Item 1. Description of Business
General
Calvin B. Taylor Bankshares, Inc. (the "Company") was incorporated as a Maryland corporation on October 31, 1995. The Company owns all of the stock of two banks. The Maryland bank is a commercial bank incorporated under the laws of the State of Maryland on December 17, 1907. This bank operates nine banking offices in Worcester County with the Bank's main office located in Berlin, Maryland. It is engaged in a general commercial and retail banking business serving individuals, businesses, and governmental units in Worcester County, Maryland and neighboring counties. The second bank was incorporated in Delaware in 1997 but opened late in the second quarter of 1998. This one-branch Delaware bank offers the same services as the Maryland bank.
The Company's holding company structure can assist the banks in maintaining their required capital ratios because the Company may, subject to compliance with debt guidelines implemented by the Board of Governors of the Federal Reserve System (the "Board of Governors" or the "Federal Reserve"), borrow money and contribute the proceeds to the banks as primary capital. The holding company structure also permits greater flexibility in issuing stock for cash, property, or services and in reorganization transactions. Moreover, subject to certain regulatory limitations, a holding company can purchase shares of its own stock, which the banks may not do without regulatory approval. A holding company may also engage in certain non-banking activities which the Board of Governors has deemed to be closely related to banking and proper incidents to the business of a bank holding company. These activities include making or servicing loans and certain types of leases; performing certain data processing services; acting as a fiduciary or investment or financial advisor; acting as a management consultant for other depository institutions; providing courier, appraisal, and consumer financial counseling services; providing tax planning and preparation services; providing check guaranty and collection agency services; engaging in limited real estate investment activities; underwriting, brokering, and selling credit life and disability insurance; engaging in certain other limited insurance activities; providing discount brokerage services; underwriting and dealing in certain government obligations and money market instruments and providing portfolio investment advice; acting as a futures commission merchant with respect to certain financial instrument transactions; providing foreign exchange advisory and transactional services; making investments in certain corporations for projects designed primarily to promote community welfare; and owning and operating certain healthy savings and loan associations. Although the Company has no present intention of engaging in any of these services, if circumstances should lead the Company's management to believe that there is a need for these services in the banks' marketing areas and that such activities could be profitably conducted, the management of the Company would have the flexibility of commencing these activities upon filing notice thereof with the Board of Governors.
Location and Service Area
The Company conducts general commercial banking in its primary service areas, emphasizing the banking needs of individuals and small- to medium-sized businesses and professional concerns. The Maryland bank operates from nine branches located throughout Worcester County, Maryland while the Delaware bank operates from one branch located in Sussex County, Delaware. The Banks draw most of their customer deposits and conduct most of their lending transactions from within their primary service areas, which encompass Worcester County, Maryland, Sussex County, Delaware and neighboring counties.
Both Sussex County, Delaware and Worcester County, Maryland are located along the shores of the Atlantic Ocean and have experienced population growth in recent years. The area is growing as both a resort and a retirement community.
The principal components of the economy of the counties are tourism and agriculture. Berlin has a strong component of health-care related businesses. The tourist businesses of Ocean City, Maryland and Bethany, Delaware and the health-care facilities in Berlin, Maryland (including Berlin Nursing Home and Atlantic General Hospital) are the largest employers in the counties. The largest industrial employers are Perdue Farms and Hudson Farms.
Banking Services
The banks offer a full range of deposit services including checking, NOW and Money Market accounts, savings and time deposits including certificates of deposit. The transaction accounts and time certificates are tailored to the banks' principal market areas at rates competitive to those offered in the area. In addition, the banks offer certain retirement account services, such as Individual Retirements Accounts ("IRAs"). All deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum amount allowed by law (generally, $100,000 per depositor subject to aggregation rules). The banks solicit these accounts from individuals, businesses, associations and organizations, and governmental authorities.
The Company, through its banks, also offers a full range of short- to medium-term commercial and personal loans. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements), and purchase of equipment and machinery. Consumer loans include secured and unsecured loans for financing automobiles, home improvements, education, and personal investments. The Company originates commercial and residential mortgage loans and real estate construction and acquisition loans. These lending activities are subject to a variety of lending limits imposed by state and federal law. Neither bank may make any loans to any director, officer, or employee (except for commercial loans to directors who are not officers or employees) unless the loans are approved by the Board of Directors of the lending bank. The Board of Directors must review any such loans every six months.
Other bank services include cash management services, 24-hour ATM's, credit cards, debit cards, safe deposit boxes, travelers' checks, direct deposit of payroll and social security checks, and automatic drafts for various accounts. In 2002, the banks plan to offer Internet banking including electronic bill-payment services to both commercial and retail customers.
Competition
The Company faces strong competition in all areas of its operations. The competition comes from entities operating in Worcester County, Maryland and Sussex County, Delaware and neighboring counties and includes branches of some of the largest banks in Maryland, Delaware, and Virginia. Its most direct competition for deposits historically has come from other commercial banks, savings banks, savings and loan associations, and credit unions operating in its service areas. The banks also compete for deposits with money market mutual funds and corporate and government securities. The banks compete for loans with the same banking entities, as well as mortgage banking companies and other institutional lenders. The competition for loans varies from time to time depending on certain factors. These factors include, among others, the general availability of lendable funds and credit, general and local economic conditions, current interest rate levels, conditions in the mortgage market, and other factors which are not readily predictable.
The banks' employ traditional marketing media including local newspapers and radio, to attract new customers. Bank officers, directors and employees are active in numerous community organizations and participate in community-based events. These activities and referrals of satisfied customers result in new business.
Employees
As of December 31, 2001, the banks employed 97 full- time equivalent employees. The Company's operations are conducted through the banks. Consequently, the Company does not have separate employees. None of the employees of the banks are represented by any collective bargaining unit. The banks consider their relations with their employees to be good.
SUPERVISION AND REGULATION
The Company and the banks are subject to state and federal banking laws and regulations which impose specific requirements or restrictions on, and provide for general regulatory oversight with respect to, virtually all aspects of operations. These laws and regulations are generally intended to protect depositors, not shareholders. The following is a brief summary of certain statutes, rules, and regulations affecting the Company and the banks. To the extent that the following summary describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Beginning with the enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) and following with the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), numerous additional regulatory requirements have been placed on the banking industry, and additional changes have been proposed. Legislative changes and the policies of various regulatory authorities may affect the operations of the Company and the banks and those effects may be material. The Company is unable to predict the nature or the extent of the effect on its business and earnings that fiscal or monetary policies, economic controls, or new federal or state legislation may have in the future.
Gramm-Leach-Bliley Act
On November 12, 1999, the Gramm-Leach-Bliley Act was signed into law. Among other things, the Act repeals the restriction, contained in the Glass-Steagall Act, on banks affiliating with securities firms. The Act permits bank holding companies to engage in a statutorily provided list of financial activities, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities. The Act also authorizes activities that are "complementary" to financial activities. The Act is intended to grant certain powers to community banks that larger institutions have accumulated on an ad hoc basis. The Act may have the result of increasing competition that the Company and the banks face from larger institutions and other types of companies. In fact, it is not possible to predict the full effect that the Act will have on the Company and the banks.
The Company
Because it owns the outstanding common stock of the banks, the Company is a bank holding company within the meaning of the federal Bank Holding Company Act of 1956 (the "BHCA"). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require. The Company's and the banks' activities are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries, or engaging in any other activity that the Federal Reserve determines to be so closely related to banking or managing and controlling banks as to be a proper incident thereto.
Investments, Control, and Activities. With certain limited exceptions, the BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring substantially all the assets of any bank, (ii) acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares), or (iii) merging or consolidating with another bank holding company.
In addition, and subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with regulations thereunder, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring "control" of a bank holding company, such as the Company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Because the Company's Common Stock is registered under the Securities Exchange Act of 1934, under Federal Reserve regulations, control will be rebuttably presumed to exist if a person acquires at least 10% of the outstanding shares of any class of voting securities of the Company. The regulations provide a procedure for challenge of the rebuttable control presumption.
Under the BHCA, the Company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities, unless the Federal Reserve, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve has determined by regulation to be proper incidents to the business of banking include making or servicing loans and certain types of leases, engaging in certain insurance and discount brokerage activities, performing certain data processing services, acting in certain circumstances as a fiduciary or investment or financial advisor, owning savings and loan associations, and making investments in certain corporations or projects designed primarily to promote community welfare.
Source of Strength; Cross-Guarantee. In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to its banks and to commit resources to support the banks in circumstances in which the Company might not otherwise do so. Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve's determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution's financial condition. The banks may be required to indemnify, or cross-guarantee, the FDIC against losses it incurs with respect to any other bank controlled by the Company, which in effect makes the Company's equity investments in healthy bank subsidiaries available to the FDIC to assist any failing or failed bank subsidiary of the Company.
The Banks
General. The banks operate as state nonmember banking associations incorporated under the laws of the State of Maryland and the State of Delaware. They are subject to examination by the FDIC and each state's department of banking regulation. Deposits in the banks are insured by the FDIC up to a maximum amount (generally $100,000 per depositor, subject to aggregation rules). The States and FDIC regulate or monitor all areas of the banks' operations, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, interest rates payable on deposits, interest rates or fees chargeable on loans, establishment of branches, corporate reorganizations, maintenance of books and records, and adequacy of staff training to carry on safe lending and deposit gathering practices. The FDIC requires the banks to maintain certain capital ratios and imposes limitations on each of the banks' aggregate investment in real estate, bank premises, and furniture and fixtures. The banks are required by the FDIC to prepare quarterly reports on the banks' financial condition.
Under provisions of the FDICIA, all insured institutions must undergo periodic on-site examination by the appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the agency against each institution or affiliate, as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC and the appropriate agency (and state supervisor when applicable). FDICIA also directs the FDIC to develop with other appropriate agencies a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition, or other report of any insured depository institution. FDICIA also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to: (i) internal controls, information systems, and audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset quality.
Transactions With Affiliates and Insiders. The banks are subject to Section 23A of the Federal Reserve Act, which places limits on the amount of loans or extensions of credit to, or investment in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of each bank's capital and surplus and, as to all affiliates combined, to 20% of each bank's capital and surplus. In addition, each covered transaction must meet specific collateral requirements. The banks are also subject to Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. The banks are subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.
Branching. Under Maryland law, the Maryland bank may open branches statewide, subject to the prior approval of the State Department of Financial Regulation and the FDIC. Maryland law permits banking organizations in other states to acquire Maryland banking organizations, as long as such states grant similar privileges to banking organizations in Maryland to acquire banking organizations in their states, by opening a de novo branch, by acquiring an existing branch from a Maryland depository institution, or as a result of an interstate merger with a Maryland banking organization. Delaware law also allows branches statewide with prior approval of the Office of the State Bank Commissioner and the FDIC. Delaware law is more restrictive allowing other state banking organizations to branch to Delaware only through opening a de novo bank, or as the result of an interstate merger.
Community Reinvestment Act. The Community Reinvestment Act requires that each insured depository institution shall be evaluated by its primary federal regulator with respect to its record in meeting the credit needs of its local community, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria would impose additional requirements and limitations on the banks. The banks received satisfactory ratings in their most recent evaluations.
Other Regulations. Interest and certain other charges collected or contracted for by the banks are subject to state and federal laws concerning interest rates. The banks' loan operations are also subject to certain federal laws applicable to credit transactions, such as the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers, the Home Mortgage Disclosure Act of 1975 requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed, or other prohibited bases in extending credit, the Fair Credit Reporting Act of 1978 governing the use and provision of information to credit reporting agencies, the Fair Debt Collection Act governing the manner in which consumer debts may be collected by collection agencies, and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. The deposit operations of the banks are also subject to the Right to Financial Privacy Act which imposes a duty to maintain confidentiality of customers' financial records and prescribes procedures for complying with administrative subpoenas of financial records, and the Electronic Funds Transfer Act as implemented by the Federal Reserve Board's Regulation E which governs automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services.
Deposit Insurance
The FDIC establishes rates for the payment of premiums by federally insured banks and thrifts for deposit insurance. Separate insurance funds are maintained for commercial banks (BIF) and thrifts (SAIF), with insurance premiums from the industry used to offset losses from insurance payouts when banks and thrifts fail. Since 1993, insured depository institutions like the banks have paid for deposit insurance under a risk-based premium system. Under this system, until mid-1995 depository institutions paid to BIF or SAIF from $0.23 to $0.31 per $100 of insured deposits depending on the capital levels and risk profile of the institution, as determined by its primary federal regulator on a semi- annual basis. When BIF reached its legally mandated reserve ratio in mid-1995, the FDIC lowered premiums for well-capitalized banks, eventually to a level of $.00 per $100 of insured deposits, with a minimum semiannual assessment of $1,000. In 1996, congress enacted the Deposit Insurance Funds Act of 1996, which eliminated this minimum assessment. The BIF insurance assessment rate for the first semiannual assessment period of 2002 is proposed to remain at $.00 to $.27 per $100 in deposits. In addition to the amount paid for deposit insurance, banks are assessed an additional amount to service the interest on the bond obligations of the Financial Corporation (FICO). Any increase in deposit insurance premiums for the banks will increase the banks' cost of funds, and there can be no assurance that such costs can be passed on to the banks' customers.
Dividends
The principal source of the Company's cash revenues comes from dividends received from the Maryland bank. The amount of dividends that may be paid by the bank to the Company depends on the bank's earnings and capital position and is limited by federal and state laws, regulations, and policies. The Federal Reserve has stated that bank holding companies should refrain from or limit dividend increases or reduce or eliminate dividends under circumstances in which the bank holding company fails to meet minimum capital requirements or in which earnings are impaired.
The Company's ability to pay any cash dividends to its shareholders in the future will depend primarily on the Maryland bank's ability to pay dividends to the Company. In order to pay dividends to the Company, the bank must comply with the requirements of all applicable laws and regulations. Under Maryland law, the bank must pay a cash dividend only from the following, after providing for due or accrued expenses, losses, interest, and taxes: (i) its undivided profits, or (ii) with the prior approval of the Department of Financial Regulation, its surplus in excess of 100% of its required capital stock. Under FDICIA, the bank may not pay a dividend if, after paying the dividend, the bank would be undercapitalized. See "Capital Regulations" below. See Item 5 for a discussion of dividends paid by the bank in the past two years.
In addition to the availability of funds from the Maryland bank, the future dividend policy of the Company is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, financial condition, cash needs, and general business conditions. The amount of dividends that might be declared in the future presently cannot be estimated and it cannot be known whether such dividends would continue for future periods.
Capital Regulations
The federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, account for off- balance sheet exposure, and minimize disincentives for holding liquid assets. The resulting capital ratios represent qualifying capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimums.
Current guidelines require bank holding companies and federally regulated banks to maintain a minimum ratio of total capital to risk-based assets equal to 8%, of which at least 4% must be Tier 1 capital. Tier 1 capital includes common shareholders' equity before the unrealized gains and losses on securities available for sale, qualifying perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, but excludes goodwill and most other intangibles, and excludes the allowance for loan and lease losses. Tier 2 capital includes the excess of any preferred stock not included in Tier 1 capital, mandatory convertible securities, hybrid capital instruments, subordinated debt and intermediate term-preferred stock, and general reserves for loan and lease losses up to 1.25% of risk- weighted assets. Total capital is the sum of Tier 1 plus Tier 2 capital.
Under the guidelines, banks' and bank holding companies' assets are given risk-weights of 0%, 20%, 50%, and 100%. In addition, certain off-balance sheet items are given credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk- weight will apply. These computations result in the total risk-weighted assets.
The federal bank regulatory authorities have also implemented a leverage ratio, which is Tier 1 capital as a percentage of average total assets less intangibles, to be used as a supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The minimum required leverage ratio for top-rated institutions is 3%, but most institutions are required to maintain an additional cushion of at least 100 to 200 basis points.
FDICIA established a new capital-based regulatory scheme designed to promote early intervention for troubled banks and requires the FDIC to choose the least expensive resolution of bank failures. The new capital-based regulatory framework contains five categories for compliance with regulatory capital requirements, including "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." To qualify as a "well capitalized" institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total risk-based capital ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. As of December 31, 2001, the Company and its banks were qualified as "well capitalized." For further discussions, see "Item 7. Management's Discussion and Analysis or Plan of Operation - - Capital."
Recent Legislative Developments
Periodically, the federal and state legislatures consider bills with respect to the regulation of financial institutions. Some of these proposals could significantly change the regulation of banks and the financial services industry. The Company cannot predict if such proposals will be adopted or the affect to the Company.
Item 2.
Item 2. Description of Property
The Company has ten branch locations, all of which are owned by the Company or the banks. The locations are described as follows:
Office Location Square Footage Main Office, Maryland 24 North Main Street, Berlin, Maryland 21811 6,500 East Berlin Office 10524 Old Ocean City Blvd, Berlin, MD 21811 1,500 20th Street Office 100 20th Street, Ocean City, Maryland 21842 3,100 Ocean Pines Office 11003 Cathell Road, Berlin, Maryland 21811 2,420 Mid-Ocean City Office 9105 Coastal Highway, Ocean City, Maryland 21842 1,984 North Ocean City Office 14200 Coastal Highway, Ocean City, Maryland 21842 2,545 West Ocean City Office 9923 Golf Course Road, Ocean City, Maryland 21842 2,496 Pocomoke Office 2140 Old Snow Hill Road, Pocomoke, Maryland 21851 2,624 Snow Hill Office 108 West Market Street, Snow Hill, Maryland 21863 3,773 Main Office, Delaware 50 Atlantic Avenue, Ocean View, Delaware 19970 4,900
The Berlin office is the centralized location for the Company and for all the Maryland branches; that is to say that all proof and bookkeeping is performed there. The Delaware office has its own proof and bookkeeping functions. Each branch has a manager that also serves as its loan officer, with exception of the East Berlin office which does not have a loan officer. All offices participate in normal day-to-day banking operations. Eight Maryland offices offer automated teller machines; all locations except the East Berlin office. The Delaware bank has an automated teller machine on- premise. The Company operates one automated teller machine which is located at a local hospital.
Item 3.
Item 3. Legal Proceedings
There are no material pending legal proceedings to which the Company or the banks or any of their properties are subject.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of the shareholders of the Company during the fourth quarter of 2001.
PART II
Item 5.
Item 5. Market for Common Equity and Related Stockholder Matters
The Company's Articles of Incorporation, as amended, authorize it to issue up to 10,000,000 shares of common stock.
As of February 28, 2001, there were approximately 905 holders of record of the common stock and 3,240,000 shares of Common Stock issued and outstanding. There is no established public trading market in the stock, and there is no likelihood that a trading market will develop in the near future. Transactions in the common stock are infrequent and are negotiated privately between the persons involved in those transactions.
All outstanding shares of common stock of the Company are entitled to share equally in dividends from funds legally available, when, as, and if declared by the Board of Directors. The Company paid dividends of $.37 per share in 2001 and $.61 per share in 2000 which includes a special cash dividend of $.25 per share which is not expected to be an annual event. Per share data for 2000 is restated to give retroactive effect to the 2000 stock split effected in the form of a 100% stock dividend.
Item 6.
Item 6. Selected Financial Data The following table presents selected financial data for the five years ended December 31, 2001. Prior period per share data is restated to reflect 100% stock dividends paid in 1998 and 2000.
Item 7.
Item 7. Management's Discussion and Analysis or Plan of Operation
BUSINESS OF THE COMPANY
Calvin B. Taylor Bankshares, Inc. (the "Company") is a bank holding company which was incorporated in the State of Maryland on October 31, 1995. Calvin B. Taylor Banking Company (the "Maryland Bank"), which commenced operation in 1890, was incorporated under the laws of the State of Maryland on December 17, 1907 and is a state nonmember bank under the laws of the State of Maryland. Calvin B. Taylor Bank of Delaware (the "Delaware Bank") was incorporated under the laws of the State of Delaware on September 18, 1997, and is a state nonmember bank under the laws of the State of Delaware. Both banks are engaged in a general commercial banking business, emphasizing in their marketing the Company's local management and ownership, from their main offices located in their primary service areas of Worcester County, Maryland and Sussex County, Delaware, and their neighboring counties. The banks offer a full range of deposit services, including checking accounts, NOW accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. In addition, the banks offer certain retirement account services, such as Individual Retirement Accounts. The banks also offer a full range of short- to medium-term commercial and personal loans. The banks originate fixed rate mortgage loans and real estate construction and acquisition loans. These loans generally have a demand feature. Other bank services include cash management services, safe deposit boxes, travelers' checks, direct deposit of payroll and social security checks, debit cards, and automatic drafts for various accounts.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the Company's financial condition and results of operations should be read in conjunction with the Company's financial statements and related notes and other statistical information included elsewhere herein.
Overview
Consolidated income of the Company is derived primarily from operations of the banks. The 2001 net income was $5,414,404, compared to $5,624,558 for 2000, and $5,019,660 for 1999. The Company continued its history of above average earnings with a return on average equity of 9.54% and return on average assets of 1.75% for 2001, compared to returns on average equity of 10.84% and 10.47%, and returns on average assets of 1.94% and 1.78%, for 2000 and 1999, respectively.
Results of Operations
The Company reported net income of $5,414,404, or $1.67 per share, for the year ended December 31, 2001, which was a decrease of $210,154, or 3.74%, from the net income of $5,624,558, or $1.74 per share, for the year ended December 31, 2000. Primarily responsible for this decrease was the decline in net interest income and increased personnel costs. Net income for 2000 increased by $604,898, or 12.05%, over the net income of $5,019,660, or $1.55 per share for the year ended December 31, 1999. Per share data for 1999 is restated for the effect of the 100% stock dividend distributed 2000. Primarily responsible for this increase was the growth in net interest income.
Net interest income decreased $283,039, or 2.08%, to $13,296,966 in 2001, from $13,580,005 in 2000. This decrease was the result of a lower net interest spread between the rates on interest-earning assets and interest-bearing liabilities. Interest expense increased $388,357 while interest income increased by $105,318. The yield on interest-earning assets decreased to 6.91% in 2001, from 7.39% in 2000, while the combined yield on deposits and borrowed funds was stable at 2.48% for the same periods.
Net interest income increased $1,359,187, or 11.12%, to $13,580,005 in 2000, from $12,220,818 in 1999. This increase was the result of an increase in interest revenue of $1,440,460 while interest expense increased by $81,273. Net interest income increased primarily due to growth of $18,090,114 in the mortgage loan portfolio funded largely by a decrease of $13,648,377 in the amortized cost of investment securities held to maturity. Decreasing deposit balances offset increased rates, resulting in an increase of $47,198 of deposit interest expense. Interest expense on retail repurchase agreements, which were first offered by the Bank in 2000, was $23,427. The yield on interest-earning assets increased to 7.39% in 2000, from 6.97% in 1999, while the combined yield on deposits and borrowed funds increased to 2.48% from 2.47% for the same periods.
Noninterest income and noninterest expense increased by 17.83% and 5.45%, respectively, during 2001 compared to 2000. Noninterest income and noninterest expense increased by 5.60% and 4.54%, respectively, during 2000 compared to 1999.
The Company reproted net income of $1,165,144 or $.36 per share for the quarter ended December 31, 2001, which was a decrease of $273,045, or 18.99% from the net income of $1,438,189, or $.44 epr share, for the quarter ended December 31, 2000. Primarily responsible was the decrease in quarterly net income from $3,532,645 in fourth quarter 2000 to $3,253,986 in fourth quarter 2001. Management attributes this $278,657 or 7.89% decline in net interest income to several factors related to the national economic environment. Decreased yields on federa; funds sold and investment securities, coupled with the banks' loan rate reductions caused interest income to lag by $255,829 or 5.06% behind the comparable quarter last year. Throughout the year, the banks' lowered the rate they pay on time deposit. In mid- fourth quarter, they lowered rated on interest-bearing checking and savings deposits.
Net Interest Income
The primary source of income for the Company is net interest income, which is the difference between revenue on interest-earning assets, such as investment securities and loans, and interest incurred on interest-bearing sources of funds, such as deposits and borrowings. The level of net interest income is determined primarily by the average balance of interest-earning assets and funding sources and the various rate spreads between the interest-earning assets and the Company's funding sources. Changes in net interest income from period to period result from increases or decreases in the volume of interest- earning assets and interest-bearing liabilities, and increases or decreases in the average rates earned and paid on such assets and liabilities. The volume of interest-earning assets and interest-bearing liabilities is affected by the ability to manage the earning-asset portfolio, which includes loans, and the availability of particular sources of funds, such as noninterest bearing deposits.
The key performance measure for net interest income is the "net margin on interest-earning assets," or net interest income divided by average interest- earning assets. The Company's net interest margin for 2001 was 4.74% compared to 5.21% for 2000 and 4.77% for 1999. Because most of the loans of the banks are written with a demand feature, the income of the banks should not change dramatically as interest rates change. Management of the Company expects to maintain the net margin on interest-earning assets. The net margin may decline, however, if competition increases, loan demand decreases, or the cost of funds rises faster than the return on loans and securities. Although such expectations are based on management's judgment, actual results will depend on a number of factors that cannot be predicted with certainty, and fulfillment of management's expectations cannot be assured.
Analysis of Changes in Net Interest Income (Dollars stated in thousands)
Dividends and interest on tax-exempt securities and loans are reported on fully taxable equivalent basis. The variance that is both rate/volume related is reported with the rate variance.
Composition of Loan Portfolio
Because loans are expected to produce higher yields than investment securities and other interest-earning assets (assuming that loan losses are not excessive), the absolute volume of loans and the volume as a percentage of total earning assets is an important determinant of net interest margin. Average loans, net of the allowance for loan losses, were $170,116,213, $161,796,946 and $145,219,090 during 2001, 2000 and 1999, respectively, which constituted 59.04%, 60.22% and 55.36% of average interest-earning assets for the periods. The Company's loan to deposit ratio was 60.73%, 72.68%, and 63.67% at December 31, 2001, 2000, and 1999, respectively. Average loans to average deposits were 68.70%, 68.94%, and 62.08% for the same periods. The decrease in the loan to deposit ratio as of year-end 2001 versus year-end 2000 is attributable to a dramatic increase in deposits.
The Company extends loans primarily to customers located in and near Worcester County, Maryland and Sussex County, Delaware. There are no industry concentrations in the Company's loan portfolio. The Company does, however, have a substantial portion of its loans in real estate and performance of the will be influenced by the real estate market in the region.
The following table sets forth the composition of the Company's loan portfolio as of December 31, 2001, 2000 and 1999, respectively.
The following table sets forth the maturity distribution, classified according to sensitivity to changes in interest rates, for selected components of the Company's loan portfolio as of December 31, 2001.
Loan Maturity Schedule and Sensitivity to Changes in Interest Rates
As of December 31, 2001, $163,717,356 or 97.05%, of the total loans were either variable rate loans or loans written on demand.
The Company has the following commitments, lines of credit, and letters of credit outstanding as of December 31, 2001, 2000 and 1999, respectively.
Loan commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments may have interest fixed at current rates, fixed expiration dates, and may require the payment of a fee. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Loan commitments and letters of credit are made on the same terms, including collateral, as outstanding loans. The Company's exposure to credit loss in the event of nonperformance by the borrower is represented by the contract amount of the commitment.
Loan Quality
The allowance for loan losses represents a reserve for potential losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated periodically based on a review of all significant loans, with a particular emphasis on non-accruing, past due, and other loans that management believes require attention. The determination of the reserve level rests upon management's judgment about factors affecting loan quality and assumptions about the economy. Management considers the year-end allowance appropriate and adequate to cover possible losses in the loan portfolio; however, management's judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for credit loss or that additional increases in the credit loss allowance will not be required. The Company has a history of low loan charge-offs.
For significant problem loans, management's review consists of evaluation of the financial strengths of the borrowers and guarantors, the related collateral, and the effects of economic conditions. The overall evaluation of the adequacy of the total allowance for loan losses is based on an analysis of historical loan loss ratios, loan charge-offs, delinquency trends, and previous collection experience, along with an assessment of the effects of external economic conditions. It is the Company's policy to have each bank evaluate loan portfolio risk for the purpose of establishing an adequate allowance. The banks' target levels for their allowances as a percentage of gross loans range from approximately 1.00% to 1.35%. This allowance may be increased for reserves for specific loans identified as substandard during management's loan review. Generally, the Company will not require a negative provision to reduce the allowance as a result of either net recoveries or a decrease in loans, even though this may cause the allowance as a percentage of gross loans to exceed the Company's target.
The provision for loan losses is a charge to earnings in the current period to replenish the allowance and maintain it at a level management has determined to be adequate. As of December 31, 2001, 2000 and 1999, the respective allowances for loan losses were 1.30%, 1.28% and 1.35% of outstanding loans.
The provision for loan losses was $22,985 in 2001, a decrease of $151,095 from the $174,080 provision in 2000. This decrease is due to the stable size and delinquency status of the loan portfolio, and the low level of net charge-offs in 2001. The provision for loan losses was $174,080 in 2000, an increase of $168,335 from the $5,745 provision in 1999. The increased provision is the result of a $56,295 increase in net charge-offs for 2000, which totaled $63,356. Outstanding loans increased 10.83% during the same period.
As a result of management's ongoing review of the loan portfolio, loans are classified as nonaccrual when it is not reasonable to expect collection of interest under the original terms. These loans are classified as nonaccrual even though the presence of collateral or the borrower's financial strength may be sufficient to provide for ultimate repayment. Interest on nonaccrual loans is recognized only when received. A delinquent loan is generally placed in nonaccrual status when it becomes 90 days or more past due. When a loan is placed in nonaccrual status, all interest that has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. The Company had no nonperforming loans at December 31, 2001, 2000 or 1999.
Where real estate acquired by foreclosure and held for sale is included with nonperforming loans, the result comprises nonperforming assets. There were no nonperforming assets at December 31, 2001, 2000 or 1999. Loans are classified as impaired when the collection of contractual obligations, including principal and interest, is doubtful. Management has identified no significant impaired loans as of December 31, 2001, 2000 or 1999.
Liquidity and Interest Rate Sensitivity
The primary objective of asset/liability management is to ensure the steady growth of the Company's primary source of earnings, net interest income. Net interest income can fluctuate with significant interest rate movements. To lessen the impact of these margin swings, the balance sheet should be structured so that repricing opportunities exist for both assets and liabilities in roughly equivalent amounts at approximately the same time intervals. Imbalances in these repricing opportunities at any point in time constitute interest rate sensitivity.
Liquidity represents the ability to provide steady sources of funds for loan commitments and investment activities, as well as to provide sufficient funds to cover deposit withdrawals and payment of debt and operating obligations. These funds can be obtained by converting assets to cash or by attracting new deposits.
Average liquid assets (cash and amounts due from banks, interest bearing deposits in other banks, federal funds sold, and investment securities) were 53.08% of average deposits for 2001, compared to 50.93% and 55.60% for 2000 and 1999, respectively.
As of December 31, 2001, $41,521,902, or 47.87% of the investment debt securities mature in one year or less. Funds invested in federal funds sold provide liquidity so the banks do not need a large portfolio of securities classified as "available-for-sale." Other sources of liquidity include letters of credit, overnight federal funds, and reverse repurchase agreements available from correspondent banks. The total lines of credit available from correspondent banks at December 31, 2001 were $39,000,000. At December 31, 2000 and 1999, they were $19,000,000.
Interest rate sensitivity refers to the responsiveness of interest-bearing assets and liabilities to changes in market interest rates. The rate-sensitive position, or gap, is the difference in the volume of rate-sensitive assets and liabilities at a given time interval. The general objective of gap management is to actively manage rate-sensitive assets and liabilities to reduce the impact of interest rate fluctuations on the net interest margin. Management generally attempts to maintain a balance between rate- sensitive assets and liabilities as the exposure period is lengthened to minimize the overall interest rate risk to the Company.
Interest rate sensitivity may be controlled on either side of the balance sheet. On the asset side, management exercises some control over maturities. Also, loans are written to provide repricing opportunities on fixed rate notes. The Company's investment portfolio, including federal funds sold, provides the most flexible and fastest control over rate sensitivity since it can generally be restructured more quickly than the loan portfolio.
On the liability side, deposit products are structured to offer incentives to attain the maturity distribution desired. Competitive factors sometimes make control over deposits more difficult and, therefore, less effective as an interest rate sensitivity management tool.
The asset mix of the balance sheet is continually evaluated in terms of several variables; yield, credit quality, appropriate funding sources, and liquidity. Management of the liability mix of the balance sheet focuses on expanding the various funding sources.
The Company was asset-sensitive for all time horizons. For asset-sensitive institutions, if interest rates should decrease, the net interest margins should decline. Since all interest rates and yields do not adjust at the same velocity, the gap is only a general indicator of rate sensitivity.
Interest Sensitivity Analysis December 31, 2001
Investment Securities Maturity Distribution and Yields
Deposits and Other Interest-Bearing Liabilities
	Average interest-bearing liabilities increased $4,680,417, or 2.45%, to $196,079,693 in 2001, from $191,399,276 in 2000. Average interest-bearing deposits increased $2,180,688, or 1.15%, to $191,730,858 in 2001, from $189,550,170 in 2000, while average demand deposits increased $10,735,100, or 23,78% to $55,879,394 in 2000, from $45,144,294 in 2000. At December 31, 2001, total deposits were $274,149,181, compared to $231,926,192 at December 31, 2000, an increase of 18.21%.
	Average interest-bearing liabilities decreased $5,340,895, or 2.71%, to $191,399,276 in 2000, from $196,740,171 in 1999. Average interest-bearing deposits decreased $7,067,017, or 3.59%, to $189,550,170 in 2000, from $196,617,187 in 1999, while average demand deposits increased $7,853,381, or 21.06% to $45,144,294 in 2000, from $37,290,913 in 1999. At December 31, 2000, total deposits were $231,926,192, compared to $238,725,852 at December 31, 1999, a decrease of 2.85%.
	The following table sets forth the deposits of the Company by category as of December 31, 2001, 2000 and 1999, respectively.
Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for the Company's loan portfolio and other earning assets. The Company's core deposits increased $36,661,508 during 2001. Management believes that this increase is largely attributable to a migration of funds from the stock market into insured deposits. Deposits, and particularly core deposits, have been the Company's primary source of funding and have enabled the Company to meet both its short-term and long-term liquidity needs. Management anticipates that such deposits will continue to be the Company's primary source of funding in the future.
The maturity distribution of the Company's time deposits over $100,000 at December 31, 2001, is shown in the following table.
Maturities of Certificates of Deposit and Other Time Deposits of $100,000 or More
December 31, 2001
Large certificate of deposit customers tend to be extremely sensitive to interest rate levels, making these deposits less reliable sources of funding for liquidity planning purposes than core deposits. Some financial institutions partially fund their balance sheets using large certificates of deposit obtained through brokers. These brokered deposits are generally expensive and are unreliable as long-term funding sources. Accordingly, the Company does not accept brokered deposits.
Noninterest Income
Noninterest income for 2001 increased $196,777, or 17.83% over the previous year. Service charges on deposit accounts, which contributed $128,262 of this increase, were due to the growth of deposits. VISA Check Card fees increased by $29,761 due to increased use. Noninterest income for 2000 increased $58,531, or 5.60% over the previous year. Additional revenues from Credit Card and VISA Check Card fees contributed $49,710 of this increase.
The following table presents the principal components of noninterest income for the years ended December 31, 2001, 2000, and 1999, respectively.
Noninterest Income
Noninterest Expense
Noninterest expense increased by $321,782, or 5.45%, from 2000 to 2001. Increased personnel costs of $297,807 were due to annual raises, increased 401(k) expense, and increased costs of group insurance. Occupancy expense decreased due to the bank's adoption of accrual basis accounting for real property taxes, which were previously recorded on the cash basis. Of the $53,987 increase in other operating expense, $30,891 was attributable to increased fees related to ATM operation.
	Noninterest expense increased by $256,594, or 4.54%, from 1999 to 2000. Increased personnel costs of $162,545 were due to annual raises and the addition of a fulltime audit position. Furniture and equipment expense increased $160,003 of which approximately $110,000 was attributable to costs associated with the Check Imaging system installed in 1999. Included in noninterest expense in 1999 was property with a book value of $128,806, which was donated to a Worcester County municipality. In 1999, costs of stationery and supplies were above normal due to a branch relocation and costs associated with potential year 2000 computer problems; in 2000, stationery and supplies costs decreased $47,994, returning to a pre-1999 level.
The following table presents the principal components of noninterest expense for the years ended December 31, 2001, 2000 and 1999, respectively.
Noninterest Expense
Capital
Under the capital guidelines of the Federal Reserve Board and the FDIC, the Company and its banks are currently required to maintain a minimum risk-based total capital ratio of 8%, with at least 4% being Tier 1 capital. Tier 1 capital consists of common shareholders' equity, qualifying perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less certain intangibles. In addition, the Company and the banks must maintain a minimum Tier 1 leverage ratio (Tier 1 capital to total assets) of at least 3%, but this minimum ratio is increased by 100 to 200 basis points for other than the highest-rated institutions.
At December 31, 2001, the Company and the banks exceeded their regulatory capital ratios, as set forth in the following table.
Analysis of Capital
Accounting Rule Changes
FASB Statement No. 141, Business combination requires that business combinations be accounted for using the purchase method. The pooling-of-interest method is no longer permitted. This Statement applies to business combinations initiated after June 30, 2001.
FASB Statement No. 142 Goodwill and Other Intangible Assets changes the accounting for acquired goodwill and other intangibles. Annually, management should review these items to determine if they should be reduced due to impairment. Systematic amortization is no longer permitted. The effective date of the Statement is for fiscal years beginning after December 31, 2001. Core deposit intangibles are not goodwill and are still amortizable.
FASB Statement No. 143 Accounting for Asset Retirement obligations applies to legal obligtaions associated with the retirement of a tangible long-lived asset. The statement requires that management recognize the fair value of an asset retirement obligation in the period incurred, adding capitalization of this cost to the cost of the asset. Annually the asset, including the capitalized cost, should be reviewed for impairment. The effective date of the Statement is for years beginning after June 15, 2002.
Impact of Inflation
Unlike most industrial companies, the assets and liabilities of financial institutions such as the Company and the banks are primarily monetary in nature. Therefore, interest rates have a more significant effect on the Company's performance than do the effects of changes in the general rate of inflation and change in prices. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. As discussed previously, management seeks to manage the relationships between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation. See "Liquidity and Interest Rate Sensitivity" above.
Item 8.
Item 8. Financial Statements
In response to this Item, the information included on pages 1 through 22 of the Company's Annual Report to Shareholders for the year ended December 31, 2001, is incorporated herein by reference.
PART III
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Not applicable.
Item 10.
Item 10. Directors and Executive Officers; Compliance with Section 16(a) of the Exchange Act
In response to this item, the information included on pages 2 through 3 of the Company's Proxy Statement for Annual Meeting of Shareholders To Be Held on May 8, 2002, is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
In response to this item, the information included on page 4 of the Company's Proxy Statement for Annual Meeting of Shareholders To Be Held on May 8, 2002, is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
In response to this item, the information included on pages 4 through 5 of the Company's Proxy Statement for Annual Meeting of Shareholders to be held May 8, 2002, is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
In response to this item, the information included on page 6 of the Company's Proxy Statement for Annual Meeting of Shareholders to be held May 8, 2002, is incorporated herein by reference.
Item 14.
Item 14. Exhibits and Reports on Form 8-K
(a) Exhibits 3.1 Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of Registration Statement Form S-4, File No. 33-99762). 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 of Registration Statement Form S-4, File No. 33-99762). 13 Annual Report to Shareholders for the year ended December 31, 2001. 21 Subsidiaries of the Company.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 2001.
SIGNATURES In accordance with 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.
CALVIN B. TAYLOR BANKSHARES, INC. (Registrant)
Date:	 By: /s/ Reese F. Cropper, Jr. President and Chief Executive Officer
Date:	 By: /s/ William H. Mitchell Vice President and Chief Financial Officer
In accordance with 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.
Date: By: /s/ James R. Bergey, Jr., Director
Date: By: /s/ James R. Bergey, Sr., Director
Date: By: /s/ George H. Bunting, Jr., Director
Date: By: /s/ John H. Burbage, Jr., Director
Date:	 By: /s/ Reese F. Cropper, Jr. President, Chief Executive Officer and Director
Date: By: /s/ Reese F. Cropper, III, Director
Date:	 By: /s/ Hale Harrison, Director
Date:	 By: /s/ Gerald T. Mason, Director
Date:	 By: /s/ William H. Mitchell, Vice President and Director
Date:	 By: /s/ Joseph E. Moore, Director
Date:	 By: /s/ Michael L. Quillin, Sr., Director
Date:	 By: /s/ D. Bruce Rogers, Director
EXHIBIT 13
ANNUAL REPORT TO SHAREHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2001
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Financial Statements
December 31, 2001
Calvin B. Taylor Bankshares, Inc. and subsidiaries
	 Page
Report of independent auditors 1
Consolidated financial statements
Consolidated balance sheets 2
Consolidated statements of income 3
Consolidated statements of changes in stockholders' equity 4
Consolidated statements of cash flows 5-6
Notes to consolidated financial statements 7-21
Report of Independent Auditors The Board of Directors and Stockholders Calvin B. Taylor Bankshares, Inc. and Subsidiaries Berlin, Maryland
	We have audited the accompanying consolidated balance sheets of Calvin B. Taylor Bankshares, Inc. and Subsidiaries as of December 31, 2001, 2000, and 1999, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended. These consolidated 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
	In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Calvin B. Taylor Bankshares, Inc. and Subsidiaries as of December 31, 2001, 2000, and 1999, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the Untied States.
			/s/ Rowles & Company, LLP
Salisbury, Maryland January 8, 2002
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
The accounting and reporting policies reflected in the financial statements conform to generally accepted accounting principles and to general practices within the banking industry.
Calvin B. Taylor Bankshares, Inc. is a bank holding company. Its principal subsidiary, Calvin B. Taylor Banking Company, is a financial institution operating primarily in Worcester County, Maryland. The other subsidiary, Calvin B. Taylor Bank of Delaware, is a financial institution operating primarily in Sussex County, Delaware. The Banks offer deposit services and loans to individuals, small businesses, associations and government entities. Other services include direct deposit of payroll and social security checks, automatic drafts from accounts, automated teller machine services, safe deposit boxes, money orders and travelers cheques. The Banks also offer credit card services and discount brokerage services through correspondents.
The preparation of financial statements in conformity with generally accepted accounting principles 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 may affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Principles of consolidation The consolidated financial statements of Calvin B. Taylor Bankshares, Inc. include the accounts of its wholly owned subsidiaries, Calvin B. Taylor Banking Company and Calvin B. Taylor Bank of Delaware. All significant intercompany balances and transactions have been eliminated in consolidation.
Cash equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Federal funds are purchased and sold for one-day periods.
Investment securities As securities are purchased, management determines if the securities should be classified as held to maturity or available for sale. Securities which management has the intent and ability to hold to maturity are recorded at amortized cost which is cost adjusted for amortization of premiums and accretion of discounts to maturity. Securities classified as available- for-sale are recorded at fair value.
Gains and losses on disposal are determined using the specific-identification method.
Premises and equipment Premises and equipment are recorded at cost less accumulated depreciation. Depreciation is computed under both straight-line and accelerated methods over the estimated useful lives of the assets.
Intangible assets The Company amortizes software costs over their useful lives using the straight-line method.
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies (Continued)
Loans and allowance for loan losses Loans are stated at face value less the allowance for loan losses. Interest on loans is credited to income based on the principal amounts outstanding. The accrual of interest is discontinued when any portion of the principal or interest is ninety days past due and collateral is insufficient to discharge the debt in full.
The allowance for loan losses is maintained at a level deemed appropriate by management to provide adequately for known and inherent risks in the loan portfolio. The minimum range of the allowance for loan losses is calculated by applying risk-weighted percentages to loans based on their delinquency and underlying collateral. The portion of the allowance that is a result of geographic and industry concentrations and current economic conditions is not allocated to specific loans. At December 31, 2001, the allowance included approximately $850,186 that was not allocated to specific loans. Management has historically maintained the allowance at a level of approximately 1.30% to 1.35% of gross loans.
If the current economy or real estate market were to suffer a severe downturn, the estimate for uncollectible accounts would need to be increased. Loans which are deemed to be uncollectible are charged off and deducted from the allowance. The provision for loan losses and recoveries on loans previously charged off are added to the allowance.
Loans are considered impaired when, based on current information, management considers it unlikely that collection of principal and interest payments will be made according to contractual terms. Generally, loans are not reviewed for impairment until the accrual of interest has been discontinued.
Advertising Advertising costs are expensed as incurred.
Income taxes The provision for income taxes includes taxes payable for the current year and deferred income taxes. Deferred income taxes are provided for the temporary differences between financial and taxable income. Tax expense and tax benefits are allocated to the banks and company based on their proportional share of taxable income.
Per share data Earnings per common share and dividends per common share are determined by dividing net income and dividends by the 3,240,000 shares outstanding, giving retroactive effect to the stock dividends distributed.
2. Cash and Due From Banks
The Company normally carries balances with other banks that exceed the federally insured limit. The average balances carried in excess of the limit, including unsecured federal funds sold to the same banks, were $53,138,449 for 2001, $27,192,359 for 2000, and $25,041,212 for 1999.
Banks are required to carry noninterest-bearing cash reserves at specified percentages of deposit balances. The Company's normal amount of cash on hand and on deposit with other banks is sufficient to satisfy the reserve requirements.
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
3. Investment Securities
Investment securities are summarized as follows:
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
3. Investment Securities (Continued)
The amortized cost and estimated market value of debt securities, by contractual maturity and the amount of pledged securities, follow. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investments are pledged to secure deposits of federal and local governments. Pledged securities also serve as collateral for securities sold under agreements to repurchase.
4. Lines of Credit
The Company has available lines of credit, including overnight federal funds, reverse repurchase agreements and letters of credit, totaling $ 39,000,000 as of December 31, 2001, and $19,000,000 as of December 31, 2000 and 1999.
5. Loans and Allowance for Loan losses
Major classifications of loans are as follows:
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
5. Loans and Allowance for Loan losses (Continued)
The rate repricing distribution of the loan portfolio follows:
Outstanding loan commitments and letters of credit are as follows:
Loan commitments are agreements to lend to customers as long as there is no violation of any conditions of the contracts. Loan commitments generally have interest at current market rates, fixed expiration dates, and may require payment of a fee.
Letters of credit are commitments issued to guarantee the performance of a customer to a third party.
Loan commitments and letters of credit are made on the same terms, including collateral, as outstanding loans. The Company's exposure to credit loss in the event of nonperformance by the borrower is represented by the contract amount of the commitment.
The Company makes loans to customers located primarily in the Delmarva region. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
5. Loans and Allowance for Loan losses (Continued)
Transactions in the allowance for loan losses were as follows:
Amounts past due 90 days or more, and still accruing interest, are as follows:
Management has identified no impaired or nonaccrual loans at December 31, 2001, 2000, and 1999.
6. Premises and Equipment
A summary of premises and equipment and the related depreciation is as follows:
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
7. Deposits
Major classifications of interest-bearing deposits are as follows:
Included in other time deposits are certificates of deposit of $100,000 or more with the following maturities:
8. Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase represent overnight borrowings from customers. The government agency securities that collateralize these agreements are owned by the company but maintained in the custody of an unaffiliated bank designated by the Company. Additional information follows.
9. Note Payable
The Company purchased real estate, financing 100% of the purchase price. The 6% unsecured note has a final maturity of September, 2011. Maturities of this note are as follows:
2002 16,790 2003 17,826 2004 18,925 2005 20,092 2006 21,332 Remaining years 120,737 215,702
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
10. Profit Sharing and Pension Plans
In 1999, the Company adopted a defined contribution profit sharing plan under Section 401(k) of the Internal Revenue Code. The plan covers substantially all of the employees and allows discretionary Company contributions. Annually, the Board of Directors approves a discretionary contribution in addition to matching 50% of employee contributions to a maximum of 6% of the employee wages.
The Company terminated its defined benefit pension plan during 1999. The plan covered substantially all of the employees. Benefits were based on years of service and the employee's average rate of earnings for the final five full years before retirement. The total cost of the pension and profit sharing plans for 2001, 2000, and 1999, were $140 620, $119,307, and $155,869, respectively.
11. Other Operating Expenses
The components of other operating expenses follow:
12. Income Taxes
The components of income tax expense, including taxes related to the change in accounting method for organization costs, are as follows:
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
12. Income Taxes (continued)
The components of the deferred tax (benefit) are as follows:
9,234 (20,599) (30,721)
The components of the net deferred tax assets are as follows:
A reconciliation of the provision for taxes on income from the statutory federal income tax rates to the effective income tax rates follows:
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
13. Related Party Transactions
The executive officers and directors of the Company enter into loan transactions with the Banks in the ordinary course of business. The terms of these transactions are similar to the terms provided to other borrowers entering into similar loan transactions.
The Company obtains legal services from a law firm in which one of the principal attorneys is also a member of the Board of Directors. Fees charged for these services are at similar rates charged by unrelated law firms for similar legal work. Amounts paid to this related party totaled $2,003, $1,805 and $3,746 during the years ended December 31, 2001, 2000 and 1999.
14. Lease Commitments
The Company leases the land on which the Route 50 branch is located. The lease obligation, which expires August 31, 2009, requires payments as follows:
Minimum Period rentals
2002 15,000 2003 15,000 2004 15,000 2005 15,000 2006 15,000 Remaining years 40,000 115,000
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
15. Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques prescribed by the FASB and may not be indicative of the net realizable or liquidation values. The calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values. The fair value of financial instruments equals the carrying value of the instruments except as follows.
The fair value of silver coin included with cash is determined based on quoted market prices.
The fair value of interest-bearing deposits with other financial institutions is estimated based on quoted interest rates for certificates of deposit with similar remaining terms.
The fair values of equity securities are determined using market quotations. The fair values of debt securities are estimated using a matrix that considers yield to maturity, credit quality, and marketability.
The fair value of fixed-rate loans is estimated to be the present value of scheduled payments discounted using interest rates currently in effect for loans of the same class and term. The fair value of variable-rate loans, including loans with a demand feature, is estimated to equal the carrying amount. The valuation of loans is adjusted for possible loan losses.
The fair value of interest-bearing checking, savings, and money market deposit accounts is equal to the carrying amount. The fair value of fixed- rate time deposits is estimated based on interest rates currently offered for deposits of similar remaining maturities.
It is not practicable to estimate the fair value of outstanding loan commitments, unused lines, and letters of credit.
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
16. Capital Standards
The Federal Reserve Board and the Federal Deposit Insurance Corporation have adopted risk- based capital standards for banking organizations. These standards require ratios of capital to assets for minimum capital adequacy and to be classified as well capitalized under prompt corrective action provisions. The capital ratios and minimum capital requirements of the Company are as follows:
Tier 1 capital consists of capital stock, additional paid in capital, and retained earnings. Total capital includes a limited amount of the allowance for loan losses. In calculating risk- weighted assets, specific risk percentages are applied to each category of asset and off-balance sheet items.
Failure to meet the capital requirements could affect the Company's ability to pay dividends and accept deposits, and may significantly affect the operations of the Company.
In the most recent regulatory report, the Company was determined to be well capitalized. Management has no plans which should change the classification of the capital adequacy.
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
17.	Parent Company Financial Information
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
17.	Parent Company Financial Information (Continued)
Calvin B. Taylor Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
18. Quarterly Results of Operations (Unaudited)