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SASR > SEC Filings for SASR > Form 10-K on 18-Mar-2013All Recent SEC Filings

Show all filings for SANDY SPRING BANCORP INC | Request a Trial to NEW EDGAR Online Pro



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations


Net income for Sandy Spring Bancorp, Inc. and subsidiaries (the "Company") for the year ended December 31, 2012 totaled $36.6 million ($1.48 per diluted share), compared to net income of $34.1 million ($1.41 per diluted share) for the prior year. These results reflect the following events:

Net interest income increased 7% in 2012 compared to 2011. This increase was due primarily to growth in average interest-earning assets, largely resulting from higher-earning commercial loans added in the acquisition of CommerceFirst Bancorp, Inc. ("CommerceFirst") and organic loan growth. Combined with an improved deposit mix, these factors more than offset lower overall earning asset yields.

The provision for loan and lease losses totaled $3.6 million for 2012 compared to $1.4 million for 2011. The increase in the provision for 2012 compared to the prior year was due primarily to a decline in historical losses in 2011 which caused a credit balance in the provision for the third quarter of 2011, thus reducing the full year provision.

Non-interest income increased $3.5 million or 8% for 2012 compared to 2011 due largely to growth in income from mortgage banking activities due to a higher volume of refinancing activity.

Total loans at December 31, 2012 increased 13% compared to the balance at December 31, 2011. This improvement was driven primarily by the growth in loans mentioned above.

In 2012, the Mid-Atlantic region in which the Company operates continued to show slow but steady economic improvement. Concerns over a struggling national economy and possible large federal government spending cuts and tax increases ("the fiscal cliff") at year-end continued to impede both the regional and national economic outlook. While the housing markets have improved, this sector is still significantly below levels experienced in prior economic recoveries. The positive trends in housing and consumer spending have been offset by a contraction in manufacturing and stubbornly high unemployment which have caused uncertainty on the part of both large and small businesses which has limited economic expansion. The financial stability of the European Union continues to be an underlying volatility factor. Together with state and municipal budget challenges across the country, these factors have caused enough economic uncertainty, particularly among individual consumers and small and medium-sized businesses, to suppress confidence and thus constrain the pace of economic expansion and lending. Despite this challenging business environment, the Company has emphasized the fundamentals of community banking as it has maintained strong levels of liquidity and capital while overall credit quality has continued to improve.

The net interest margin increased to 3.60% in 2012 compared to 3.57% for 2011. During 2012, the growth in average interest-earning assets and noninterest-bearing deposits largely offset a decline in the average rates earned on interest-earning assets. Average total deposits increased 6%, compared to the prior year, while average loans increased 12% compared to 2011.

Liquidity remained strong due to the borrowing lines with the Federal Home Loan Bank of Atlanta and the Federal Reserve and the size and composition of the investment portfolio.

The Company's credit quality continued to improve as non-performing assets decreased to $63.8 million at December 31, 2012 from $83.6 million at December 31, 2011. This decrease was due primarily to a combination of the Company's continuing efforts at resolution of non-performing loans and reduced migration of existing loans into nonperforming status, particularly in the commercial real estate portfolio. Non-performing assets represented 1.61% of total assets at December 31, 2012 compared to 2.25% at December 31, 2011. The ratio of net charge-offs to average loans and leases was .42% for 2012, compared to .66% for the prior year.

At December 31, 2012, the Bank remained above all "well-capitalized" regulatory requirement levels. In addition, tangible book value per common share increased 6% to $15.43 from $14.58 at December 31, 2011.

Total assets at December 31, 2012 increased 7% compared to December 31, 2011. Loan balances increased 13% compared to the prior year end due primarily to increases of 15% in residential mortgage and construction loans and 16% in commercial loans, which were somewhat offset by a 1% decrease in consumer loans. The increase in commercial loans was due to organic loan growth during the year and the CommerceFirst acquisition during the second quarter of 2012. Customer funding sources, which include deposits plus other short-term borrowings from core customers, increased 9% compared to balances at December 31, 2011, again due largely to the CommerceFirst acquisition. The increase in customer funding sources was driven primarily by a combined increase of 25% in interest-bearing and noninterest-bearing checking accounts and an increase of 17% in regular savings accounts. These increases were somewhat offset by a 10% decline in certificates of deposit. The Company continued to manage its net interest margin, primarily by reducing rates on certificates of deposit during this extended period of historically low interest rates. During the same period, stockholders' equity increased to $484 million due to stock issued in connection with the CommerceFirst acquisition and net income in 2012.

Net interest income increased by $8.3 million, or 7% compared to the prior year. The effects of a 17 basis point decrease in the cost of interest-bearing liabilities, growth of 19% in average noninterest-bearing deposits, 6% growth in average interest-earning assets and a 24% decrease in non-performing assets more than offset a decline of 13 basis points in the yield on average interest-earning assets.

Non-interest income increased 8% in 2012 compared to 2011. Income from mortgage banking activities increased 87% due to higher volumes and increased average gains from refinancing activity in the current year. In addition, other non-interest income increased 17% over the prior year due to higher gains on asset dispositions and vendor incentives. These increases were somewhat offset by a decrease of 6% in service charges on deposits due to lower overdraft fees.

Non-interest expenses increased 5% in 2012 compared to the prior year due primarily to higher salaries and benefits expenses, outside data services costs and professional fees primarily resulting from the CommerceFirst acquisition. These increases were somewhat offset by a 19% decrease in FDIC insurance expense due primarily to improved financial ratios compared to 2011.

Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") in the United States of America and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements may reflect different estimates, assumptions, and judgments. Certain policies inherently rely to a greater extent on the use of estimates, assumptions, and judgments and as such may have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary for assets and liabilities that are required to be recorded at fair value. A decline in the value of assets required to be recorded at fair value will warrant an impairment write-down or valuation allowance to be established. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when readily available. Management believes the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results:

Allowance for loan and lease losses;

Goodwill impairment;

Accounting for income taxes;

Fair value measurements, including assessment of other than temporary impairment;

Defined benefit pension plan.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses is an estimate of the losses that are inherent in the loan and lease portfolio at the balance sheet date. The allowance is based on the basic principle that a loss be accrued when it is probable that the loss has occurred at the date of the financial statements and the amount of the loss can be reasonably estimated.

Management believes that the allowance is adequate. However, its determination requires significant judgment, and estimates of probable losses in the lending portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future additions or reductions 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, resulting 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 reviews may result in additional provisions based on their judgments of information available at the time of each examination.

The Company's allowance for loan and lease losses has two basic components: a general allowance reflecting historical losses by loan category, as adjusted by several factors whose effects are not reflected in historical loss ratios, and specific allowances for individually identified loans. Each of these components, and the allowance methodology used to establish them, are described in detail in Note 1 of the Notes to the Consolidated Financial Statements included in this report. The amount of the allowance is reviewed monthly by the Credit and Investment Risk Committee of the board of directors and formally approved quarterly by that same committee of the board.

General allowances are based upon historical loss experience by portfolio segment measured over the prior eight quarters and weighted so that losses realized in the most recent quarters have the greatest effect. The historical loss experience is supplemented to address various risk characteristics of the Company's loan portfolio including:

trends in delinquencies and other non-performing loans;

changes in the risk profile related to large loans in the portfolio;

changes in the categories of loans comprising the loan portfolio;

concentrations of loans to specific industry segments;

changes in economic conditions on both a local and national level;

changes in the Company's credit administration and loan portfolio management processes; and

quality of the Company's credit risk identification processes.

The general allowance comprised 88% of the total allowance at December 31, 2012 and 84% at December 31, 2011. The general allowance is calculated in two parts based on an internal risk classification of loans within each portfolio segment. Allowances on loans considered to be "criticized" and "classified" under regulatory guidance are calculated separately from loans considered to be "pass" rated under the same guidance. This segregation allows the Company to monitor the allowance applicable to higher risk loans separate from the remainder of the portfolio in order to better manage risk and ensure the sufficiency of the allowance for loan and lease losses.

The portion of the allowance representing specific allowances is established on individually impaired loans. As a practical expedient, for collateral dependent loans, the Company measures impairment based on the net realizable value of the underlying collateral. For loans on which the Company has not elected to use a practical expedient to measure impairment, the Company will measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. In determining the cash flows to be included in the discount calculation the Company considers the following factors that combine to estimate the probability and severity of potential losses:

the borrower's overall financial condition;

resources and payment record;

demonstrated or documented support available from financial guarantors; and

the adequacy of collateral value and the ultimate realization of that value at liquidation.

At December 31, 2012, the specific allowance accounted for 12% of the total allowance as compared to 16% at December 31, 2011. The estimated losses on impaired loans can differ substantially from actual losses.

Goodwill and Other Intangible Asset Impairment

Goodwill represents the excess purchase price paid over the fair value of the net assets acquired in a business combination. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of each of the Company's reporting units be compared to the carrying amount of the reporting unit's net assets, including goodwill. The Company's reporting units were identified based upon an analysis of each of its individual operating segments. If the fair values of the reporting units exceed their book values, no write-down of recorded goodwill is required. If the fair value of a reporting unit is less than book value, an expense may be required to write-down the related goodwill to the proper carrying value. The Company tests for impairment of goodwill as of October 1 of each year using September 30 data and again at any quarter-end if any triggering events occur during a quarter that may affect goodwill. Examples of such events include, but are not limited to, a significant deterioration in future operating results, adverse action by a regulator or a loss of key personnel. Determining the fair value of a reporting unit requires the Company to use a degree of subjectivity.

Under current accounting guidance, the Company has the option to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Based on the assessment of these qualitative factors, if it is determined that the fair value of a reporting unit is not less than the carrying value, then performing the two-step impairment process, previously required, is unnecessary. However, if it is determined that the carrying value exceeds the fair value the second step, described above, of the two-step process must be performed. The Company has elected this accounting guidance with respect to its Community Banking and Investment Management segments. At September 30, 2012 there was no evidence of impairment of goodwill or intangibles in any of the Company's reporting units.

Other intangible assets represent purchased assets that 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. Other intangible assets have finite lives and are reviewed for impairment annually. These assets are amortized over their estimated useful lives on a straight-line basis over varying periods that initially did not exceed 15 years.

Accounting for Income Taxes

The Company accounts for income taxes by recording deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company's accounting policy follows the prescribed authoritative guidance that a minimal probability threshold of a tax position must be met before a financial statement benefit is recognized. The Company recognized, when applicable, interest and penalties related to unrecognized tax benefits in other non-interest expenses in the Consolidated Statements of Income. Assessment of uncertain tax positions requires careful consideration of the technical merits of a position based on management's analysis of tax regulations and interpretations. Significant judgment may be involved in applying the applicable reporting and accounting requirements.

Management expects that the Company's adherence to the required accounting guidance may result in increased volatility in quarterly and annual effective income tax rates due to the requirement that any change in judgment or measurement of a tax position taken in a prior period be recognized as a discrete event in the period in which it occurs. Factors that could impact management's judgment include changes in income, tax laws and regulations, and tax planning strategies.

Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value in accordance with applicable accounting standards. Significant financial instruments measured at fair value on a recurring basis are investment securities available-for-sale, residential mortgages held for sale and commercial loan interest rate swap agreements. Loans where it is probable that the Company will not collect all principal and interest payments according to the contractual terms are considered impaired loans and are measured on a nonrecurring basis.

The Company conducts a quarterly review for all investment securities that have potential impairment to determine whether unrealized losses are other-than-temporary. Valuations for the investment portfolio are determined using quoted market prices, where available. If quoted market prices are not available, valuations are based on pricing models, quotes for similar investment securities, and, where necessary, an income valuation approach based on the present value of expected cash flows. In addition, the Company considers the financial condition of the issuer, the receipt of principal and interest according to the contractual terms and the intent and ability of the Company to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value.

The above accounting policies with respect to fair value are discussed in further detail in "Note 21-Fair Value" to the Consolidated Financial Statements.

Defined Benefit Pension Plan

The Company has a qualified, noncontributory, defined benefit pension plan. The plan was frozen for existing entrants after December 31, 2007 and all benefit accruals for employees were frozen as of December 31, 2007 based on past service. Future salary increases and additional years of service will no longer affect the defined benefit provided by the plan although additional vesting may continue to occur.

Several factors affect the net periodic benefit cost of the plan, including (1) the size and characteristics of the plan population, (2) the discount rate, (3) the expected long-term rate of return on plan assets and (4) other actuarial assumptions. Pension cost is directly related to the number of employees covered by the plan and other factors including salary, age, years of employment, and the terms of the plan. As a result of the plan freeze, the characteristics of the plan population should not have a materially different effect in future years. The discount rate is used to determine the present value of future benefit obligations. The discount rate is determined by matching the expected cash flows of the plan to a yield curve based on long term, high quality fixed income debt instruments available as of the measurement date, which is December 31 of each year. The discount rate is adjusted each year on the measurement date to reflect current market conditions. The expected long-term rate of return on plan assets is based on a number of factors that include expectations of market performance and the target asset allocation adopted in the plan investment policy. Should actual asset returns deviate from the projected returns, this can affect the benefit plan expense recognized in the financial statements.

Consolidated Average Balances, Yields and Rates

                                                                                                     Year Ended December 31,
                                                                2012                                          2011                                          2010
                                                                            Annualized                                    Annualized                                    Annualized
                                                Average          (1)          Average         Average          (1)          Average         Average          (1)          Average
(Dollars in thousands and tax-equivalent)      Balances       Interest      Yield/Rate       Balances       Interest      Yield/Rate       Balances       Interest      Yield/Rate
Residential mortgage loans (2)                $   503,963     $  21,281            4.22 %   $   457,886     $  21,971            4.80 %   $   464,462     $  24,838            5.35 %
Residential construction loans                    125,295         4,581            3.66          89,823         3,410            3.80          88,729         4,037            4.55
Commercial ADC loans                              147,881         7,721            5.22         149,571         6,819            4.56         157,879         6,459            4.09
Commercial investor real estate loans             421,505        23,167            5.50         349,447        20,213            5.78         335,141        20,174            6.02
Commercial owner occupied real estate loans       554,397        30,236            5.45         511,692        30,197            5.90         512,008        30,820            6.02
Commercial business loans                         299,462        16,511            5.51         229,825        11,344            4.94         264,281        13,329            5.04
Leasing                                             5,117           326            6.36          10,505           707            6.73          20,682         1,460            7.06
Consumer loans                                    357,839        12,592            3.52         363,010        13,271            3.68         393,703        15,206            3.88
Total loans and leases (3)                      2,415,459       116,415            4.82       2,161,759       107,932            5.00       2,236,885       116,323            5.20
Taxable securities                                774,030        19,254            2.49         885,023        23,471            2.65         875,292        25,630            2.93
Tax-exempt securities (4)                         288,347        13,463            4.67         244,958        13,590            5.55         163,834        11,052            6.75
Interest-bearing deposits with banks               42,668           111            0.26          30,270            77            0.25          69,755           177            0.25
Federal funds sold                                    724             1            0.18           1,337             2            0.14           1,773             3            0.17
Total interest-earning assets                   3,521,228       149,244            4.24       3,323,347       145,072            4.37       3,347,539       153,185            4.58

Less: allowance for loan and lease losses         (46,260 )                                     (56,770 )                                     (69,393 )
Cash and due from banks                            46,588                                        45,721                                        44,736
Premises and equipment, net                        48,875                                        49,047                                        48,738
Other assets                                      209,653                                       220,221                                       241,368
Total assets                                  $ 3,780,084                                   $ 3,581,566                                   $ 3,612,988

Liabilities and Stockholders' Equity
Interest-bearing demand deposits              $   385,004           344            0.09 %   $   340,110           364            0.11 %   $   292,106           324            0.11 %
Regular savings deposits                          212,659           199            0.09         184,050           183            0.10         165,032           164            0.10
Money market savings deposits                     877,546         1,943            0.22         859,608         3,547            0.41         890,187         5,015            0.56
Time deposits                                     566,658         4,871            0.86         611,192         6,908            1.13         706,487        11,431            1.62
Total interest-bearing deposits                 2,041,867         7,357            0.36       1,994,960        11,002            0.55       2,053,812        16,934            0.82
Other borrowings                                   70,477           204            0.29          78,207           212            0.27          89,932           269            0.30
Advances from FHLB                                405,227        14,131            3.49         405,577        14,397            3.55         409,697        14,599            3.56
Subordinated debentures                            35,000           959            2.74          35,000           913            2.61          35,000           940            2.69
Total interest-bearing liabilities              2,552,571        22,651            0.89       2,513,744        26,524            1.06       2,588,441        32,742            1.27

Noninterest-bearing demand deposits               735,231                                       619,260                                       557,197
Other liabilities                                  26,563                                        25,881                                        26,155
Stockholders' equity                              465,719                                       422,681                                       441,195
Total liabilities and stockholders' equity    $ 3,780,084                                   $ 3,581,566                                   $ 3,612,988

Net interest income and spread                                $ 126,593            3.35 %                   $ 118,548            3.31 %                   $ 120,443            3.31 %
Less: tax-equivalent adjustment                                   5,374                                         5,602                                         4,836
Net interest income                                           $ 121,219                                     $ 112,946                                     $ 115,607

Interest income/earning assets                                                     4.24 %                                        4.37 %                                        4.58 %
Interest expense/earning assets                                                    0.64                                          0.80                                          0.98
Net interest margin                                                                3.60 %                                        3.57 %                                        3.60 %

(1) Tax-equivalent income has been adjusted using the combined marginal federal and state rate of 39.88% for 2012 and 2011. The annualized taxable-equivalent . . .

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