Year Ended December 31,
(Dollars in thousands)		2009				2008				2007				2006				2005
Balance, January 1		$	50,526			$	25,092			$	19,492			$	16,886			$	14,654
Provision for loan and lease losses			76,762				33,192				4,094				2,795				2,600
Allowance acquired from acquisitions			-				-				2,798				-				-
Loan charge-offs:
Residential real estate			(4,847	)			(4,798	)			-				-				-
Commercial loans and leases			(57,099	)			(2,677	)			(1,103	)			(230	)			(491	)
Consumer			(1,575	)			(988	)			(341	)			(85	)			(44	)
Total charge-offs			(63,521	)			(8,463	)			(1,444	)			(315	)			(535	)
Loan recoveries:
Residential real estate			41				21				12				-				64
Commercial loans and leases			641				475				110				89				89
Consumer			110				209				30				37				14
Total recoveries			792				705				152				126				167
Net charge-offs			(62,729	)			(7,758	)			(1,292	)			(189	)			(368	)
Balance, period end		$	64,559			$	50,526			$	25,092			$	19,492			$	16,886
Net charge-offs to average loans and leases			2.61	%			0.32	%			0.06	%			0.01	%			0.02	%
Allowance to total loans and leases			2.81	%			2.03	%			1.10	%			1.08	%			1.00	%

 

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Table 14 – Analysis of Credit Risk

		At December 31,
(Dollars in thousands)		2009				2008				2007				2006				2005
Non-accrual loans and leases
Residential real estate		$	9,520			$	11,679			$	599			$	354			$	-
Commercial loans and leases			100,894				55,890				22,368				1,534				409
Consumer			766				381				73				22				28
Total non-accrual loans and leases (1)			111,180				67,950				23,040				1,910				437
Loans and leases 90 days past due
Residential real estate			14,887				471				3,992				123				281
Commercial loans and leases			3,321				567				7,236				1,665				663
Consumer			793				-				134				35				14
Total 90 days past due loans and leases			19,001				1,038				11,362				1,823				958
Restructured loans and leases			3,549				395				-				-				-
Total non-performing loans and leases (2)			133,730				69,383				34,402				3,733				1,395
Other real estate owned, net			7,464				2,860				461				182				-
Total non-performing assets		$	141,194			$	72,243			$	34,863			$	3,915			$	1,395
Non-performing loans to total loans and leases			5.82	%			2.79	%			1.51	%			0.21	%			0.08	%
Non-performing assets to total assets			3.89	%			2.18	%			1.15	%			0.15	%			0.06	%
Allowance for loan and leases to non-performing loans and leases			48.28	%			72.82	%			72.94	%			522.15	%			1210.47	%

(1)

Gross interest income that would have been recorded in 2009 if non-accrual loans and leases shown above had been current and in accordance with their original terms was $6.4 million. No interest was recorded on these loans during the year. Please see Note 1 of the Notes to Consolidated Financial Statements for a description of the Company’s policy for placing loans on non-accrual status.

(2)

Performing loans considered potential problem loans, as defined and identified by management, amounted to $63.3 million at December 31, 2009. Although these are loans where known information about the borrowers' possible credit problems causes management to have doubts as to the borrowers' ability to comply with the loan repayment terms, most are well collateralized and are not believed to present significant risk of loss.  Loans classified for regulatory purposes not included in either non-performing or potential problem loans consist only of "other loans especially mentioned" and do not, in management's opinion, represent or result from trends or uncertainties reasonably expected to materially impact future operating results, liquidity or capital resources, or represent material credits where known information about the borrowers' possible credit problems causes management to have doubts as to the borrowers' ability to comply with the loan repayment terms.

Market Risk Management

The Company's net income is largely dependent on its net interest income.  Net interest income is susceptible to interest rate risk to the extent that interest-bearing liabilities mature or re-price on a different basis than interest-earning assets.  When interest-bearing liabilities mature or re-price more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income.  Similarly, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income. Net interest income is also affected by changes in the portion of interest-earning assets that are funded by interest-bearing liabilities rather than by other sources of funds, such as noninterest-bearing deposits and stockholders' equity.

The Company’s interest rate risk management goals are (1) to increase net interest income at a growth rate consistent with the growth rate of total assets, and (2) to minimize fluctuations in net interest margin as a percentage of earning assets.  Management attempts to achieve these goals by balancing, within policy limits, the volume of floating-rate liabilities with a similar volume of floating-rate assets; by keeping the average maturity of fixed-rate asset and liability contracts reasonably matched; by maintaining a pool of administered core deposits; and by adjusting pricing rates to market conditions on a continuing basis.

The Company’s board of directors has established a comprehensive interest rate risk management policy, which is administered by management’s ALCO. The policy establishes limits on risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity or “EVE” at risk) resulting from a hypothetical change in U.S. Treasury interest rates for maturities from one day to thirty years. The Company measures the potential adverse impacts that changing interest rates may have on its short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology used by the Company. When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model. Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan customers’ ability to service their debts, or the impact of rate changes on demand for loan, lease, and deposit products.

 

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The Company prepares a current base case and eight alternative simulations at least once a quarter, and reports the analysis to the board of directors.  In addition, more frequent forecasts are produced when interest rates are particularly uncertain or when other business conditions so dictate.

The statement of condition is subject to quarterly testing for eight alternative interest rate shock possibilities to indicate the inherent interest rate risk.  Average interest rates are shocked by +/- 100, 200, 300, and 400 basis points (“bp”), although the Company may elect not to use particular scenarios that it determines are impractical in a current rate environment.  It is management’s goal to structure the balance sheet so that net interest earnings at risk over a twelve-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels.

The Company augments its quarterly interest rate shock analysis with alternative external interest rate scenarios on a monthly basis. These alternative interest rate scenarios may include non-parallel rate ramps and non-parallel yield curve twists.  If a measure of risk produced by the alternative simulations of the entire balance sheet violates policy guidelines, ALCO is required to develop a plan to restore the measure of risk to a level that complies with policy limits within two quarters.

Measures of net interest income at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments.  These measures are typically based upon a relatively brief period, usually one year.  They do not necessarily indicate the long-term prospects or economic value of the institution.

Table 15 - Estimated Changes in Net Interest Income

Change in Interest Rates:		+ 400 bp				+ 300 bp				+ 200 bp				+ 100 bp				- 100 bp				- 200 bp				-300 bp				-400 bp
Policy Limit			25.00	%			20.00	%			17.50	%			12.50	%			12.50	%			17.50	%			20.00	%			25.00	%
December 31, 2009			(15.27	)%			(9.52	)%			(5.03	)%			(1.71	)%			N/A				N/A				N/A				N/A
December 31, 2008			4.19	%			4.81	%			4.35	%			2.80	%			N/A				N/A				N/A				N/A

As shown above, measures of net interest income at risk increased from December 31, 2008 at all interest rate shock levels.  All measures remained well within prescribed policy limits.

The risk position increased substantially in the rising rate scenarios due to a lengthening of durations in the securities portfolio resulting from growth in CMO’s, a decrease in variable rate loans, and an increase in money market deposit accounts due to the growth in the newly introduced money market product. Also, the subordinated debt, which previously carried a fixed rate, converted to a much lower floating rate in 2009 and now re-prices to the higher shock rates therefore adding to the overall net interest income risk.

The measures of equity value at risk indicate the ongoing economic value of the Company by considering the effects of changes in interest rates on all of the Company’s cash flows, and by discounting the cash flows to estimate the present value of assets and liabilities.  The difference between these discounted values of the assets and liabilities is the economic value of equity, which, in theory, approximates the fair value of the Company’s net assets.

Table 16 - Estimated Changes in Economic Value of Equity (EVE)

Change in Interest Rates:		+ 400 bp				+ 300 bp				+ 200 bp				+ 100 bp				- 100 bp				- 200 bp				-300 bp				-400 bp
Policy Limit			40.00	%			30.00	%			22.50	%			10.00	%			12.50	%			22.50	%			30.00	%			40.00	%
December 31, 2009			-23.29	%			-12.78	%			-7.43	%			-2.29	%			N/A				N/A				N/A				N/A
December 31, 2008			-4.80	%			1.92	%			3.61	%			1.59	%			N/A				N/A				N/A				N/A

Measures of the economic value of equity (EVE) at risk increased over year-end 2008 in all interest rate shock levels. The economic value of equity exposure at +200 bp is now -7.43% compared to 3.61% at year-end 2008, and is well within the policy limit of 22.5%, as are measures at all other shock levels.

During 2009, the securities portfolio has realized a negative impact compared to 2008 due to the significant growth in the portfolio and the lengthening of the duration of the portfolio due to rising interest rates.  The increase in the balance of the newly introduced money market product is causing a negative impact to EVE in the rising shock bands as those funds provide no additional premium as the interest rates move upward because of the assumption that the rate will re-price to market as rates increase.

 

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Liquidity Management

Liquidity is measured by a financial institution's ability to raise funds through loan and lease repayments, maturing investments, deposit growth, borrowed funds, capital and the sale of highly marketable assets such as investment securities and residential mortgage loans. The Company's liquidity position, considering both internal and external sources available, exceeded anticipated short-term and long-term needs at December 31, 2009.  Management considers core deposits, defined to include all deposits other than time deposits of $100 thousand or more, to be a relatively stable funding source. Core deposits equaled 70% of total earning assets at December 31, 2009. In addition, loan and lease payments, maturities, calls and pay downs of securities, deposit growth and earnings contribute a flow of funds available to meet liquidity requirements. In assessing liquidity, management considers operating requirements, the seasonality of deposit flows, investment, loan and deposit maturities and calls, expected funding of loans and deposit withdrawals, and the market values of available-for-sale investments, so that sufficient funds are available on short notice to meet obligations as they arise and to ensure that the Company is able to pursue new business opportunities.

Liquidity is measured using an approach designed to take into account, in addition to factors already discussed above, the Company’s growth and mortgage banking activities.  Also considered are changes in the liquidity of the investment portfolio due to fluctuations in interest rates.  Under this approach, implemented by the Funds Management Subcommittee of ALCO under formal policy guidelines, the Company’s liquidity position is measured weekly, looking forward at thirty day intervals from thirty (30) to three hundred sixty (360) days.  The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth.  Resulting projections as of December 31, 2009, show short-term investments exceeding short-term borrowings by $52.8 million over the subsequent 360 days.  This projected excess of liquidity versus requirements provides the Company with flexibility in how it funds loans and other earning assets.

The Company also has external sources of funds, which can be drawn upon when required.  The main sources of external liquidity are available lines of credit with the Federal Home Loan Bank of Atlanta and the Federal Reserve. The line of credit with the Federal Home Loan Bank of Atlanta totaled $1.1 billion, of which $493.8 million was available for borrowing based on pledged collateral, with $426.6 million borrowed against it as of December 31, 2009. The line of credit at the Federal Reserve totaled $272.7 million, all of which was available for borrowing based on pledged collateral, with no borrowings against it as of December 31, 2009.   Other external sources of liquidity available to the Company in the form of unsecured lines of credit granted by correspondent banks totaled $40.0 million at December 31, 2009, against which there were no outstanding borrowings.  In addition, the Company had a secured line of credit with a correspondent bank of $20.0 million as of December 31, 2009. Based upon its liquidity analysis, including external sources of liquidity available, management believes the liquidity position was appropriate at December 31, 2009.

 

The parent company (“Bancorp”) is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, Bancorp is responsible for paying any dividends declared to its common shareholders, dividends on its preferred stock, and interest and principal on outstanding debt. Bancorp’s primary source of income is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to Bancorp in any calendar year, without the receipt of prior approval from the Federal Reserve, cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. At December 31, 2009, Bancorp had liquid assets of $2.8 million.

 

The Company has various contractual obligations that affect its cash flows and liquidity.  For information regarding material contractual obligations, please see “Market Risk Management” above, “Contractual Obligations” below, and “Note 7-Premises and Equipment,” “Note 10-Borrowings,” “Note 14-Pension, Profit Sharing and Other Employee Benefit Plans,” “Note 19-Financial Instruments with Off-balance Sheet Risk and Derivatives,” and “Note 21-Fair Value” of the Notes to the Consolidated Financial Statements.

Off-Balance Sheet Arrangements

With the exception of the Company’s obligations in connection with its trust preferred securities, irrevocable letters of credit, and loan commitments, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors.  The trust preferred securities were issued by Sandy Spring Capital Trust II (the “Trust”), a subsidiary of the Company created for the purpose of issuing the trust preferred securities and purchasing the Company’s junior subordinated debentures, which are its sole assets.  These junior subordinated debentures bear a maturity date of October 7, 2034, which may be shortened, subject to conditions, to a date no earlier than October 7, 2009. The Company owns all of the Trust’s outstanding securities.  The Company and the Trust believe that, taken together, the Company’s obligations under the junior subordinated debentures, the Indenture, the Trust Agreement, and the Guarantee entered into in connection with the issuance of the trust preferred securities and the debentures, in the aggregate constitute a full, irrevocable and unconditional guarantee of the Trust’s obligations.  For additional information on off-balance sheet arrangements, please see “Note 19-Financial Instruments with Off-balance Sheet Risk and Derivatives” and “Note 10- Borrowings” of the Notes to the Consolidated Financial Statements, and “Capital Management” and “Securities”.

 

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Table 17 – Contractual Obligations (1)

		Payment Due by Period
						Less than												After
(In thousands)		Total				1 year				1-3 Years				3-5 Years				5 Years
Advances from FHLB		$	411,584			$	5,476			$	-			$	1,108			$	405,000
Certificates of deposit			785,785				616,400				136,105				33,280				-
Operating lease obligations			24,947				5,133				8,753				5,781				5,280
Preferred stock dividends			45,885				4,155				8,309				10,987				22,434
Purchase obligations (2)			11,937				2,397				4,975				4,565				-
Total		$	1,280,138			$	633,561			$	158,142			$	55,721			$	432,714

(1)

The Company enters into contractual obligations in the normal course of business.  Among these obligations are FHLB advances, operating leases related to branch and administrative facilities, a long-term contract with a data processing provider and purchase contracts related to construction of new branch offices.  Payments required under these obligations, are set forth in the table below as of December 31, 2009. Assumed a seven year term for purposes of this table.

(2)	Represents payments required under contract, based on average monthly charges for 2010 and assuming a growth rate of 3% with the Company’s current data processing service provider that expires in September 2014.

 

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PART II

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting.  As required by SEC rules, the Company’s management evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009.  The Company’s chief executive officer and chief financial officer participated in the evaluation, which was based upon the criteria for effective internal control over financial reporting included in the “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s internal control over financial reporting was effective as of December 31, 2009.

The attestation report by the Company’s independent registered public accounting firm, Grant Thornton LLP, on the Company’s internal control over financial reporting begins on the following pages.

Fourth Quarter 2009 Changes In Internal Controls Over Financial Reporting

No change occurred during the fourth quarter of 2009 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Sandy Spring Bancorp, Inc.

We have audited Sandy Spring Bancorp, Inc. (a Maryland corporation) and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Sandy Spring Bancorp, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control— Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sandy Spring Bancorp, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2009. Our report dated March 12, 2010, expressed an unqualified opinion.

 

Philadelphia, Pennsylvania

March 12, 2010

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Sandy Spring Bancorp, Inc.

We have audited the accompanying consolidated balance sheets of Sandy Spring Bancorp, Inc. (a Maryland corporation) and subsidiaries (the Company) as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2009. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sandy Spring Bancorp, Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of its consolidated operations and its cash flows for each of the two years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 21 to the consolidated financial statements, the Company adopted the guidance for fair value measurements and disclosures issued by the Financial Accounting Standard Board (FASB) in 2008.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sandy Spring Bancorp, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 12, 2010 expressed an unqualified opinion on internal control over financial reporting.

  

Philadelphia, Pennsylvania

March 12, 2010

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Sandy Spring Bancorp, Inc.

We have audited the consolidated statements of income, changes in stockholders’ equity and cash flows of Sandy Spring Bancorp, Inc. and Subsidiaries for the year ended December 31, 2007.  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 audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of the Company’s operations and cash flows for the year ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

Frederick, Maryland

February 29, 2008

 

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SANDY SPRING BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

		Year Ended December 31,
(Dollars in thousands, except per share data)		2009				2008				2007
Interest Income:
Interest and fees on loans and leases		$	126,899			$	148,765			$	152,723
Interest on loans held for sale			767				436				815
Interest on deposits with banks			149				112				1,123
Interest and dividends on securities:
Taxable			19,945				10,177				13,989
Exempt from federal income taxes			7,467				8,800				10,168
Interest on federal funds sold			3				555				2,157
Total interest income			155,230				168,845				180,975
Interest Expense:
Interest on deposits			34,921				42,816				59,916
Interest on retail repurchase agreements and federal funds purchased			308				1,795				4,392
Interest on advances from FHLB			14,708				13,553				9,618
Interest on subordinated debt			1,585				2,222				2,223
Total interest expense			51,522				60,386				76,149
Net interest income			103,708				108,459				104,826
Provision for loan and lease losses			76,762				33,192				4,094
Net interest income after provision for loan and lease losses			26,946				75,267				100,732
Noninterest Income:
Securities gains			418				663				43
Service charges on deposit accounts			11,433				12,778				11,148
Gains on sales of mortgage loans			3,253				2,288				2,739
Fees on sales of investment products			2,823				3,475				2,989
Trust and investment management fees			9,421				9,483				9,588
Insurance agency commissions			5,236				5,908				6,625
Income from bank owned life insurance			2,906				2,902				2,829
Visa check fees			2,920				2,875				2,784
Other income			6,831				5,871				5,544
Total noninterest income			45,241				46,243				44,289
Noninterest Expenses:
Salaries and employee benefits			54,460				53,015				55,207
Occupancy expense of premises			10,710				10,762				10,360
Equipment expenses			5,691				6,156				6,563
Marketing			2,166				2,163				2,237
Outside data services			3,721				4,373				3,967
FDIC insurance			6,092				1,751				433
Amortization of intangible assets			3,646				4,447				4,080
Goodwill impairment loss			-				4,159				-
Other expenses			16,553				15,263				16,941
Total noninterest expense			103,039				102,089				99,788
Income (loss) before income taxes			(30,852	)			19,421				45,233
Income tax expense (benefit)			(15,997	)			3,642				12,971
Net income (loss)		$	(14,855	)		$	15,779			$	32,262
Preferred stock dividends and discount accretion			4,810				334				-
Net income (loss) available to common stockholders		$	(19,665	)		$	15,445			$	32,262
Net Income (Loss) Per Share Amounts:
Basic net income (loss) per share		$	(0.90	)		$	0.96			$	2.01
Basic net income (loss) per common share			(1.20	)			0.94				2.01
Diluted net income (loss) per share			(0.90	)		$	0.96			$	2.01
Diluted net income (loss) per common share			(1.20	)			0.94				2.01
Dividends declared per common share			0.37			$	0.96			$	0.92

The accompanying notes are an integral part of these statements

 

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SANDY SPRING BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Year Ended December 31,
(Dollars in thousands)		2009				2008				2007
Operating activities:
Net income (loss)		$	(14,855	)		$	15,779			$	32,262
Adjustments to reconcile net income (loss) to net cash (used in ) provided by operating activities:
Depreciation and amortization			9,827				10,837				10,648
Goodwill impairment loss							4,159				-
Provision for loan and lease losses			76,762				33,192				4,094
Share based compensation expense			762				772				1,128
Deferred income tax benefit			(7,237	)			(10,517	)			(2,721	)
Origination of loans held for sale			(339,553	)			(188,899	)			(280,152	)
Proceeds from sales of loans held for sale			341,798				186,723				286,398
Gains on sales of loans held for sale			(3,352	)			(2,126	)			(2,739	)
Securities gains			(418	)			(663	)			(43	)
Gains (losses) on sales of premises and equipment			-				46				(289	)
Net (increase) decrease in accrued interest receivable			(1,843	)			3,145				2,020
Net increase in other assets			(30,914	)			(8,647	)			(4,931	)
Net (decrease) increase in accrued expenses and other liabilities			(9,688	)			8,620				(2,913	)
Other – net			5,602				(2,610	)			5,153
Net cash provided by operating activities			26,891				49,811				47,915
Investing activities:
Net decrease in interest-bearing deposits with banks			-				-				2,609
Purchases  of other equity securities			(3,627	)			(5,379	)			(4,548	)
Purchases of investments available-for-sale			(911,277	)			(295,661	)			(83,440	)
Proceeds from maturities, calls and principal payments of investments held-to-maturity			39,184				63,105				36,038
Proceeds from maturities, calls and principal payments of investments available-for-sale			347,856				189,569				208,555
Proceeds from redemption of VISA stock			-				429				-
Net decrease (increase) in loans and leases			124,290				(231,853	)			(179,464	)
Contingent consideration payout			(2,308	)			(3,915	)			(1,491	)
Acquisition of business activity, net			-				-				(15,729	)
Proceeds from the sales of other real estate owned			967				240				(179	)
Proceeds from the sales of premises and equipment			-				-				650
Expenditures for premises and equipment			(3,110	)			(2,250	)			(4,780	)
Net cash used in investing activities			(408,025	)			(285,715	)			(41,779	)
Financing activities:
Net increase (decrease) in deposits			331,585				91,389				(57,031	)
Net increase in retail repurchase agreements and federal funds purchased			13,956				(22,911	)			(26,483	)
Proceeds from advances from FHLB			-				246,000				187,212
Repayment of advances from FHLB			(968	)			(126,956	)			(110,861	)
Common stock issued pursuant to West Financial Services acquisition			628				-				-
Proceeds from issuance of common stock			521				743				1,823
Common stock purchased and retired			-				-				(4,354	)
Proceeds from issuance of preferred stock			-				83,094				-
Tax benefits associated with shared based compensation			26				51				110
Dividends paid			(10,047	)			(15,764	)			(14,988	)
Net cash provided (used) by financing activities			335,701				255,646				(24,572	)
Net increase (decrease) in cash and cash equivalents			(45,433	)			19,742				(18,436	)
Cash and cash equivalents at beginning of period			105,229				85,487				103,923
Cash and cash equivalents at end of period		$	59,796			$	105,229			$	85,487
Supplemental Disclosures:
Interest payments		$	52,416			$	59,902			$	76,000
Income tax payments			3,920				21,404				14,149
Transfers from loans to other real estate owned			5,617				2,723				90
Details of acquisition:
Fair value of assets ascuired		$	-			$	-			$	417,434
Fair value of liabilites assumed			-				-				(365,709	)
Stock issued for acquisition			-				-				(58,916	)
Purchase price in excess of net assets acquired			-				-				62,600
Cash paid for acquisitions		$	-			$	-			$	55,409
Cash and cash equivalents acquired with acquisitions			-				-				(39,680	)
Acquisition of business activity, net		$	-			$	-			$	15,729

The accompanying notes are an integral part of these statements

 

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SANDY SPRING BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

																						Accumulated
														Additional								Other				Total
		Preferred				Common								Paid-In				Retained				Comprehensive				Stockholders’
(Dollars in thousands, except per share data)		Stock				Stock				Warrants				Capital				Earnings				Loss				Equity
Balances at December 31, 2006		$	-			$	14,827			$	-			$	27,869			$	199,102			$	(4,021	)		$	237,777
Comprehensive Income:
Net income			-				-				-				-				32,262				-				32,262
Other comprehensive income , net of tax:
Net unrealized gain on debt securities, net of reclassification adjustment			-				-				-				-				-				1,261				1,261
Change in funded status of defined benefit pension			-				-				-				-				-				1,705				1,705
Total Comprehensive Income																											35,228
Common stock dividends - $0.92 per share			-				-				-				-				(14,988	)			-				(14,988	)
Stock compensation expense			-				-				-				1,128				-				-				1,128
Common stock repurchases - 156,249 shares			-				(156	)			-				(4,198	)			-				-				(4,354	)
Common stock issued pursuant to:
Acquisition of Potomac Bank - 886,989 shares			-				887				-				32,190				-				-				33,077
Acquisition of CN Bancorp, Inc. - 690,047 shares			-				690				-				25,149				-				-				25,839
Stock option plan - 68,098 shares (78,264 shares issued less 10,166 shares retired)			-				68				-				1,095				-				-				1,163
Employee stock purchase plan – 25,147 shares			-				25				-				662				-				-				687
Director stock purchase plan – 2,402 shares			-				2				-				75				-				-				77
Restricted stock- 6,078 shares			-				6				-				-				-				-				6
Balances at December 31, 2007			-				16,349				-				83,970				216,376				(1,055	)			315,640
Adjustment to reflect adoption of EITF Issue 06-04 effective January 1, 2008			-				-				-				-				(1,647	)			-				(1,647	)
Balance as of January 1, 2008 following adoption of EITF issue 06-04			-				16,349				-				83,970				214,729				(1,055	)			313,993
Comprehensive Income:
Net income			-				-				-				-				15,779				-				15,779
Other comprehensive income (loss), net of tax:
Net unrealized gain on debt securities, net of reclassification adjustment			-				-				-				-				-				(581	)			(581	)
Change in funded status of defined benefit pension			-				-				-				-				-				(5,936	)			(5,936	)
Total Comprehensive Income																											9,262
Common stock dividends-  $0.96 per share			-				-				-				-				(15,764	)			-				(15,764	)
Preferred stock dividends - $3.48 per share			-				-				-				-				(289	)			-				(289	)
Stock compensation expense			-				-				-				772				-				-				772
Common stock issued pursuant to:
Stock option plan - 9,127 shares (16,837 shares issued less 7,710 shares retired)			-				9				-				53				-				-				62
Employee stock purchase plan – 32,891 shares			-				33				-				609				-				-				642
Director stock purchase plan – 1,479 shares			-				2				-				38				-				-				40
Restricted stock- 5,709 shares			-				6				-				44				-				-				50
Preferred stock issued pursuant to:
TARP - 83,094 shares			83,094				-				-				-				-				-				83,094
Discount from issuance of preferred stock			(3,699	)			-				-				-				-				-				(3,699	)
Discount accretion			45				-				-				-				(45	)			-				-
Warrant issued			-				-				3,699				-				-				-				3,699
Balances at December 31, 2008			79,440				16,399				3,699				85,486				214,410				(7,572	)			391,862
Comprehensive Income:
Net income (loss)			-				-				-				-				(14,855	)			-				(14,855	)
Other comprehensive income (loss), net of tax:
Net unrealized gain on debt securities, net of reclassification adjustment			-				-				-				-				-				3,384				3,384
Change in funded status of defined benefit pension			-				-				-				-				-				1,536				1,536
Total Comprehensive Income																											(9,935	)
Cash dividends-  $0.37 per share			-				-				-				-				(6,123	)			-				(6,123	)
Preferred stock dividends - $50.00per share			-				-				-				-				(4,155	)			-				(4,155	)
Stock compensation expense			-				-				-				762				-				-				762
Discount accretion			655				-				-				-				(655	)			-				-
Common stock issued pursuant to:
Contingent consideration relating to 2005 acquisition of West Financial - 31,663 shares			-				32				-				596				-				-				628
Employee stock purchase plan - 40,598 shares			-				41				-				429				-				-				470
Director stock purchase plan - 2,988 shares			-				3				-				37				-				-				40
Restricted stock - 11,574 shares			-				11				-				(6	)			-				-				5
DRIP plan - 2,560 shares			-				2				-				30				-				-				32
Balances at December 31, 2009		$	80,095			$	16,488			$	3,699			$	87,334			$	188,622			$	(2,652	)		$	373,586

The accompanying notes are an integral part of these statements

 

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SANDY SPRING BANCORP, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accounting and reporting policies of the Company, which include Sandy Spring Bancorp, Inc. and its wholly-owned subsidiary, Sandy Spring Bank (the "Bank"), together with the Bank’s subsidiaries, Sandy Spring Insurance Corporation, The Equipment Leasing Company, and West Financial Services, Inc., conform to accounting principles generally accepted in the United States (“GAAP”) and to general practice within the financial services industry.

Policy for Consolidation

The consolidated financial statements include the accounts of Sandy Spring Bancorp, Inc. and the Bank. Consolidation has resulted in the elimination of all significant inter-company balances and transactions. The financial statements of Sandy Spring Bancorp, Inc. (Parent Only) include its investment in the Bank under the equity method of accounting.

Use of Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Examples of such estimates that could change significantly relate to the provision for loan and lease losses and the related allowance, potential impairment  of goodwill or intangibles, estimates with respect to other than temporary impairment involving investment securities, non-accrual loans, other real estate owned, prepayment rates, share-based payment, litigation, income taxes and projections of pension expense and the related liability.

Nature of Operations

Through its subsidiary bank, the Company conducts a full-service commercial banking, mortgage banking and trust business. Services to individuals and businesses include accepting deposits, extending real estate, consumer and commercial loans and lines of credit, equipment leasing, general insurance, personal trust, and investment and wealth management services. The Company operates in the six Maryland counties of Anne Arundel, Carroll, Frederick, Howard, Montgomery, and Prince George's, and in Fairfax and Loudoun counties in Virginia. The Company offers investment and wealth management services through the Bank’s subsidiary, West Financial Services.  Insurance products are available to clients through Chesapeake Insurance Group, and Neff & Associates, which are agencies of Sandy Spring Insurance Corporation. The Equipment Leasing Company provides leasing for primarily technology-based equipment for retail businesses.

Assets Under Management

Assets held for others under fiduciary and agency relationships are not assets of the Company or its subsidiaries and are not included in the accompanying balance sheets.  Trust department income and investment management fees are presented on an accrual basis.

Cash Flows

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and interest-bearing deposits with banks (items with an original maturity of three months or less).

Residential Mortgage Loans Held for Sale

The Company engages in sales of residential mortgage loans originated by the Bank.  Loans held for sale are carried at the lower of aggregate cost or fair value. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of these loans are recorded as a component of non-interest income in the Consolidated Statements of Income.  The Company's current practice is to sell such loans on a servicing released basis.

Derivative Financial Instruments

Derivative Loan Commitments

Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding.  Loan commitments that are derivatives are recognized at fair value on the consolidated balance sheet in other assets or other liabilities with changes in their fair values recorded in net gain on sale of loans.

The Company records a zero value for the loan commitment at the time the commitment is issued to a borrower.  Subsequent to inception, changes in the fair value of the loan commitment are recognized based on changes in the fair value of the underlying mortgage loan due to interest rate changes, changes in the probability the derivative loan commitment will be exercised, and the passage of time.  In estimating fair value, the Company assigns a probability to a loan commitment based on an expectation that it will be exercised and the loan will be funded.

 

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Forward Loan Sale Commitments

The Company carefully evaluates all loan sales agreements to determine whether they meet the definition of a derivative as facts and circumstances may differ significantly. If agreements qualify, to protect against the price risk inherent in derivative loan commitments, the Company utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments. Mandatory delivery contracts are accounted for as derivative instruments. Generally, the Company’s best efforts contracts also meet the definition of derivative instruments after the loan to the borrower has closed.  Accordingly, forward loan sale commitments that economically hedge the closed loan inventory are recognized at fair value on the Consolidated Balance Sheets in other assets and other liabilities with changes in their fair values recorded in net gain on sale of loans.  The Company estimates the fair value of its forward loan sales commitments using a methodology similar to that used for derivative loan commitments.

Interest Rate Swap Agreements

Beginning in 2007, the Company entered into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs.  The swaps are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a swap depends on whether it has been designated and qualifies as part of a hedging relationship. The Company's swaps qualify as derivatives, but are not designated as hedging instruments, thus any gain or loss resulting from changes in the fair value is recognized in net income.  Further discussion of the Company's financial derivatives is set forth Note 19 to the Consolidated Financial Statements.

Investments Held to Maturity and Other Equity Securities

Investments held to maturity are those securities which the Company has the ability and positive intent to hold until maturity. These securities are recorded at cost at the time of purchase. The carrying values of securities held to maturity are adjusted for premium amortization and discount accretion to the maturity date.  Related interest and dividends are included in interest income. Declines in the fair value of individual held-to-maturity securities below their cost that are other-than-temporary result in write-downs of the individual securities to their fair value.  Factors that may affect the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by the rating agency, a significant deterioration in the financial condition of the issuer, or that management would not have the ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value. Other equity securities represent Federal Reserve Bank, Federal Home Loan Bank of Atlanta stock and Atlantic Central Banker’s Bank stocks are considered restricted as to marketability and recorded at cost.

Investments Available for Sale

Marketable equity securities and debt securities not classified as held to maturity or trading are classified as securities available for sale. Securities available for sale are acquired as part of the Company's asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk and other factors. Securities available for sale are carried at fair value, with unrealized gains or losses based on the difference between amortized cost and fair value, reported net of deferred tax, as accumulated other comprehensive income (loss), a separate component of stockholders' equity. The carrying values of securities available for sale are adjusted for premium amortization and discount accretion to the maturity date. Realized gains and losses, using the specific identification method, are included as a separate component of non-interest income. Related interest and dividends are included in interest income.  Declines in the fair value of individual available-for-sale securities below their cost that are other-than-temporary result in write-downs of the individual securities to their fair value.  Factors affecting the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value.

Loans and Leases

Loans are stated at their principal balance outstanding net of any deferred fees and costs. Interest income on loans is accrued at the contractual rate based on the principal outstanding. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Lease financing assets, all of which are direct financing leases, include aggregate lease rentals, net of related unearned income.  Leasing income is recognized on a basis that achieves a constant periodic rate of return on the outstanding lease financing balances over the lease terms.

The Company generally places loans and leases, except for consumer loans, on non-accrual when any portion of the principal or interest is ninety days past due and collateral is insufficient to discharge the debt in full. Interest accrual may also be discontinued earlier if, in management's opinion, collection of amounts that are contractually due are unlikely. Generally, consumer installment loans are not placed on non-accrual, but are charged off when they are five months past due.  Accrual of interest on non-accrual loans is discontinued and all previously accrued but unpaid interest is reversed.  Interest on non-accrual loans is accounted for on the cash-basis or cost-recovery method, until the loan returns to accrual status.  Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

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Loans are considered impaired when, based on available information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal and interest payments are past due and they are placed on non-accrual. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance homogeneous credits such as residential real estate, consumer installment loans, and commercial leases, which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of "minimal delay" in payment (usually ninety days or less) provided eventual collection of all amounts due is expected. The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, the Company measures impairment on such loans by reference to the fair value of the collateral.  Fair value of the collateral is generally determined using third party appraisals that are reviewed by management for propriety and reasonableness. Third party appraisals are conducted at least annually.  Additionally, internal evaluations of collateral value are conducted quarterly to ensure any further deterioration of the collateral value is recognized on a timely basis.   Once a loss is determined to have occurred, the loan is charged-down to the fair value of the collateral, net of any disposal costs, or net realizable value.   Income on impaired loans is recognized similar to the method followed on nonaccrual loans.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses (“allowance”) represents an estimated amount which, in management's judgment, is adequate to absorb the estimate of probable losses on outstanding loans and leases.  The allowance is reduced by charge-offs and is increased by the provision for loan and lease losses and recoveries of previous losses.  The provision for loan losses is charged to earnings to bring the total allowance to a level considered necessary by management.  The allowance is based on two basic principles of accounting: (1) the requirement that a loss be accrued when it is probable that the loss has occurred at the date of the consolidated financial statements and the amount of the loss can be reasonably estimated and (2) the requirement that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the loan’s or lease’s contractual terms.  Assessment of the collectability of amounts due from the loan and lease portfolios is based on management’s continuing review and credit risk evaluation of the respective lending portfolios.

The Company’s allowance for loan and lease losses is comprised of two basic components: a general reserve reflecting historical losses by loan category, as adjusted by several factors whose effects are not reflected in historical loss ratios, and specific allowances. The use of historical loss factors is intended to reduce the differences between estimated losses inherent in the loan and lease portfolio and actual losses.

The adequacy of the allowance is determined through careful and continuous evaluation of the loan and lease portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level.  Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change.  The Company’s systematic methodology for assessing the appropriateness of the allowance includes a formula allowance reflecting historical losses, as adjusted, by credit category, and a specific allowance for risk-rated credits on an individual basis.  The amount of the allowance is reviewed monthly by the Credit Risk Committee of the board of directors and formally approved quarterly by that same committee of the board.

The formula allowance is based upon historical loss factors, as adjusted, and establishes allowances for the major loan categories based upon adjusted historical loss experience over the prior eight quarters, weighted so that losses realized in the most recent quarters have the greatest effect.  The factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan portfolio including: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the categories of loans comprising the loan portfolio, (4) concentrations of loans to specific industry segments, (5) changes in economic conditions on both a local and national level, (6) changes in the Company’s credit administration and loan portfolio management processes, and (7) quality of the Company’s credit risk identification processes.

The specific allowance is used to calculate an allowance for specifically identified impaired loans. Analysis resulting in specific allowances, including those on loans identified for evaluation of impairment, includes consideration of the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of collateral.  These factors are combined to estimate the probability and severity of potential losses.  Then a specific allowance is established based on the Company’s calculation of the probable loss inherent in the individual loan.  Allowances are also established by application of credit risk factors to other internally risk-rated homogeneous pools of loans, such as consumer and residential loans and commercial leases having reached non-accrual or 90-day past due status.  Each risk rating category is assigned a credit risk factor based on management’s estimate of the associated risk, complexity, and size of the individual loans within the category.  Additional allowances may also be established in special circumstances involving a particular group of credits or portfolio within a risk category when management becomes aware that losses incurred may exceed those determined by application of the risk factor alone. The actual occurrence and severity of losses involving risk-rated credits can differ substantially from estimates, and some risk-rated credits may not be identified

 

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Management believes that it uses relevant information available to make determinations about the allowance and that it has established the existing allowance in accordance with GAAP. However, the determination of the allowance requires significant judgment, and estimates of probable losses in the loan and lease portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future additions to the allowance may be necessary based on changes in the loans and leases comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Company, periodically review the loan and lease portfolio and the allowance.  Such review may result in additional provisions based on management’s  judgments of information available at the time of each examination.

Premises and Equipment

Premises and equipment are stated at cost, less accumulated depreciation and amortization, computed using the straight-line method. Premises and equipment are depreciated over the useful lives of the assets, which generally range from 3 to 10 years for furniture, fixtures and equipment, 3 to 5 years for computer software and hardware, and 10 to 40 years for buildings and building improvements.  Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are included in non-interest expense.

Other Real Estate Owned (“OREO”)

OREO is comprised of properties acquired in partial or total satisfaction of problem loans. The properties are recorded at the lower of cost, or fair value less estimated costs of disposal, on the date acquired. Losses arising at the time of acquisition of such properties are charged against the allowance for loan and lease losses. Subsequent write-downs that may be required are expensed as incurred. Gains and losses realized from the sale of OREO, as well as valuation adjustments, are included in non-interest income. Expenses of operation are included in non-interest expense.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired.  Other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability.  Goodwill is not amortized over an estimated life, but rather is tested at least annually for impairment. If it is determined that an event has occurred that may indicate that the value of the goodwill has become impaired (a “triggering event”) then the goodwill is subject to impairment testing.  The initial step in the process determines whether the fair value of a reporting unit is less than its cost basis.  If this is indicated, the Company proceeds to a second step and uses various methods to determine the extent, if any, of the impairment based on a composite of valuation methods comprised of market value indicators and discounted cash flows from both the assets and liabilities of the reporting unit.  Any impairment is realized through a reduction of goodwill and an offsetting charge to non-interest expense.

 

Intangible assets that have finite lives are amortized over their estimated useful lives and also continue to be subject to impairment testing.  All of the Company’s other intangible assets have finite lives and are being amortized on a straight-line basis over varying periods that initially did not exceed 15 years.

  

A summary of the Company’s goodwill and other intangible assets is included in Note 8. The unidentifiable intangible assets resulting from branch acquisitions resulted from two transactions: the purchase of a commercial bank in 1996 and the purchase of seven commercial bank branches in a single transaction in 1999. No goodwill was recorded as a result of these branch acquisitions.   Accordingly, the Company has continued to amortize these unidentifiable intangible assets without a change in method.

 

Valuation of Long-Lived Assets

The Company reviews long-lived assets and certain identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of the long-lived asset is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset.  If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets.  Assets to be disposed of are reportable at the lower of the carrying amount or the fair value, less costs to sell.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Insurance Commissions and Fees

Commission revenue is recognized on the date the customer is billed.  The Company also receives contingent commissions from insurance companies as additional incentive for achieving specified premium volume goals and/or the loss experience of the insurance placed by the Company. Contingent commissions from insurance companies are recognized when determinable, which is generally when such commissions are received.

 

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Advertising Costs

Advertising costs are expensed as incurred and included in non-interest expenses.

Earnings per Common Share

Basic earnings per common share is derived by dividing net income available to common stockholders by the weighted-average number of common shares outstanding, and does not include the impact of any potentially dilutive common stock equivalents. The diluted earnings per common share is derived by dividing net income by the weighted-average number of common shares outstanding, adjusted, if applicable, for the dilutive effect of outstanding stock options as well as any adjustment to income that would result from the assumed issuance.  The number of potential shares issued pursuant to the stock option plans is determined using the treasury stock method.

Income Taxes

Income tax expense is based on the results of operations, adjusted for permanent differences between items of income or expense reported in the financial statements and those reported for tax purposes. Deferred income tax assets and liabilities are determined using the liability method. Under the liability method, deferred income taxes are determined based on the differences between the financial statement carrying amounts and the income tax bases of assets and liabilities and are measured at the enacted tax rates that will be in effect when these differences reverse.

The Company does not have uncertain tax positions that are deemed material, and did not recognize any adjustments for unrecognized tax benefits. The Company’s policy is to recognize interest and penalties on income taxes in other non-interest expenses. The Company remains subject to examination for income tax returns for the years ending after December 31, 2007.

Adopted Accounting Pronouncements

The Company applies the guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Topic (“ASC”) regarding the measurement of the fair value of a liability.  This guidance is effective for the first reporting period subsequent to August 2009. The guidance provides clarification regarding what techniques may be used to measure the fair value of a liability when a quoted price for a liability in an active market is not available.  It further clarifies that an adjustment to the fair value is not required due to the existence of a restriction that prevents the transfer of the liability.

 

The Company adopted new guidance for other-than-temporary impairment (“OTTI”) of debt securities and uses the criteria used to assess the collectability of cash flows to determine potential OTTI.  This topic is effective for interim and annual reporting periods ending after June 15, 2009.  This guidance modifies the presentation of OTTI losses and increases the frequency of and expands existing disclosure requirements. The Company’s adoption of this accounting standard in the second quarter of 2009 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

The Company adopted new guidance  relating to the use of judgment in evaluating the relevance of inputs when determining fair value, estimating fair values when the volume and level of activity for an asset or liability decreased significantly and identifying transactions that are not orderly.  The Company’s adoption of this accounting standard in the second quarter of 2009 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

The Company includes non-forfeitable rights to dividends or dividend equivalents on unvested shared based payment awards on participating securities in the earnings allocation when computing earnings per share (“EPS”). These EPS computation requirements were effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior period per share data presented must be adjusted retrospectively. The adoption of these EPS calculation requirements did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

The Company applies the general standards of accounting for and disclosure of events that occurred after the balance sheet date but before financial statements are issued or are available to be issued. These accounting and disclosure requirements are effective for interim or annual financial periods ending after June 15, 2009 and shall be applied prospectively.  There are two types of subsequent events that must be evaluated: recognized and non-recognized subsequent events. An entity must recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. An entity may not recognize subsequent events that provide evidence about conditions that did not exist at the date of the balance sheet but that arose after the balance sheet date but prior to the issuance of the financial statements.  Certain non-recognized subsequent events may be of such a nature that they must be disclosed to keep the financial statements from being misleading. The adoption of these accounting and disclosure standards did not have an impact on the Company’s financial position, results of operations or cash flows.

 

The Company adopted new guidance related to the disclosure of information about fair value measurements of plan assets that would be similar to the currently required disclosures about fair value measurements.  The adoption of the disclosure requirements in 2009 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

 

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Pending Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets an amendment of FASB Statement No. 140” (“SFAS No. 166”). The disclosure requirements apply to transfers that occur both before and after the effective date of the statement. SFAS No. 166 is effective as of the beginning of a reporting entity’s first annual reporting period beginning after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. This statement changes the de-recognition guidance for transferors of financial assets, including entities that sponsor securitizations, to align that guidance with the original intent of FASB Statement No. 140, “Accounting for the Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” In addition, on and after the effective date, existing qualifying special-purpose entities must be evaluated for consolidation by the reporting entity.

SFAS No. 166 eliminates the concept of a qualifying special purpose entity (“QSPE”). The statement eliminates any reference to a QSPE and requires a transferor to evaluate transfers to such entities under the amended guidance. SFAS No. 166 also introduces the concept of a participating interest. A participating interest is defined as a proportionate ownership interest in a financial asset in which the cash flows from the asset are allocated to the participating interest holders in proportion to their ownership share.

 

Additionally, SFAS No. 166 significantly modifies the conditions required for a transfer of a financial asset or a participating interest therein to qualify as a sale. SFAS No. 166 also changes the measurement guidance for transfers of financial assets in that it requires that a transferor recognize and initially measure at fair value any servicing assets, servicing liabilities, and any other assets obtained and liabilities incurred in a sale.  The statement amends the disclosure requirements to allow financial statement users to understand the nature and extent of the transferor’s continuing involvement with financial assets that have been transferred. The Company does not expect that the adoption of this statement will have a material impact on its financial position, results of operations or cash flows.

 

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”). This statement is effective as of the beginning of a reporting entity’s first annual reporting period that begins after November 15, 2009 and for interim periods within the first annual reporting period.  Earlier application is prohibited. The objective of this Statement is to improve the accounting and disclosure of any involvement with variable interest entities (“VIEs”). SFAS No. 167 eliminates the existing approach for identifying the primary beneficiary of a VIE. It changes that approach with an analysis to determine if an enterprise’s variable interests give it a controlling financial interest in the VIE. The statement also expands the disclosure requirements for an enterprise that has a variable interest in a VIE. The Company does not expect that the adoption of this statement will have a material impact on its financial position, results of operations or cash flows.

 

NOTE 2 – ACQUISITIONS

On February 15, 2007, the Company completed the acquisition of Potomac Bank of Virginia (“Potomac”), a bank headquartered in Fairfax, Virginia.  Potomac operated five branch offices in the Northern Virginia metropolitan market at the time of the acquisition.  The total consideration paid to Potomac shareholders and related merger costs in connection with the acquisition was $68.2 million.  The results of Potomac’s operations have been included in the Company’s consolidated financial results subsequent to February 15, 2007. The assets and liabilities of Potomac were recorded on the Consolidated Balance Sheet at their respective fair values.  The fair values were determined as of February 15, 2007 and are not subject to further refinements. The transaction resulted in total assets acquired as of February 15, 2007 of $252.5 million, including approximately $196.0 million of loans and leases; liabilities assumed were $224.3 million, including $197.0 million of deposits. Additionally, the Company recorded $40.0 million of goodwill, $5.1 million of core deposit intangibles (“CDI”) and $0.3 million of other intangibles. CDI’s are subject to amortization and are being amortized over seven years on a straight-line basis.

On May 31, 2007, the Company completed the acquisition of CN Bancorp Inc. (“CNB”) and it’s wholly owned subsidiary, County National Bank (“County”).  County was headquartered in Glen Burnie, Maryland, and had four full-service branches located in Anne Arundel County, Maryland at the time of the acquisition. The total consideration paid to CNB shareholders and related merger costs in connection with the acquisition was $46.1 million.  The results of CNB’s operations have been included in the Company’s consolidated financial results subsequent to May 31, 2007.   The assets and liabilities of CNB were recorded on the Consolidated Balance Sheet at their respective fair values.  The fair values were determined as of May 31, 2007 and are not subject to further refinements. The transaction resulted in total assets acquired as of May 31, 2007 of $164.9 million, including approximately $98.7 million of loans; liabilities assumed were $141.4 million, including $138.4 million of deposits.  Additionally, the Company recorded $22.6 million of goodwill, $4.6 million of CDI’s and $0.1 million of other intangibles.  CDI’s are subject to amortization and are being amortized over seven years on a straight-line basis.

The acquisitions of Potomac and CNB, individually and in the aggregate, were not considered material acquisitions for purposes of any required pro forma disclosures.

NOTE 3 – CASH AND DUE FROM BANKS

Regulation D of the Federal Reserve Act requires that banks maintain reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. At its option, the Company maintains additional balances to compensate for clearing and safekeeping services. The average balance maintained in 2009 was $58.9 million and in 2008 was $10.2 million.  The increase in the average balance from 2008 to 2009 was the result of the Federal Reserve paying interest on excess balances maintained after November 2008.

 

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NOTE 4 – INVESTMENTS

Portfolio quality discussion

At December 31, 2009, any unrealized losses associated with AAA-rated U.S. Government Agencies are caused by changes in interest rates and are not considered credit related as the contractual cash flows of these investments are either explicitly or implicitly backed by the full faith and credit of the U.S. government.  Unrealized losses that are related to the prevailing interest rate environment will decline over time and recover as these securities approach maturity.  The municipal securities portfolio segment is not experiencing any significant credit problems at December 31, 2009 and the Company believes it will receive all contractual cash flows due on this portfolio.  The mortgage-backed securities portfolio at December 31, 2009 is composed entirely of either the most senior tranches of GNMA collateralized mortgage obligations ($189.8 million), or GNMA, FNMA or FHLMC mortgage-backed securities ($264.2 million).  Any associated unrealized losses are caused by changes in interest rates and are not considered credit related as the contractual cash flows of these investments are either explicitly or implicitly backed by the full faith and credit of the U.S. government.  Unrealized losses that are related to the prevailing interest rate environment will decline over time and recover as these securities approach maturity.

At December 31, 2009 the Company owned a total of $ $3.1 million in securities backed by single issuer trust preferred securities issued by banks. The fair value of $3.3 million of such securities was determined from available market quotations. The Company also owns collateralized debt securities, which total $4.7 million, with a fair value of $3.1 million, which are backed by pooled trust preferred securities issued by banks, thrifts, and insurance companies. These particular securities have exhibited limited activity due to the status of the economy at December 31, 2009 and 2008, respectively.  There are currently very few market participants who are willing and or able to transact for these securities.

Given current conditions in the debt markets and the absence of observable transactions in the secondary markets, the Company has determined:

·

The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at December 31, 2009 and 2008.

·

An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be more representative of fair value than a market approach valuation technique.

·

The pooled trust preferred securities will be classified within Level 3 of the fair value hierarchy because the Company has determined that significant adjustments are required to determine fair value at the measurement date.

The assumptions used by the Company in order to determine fair value on a present value basis, in the absence of observable trading prices as noted, included the following:

·

Detailed credit and structural evaluation for each piece of collateral in the CDO.

·

Collateral performance projections for each piece of collateral in the CDO (default, recovery and prepayment/amortization probabilities). Of the approximately 25 issuers, collateral with respect to one has defaulted and two have deferred payments.  Based on the view that it was unlikely that financing would become available in the foreseeable future, no collateral prepays were assumed over the lives of the investments.

·

Terms of the CDO structure as established in the indenture.

·

14% discount rate.

As part of its formal quarterly evaluation of investment securities for the presence of  OTTI, the Company considered a number of factors including:

·

The length of time and the extent to which the fair value has been less than the amortized cost

·

Adverse conditions specifically related to the security, industry, or geographic area

·

Historical and implied volatility of the fair value of the security

·

Credit risk concentrations

·

The ability of the issuer to make scheduled interest or principal payments

·

Amount of principal to be recovered by stated maturity

·

Ratings changes of the security

·

Performance of bond collateral

·

Recoveries of additional declines in fair value subsequent to the date of the statement of condition

·

The securities are senior notes with first priority

·

Other information currently available, such as the latest trustee reports

·

An analysis of the credit worthiness of the individual pooled banks.

 

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As a result of this evaluation, which takes into account (1) that all payments have been received on a timely basis, and (2) that the Company has the intent and ability to hold the securities to maturity, the Company determined that the credit quality of these securities remains adequate to absorb further economic declines and that no OTTI existed with respect to these securities at December 31, 2009.

Marketable equity securities are composed almost entirely of FHLB stock and Federal Reserve Bank stock, at cost.  With respect to the FHLB stock, the Company has received the most recent quarterly dividend that was due.  The Company has determined through a comprehensive earnings and liquidity review that there have been no other events that would result in a significant adverse effect on the fair value of the FHLB stock and that the par value of this investment will ultimately be recovered.

Investments available-for-sale

The amortized cost and estimated fair values of investments available-for-sale for the periods indicated are as follows:

		As of December 31, 2009																As of December 31, 2008
						Gross				Gross				Estimated								Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair				Amortized				Unrealized				Unrealized				Fair
(In thousands)		Cost				Gains				Losses				Value				Cost				Gains				Losses				Value
U.S. government agencies		$	352,841			$	3,190			$	(434	)		$	355,597			$	135,418			$	2,003			$	(101	)		$	137,320
State and municipal			41,283				903				(44	)			42,142				2,663				78				(41	)			2,700
Mortgage-backed			449,722				5,767				(1,491	)			453,998				144,638				1,358				(920	)			145,076
Trust preferred			7,841				180				(1,675	)			6,346				7,890				24				(1,633	)			6,281
Total debt securities			851,687				10,040				(3,644	)			858,083				290,609				3,463				(2,695	)			291,377
Marketable equity securities			350				-				-				350				350				-				-				350
Total investments available-for-sale		$	852,037			$	10,040			$	(3,644	)		$	858,433			$	290,959			$	3,463			$	(2,695	)		$	291,727

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in an unrealized loss position for the periods indicated are as follows: