bank of Maryland's primary market is central Maryland, where it mainly serves the needs of small and medium sized businesses and professional organizations. Its predominant competitors are large regional banks, which are able to finance extensive advertising campaigns, make large commercial loans, and allocate their assets among investments of the highest yield in geographic areas with the greatest demand. Many of these major commercial banks offer services which are not directly offered by Bank of Maryland. In order to compete with the other financial institutions in its primary service areas, Bank of Maryland relies upon personal contacts by officers, directors, Boards of Advisors, and employees, as well as extended hours and highly personalized services. Bank of Maryland's promotional activities emphasize the advantages of dealing with a locally headquartered bank attuned to the particular needs of the community. The consumer finance business is also highly competitive. Rose Shanis competes with many larger national finance companies, many of which have greater resources. The profitability of Rose Shanis depends on its continued ability to maintain its personalized business and quality service in its local market areas, and to preserve its relationships with the third party dealer network that indirectly sources prospective Rose Shanis borrowers. Consumer finance companies differ from banks in several respects. Due to the nature of lending to individuals with limited or impaired credit histories, delinquencies and write-off levels are generally higher than those experienced in the banking industry. In addition, consumer finance companies typically place a lesser reliance on collateral as a repayment source. To mitigate these characteristics, rates charged on loans by consumer finance companies are typically higher than rates charged by banks, which results in higher interest income to compensate for increased risk. Supervision and Regulation Bank holding companies and their subsidiaries operate in a highly regulated environment and are subject to the supervision and examination by several federal and state regulatory agencies. Mason-Dixon, as a bank holding company, is subject to supervision and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended (the "BHCA"). In general, the BHCA and regulations promulgated by the Federal Reserve Board limit the business of bank holding companies to owning or controlling banks and engaging in such other activities as the Federal Reserve Board may determine to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. With certain exceptions, the BHCA prohibits bank holding companies from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares in any company, 5 including any bank, without the prior approval of the Federal Reserve Board. Mason-Dixon's two-bank subsidiaries are Maryland state-chartered banks regulated by the Division of Financial Regulation and the Federal Deposit Insurance Corporation (the "FDIC"). Various consumer laws and regulations also affect the operations of the subsidiaries. The banks are also members of the Federal Home Loan Bank of Atlanta ("FHLB") and are subject to regulation thereby. Consumer finance companies and insurance agencies operate in a highly regulated environment and are subject to supervision and examination by several federal and state agencies. Rose Shanis is subject to regulation by the Maryland Commissioner of Financial Regulation and Bay Insurance, LLC is subject to and supervision by the Maryland Insurance Administration. Federal and state laws and regulations govern matters ranging from permissible lending activities, reserves, permissible types, amounts and terms of loans, the maximum rate of interest that may be charged, and comprehensive disclosure obligations. These and other restrictions limit the manner in which the consumer finance subsidiaries conduct their business. Holding Company Structure Under Federal Reserve Board 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 Federal Reserve Board may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. Any capital loans by a holding company to its subsidiary bank would be subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In addition, under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), depository institutions insured by the FDIC can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. Accordingly, if an insured subsidiary of Mason-Dixon causes a loss to the FDIC, other insured subsidiaries of Mason-Dixon could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss. Capital Requirements Bank holding companies are required to comply with risk-based capital guidelines established by the Federal Reserve Board. The guidelines establish a framework that is intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and to take off-balance sheet exposures into explicit account in assessing capital adequacy. The risk-based ratios are determined by allocating assets and specified off-balance sheet commitments into four risk-weight categories, with higher levels of capital being required for categories perceived as representing greater risk. Generally, under the applicable guidelines, a banking organization's capital is divided into two tiers. "Tier 1", or core capital, includes common equity, perpetual preferred stock (excluding auction rate issues), and minority interests 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. "Total capital" is the sum of Tier 1 and Tier 2 capital. The Tier 1 component must comprise at least 50% of qualifying total capital. Banking organizations that are subject to the 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 an organization's particular circumstances warrant. The Federal Reserve Board and the FDIC have also adopted leverage capital guidelines to which Mason-Dixon and its bank subsidiaries are subject. The guidelines provide for a minimum leverage ratio (Tier 1 capital to adjusted total average assets) of 3% for financial institutions that have the highest regulatory examination ratings 6 and are not experiencing or anticipating significant growth. Financial institutions not meeting these criteria are required to maintain leverage ratios of at least one to two percentage points higher. 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", as applicable to undercapitalized institutions. The following table sets forth the capital ratios of Mason-Dixon and its bank subsidiaries as of December 31, 1998:
Carroll County Bank of Regulatory Mason-Dixon Bank & Trust Maryland Minimum ----------- -------------- -------- ---------- Tier 1 risk-based capital ratio 14.99% 12.04% 11.44% 4.00% Total risk-based capital ratio 18.30% 12.75% 12.69% 8.00% Leverage ratio 8.87% 6.39% 7.84% 3.00%
Based upon the foregoing capital ratios, Mason-Dixon and its bank subsidiaries are considered "well capitalized" within the meaning of the regulations adopted by the Federal Reserve Board and the FDIC. 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) a recapitalization of the Bank Insurance Fund of the FDIC (the "BIF") by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; and (v) 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. 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". A depository institution is "well capitalized" if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater, and (iv) is not subject to any order, regulatory agreement, or written directive to meet and maintain a specific capital level for any capital measure. An "adequately capitalized" institution is defined as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater, and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with a composite regulatory rating of 1). 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 7 submit capital restoration plans. For a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee (subject to certain limitations) that the institution will comply with such capital restoration plan. Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized and requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized 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. Effects of Monetary Policy Mason-Dixon and its bank subsidiaries are affected by the ongoing and changing monetary policy set forth by the Federal Reserve Board. Through its powers, the Federal Reserve Board can influence the supply of bank credit to affect the level of economic activity. Changes in the discount rate and reserve requirements are among the instruments used to influence the market. The monetary policies of the Federal Reserve have in the past and will in the future affect the operating results of financial institutions, including Mason-Dixon and its bank subsidiaries. Recent Developments On January 5, 1999, Mason-Dixon acquired Sterling Bancorp, a privately held bank holding company headquartered in Baltimore, Maryland. Sterling Bank & Trust Co. ("Sterling"), Sterling Bancorp's principal subsidiary was merged into Bank of Maryland on February 12, 1999. The acquisition added banking branches in Timonium (Baltimore County) and Annapolis (Anne Arundel County). Two existing branches of Sterling, Baltimore City and Pikesville, were closed as existing branches of Bank of Maryland were nearby to service Sterlings customers. At the date of acquisition, Sterling Bancorp had total assets of approximately $74 million and deposits of $67 million. Mason-Dixon paid $10.294 million in cash for Sterling Bancorp. The acquisition was accounted for using the purchase method of accounting. On January 27, 1999, Mason-Dixon entered into an Agreement and Plan of Reorganization with BB&T Corporation ("BB&T") of Winston-Salem, North Carolina. The agreement allows for the acquisition of Mason-Dixon by BB&T. The terms of the agreement call for stockholders of Mason-Dixon to receive 1.3 shares of BB&T common stock for each common share of Mason-Dixon. The acquisition will be structured as a tax-free exchange and accounted for as a pooling-of-interests. The transaction is subject to various regulatory approvals and approval by Mason-Dixon stockholders. In conjunction with the agreement, Mason-Dixon entered into a Stock Option Agreement which grants BB&T the option to purchase up to 1,006,868 common shares of Mason-Dixon at a price per share of $40.00. Under the conditions of the Agreement and Plan of Reorganization, Mason-Dixon is not permitted to issue any new shares of common stock other than those shares which can be exercised under option agreements and conversion of any unexchanged shares relating to the Bank of Maryland acquisition shares without prior written consent of BB&T. Additionally, Mason-Dixon may not issue any new debt, enter into any long-term contracts, or operate outside its normal course of business without written consent from BB&T. 8 Distribution of Assets, Liabilities, and Stockholders' Equity The following table sets forth the amounts of Mason-Dixon's daily average assets, liabilities, and stockholders' equity for the period indicated, the amounts of interest earned and the interest paid thereon, the average interest rate earned for each type of earning asset and the average rate paid for each type of interest bearing liability. Interest earned on non-accruing loans is included in the interest earned only when collected. The average balances on non-accruing loans are included in the average balances on loans. Interest income is presented on a tax equivalent basis using the statutory Federal and state income tax rates. A significant portion of securities are exempt for state income tax purposes and are presented on a tax equivalent basis.
(dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------------- Earning assets Loans $ 482,300 $ 48,812 10.12% $ 432,581 $ 39,175 9.06% Interest bearing deposits in banks 6,228 368 5.91% 634 23 3.63% Federal funds sold 21,821 1,185 5.43% 19,725 1,110 5.63% Investments: Mortgage-backed securities(1) 251,388 16,936 6.74% 249,611 17,579 7.04% U.S. Government(2) 135,173 8,934 6.61% 69,053 4,543 6.58% Other securities(3) 27,813 2,044 7.35% 11,202 913 8.15% State and municipal(4) 84,603 7,017 8.29% 81,902 6,833 8.34% ------------------------------------------------------------------------------------------ Total earning assets 1,009,326 85,296 8.45% 864,708 70,176 8.12% ----------- ----------- Non-interest earning assets Cash and due from banks 18,803 20,294 Premises and equipment 15,171 15,427 Other assets 28,297 24,688 Allowance for credit losses (8,550) (5,320) ----------- ----------- Total assets $ 1,063,047 $ 919,797 =========== =========== Interest bearing liabilities Demand deposits $ 58,315 1,166 2.00% $ 58,169 1,336 2.30% Savings deposits 174,830 5,158 2.95% 184,972 5,964 3.22% Time deposits 317,714 17,841 5.62% 302,205 16,898 5.59% Borrowings 332,649 20,026 6.02% 204,608 11,977 5.85% ------------------------------------------------------------------------------------------ Total interest bearing liabilities 883,508 44,191 5.00% 749,954 36,175 4.82% ----------- ----------- Non-interest bearing liabilities Demand deposits 90,666 89,488 Other 10,621 7,858 Stockholders' equity 78,252 72,497 ----------- ----------- Total liabilities and stockholders' equity $ 1,063,047 $ 919,797 =========== =========== Net interest spread $ 41,105 3.45% $ 34,001 3.30% =========== =========== Net interest margin 4.07 3.93 (dollars in thousands) 1996 - ----------------------------------------------------------------------------------- Average Yield/ Balance Interest Rate - ----------------------------------------------------------------------------------- Earning assets Loans $ 365,778 $ 34,122 9.33% Interest bearing deposits in banks 210 16 7.62% Federal funds sold 21,826 1,176 5.39% Investments: Mortgage-backed securities (1) 221,624 15,315 6.91% U.S. Government(2) 61,575 4,128 6.70% Other securities(3) 4,929 357 7.24% State and municipal(4) 72,394 6,029 8.33% -------------------------------------- Total earning assets 748,336 61,143 8.17% --------- Non-interest earning assets Cash and due from banks 19,701 Premises and equipment 15,552 Other assets 26,313 Allowance for credit losses (4,827) --------- Total assets $ 805,075 ========= Interest bearing liabilities Demand deposits $ 58,676 1,514 2.58% Savings deposits 182,857 5,628 3.08% Time deposits 286,557 15,860 5.53% Borrowings 115,919 6,242 5.38% -------------------------------------- Total interest bearing liabilities 644,009 29,244 4.54% --------- Non-interest bearing liabilities Demand deposits 83,825 Other 8,471 Stockholders' equity 68,770 --------- Total liabilities and stockholders' equity $ 805,075 ========= Net interest spread $ 31,899 3.63% ========= Net interest margin 4.26%
- ---------- (1) Interest income includes tax equivalent adjustments of $194,000 for 1998, $164,000 for 1997, and $165,000 for 1996. (2) Interest income includes tax equivalent adjustments of $589,000 for 1998, $190,000 for 1997, and $132,000 for 1996. (3) Interest income includes tax equivalent adjustments of $62,000 for 1998, $61,000 for 1997, and $0 for 1996. (4) Interest income includes tax equivalent adjustments of $2,385,000 for 1998, $2,326,000 for 1997, and $2,050,000 for 1996. 9 Interest Rates and Interest Differential The following table sets forth for the periods indicated a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates.
(dollars in thousands) 1998 compared to 1997 1997 compared to 1996 - ----------------------------------------------------------------------------------------------------------------- Increase Increase (decrease) (decrease) due to due to ---------------------------------- ---------------------------------- Volume Rate Total Volume Rate Total - ----------------------------------------------------------------------------------------------------------------- Interest income Loans $ 4,503 $ 5,134 $ 9,637 $ 6,232 $ (1,179) $ 5,053 Investments: Mortgage-backed securities(1) 125 (768) (643) 1,934 330 2,264 U.S. Government 4,350 41 4,391 501 (86) 415 Other securities 1,354 (223) 1,131 454 102 556 State and municipal 226 (42) 184 792 12 804 Other earning assets 321 99 420 (81) 22 (59) ---------------------------------- ---------------------------------- Total interest income 10,879 4,241 15,120 9,832 (799) 9,033 Interest expense Interest bearing demand deposits 3 (173) (170) (13) (165) (178) Savings deposits (327) (479) (806) 65 271 336 Time deposits 867 76 943 866 172 1,038 Borrowings 7,495 554 8,049 4,776 959 5,735 ---------------------------------- ---------------------------------- Total interest expense 8,038 (22) 8,016 5,694 1,237 6,931 ---------------------------------- ---------------------------------- Net interest income $ 2,841 $ 4,263 $ 7,104 $ 4,138 $ (2,036) $ 2,102 ================================== ==================================
10 Investment Portfolio The following table sets forth the composition of investment securities at the dates indicated:
December 31 1998 1997 1996 -------------------- ---------------------- --------------------- Available Held To Available Held To Available Held To (dollars in thousands) For Sale Maturity For Sale Maturity For Sale Maturity -------------------- ---------------------- --------------------- U.S. Treasury and other U.S. Government agencies and corporations $139,693 $ 26,292 $ 50,318 $ 40,447 $ 9,563 $ 45,068 Mortgage-backed securities 221,615 52,269 186,947 77,793 150,829 70,106 State and political subdivisions -- 99,885 -- 84,490 -- 78,070 Other debt securities -- 6,920 -- -- -- -- Common and preferred stocks 20,204 -- 12,590 1,315 4,895 -- -------- -------- -------- -------- -------- -------- Total Investment Securities $381,512 $185,366 $249,855 $204,045 $165,287 $193,244 ======== ======== ======== ======== ======== ========
There were no state, county, or municipal securities whose book value, as to any issuer, exceeded 10% of stockholders' equity at December 31, 1998, 1997, or 1996. The following schedule sets forth the maturities of investment securities at December 31, 1998 and the weighted average yields of such securities. Yields of tax-exempt securities have been computed on a tax equivalent basis using statutory Federal and state income tax rates. Available for sale securities yields are based on fair value; held to maturity yields are based on amortized cost. Mortgage-backed securities are grouped by final maturity.
(dollars in thousands) Maturity Distribution - Available For Sale Portfolio ----------------------------------------------------------------------------------------------------- Within After One But After Five But After One Year Within Five Years Within Ten Years Ten Years --------------------- --------------------- ------------------------ ------------------------ Amount Yield Amount Yield Amount Yield Amount Yield --------------------- --------------------- ------------------------ ------------------------ U.S. Treasury and other U.S. Government agencies $ 5,315 5.58% $ 24,039 6.12% $110,339 6.83% $ -- -- State and political subdivisions -- -- -- -- -- -- -- -- Mortgage-backed securities -- -- -- -- 4,254 5.79% 217,361 6.67% Equity securities 19,233 6.87% -- -- -- -- 971 8.65% -------- -------- -------- -------- At Fair Value $ 24,548 6.59% $ 24,039 6.12% $114,593 6.80% $218,332 6.68% -------- -------- -------- -------- At Amortized Cost $ 24,802 $ 23,653 $114,081 $216,053 -------- -------- -------- --------
(dollars in thousands) Maturity Distribution - Held to Maturity Portfolio ----------------------------------------------------------------------------------------------------- Within After One But After Five But After One Year Within Five Years Within Ten Years Ten Years --------------------- --------------------- ------------------------ ------------------------ Amount Yield Amount Yield Amount Yield Amount Yield --------------------- --------------------- ------------------------ ------------------------ U.S. Treasury and other U.S. Government agencies $ 5,015 7.00% $ 8,994 6.73% $ 12,283 6.80% $ -- -- State and political subdivisions 2,300 9.28% 4,551 9.18% 28,808 8.20% 64,226 7.83% Mortgage-backed securities -- -- 107 8.71% 3,683 7.96% 48,479 6.13% Other debt securities -- -- -- -- -- -- 6,920 8.27% -------- -------- -------- -------- At Amortized Cost $ 7,315 7.72% $ 13,652 7.56% $ 44,774 7.80% $119,625 7.17% -------- -------- -------- -------- At Fair Value $ 7,368 $ 14,037 $ 45,791 $120,306 -------- -------- -------- --------
11 Loan Portfolio The following table shows Mason-Dixon's loan distribution at the end of each of the last five years:
December 31 (dollars in thousands) 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- Construction and land development $ 41,262 $ 31,427 $ 24,202 $ 17,286 $ 12,543 Residential real estate - mortgage 151,003 186,978 164,656 137,372 100,941 Commercial real estate - mortgage 127,825 136,194 111,724 93,504 56,280 Commercial 87,166 88,669 77,579 88,531 15,447 Consumer 55,303 17,464 20,575 17,399 11,249 --------- --------- --------- --------- --------- Total Loans 462,559 460,732 398,736 354,092 196,460 Unearned income on loans (2) (341) (572) (1,142) (948) --------- --------- --------- --------- --------- Loans (net of unearned income) $ 462,557 $ 460,391 $ 398,164 $ 352,950 $ 195,512 ========= ========= ========= ========= =========
The following table shows the amounts of loans outstanding as of December 31, 1998 which, based on the remaining scheduled repayments of principal, are due in the periods indicated. Also included is the sensitivity of loans to interest rate fluctuations at December 31, 1998 for loans due after one year.
Within After 1 But After (dollars in thousands) 1 Year Within 5 Yrs 5 Yrs Total ------ ------------ ----- ----- Construction and land development $ 13,476 $ 23,183 $ 4,603 $ 41,262 Commercial 25,203 25,551 36,412 87,166 -------- -------- -------- -------- Total 38,679 48,734 41,015 128,428
Sensitivity of loans due after one year to changes in interest rates: Loans at predetermined interest rates $ 58,124 Loans at floating or adjustable rates 31,625 -------- Total $ 89,749 12 Risk Elements Non-Performing Loans The following table presents information concerning the aggregate amount of risk elements for the past five years. Risk elements comprise 1) loans accounted for on a non-accrual basis, 2) loans contractually past due ninety days or more as to interest or principal payments, and 3) foreclosed property.
(dollars in thousands) December 31, 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- Loans accounted for on a non-accrual basis $ 6,018 $ 3,189 $ 2,821 $ 1,560 $ 211 Accruing loans past due 90 days or more 60 597 214 277 62 Restructured loans 826 221 214 -- -- -------- -------- -------- -------- -------- Total nonperforming loans 6,904 4,007 3,249 1,837 273 Foreclosed property 191 488 304 250 -- -------- -------- -------- -------- -------- Total nonperforming assets $ 7,095 $ 4,495 $ 3,553 $ 2,087 $ 273 Nonperforming loans to year-end loans 1.49% 0.87% 0.82% 0.52% 0.14% Nonperforming assets to year-end loans and foreclosed property 1.53% 0.98% 0.89% 0.59% 0.14% Year-end allowance for credit losses times Nonperforming loans 1.29 x 1.31 x 1.59 x 2.57 x 9.62 x Year-end allowance for credit losses times Nonperforming assets 1.25 x 1.16 x 1.45 x 2.27 x 9.62 x Interest income which would have been recognized under original term 278 229 443 220 236 Interest income recognized 95 142 29 93 222
Summary of Loss Experience The following table summarizes Mason-Dixon's loan loss experience for the five years ended December 31:
(dollars in thousands) 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- Daily Average Loans (net of unearned income) $482,300 $432,581 $365,778 $260,511 $194,711 Balance of allowance for credit losses at beginning of the year $ 5,231 $ 5,167 $ 4,729 $ 2,627 $ 2,686 Allowance applicable to loans of purchased company 2,881 -- -- 2,355 -- Loans charged-off: Construction and Land Development -- -- -- -- -- Residential Real Estate - Mortgage 216 73 117 40 78 Commercial Real Estate - Mortgage -- 33 106 -- -- Commercial 167 197 336 314 25 Consumer 3,092 274 177 56 132 -------- -------- -------- -------- -------- Total charged-offs 3,475 577 736 410 235 Recoveries of loans previously charged-off: Construction and Land Development -- -- -- -- -- Residential Real Estate - Mortgage 3 2 4 7 2 Commercial Real Estate - Mortgage -- 27 116 -- -- Commercial 134 343 144 43 1 Consumer 442 131 74 107 173 -------- -------- -------- -------- -------- Total recoveries 579 503 338 157 176 Net loans charged-off 2,896 74 398 253 59 Additions to allowance charged to expense 3,677 138 836 -- -- Balance of allowance for credit losses at end of the year $ 8,893 $ 5,231 $ 5,167 $ 4,729 $ 2,627 Ratio of net charge-offs during period to average loans outstanding 0.60% 0.02% 0.11% 0.10% 0.03%
13 Allocation of Allowance for Credit Losses The allowance for credit losses is based on management's evaluation of historical and anticipated net charge-offs, analysis of non-performing loans, prevailing and anticipated economic conditions, and bank industry standards. In the opinion of management, the allowance is considered adequate based upon its evaluation of the various factors affecting the collectability of loans. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The allocations do not necessarily reflect the expected future charge-offs applicable to each category.
December 31 (dollars in thousands) 1998 1997 1996 1995 1994 --------------- -------------- ---------------- -------------- --------------- As a As a As a As a As a % of % of % of % of % of Reserve Loans Reserve Loans Reserve Loans Reserve Loans Reserve Loans Construction and Land Development, Commercial Real Estate - Mortgage, and Commercial(1) $2,953 55% $3,189 56% $4,062 54% $3,353 56% $1,866 43% Residential Real Estate - Mortgage 727 33% 527 40% 553 41% 857 39% 242 51% Consumer 3,105 12% 251 4% 133 5% 193 5% 293 6% Not Allocated 2,108 N/A 1,264 N/A 419 N/A 326 N/A 226 N/A -------------- --------------- --------------- --------------- --------------- Total Allowance for Credit Losses $8,893 100% $5,231 100% $5,167 100% $4,729 100% $2,627 100% -------------- --------------- --------------- --------------- ---------------
- ---------- (1) These categories have been consolidated and the reserve amount is based on a detailed analysis of the estimated credit risk for these loan types. The reserve amount is established by evaluating various factors including current economic conditions, the financial condition of the borrower, and the risk elements which may pertain to certain types of loans. 14 Rate Sensitivity Analysis
December 31, 1998 After 3 After 1 Non- Months- Year- Interest Within Within Within After Sensitive (dollars in thousands) 3 Months 1 Year 5 Years 5 Years Funds Total -------------------------------------------------------------------------------------- Assets Federal funds sold $ 2,363 $ -- $ -- $ -- $ -- $ 2,363 Interest bearing deposits in banks 638 -- -- -- -- 638 Investment securities 101,482 99,957 265,821 99,618 -- 566,878 Loans (including loans held for sale) 175,120 52,588 194,444 48,050 -- 470,202 Interest sensitivity hedges on assets 15,000 -- (5,000) (10,000) -- -- Non-interest earning assets -- -- -- -- 62,161 62,161 -------------------------------------------------------------------------------------- Total Assets $ 294,603 $ 152,545 $ 455,265 $ 137,668 $ 62,161 $1,102,242 ----------------------------------------------------------------------------========== Liabilities and Stockholders' Equity Interest bearing deposits $ 71,499 $ 205,888 $ 242,629 $ 25,387 $ -- $ 545,403 Short-term borrowings 41,816 -- -- -- -- 41,816 Long-term borrowings 142,885 52,143 73,285 60,034 -- 328,347 Interest sensitivity hedges on liabilities (22,000) -- 22,000 -- -- -- Non-interest bearing liabilities and stockholders' equity -- -- -- -- 186,676 186,676 -------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 234,200 $ 258,031 $ 337,914 $ 85,421 $ 186,676 $1,102,242 ----------------------------------------------------------------------------========== Interest rate sensitivity gap $ 60,403 $ (105,486) $ 117,351 $ 52,247 $ (124,515) Cumulative interest rate sensitivity gap 60,403 (45,083) 72,268 124,515 -- Cumulative ratio of interest sensitive assets to interest sensitive liabilities 1.26 0.91 1.09 1.14 1.00
Assumptions: The rate sensitivity analysis provided in the preceding table indicates the sensitivity to fluctuations in interest rates by analyzing maturity and repricing information for selected categories of assets and liabilities. Other rate sensitive assets, consisting of Federal funds sold and interest bearing deposits in banks, are assigned to an immediately repricable category, as these are overnight investments. Mortgage-backed investments are categorized based on the estimated amortization of these securities using recent prepayment histories. Fixed rate, noncallable investments are grouped by final maturity date. Fixed rate callable investments are grouped based on management's estimates of call probability. Variable rate investments are categorized according to the next available repricing opportunity. Fixed rate loans are grouped in the appropriate category based on normal scheduled amortization. Variable rate loans are categorized based on the next available repricing opportunity. Interest bearing deposits without a contractual maturity are estimated based on management's estimates of deposit withdrawals. Interest bearing deposits with contractual maturities are categorized based on the effective maturity of the deposit. Long-term borrowings with call provisions are grouped based on management's estimates of call probability. 15 Deposits The following schedule presents daily average amounts of deposits by type: (dollars in thousands) December 31, 1998 1997 1996 -------- ------------ -------- Non-interest bearing demand deposits $ 90,666 $ 89,488 $ 83,825 Interest bearing demand deposits 58,315 58,169 58,676 Savings deposits 174,830 184,972 182,857 Time deposits 317,714 302,205 286,557 ======== ======== ======== Total Deposits $641,525 $634,834 $611,915 ======== ======== ======== The following schedule presents daily average rates paid on deposits by type: (dollars in thousands) December 31, 1998 1997 1996 -------- ------------ -------- Non-interest bearing demand deposits -- -- -- Interest bearing demand deposits 2.00% 2.30% 2.58% Savings deposits 2.95% 3.22% 3.08% Time deposits 5.62% 5.59% 5.53% ---- ---- ---- Total Deposits 4.39% 4.44% 4.36% ---- ---- ---- At December 31, the maturity distribution for time deposits issued in amounts of $100,000 or more was: (dollars in thousands) 3 months or less $17,306 Over 3 months through 6 months 1,534 Over 6 months through 12 months 20,152 Over 12 months 11,909 ------- Total $50,901 ======= 16 Short-Term Borrowings Short-term borrowings were as follows: (dollars in thousands) December 31 1998 1997 1996 -------- -------- -------- Average amount outstanding during year $ 68,729 $ 87,173 $ 45,823 Weighted average interest rate during year 5.50% 5.60% 5.48% Amount outstanding at year end $ 41,816 $ 97,203 $ 53,734 Weighted average interest rate at year end 4.70% 5.73% 5.42% Maximum amount at any month end $107,529 $119,774 $ 67,607 17 Return on Equity and Assets The following table shows net income as a percent of average stockholders' equity and average total assets, as well as certain other ratios for the periods indicated:
December 31, 1998 1997 1996 ---- ---- ---- Percentage of net income to: Average stockholders' equity 13.82% 12.63% 12.27% Daily average total assets 1.02% 1.00% 1.05% Percentage of tangible net income to: Average tangible stockholders' equity 16.41% 14.51% 14.02% Daily average tangible total assets 1.11% 1.08% 1.12% Percentage of dividends declared per share to net income Per common share 32.85% 35.10% 32.60% Percentage of average stockholders' equity to daily average total assets 7.36% 7.88% 8.54%
18 Item 2: Properties Mason-Dixon Bancshares, Inc. Corporate Office 45 West Main Street Westminster, MD 21157 Carroll County Bank and Trust Company Main Office Finksburg Office * 45 West Main Street 3000 Gamber Road Westminster, MD 21157 Finksburg, MD 21048 Englar Road Office Heartlands Office ** 401 Englar Road 3004 North Ridge Road Westminster, MD 21157 Ellicott City, MD 21043 East Main Street Office Mount Airy Office * 193 East Main Street 1001 Twin Arch Road Westminster, MD 21157 Mt. Airy, MD 21771 Manchester Office Operations Center 3200 Main Street 200 Baltimore Boulevard Manchester, MD 21102 Westminster, MD 21157 Manchester Drive-in 3068 Westminster Street Mason-Dixon Bancshares Manchester, MD 21102 Mortgage Company Eldersburg Office 1643 Liberty Road ** 1300 Liberty Road Suite 202 Sykesville, MD 21784 Eldersburg, MD 21784 Hampstead Office 502 Washington Avenue ** 999 South Main Street 3rd Floor Hampstead, MD 21074 Towson, MD 21204 Melrose Office 309 East Main Street ** 4501 Hanover Pike Suite 100 Manchester, MD 21102 Salisbury, MD 21801 Taneytown Office 4345 Old Taneytown Road Taneytown, MD 21787 * Properties are subject to land leases ** Properties are leased 19 Item 2: Properties (continued) Bank of Maryland Executive Offices ** Parole Office** 502 Washington Avenue Route 2 and MD 665 Towson, MD 21204 Annapolis, MD 21401 B & O Office ** Perry Hall Office ** 2 North Charles Street 9650 Belair Road Baltimore, MD 21202 Perry Hall, MD 21236 Annapolis Office ** Pikesville Office ** 2661 Riva Road 44 E. Sudbrook Lane Annapolis, MD 21401 Baltimore, MD 21208 Cherryvale Plaza Office ** Towson Office ** 11700 Reisterstown Road 600 Washington Avenue Reisterstown, MD 21136 Towson, MD 21204 Harford County Office ** Timonium Office ** 333 Baltimore Pike 2045 York Road Bel Air, MD 21014 Timonium, MD 21093 ** Properties are leased 20 Item 2: Properties (continued) Rose Shanis Financial Services, LLC Executive Offices ** Catonsville Office ** 11419 Cronridge Drive 924 Frederick Road Suite 10 P.O. Box 21197 Owings Mills, MD 21117 Baltimore, MD 21228 Highlandtown Office ** Glen Burnie Office ** 3605 Eastern Avenue 7566 Ritchie Highway P.O. Box 12059 Glen Burnie, MD 21061 Baltimore, MD 21281 Essex Office ** Dundalk Office ** 136 Eastern Boulevard 1713 Poplar Place Baltimore, MD 21221 P.O. Box 21795 Baltimore, MD 21222 Randallstown Office ** 8519 Liberty Road Howard Street Office ** Randallstown, MD 21133 313 North Howard Street P.O. Box 296 Bel Air Office ** Baltimore, MD 21203 136 Office Street Bel Air, MD 21014 Light Street Office ** 1103 Light Street Easton Office ** Baltimore, MD 21230 218 North Washington Street Suite 17 Parkville Office ** Easton, MD 21601 8301 Harford Road Baltimore, MD 21234 Annapolis Office ** 2621 Riva Road P.O. Box 6357 Annapolis, MD 21401 ** Properties are leased Mason-Dixon's subsidiaries lease properties from other parties and, during 1998, incurred rental expense of $1,151,000 on these properties. See Note 6 (Premises and Equipment) of the Consolidated Financial Statements. The premises occupied or leased by Mason-Dixon and its subsidiaries are considered to be well located and suitably equipped to serve as financial services facilities. Neither the location of any particular office nor the unexpired term of any lease is deemed material to Mason-Dixon's business. 21 Item 3: Legal Proceedings Mason-Dixon is a party to litigation related to its business. In the opinion of management, the ultimate liability, if any, resulting from these matters would not have a significant effect on Mason-Dixon's consolidated financial position, results of operations, or liquidity. Item 4: Submission of Matters to a Vote of Securities Holders None Item 4A: Executive Officers Mason-Dixon Bancshares, Inc.:
NAME AGE HIRE DATE CURRENT POSITION - ---- --- --------- ---------------- William B. Dulany 71 April, 1970 Chairman of the Board for the last five years. Thomas K. Ferguson 56 September 13, 1965 President and Chief Executive Officer for the last five years. Michael L. Oster 46 September 2, 1986 President and Chief Executive Officer of Carroll County Bank for the previous two years, held various executive positions for prior three years. Hunter F. Calloway 50 April 8, 1996 President of Bank of Maryland. Senior Vice President of Commercial Lending the past three years. Senior Vice President - Real Estate lending with NationsBank for the prior two years. A. Gary Rever 46 January 28, 1991 President of Mason Dixon Business Services, LLC, a recently formed operations subsidiary. Chief Financial Officer of Bank of Maryland for previous five years. Mark A. Keidel 37 August 17, 1987 Held various accounting positions for Carroll County Bank since 1987 and has been Senior Vice President/Chief Financial Officer for the last four years. Also, Vice President/Chief Financial Officer for Mason-Dixon for the last four years. Gerald G. Alsentzer 51 June 26, 1989 Senior Vice President and Director of the Human Resources Division for the last five years. M. Lee Primm 57 May 13, 1974 Senior Vice President and Director of Retail Operations for Carroll County Bank for the last five years.
22 Part II Item 5: Market for Registrant's Common Stock and Related Stockholders Matters Common Stock Data -- Annual Stockholders Report, page 20, incorporated herein by reference. Limits on Dividends and Other Payments Both federal and state laws impose restrictions on the ability of the bank subsidiaries to pay dividends to Mason-Dixon. In general, bank regulatory agencies have the ability to prohibit proposed dividends by a bank if the regulatory body determines that such distribution would constitute an unsafe or unsound practice. For a Maryland state-chartered bank, dividends may be paid out of undivided profits or, with the prior approval of the Division of Financial Regulation, from surplus in excess of 100% of required capital stock after providing for all expenses, losses, interest, and taxes that are due or accrued. There are also statutory limits on the transfer of funds to a holding company and its nonbanking subsidiaries by its banking subsidiaries, whether in the form of loans or other extensions of credit, investments, or asset purchases. Such transfers by any banking subsidiary to a holding company or to any such nonbanking subsidiary generally are limited in amount, and such loans and extensions of credit are required to be collateralized in specified amounts. Item 6: Selected Financial Data Five Year Comparative Summary -- Annual Stockholders Report, page 5, incorporated herein by reference. Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations Annual Stockholders Report, pages 6-20, incorporated herein by reference. See also recent developments in Item 1. Item 7a: Quantitative and Qualitative Disclosures About Market Risk Annual Stockholders Report, pages 12-14, incorporated herein by reference. Item 8: Financial Statements and Supplementary Data Financial Statements and related notes are included in the Annual Stockholders Report, pages 21-43, incorporated herein by reference. Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosures None. 23 Part III Item 10: Directors and Executive Officers of the Registrant Directors The following table provides certain information regarding each Director of Mason-Dixon:
- -------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DIRECTOR NAME DURING PAST FIVE YEARS AGE SINCE - -------------------------------------------------------------------------------------------------------------- CLASS I DIRECTORS (TERM EXPIRES IN 1999) MIRIAM F. BECK Retired Administrator - Carroll County Board of 67 1991 Education; Officer-Director - Highland View Cemetery Assoc., Inc.; Director and Treasurer - Carroll County Health Services Corporation; Director - Carroll Community College Foundation; Trustee - Carroll Hospice; Director - Carroll County Bank. THOMAS K. FERGUSON President and Chief Executive Officer of Mason-Dixon. 56 1991 EDWIN W. SHAUCK Retired April 1990 as Executive Vice President 73 1991 Carroll County Bank; Director - Carroll County Health Services Corporation; Director - Carroll County Bank. STEVENSON B. YINGLING President/Owner - Yingling General Tire Service, 57 1992 Inc.; Director - Carroll County Bank. CLASS II DIRECTORS (TERM EXPIRES IN 2000) DAVID S. BABYLON, JR. Retired Accountant - Tax Consultant; 75 1991 Vice Chairman of the Board of Directors - Carroll County Bank. R. NEAL HOFFMAN Managing Partner - Hoffman, Comfort, Galloway & 56 1995 Offutt, LLP, Attorneys-At-Law; Board of Trustees - Carroll Lutheran Village; Director - Carroll County Bank; Board of Trustees, Carroll County General Hospital Foundation, Inc. J. WILLIAM MIDDELTON Chairman - Middelton, Limberg & Co., Inc., a 67 1998 business consulting firm; Director - Medical Group Holdings, Inc.; Director - Medical Mutual Liability Insurance Society of Maryland; Director - ProAd Medical Insurance Company; Director - Bank of Maryland. DONALD H. CAMPBELL President and CEO - First State Packaging, Inc., 62 1995 Salisbury, MD; Director - Bank of Maryland. CLASS III DIRECTORS (TERM EXPIRES IN 2001) WILLIAM B. DULANY Managing Partner - Dulany & Leahy, LLP, 71 1991 Attorneys-At-Law; Chairman of the Board and Director - Mutual Fire Insurance Company of Carroll County; Trustee and Member Executive Committee - Western Maryland College; Chairman of Board and Director - Episcopal Ministries To The Aging, Inc. (Fairhaven, Copper Ridge,
24
and related entities), Sykesville, MD; Trustee - Maryland Historical Society; Chairman of the Board of Directors - Mason-Dixon and Carroll County Bank. S. RAY HOLLINGER Chairman - W. H. Davis Co. t/a Davis Buick-GMC 68 1991 Truck; President - Davis Library, Inc.; Director - Community Foundation of Carroll County, Inc.; Director - Carroll County Bank. JAMES C. SNYDER Retired. Previously engaged in manufacturing and 68 1991 distribution of truck equipment; Director - Carroll County Bank. HENRY S. BAKER, JR. Self-employed management consultant; Chairman of the 72 1995 Board of Directors of Bank of Maryland; Chairman, AAA Maryland; Chairman, Keswick Multi Care Center; Director, AAA MidAtlantic, Keystone Insurance Co., and Keystone Insurance Company of New Jersey.
Executive Officers The list of Executive Officers described under Part I, Item 4A, under the heading "Executive Officers", is incorporated herein by reference. Section 16(a) Beneficial Ownership Reporting Compliance Section 16 (a) of the Securities and Exchange Act of 1934, as amended, requires that Mason-Dixon's directors and executive officers and persons who own more than 10% of Mason-Dixon's Common Stock file with the Securities and Exchange Commission ("SEC") an initial report of beneficial ownership and subsequent reports of changes in beneficial ownership of the Common Stock. To Mason-Dixon's knowledge, all reports required to be filed by such persons have been filed on a timely basis. Mason-Dixon believes that all of its directors and executive officers complied with all filing requirements applicable to them with respect to transactions during the fiscal year ended December 31, 1998. 25 Item 11: Executive Compensation The following table summarizes the remuneration earned in 1998 and the prior two years by the Chief Executive Officer ("CEO") of Mason-Dixon and by any other executive officer whose total remuneration in the last fiscal year exceeded $100,000 and who performed a policy-making function for Mason-Dixon.
=========================================================================================================================== SUMMARY COMPENSATION TABLE =========================================================================================================================== Long-Term Compensation All Other Annual Compensation Awards Compensation(c) ------------------------------------------- -------------------------------------------- Restricted Securities Name and Other Annual Stock Underlying Principal Position Year Salary(a) Bonus Compensation(b) Awards(c) Options/SARs(d) - ------------------ ---- --------- ----- --------------- --------- --------------- Thomas K. Ferguson 1998 $183,753 $ 0 $ 5,308 $ 0 7,259 $ 31,685 President and CEO of 1997 $170,872 $ 14,744 $ 5,633 $ 0 2,547 $ 0 Mason-Dixon 1996 $170,366 $ 16,107 $ 4,629 $ 32,193 4,500 $ 0 Michael L. Oster 1998 $162,719 $ 5,138 $ 5,528 $ 8,712 1,108 $ 14,989 President and CEO 1997 $137,875 $ 3,237 $ 4,716 $ 4,918 953 $ 0 of Carroll County Bank 1996 $114,781 $ 0 $ 3,750 $ 0 0 $ 0 H. David Shumpert 1998 $216,145 $ 36,017 $ 18,008 $ 11,088 1,408 $ 455,180 President and CEO of 1997 $180,350 $ 110,000 $ 6,095 $ 0 0 $ 0 Bank of Maryland 1996 $166,528 $ 95,000 $ 5,411 $ 0 0 $ 0 A. Gary Rever 1998 $133,800 $ 3,515 $ 7,138 $ 5,973 760 $ 12,133 Executive Vice President, 1997 $ 95,127 $ 46,600 $ 1,087 $ 0 0 $ 0 CFO and Secretary of 1996 $ 89,159 $ 45,000 $ 1,065 $ 0 0 $ 0 Bank of Maryland Mark A. Keidel 1998 $105,771 $ 3,358 $ 3,578 $ 5,742 728 $ 8,196 Vice President and CFO 1997 $89,558 $ 0 $ 3,078 $ 3,022 581 $ 0 of Mason-Dixon 1996 $77,577 $ 0 $ 2,986 $ 0 0 $ 0 NOTES: (a) Includes base salary plus amounts deferred under the Management Deferred Compensation Plan. Mr. Ferguson deferred the following amounts during the years shown: 1998 - $27,000; 1997 - $18,000; 1996 - $54,450; Mr. Oster deferred $8,702 in 1998, $4,918 in 1997, and $1,515 in 1996; Mr. Keidel deferred $6,346 in 1998. (b) For 1998, includes $4,702, $5,036, $5,694, $3,969,and $3,255, reflecting matching contributions to Mr. Ferguson, Mr. Oster, Mr. Shumpert, Mr. Rever, and Mr. Keidel, respectively, to each of their ESIP accounts. For 1997, includes $5,028, $4,270, $3,566, $926, and $2,745, reflecting matching contributions to Mr. Ferguson, Mr. Oster, Mr. Shumpert, Mr. Rever, and Mr. Keidel, respectively, to each of their ESIP accounts. For 1996, includes $3,748, $3,398, $3,350, $880, and $2,704, reflecting matching contributions to Mr. Ferguson, Mr. Oster, Mr. Shumpert, Mr. Rever, and Mr. Keidel, respectively, to each of their ESIP accounts. Also includes, for 1998, $12,000, representing the value of the use of a company automobile for Mr. Shumpert, and $3,000 representing an automobile allowance for Mr. Rever. Remaining amounts are attributable to the group term life insurance coverage premiums paid for each named executive officer. (c) For Mr. Ferguson, for shares awarded in 1996, represents 1,533 restricted shares of Common Stock, valued at $21.00 per share as of December 27, 1996, the date of grant, all of which are vested. For Mr. Oster, for shares awarded in 1997, represents 249 restricted shares of Common Stock, valued at $19.75 per share as of February 12, 1997, the date of grant, with a four year vesting term; for shares awarded in 1998, represents 264 restricted shares of Common Stock, valued at $33.00 per share as of January 27, 1998, the date of grant, with a 1 year vesting term. For Mr. Shumpert, for shares awarded in 1998, represents 336 restricted shares of Common Stock, valued at $33.00 per share as of January 27, 1998, the date of grant, with a 1 year vesting term. For Mr. Rever, for shares awarded in 1998, represents 181 restricted shares of Common Stock, valued at $33.00 per share as of January 27, 1998, the date of grant, with a 1 year vesting term. For Mr. Keidel, for shares awarded in 1998, represents 174 restricted shares of Common Stock, valued at $33.00 per share as of January 27, 1998, the date of grant, with a three year vesting term; for shares awarded in 1997, represents 152 restricted shares of Common Stock, valued at $19.75 per share as of February 12, 1997, the date of grant, with a four year vesting term. Restricted stock holders are entitled to exercise the voting rights associated with, and to collect any dividends on, all such shares. The value of the aggregate restricted stock holdings (whether or not vested) as of December 31, 1998 is $44,840, $15,122, $9,974, $5,294, and $5,090, for Mr. Ferguson, Mr. Oster, Mr. Shumpert, Mr. Rever and Mr. Keidel, respectively. (d) The exercise price for options awarded is $33.00, $19.75 and $21.00 per share, for 1998, 1997, and 1996 respectively, a price equal to the mid-point of the bid and ask prices on NASDAQ as of the grant date. (e) Represents amounts contributed in 1998 for fiscal year 1997 by Mason-Dixon under the Supplemental Executive Retirement Plan (SERP), for Mr. Shumpert, also includes a one-time severance payment. ===========================================================================================================================
26 The following table sets forth information regarding stock options to purchase Mason-Dixon's Common Stock granted to the named executives during 1998:
================================================================================================================ Option Grants in Fiscal Year 1998 - ---------------------------------------------------------------------------------------------------------------- Individual Grants --------------------------------------------------------- Percent of Total Number of Securities Options Granted Exercise Underlying Options to Employees in or Base Expiration Grant Date Name Granted (1) Fiscal Year Price ($/Sh) Date Present Value $(2) - ---- -------------------- ---------------- ----------- ---------- ------------------ Thomas K. Ferguson 7,259 55.9% $33.00 1-27-08 $90,738 Michael L. Oster 1,108 8.5% $33.00 1-27-08 $13,850 H. David Shumpert 1,408 10.8% $33.00 1-27-08 $17,600 A. Gary Rever 760 5.9% $33.00 1-27-08 $ 9,500 Mark A. Keidel 728 5.6% $33.00 1-27-08 $ 9,100 NOTES: (1) Options were granted on January 27, 1998, at a price equal to the mid-point of the bid and ask prices on NASDAQ as of the grant date and are exercisable in three increments on January 27, 1998, 1999, and 2000. (2) This value, calculated by utilizing the Modified Black-Scholes American option-pricing model, assumes a 5.69% risk-free interest rate, 10-year expected life, 30% expected volatility of the stock, and 2.06% expected dividend yield on the stock. ================================================================================================================
The following table sets forth information regarding the number and value of underlying unexercised stock options held by the named executives as of December 31, 1998.
================================================================================================================ Aggregated Option Exercises in 1998 and 1998 Year End Option Values - ---------------------------------------------------------------------------------------------------------------- Number of Securities Underlying Unexercised Value of Unexercised Options at Fiscal Year-End In-the-Money Options at (#) Fiscal Year-End ($)(1) ------------------------------ ------------------------------ Name Exercisable Unexercisable Exercisable Unexercisable - ---- ----------- ------------- ----------- ------------- Thomas K. Ferguson 9,467 4,839 $ 61,321 $ 8,065 Michael L. Oster 1,005 1,056 $ 6,042 $ 3,011 H. David Shumpert 469 939 $ 0 $ 0 A. Gary Rever 253 507 $ 0 $ 0 Mark A. Keidel 631 678 $ 3,686 $ 1,833 NOTES: (1) Represents the total gain which would be realized if all in-the-money options held at December 31, 1998 were exercised, determined by multiplying the number of shares underlying the options by the difference between the per share option exercise price and the fair market value of the shares at December 31, 1998 of $29.25 per share. ================================================================================================================
27 Severance, Key Employee Retention and Supplemental Executive Retirement Plans Effective November 1, 1997, Mason-Dixon adopted an updated, uniform severance plan for Mason-Dixon and its banking subsidiaries. The plan was restated in its entirety and represents a continuation of the prior Carroll County Bank and Trust Company Severance Plan with the Bank of Maryland adopting this restated plan as well, on the effective date. The Mason-Dixon Severance Plan now reflects updated eligibility criteria allowing for increased coverage and flexibility of use by the individual participating employer, while providing for a common schedule of severance benefits using a formula based on the number of full years of service. Under the plan, eligible employees who are not officers are eligible for one week of base pay for each full year of service, but in no event less than eight weeks nor more than 13 weeks; appointed/elected officers (bank and corporate secretaries, assistant vice presidents, officers, and senior officers) are eligible for one week of base pay for each full year of service with a minimum of 13 weeks and a maximum of 26 weeks; vice presidents and managing directors are eligible for two weeks of base pay for each full year of service with a minimum of 26 weeks and a maximum of 39 weeks; and other elected officers (senior vice presidents, executive vice president, president/CEO) are eligible for a flat 52 weeks of base pay. Effective July 1998, the plan was amended by the Board of Directors to provide 104 weeks of base pay for any bank or corporate president or CEO who has been employed in that position for at least 5 years. All participants are also eligible to continue to receive the same group term life and health insurance benefits until the termination of the severance payments or the employee becomes eligible under another group plan. In addition, in July 1996, Mason-Dixon's Board of Directors adopted a Key Employee Retention Plan (the "Retention Plan"). Mason-Dixon adopted and modified Carroll County Bank's Retention Plan to provide certain incentives to attract and retain key employees of Mason-Dixon and all of its participating subsidiaries. The Retention Plan provides severance benefits (including health insurance) in the event a participant's employment is terminated or if the participant resigns for good cause as a result of a change in control of Mason-Dixon. The Retention Plan provides that participants with less than five years of service may receive 12 months of base salary; participants with five to 10 years of service may receive 24 months of base salary; and participants with more than 10 years of service may receive 36 months of base salary; provided that 50% of these benefits are reduced by any amount the participant may be eligible for under any other severance plan of or similar benefit from Mason-Dixon. The remaining 50% of the separation payments will be reduced by any amount which the participant receives, or is entitled to receive, from other employment, including self employment, during the time that the employee is receiving benefits from the Retention Plan. Finally, the amounts payable under the Retention Plan are limited so that the aggregate present value of all payments to be received by the participant upon termination may not exceed 2.99 times the participant's average annual compensation for the preceding five years. Effective October 23, 1996, Mason-Dixon's Board of Directors adopted a Supplemental Executive Retirement Plan (SERP), administered by Mason-Dixon's Compensation Committee, which has discretionary authority over the plan. The plan is performance based and directly linked to Mason-Dixon and its subsidiary banks attaining or exceeding their respective pre-established annual goals. Effective for 1998, the ratio of actual to budgeted earnings per share attributable to Mason-Dixon's banking affiliates is the key factor in determining the SERP contribution. The SERP was established to provide supplemental income to the participant at an estimated rate of 10% of the participant's final base pay at age 65, assuming 30 years of service. Any amounts credited to a participant's SERP account are deferred through a rabbi trust; such amounts are restricted during the term of the participant's employment. 28 Pension Plan Carroll County Bank sponsors a non-contributory defined benefit Pension Plan and Trust (the "Pension Plan") which covers eligible employees of Carroll County Bank. The Pension Plan also covers employees of Mason-Dixon who are covered by the Pension Plan as employees of Carroll County Bank at the time they become employees of Mason-Dixon. The Pension Plan provides a pension benefit value that is calculated by multiplying years of credited service by a percentage multiplier (ranging from 7% to 11% per year of service), the result of which is multiplied by final average compensation. The pension benefit value is then converted into a monthly benefit. No participant's monthly benefit will be less than his/her accrued benefit as of June 1, 1997. Benefits eligibility is as follows: normal retirement at age 65; early retirement after completing 10 years of service and attaining age 55; vested benefits after completing five years of service; and actuarial reduction of benefits for commencement before age 65. The Pension Plan Table below shows estimated annual benefits payable upon retirement to qualified persons in the specified remuneration and years-of-service categories if such retirement had occurred on December 31, 1998. The benefits listed are calculated as a life annuity and are not integrated with Social Security or subject to other offsets. Compensation, as defined in the Pension Plan, reflects each participant's total compensation, including overtime, incentives and bonuses, as well as pre-tax contributions through payroll deductions to Sections 401(k) and 125 Plans as provided by the Internal Revenue Code of 1986 ("Code"). ================================================================================ ESTIMATED ANNUAL BENEFITS Years of Service FAC* 10 15 20 25 ------- ------ ------ ------ ------ $20,000 $1,301 $2,081 $2,948 $3,902 30,000 1,975 3,121 4,422 5,852 40,000 2,909 4,623 6,511 8,572 50,000 3,906 6,184 8,678 11,390 60,000 4,903 7,744 10,846 14,208 70,000 5,900 9,305 13,013 17,025 80,000 6,897 10,866 15,181 19,843 90,000 7,894 12,426 17,349 22,661 100,000 8,891 13,987 19,516 25,479 110,000 9,888 15,547 21,684 28,297 120,000 10,885 17,108 23,851 31,114 130,000 11,882 18,669 26,019 33,932 140,000 12,879 20,229 28,186 36,750 150,000 13,876 21,790 30,354 39,568 160,000 14,873 23,350 32,521 42,385 * Final Average Compensation, computed as the average of annual compensation for the five consecutive years (out of the most recent ten years) for which compensation is the highest. ================================================================================ Covered compensation under the Pension Plan includes those amounts shown in the Summary Compensation Table as to Mason-Dixon's President and CEO, with the exception of amounts deferred through the Management Deferred Compensation Plan. Covered compensation for 1998 is limited to $160,000. As of December 31, 1998, Mr. Ferguson had accumulated 25 years of credited service toward retirement. 29 Compensation Committee Report The fundamental philosophy of Mason-Dixon's executive compensation program is to provide competitive compensation opportunities for its executive officers which is based both on the individual's contribution and on Mason-Dixon's performance. Compensation levels are designed to attract, retain, and reward executive officers who are capable of leading Mason-Dixon in achieving its business objectives in an industry characterized by complexity, competitiveness, and constant change. The compensation of Mason-Dixon's key executives is established by and reviewed regularly for continued relevance by the Compensation Committee, and actions taken are reported in summary form to the full Board of Directors. Annual compensation for Mason-Dixon's President/CEO, and other executive officers, consists of two elements: 1) base salary, and 2) both annual and long-term incentives or bonuses. These are awarded in the form of cash and/or stock, are variable in amount, fluctuate in value annually, and are linked directly to individual and Mason-Dixon's corporate goals attainment. For Mr. Ferguson, Mason-Dixon's President/CEO, cash incentives provided during 1996 represented 9.4% of base salary. In 1997 and 1998, no cash incentive was provided; however, consistent with the Committee's executive compensation strategy, stock options were awarded reflecting an amount to help make up the difference in value for a base pay gap, compared to a selected external banking peer group, and to reflect a performance bonus award, in lieu of cash. These stock grants represent, in aggregate, 53% of Mr. Ferguson's base salary as of year end 1997, and 51% of his 1998 base salary, which was increased by 4%. The Committee determined that this compensation was warranted in view of Mason-Dixon's and its subsidiaries meeting or exceeding certain business goals during 1997. For example, key profitability goals were met or exceeded for the year, including return on equity and earnings per share. Return on assets, net income, and net interest margin were less than goal for the year, primarily because of management's emphasis on increasing earnings per share and return on equity, as well as volatility of pricing, and strong regional competition for quality loans. Compared on a year to year basis, return on equity, earnings per share, and net income increased significantly while return on assets and net interest margin decreased somewhat. Both base salary and the variable portion of compensation is closely linked to Mason-Dixon's performance. The variable compensation element is directly contingent upon Mason-Dixon's goal attainment, and provides the executive the opportunity to make up the difference between their base salary and comparable base salaries paid by similarly situated commercial and retail banking organizations. Beginning in 1997 and updated for 1998, the Compensation Committee of the Board formalized a system of paying incentives to Mason-Dixon's CEO and other executive officers based on Mason-Dixon's performance, exclusive of extraordinary events, in the following areas: return on assets, return on equity, ratio of net overhead to average assets, efficiency ratio, net income, net charge-offs and non-performing loans as a percentage of outstanding, and regulatory ratings. The Compensation Committee has implemented an executive salary structure for executive officers which includes the assignment of salary grades for individual officers. Additionally, the Committee has established a long-term goal of compensating executive officers with a mix of base salary plus variable compensation based upon Mason-Dixon's performance. The goal is to provide 60% of compensation as base salary and 40% as variable or incentive based. The purpose of this structure is to align the executives' pay opportunities with increased values returned to stockholders. The executive salary structure was developed through identification of and comparison with regional and local peer groups consisting of commercial banks and holding companies having an asset size and performance characteristics comparable to Mason-Dixon. Finally, various other performance indicators are used to establish executive officer compensation, including achievement of individual and divisional goals, satisfactory or better audit and regulatory reviews and examinations, asset quality, and increases in per share earnings, dividends and book value. The performance of Mason-Dixon's Common Stock during the past fiscal year is reflected in the following Performance Graph. The Compensation Committee considers the performance of the common stock 30 in determining compensation for Mason-Dixon's President/CEO but is not weighted heavily in view of the historically limited trading activity. BY THE COMPENSATION COMMITTEE: Edwin W. Shauck Miriam F. Beck Henry S. Baker, Jr. S. Ray Hollinger Stevenson B. Yingling Director Compensation For 1998, Mason-Dixon paid its non-employee directors a fee of $5,000, except for Mr. Dulany, the Chairman of the Board, who received a fee of $12,500. Directors, whose ownership interest in Common Stock was less than .5% of all outstanding shares, received 50% of the fee in cash other than Mr. Dulany, who received 80% of his fee in cash. Messrs. Babylon, Hoffman, and Shauck elected to receive their fees in cash since their ownership interest exceeded the minimum .5% requirement. Each non-employee Mason-Dixon Director received in 1998 an option to purchase 706 shares at an exercise price of $29.75 per share, the fair market value at the time of grant, exercisable as follows: 236 shares on January 2, 1998, 235 shares on January 2, 1999, and 235 shares on January 2, 2000. As of October 28, 1998 non-employee directors who attend special board meetings are paid an additional $150.00 per meeting. Two special board meetings were held in the last quarter of 1998. Those directors who were also directors of Carroll County Bank received an additional fee of $10,000 in that capacity, except for Messrs. Dulany and Babylon, the Chairman and Vice Chairman, who received additional fees of $40,000 and $11,500 respectively. Mr. Baker, in his capacity as Chairman of the Board of Bank of Maryland, received an additional $20,000. Mr. Middelton and Mr. Campbell, in their capacities as directors of Bank of Maryland, received $400 per meeting attended, or $4,400 and $3,200 respectively. Any non-employee director of Mason-Dixon and each participating subsidiary may defer all or a portion of his or her director's fees. In addition to meeting as a group, certain members of the Board of Directors also devote their time to certain standing committees. The Board of Directors has established two standing committees: The Compensation Committee and the Audit Committee. Each member of the Compensation Committee received an annual fee of $1,600. Audit Committee members do not receive any additional fee for their service on the committee. Compensation Committee Interlocks and Insider Participation No member of the Compensation Committee currently serves as an officer of Mason-Dixon or any of its subsidiaries. However, Mr. Edwin Shauck, currently a Mason-Dixon and Carroll County Bank director, is a retired Executive Vice President of Carroll County Bank. 31 Performance Graph The performance graph shown below compares the cumulative total return to Mason-Dixon's stockholders over the most recent five-year period with the NASDAQ Composite Index (reflecting overall stock market performance), the NASDAQ Bank Index (reflecting changes in banking industry stocks), and a peer group selected by Mason-Dixon. The peer group is made up of publicly traded bank holding companies in Maryland, Virginia, Pennsylvania, Delaware, and the District of Columbia with total assets between $500 million and $2.5 billion. This peer group was added to facilitate stock performance comparisons between Mason-Dixon and a comparable group based on asset size and geography. Returns are shown on a total return basis, assuming the reinvestment of dividends. Mason-Dixon's Common Stock was listed on the NASDAQ National Market System effective April 1, 1993. COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN MASON-DIXON BANCSHARES, INC., NASDAQ COMPOSITE INDEX, NASDAQ BANK INDEX & PEER GROUP [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.] - -------------------------------------------------------------------------------- 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97 12/31/98 - -------------------------------------------------------------------------------- Mason-Dixon $100.00 $109.78 $137.71 $148.89 $220.00 $222.81 - -------------------------------------------------------------------------------- NASDAQ $100.00 $97.75 $138.26 $170.01 $208.58 $293.21 Composite - -------------------------------------------------------------------------------- NASDAQ Bank $100.00 $99.64 $148.38 $195.91 $328.02 $324.90 Index - -------------------------------------------------------------------------------- Peer Group* $100.00 $101.00 $127.00 $139.00 $222.00 $218.00 - -------------------------------------------------------------------------------- Assumes $100 invested on January 1, 1994 in Mason Dixon Bancshares, Inc., NASDAQ Composite Index, NASDAQ Bank Index & Peer Group. * Peer group includes bank holding companies in DC, DE, MD, PA and VA with assets between $500 million and $2.5 billion. 32 Item 12: Security Ownership of Certain Beneficial Owners and Management The following tables reflect the beneficial ownership of Mason-Dixon Common Stock, $1.00 par value, ("Common Stock") by directors and executive officers of Mason-Dixon and by each person that, to the knowledge of management, beneficially owns more than 5% of the Common Stock as of the February 26, 1999. Unless otherwise indicated below, and except for shares described below held in the Non-Employee Directors Deferred Compensation and Fee Plan (the "Directors Plan") or the Management Deferred Compensation Plan (the "Management Plan") which are voted by Mason-Dixon, each person specified below has sole investment and voting power (or shares such power with his or her spouse) with regard to the shares set forth in the following table. Shares of Common Stock subject to options held by directors and executive officers that are exercisable within 60 days are included in such director's or executive officer's beneficial ownership and in the beneficial ownership of the group. The address of each of the persons named below is the address of Mason-Dixon. Name Number of Shares Percent of Class ---- ---------------- ---------------- David S. Babylon, Jr. 44,425 (1) * Henry S. Baker, Jr. 4,748 (2) * Miriam F. Beck 17,836 (3) * Donald H. Campbell 10,903 (4) * William B. Dulany 20,180 (5) * Thomas K. Ferguson 51,566 (6) 1.0% R. Neal Hoffman 75,031 (7) 1.5% S. Ray Hollinger 13,871 (8) * J. William Middelton 745 (9) * Edwin W. Shauck 45,000 (10) * James C. Snyder 13,964 (11) * Stevenson B. Yingling 8,126 (12) * Named Executive Officers Michael L. Oster 6,726 (13) * H. David Shumpert 336 * A. Gary Rever 6,510 (14) * Mark A. Keidel 8,492 (15) * All Directors and Executive Officers as a group (22 persons) 349,616 7.0% * Signifies less than 1% of the Common Stock - ---------- (1) Includes 1,021 shares held in the Directors Plan. (2) Includes 509 shares held in the Directors Plan and 471 shares that may be purchased upon the exercise of stock options. (3) Includes 3,639 shares held jointly with her husband, Edward R. Beck, 9,564 shares held in the Directors Plan, and 471 shares that may be purchased upon the exercise of stock options. (4) Includes 3,667 shares held by his wife, Isabelle T. Campbell, 914 shares held by a company controlled by Mr. Campbell, 827 shares held in the Directors Plan, and 471 shares that may be purchased upon the exercise of stock options. 33 (5) Includes 1,002 shares held by his wife, Winifred S. Dulany, 415 shares held by his daughter, Anne French Dulany, 176 shares held in the Directors Plan, and 471 shares that may be purchased upon the exercise of stock options. Mr. Dulany disclaims beneficial ownership as to the Common Stock held by his wife and daughter. (6) Includes 4,303 shares held by his wife, Sandra L. Ferguson, 19,636 shares held in the Employee Savings and Investment Plan, 15,768 shares that may be purchased upon the exercise of stock options, and 6,931 shares held in the Management Plan. (7) Includes 1,575 shares held by his wife, Nancy L. Hoffman, 4,243 shares held as trustee under a trust agreement, and 21,284 shares held as co-trustee under the will of his father. Mr. Hoffman disclaims beneficial ownership as to the Common Stock held by his wife. (8) Includes 1,280 shares held by his wife, Joan R. Hollinger, 3,203 shares held in the Directors Plan, and 471 shares that may be purchased upon the exercise of stock options. (9) Includes 74 shares held in the Directors Plan, and 471 shares that may be purchased upon the exercise of stock options. (10) Includes 43,500 shares held jointly with his wife, Mary Jane Shauck. (11) Includes 1,168 shares held by his wife, Dolores J. Snyder, 4,632 shares held in the Directors Plan, and 471 shares that may be purchased upon the exercise of stock options. (12) Includes 263 shares held jointly with his son, Edward R. Yingling, 263 shares held jointly with his daughter, Elizabeth A. Yingling, 263 shares held jointly with his daughter, Stacy L. Yingling, 3,482 held in the Directors Plan, and 471 shares that may be purchased upon the exercise of stock options. (13) Includes 2,530 shares that may be purchased upon the exercise of stock options, 258 shares held in the Management Plan, and 2,923 shares held in the Employee Savings and Investment Plan. (14) Includes 3,507 shares held jointly with his wife, Mary Rever, 345 shares held in the Management Plan, and 961 shares held in the Employee Savings and Investment Plan, and 1,213 shares that may be purchased upon the exercise of stock options. (15) Includes 719 shares held jointly with his wife, Leslie J. Keidel, 445 shares held in the Management Plan, 2,979 shares held in the Employee Savings and Investment Plan, 1,502 shares held by his wife, Leslie J. Keidel, and 2,001 shares that may be purchased upon the exercise of stock options. Other Beneficial Owners Name Number of Shares Percent of Class ---- ---------------- ---------------- Carroll County Bank and Trust Company 377,706 7.44% Carroll County Bank holds shares of Common Stock in a fiduciary capacity for numerous trusts and agency accounts and other fiduciary accounts. Carroll County Bank may be deemed a "beneficial owner" of certain of these shares because of its power to vote or direct the voting of, or to dispose or direct a disposition of, such shares, even if these powers are shared with co-fiduciaries and others. The full Board of Directors of Carroll County Bank, acting as the Trust Committee, reviews quarterly the minutes and actions of the Trust Investment Committee, which Committee reviews all individual trust accounts. 34 The Board of Directors of Mason-Dixon has no power to directly or indirectly vote Mason-Dixon Common Stock held in such accounts, except shares held under the Directors Plan and the Management Plan; all other shares are voted by Mason-Dixon Trust Company (a division of Carroll County Bank) in its sole discretion. As of December 31, 1998, the Trust Company had sole voting power with respect to approximately 128,595 shares of Mason-Dixon Common Stock, which represents approximately 2.5% of the issued and outstanding shares of Common Stock, and sole investment power with respect to approximately 115,381 shares of Mason-Dixon Common Stock, which represents 2.3% of the issued and outstanding shares of Common Stock. BB&T Agreement On January 27, 1999, Mason-Dixon entered into a definitive agreement to be acquired by and merged into BB&T Corporation ("BB&T"), a North Carolina corporation and bank holding company. The agreement is subject to various regulatory approvals, and approval by Mason-Dixon's stockholders. Upon approval, Mason-Dixon stockholders will receive 1.30 shares of BB&T common stock for each share of Mason-Dixon common stock. As a condition to the definitive agreement, Mason-Dixon granted an option which allows BB&T to purchase up to 1,006,868 shares of Mason-Dixon's common stock. The exercise price of the option is $40.00 per share. BB&T can exercise the option only if another party attempts to acquire control of Mason-Dixon. Item 13: Certain Relationships and Related Transactions Mason-Dixon, through its subsidiaries, has had in the past, and expects to have in the future, banking transactions in the ordinary course of business with directors and executive officers on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with other unaffiliated persons and, in the opinion of management, these transactions do not and will not involve more than the normal risk of collectability or present other unfavorable features. 35 Part IV Item 14: Exhibits, Financial Statement Schedules, and Reports on 8-K (a) Documents filed as part of this report: (1) The following financial statements of the Registrant, included on pages 21 through 43 of the registrants 1998 Annual Report to Stockholders, are incorporated herein by reference in item 8: Consolidated Balance Sheets -- December 31, 1998 and 1997 Consolidated Statements of Income -- Years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Changes in Stockholders' Equity -- Years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Cash Flows - Years ended December 31, 1998, 1997, and 1996 Notes to Consolidated Financial Statements -- Years ended December 31, 1998, 1997, and 1996 Report of Independent Auditors for the year ending December 31, 1998 (2) Financial statement schedules are omitted from this 10-K since the required information is not applicable to the Registrant. (3) Listing of Exhibits: The following documents are attached as Exhibits to this Form 10-K as indicated by the Exhibit number or are incorporated by reference to the prior filings of the Registrant with the Commission. Form 10-K Exhibit # Exhibit ------------------- ------- Exhibit 3(i)* Certificate of Incorporation Exhibit 3(ii)** Bylaws of the Corporation Exhibit 13 Annual Report to Stockholders Exhibit 21 List of Registrant's Subsidiaries Exhibit 23 Consent of Independent Auditors Exhibit 27 Financial Data Schedule (Filed electronically) Exhibit 99 Risk Factors * Exhibit 3(i) is incorporated herein by reference to the identically numbered exhibit to the Form S-4 Registration Statement filed by Mason-Dixon with the Securities and Exchange Commission on October 15, 1991. ** Exhibit 3(ii) is incorporated herein by reference to the identically numbered exhibit to the 1997 Form 10-k filed by Mason-Dixon with the Securities and Exchange Commission on March 31, 1998. Item 14(b) On October 16, 1998, Mason-Dixon filed on Form 8-K its announcement that it had entered into an agreement to acquire Sterling Bancorp, a privately held, Baltimore-based bank holding company. This event was reported under Item 5 on Form 8-K On January 8, 1999, Mason-Dixon filed on Form 8-K its announcement that it had completed its acquisition of Sterling Bancorp, a privately held, Baltimore-based bank holding company. This event was reported under Item 5 on Form 8-K. On January 29, 1999, Mason-Dixon filed on Form 8-K its announcement that it had entered into an Agreement and Plan of Reorganization with BB & T Corporation of Winston-Salem, North Carolina. Under the terms of this agreement, Mason-Dixon would be acquired by BB & T Corporation. This event was reported under Item 5 on Form 8-K. Item 14(c) See Item 14(a)(3) above. 36 Item 14(d) See item 14(a)(2) above. 37 Signatures Pursuant to the registration requirements of 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 by the undersigned, thereunto duly authorized. MASON-DIXON BANCSHARES, INC. --------------------------- (Registrant) Date: March 24, 1999 By /s/ Thomas K. Ferguson ------------------------------ Date: March 24, 1999 By /s/ Mark A. Keidel ------------------------------ Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ David S. Babylon, Jr. Director Date: March 24, 1999 - -------------------------------- /s/ Miriam F. Beck Director Date: March 24, 1999 - -------------------------------- /s/ William B. Dulany Director Date: March 24, 1999 - -------------------------------- /s/ R. Neal Hoffman Director Date: March 24, 1999 - -------------------------------- /s/ S. Ray Hollinger Director Date: March 24, 1999 - -------------------------------- /s/ Edwin W. Shauck Director Date: March 24, 1999 - -------------------------------- /s/ Stevenson B. Yingling Director Date: March 24, 1999 - -------------------------------- 38 EX-13.1 2 ANNUAL REPORT TO SHAREHOLDERS [LOGO] MASON-DIXON BANCSHARES, INC. o COMMITTED TO THE TRADITION OF FINE BANKING SERVICES [LOGO] Rose Shanis FINANCIAL SERVICES, LLC, [LOGO] CARROLL COUNTY BANK AND TRUST COMPANY [LOGO] M BANK OF MARYLAND ANNUAL 1998 REPORT - -------------------------------------------------------------------------------- COMPANY PROFILE Mason-Dixon Bancshares, Inc. is a multi-bank holding company organized in 1991 that provides a full range of consumer, commercial, trust, real estate and other specialty banking services. The company is headquartered in Westminster, Maryland and operates two bank subsidiaries, Carroll County Bank and Trust Company and Bank of Maryland, which have a combined total of 21 retail banking offices in central Maryland. Mason-Dixon also operates a consumer finance subsidiary, Rose Shanis Financial Services, LLC. Carroll County Bank and Trust Company and predecessor organizations span nearly 150 years. As a result, it is the market leader in the rapidly expanding region located northwest of Baltimore, in contiguous proximity to both the dynamic Baltimore-Washington business corridor and southern Pennsylvania. The bank's location adjacent to these very different (but complementary) markets has enabled significant opportunities and competitive advantages. The bank provides primary banking services to over 25% of Carroll County residents, while maintaining some form of relationship with nearly 40% of the population in the county. Operating divisions of Carroll County Bank and Trust Company include Mason-Dixon Trust Company, which offers a variety of trust products and services to individuals, corporations and non-profit organizations, and Mason-Dixon Bancshares Mortgage Company, which originates and services residential real estate mortgage and construction loans as a principal and as an agent. Bank of Maryland, acquired by Mason-Dixon Bancshares in mid-1995, was founded de novo in 1985. Via the provision of a variety of commercial, real estate and asset-based lending services, deposit acceptance, cash management and short-term investing, the bank is one of the leading locally-managed institutions serving small to mid-market businesses in the Baltimore metropolitan area and surrounding sub-markets. Complementing the Bank of Maryland's business banking focus is its retail network of offices, which draw customers from a combination of urban, suburban and rural locations. In February 1998, Mason-Dixon Bancshares acquired Baltimore based Rose Shanis Financial Services, LLC, an old-line, family-owned consumer finance company consisting of a network of 12 strategically located branch offices that are positioned concentrically around the Baltimore Beltway and in the hub cities of Annapolis, Bel Air and Easton, Maryland. In addition to originating basic consumer loans through its proprietary branches, the company also finances consumers' purchases of large ticket items, such as automobiles, appliances and furniture through a network of dealers with whom Rose Shanis Financial Services has developed strong, long-term relationships. CORPORATE INFORMATION MASON-DIXON BANCSHARES, INC. Corporate Headquarters 45 West Main Street P.O. Box 1100 Westminster, MD 21158-0199 410-857-3401 Stock Information Mason-Dixon Bancshares, Inc. common stock is traded on the Nasdaq National Market(R) under the symbol "MSDX". Mason-Dixon Bancshares, Inc. preferred securities are traded on the Nasdaq National Market(R) under the symbols "MSDXO" and "MSDXP". Transfer Agent, Registrar, and Dividend Disbursing Agent American Stock Transfer & Trust Company 40 Wall Street New York, NY 10005 1-800-937-5449 Auditors Stegman & Company 405 E. Joppa Road, Suite 200 Baltimore, MD 21286 General Counsel Gordon, Feinblatt, Rothman, Hoffberger & Hollander, LLC The Garrett Building 233 East Redwood Street Baltimore, MD 21202-3332 SEC Form 10-K A copy of the Company's annual report on Form 10-K for the year ended December 31, 1998, as filed with the Securities and Exchange Commission, may be obtained without charge upon written request to: Corporate Secretary Mason-Dixon Bancshares, Inc. 45 West Main Street P.O. Box 1100 Westminster, MD 21158-0199 Dividend Reinvestment and Stock Purchase Plan Mason-Dixon Bancshares, Inc. offers its stockholders a plan whereby they may automatically invest their cash dividends in Mason-Dixon Bancshares, Inc. common stock. Plan participants may also make additional cash payments to purchase stock through the Plan at the market price. Mason-Dixon Bancshares, Inc. absorbs all fees and transaction costs. Stockholders who wish to enroll in the Plan should contact the Corporation's Transfer Agent. Direct Deposit Stockholders of Mason-Dixon Bancshares, Inc. may have their cash dividends deposited directly into the account of their choice at any banking institution. It will be deposited on the date it is payable, and a confirmation of payment from the transfer agent will be sent. An enrollment card may be obtained by contacting the Corporation's Transfer Agent. Investor Information The Company's 1998 Annual Report, recent quarterly reports, press releases, and current stock and member bank information are available on the Internet at www.msdx.com. - -------------------------------------------------------------------------------- CORPORATE LOCATIONS Carroll County Bank and Trust Company Headquarters: 45 West Main Street Westminster, MD 21157 Branch Locations: Eldersburg Ellicott City Finksburg Hampstead Manchester Melrose Mt. Airy Sykesville Taneytown Westminster (3) Mason-Dixon Bancshares Mortgage Company Headquarters: 1643 Liberty Road Eldersburg, MD 21784 Branch Locations: Eldersburg Salisbury Towson Bank of Maryland Headquarters: Towson Office 502 Washington Avenue Towson, MD 21204 Branch Locations: Annapolis (2) Baltimore City Bel Air Perry Hall Pikesville Reisterstown Timonium Towson Rose Shanis Financial Services, LLC Headquarters: 11419 Cronridge Drive, Suite 10 Owings Mills, MD 21117 Branch Locations: Annapolis Baltimore City (3) Bel Air Catonsville Dundalk Easton Essex Glen Burnie Parkville Randallstown [GRAPHIC] - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS (dollars in thousands, except per share data) - -------------------------------------------------------------------------------- 1998 1997 % Change - -------------------------------------------------------------------------------- For the Year Net income $ 10,811 $ 9,159 18% Common dividends paid $ 3,551 $ 3,215 10% Per Common Share Net income--basic $ 2.13 $ 1.77 20% Net income--diluted $ 2.13 $ 1.77 20% Dividends paid $ 0.70 $ 0.62 13% Book value $ 16.20 $ 14.86 9% Tangible book value $ 14.88 $ 14.28 4% Market price--close $ 29.25 $ 29.50 (1%) Price/earnings ratio 13.73 16.67 (18%) Financial Ratios Return on average assets (ROA) 1.02% 1.00% 2% Return on average equity (ROE) 13.82% 12.63% 9% Net interest margin (taxable equivalent) 4.07% 3.93% 4% At December 31 Total assets $1,102,242 $ 992,180 11% Total investments $ 566,878 $ 453,900 25% Total loans--net $ 453,664 $ 455,160 -- Total deposits $ 640,349 $ 651,249 (2%) Total stockholders' equity $ 82,139 $ 75,449 9% Common shares outstanding 5,071,682 5,077,468 -- - -------------------------------------------------------------------------------- TABLE OF CONTENTS: Financial Highlights 1 Stockholders' Letter 2 Economic Outlook 4 Selected Financial Data 5 Management Discussion and Analysis 6 Consolidated Balance Sheets 21 Consolidated Statements of Income 22 Consolidated Statements of Changes in Stockholders' Equity 23 Consolidated Statements of Cash Flows 24 Notes 25 Independent Auditors' Report 43 Corporate Information 44 - -------------------------------------------------------------------------------- Page 1 - -------------------------------------------------------------------------------- TO OUR STOCKHOLDERS: We are pleased to report the 14th consecutive year of increased earnings for Mason-Dixon Bancshares, Inc. complemented by the achievement during 1998 of a series of major milestones that set the stage for our recent announcement in January that, subject to stockholder and regulatory approval, we will merge with BB&T Corporation of Winston-Salem, NC later in 1999. We are equally pleased to report that the planned merger with BB&T is set at a price that fully reflects the intrinsic value of the franchise we have built, and also that the combination of the two companies will ensure that our people and our organization can continue to grow and prosper in the markets in which we have been the leader for many decades. Net income for the year ended December 31, 1998 increased 18% from a year earlier. Earnings per share also reached record levels and totaled $2.13, up 20% from the prior year end. Fundamental measures of performance were strong We ended a busy and exciting year with very solid financial results, as core earnings per share were up 13% for the year. We continued to make progress toward improving our return on average stockholders' equity, which increased to 12.97% based on core earnings. We also improved our net interest margin to 4.07%. Importantly, we were able to deliver continuing improvement in these key underlying measures of our financial performance in an increasingly competitive banking environment, while maintaining acceptable credit quality and focusing on those businesses and geographic sub-markets where we have proven expertise. Total assets were $1.102 billion at year end, up 11% over the prior year, loans grew by 4% (excluding changes relating to branch sales and other acquisitions) in an intensely competitive lending environment, deposits were up 12% (excluding changes related to branch sales), and stockholders' equity totaled $82 million, up 9%. Book value advanced by 9% to $16.20 per common share while market capitalization remained stable. We continued to place a high priority on maintaining a flexible balance sheet and strong capital position. New activities reflected clear strategic direction We have always strongly believed that strategically we should concentrate on those activities and geographic areas where we have the most expertise, as the most effective means to both solidify the intrinsic value of the organization long-term and leverage our market share of the most profitable activities that make sense for us to pursue in the short-term. Consistent with this disciplined, focused approach and our determination to deliver results accordingly, we acquired the Baltimore-based Rose Shanis Companies and we completed the divestiture of five former Bank of Maryland branches on the Eastern Shore of Maryland. In late 1997 we signed a purchase agreement for Rose Shanis, the family-owned consumer finance company with approximately $45 million in loans and 12 branch offices. By mid-February of 1998 we had closed the transaction and, after a one-time charge related to a change in charge-off policy, results were immediately accretive. Earnings, credit quality, and growth at Rose Shanis have exceeded the initial expectations we had set for this company. The addition of this different, but truly complementary line of business reinforced our commitment to find opportunities to diversify revenue streams and enhance franchise value. Double-digit growth experienced over the past several months with the Rose Shanis organization has validated the strategy that led us to do the transaction: it is a logical extension of the balance sheet, in a business line where we already have considerable know-how and a favorable track record...and we have been able to expand significantly our physical presence, locational convenience, and ability to market to meaningful numbers of prospective new customers. Rose Shanis has a solid history dating to 1932, and had created a branch network of 12 strategically located offices concentrically around the Baltimore Beltway, and in the highly desirable centers of sub-market hubs; Annapolis (Anne Arundel County), Bel Air (Harford County), and Easton (central Eastern Shore). In addition to originating consumer loans, the company also finances purchases of large ticket items such as cars, appliances, and furniture through a network of dealers with whom strong, long-term relationships exist. We are firmly convinced it is a unique opportunity that could not be replicated elsewhere in the marketplace. The move to sell our Eastern Shore network enabled us to redirect valuable resources to our Central Maryland core market. Specifically, we completed the acquisition of Sterling Bancorp in Baltimore in January 1999, which provided a cost-effective and quantifiable way to improve the overall deposit base and expand our presence in selected areas where we already had good experience and an established customer following. Further, the acquisition enabled us to increase our penetration in four highly desirable sub-markets: downtown Baltimore, Pikesville, Timonium and Annapolis...all highly competitive areas in which otherwise it would have been very difficult to grow market share at a reasonable cost. In addition to the redirection of resources, the sale of the Eastern Shore branches resulted in the realization of a substantial gain. In fact, the premium received on the sale of branches exceeded the premium paid for the entire Bank of Maryland franchise in 1995 and was nearly double the premium paid for Sterling Bancorp, which was of comparable size to the branches sold. The merger with Sterling was completed in early January 1999 at a final cash purchase price of $10.294 million, adding about $74 million in total assets, $67 million in deposits, and $45 million in loans. Including Sterling, the scope of our core market network amounted to 21 banking offices. We successfully executed our basic business plan There were a number of ongoing complex, time-consuming initiatives that the organization worked on diligently throughout the past year, perhaps best described as basic blocking and tackling. First and foremost, we continued to - -------------------------------------------------------------------------------- Page 2 - -------------------------------------------------------------------------------- WHAT MAKES AN ORGANIZATION GREAT IS THE QUALITY OF ITS PEOPLE. IT IS THE PEOPLE AT EVERY LEVEL WHO HAVE CREATED THE VALUE OUR STOCKHOLDERS WILL RECEIVE IN THE MERGER. AND THE VALUE BB&T RECEIVES IN RETURN WILL BE THE SAME COMMITMENT, SUPPORT, AND LOYALTY THAT HAS BEEN SO GRACIOUSLY GIVEN TO ME BY OUR EMPLOYEES. excel at the basic business of making sound, profitable loans and gathering deposits while delivering the consistent, unparalleled brand of customer service that has garnered us the dominant (26.5+%) market share of deposits and a 40% household penetration in our Carroll County home market. Moreover, during the year we consolidated both our organizational structure and a significant number of operational activities in the Executive, Retail Banking, and Finance areas of the company to achieve permanent cost savings and greater overall efficiency in running the business. The impact and energy involved in implementing these changes tends to be somewhat under-appreciated, because we try to make the process appear transparent to customers and outsiders. Day-to-day activities were overshadowed at times by mergers and acquisitions. This is a testament to our ability to integrate new businesses and successfully manage change. Along these lines, we opened de novo branches in Baltimore City and in Reisterstown, filling gaps in market coverage in two important areas. The organization continued to advance its Year 2000 readiness across a multitude of applications and business lines under a thorough but necessary process that is a clear example of our ability to execute the basics of our business. We ensured our future viability and local focus All of these successful activities during 1998 helped position Mason-Dixon Bancshares as a highly attractive addition to BB&T Corporation's growing franchise in this region and similarly enabled our company to command a superlative valuation under the terms of the transaction. Clearly, Mason-Dixon is an excellent strategic alignment with the BB&T community banking model, where major customer decisions are made locally, where there is an intense demonstrated focus on customer service, where there will be far broader and longer-lasting opportunities for Mason-Dixon's existing employees, and where the core values and culture of the surviving institution will be remarkably similar to our own. The decision to change our strategic plan from one of independence was not easy. We arrived at this point only after your president and directors undertook a thorough and extensive study of alternative strategies to determine how we could best enhance stockholder value over the long-term. Each alternative strategy was examined with an eye toward risk and reward opportunities for stockholders, employees, customers, and the communities we serve. We chose BB&T Corporation as our merger partner because of its demonstrated commitment to enhancing stockholder value, the value it places upon employees, the support it provides to the communities in which it does business, and the extraordinary emphasis it places on superior customer service. These are the same values we subscribe to. Simply stated, a merger with BB&T was so compelling that it could not be ignored. We are proud of the objective, thoughtful, and deliberative process the board undertook in reaching this decision. While not an easy one, the board is confident that its decision is the right one. A personal note from the President I began my career with this company in 1965. At that time, its total assets were $35 million and there were four branches. Today, total assets are over $1.1 billion with 21 banking offices and 12 consumer finance offices. Over these past 34 years, I have been blessed in so many ways. I have been associated with some of the best professionals there are in this business and I have been privileged to have had the opportunity to serve as president for 17 years. What makes an organization great is the quality of its people. It is the people at every level who have created the value our stockholders will receive in the merger. And the value BB&T receives in return will be the same commitment, support, and loyalty that has been so graciously given to me by our employees. It is not the hard assets or the stockholders' equity that is of value to an acquiror, for that comes with the transaction. The real value is the people and their relationship with our customers and our communities. BB&T knows this full well and it is committed to continuing that same legacy into the future. It is our people who created the value we stockholders are receiving and it is they who deserve our heartfelt thanks. Thomas K. Ferguson President and Chief Executive Officer William B. Dulany Chairman of the Board of Directors [PHOTO] standing: Thomas K. Ferguson seated: WIlliam B. Dulany - -------------------------------------------------------------------------------- Page 3 - -------------------------------------------------------------------------------- ECONOMIC OUTLOOK ACROSS MASON-DIXON'S MAJOR MARKETS Home Market is Vibrant, Economically Diverse The company's home market, Carroll County, is situated in the northwestern quadrant of the Washington/Baltimore Common Market, which in its entirety is the nation's fourth largest consumer market. This combined region supports 6.5 million people, 2.5 million households and produces a collective personal income exceeding $131 billion in its entirety. In contrast, with a population of about 1.3 million, Carroll County is relatively small (450 square miles), but it is growing at a rate over 20% faster than the state as a whole. Over 42% of county residents are employed in managerial, professional and specialty occupations; 30% are in precision production, machine operation or craft and repair operations; administrative and clerical workers comprise 17% of the workforce and service industry accounts for 11%. Unlike other jurisdictions in which Mason-Dixon has a strong presence, Carroll County consists of a substantial agricultural base. Carroll County lies 31 miles northwest of Baltimore and 56 miles north of Washington, D.C., with the largest business clusters located in the central, western and southern portions of the county. Nearly 4,000 businesses employ 34,600 workers and manufacturing accounts for 14% of total employment. Major employers with facilities in the county include Random House, Londontown Corporation, Black & Decker, Jos. A. Bank Clothiers, Knorr Brake, Lehigh Portland Cement, English American Tailoring and Ingersoll-Dresser. The county's strategic position on the Atlantic seaboard allows overnight truck and rail access to one-third of the nation's population and manufacturing establishments. [THE FOLLOWING TABLE WAS PRESENTED AS A BAR CHART IN THE PRINTED DOCUMENT] BALTIMORE REGION SECTOR EMPLOYMENT 1986 vs. 1996 Growth Sector Employment 1986 1996 Rate - ----------------- ---- ---- ---- Services 255,768 349,561 36.7 Retail Trade 192,878 200,310 3.9 Government 186,084 199,984 7.5 Manufacturing 134,359 100,930 -24.9 FIRE* 69,214 69,950 1.1 Construction 63,867 59,269 -7.2 Wholesale Trade 60,322 57,557 -4.6 TCPU** 49,548 53,635 8.2 * FIRE is finance, insurance and real estate. ** TCPU is transportation, communications and utilities. Source: Maryland Department of Labor [THE FOLLOWING TABLE WAS PRESENTED AS A PIE CHART IN THE PRINTED DOCUMENT] BALTIMORE REGION TOTAL EMPLOYMENT BY SECTOR 1998 Services & Technology 33.3% Wholesale & Retail 23.8% Government 18.4% Manufacturing 7.8% Construction 6.1% Finance 5.8% Transportation 4.8% Source: Bureau of Labor Statistics [THE FOLLOWING TABLE WAS PRESENTED AS A PIE CHART IN THE PRINTED DOCUMENT] BALTIMORE REGION TECHNOLOGY EMPLOYMENT BY SECTOR Information Technology Services 42% High Technology Research 29% High Tech Machining & Instruments 13% Biotech & Biomedical 9% Defense & Aerospace 5% Energy & Chemicals 2% Source: Dun & Bradstreet Marketplace. 1997 - -------------------------------------------------------------------------------- EFFECTIVE BUYING INCOME* Mason-Dixon's Carroll County Core Market Maryland U.S. - -------------------------------------------------------------------------------- Median Household $ 42,068 $ 40,543 $ 33,482 Average Household 45,980 47,833 42,191 Per Capita 15,917 17,520 15,555 Total EBI (Millions) 2,313 89,147 4,161,512 * Effective Buying Income is money income less personal tax and nontax payments. It is also known as "disposable income." Source: U.S. Bureau of Economic Analysis--12/97 Data - -------------------------------------------------------------------------------- Key Contiguous Counties Show Good Growth To the east, Baltimore County firmly anchors the northern segment of the Common Market, and represents the most important contiguous natural market adjacent to Mason-Dixon's home territory. This jurisdiction features an extremely diverse economic base, ranging from heavy concentrations in primary industries to a large presence in a spectrum of high-technology sectors. Complementing and supporting this broad base is a highly skilled workforce, several national-recognized universities, unique transportation access to national and international markets, and headquarters of 6 Fortune 500 companies. The county's 19,300 businesses employ 284,000 workers. In the heart of the corridor between Baltimore and Washington, D.C. lies Anne Arundel County, which is also a natural extension of Mason-Dixon's home territory providing a spectrum of complementary dynamics to add balance and solid opportunity for future growth. The county's economy is grounded in high-technology communications, distribution and computerized support services. Over 11,000 businesses employ 138,500 workers, in a rapidly growing environment. Broader Region served by Mason-Dixon is Strong Most economists agree that the company's multi-county market area should continue to outperform the rest of the state (and the nation), in terms of leading indicators such as low unemployment, personal income growth, new housing starts, improving commercial occupancy rates, and the ongoing fundamental migration of the area's economic base towards technology and service sectors as the principal drivers of new growth and diversification. - -------------------------------------------------------------------------------- DEMOGRAPHICS OF MASON-DIXON'S PRIMARY MARKETS Est. 5-yr. Est. 5-yr. Growth Per Capita Growth Area Households Rate Income Rate - -------------------------------------------------------------------------------- Counties Carroll 50,602 11.4% $20,744 18.9% Baltimore 282,991 2.9% 23,102 16.6% Harford 75,725 10.3% 19,558 12.4% Howard 85,323 13.3% 27,078 13.5% Anne Arundel 166,662 6.2% 22,483 15.0% Maryland 1,878,523 4.3% 21,922 16.3% U.S. 98,741,200 4.9% 18,885 21.7% Average of the the 50 states and the District of Columbia Source: U.S. Dept. of Commerce--6/97 Data - --------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------- Total Households Total Employment - ------------------------------------------------------------------------------------------------------------------------------------ Jurisdiction 1995 2000 2005 CAGR (%) 1995 2000 2005 CAGR (%) - ------------------------------------------------------------------------------------------------------------------------------------ Baltimore City 268,000 268,900 270,800 .11% 452,500 457,200 461,800 .20% Anne Arundel 162,700 176,100 188,500 1.48% 258,300 274,300 289,800 1.16% Baltimore 289,000 299,700 309,900 .70% 409,600 429,100 446,400 .86% Carroll 48,400 53,300 58,200 1.86% 57,400 61,800 65,800 1.38% Harford 73,600 81,700 88,100 1.81% 80,500 89,200 96,000 1.78% Howard 81,200 94,900 108,600 2.95% 123,600 138,800 153,100 2.16% Total Region 922,900 974,600 1,024,100 1.04% 1,381,900 1,450,400 1,512,900 .91% - ------------------------------------------------------------------------------------------------------------------------------------
Source: Baltimore Metropolitan Council - -------------------------------------------------------------------------------- Page 4 - -------------------------------------------------------------------------------- SELECTED FINANCIAL DATA
Years Ended December 31, - ----------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands, except per share data) 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------------------------------- Summary of Operations Interest income $ 82,066 $ 67,435 $ 58,796 $ 46,737 $ 34,790 Interest expense 44,191 36,175 29,244 23,071 15,392 -------------------------------------------------------------------------- Net interest income 37,875 31,260 29,552 23,666 19,398 Provision for credit losses 3,677 138 836 -- -- -------------------------------------------------------------------------- Net interest income after provision for credit losses 34,198 31,122 28,716 23,666 19,398 Other operating income 17,014 7,990 7,481 4,159 3,245 Other operating expenses 36,113 26,791 24,758 17,944 13,806 -------------------------------------------------------------------------- Income before taxes 15,099 12,321 11,439 9,881 8,837 Applicable income taxes 4,288 3,162 3,003 2,582 2,225 -------------------------------------------------------------------------- Net income $ 10,811 $ 9,159 $ 8,436 $ 7,299 $ 6,612 ========================================================================== Per Share Data Net income (basic)* $ 2.13 $ 1.77 $ 1.60 $ 1.54 $ 1.52 Net income (diluted)* $ 2.13 $ 1.77 $ 1.60 $ 1.54 $ 1.52 Dividends paid* $ 0.70 $ 0.62 $ 0.52 $ 0.485 $ 0.45 Book value $ 16.20 $ 14.86 $ 13.71 $ 12.67 $ 9.89 Tangible book value $ 14.88 $ 14.28 $ 12.80 $ 11.66 $ 9.89 Shares outstanding 5,071,682 5,077,468 5,303,166 5,258,040 4,326,125 Other Data Total assets $1,102,242 $ 992,180 $ 841,074 $ 765,781 $ 507,572 Total investments $ 566,878 $ 453,900 $ 358,531 $ 340,512 $ 282,202 Total loans--net $ 453,664 $ 455,160 $ 392,997 $ 348,221 $ 192,885 Total deposits $ 640,349 $ 651,249 $ 620,735 $ 593,835 $ 383,058 Total stockholders' equity $ 82,139 $ 75,449 $ 72,699 $ 66,596 $ 42,773 Key Ratios Return on average stockholders' equity 13.82% 12.63% 12.27% 13.69% 15.28% Return on average total assets 1.02% 1.00% 1.05% 1.18% 1.34% Dividends declared to net income 32.85% 35.10% 32.60% 31.83% 29.71% Average stockholders' equity to average total assets 7.36% 7.88% 8.54% 8.60% 8.75%
* Based on the weighted average number of shares after giving effect to the 3-for-1 stock split in 1994. - -------------------------------------------------------------------------------- Page 5 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following pages of this report present management's discussion and analysis of the consolidated financial condition, results of operations and cash flows of Mason-Dixon Bancshares, Inc. ("Mason-Dixon") and subsidiaries, including its principal operating subsidiaries: Carroll County Bank and Trust Company ("Carroll County Bank"), Bank of Maryland, Rose Shanis Financial Services, LLC ("Rose Shanis") and Bay Insurance, LLC. Certain reclassifications have been made to amounts previously reported to conform with classifications made in 1998. Mason-Dixon is a multi-entity bank-holding company headquartered in Westminster, Maryland. On February 11, 1998, Mason-Dixon acquired substantially all of the assets and assumed certain liabilities of Rose Shanis Companies, a consumer finance company located in Baltimore, Maryland. Mason-Dixon paid $15.4 million in cash in a transaction accounted for as a purchase. As a result of the acquisition, Rose Shanis became a wholly-owned subsidiary of Mason-Dixon. The application of the purchase method of accounting requires that the earnings of any newly acquired company be included in consolidated earnings after the acquisition date. Assets and liabilities of the acquired company are adjusted to market value as of the date of the acquisition and are included in the consolidated statement of condition subsequent to the acquisition. Any excess of the purchase price over the net assets acquired is considered goodwill and is amortized over a period usually ranging from five to forty years. As a result of applying the purchase method of accounting, historical statements of earnings included in this Management Discussion and the accompanying financial statements are not restated to include the historical financial information of Rose Shanis prior to the acquisition. Therefore, results of operations include Rose Shanis for approximately 11 months for 1998 and not at all in 1997 or 1996. Portions of this annual report contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about the Company's confidence, policies, and strategies, the Year 2000 issue, provisions and allowance for credit losses, adequacy of capital levels, and liquidity. Such forward-looking statements involve certain risks and uncertainties, including general economic conditions, competition in the geographic and business areas in which the Company and its affiliates operate, inflation, fluctuations in interest rates, legislation, and governmental regulations. These risks and uncertainties are described in more detail in Mason-Dixon's Form 10-K, Exhibit 99, under the heading "Risk Factors." Actual results may differ materially from such forward-looking statements. Mason-Dixon assumes no obligation to update forward-looking statements at any time. Performance Overview Mason-Dixon achieved a record level of earnings for 1998, marking the 14th consecutive year of higher profits. Net income for 1998 totaled $10,811,000, an increase of 18% over 1997's net income of $9,159,000. Basic and diluted earnings per share were $2.13 in 1998, up 20% from $1.77 in 1997. Mason-Dixon's return on average assets was 1.02%, compared to 1.00% posted in 1997. Return on average stockholders' equity was 13.82%, increasing from 12.63% in 1997. Several significant non-recurring items affected net income in 1998. The table below highlights the various non-recurring gains and expenses and their effects on reported net income. Core net income (excludes non-recurring gains and expenses of $665,000) for 1998 totaled $10,146,000, an increase of 11% over $9,159,000 reported in 1997. Basic and diluted earnings per share on core earnings totaled $2.00, an increase of 13% compared to $1.77 for 1997. Mason-Dixon's return on average assets based on core earnings was .95%, lower than the 1.00% posted in 1997. Return on average stockholders' equity was 12.97%, increasing from 12.63% in 1997. Contributing to the rise in core earnings were increased levels of net interest income of $6,615,000 and higher levels of fee income which grew by $2,307,000. Offsetting these increases were increased non-interest expenses of $7,316,000. (dollars in thousands, except per share data) 1998 - -------------------------------------------------------------------------------- Reported net income $ 10,811 Non-recurring items Gain on sale of branches (6,717) Special loan loss provision for loans with Year 2000 risk 918 Special loan loss provision for change in chargeoff policy 2,000 Reorganization costs 465 Year 2000 costs 700 Impairment loss on mortgage sub-servicing rights 841 Income tax expense on the non-recurring items above 1,128 -------- Core net income $ 10,146 ======== The acquisition of Rose Shanis in 1998, as well as the acquisition of Bank of Maryland in 1995, required the application of the purchase method of accounting, which created significant levels of goodwill. The recorded goodwill is a non-cash charge to earnings being amortized over a 10 year period for Rose Shanis and 15 years for Bank of Maryland, using the straight-line method. The amortization of goodwill and other non-cash items created as a result of the application of purchase accounting has significant effects on Mason-Dixon's reported earnings and operating ratios. The introduction of these non-cash items affects the comparability of - -------------------------------------------------------------------------------- Page 6 - -------------------------------------------------------------------------------- Mason-Dixon's earnings and operating ratios for periods subsequent to these acquisitions. To assist in the comparison of earnings and operating ratios, the table below adjusts reported earnings and operating ratios to "cash" or "tangible" results, which negates the effects of purchase accounting on earnings and operating ratios. The reporting of tangible results for comparative purposes has become more important to stockholders over recent years due to the increase in acquisitions being accounted for under the purchase method of accounting. (dollars in thousands, except per share data) 1998 1997 - -------------------------------------------------------------------------------- Reported net income $ 10,811 $ 9,159 Purchase method adjustments Tax-deductible goodwill amortization 188 -- Non-deductible goodwill amortization 268 346 Other purchase accounting adjustments (net of income taxes) (126) (250) Acquired net operating loss income tax benefits 609 609 ------------------------ Tangible net income $ 11,750 $ 9,864 ======================== Tangible operating ratios Tangible basic earnings per share (1) $ 2.32 $ 1.90 Tangible return on average assets (2) 1.11% 1.08% Tangible return on average equity (3) 16.41% 14.51% (1) Tangible net income divided by average shares outstanding. (2) Tangible net income divided by average total assets, less average goodwill. (3) Tangible net income divided by average equity, less average goodwill. Tangible net income totaled $11,750,000 for 1998, compared to $9,864,000 in 1997; an increase of 19%. Tangible earnings per share increased 22% to $2.32 for 1998, compared to $1.90 for 1997. Tangible return on average assets and return on average equity were 1.11% and 16.41%, respectively, for 1998, compared to 1.08% and 14.51% in 1997. Adjusting for the various non-recurring items discussed earlier, tangible net income from core earnings totaled $11,084,000 for 1998, increasing by 12%, compared to $9,864,000 in 1997. Tangible earnings per share (basic and diluted) equaled $2.18, an increase of 15% compared to the $1.90 recorded in 1997. Tangible return on average assets and return on average equity based on core earnings were 1.05% and 15.48%, respectively, for 1998, compared to 1.08% and 14.51% in 1997. Net Interest Income Net interest income continues to be the principal component of net income and totaled $37,875,000. Net interest income for 1997 was $31,260,000. The increase in net interest income was primarily attributable to the growth in earning assets and the acquisition of Rose Shanis. - -------------------------------------------------------------------------------- Page 7 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) A significant portion of earning assets are tax exempt instruments; therefore, it is more appropriate to analyze net interest income on a tax equivalent basis which adjusts interest income for the tax exempt status of certain loans and investment securities to an amount approximating what would have been earned if the income were fully taxable. The following table highlights the major components of net interest income, adjusting for tax equivalency, for the past three years:
(dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------------ Earning assets Loans (1) $ 482,300 $48,812 10.12% $432,581 $39,175 9.06% $365,778 $34,122 9.33% Interest bearing deposits in banks 6,228 368 5.91% 634 23 3.63% 210 16 7.62% Federal funds sold 21,821 1,185 5.43% 19,725 1,110 5.63% 21,826 1,176 5.39% Investments: Mortgage-backed securities 251,388 16,936 6.74% 249,611 17,579 7.04% 221,624 15,315 6.91% U.S. Government (2) 135,173 8,934 6.61% 69,053 4,543 6.58% 61,575 4,128 6.70% Other securities (3) 27,813 2,044 7.35% 11,202 913 8.15% 4,929 357 7.24% State and municipal (4) 84,603 7,017 8.29% 81,902 6,833 8.34% 72,394 6,029 8.33% ------------------------------------------------------------------------------------------- Total earning assets 1,009,326 85,296 8.45% 864,708 70,176 8.12% 748,336 61,143 8.17% ------ ------ ------ Non-interest earning assets Cash and due from banks 18,803 20,294 19,701 Premises and equipment 15,171 15,427 15,552 Other assets 28,297 24,688 26,313 Allowance for credit losses (8,550) (5,320) (4,827) ---------- -------- -------- Total assets $1,063,047 $919,797 $805,075 ========== ======== ======== Interest bearing liabilities Demand deposits $ 58,315 $ 1,166 2.00% $ 58,169 $ 1,336 2.30% $ 58,676 $ 1,514 2.58% Savings deposits 174,830 5,158 2.95% 184,972 5,964 3.22% 182,857 5,628 3.08% Time deposits 317,714 17,841 5.62% 302,205 16,898 5.59% 286,557 15,860 5.53% Borrowings 332,649 20,026 6.02% 204,608 11,977 5.85% 115,919 6,242 5.38% ------------------------------------------------------------------------------------------- Total interest bearing liabilities 883,508 44,191 5.00% 749,954 36,175 4.82% 644,009 29,244 4.54% ------ ------ ------ Non-interest bearing liabilities Demand deposits 90,666 89,488 83,825 Other 10,621 7,858 8,471 Stockholders' equity 78,252 72,497 68,770 ---------- -------- -------- Total liabilities and stockholders' equity $1,063,047 $919,797 $805,075 ========== ======== ======== Net interest spread $41,105 3.45% $34,001 3.30% $31,899 3.63% ======= ======= ======= Net interest margin 4.07% 3.93% 4.26%
(1) Interest income includes tax equivalent adjustment of $194,000 for 1998, $164,000 for 1997 and $165,000 for 1996. (2) Interest income includes tax equivalent adjustment of $589,000 for 1998, $190,000 for 1997 and $132,000 for 1996. (3) Interest income includes tax equivalent adjustment of $62,000 for 1998, $61,000 for 1997 and $0 for 1996. (4) Interest income includes tax equivalent adjustment of $2,385,000 for 1998, $2,326,000 for 1997 and $2,050,000 for 1996. - -------------------------------------------------------------------------------- Page 8 - -------------------------------------------------------------------------------- Net interest income on a tax equivalent basis was $41,105,000, an increase of 21% from 1997's net interest income of $34,001,000. The tax equivalent net interest margin increased to 4.07% from 3.93%. The increase in the margin occurred as average rates on earning assets increased 33 basis points, while the average rates paid on deposits and borrowings increased by 18 basis points. Yields on loans increased 106 basis points, primarily due to the addition of Rose Shanis. Changes in net interest income occur from year to year due to changes in both the levels of earning assets and interest bearing liabilities, as well as the average rates received on earning assets and average rates paid on deposits and borrowings. Changes in the levels of earning assets and interest bearing liabilities are referred to as volume-related variances, while changes in average rates received on earning assets and average rates paid on deposits and borrowings are referred to as rate-related variances. The following table summarizes the changes in tax equivalent net interest income due to volume and rate variances: (dollars in thousands) 1998 compared to 1997 - -------------------------------------------------------------------------------- Increase (decrease) due to - -------------------------------------------------------------------------------- Volume Rate Total - -------------------------------------------------------------------------------- Interest income Loans $ 4,503 $ 5,134 $ 9,637 Investments: Mortgage-backed securities 125 (768) (643) U.S. Government 4,350 41 4,391 Other securities 1,354 (223) 1,131 State and municipal 226 (42) 184 Other earning assets 321 99 420 ----------------------------------- Total interest income 10,879 4,241 15,120 Interest expense Interest bearing demand deposits 3 (173) (170) Savings deposits (327) (479) (806) Time deposits 867 76 943 Borrowings 7,495 554 8,049 ----------------------------------- Total interest expense 8,038 (22) 8,016 ----------------------------------- Net interest income $ 2,841 $ 4,263 $ 7,104 =================================== (dollars in thousands) 1997 compared to 1996 - -------------------------------------------------------------------------------- Increase (decrease) due to - -------------------------------------------------------------------------------- Volume Rate Total - -------------------------------------------------------------------------------- Interest income Loans $ 6,232 $(1,179) $ 5,053 Investments: Mortgage-backed securities 1,934 330 2,264 U.S. Government 501 (86) 415 Other securities 454 102 556 State and municipal 792 12 804 Other earning assets (81) 22 (59) ----------------------------------- Total interest income 9,832 (799) 9,033 Interest expense Interest bearing demand deposits (13) (165) (178) Savings deposits 65 271 336 Time deposits 866 172 1,038 Borrowings 4,776 959 5,735 ----------------------------------- Total interest expense 5,694 1,237 6,931 ----------------------------------- Net interest income $ 4,138 $(2,036) $ 2,102 =================================== Interest income on a tax equivalent basis totaled $85,296,000, an increase of $15,120,000 or 22%, from 1997. The increase was attributable to higher levels of average earning assets which grew $144,618,000 or 17%, compared to 1997, as well as higher yields on loans. The mix of average earning assets changed little from 1997, while average yields increased 33 basis points due to higher yields on loans added in the Rose Shanis acquisition. Interest expense totaled $44,191,000, up $8,016,000 or 22%, from $36,175,000 in 1997. Average interest bearing deposits increased $5,513,000 and average borrowings increased $128,041,000, resulting in higher interest expense. The mix of interest bearing liabilities shifted to more costly borrowings and time deposits and resulted in an overall increase in average rates paid for interest bearing liabilities of 18 basis points. Included in the increase in borrowings is the issuance of $20,000,000 of Preferred Securities issued by Mason-Dixon Capital Trust II, which carry an annual dividend rate of 8.40% and a $20,000,000, 10-year subordinated note with an annual cost of 7.48%. The Trust Preferred Securities and the notes were issued to raise cash for the acquisition of Rose Shanis and to payoff an existing line of credit maintained by Rose Shanis which had a higher overall cost. The Trust Preferred Securities and the note are discussed further in the Balance Sheet Review of this Management Discussion, as well as in Note 11 of the consolidated financial statements. - -------------------------------------------------------------------------------- Page 9 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Provision and Allowance for Credit Losses Mason-Dixon places a strong emphasis on asset quality and performs a thorough analysis of the risks in its loan portfolio and the allowance for credit losses. Each subsidiary maintains an adequate allowance for credit losses and performs a regular overview to assure that adequacy. Review of the loan portfolio and assessment of the adequacy of the allowance for credit losses is a continuing process in light of changing economic conditions and changes in the strength of borrowers. In management's opinion, the allowance for credit losses is adequate as of December 31, 1998. The provision for credit losses in 1998 totaled $3,677,000, compared to $138,000 in 1997. The increase in the provision is largely due to two significant provisions recognized in 1998. Concurrent with the acquisition of Rose Shanis, the chargeoff policy for the consumer finance receivables purchased was changed to align write-offs of these receivables more closely with industry standards. As a result, consumer finance receivables are now generally charged off when they become 180 days delinquent on a contractual basis. Prior to the acquisition, Rose Shanis charged off receivables at 270 days delinquent on a contractual basis and 90 days on a recency basis. This change in policy resulted in a one-time increase in net chargeoffs approximating $2,000,000. Also during 1998, Mason-Dixon's banking affiliates performed necessary due diligence of loans with possible risks related to the Year 2000 issue. The resultant analysis of these loans resulted in a special provision of $918,000. Net chargeoffs increased by $2,822,000 to total $2,896,000. As a percentage of average loans, net chargeoffs were .60%, compared to .02% in 1997. Excluding the chargeoffs associated with the change in chargeoff policy for Rose Shanis (approximately $2,000,000), net chargeoffs as a percentage of average loans totaled .19%. This increase resulted due to higher net chargeoffs at banking affiliates, as well as chargeoffs associated with Rose Shanis. The table below shows net chargeoffs of banking affiliates, and Rose Shanis individually. Loss levels increased during 1998 primarily as a result of losses associated with Rose Shanis. Mason-Dixon will likely experience higher net chargeoffs in the future due to the somewhat higher risk associated with consumer finance receivables. The effects of these losses are significantly mitigated by the higher margins associated with the consumer finance receivables and higher reserve levels which exist for Rose Shanis. Net Chargeoffs Analysis (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Net chargeoffs Banking affiliates $ 493 $ 74 Rose Shanis 2,403 -- -------------------------- Total $ 2,896 $ 74 ========================== Average loans Banking affiliates $444,361 $432,581 Rose Shanis 37,939 -- -------------------------- Total $482,300 $432,581 ========================== Net chargeoffs as a percentage of average loans Banking affiliates 0.11% 0.02% Rose Shanis 6.33% -- Total 0.60% 0.02% The allowance for credit losses was 1.92% of loans outstanding at December 31, 1998 and 1.14% at December 31, 1997. The significant increase is associated with the higher reserves of Rose Shanis, as well as increased reserves for the banking affiliates. The table below highlights the reserve levels for banking affiliates and Rose Shanis. Allowance for Credit Losses Analysis (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Allowance for credit losses Banking affiliates $ 5,853 $ 5,231 Rose Shanis 3,040 -- -------------------------- Total $ 8,893 $ 5,231 ========================== Period end loans Banking affiliates $418,719 $460,391 Rose Shanis 43,838 -- -------------------------- Total $462,557 $460,391 ========================== Allowance as a percentage of period end loans Banking affiliates 1.40% 1.14% Rose Shanis 6.93% -- Total 1.92% 1.14% - -------------------------------------------------------------------------------- Page 10 - -------------------------------------------------------------------------------- In addition to the stated reserves, Rose Shanis further mitigates losses through reserves established by dealers who sell notes to Rose Shanis. These reserves are held to absorb losses on notes purchased from dealers and are classified as liabilities on the balance sheet, since the reserves are refundable to the dealer if the notes are paid off as agreed. The total amount of dealer reserves at December 31, 1998 included in other liabilities totaled $331,000. Accruing loans 90 days past due and non-accrual loans (non-performing loans) totaled $6,078,000 (1.31% of loans outstanding), compared to $3,786,000 (.82% of loans outstanding) at year end 1997. Coverage of non-performing loans (allowance for credit losses divided by non-performing loans) equaled 1.46x at December 31, 1998, compared to 1.38x at December 31, 1997. As with other credit quality statistics, Mason-Dixon's level of non-performing loans has been materially increased as a result of the Rose Shanis acquisition. Again, this risk is mitigated by substantially higher net interest margins and significant reserves. The table below highlights levels of non-performing loans and coverage ratios for banking affiliates and Rose Shanis separately. Non-Performing Loans Analysis (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Non-performing loans Banking affiliates $ 4,030 $ 3,786 Rose Shanis 2,048 -- -------------------------- Total $ 6,078 $ 3,786 ========================== Period end loans Banking affiliates $418,719 $460,391 Rose Shanis 43,838 -- -------------------------- Total $462,557 $460,391 ========================== Non-performing loans as a percentage of period end loans Banking affiliates 0.96% 0.82% Rose Shanis 4.67% -- - -------------------------------------------------------------------------------- Total 1.31% 0.82% Allowance coverage of non-performing loans Banking affiliates 1.45x 1.38x Rose Shanis 1.48x -- - -------------------------------------------------------------------------------- Total 1.46x 1.38x Other Operating Income Other operating income consists of service charges on deposit accounts, fees for trust services, gains on sales of loans and securities, commissions received on sales of retail investment products and credit related insurance products, loan servicing fees and other miscellaneous income, such as safe deposit box rental fees and sales of assets. Total other operating income amounted to $17,014,000, up $9,024,000 or 113%, from 1997. Other operating income in 1998 included a one-time gain on the sale of branches of $6,717,000. Excluding the one-time gain, other operating income increased by $2,307,000, or 29%. Contributing to the increase was significant growth in mortgage banking revenue, commission income of Rose Shanis and Bay Insurance, as well as increases in most other components of other operating income. Service charges decreased $183,000 due to the loss of service charge income associated with the demand deposit accounts of the branches which were sold in June of 1998. Trust Division income continued to increase, up by $195,000, or 13%. Trust assets under management grew by $20,100,000 to reach $224,000,000. Gains on sales of securities totaled $792,000, compared to $554,000 in 1997. Gains on sales of mortgage loans increased to $2,140,000, compared to gains of $1,843,000 in 1997. The increase accompanied continued growth in mortgage loan origination volume. All other sources of other operating income increased by $1,760,000, or 93%. Most of the increase resulted from commissions from the sales of credit related insurance products from Rose Shanis and Bay Insurance which added $1,566,000. Fees on debit card transactions increased $66,000, while commissions from the sales of mutual funds increased $58,000. Other Operating Expenses Total other operating expenses increased by $9,322,000 or 35%. Most components of other operating expenses increased. Total operating expenses added through the acquisition of Rose Shanis totaled $5,746,000. Non-recurring items included in the overall increase in operating expenses include reorganization costs of $465,000, Year 2000 expenses totaling $700,000 and an impairment recognition in value of mortgage sub-servicing rights of $841,000. Excluding the effects of Rose Shanis and the various non-recurring items, expenses increased $1,570,000, or 6%. Salaries and employee benefits increased by $5,127,000 or 32%. Salary costs related to Rose Shanis added approximately $3,386,000, while reorganization costs added $465,000. Otherwise, salaries and benefits increased by $1,276,000, or 8%. This increase resulted from normal increases in salaries, as well as higher incentive compensation paid from increased mortgage and mutual fund volume. Net occupancy expenses grew by $175,000 or 7%. Occupancy costs associated with Rose Shanis added $244,000. Excluding Rose Shanis, occupancy declined $69,000, reflecting the decrease in occupancy costs associated with the sale of the branches. Equipment expenses increased by $340,000. This increase is attributable to added costs of Rose Shanis of - -------------------------------------------------------------------------------- Page 11 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) $152,000, as well as higher depreciation expenses associated with several technology related initiatives. Legal and other professional fees decreased by $71,000. Expenses in 1997 were higher as a result of litigation expenses associated with a group of dissident stockholders, as well as increased consulting fees. Outside data processing expenses increased by $22,000 or 2%. Normal inflationary increases in this category were mitigated somewhat by the sale of the branches which decreased average account volumes for 1998. Amortization of mortgage sub-servicing rights totaled $1,198,000 in 1998, increasing $783,000 when compared to 1997. The increase in expense reflects the write-down of the book value of mortgage sub-servicing rights of $841,000. Mortgage sub-servicing rights permit the company to maintain escrow and other deposits for loans serviced by a third party. The impairment recognition resulted from a change in valuation method which more closely aligns the carrying value of these rights to current market rates of interest as well as recently quoted market values. Decreases in market interest rates and increases in prepayments of the underlying pools have both contributed to the underlying valuation. Decreases in market interest rates result in lower potential investment income from investing the deposits, while higher prepayments reduce the projected remaining life of the income stream generated by investing the deposits. Mortgage sub-servicing rights are discussed in detail in the Balance Sheet Review of this Management Discussion, as well as in the notes to the consolidated financial statements. Amortization of intangible assets totaled $643,000 in 1998, compared to $444,000 in 1997. Intangible assets being amortized included goodwill created as a result of purchase acquisitions, as well as a core deposit intangible acquired in the Bank of Maryland merger. Amortization for 1998 reflects increases for the goodwill associated with the Rose Shanis acquisition of $436,000. Intangible amortization relating to the acquisition of Bank of Maryland decreased $237,000 due to a core deposit amortization which was fully amortized in the fourth quarter of 1997, as well as a reduction in goodwill associated with the branches which were sold during 1998, thereby reducing amortization expense beginning in June 1998. The adjustment in the goodwill for the sale of the branches is discussed in more detail in the Balance Sheet section of this Management Discussion. Other expenses increased by $2,749,000 or 81%. Other expenses of Rose Shanis added $1,965,000, while costs associated with remedying Year 2000 issues approximated $700,000. Excluding these items, other expenses increased by $84,000, or 2%. Income Taxes Income tax expenses increased $1,126,000 from 1997, and the effective tax rate for 1998 was 28.4%, up from 25.7% in 1997. The increase is attributable to increased taxable income and the non-deductibility of the goodwill reduction associated with the sale of branches, which more than offset higher levels of tax exempt income. Note 17 of the consolidated financial statements includes a reconciliation of Federal income tax expense computed using the Federal statutory rate of 35%. See Notes 1 and 17 of the consolidated statements for additional information relating to income tax expense and deferred tax benefits. LIQUIDITY AND INTEREST RATE RISK Liquidity describes the ability of Mason-Dixon and its bank subsidiaries to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the banks' customers and to fund current and planned expenditures. Through its bank subsidiaries, Mason-Dixon derives liquidity from increased customer deposits, the maturity distribution of the investment portfolio, loan repayments and income from earning assets. To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met utilizing short-term funds markets. Longer term funding requirements can be obtained through advances from the Federal Home Loan Bank ("FHLB"). Mason-Dixon's bank subsidiaries maintain lines of credit with the FHLB of $315,000,000, with a remaining availability of $45,449,000. At December 31, 1998, Mason-Dixon's loan-to-deposit ratio was 72%. Additionally, Mason-Dixon's securities classified as available for sale, which totaled $381,512,000, were available for the management of liquidity and interest rate risk. Mortgage-backed securities classified as held to maturity, which totaled $52,269,000, provide significant cash flow each month. Cash and cash equivalents at December 31, 1998 were $25,643,000, down from $37,963,000 at year end 1997, primarily due to a decline in Federal funds sold. Management is not aware of any trends, demands, commitments, or uncertainties that are reasonably likely to result in material changes in liquidity. Interest rate sensitivity is an important factor in the management of the composition and maturity configurations of earning assets and funding sources. Asset/Liability Committees of the subsidiary banks manage the interest rate sensitivity position in order to maintain an appropriate balance between the maturity and repricing characteristics of assets and liabilities that is consistent with liquidity, growth and capital adequacy goals. - -------------------------------------------------------------------------------- Page 12 - -------------------------------------------------------------------------------- Mason-Dixon's interest rate sensitivity at December 31, 1998, on a consolidated basis, is set forth in the table below:
After 3 After 1 Non- Months- Year- Interest Within Within Within After Sensitive (dollars in thousands) 3 Months 1 Year 5 Years 5 Years Funds Total - --------------------------------------------------------------------------------------------------------------------------- Assets Investment securities $101,482 $ 99,957 $265,821 $ 99,618 $ -- $ 566,878 Loans (including loans held for sale) 175,120 52,588 194,444 48,050 -- 470,202 Other rate sensitive assets 3,001 -- -- -- -- 3,001 Interest sensitivity hedges on assets 15,000 -- (5,000) (10,000) -- -- Non-interest earning assets -- -- -- -- 62,161 62,161 --------------------------------------------------------------------- Total Assets $294,603 $ 152,545 $455,265 $137,668 $ 62,161 $1,102,242 ===================================================================== Liabilities and Stockholders' Equity Interest bearing deposits $ 71,499 $ 205,888 $242,629 $ 25,387 $ -- $ 545,403 Short-term borrowings 41,816 -- -- -- -- 41,816 Long-term borrowings 142,885 52,143 73,285 60,034 -- 328,347 Interest sensitivity hedges on liabilities (22,000) -- 22,000 -- -- -- Non-interest bearing liabilities and stockholders' equity -- -- -- -- 186,676 186,676 --------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $234,200 $ 258,031 $337,914 $ 85,421 $ 186,676 $1,102,242 ===================================================================== Interest rate sensitivity gap $ 60,403 $(105,486) $117,351 $ 52,247 $(124,515) Cumulative interest rate sensitivity gap $ 60,403 $ (45,083) $ 72,268 $124,515 $ -- Cumulative ratio of interest sensitive assets to interest sensitive liabilities 1.26 0.91 1.09 1.14 1.00
Assumptions: The rate sensitivity analysis provided in the preceding table indicates the sensitivity to fluctuations in interest rates by analyzing maturity and repricing information for selected categories of assets and liabilities. Other rate sensitive assets, consisting of Federal funds sold and interest bearing deposits in banks, are assigned to an immediately repricable category, as these are overnight investments. Mortgage-backed investments are categorized based on the estimated amortization of these securities using recent prepayment histories. Fixed rate, noncallable investments are grouped by final maturity date. Fixed rate callable investments are grouped based on management's estimates of call probability. Variable rate investments are categorized according to the next available repricing opportunity. Fixed rate loans are grouped in the appropriate category based on normal scheduled amortization. Variable rate loans are categorized based on the next available repricing opportunity. Interest bearing deposits without a contractual maturity are based on management's estimates of deposit withdrawals. Interest bearing deposits with contractual maturities are categorized based on the effective maturity of the deposit. Long-term borrowings with call provisions are grouped based on management's estimates of call probability. At December 31, 1998, Mason-Dixon had a negative one year GAP (rate sensitive liabilities in excess of rate sensitive assets) of $45,083,000, which was 4% of total assets. At five years, Mason-Dixon has a positive GAP (rate sensitive assets in excess of rate sensitive liabilities) of $72,268,000, or 7% of total assets. At December 31, 1997, Mason-Dixon had a positive one year GAP of $42,252,000 and a positive five year GAP of $85,069,000. The change in cumulative GAP position at one-year was due to increases in investment securities with maturities beyond one year, and increases in interest bearing deposits and long-term borrowings which are assumed to reprice within one year. These changes were the result of balance sheet strategies employed after the sale of branches. Securities with longer maturities were purchased to replace the loans sold, while borrowings with somewhat shorter repricing opportunities replaced a portion of the deposits sold. Mason-Dixon tests its interest rate sensitivity through the deployment of simulation analysis. Earnings simulation models are used to estimate what effect specific interest rate changes would have on one year of net interest income. Derivative financial instruments, such as interest rate swaps, are included in the analysis. Interest rate caps and floors on all products are included to the extent they become effective within a one year period. Changes in prepayments have been included where changes in payment behavior pattern are assumed to be significant to the simulation. Call features on certain securities are based on their projected call probability in view of the assumed rate environment. At December 31, 1998, Mason-Dixon's estimated earnings sensitivity profile reflected a modest sensitivity to interest rate changes. Based on an assumed - -------------------------------------------------------------------------------- Page 13 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 100 basis point immediate increase in interest rates, Mason-Dixon's pretax net interest income would increase by $576,000 (1%) if rates were to increase by 100 basis points, and decline by $1,097,000 (3%) should rates fall 100 basis points. Mason-Dixon's bank subsidiaries employ the use of interest rate swaps to manage the interest rate risks of certain transactions and manage overall levels of interest rate risk. Interest rate swaps involve an agreement to exchange fixed and variable rate interest payments based on a notional amount. The use of interest rate swaps involves no exposure to loss of principal, as swaps do not involve the exchange of notional amounts, only net interest payments. Any credit risk is equal to the fair value of the instrument if a counterparty fails to perform, which is normally a small percentage of the notional amount and fluctuates with movements in interest rates. Counterparty risk is mitigated by executing all transactions in national markets with highly rated counterparties using International Derivatives Association Master Agreements. At December 31, 1998, the notional amount of all interest rate swaps totaled $82,000,000. The risk of loss due to failure of the counterparty to perform was $112,000, which is the total of all interest rate swaps in a gain position. The terms of all interest rate swaps as of December 31, 1998 were as follows: Interest Rate Swaps that mature within: One Two Five Ten (dollars in thousands) Year Years Years Years Total - ------------------------------------------------------------------------------ Pay fixed/receive floating: Notional amount $5,000 $15,000 $10,000 $32,000 $62,000 Weighted average rates received 5.19% 5.45% 5.69% 5.36% 5.42% Weighted average rates paid 5.11% 6.44% 5.24% 5.36% 5.58% Receive fixed/pay floating: Notional amount $ -- $20,000 $ -- $ -- $20,000 Weighted average rates received -- 5.55% -- -- 5.55% Weighted average rates paid -- 5.38% -- -- 5.38% Balance Sheet Review Total assets ended 1998 at $1,102,242,000, eclipsing $1 billion for the first time and increasing $110,062,000, or 11%. The growth in total assets reflects increased levels of loans and investment securities. The increase in assets was funded through increases in borrowed funds and stockholders' equity. Investment securities totaled $566,878,000, an increase of $112,978,000 or 25%. Much of the increase occurred due to the purchase of $60,000,000 of investment securities to replace loans sold in the branch sale. Securities classified as held to maturity decreased $18,679,000, or 9%, as maturities and prepayments exceeded purchases in this portfolio. The market value of the held to maturity investments was $188,522,000, a 2% unrealized appreciation over the amortized cost of $185,366,000. Securities classified as available for sale increased by $131,657,000, driven by the securities purchased to replace sold loans, as well as more aggressive management of Federal funds sold. Management believes that the available for sale portfolio, which totaled $381,512,000 at December 31, 1998, is more than sufficient to allow for prudent management of liquidity and interest rate risk. Overall, the securities portfolio was comprised mainly of U.S. Treasury securities and obligations of U.S. government agencies or sponsored agencies, which totaled $339,311,000 (60%). Obligations of states and political subdivisions totaled $99,885,000 (18%) at December 31, 1998. For several years, management has increased the holdings of tax exempt securities. The increase has been attributable to attractive tax equivalent yields, compared to alternative high quality securities with similar term structures. Continued growth in the level of the tax exempt portfolio will be influenced by tax equivalent rates offered on tax exempt securities compared to other investment alternatives, potential changes in tax laws and Alternative Minimum Tax considerations. - -------------------------------------------------------------------------------- Page 14 - -------------------------------------------------------------------------------- Loans increased by $2,166,000. In June of 1998, approximately $58,370,000 of loans were included in the sale of the Eastern Shore branches. In February 1998, approximately $44,366,000 of loans were added with the acquisition of Rose Shanis. Excluding the sale and acquisition, loans increased $16,170,000 or 4%. Changes in loans outstanding resulting from the branch sale, the acquisition of Rose Shanis, and other activity are presented in the table below:
Rose Shanis Branch December 31, Loans Loans Other December 31, (dollars in thousands) 1997 Acquired Sold Activity 1998 - ----------------------------------------------------------------------------------------------------------------------------------- Construction and land development $ 31,427 $ -- $ -- $ 9,835 $ 41,262 Residential real estate--mortgage 186,978 423 (42,452) 6,054 151,003 Commercial real estate--mortgage 136,194 -- (4,308) (4,061) 127,825 Commercial 88,669 -- (6,850) 5,347 87,166 Consumer 17,464 44,619 (4,760) (2,020) 55,303 -------------------------------------------------------------------------------- Total loans 460,732 45,042 (58,370) 15,155 462,559 Unearned income on loans (341) (676) -- 1,015 (2) -------------------------------------------------------------------------------- Loans (net of unearned income) $ 460,391 $ 44,366 $ (58,370) $ 16,170 $ 462,557 ================================================================================
Construction and land development loans increased $9,835,000, or 31%. Residential real estate mortgages decreased by $35,975,000, or 19%. Residential loans sold with the branch sale totaled $42,452,000. While the volume of portfolio mortgage loans increased in 1998, maturities and prepayments accelerated. These effects resulted in a net gain in outstandings of $6,054,000, or 3%, excluding the effects of the branch sale and Rose Shanis acquisition. Commercial real estate mortgage loans decreased with loans divested in the branch sale totaling $4,308,000. Commercial loans also decreased ($1,503,000, or 2%) with total commercial loans sold equaling $6,850,000. Prepayment activity accelerated in commercial mortgages and regular commercial loans. Consumer loans increased $37,839,000, primarily due to the acquisition of Rose Shanis, bringing consumer loans to 12% of total loans outstanding. As a result of activity during 1998, the mix in the portfolio is more evenly balanced compared to December 31, 1997. Deferred income taxes decreased by $392,000. Utilization of net operating loss carryforwards totaled $609,000. This decline in deferred taxes was offset by the increase in deferred taxes related to the available for sale investment portfolio. The unrealized gain on available for sale securities decreased by $579,000, increasing deferred income taxes by $223,000. Mortgage servicing and sub-servicing rights declined by $1,199,000, due to normal scheduled amortization, as well as the recognition of an impairment loss of $841,000. The valuation method of these rights was changed in light of recent declines in market interest rates and declines in approximate market value of the sub-servicing rights. Bank of Maryland holds mortgage sub-servicing rights to maintain escrow and other deposits for mortgages serviced by Greystone, a mortgage servicing company. These rights are valued much like a core deposit intangible, with the value of the rights to place the deposits driven by current market rates of interest and expected life of the mortgages being serviced. Recent declines in market interest rates and increasing prepayments of the underlying mortgages resulted in a reduced value. The right to maintain these deposits, both interest bearing and non-interest bearing, were purchased originally for $10,030,000. The purchase price is being amortized using the straight-line method. At year end, accumulated amortization had reduced the book value to $2,119,000. Valuations are performed regularly to determine if there has been any significant deterioration in value which would require an adjustment in reported book value. Carroll County Bank had unamortized mortgage servicing rights totaling $94,000 at year end 1998, compared to $95,000 on December 31, 1997. Intangible assets at December 31, 1998 represent goodwill created as a result of the Bank of Maryland and Rose Shanis acquisitions. Goodwill is typically created in acquisitions accounted for under the purchase method of accounting and represents the excess of the purchase price over the fair value of the net assets acquired. This amount is being amortized over 15 years for the Bank of Maryland acquisition and 10 years for the Rose Shanis acquisition using the straight-line method. Goodwill was also reduced by $1,128,000 to recognize the proportionate decrease in unamortized goodwill associated with the Eastern Shore branches sold. The proportionate goodwill reduction amount was based on the estimated net income produced by these branches as a percentage of total net income for Bank of Maryland. This reduction of goodwill is governed by Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of," which requires the - -------------------------------------------------------------------------------- Page 15 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) immediate recognition of any impairment in long-lived assets. The remaining book value of Bank of Maryland goodwill was $1,640,000 at December 31, 1998. Goodwill attributable to the acquisition of Rose Shanis of $5,450,000 was recorded in February of 1998. The remaining unamortized goodwill totaled $5,014,000 at December 31, 1998. Total deposits decreased by $10,900,000, or 2%. Most deposit types decreased due to the sale of branches. The following table highlights the changes in overall deposit levels and the amounts attributable to the sale of the branches: Branch December 31, Deposits Other December 31, (dollars in thousands) 1997 Sold Activity 1998 - -------------------------------------------------------------------------------- Non-interest bearing deposits $ 89,692 $ (8,553) $ 13,807 $ 94,946 NOW accounts 63,782 (8,292) 9,182 64,672 Regular savings 94,248 (8,010) 2,942 89,180 Money market savings 89,106 (5,655) (9,008) 74,443 Time deposits 314,421 (56,742) 59,429 317,108 ---------------------------------------------------- Total deposits $651,249 $(87,252) $ 76,352 $640,349 ==================================================== Deposits balances sold totaled $87,252,000. Excluding the sale of deposits, deposits increased $76,352,000 or 12%. Trends continued toward growth in non-interest demand deposits accounts and higher cost certificates of deposits. Most of the growth in deposits (excluding the deposits sold) occurred in time deposits which grew by $59,429,000, or 19%. Non-interest bearing deposits increased $13,807,000, or 15%. NOW accounts also grew by 14%, to $64,672,000 at year end 1998. Money market accounts decreased 10%, while regular savings accounts decreased by 3%. Short-term borrowings decreased by $55,387,000. The decrease resulted as a significant amount of short-term borrowings were converted to long-term FHLB advances. These increased advances were utilized to achieve lower overall cost or to realize other beneficial features of a longer-term maturity structure. Long-term borrowings increased by $167,458,000 or 104%. Borrowings from the FHLB increased $128,075,000, which supported growth in earning assets, replaced a portion of the deposits sold and converted several short-term borrowings to long-term borrowings. The use of advances from the FHLB has increased over the last several years. These advances often carry longer-term fixed rates and provide a funding source that minimizes interest rate risk on long-term fixed rate loans. Variable rate advances are also utilized to lower funding costs, as FHLB advances can be an alternative to repurchase agreements or other short-term funding sources. Longer-term maturities available on variable rate FHLB advances provide a longer-term source of liquidity, compared to short-term funding sources. Some of the fixed rate advances have call provisions, which may result in repayment of the advance before the stated maturity. Several variable rate advances have interest rate reset options, which may result in adjustments to stated rates of interest. In addition to increases in FHLB borrowings, Mason-Dixon completed the issuance of $20,000,000 of Preferred Securities of Mason-Dixon Capital Trust II, a Trust established by Mason-Dixon for financing purposes. The issuance was completed in April of 1998. Mason-Dixon also completed in April of 1998 the placement of $20,000,000 of long-term fixed rate senior notes with a 10-year maturity. The proceeds from the issuance of the Preferred Securities and the notes were used to pay for the cash acquisition of Rose Shanis, as well as to repay a line of credit Rose Shanis maintained with a financial institution. The repayment of the variable rate line of credit with the fixed rate notes and Preferred Securities provided Rose Shanis with a fixed rate source of funding, thereby insulating Rose Shanis from any interest rate risk on its fixed rate loan portfolio. The Preferred Securities issued during 1998 have a fixed dividend yield of 8.40%, redemption date of June 30, 2028 and are subject to varying call provisions beginning April 22, 2003. The stated value of the Preferred Securities is unconditionally guaranteed on a subordinated basis by Mason-Dixon. Issuance costs associated with the Preferred Securities are being amortized to maturity using the straight-line method. The senior notes carry a fixed interest rate of 7.48% and a redemption date of April 22, 2008. Stockholders' Equity and Capital Resources Total stockholders' equity ended 1998 at $82,139,000, up $6,690,000 from year end 1997. Retained earnings grew $7,260,000 as a result of $10,811,000 in net income, less $3,551,000 in cash dividends paid. Accumulated other comprehensive income, consisting solely of unrealized appreciation in certain debt and equity securities, decreased by $355,000, as market values ended 1998 somewhat lower than year end 1997. The market value, net of tax effect, is included as a separate component of stockholders' equity. Net reduction in common stock and surplus totaled $215,000, reflecting several small share repurchases and issuances during 1998. Various regulatory agencies have implemented capital adequacy guidelines which are based on an individual institution's risk profile. By regulatory definition, a "well capitalized" institution has a total capital ratio of 10% or more, a Tier 1 capital ratio of 6% or more and a capital leverage ratio of 5% or more. Institutions which maintain ratios to qualify as "well capitalized" face fewer regulatory hindrances in operations and qualify for the lowest deposit insurance premiums. Minimum ratios of 8%, 4%, and 3% have been established for - -------------------------------------------------------------------------------- Page 16 - -------------------------------------------------------------------------------- total capital, Tier 1 capital and capital leverage ratios, respectively. Tier 1 capital consists of stockholders' equity and qualifying Trust Preferred Securities, less unrealized gains on securities classified as available for sale and intangible assets. Deferred income tax assets which cannot be realized in the next 12 months are also disallowed from Tier 1 capital. Total capital consists of Tier 1 capital, plus any portion of Trust Preferred Securities which do not qualify as Tier 1 capital, and the qualifying amount of the allowance for credit losses. Trust Preferred Securities are limited by regulation for inclusion as Tier 1 capital to a maximum of one-third of "core capital elements." Any amount in excess of one-third of core capital elements qualifies for inclusion as total capital. Core Capital Elements are defined as total stockholders' equity adjusted for any unrealized gain or loss on securities classified as available for sale. The amount of the allowance for credit losses which is included as total capital is limited to a maximum of 1.25% of risk-adjusted assets. The following table summarizes Mason-Dixon's capital adequacy for 1998 and 1997: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Tier 1 Capital: Total stockholders' equity $ 82,139 $ 75,449 Qualifying trust preferred securities (1) 26,782 20,000 Less: Unrealized appreciation on certain debt and equity securities 1,794 2,149 Intangible assets 6,654 2,956 Disallowed deferred income taxes 4,208 4,771 ---------------------------- Total Tier 1 Capital 96,265 85,573 Total Capital: Add: Qualifying trust preferred securities (1) 13,218 -- Qualifying allowance for credit losses (2) 8,025 5,231 ---------------------------- Total Capital $ 117,508 $ 90,804 ============================ Risk-weighted assets $ 642,007 $ 580,693 Quarterly average assets $1,084,984 $ 979,160 Total Capital Ratio (3) 18.30% 15.64% Tier 1 Capital Ratio (4) 14.99% 14.74% Capital Leverage Ratio (5) 8.87% 8.74% (1) Trust Preferred Securities qualifying as Tier 1 Capital are limited to one-third of core capital elements. Remainder qualify as Total Capital. (2) Allowance for credit losses qualifying for Total Capital is limited to 1.25% of risk-weighted assets. (3) Total Capital divided by risk-weighted assets. (4) Tier 1 Capital divided by risk-weighted assets. (5) Tier 1 Capital divided by quarterly average assets. All measures of capital adequacy improved significantly in 1998 primarily due to growth in stockholders' equity and the issuance of additional Trust Preferred Securities. The issuance of Trust Preferred Securities in 1998 added $6,782,000 to eligible Tier 1 and $20,000,000 to Total Capital of Mason-Dixon. The Capital Leverage Ratio improved from 1997 as the percentage increase in qualifying capital was greater than the increase in average quarterly assets. Both Total Capital and Tier 1 Capital Ratios increased as the rate of growth of qualifying capital was greater than the rate of growth of risk-weighted assets. Management believes the increased levels of regulatory capital are sufficient to support the future growth of Mason-Dixon while maintaining a "well capitalized" regulatory status. See Note 12 to the consolidated financial statements for more detailed information relating to capital adequacy ratios. 1997 Compared to 1996 The following discussion and analysis provides a comparison of Mason-Dixon's results of operations for the years ended December 31, 1997 and 1996. This discussion should be read in conjunction with the consolidated financial statements and related notes included in this report. Performance Overview Mason-Dixon's net income of $9,159,000 represented a 9% increase over 1996's net income of $8,436,000. Basic and diluted earnings per share were $1.77 and $1.60 for 1997 and 1996, respectively; an increase of 11%. Return on average stockholders' equity was 12.63%, increasing from 12.27% in 1996. Return on average assets for 1997 was 1.00%, down from 1.05% in 1996. Factors contributing to the increase in profits were higher levels of net interest income, which increased $1,708,000, and other operating income which grew by $509,000. Tangible net income was $9,864,000, an increase of 10% over 1996 tangible net income of $8,960,000. Tangible return on average assets was 1.08% for 1997, compared to 1.12% for 1996. Tangible return on average equity equaled 14.51%, up from 14.02% for 1996. Net interest income totaled $31,260,000, compared to $29,552,000 for 1996, with most of the increase attributable to growth in average earning assets, which increased by 16%. The tax equivalent net interest margin decreased to 3.93% in 1997, down from 4.26% in 1996. The decrease occurred as average rates earned on earning assets decreased 5 basis points, while average rates on deposits and borrowings increased by 28 basis points. The provision for credit losses in 1997 totaled $138,000, compared to $836,000 recognized in 1996. The decrease in the provision was largely attributable to the decrease in net chargeoffs. Net chargeoffs totaled $74,000 in 1997, compared - -------------------------------------------------------------------------------- Page 17 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) to $398,000 in 1996. Net losses as a percentage of average total loans was .02% in 1997, compared to .11% in 1996. Other operating income increased $509,000 or 7% from 1996. Service charges increased $100,000 due to increased volume of overdrafts and Automated Teller Machine transactions. Trust Division income continued to increase, up by 5%, or $64,000. Trust assets under management grew by $42,645,000 to reach $203,900,000. Gains on sales of securities totaled $554,000, compared to $271,000 for 1996. Gains on sales of mortgage loans increased to $1,843,000, compared to $584,000 for 1996, due to a significant increase in the volume of loan originations and subsequent sales. 1996's other operating income included a gain on the sale of branch deposits of $1,469,000. All remaining sources of other operating income for 1997 increased by $272,000, largely due to increased commissions from sales of mutual funds and annuities. Total other operating expenses increased by $2,033,000 or 8%. All components of other operating expenses increased, with the exception of amortization expense of other intangible assets. Salaries and employee benefits increased by $1,676,000 or 12%. Salary costs related to mortgage banking activities increased approximately $826,000. Otherwise, salaries and benefits increased by $850,000, or 6%. This increase resulted from normal increases in salaries, as well as staff increases. Retirement plan expenses decreased by $168,000. Net occupancy expenses grew by $214,000 or 9%. Increases in maintenance and repairs, as well as additional rental expenses for the opening of additional mortgage offices, contributed to the increase. Equipment expenses increased by $50,000. This increase is primarily attributable to higher depreciation expenses associated with several technology related initiatives. Federal Deposit Insurance Corporation (FDIC) insurance expenses increased to $78,000. Congress enacted legislation in 1996 resulting in the merger of the Bank Insurance Fund (BIF) with the Savings Association Insurance Fund (SAIF). Pursuant to the recapitalization and merger of the insurance funds, annual assessments for banks were increased by the FDIC beginning in 1997. Outside data processing expenses increased by $60,000 or 6%, due primarily to additional account volume. Amortization of mortgage sub-servicing rights totaled $415,000 in 1997, equal to 1996. This expense reflects the amortization of the purchase price of mortgage sub-servicing rights acquired in the purchase of Bank of Maryland. Mortgage sub-servicing rights permit the company to maintain escrow and other deposits for loans serviced by a third party. These rights are discussed in detail in the Balance Sheet Review of this Management Discussion, as well as in the notes to the consolidated financial statements. Amortization of intangible assets totaled $444,000 in 1997, compared to $493,000 in 1996. Intangible assets being amortized included goodwill created as a result of the merger, as well as a core deposit intangible acquired in the merger. The lower amortization amount for 1997 reflects a reduction in amortization for the core deposit intangible, which was fully amortized at November 30, 1997. Other expenses decreased by $380,000 or 10%. Expenses in 1996 included $256,000 for costs associated with the disposition of the Bethesda branch of Bank of Maryland. Income tax expenses increased $159,000 from 1996, due to higher levels of pretax net income. The effective tax rate for 1997 was 25.7%, down slightly from 26.3% in 1996. Note 17 to the consolidated financial statements includes a reconciliation of Federal income tax expense computed using the Federal statutory rate of 35%. See Notes 1 and 17 to the consolidated statements for additional information relating to income tax expense and deferred tax benefits. Year 2000 This is a Year 2000 Readiness Disclosure under the Year 2000 Information and Readiness Disclosure Act of 1998. Mason-Dixon continued its progress in preparing for the Year 2000 throughout 1998. The Year 2000 Issue is the result of computer programs and equipment which are dependent on using two digits rather than four to define any particular year. Any of Mason-Dixon's computer programs or other equipment that are date-dependent may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations, causing disruptions of operations, a temporary inability to process transactions, send invoices or engage in similar normal business activity. Mason-Dixon has had in place a task force which has been preparing information technology (IT) systems, as well as non-IT systems for over a year. Representatives of the task force regularly update Mason-Dixon's Senior Management and Board of Directors with progress reports which outline progress and future timetables for completion of critical phases of the Year 2000 project. Mason-Dixon adopted a Year 2000 plan developed by its task force in accordance with guidelines set forth by the Federal Financial Institutions Examination Council (FFIEC). Mason-Dixon expects that all phases of its Year 2000 plan will be completed by the deadlines established by the FFIEC. - -------------------------------------------------------------------------------- Page 18 - -------------------------------------------------------------------------------- The initial "assessment" phase of the Year 2000 project began in 1997 and included an inventory of all systems (IT and non-IT) with potential Year 2000 risk. Critical IT systems, which include item processing, communications with the Federal Reserve ("Fedline") and core loan and deposit processing systems were identified. Critical non-IT systems which include telephone and internal communications systems, ATM's and payroll were also identified. Vendors who provide various systems were contacted to assess their Year 2000 readiness. Mason-Dixon has completed its review of customized computer code included in the data processing system provided by its primary supplier of data processing services. The assessment phase is complete, although it is updated periodically as necessary. During the most recent quarter, the project progressed with the renovation and/or replacement of systems to achieve Year 2000 readiness and the testing of all critical and noncritical systems. Test scripts were completed for testing critical software during the most recent quarter. Mason-Dixon has completed testing of a significant number (48%) of systems as of December 31, 1998 and expects to complete testing all critical applications by March 31, 1999. Mason-Dixon expects to complete testing all systems (critical and non-critical) by September 30, 1999. From vendor responses and/or certifications of Year 2000 compliance, Mason-Dixon has determined that several critical IT and non-IT systems will have to be modified to achieve Year 2000 readiness or be replaced with Year 2000 compliant systems. Mason-Dixon does not perform in-house programming, and thus is dependent on external vendors to modify customized software code. Mason-Dixon's primary supplier of data processing services had adopted a Year 2000 plan and timetable and has provided written assurances to Mason-Dixon of its progress and intention to achieve Year 2000 readiness of both its standard system and customized computer code by March 31, 1999. Mason-Dixon expects that non-compliant systems will be replaced or renovated prior to January 1, 2000. The contingency planning phase of Mason-Dixon's Year 2000 project began during the third quarter of 1998 and was completed by the end of January 1999. This process incorporates both Business Redemption Plans and Business Resumption Plans. Business Redemption Plans identify alternative vendors with the capacity to convert systems which are not Year 2000 compliant to compliant systems prior to the end of 1999. Business Resumption Plans establish manual procedures capable of processing critical systems where transactions or volumes are limited in the event normal business operations are disrupted. The expected cost of modifications and replacements to non-compliant systems is currently estimated to be between $700,000 and $1,000,000 and is being funded through operating cash flows. To date, direct expenses related to the Year 2000 issue have been $387,000 and does not include any internal personnel costs. In the second quarter of 1998, Mason-Dixon recorded a charge to earnings of $700,000 for these estimated costs. During the second quarter of 1998, Mason-Dixon completed a review of the Year 2000 readiness of all significant borrowers. Mason-Dixon has determined that the ability of some of Mason-Dixon's customers to repay their obligations to Mason-Dixon may be impaired by their inability to remedy their own Year 2000 issues. Mason-Dixon does not anticipate that such impairment will materially impact its financial position. Mason-Dixon's monitoring of credit risk attributable to the Year 2000 issue continued through the remainder of 1998 and resulted in a year-to-date increase in the allowance for credit losses of approximately $918,000. Mason-Dixon has distributed surveys to determine the Year 2000 readiness of significant funds providers to Mason-Dixon. Responses have been received from a significant number of these providers, however, since Mason-Dixon's assessment process is not yet complete, the potential for unplanned reductions in the availability of funds from significant funding sources that have not taken appropriate steps to manage their own Year 2000 problems exists. Most of the significant funds providers are banks or bankers' banks which are subject to regulatory oversight relating to the Year 2000 issue. Follow-up and assessment of the Year 2000 readiness of significant funds providers will continue until determination of Year 2000 readiness is made. Contingency plans will be developed to provide alternative funding sources should funds providers fail to provide adequate assurance of Year 2000 readiness. Management of Mason-Dixon believes that the potential effects on Mason-Dixon's internal operations of the Year 2000 problem can and will be addressed prior to the year 2000. However, if required modifications or conversions are not made or are not completed on a timely basis prior to the year 2000, the Year 2000 problem could disrupt normal business operations. The most reasonably likely worst case Year 2000 scenarios foreseeable at this time would include Mason-Dixon temporarily not being able to process, in some combination, various types of customer transactions. This could affect the ability of Mason-Dixon to, among other things, originate new loans, post loan payments, accept deposits or allow immediate withdrawals and, depending on the amount of time such a scenario lasted, could have material adverse effects on Mason-Dixon. - -------------------------------------------------------------------------------- Page 19 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Ultimately, the success of Mason-Dixon's efforts to address the Year 2000 issue depends to a large extent not only on the corrective measures that Mason-Dixon undertakes, but also on the efforts undertaken by businesses, government entities and other independent entities who provide data to, or receive data from, Mason-Dixon, such as borrowers, vendors or deposit customers. In particular, Mason-Dixon's credit risk associated with its borrowers may increase as a result of problems such borrowers may have resolving their own Year 2000 issues. Although it is not possible to evaluate the magnitude of any potential increased credit risk at this time, the impact of the Year 2000 issue on borrowers could result in increases in problem loans and credit losses in future years. The entire cost of the project and projected completion dates are based on management's best estimates, which were derived using numerous assumptions of future events. There can be no guarantee that these estimates will be achieved and actual results could materially differ from the estimates. Factors that might affect the timely and efficient completion of Mason-Dixon's Year 2000 projects include, but are not limited to, vendors' abilities to adequately correct or convert software and the effect on Mason-Dixon's ability to test its systems, the availability and the cost of personnel trained in the Year 2000 area and the ability to identify and correct all relevant computer programs and similar uncertainties. Bank regulatory agencies assess Year 2000 readiness. The failure of a financial institution to take appropriate action to address deficiencies in the Year 2000 project management process may result in enforcement actions which could have a material adverse effect on Mason-Dixon, result in civil money penalties or result in the delay of applications seeking to acquire other entities or otherwise expand activities. Recent Stock Prices and Dividends Mason-Dixon's common stock is traded on the Nasdaq National Market(R) system under the symbol "MSDX." The number of stockholders of record as of December 31, 1998 and 1997 was 1,769 and 1,822, respectively. The table below indicates the range of stock prices and cash dividends paid in 1998 and 1997: 1998 - -------------------------------------------------------------------------------- Cash High Low Dividend - -------------------------------------------------------------------------------- 1st Quarter $36.63 $29.00 $0.17 2nd Quarter $35.25 $31.50 $0.17 3rd Quarter $33.00 $29.50 $0.17 4th Quarter $30.75 $25.00 $0.19 ================================================================================ 1997 - -------------------------------------------------------------------------------- Cash High Low Dividend - -------------------------------------------------------------------------------- 1st Quarter $22.00 $19.25 $0.15 2nd Quarter $22.25 $20.75 $0.15 3rd Quarter $28.75 $21.63 $0.15 4th Quarter $30.25 $26.00 $0.17 ================================================================================ - -------------------------------------------------------------------------------- Page 20 - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS
December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ Assets Cash and due from banks $ 22,642 $ 20,245 Interest bearing deposits in other banks 638 482 Federal funds sold 2,363 17,236 Investment securities available for sale (AFS)--at fair value 381,512 249,855 Investment securities held to maturity (HTM)--at amortized cost-- fair value of $188,522 (1998) and $206,515 (1997) 185,366 204,045 Loans held for sale 7,645 4,439 Loans (net of unearned income) 462,557 460,391 Less: Allowance for credit losses (8,893) (5,231) ---------------------------------- Loans, net 453,664 455,160 Premises and equipment 15,213 15,530 Other real estate owned 388 685 Deferred income taxes 5,697 6,089 Mortgage servicing and sub-servicing rights 2,213 3,412 Intangible assets 6,654 2,956 Accrued interest receivable and other assets 18,247 12,046 ---------------------------------- Total Assets $ 1,102,242 $ 992,180 ================================== Liabilities Non-interest bearing deposits $ 94,946 $ 89,692 Interest bearing deposits 545,403 561,557 ---------------------------------- Total deposits 640,349 651,249 Short-term borrowings 41,816 97,203 Long-term borrowings 328,347 160,889 Accrued expenses and other liabilities 9,591 7,390 ---------------------------------- Total Liabilities 1,020,103 916,731 ---------------------------------- Stockholders' Equity Common stock--$1.00 par value, authorized: 10,000,000 share, issued and outstanding: 5,071,682 shares (1998) and 5,077,468 (1997) 5,072 5,077 Surplus 35,738 35,948 Retained earnings 39,535 32,275 Accumulated other comprehensive income 1,794 2,149 ---------------------------------- Total Stockholders' Equity 82,139 75,449 ---------------------------------- Total Liabilities and Stockholders' Equity $ 1,102,242 $ 992,180 ==================================
See accompanying notes to consolidated financial statements. - -------------------------------------------------------------------------------- Page 21 CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands, except per share data) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Interest Income Interest and fees on loans $48,618 $39,011 $33,957 Interest on deposits in other banks 368 23 16 Interest on Federal funds sold 1,185 1,110 1,176 Interest and dividends on investment securities: Taxable interest on mortgage-backed securities 16,936 17,579 15,315 Other taxable interest and dividends 10,157 5,063 4,353 Tax exempt interest and dividends 4,802 4,649 3,979 ----------------------------------------- Total interest income 82,066 67,435 58,796 ----------------------------------------- Interest Expense Interest on deposits: Time certificates of deposit of $100,000 or more 2,445 2,168 1,466 Other deposits 21,720 22,030 21,536 ----------------------------------------- Total interest on deposits 24,165 24,198 23,002 Interest on short-term borrowings 3,780 4,880 2,511 Interest on long-term borrowings 16,246 7,097 3,731 ----------------------------------------- Total interest expense 44,191 36,175 29,244 ----------------------------------------- Net interest income 37,875 31,260 29,552 Provision for Credit Losses 3,677 138 836 ----------------------------------------- Net interest income after provision for credit losses 34,198 31,122 28,716 ----------------------------------------- Other Operating Income Service charges on deposit accounts 2,045 2,228 2,128 Trust Division income 1,666 1,471 1,407 Gain on sale of securities 792 554 271 Gain on sale of mortgage loans 2,140 1,843 584 Gain on sale of deposits -- -- 1,469 Gain on sale of branches 6,717 -- -- Other income 3,654 1,894 1,622 ----------------------------------------- Total other operating income 17,014 7,990 7,481 ----------------------------------------- Other Operating Expenses Salaries and employee benefits 21,236 16,109 14,433 Net occupancy expenses 2,708 2,533 2,319 Equipment expenses 1,994 1,654 1,604 Legal and professional fees 1,007 1,078 690 FDIC insurance expense 76 78 4 Outside data processing expense 1,090 1,068 1,008 Amortization of mortgage sub-servicing rights 1,198 415 415 Amortization of other intangible assets 643 444 493 Other expenses 6,161 3,412 3,792 ----------------------------------------- Total other operating expenses 36,113 26,791 24,758 ----------------------------------------- Income Before Taxes 15,099 12,321 11,439 Applicable Income Taxes 4,288 3,162 3,003 ----------------------------------------- Net Income $10,811 $ 9,159 $ 8,436 ========================================= Per Share Data Net Income Per Common Share (Basic) $ 2.13 $ 1.77 $ 1.60 ========================================= Net Income Per Common Share (Diluted) $ 2.13 $ 1.77 $ 1.60 =========================================
See accompanying notes to consolidated financial statements. - -------------------------------------------------------------------------------- Page 22 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated Other Total Common Retained Comprehensive Stockholders' (dollars in thousands, except per share data) Stock Surplus Earnings Income Equity - --------------------------------------------------------------------------------------------------------------------------- Balances at January 1, 1996 $5,258 $39,807 $20,645 $ 886 $66,596 Net income -- -- 8,436 -- 8,436 Other comprehensive income, net of tax: unrealized loss on securities of $482, net of reclassification adjustment for losses of $101 (381) (381) ------- Total comprehensive income 8,055 Cash dividends ($0.52 per share) -- -- (2,750) -- (2,750) Issuance of additional shares of common stock 45 753 -- -- 798 --------------------------------------------------------------- Balances at December 31, 1996 5,303 40,560 26,331 505 72,699 Net income -- -- 9,159 -- 9,159 Other comprehensive income, net of tax: unrealized gain on securities of $1,646, net of reclassification adjustment for losses of $2 1,644 1,644 ------- Total comprehensive income 10,803 Cash dividends ($0.62 per share) -- -- (3,215) -- (3,215) Issuance of additional shares of common stock 24 551 -- -- 575 Repurchase of common stock (250) (5,163) -- -- (5,413) --------------------------------------------------------------- Balances at December 31, 1997 5,077 35,948 32,275 2,149 75,449 Net income -- -- 10,811 -- 10,811 Other comprehensive income, net of tax: unrealized loss on securities of $565, net of reclassification adjustment for losses of $210 (355) (355) ------- Total comprehensive income 10,456 Cash dividends ($0.70 per share) -- -- (3,551) -- (3,551) Issuance of additional shares of common stock 27 777 -- -- 804 Repurchase of common stock (32) (987) -- -- (1,019) --------------------------------------------------------------- Balances at December 31, 1998 $5,072 $35,738 $39,535 $1,794 $82,139 ===============================================================
See accompanying notes to consolidated financial statements. - -------------------------------------------------------------------------------- Page 23 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows From Operating Activities Net Income $ 10,811 $ 9,159 $ 8,436 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,611 1,519 1,392 Amortization of mortgage sub-servicing rights 1,198 415 415 Amortization of intangibles 643 444 493 Net accretion of purchase accounting adjustments (206) (408) (702) Provision for credit losses 3,677 138 836 Provision for deferred taxes 616 551 598 Proceeds from sales of investment securities--Trading 12,826 3,177 4,002 Purchases of investment securities--Trading (12,740) (3,152) (4,000) Originations of loans held for sale (52,126) (46,879) (22,485) Proceeds for sales of loans held for sale 50,386 47,425 21,590 Net gain on sale of assets (8,969) (2,397) (846) Gain on sale of deposits -- -- (1,469) Net (increase) decrease in accrued interest receivable and other assets (5,759) (2,853) 913 Net (decrease) increase in accrued expenses and other liabilities (46) (1,241) 1,861 Other--net (22) 300 299 -------------------------------------- Net cash provided by operating activities 1,900 6,198 11,333 -------------------------------------- Cash Flows From Investing Activities Proceeds from maturities of investment securities--HTM 82,059 23,529 29,915 Purchases of investment securities--HTM (63,283) (35,612) (56,759) Proceeds from maturities of investment securities--AFS 88,314 27,313 46,137 Proceeds from sales of investment securities--AFS 99,399 74,842 71,249 Purchases of investment securities--AFS (319,626) (182,634) (109,518) Net increase in loans (18,563) (62,033) (45,065) Capital expenditures (3,251) (1,578) (1,873) Purchases of mortgage servicing rights -- -- (15) Purchase of loans (18) -- -- Proceeds from sales of fixed assets 2,500 -- 709 Sale of branches (21,037) -- -- Sale of deposits -- -- (18,694) Acquisitions of subsidiaries, net of cash acquired (14,993) -- -- -------------------------------------- Net cash used by investing activities (168,499) (156,173) (83,914) -------------------------------------- Cash Flows From Financing Activities Net increase in deposits 76,352 30,562 47,347 Net (decrease) increase in short-term borrowings (85,730) 43,469 4,283 Proceeds from long-term borrowings 179,350 139,402 42,819 Repayments of long-term borrowings (11,927) (63,788) (6,673) Issuance of additional shares of common stock 804 575 798 Repurchase of common stock (1,019) (5,413) -- Dividends paid (3,551) (3,215) (2,750) -------------------------------------- Net cash provided by financing activities 154,279 141,592 85,824 -------------------------------------- Net (Decrease) Increase in Cash and Cash Equivalents (12,320) (8,383) 13,243 Cash and Cash Equivalents at Beginning of Year 37,963 46,346 33,103 -------------------------------------- Cash and Cash Equivalents at End of Year $ 25,643 $ 37,963 $ 46,346 ====================================== Supplemental Cash Flow Information Interest payments $ 44,806 $ 35,439 $ 28,306 Income tax payments $ 4,778 $ 2,378 $ 1,406 Noncash Investing Activities Transfers from loans to other real estate owned $ 133 $ 184 $ 170 Elimination of valuation for deferred income taxes $ -- $ 1,400 $ --
See accompanying notes to consolidated financial statements. - -------------------------------------------------------------------------------- Page 24 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 1. Summary of Significant Accounting Policies The consolidated financial statements include the accounts of Mason-Dixon Bancshares, Inc. ("Mason-Dixon") and its subsidiaries, including principal operating subsidiaries Carroll County Bank and Trust Company ("Carroll County Bank"), Bank of Maryland, Rose Shanis Financial Services, LLC ("Rose Shanis") and Bay Insurance, LLC with all significant intercompany transactions eliminated. The accounting and reporting policies of Mason-Dixon conform to generally accepted accounting principles (GAAP) and to general practices in the banking industry. Certain reclassifications have been made to amounts previously reported to conform with the classifications made in 1998. Nature of Operations--Mason-Dixon, through its subsidiaries, conducts domestic financial services business in Central Maryland. Mason-Dixon's largest subsidiary, Carroll County Bank, is the largest commercial bank operating in Carroll County. Bank of Maryland, Rose Shanis, and Bay Insurance operate in the Baltimore Metropolitan area defined as Baltimore City and its surrounding counties. The primary financial services provided include real estate, commercial and consumer lending, as well as offering demand deposits, savings products, trust services and retail investment products. Products and services are offered to individuals, partnerships, corporations, governments and associations. Use of Estimates--The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Purchase Method of Accounting--Net assets of companies acquired in purchase transactions are recorded at the fair value at the date of acquisition. The excess of purchase price over the fair value of net assets acquired (goodwill) is amortized on a straight-line basis. Goodwill related to the acquisition of Bank of Maryland is being amortized over 15 years. Goodwill related to the acquisition of Rose Shanis is being amortized over 10 years. Investment Securities Held to Maturity--Investment securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts. Mason-Dixon has the ability and intent to hold these securities until maturity. Investment Securities Available for Sale--Investment securities designated as available for sale are stated at fair value based on quoted market prices. Securities available for sale represent those securities which management may sell as part of its asset/liability management or in response to changing interest rates, prepayment risk, or liquidity needs. The cost of securities sold is determined by the specific identification method. Trading Account Securities--Investment securities designated for the trading account are carried at fair value. Gains and losses on trading account securities are included in other operating income. Mason-Dixon had no securities classified as "trading" at December 31, 1998 or 1997. Loans Held for Sale--Loans held for sale are carried at the lower of aggregate cost or fair value. Gains and losses on sales of these loans are shown as a separate component of other operating income. Loans held for sale are originated and sold without recourse. Retention of the servicing rights to these loans for the collection of principal and interest payments and escrow account management is elected by the customer at the time of origination. The income derived from servicing these loans is included in other operating income. Loans--Loans are stated at their principal balance outstanding, net of any deferred fees and costs. Interest income on most loans is accrued at the contractual rate based on the principal outstanding. Interest income on certain installment loans is recognized on the actuarial method. Mason-Dixon discontinues the accrual of interest on loans when any portion of the principal or interest is ninety days past due and collateral is insufficient to discharge the debt in full. Interest accruals may also be discontinued earlier if management believes collection is unlikely. Loans are considered impaired when, based on current information, it is probable that the full amount of principal and interest will not be fully collected according to contractual terms. Loans are generally considered impaired once principal payments become ninety days or more past due, and the accrual of interest is discontinued. Management also considers the cash flow of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller, homogeneous loans such as consumer and residential real estate loans which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during the periods where payments are less than ninety days past due, provided eventual collection of all amounts due is expected. The impairment of a loan is measured based on present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the repayment of the loan is expected to be provided through the liquidation of the collateral. Interest income on impaired loans is recognized on the cash basis. Allowance for Credit Losses--The allowance for credit losses represents an amount which, in management's opinion, is sufficient to absorb probable future losses on existing loans and other extensions of credit that may become uncollectible. - -------------------------------------------------------------------------------- Page 25 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 The adequacy of the allowance is determined through continual review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish an appropriate level. Management considers historical loss experience, loss allocations for specific nonperforming credits, portfolio trends, the Year 2000 issue and general economic conditions. Allowances for impaired loans are generally determined based on collateral values. Loans 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 recognized as a current period expense. Management believes the allowance for credit losses is adequate to provide for potential loan losses. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions or deterioration in the overall quality of the loan portfolio. Long-Lived Assets--Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization of physical properties are computed on the straight-line method over the estimated useful lives of the properties. Expenditures for maintenance, repairs, and minor renewals are charged to operating expenses; expenditures for betterments are charged to the property accounts. Upon retirement or other disposition of properties, the carrying value and the related accumulated depreciation are removed from the accounts. Intangible assets are amortized using the straight-line method. Goodwill is being amortized over periods ranging from 10 to 15 years. Long-lived assets are evaluated regularly for other-than-temporary impairment. If circumstances suggest that their value may be impaired and the write-down would be material, an assessment of recoverability is performed prior to any write-down of the asset. Other Real Estate Owned--Real estate acquired in foreclosure of loans is carried at cost or fair value, less estimated costs of disposal, whichever is lower. Fair value is based on independent appraisals and other relevant factors. At the time of acquisition, any excess of loan balance over fair value is charged to the allowance for credit losses. Any subsequent reduction in value, as well as any operating expenses, are included in other operating expenses. Mortgage Servicing Rights--The rights to service certain mortgages, including those purchased as well as originated, are amortized in proportion to, and over the estimated period of, the related net servicing revenues. Mortgage sub-servicing rights to maintain escrow and other deposits for mortgages serviced by a mortgage servicing company are amortized using the straight-line method. Pension Plan--Mason-Dixon sponsors a defined benefit pension plan covering certain employees if they satisfy specific plan criteria. The benefits are based on years of service and the employee's average compensation during the final five years of employment. The funding policy is to contribute the maximum amount that can be deducted for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Post-Retirement Benefits--Mason-Dixon provides health care benefits for its retired employees. Certain currently active employees who meet established age and service criteria will also be eligible for health care benefits upon retirement. Carroll County Bank also provides life insurance benefits for retirees. Current employees may become eligible for these benefits if they satisfy specific plan criteria. The plan is not funded, and obligations under the plan are recognized on the accrual basis. Net Income Per Share--Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year. Diluted net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year, including any potential dilutive common shares outstanding, such as options and warrants. Stock-Based Compensation--Stock-based compensation is recognized using the intrinsic value method. For disclosure purposes, pro forma net income and earnings per share impacts are provided as if the fair value method had been applied. Income Taxes--Deferred income taxes reflect the future years' tax consequences of differences between the tax and financial accounting bases of assets and liabilities. Trust Assets and Income--Assets (other than cash deposits) held for others under fiduciary and agency relationships are not included in the accompanying balance sheets. Trust Division income is accounted for on a cash basis. Recognition of such income on an accrual basis would not materially affect reported income. Cash Flows--Mason-Dixon has defined cash and cash equivalents as those amounts included in the balance sheet captions "Cash and due from banks," "Interest bearing deposits in other banks," and "Federal funds sold." Financial Instruments--Interest rate swaps used in asset/liability management activities are accounted for using the accrual method. Net interest income (expense) resulting - -------------------------------------------------------------------------------- Page 26 - -------------------------------------------------------------------------------- from the differential between exchanging floating and fixed-rate interest payments is recorded on a current basis. Fair Value Disclosure--Disclosure of fair value information about financial instruments is presented for instruments where it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of Mason-Dixon. Cash and Cash Equivalents--The carrying amounts reported in the balance sheet for cash and cash equivalents approximate fair values for those assets. Investment Securities (including mortgaged-backed securities)--Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans Held for Sale--The fair value of loans held for sale is based upon secondary market quotations for similar instruments. Loans--For all variable rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. The fair values for fixed rate commercial, consumer and some mortgage loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Deposit Liabilities--The fair values disclosed for demand deposits (e.g., interest and non-interest bearing checking), savings and certain types of money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Short-Term and Long-Term Borrowings--The fair values of short-term and long-term borrowings (except Trust Preferred securities) are estimated using discounted cash flow analyses, based on the Banks' current incremental borrowing rates for similar types of borrowing arrangements. The fair value of Trust Preferred securities included in long-term borrowings is based on quoted market prices. Off-Balance Sheet Instruments--Fair values for loan commitments are based on fees currently charged to enter into similar agreements, taking into account remaining terms of the agreements and the counterparties' credit standards. The fair value of interest rate swaps is based upon secondary market quotations for similar contracts with like terms and conditions. Recent Accounting Pronouncements--Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive Income," was issued in June 1997. This statement established standards for reporting and displaying of comprehensive income and its components in the financial statements. The provisions of this disclosure requirement were adopted on January 1, 1998 and did not affect Mason-Dixon's financial condition or results of operations. SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," was also issued in June 1997. This statement requires that public business enterprises report financial and descriptive information about their reportable operating segments. Reportable operating segments are defined as components of an enterprise about which separate financial information is available and is evaluated regularly by the chief operating decision maker as a basis for allocating resources and assessing performance. The statement was adopted by Mason-Dixon for 1998 annual reporting and did not impact Mason-Dixon's financial condition or results of operations. SFAS No. 132, "Employer's Disclosures about Pensions and Other Postretirement Benefits," was issued in 1998. This statement modifies previous disclosure requirements and was adopted in 1998 for annual reporting. The provisions of this statement did not impact Mason-Dixon's financial condition or results of operations. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued in June 1998. This statement requires that derivative financial instruments be carried at fair value on the balance sheet. The statement continues to allow the continued use of derivatives to hedge certain risks and establishes specific criteria for the use of hedge accounting. The statement also allows for offsetting changes in fair values or cash flows of both the derivative instrument and hedged asset or liability to be recognized in earnings in the same period. Derivative instruments not accounted for as hedges must have changes in fair value recognized in earnings. This statement will become effective for reporting beginning January 1, 2000, with early adoption permitted. Mason-Dixon is reviewing the provisions of this statement. The impact of - -------------------------------------------------------------------------------- Page 27 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 adoption will depend on a number of factors, including the financial position of Mason-Dixon and the nature and purpose of the derivative instruments in place at the time the statement is adopted. 2. Mergers and Acquisitions On February 11, 1998, Mason-Dixon purchased substantially all of the assets and assumed certain liabilities of Rose Shanis Companies ("Rose Shanis") of Baltimore, Maryland. Rose Shanis is a consumer finance company which operates twelve branch offices; eleven in Central Maryland and one on Maryland's Eastern Shore. At the acquisition date, Mason-Dixon purchased assets totaling $42,500,000 and assumed certain liabilities totaling $32,600,000, for a consideration of $15,400,000 which was paid in cash. Goodwill recognized in the transaction totaled $5,450,000 and is being amortized over 10 years using the straight-line method. The acquisition is being accounted for as a purchase in accordance with Accounting Principles Board Opinion No. 16, "Business Combinations" ("APB 16"). Under the rules of this opinion, historical results of Mason-Dixon have not been restated to include Rose Shanis, however, disclosure rules governed by APB 16 require certain supplemental data be presented on a pro forma basis for the current and prior year. The following pro forma combined information reflects the results of operations for the current and prior year as though Mason-Dixon and Rose Shanis had combined at the beginning of each respective period: (dollars in thousands, except per share data) 1998 1997 - -------------------------------------------------------------------------------- Revenue $100,488 $ 89,255 Net income $ 10,615 $ 9,136 Earnings per share $ 2.09 $ 1.76 On January 5, 1999, Mason-Dixon completed the acquisition of Sterling Bancorp, a privately held commercial bank headquartered in Baltimore, Maryland. Sterling Bancorp was the parent company of Sterling Bank & Trust Co., which operated four branches; one in Baltimore City, two in Baltimore County (Pikesville and Timonium) and one in Anne Arundel County (Annapolis). On February 12, 1999, Mason-Dixon merged Sterling Bank & Trust Co. into Bank of Maryland and simultaneously closed the branch offices in Pikesville and Baltimore City, servicing existing customers of these branches through nearby Bank of Maryland locations. The acquisition was paid for in cash totaling $10,300,000 and will be accounted for as a purchase in accordance with APB 16. At December 31, 1998, Sterling Bancorp had consolidated assets approximating $73,800,000, liabilities of $67,200,000 and stockholders' equity of $6,600,000. Sterling recorded a net loss for 1998 of $250,000 before merger related expenses. Goodwill associated with the purchase will be amortized over 15 years using the straight-line method. 3. Restrictions on cash and due from banks The Federal Reserve requires banks to maintain certain minimum cash balances consisting of vault cash and deposits in the Federal Reserve Bank or in other commercial banks. The amounts of such reserves are based on percentages of certain deposit types and totaled $7,394,000 at December 31, 1998. 4. Investment Securities The amortized cost and estimated fair values of investment securities available for sale are as follows:
(dollars in thousands) 1998 - --------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - --------------------------------------------------------------------------------------------------- U.S. Treasury securities and obligations of U.S. government agencies $138,864 $ 898 $ 69 $139,693 Mortgage-backed securities 219,202 2,460 47 221,615 -------------------------------------------------- Total debt securities available for sale 358,066 3,358 116 361,308 Equity securities available for sale 20,523 94 413 20,204 -------------------------------------------------- Total investment securities available for sale $378,589 $ 3,452 $ 529 $381,512 ==================================================
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(dollars in thousands) 1997 - ------------------------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - ------------------------------------------------------------------------------------------------ U.S. Treasury securities and obligations of U.S. government agencies $ 50,233 $ 85 $ -- $ 50,318 Mortgage-backed securities 184,160 2,799 12 186,947 ----------------------------------------------- Total debt securities available for sale 234,393 2,884 12 237,265 Equity securities available for sale 11,960 630 -- 12,590 ----------------------------------------------- Total investment securities available for sale $246,353 $ 3,514 $ 12 $ 249,855 ===============================================
The amortized cost and estimated fair values of investment securities held to maturity are as follows:
(dollars in thousands) 1998 - ------------------------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - ------------------------------------------------------------------------------------------------ U.S. Treasury securities and obligations of U.S. government agencies $ 26,292 $ 190 $ -- $ 26,482 Obligations of states and political subdivisions 99,885 2,862 313 102,434 Mortgage-backed securities 52,269 544 342 52,471 Other debt securities 6,920 215 -- 7,135 ----------------------------------------------- Total debt securities held to maturity 185,366 3,811 655 188,522 Other securities -- -- -- -- ----------------------------------------------- Total investment securities held to maturity $185,366 $ 3,811 $ 655 $ 188,522 ===============================================
(dollars in thousands) 1997 - ------------------------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - ------------------------------------------------------------------------------------------------ U.S. Treasury securities and obligations of U.S. government agencies $ 40,447 $ 116 $ 34 $ 40,529 Obligations of states and political subdivisions 84,490 2,032 3 86,519 Mortgage-backed securities 77,793 674 312 78,155 ----------------------------------------------- Total debt securities held to maturity 202,730 2,822 349 205,203 Other securities 1,315 -- 3 1,312 ----------------------------------------------- Total investment securities held to maturity $204,045 $ 2,822 $ 352 $ 206,515 ===============================================
The amortized cost and fair value of debt securities at December 31, 1998, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Available for Held to (dollars in thousands) Sale Portfolio Maturity Portfolio - -------------------------------------------------------------------------------- Amortized Fair Amortized Fair Cost Value Cost Value - -------------------------------------------------------------------------------- Due in one year $ 5,304 $ 5,315 $ 7,313 $ 7,388 Due after one year through five years 23,653 24,039 13,546 13,928 Due after five years through ten years 109,907 110,339 41,091 41,973 Due after ten years -- -- 71,147 72,762 Mortgage-backed securities 219,202 221,615 52,269 52,471 ----------------------------------------- Total debt securities $358,066 $361,308 $185,366 $188,522 ========================================= Proceeds from sales of investments in securities were $99,399 in 1998, $74,842 in 1997, and $71,249 in 1996. - -------------------------------------------------------------------------------- Page 29 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 Gross gains and gross losses on investment securities were as follows: (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Gross gains $812 $778 $431 Gross losses $ 20 $224 $160 Investment securities held to maturity with a book value of $43,166,000 and investment securities available for sale with a book value of $263,848,000 at December 31, 1998, were pledged as collateral for certain liabilities as required or permitted by law. There were no state, county, and municipal securities whose book value, as to any issuer, exceeded 10% of stockholders' equity at December 31, 1998 or 1997. 5. Loans and Allowance for Credit Losses At December 31, loans were as follows: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Construction and land development $ 41,262 $ 31,427 Residential real estate--mortgage 151,003 186,978 Commercial real estate--mortgage 127,825 136,194 Commercial 87,166 88,669 Consumer 55,303 17,464 --------------------------- Total loans 462,559 460,732 Unearned income on loans (2) (341) --------------------------- Loans (net of unearned income) $ 462,557 $ 460,391 =========================== Proceeds from sales of loans in 1998 and 1997 were $50,386,000 and $47,425,000, respectively. Changes in the allowance for credit losses were as follows: (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Balance at January 1 $ 5,231 $ 5,167 $ 4,729 Allowance applicable to loans of acquired company 2,881 -- -- Provision charged to operating expense 3,677 138 836 Recoveries 579 503 338 Loans charged off (3,475) (577) (736) ------------------------------------ Balance at December 31 $ 8,893 $ 5,231 $ 5,167 ==================================== In accordance with SFAS Nos. 114 and 118, "Accounting By Creditors for Impairment of a Loan" and "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures," Mason-Dixon has identified certain loans as impaired. The following table presents information relating to impaired loans as of December 31: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Actual recorded investment at year end $2,237 $1,716 ==================== Average recorded investment $2,044 $1,586 ==================== Allowance for credit losses relating to all impaired loans $ 339 $ 364 ==================== Cash payments: Applied to principal $ 14 $ 40 Applied to interest 49 95 -------------------- Totals $ 63 $ 135 ==================== 6. Premises and Equipment At December 31, premises and equipment consisted of the following: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Land $ 2,981 $ 3,325 Buildings and leasehold improvements 12,808 14,911 Vehicles and equipment 10,865 10,187 Construction and projects-in-process 1,263 463 -------------------- 27,917 28,886 Accumulated depreciation and amortization 12,704 13,356 -------------------- Premises and equipment, net $15,213 $15,530 ==================== Depreciation expense on premises, equipment and leasehold improvements totaled $1,611,000, $1,519,000 and $1,392,000, for 1998, 1997 and 1996, respectively. Total rental expenses for premises and equipment were $1,151,000 for 1998, $1,077,000 for 1997 and $1,060,000 for 1996. At December 31, 1998, the aggregate minimum rental commitments under all noncancelable operating leases for premises are indicated below. There were no rental commitments for equipment. (dollars in thousands) - -------------------------------------------------------------------------------- 1999 $ 1,233 2000 1,167 2001 1,132 2002 1,074 2003 1,010 Thereafter 4,408 ------- Total $10,024 ======= In addition to minimum rentals, certain leases have escalation clauses and include provisions for additional payments to cover taxes, insurance and maintenance. - -------------------------------------------------------------------------------- Page 30 - -------------------------------------------------------------------------------- 7. Mortgage Servicing and Sub-Servicing Rights Bank of Maryland retains the mortgage sub-servicing rights to maintain escrow and other deposits for mortgages currently serviced by Greystone, a mortgage servicing company. As of December 31, the total amounts of these deposits included in the consolidated statements of financial condition were $13,278,000 for 1998 and $16,373,000 for 1997. The $10,030,000 purchase price is reduced by $7,911,000 in accumulated amortization and write-down costs as of December 31, 1998. An impairment loss of $841,000 was recorded during 1998, reflecting a deterioration in value precipitated by lower market interest rates and higher prepayment levels related to the underlying mortgages. Carroll County Bank retains servicing on certain loans it sells into the secondary market. At December 31, 1998, Carroll County Bank's servicing portfolio totaled $74,998,000. The servicing portfolio totaled $95,463,000 and $106,880,000 at December 31, 1997 and 1996, respectively. Escrow deposit balances relating to the servicing portfolio were $303,000, $911,000 and $1,310,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The amounts capitalized in connection with acquiring the right to service mortgage loans were $12,000 in 1998, $26,000 in 1997 and $50,000 in 1996. Unamortized mortgage servicing rights at December 31, 1998 and 1997 were $94,000 and $95,000, respectively. 8. Intangible Assets Intangible assets at December 31, 1998 consisted of the unamortized portion of goodwill related to the purchases of Bank of Maryland and Rose Shanis. The original goodwill for Bank of Maryland of $5,191,000 has been reduced by accumulated amortization of $1,023,000, the elimination during 1997 of a $1,400,000 valuation originally established for deferred income tax assets acquired and a reduction of $1,128,000 in 1998 reflecting the goodwill associated with the sale of five branches on the Eastern Shore of Maryland. 9. Deposits At December 31, deposits were as follows: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Non-interest bearing deposits $ 94,946 $ 89,692 Interest bearing deposits: Passbook and statement savings 89,180 94,248 Money market savings 74,443 89,106 Time deposits: $100,000 or more 50,901 45,068 Less than $100,000 266,207 269,353 ------------------------ Total time deposits 317,108 314,421 NOW accounts 64,672 63,782 ------------------------ Total interest bearing deposits 545,403 561,557 ------------------------ Total deposits $640,349 $651,249 ======================== 10. Short-Term Borrowings Short-term borrowings include securities sold under agreements to repurchase, which are securities sold to customers, at the customers' request, under a "roll-over" contract that matures in one business day. The underlying securities sold are U.S. Treasury notes or notes of Federal agencies which are segregated in Mason-Dixon's custodial accounts from other investments securities. The following table summarizes certain information for short-term borrowings: (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Average amount outstanding during year $ 68,729 $ 87,173 $ 45,823 Weighted average interest rate during year 5.50% 5.60% 5.48% Amount outstanding at year end $ 41,816 $ 97,203 $ 53,734 Weighted average interest rate at year end 4.70% 5.73% 5.42% Maximum amount at any month end $107,529 $119,774 $ 67,607 - -------------------------------------------------------------------------------- Page 31 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 11. Long-Term Borrowings Long-term borrowings consisted of the following as of December 31, 1998: (dollars in thousands) 1998 - -------------------------------------------------------------------------------- Federal Home Loan Bank of Atlanta (FHLB): 5.30% Advance due January 18, 1999 $ 3,980 5.09% Advance due February 3, 2000 10,000 5.47% Advance due April 18, 2000 40,000 5.26% Advance due May 2, 2000 30,000 5.31% Advance due July 10, 2000 11,918 5.20% Advance due July 10, 2000 582 5.00% Advance due September 20, 2000 571 5.21% Advance due July 10, 2001 9,500 6.03% Advance due June 26, 2002 25,000 5.66% Advance due September 24, 2002 5,000 4.91% Advance due January 15, 2003 10,000 4.91% Advance due September 15, 2003 6,000 5.03% Advance due November 26, 2007 25,000 4.99% Advance due June 12, 2008 25,000 5.51% Advance due June 23, 2008 5,000 4.89% Advance due July 10, 2008 25,000 5.31% Advance due July 20, 2008 5,000 5.31% Advance due July 21, 2008 20,000 5.09% Advance due August 28, 2008 5,000 4.74% Advance due September 11, 2008 7,000 -------- Subtotal 269,551 Unsecured Senior Notes--7.48% due April 22, 2008 20,000 Mason-Dixon Capital Trust I--10.07% due June 15, 2027, net of $569 underwriting discount 19,431 Mason-Dixon Capital Trust II--8.40% due June 30, 2028, net of $635 underwriting discount 19,365 -------- Total $328,347 ======== The contractual annual maturities on long-term borrowings over the next five years are as follows: 1999--$3,980,000; 2000--$93,071,000; 2001--$9,500,000; 2002--$30,000,000; 2003--$16,000,000. Actual principal payments on the advances may vary, as Mason-Dixon has the option of prepaying principal on several advances. Some advances have interest rate reset provisions, which may result in changes to interest rates from the rates included in the table above. Mason-Dixon has pledged $89,548,000 of residential mortgage loans and $222,042,000 of investment securities as collateral for the advances. In June of 1997, Mason-Dixon Capital Trust ("MDCT"), a wholly-owned subsidiary of Mason-Dixon, issued $20,000,000 10.07% Preferred Securities due in 2027. MDCT invested the proceeds of the Preferred Securities, combined with $619,000 paid by Mason-Dixon for MDCT's Common Securities, in $20,619,000 of Mason-Dixon's 10.07% Junior Subordinated Debentures. MDCT's sole asset is the Junior Subordinated Debentures which matures in 2027. Mason-Dixon has fully and unconditionally guaranteed all of MDCT's obligations under the Preferred Securities. The Preferred Securities of MDCT qualify for inclusion in Tier 1 Capital under current capital guidelines and are subject to varying call provisions beginning in 2007. In April of 1998, Mason-Dixon Capital Trust II ("MDCT II"), a wholly-owned subsidiary of Mason-Dixon, issued $20,000,000 8.40% Preferred Securities due in 2028. MDCT II invested the proceeds of the Preferred Securities, combined with $619,000 paid by Mason-Dixon for MDCT II's Common Securities, in $20,619,000 of Mason-Dixon's 8.40% Junior Subordinated Debentures. MDCT II's sole asset is the Junior Subordinated Debentures which matures in 2028. Mason-Dixon has fully and unconditionally guaranteed all of MDCT II's obligations under the Preferred Securities. A portion of the Preferred Securities of MDCT II qualify for inclusion in Tier 1 Capital under current capital guidelines, while any amount not qualifying as Tier 1 Capital is included in Total Capital. Preferred Securities issued by MDCT II are subject to varying call provisions beginning in 2003. In April of 1998, Mason-Dixon issued $20,000,000 of its 7.48% Senior Notes through a private placement. The notes are not secured by any assets of Mason-Dixon, are non-amortizing and mature in full in 2008. The note agreement contains various covenants which are considered usual and customary. 12. Stockholders' Equity Dividend Restriction--Under Maryland banking law, the Boards of Directors of Mason-Dixon subsidiary banks may declare cash dividends to Mason-Dixon from undivided profits and, with the prior consent and approval of the Bank Commissioner, from each individual bank's excess surplus after providing for expenses, losses, interest and taxes accrued or due. The amount of cash dividends that Mason-Dixon's subsidiaries could have paid without approval from the Bank Commissioner totaled $15,440,000 at December 31, 1998. Capital Adequacy--Mason-Dixon and its subsidiary banks ("the Banks") are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. - -------------------------------------------------------------------------------- Page 32 - -------------------------------------------------------------------------------- Quantitative measures defined by regulation to ensure capital adequacy require the Banks to maintain the amounts and ratios of total and Tier I capital to risk-weighted assets and of capital leverage to average assets as set forth in the following table. As of December 31, 1998, management believes that the Banks meet all capital adequacy requirements to which they are subject. The most recent notification from the Federal Deposit Insurance Corporation categorized the Banks as well capitalized under the regulatory framework for prompt corrective action as of December 31, 1998. To be categorized as well capitalized, the Banks must maintain minimum total capital, Tier I capital, and capital leverage ratios as indicated in the table. There are no conditions or events since that notification that management believes have changed the Banks' category. The Banks' actual capital amounts and ratios are also presented as of December 31, 1998 and 1997.
To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions - ----------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------------------------------------------------- As of December 31, 1998 Total Capital (to Risk-Weighted Assets): Mason-Dixon $117,508 18.30% $51,361 8.00% $64,201 10.00% Carroll County Bank $ 51,464 12.75% $32,302 8.00% $40,378 10.00% Bank of Maryland $ 23,555 12.69% $14,850 8.00% $18,562 10.00% Tier 1 Capital (to Risk-Weighted Assets): Mason-Dixon $ 96,265 14.99% $25,680 4.00% $38,520 6.00% Carroll County Bank $ 48,609 12.04% $16,151 4.00% $24,227 6.00% Bank of Maryland $ 21,234 11.44% $ 7,425 4.00% $11,137 6.00% Capital Leverage (to Average Assets): Mason-Dixon $ 96,265 8.87% $32,550 3.00% $54,249 5.00% Carroll County Bank $ 48,609 6.39% $22,810 3.00% $38,017 5.00% Bank of Maryland $ 21,234 7.84% $ 8,124 3.00% $13,541 5.00% As of December 31, 1997 Total Capital (to Risk-Weighted Assets): Mason-Dixon $ 90,804 15.64% $46,447 8.00% $58,059 10.00% Carroll County Bank $ 55,239 15.44% $28,621 8.00% $35,777 10.00% Bank of Maryland $ 22,862 10.51% $17,402 8.00% $21,753 10.00% Tier 1 Capital (to Risk-Weighted Assets): Mason-Dixon $ 85,573 14.74% $23,222 4.00% $34,833 6.00% Carroll County Bank $ 52,533 14.68% $14,314 4.00% $21,471 6.00% Bank of Maryland $ 20,337 9.35% $ 8,700 4.00% $13,050 6.00% Capital Leverage (to Average Assets): Mason-Dixon $ 85,573 8.74% $29,373 3.00% $48,955 5.00% Carroll County Bank $ 52,533 7.48% $21,069 3.00% $35,116 5.00% Bank of Maryland $ 20,337 7.71% $ 7,913 3.00% $13,189 5.00%
- -------------------------------------------------------------------------------- Page 33 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 Dividend Reinvestment Plan--Mason-Dixon sponsors a Dividend Reinvestment and Stock Purchase Plan. This plan provides for 125,000 shares of Mason-Dixon's common stock to be reserved for issuance under the plan. The plan allows for participating stockholders to purchase additional shares by reinvesting the dividends paid on shares registered in their name, by making optional cash purchases or both. Shares reinvested or purchased are acquired in the open market at fair market value (average high and low sale price on the investment date as quoted on NASDAQ). Optional cash purchases are limited to a maximum of $5,000 per calendar quarter. Mason-Dixon reserves the right to amend, modify, suspend or terminate the plan at its discretion at any time. 13. Pension and Profit Sharing Plans Mason-Dixon sponsors a defined benefit pension plan which covers certain employees. Benefits are based on years of service and the employee's average compensation. The funding policy is to contribute the maximum amount deductible for Federal income tax purposes. Contributions provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Net pension cost includes the following components: (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Service cost--benefits earned during year $ 389 $ 318 $ 373 Interest cost on projected benefit obligation 504 490 475 Expected return on plan assets (740) (616) (519) Amortization of transition asset (52) (52) (21) Amortization of prior service cost (21) -- -- ------------------------------ Net pension cost $ 80 $ 140 $ 308 ============================== Weighted average discount rate used in determining the actuarial present value of the projected benefit obligation 6.75% 7.25% 7.50% Rate of increase in future compensation 5.50% 5.50% 5.50% Long-term rate of return on assets 9.00% 9.00% 9.00% The following table sets forth the plan's funded status and amounts recognized in the balance sheet at December 31: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Change in benefit obligation Benefit obligation at beginning of year $ 7,160 $ 6,987 Service cost 389 318 Interest cost 504 490 Plan participants' contributions -- -- Amendments -- (524) Actuarial loss 667 166 Benefits paid (301) (277) ---------------------- Benefit obligation at end of year 8,419 7,160 ---------------------- Change in plan assets Fair value of assets at beginning of year 8,106 6,829 Actual return on plan assets 715 1,033 Employer contributions 504 521 Plan participants' contributions -- -- Benefits paid (301) (277) ---------------------- Fair value of assets at end of year 9,024 8,106 ---------------------- Funded status 605 946 Unrecognized transition asset (108) (160) Unamortized prior service cost (257) (278) Unrecognized actuarial loss/(gain) 458 (234) ---------------------- Net amount recognized $ 698 $ 274 ====================== Mason-Dixon sponsors an employee savings and investment plan under the provisions of Section 401(k) of the Internal Revenue Code. The plan covers substantially all employees meeting age and service requirements and provides for both employee and employer matching contributions and additional unmatched discretionary contributions. Participants in either matched or unmatched contributions may be required to invest a portion in common stock of Mason-Dixon. Contributions to the plan totaled $232,000 for 1998, $249,000 for 1997 and $352,000 for 1996. 14. Stock Options Mason-Dixon has awarded stock options to directors and executive officers pursuant to various compensation plans. Each grant was made at a price equal to the fair market value of the stock on the date of the grant. Options are granted upon approval of the Board of Directors under various vesting schedules with a maximum exercise term of 10 years. - -------------------------------------------------------------------------------- Page 34 - -------------------------------------------------------------------------------- Information with respect to options is as follows for the years ended December 31:
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Pricing Pricing Pricing Shares Range Shares Range Shares Range - --------------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 10,905 $19.75-$21.00 4,500 $ 21.00 -- $ -- Granted 18,631 29.75- 33.00 6,405 19.75 4,500 21.00 Exercised -- -- -- -- -- -- Expired/canceled/forfeited (1,040) 33.00- 33.00 -- -- -- -- ---------------------------------------------------------------- Outstanding at end of year 28,496 $19.75-$33.00 10,905 $19.75-$21.00 4,500 $21.00 ================================================================ Weighted average exercise price $ 27.48 $ 20.27 $21.00
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: 1998 1997 1996 - -------------------------------------------------------------------------------- Dividend yield 2.06% 2.73% 2.73% Expected volatility 30.00% 30.00% 30.00% Risk-free interest rate 5.69% 6.29% 6.29% Expected lives 10 years 10 years 10 years Mason-Dixon has adopted the disclosure only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," but applies Accounting Principles Board No. 25 and related interpretations in accounting for options. If Mason-Dixon had elected to recognize compensation cost based on the fair value at the grant dates for awards prescribed by SFAS 123, pro forma net income and basic earnings per share would have been as follows: (dollars in thousands, except per share data) 1998 1997 1996 - -------------------------------------------------------------------------------- Net income $ 10,742 $ 9,115 $ 8,403 Basic earnings per share $ 2.12 $ 1.76 $ 1.59 15. Post-Retirement Health Care and Life Insurance Benefits The expected cost of providing post-retirement benefits is recognized in the financial statements during the employee's active service period. Post-retirement benefit expense for the years ended December 31 is as follows: (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Service cost $ 6 $ 5 $ 6 Interest cost on projected benefit obligation 49 43 66 Amortization of prior service cost (16) (16) -- Amortization of unrecognized net loss (gain) 3 -- (1) ----------------------- Net post-retirement benefit cost $ 42 $ 32 $ 71 ======================= Mason-Dixon's post-retirement benefit plan is not funded. The status of the plan as of December 31 was as follows: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Accumulated post-retirement benefit obligations-- Retirees $(521) $(585) Fully eligible active plan participants (9) (39) Other active plan participants (73) (41) ------------------ (603) (665) Unrecognized prior service cost (221) (237) Unrecognized net loss from the effect of change of assumption 35 92 ------------------ Accrued post-retirement liability $(789) $(810) ================== The assumed health care cost trend rate used in measuring the accumulated post-retirement obligation was 6.80% for 1998, gradually declining to 5.00% over the next 7 years and remaining at that level thereafter. A one percentage-point increase in the assumed health care cost trend rate for each year would increase the accumulated post-retirement obligation as of December 31, 1998 by 10.00%. The assumed discount rate in determining the accumulated post-retirement benefit obligation was 7.25% for 1998 and 7.75% for 1997 and 8.00% for 1996. 16. Deferred Compensation Mason-Dixon, Carroll County Bank, and Bank of Maryland have entered into deferred compensation agreements with former executive officers, certain members of senior management, and Boards of Directors. Under the terms of the agreements, certain portions of officers' base salaries and the directors' fees have been deferred. The plan is entirely contributory by the participant and, therefore, no benefit expense is included in the consolidated statements of income for 1998, 1997, and 1996. - -------------------------------------------------------------------------------- Page 35 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 17. Income Taxes Applicable income taxes were as follows: (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Current: Federal $ 3,558 $ 2,347 $ 2,089 State 114 264 316 -------------------------------- Total current 3,672 2,611 2,405 -------------------------------- Deferred: Federal 505 451 490 State 111 100 108 -------------------------------- Total deferred 616 551 598 -------------------------------- Total income tax expense $ 4,288 $ 3,162 $ 3,003 ================================ Components of deferred income tax expense for the three years ended December 31 were as follows: (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Allowance for loan losses $ (502) $ (157) $ (257) Pension expense 236 75 83 Depreciation 42 26 18 Loan fees 399 (17) (23) Loan costs (34) 62 (43) Deferred compensation 21 (188) (114) Post-retirement benefits 5 13 (3) Mortgage sub-servicing rights (218) 85 85 Net operating loss carryforwards 609 609 718 Lease expense 16 (64) -- Purchase accounting adjustments 17 157 271 Other 25 (50) (137) -------------------------------- Total deferred income tax expense $ 616 $ 551 $ 598 ================================ At December 31, 1998 and 1997, net deferred income taxes are as follows: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Deferred tax assets: Allowance for credit losses $2,345 $1,843 Purchase accounting adjustments 62 79 Deferred compensation 674 695 Post-retirement benefits 305 310 Deferred loan fees and costs 37 402 Pension expense -- -- Mortgage sub-servicing rights 775 557 Net operating loss carryforwards 2,923 3,532 Lease expense 48 64 Other 146 222 --------------- Total deferred tax assets 7,315 7,704 --------------- Deferred tax liabilities: Depreciation 214 172 Pension expense 275 39 Other -- 52 Unrealized gain on securities available for sale 1,129 1,352 --------------- Total deferred tax liabilities 1,618 1,615 --------------- Net deferred income taxes $5,697 $6,089 =============== - -------------------------------------------------------------------------------- Page 36 Total income tax expense of $4,288,000, $3,162,000 and $3,003,000 for 1998, 1997 and 1996 was 28.4%, 25.7% and 26.3%, respectively, of income before taxes as compared to the maximum statutory rate for Federal income taxes, reconciled as follows:
(dollars in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Percent Percent Percent of Pretax of Pretax of Pretax Amount Income Amount Income Amount Income - ----------------------------------------------------------------------------------------------------------------------------------- Computed at statutory rate $ 5,285 35.0% $ 4,312 35.0% $ 4,004 35.0% Increases (decreases) in taxes resulting from: Tax exempt interest income (1,745) (11.5) (1,647) (13.3) (1,521) (13.3) Dividend exclusion (42) (0.3) (33) (0.3) (1) -- State income taxes, net of Federal income tax benefit 146 1.0 236 1.9 307 2.7 Nondeductible interest expense 249 1.6 234 1.9 197 1.7 Nondeductible goodwill and merger expenses 501 3.3 156 1.3 173 1.5 Other--net (106) (0.7) (96) (0.8) (156) (1.3) --------------------------------------------------------------- Actual tax expense $ 4,288 28.4% $ 3,162 25.7% $ 3,003 26.3% ===============================================================
Net operating loss carryforwards obtained through the acquisition of Bank of Maryland totaled approximately $7,571,000 for income tax purposes at December 31, 1998, and expire at various times beginning in 2002. Under Section 382 of the Internal Revenue Code, Mason-Dixon's utilization of these loss carryforwards is limited to an annual maximum amount of $1,575,000, which can only be applied to the taxable income of Bank of Maryland. At December 31, 1997, a $1,400,000 valuation allowance related to the net operating loss carryforwards was eliminated. The valuation was determined to be unnecessary in light of Bank of Maryland's continued pattern of profitability and likelihood of fully realizing all of the net operating loss carryforward. 18. Earnings Per Share In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share," which is effective for reporting periods ending after December 15, 1997. Under the provisions of SFAS No. 128, primary and fully diluted earnings per share were replaced with basic and diluted earnings per share in an effort to simplify the computation and more closely align earnings per share definitions with international rules. Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding and does not include the impact of any potentially dilutive common stock equivalents. Diluted earnings per share is arrived at by dividing net income by the weighted average number of shares outstanding, adjusted for the dilutive effect of outstanding stock options and the conversion impact of any convertible equity securities. The calculations of basic and diluted earnings per share were as follows: (dollars in thousands, except per share data) 1998 1997 1996 - -------------------------------------------------------------------------------- Basic earnings per share: Net income $10,811 $9,159 $8,436 Average common shares outstanding--basic 5,073,518 5,183,659 5,285,268 Net income per common share--basic $2.13 $1.77 $1.60 Diluted earnings per share: Net income $10,811 $9,159 $8,436 Average common shares outstanding 5,073,518 5,183,659 5,285,268 Stock option adjustment 4,260 1,492 -- Average common shares outstanding--diluted 5,077,778 5,185,151 5,285,268 Net income per common share--diluted $2.13 $1.77 $1.60 - -------------------------------------------------------------------------------- Page 37 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 19. Related Party Transactions During the ordinary course of business, Mason-Dixon's subsidiaries make loans to many of their directors and their associates and several of their policy-making officers on substantially the same terms, including interest rates and collateral, as those prevailing for comparable transactions with other customers. Loans outstanding, both direct and indirect, to directors, their associates, and policy-making officers totaled $8,644,000 and $3,552,000 at December 31, 1998 and 1997, respectively. During 1998, $25,889,000 of new loans were made and repayments totaled $20,797,000. In 1997, $1,990,000 of new loans were made and repayments totaled $1,285,000. 20. Commitments and Contingencies Mason-Dixon is a party to litigation related to its business. In the opinion of management, the ultimate liability, if any, resulting from these matters would not have a significant effect on Mason-Dixon's consolidated financial position, results of operations or liquidity. 21. Financial Instruments with Off-Balance Sheet Risk Mason-Dixon is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments may include commitments to extend credit, standby letters of credit, interest rate swaps and purchase commitments. Mason-Dixon uses these financial instruments to meet the financing needs of its customers and reduce its own exposure to fluctuations in interest rates. Financial instruments involve, to varying degrees, elements of credit, interest rate and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses which would have a material effect on the accompanying financial statements. The following is a summary of the contract or notional amount of significant commitments and contingent liabilities: (dollars in thousands) 1998 1997 - -------------------------------------------------------------------------------- Commitments to extend credit $137,278 $151,403 Standby letters of credit $ 16,475 $ 6,072 Interest rate swaps $ 82,000 $ 55,000 Purchase commitments $ 311 $ 779 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Mason-Dixon generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments. The collateral is based on management's credit evaluation of the counterparty. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Each customer's credit-worthiness is evaluated on a case-by-case basis. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Interest rate swaps involve an agreement to exchange fixed and variable rate interest payments based on a notional principal amount and maturity date. The differential between the fixed and variable rate is included as interest income or expense of the asset or liability being hedged. These derivative financial instruments are used for asset/liability management. Entering into swaps involves the risk of dealing with counterparties and their ability to meet the terms of outstanding contracts and risks related to movements in interest rates. The credit risk of interest rate swap contracts is controlled through credit approvals, limits and monitoring procedures. The principal or notional amounts are used to compute the volume of interest obligations, but the amounts potentially subject to risk are much smaller. With regard to these agreements, the risk of loss is estimated as $112,000 at December 31, 1998, representing the current cost of replacing only those swaps in a gain position in the event of counterparty failure. Purchase commitments include contract agreements to purchase land and certain computer equipment. Mason-Dixon entered into a five-year agreement for outside computer processing services expiring June, 2001. There is a minimum monthly processing fee of $78,000, plus additional amounts based on the number and types of transactions. - -------------------------------------------------------------------------------- Page 38 - -------------------------------------------------------------------------------- 22. Fair Value Of Financial Instruments The fair values of Mason-Dixon's financial instruments at December 31 were as follows:
(dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------------- Book Value Fair Value Book Value Fair Value - ------------------------------------------------------------------------------------------- Financial Assets Cash and due from banks $ 22,642 $ 22,642 $ 20,245 $ 20,245 Interest bearing deposits in other banks $ 638 $ 638 $ 482 $ 482 Federal funds sold $ 2,363 $ 2,363 $ 17,236 $ 17,236 Investment securities--HTM $ 185,366 $ 188,522 $ 204,045 $ 206,515 Investment securities--AFS $ 381,512 $ 381,512 $ 249,855 $ 249,855 Loans held for sale $ 7,645 $ 7,791 $ 4,439 $ 4,486 Loans $ 462,557 $ 462,364 $ 460,391 $ 461,278 Financial Liabilities Deposits $ 640,349 $ 640,636 $ 651,249 $ 654,301 Short-term borrowings $ 41,816 $ 41,816 $ 97,203 $ 97,203 Long-term borrowings $ 328,347 $ 331,622 $ 160,889 $ 165,242 Off-Balance Sheet Items Commitments to extend credit $ -- $ -- $ -- $ -- Standby letters of credit $ -- $ 330 $ -- $ 121 Interest rate swaps $ -- $ (2,520) $ -- $ (269)
23. Segment Information In June of 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was issued. This accounting statement requires disclosure of revenues and other information based on the way management organizes segments of the business for making operating decisions and assessing performance. Mason-Dixon is organized into two distinct lines of business; community banking and consumer finance. Community banking is comprised of lending and the sale of traditional banking products, as well as retail investment products through Mason-Dixon's community banking affiliates. Lending activities consist of commercial, small business, residential and installment lending (primarily home equity). Investment products include checking, savings, and money market accounts; certificates of deposit, trust services, and non-deposit investment products such as mutual funds and annuities. Consumer finance activities relate to the activities of Rose Shanis and Bay Insurance. These companies are involved in making small consumer loans and sales of credit related insurance products through its independent branch offices, as well as the purchase of loans through a network of dealers throughout Central Maryland. Mason-Dixon believes these are two distinct lines of business, and measures and manages financial and operating performance of business separately. - -------------------------------------------------------------------------------- Page 39 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 Information by business segment for 1998 is included in the table below. Rose Shanis and Bay Insurance were acquired during 1998. Prior to the acquisition of these companies, Mason-Dixon had no operating segments as defined by SFAS No. 131.
Community Consumer Intersegment (dollars in thousands) Banking Finance Eliminations Total - ----------------------------------------------------------------------------------------------------------------- Interest income $ 73,910 $ 9,746 $ (1,590) $ 82,066 Interest expense 43,672 2,109 (1,590) 44,191 ------------------------------------------------------- Net interest income 30,238 7,637 -- 37,875 Provision for credit losses 1,114 2,563 -- 3,677 ------------------------------------------------------- Net interest income after provision for credit losses 29,124 5,074 -- 34,198 Other operating income 15,592 1,566 (144) 17,014 Other operating expense 30,511 5,746 (144) 36,113 Net intersegment income (1,734) 1,734 -- -- ------------------------------------------------------- Income before taxes $ 12,471 $ 2,628 $ -- $ 15,099 ======================================================= Average total assets $ 1,041,173 $ 40,884 $ (19,010) $ 1,063,047 =======================================================
24. Subsequent Event (Unaudited) On January 27, 1999, Mason-Dixon entered into an Agreement and Plan of Reorganization with BB&T Corporation ("BB&T") of Winston-Salem, North Carolina. The agreement allows for the acquisition of Mason-Dixon by BB&T. The terms of the agreement call for stockholders of Mason-Dixon to receive 1.3 shares of BB&T common stock for each common share of Mason-Dixon. The acquisition will be structured as a tax-free exchange and accounted for as a pooling-of-interests. The transaction is subject to various regulatory approvals and approval by Mason-Dixon stockholders. In conjunction with the agreement, Mason Dixon entered into a Stock Option Agreement which grants BB&T the option to purchase up to 1,006,868 common shares of Mason-Dixon at a price per share of $40.00. Under the conditions of the Agreement and Plan of Reorganization, Mason-Dixon is not permitted to issue any new shares of common stock other than those permitted under Mason-Dixon's Omnibus Stock Plan without prior written consent of BB&T. Additionally, Mason-Dixon may not issue any new debt, enter into any long-term contracts or operate outside its normal course of business without written consent from BB&T. 25. Quarterly Results Of Operations (Unaudited) The following is a summary of Mason-Dixon's unaudited quarterly results of operations: (dollars in thousands, except per share data) 1998 - -------------------------------------------------------------------------------- Three months ended: 12/31 9/30 6/30 3/31 - -------------------------------------------------------------------------------- Interest income $20,780 $20,672 $20,936 $19,678 Interest expense 11,314 11,378 11,053 10,446 ------------------------------------- Net interest income 9,466 9,294 9,883 9,232 Provision for credit losses 63 125 3,172 317 Other operating income 2,777 2,252 9,076 2,117 Gain on sales of securities 287 148 46 311 Operating expenses 8,960 8,747 10,444 7,962 ------------------------------------- Income before taxes 3,507 2,822 5,389 3,381 Applicable income taxes 780 586 2,052 870 ------------------------------------- Net income $ 2,727 $ 2,236 $ 3,337 $ 2,511 ===================================== Net income per common share (Basic) $ 0.54 $ 0.44 $ 0.66 $ 0.49 ===================================== Net income per common share (Diluted) $ 0.54 $ 0.44 $ 0.66 $ 0.49 ===================================== - -------------------------------------------------------------------------------- Page 40 - -------------------------------------------------------------------------------- (dollars in thousands, except per share data) 1997 - -------------------------------------------------------------------------------- Three months ended: 12/31 9/30 6/30 3/31 - -------------------------------------------------------------------------------- Interest income $ 18,095 $ 17,720 $ 16,125 $ 15,495 Interest expense 10,149 9,910 8,356 7,760 -------------------------------------- Net interest income 7,946 7,810 7,769 7,735 Provision for credit losses 42 (12) 51 57 Other operating income 2,101 1,928 1,802 1,605 Gain on sales of securities 220 26 87 221 Operating expenses 6,949 6,717 6,720 6,405 -------------------------------------- Income before taxes 3,276 3,059 2,887 3,099 Applicable income taxes 829 771 738 824 -------------------------------------- Net income $ 2,447 $ 2,288 $ 2,149 $ 2,275 ====================================== Net income per common share (Basic) $ 0.48 $ 0.45 $ 0.41 $ 0.43 ====================================== Net income per common share (Diluted) $ 0.48 $ 0.45 $ 0.41 $ 0.43 ====================================== 26. Parent Company Only Financial Information Condensed financial information for Mason-Dixon Bancshares, Inc. (Parent Company Only) is as follows: (dollars in thousands) December 31, - -------------------------------------------------------------------------------- Condensed Balance Sheets 1998 1997 - -------------------------------------------------------------------------------- Assets Cash and due from banks $ 629 $ 1,703 Interest bearing deposits in subsidiaries 3,893 849 Investment securities available for sale-- at fair value 6,544 7,462 Investment securities held to maturity-- at amortized cost-- fair value of $1,002 (1998) and $998 (1997) 1,000 1,000 Loans to subsidiaries 28,600 -- Investment in subsidiaries 102,690 86,493 Advances to subsidiaries and other assets 2,931 948 --------------------- Total Assets $146,287 $ 98,455 ===================== Liabilities Long-term borrowings $ 63,034 $ 22,031 Deferred income taxes -- 243 Other liabilities 1,114 732 --------------------- Total Liabilities 64,148 23,006 --------------------- Stockholders' Equity Common stock 5,072 5,077 Surplus 35,738 35,948 Retained earnings 39,535 32,275 Accumulated other comprehensive income 1,794 2,149 --------------------- Total Stockholders' Equity 82,139 75,449 --------------------- Total Liabilities and Stockholders' Equity $146,287 $ 98,455 ===================== - -------------------------------------------------------------------------------- Page 41 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(dollars in thousands) December 31, - --------------------------------------------------------------------------------------------------------------------------- Condensed Statements of Income for the period ended 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Income Cash dividends from subsidiaries $ 12,379 $ 4,139 $ 6,372 Interest and dividend income 2,289 517 131 Other income 1,171 281 60 ------------------------------ Total Income 15,839 4,937 6,563 Interest expense on long-term borrowings 4,548 1,394 490 Operating expenses 863 853 498 ------------------------------ Income before income tax benefit and equity in undistributed income of subsidiaries 10,428 2,690 5,575 Income tax benefit (410) (554) (264) ------------------------------ Income before equity in undistributed income of subsidiaries 10,838 3,244 5,839 Equity in undistributed income of subsidiaries (27) 5,915 2,597 ------------------------------ Net Income $ 10,811 $ 9,159 $ 8,436 ==============================
(dollars in thousands) December 31, - --------------------------------------------------------------------------------------------------------------------------- Condensed Statements of Cash Flows for the period ended 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net Income $ 10,811 $ 9,159 $ 8,436 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiaries 27 (5,915) (2,597) Gain on sale of assets (341) (220) -- Net (increase) decrease in other assets (850) (400) 167 Net increase (decrease) in other liabilities 545 (201) 189 Other--net 35 23 -- ------------------------------ Net Cash Provided by Operating Activities 10,227 2,446 6,195 ------------------------------ Cash Flows From Investing Activities Investments in and advances to subsidiaries (46,132) (6,179) (60) Repayment of advances to subsidiaries 431 60 60 Purchases of investment securities (8,968) (10,021) -- Proceeds from sales of investment securities 9,278 3,397 -- ------------------------------ Net Cash Used by Investing Activities (45,391) (12,743) -- ------------------------------ Cash Flows From Financing Activities Proceeds from long-term borrowings 39,969 20,019 2,000 Repayment of long-term borrowings -- (1,313) (5,188) Proceeds from advances from subsidiaries 4,191 -- -- Repayment of advances from subsidiaries (3,260) -- -- Repurchase of common stock (1,021) (5,413) -- Issuance of additional shares of common stock 806 575 798 Dividends paid (3,551) (3,215) (2,750) ------------------------------ Net Cash Provided (Used) by Financing Activities 37,134 10,653 (5,140) ------------------------------ Net Increase in Cash and Cash Equivalents 1,970 356 1,055 Cash and Cash Equivalents at Beginning of Year 2,552 2,196 1,141 ------------------------------ Cash and Cash Equivalents at End of Year $ 4,522 $ 2,552 $ 2,196 ==============================
- -------------------------------------------------------------------------------- Page 42 - -------------------------------------------------------------------------------- INDEPENDENT AUDITORS' REPORT [LETTERHEAD] STEGMAN & COMPANY Stockholders and Board of Directors Mason-Dixon Bancshares, Inc. Westminster, Maryland We have audited the accompanying consolidated balance sheets of Mason-Dixon Bancshares, Inc. and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Mason-Dixon Bancshares, Inc. and Subsidiaries as of December 31, 1998 and 1997, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ STEGMAN & COMPANY Baltimore, Maryland January 15, 1999 - -------------------------------------------------------------------------------- Page 43 - -------------------------------------------------------------------------------- EXECUTIVE OFFICERS AND DIRECTORS Subsidiaries Carroll County Bank and Trust Company Executive Officers: Michael L. Oster President and Chief Executive Officer Gerald G. Alsentzer Senior Vice President William J. Gering Senior Vice President J. Edward Gottleib Senior Vice President Mark A. Keidel, CPA Senior Vice President Louna S. Primm Senior Vice President Marcus L. Primm Senior Vice President Christine L. Whiteleather, CFA Senior Vice President Directors: William B. Dulany Chairman of the Board Partner, Dulany and Leahy Attorneys Westminster David S. Babylon, Jr. Retired Accountant Westminster Miriam F. Beck Retired Administrator Carroll County Board of Education Sykesville Brian L. Haight Vice President and Treasurer Haight Funeral Home and Chapel Eldersburg Linda A. Hikel Vice President and Partner Shelter Systems Limited Westminster R. Neal Hoffman Managing Partner Hoffman, Comfort, Galloway & Offutt Attorneys Westminster S. Ray Hollinger Chairman W.H. Davis Company T/A Davis Buick-GMC Truck Westminster Michael L. Oster President and Chief Executive Officer Westminster Edwin W. Shauck Retired Executive Vice President Carroll County Bank and Trust Company Westminster James C. Snyder Retired Manufacturing and Distribution of Truck Equipment Manchester G. Lee Sturgill, CPA Partner Sturgill & Associates Westminster Stevenson B. Yingling President Yingling General Tire, Inc. Westminster Bank of Maryland Executive Officers: Hunter F. Calloway President and Chief Executive Officer Edward P. Barker Senior Vice President Douglas S. Ewalt Senior Vice President Richard C. Springer Senior Vice President Directors: Henry S. Baker, Jr. Chairman of the Board Retired Maryland National Bank Monkton Hunter F. Calloway President and Chief Executive Officer Towson Donald H. Campbell President and Chief Executive Officer First State Packaging, Inc. Salisbury Henry D. Felton Chairman of the Board Avatech Solutions, Inc. Owings Mills R. Michael Gill President and Chief Executive Officer Americom Lutherville Ethan D. Grossman President Ethan Grossman Engineering Washington, DC J. Patrick Henry Chief Operating Officer Colonial Professional Cars, Ltd. Annapolis Larry S. Kamanitz, CPA Business Consultant Grant Thornton, LLP Baltimore J. William Middelton Chairman Middelton, Limburg & Company, Inc. Lutherville Roger R. Rice President Rice & Associates Insurance Bel Air Jack A. Serber Retired Accountant Bethesda Stephen C. Winter Esquire Miles & Stockbridge Towson Mason-Dixon Business Services, LLC (Bank Operations Subsidiary) Officers: A. Gary Rever President William K. Stocksdale Senior Vice President Rose Shanis Financial Services, LLC Officers: Bonnie V. Klapaska Regional Manager Scott D. Frankle Regional Manager Joshua C. Johnson Regional Manager - -------------------------------------------------------------------------------- Page 44 EXECUTIVE OFFICERS AND DIRECTORS Mason-Dixon Bancshares, Inc. Officers: William B. Dulany Chairman of the Board Thomas K. Ferguson President and Chief Executive Officer Mark A. Keidel, CPA Vice President and Chief Financial Officer Vivian A. Davis Corporate Secretary Caroline Babylon Chief Internal Auditor Directors: William B. Dulany Chairman of the Board Partner, Dulany and Leahy Attorneys Westminster David S. Babylon, Jr. Retired Accountant Westminster Henry S. Baker, Jr. Retired Maryland National Bank Monkton Miriam F. Beck Retired Administrator Carroll County Board of Education Sykesville Donald H. Campbell President and Chief Executive Officer First State Packaging, Inc. Salisbury Thomas K. Ferguson President and Chief Executive Officer Westminster R. Neal Hoffman Managing Partner Hoffman, Comfort, Galloway & Offutt Attorneys Westminster S. Ray Hollinger Chairman W.H. Davis Company T/A Davis Buick-GMC Truck Westminster J. William Middelton Chairman Middelton, Limburg & Company, Inc. Lutherville Edwin W. Shauck Retired Executive Vice President Carroll County Bank and Trust Company Westminster James C. Snyder Retired Manufacturing and Distribution of Truck Equipment Manchester Stevenson B. Yingling President Yingling General Tire, Inc. Westminster Designed by Curran & Connors, Inc. / www.curran-connors.com - -------------------------------------------------------------------------------- MASON-DIXON BANCSHARES, INC. 45 WEST MAIN STREET WESTMINSTER, MARYLAND 21157 (410) 857-3401 www.msdx.com EX-21 3 SUBSIDIARIES OF THE REGISTRANT Exhibit 21 -- List of Registrant's Subsidiaries Subsidiaries of the Registrant: Carroll County Bank and Trust Company is a wholly-owned subsidiary of Mason-Dixon Bancshares, Inc. Mason-Dixon Merger Sub, Inc. is a wholly-owned subsidiary of Mason-Dixon Bancshares, Inc. Bank of Maryland is a wholly-owned subsidiary of Mason-Dixon Merger Sub, Inc. Mason-Dixon Capital Trust is a wholly-owned subsidiary of Mason-Dixon Bancshares, Inc. Mason-Dixon Capital Trust II is a wholly-owned subsidiary of Mason-Dixon Bancshares, Inc. Rose Shanis Financial Services, LLC is a wholly-owned subsidiary of Mason-Dixon Bancshares, Inc. Bay Insurance, LLC is a wholly-owned subsidiary of Mason-Dixon Bancshares, Inc. E-2 EX-23 4 CONSENT OF INDEPENDENT AUDITORS Exhibit 23 -- Consent of Independent Auditors We consent to the incorporation by reference in this Annual Report (Form 10-K) of Mason-Dixon Bancshares, Inc. and Subsidiaries of our report dated January 15, 1999, included in the 1998 Annual Report to Stockholders of Mason-Dixon Bancshares, Inc. and Subsidiaries. We also consent to the incorporation by reference in the Registration Statements pertaining to the Mason-Dixon Bancshares, Inc. Deferred Compensation and Fee Plan for Non-Employee Directors (Form S-8, No 333-51947), the Mason-Dixon Bancshares, Inc. Management Deferred Compensation Plan (Form S-8, No. 333-51303), the Mason-Dixon Bancshares Employee Savings and Investment Plan (Form S-8, No.333-51305), and the Mason-Dixon Bancshares, Inc. 1997 Omnibus Share Plan (Form S-8, No. 333-50731) of our report dated January 15, 1999, with respect to the consolidated financial statements of Mason-Dixon Bancshares, Inc. and Subsidiaries incorporated by reference in the Annual Report on Form 10-K for the year ended December 31, 1998. /s/ Stegman & Company Baltimore, Maryland March 25, 1999 E-3 EX-27 5 FDS FOR MASON-DIXON BANCSHARES, INC.
9 This schedule contains summary information extracted from the Mason-Dixon Bancshares, Inc. December 31, 1998 financial statements and is qualified in its entirety by reference to such financial statements. 12-MOS DEC-31-1998 DEC-31-1998 22,642,000 638,000 2,363,000 0 185,366,000 566,878,000 570,034,000 462,557,000 8,893,000 1,102,242,000 640,349,000 41,816,000 9,591,000 328,347,000 0 0 5,072,000 77,067,000 1,102,242,000 48,618,000 31,895,000 1,553,000 82,066,000 24,165,000 44,191,000 37,875,000 3,677,000 792,000 36,113,000 10,811,000 10,811,000 0 0 10,811,000 2.13 2.13 4.07 6,018,000 60,000 826,000 11,265,000 5,231,000 3,475,000 579,000 8,893,000 8,893,000 0 0
EX-99 6 RISK FACTORS Exhibit 99 - Risk Factors Regulatory Risks. The banking industry is subject to many laws and regulations. Regulations protect depositors, not stockholders. The Maryland Division of Financial Regulation and the Board of Governors of the Federal Reserve System regulate Mason-Dixon and its bank and nonbank subsidiaries. Regulations and laws increase Mason-Dixon's operating expenses, affect Mason-Dixon's earnings, and put Mason-Dixon at a disadvantage with less regulated competitors, such as finance companies, mortgage banking companies, and leasing companies. Exposure to Local Economic Conditions. Most of the loans made by Mason-Dixon subsidiaries are made to Maryland borrowers. A decline in local economic conditions would affect Mason-Dixon's earnings. Credit Risks and Inadequacy of Loan Loss Reserve. When borrowers default and do not repay the loans made to them by a Mason-Dixon subsidiary, Mason-Dixon loses money. Experience shows that some borrowers either will not pay on time or will not pay at all. In these cases, the subsidiary will cancel, or "write off," the defaulted loan or loans. A "write off" reduces Mason-Dixon's assets and hurts Mason-Dixon's earnings. Mason-Dixon 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 Mason-Dixon's loan loss reserve may not be sufficient. Interest Rate Risk. Mason-Dixon'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 Mason-Dixon earns less. Because interest rates are established by competition, Mason-Dixon cannot completely control its net interest income. Risks Associated with Real Estate Lending. Mason-Dixon subsidiaries make many real estate secured loans. Real estate loans are in 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. Mason-Dixon may lose money if the borrower does not pay a real estate loan. If real estate values decrease, then Mason-Dixon may lose more money when borrowers default. No Assurance of Growth. Mason-Dixon's ability to increase assets and earnings depends upon many factors, including competition for deposits and loans, Mason-Dixon's branch and office locations, avoidance of credit losses, and hiring and training of personnel. Many of these factors are beyond Mason-Dixon's control. 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 Mason-Dixon. Some of Mason-Dixon's competitors offer services and products that Mason-Dixon 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 Mason-Dixon's earnings. No Assurance of Cash or Stock Dividends. Whether dividends may be paid to stockholders depends on Mason-Dixon's earnings, its capital needs, law and regulations, and other factors. Mason-Dixon's payment of dividends in the past does not mean that Mason-Dixon will be able to pay dividends in the future. E-4 Stock Not Insured. Investments in the shares of Mason-Dixon's common stock are not deposits that are insured against loss by the government. Risk Involved in Acquisitions. Part of Mason-Dixon's growth may come from buying other banks and companies. A newly purchased bank or company may not be profitable after Mason-Dixon 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 Mason-Dixon for losses due to Mason-Dixon's alleged breach of fiduciary duties, errors and omissions of employees, officers and agents, incomplete documentation, Mason-Dixon's failure to comply with applicable laws and regulations, or many other reasons. Also, employees of Mason-Dixon conduct all of Mason-Dixon's business. The employees may knowingly or unknowingly violate laws and regulations. Mason-Dixon management may not be aware of any violations until after their occurrence. This lack of knowledge will not insulate Mason-Dixon from liability. Claims and legal actions may result in legal expenses and liabilities that may reduce Mason-Dixon'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. Mason-Dixon's ability to compete successfully with other banks and non-banks may depend on whether it can exploit technological changes. Mason-Dixon may not be able to exploit technological changes and expensive new technology may not make Mason-Dixon 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 Mason-Dixon's computer programs and other equipment identify a year designated "00" as the Year 1900 rather than the Year 2000. Mason-Dixon 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 Mason-Dixon's earnings. Anti-Takeover Effects of Certain Charter and Bylaw Provisions. Mason-Dixon's Articles of Incorporation and Bylaws divide Mason-Dixon'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 Mason-Dixon. These provisions may discourage or make it more difficult for another company to buy Mason-Dixon or may reduce the market price of Mason-Dixon's common stock. E-5 -----END PRIVACY-ENHANCED MESSAGE-----