UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended June 30, 2005

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period from                to               

 

Commission file number 0-5127

 

MERCANTILE BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

 

Maryland

 

52-0898572

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

2 Hopkins Plaza

Baltimore, Maryland 21201

(Address of principal executive offices) (Zip Code)

 

(410) 237-5900

(Registrant’s telephone number, including area code)

 

NONE

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý  No o

 

As of July 22, 2005, 82,000,159 shares of registrant’s Common Stock, $2 par value per share, were outstanding.

 

 



 

MERCANTILE BANKSHARES CORPORATION

Quarterly Report on Form 10-Q

June 30, 2005

 

Table of Contents

 

Part I - Financial Information

 

 

Item 1. Financial Statements (Unaudited)

 

 

Consolidated Balance Sheets

 

 

Consolidated Statements of Income

 

 

Consolidated Statements of Changes in Shareholders’ Equity

 

 

Consolidated Statements of Cash Flows

 

 

Notes to Consolidated Financial Statements

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Item 4. Controls and Procedures

 

 

 

 

Part II - Other Information

 

Item 1. Legal Proceedings

 

Item 4. Submission of Matters to a Vote of Security Holders

 

Item 6. Exhibits

 

 

 

 

Signatures

 

 

 

2



 

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

 

MERCANTILE BANKSHARES CORPORATION

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except per share data)

 

June 30,
2005

 

December 31,
2004

 

June 30,
2004

 

ASSETS

 

 

 

 

 

 

 

Cash and due from banks

 

$

382,695

 

$

244,875

 

$

296,046

 

Interest-bearing deposits in other banks

 

200

 

158

 

158

 

Federal funds sold

 

95,102

 

101

 

125,000

 

Total cash and cash equivalents

 

477,997

 

245,134

 

421,204

 

Investment securities available-for-sale

 

2,960,275

 

2,908,694

 

2,935,462

 

Investment securities held-to-maturity fair value of $18,788 (2005) $21,094 (December 2004) and $26,590 (June 2004)

 

18,056

 

20,176

 

25,663

 

Total investment securities

 

2,978,331

 

2,928,870

 

2,961,125

 

Loans held-for-sale

 

16,754

 

11,000

 

747

 

Loans:

 

 

 

 

 

 

 

Commercial

 

2,867,315

 

2,813,325

 

2,715,173

 

Commercial real estate

 

3,585,592

 

3,122,701

 

2,918,642

 

Construction

 

1,560,149

 

1,268,350

 

1,129,208

 

Residential real estate

 

1,581,472

 

1,486,106

 

1,468,804

 

Consumer

 

1,713,674

 

1,484,583

 

1,472,300

 

Lease financing

 

56,104

 

53,368

 

57,983

 

Total loans

 

11,364,306

 

10,228,433

 

9,762,110

 

Less: allowance for loan losses

 

(157,101

)

(149,002

)

(158,431

)

Loans, net

 

11,207,205

 

10,079,431

 

9,603,679

 

Bank premises and equipment, less accumulated depreciation of $151,132 (2005), $142,384 (December 2004) and $156,722 (June 2004)

 

147,774

 

139,946

 

141,523

 

Other real estate owned, net

 

777

 

212

 

402

 

Goodwill

 

667,465

 

507,791

 

517,615

 

Other intangible assets, net

 

49,830

 

48,226

 

52,478

 

Other assets

 

546,861

 

465,080

 

431,372

 

Total assets

 

$

16,092,994

 

$

14,425,690

 

$

14,130,145

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

$

3,293,344

 

$

3,049,031

 

$

3,043,242

 

Interest-bearing deposits

 

8,537,407

 

7,750,168

 

7,600,452

 

Total deposits

 

11,830,751

 

10,799,199

 

10,643,694

 

Short-term borrowings

 

1,192,782

 

887,857

 

891,879

 

Accrued expenses and other liabilities

 

140,390

 

129,996

 

115,705

 

Long-term debt

 

807,954

 

690,955

 

637,570

 

Total liabilities

 

13,971,877

 

12,508,007

 

12,288,848

 

 

 

 

 

 

 

 

 

COMMITMENTS and CONTINGENCIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Preferred stock, no par value; authorized 2,000,000 shares; issued and outstanding - None

 

 

 

 

 

 

 

Common stock, $2 par value; authorized 130,000,000 shares; issued and outstanding shares - 81,982,375 (2005), 79,300,506 (December 2004) and 79,088,986 (June 2004)

 

163,965

 

158,601

 

158,178

 

Capital surplus

 

665,006

 

530,705

 

522,758

 

Retained earnings

 

1,302,869

 

1,231,102

 

1,168,462

 

Accumulated other comprehensive loss

 

(10,723

)

(2,725

)

(8,101

)

Total shareholders’ equity

 

2,121,117

 

1,917,683

 

1,841,297

 

Total liabilities and shareholders’ equity

 

$

16,092,994

 

$

14,425,690

 

$

14,130,145

 

 

See notes to consolidated financial statements

 

3



 

MERCANTILE BANKSHARES CORPORATION

STATEMENTS OF CONSOLIDATED INCOME

 

 

 

For the 6 months
ended June 30,

 

For the 3 months
ended June 30,

 

(Dollars in thousands, except per share data)

 

2005

 

2004

 

2005

 

2004

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

322,421

 

$

261,300

 

$

169,877

 

$

132,171

 

Interest and dividends on investment securities:

 

 

 

 

 

 

 

 

 

Taxable interest income

 

50,366

 

53,566

 

25,374

 

26,165

 

Tax-exempt interest income

 

1,509

 

1,697

 

788

 

820

 

Other investment income

 

1,227

 

685

 

583

 

352

 

Total interest and dividends on investment securities

 

53,102

 

55,948

 

26,745

 

27,337

 

Other interest income

 

786

 

640

 

442

 

534

 

Total interest income

 

376,309

 

317,888

 

197,064

 

160,042

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Interest on deposits

 

56,689

 

40,640

 

31,384

 

19,873

 

Interest on short-term borrowings

 

9,526

 

2,899

 

5,484

 

1,480

 

Interest on long-term debt

 

14,644

 

10,460

 

7,829

 

5,205

 

Total interest expense

 

80,859

 

53,999

 

44,697

 

26,558

 

NET INTEREST INCOME

 

295,450

 

263,889

 

152,367

 

133,484

 

Provision for loan losses

 

756

 

4,779

 

 

2,353

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

 

294,694

 

259,110

 

152,367

 

131,131

 

NONINTEREST INCOME

 

 

 

 

 

 

 

 

 

Investment and wealth management

 

47,837

 

44,919

 

23,780

 

22,936

 

Service charges on deposit accounts

 

21,514

 

21,673

 

11,088

 

10,981

 

Mortgage banking related fees

 

5,178

 

5,233

 

2,895

 

2,293

 

Investment securities gains

 

513

 

535

 

99

 

590

 

Nonmarketable investments

 

9,493

 

4,654

 

4,222

 

450

 

Other income

 

33,400

 

27,266

 

17,982

 

13,876

 

Total noninterest income

 

117,935

 

104,280

 

60,066

 

51,126

 

NONINTEREST EXPENSES

 

 

 

 

 

 

 

 

 

Salaries

 

96,734

 

89,477

 

50,180

 

44,689

 

Employee benefits

 

23,853

 

23,441

 

11,956

 

10,928

 

Net occupancy expense of bank premises

 

13,779

 

11,879

 

6,857

 

5,819

 

Furniture and equipment expenses

 

15,203

 

14,937

 

7,924

 

7,573

 

Communications and supplies

 

8,059

 

8,499

 

4,019

 

4,195

 

Other expenses

 

46,438

 

38,520

 

22,977

 

20,163

 

Total noninterest expenses

 

204,066

 

186,753

 

103,913

 

93,367

 

Income before income taxes

 

208,563

 

176,637

 

108,520

 

88,890

 

Applicable income taxes

 

78,063

 

64,627

 

40,647

 

32,577

 

NET INCOME

 

$

130,500

 

$

112,010

 

$

67,873

 

$

56,313

 

NET INCOME PER SHARE OF COMMON STOCK:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.63

 

$

1.41

 

$

0.84

 

$

0.71

 

Diluted

 

$

1.62

 

$

1.40

 

$

0.84

 

$

0.71

 

DIVIDENDS PAID PER COMMON SHARE

 

$

0.73

 

$

0.68

 

$

0.38

 

$

0.35

 

 

See notes to consolidated financial statements

 

4



 

MERCANTILE BANKSHARES CORPORATION

STATEMENTS OF CHANGES IN CONSOLIDATED SHAREHOLDERS’ EQUITY

 

For the 6 months ended June 30, 2005 and 2004

 

(Dollars in thousands, except per share data)

 

Total

 

Common
Stock

 

Capital
Surplus

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income (Loss)

 

BALANCE, DECEMBER 31, 2003

 

$

1,841,441

 

$

159,545

 

$

548,664

 

$

1,110,748

 

$

22,484

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

112,010

 

 

 

 

 

112,010

 

 

 

Unrealized losses on securities available-for-sale, net of reclassification adjustment, net of taxes

 

(30,585

)

 

 

 

 

 

 

(30,585

)

Comprehensive income

 

81,425

 

 

 

 

 

 

 

 

 

Cash dividends paid:

 

 

 

 

 

 

 

 

 

 

 

Common stock ($.68 per share)

 

(53,957

)

 

 

 

 

(53,957

)

 

 

Issuance of 61,696 shares for dividend reinvestment and stock purchase plan

 

2,639

 

123

 

2,516

 

 

 

 

 

Issuance of 12,660 shares for employee stock purchase dividend reinvestment plan

 

557

 

25

 

532

 

 

 

 

 

Issuance of 215,631 shares for employee stock option plan

 

3,894

 

432

 

3,462

 

 

 

 

 

Directors’ deferred compensation plan:

 

 

 

 

 

 

 

 

 

 

 

Transfer opening balance

 

6,406

 

 

 

6,406

 

 

 

 

 

Contribution

 

196

 

 

 

196

 

 

 

 

 

Dividend

 

 

 

 

54

 

(54

)

 

 

Restricted stock awards

 

 

 

 

 

 

 

 

 

 

 

Issuance of 26,294 shares

 

1,199

 

53

 

1,146

 

 

 

 

 

Deferred compensation

 

(1,320

)

 

 

 

 

(1,320

)

 

 

Amortization

 

1,035

 

 

 

 

 

1,035

 

 

 

Purchase of 1,000,000 shares under stock repurchase plan

 

(44,110

)

(2,000

)

(42,110

)

 

 

 

 

Vested stock options

 

1,892

 

 

1,892

 

 

 

BALANCE, JUNE 30, 2004

 

$

1,841,297

 

$

158,178

 

$

522,758

 

$

1,168,462

 

$

(8,101

)

BALANCE, DECEMBER 31, 2004

 

$

1,917,683

 

$

158,601

 

$

530,705

 

$

1,231,102

 

$

(2,725

)

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

130,500

 

 

 

 

 

130,500

 

 

 

Unrealized losses on securities available-for-sale, net of reclassification adjustment, net of taxes

 

(7,998

)

 

 

 

 

 

 

(7,998

)

Comprehensive income

 

122,502

 

 

 

 

 

 

 

 

 

Cash dividends paid:

 

 

 

 

 

 

 

 

 

 

 

Common stock ($.73 per share)

 

(57,897

)

 

 

 

 

(57,897

)

 

 

Issuance of 2,444,408 shares for bank acquisition

 

124,335

 

4,889

 

119,446

 

 

 

 

 

Fair value of 138,764 converted options related to employee stock option plan of acquired bank

 

5,182

 

 

 

5,182

 

 

 

 

 

Issuance of 54,750 shares for dividend reinvestment and stock purchase plan

 

2,677

 

110

 

2,567

 

 

 

 

 

Issuance of 11,740 shares for employee stock purchase dividend reinvestment plan

 

592

 

23

 

569

 

 

 

 

 

Issuance of 132,034 shares for employee stock option plan

 

1,957

 

265

 

1,692

 

 

 

 

 

Directors’ deferred compensation plan:

 

 

 

 

 

 

 

 

 

 

 

Issuance of 1,599 shares

 

 

2

 

(2

)

 

 

 

 

Contribution

 

370

 

 

 

370

 

 

 

 

 

Dividend

 

 

 

 

127

 

(127

)

 

 

Restricted stock awards

 

 

 

 

 

 

 

 

 

 

 

Issuance of 37,338 shares

 

1,906

 

75

 

1,831

 

 

 

 

 

Deferred compensation

 

(2,000

)

 

 

 

 

(2,000

)

 

 

Amortization

 

1,291

 

 

 

 

 

1,291

 

 

 

Vested stock options

 

2,519

 

 

2,519

 

 

 

BALANCE, JUNE 30, 2005

 

$

2,121,117

 

$

163,965

 

$

665,006

 

$

1,302,869

 

$

(10,723

)

 

See notes to consolidated financial statements

 

5



 

MERCANTILE BANKSHARES CORPORATION

STATEMENTS OF CONSOLIDATED CASH FLOW

 

Increase (decrease) in cash and cash equivalents

 

For the 6 months ended June 30,

 

(Dollars in thousands)

 

2005

 

2004

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

130,500

 

$

112,010

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provision for loan losses

 

756

 

4,779

 

Depreciation

 

7,560

 

7,787

 

Amortization of other intangible assets

 

4,251

 

4,088

 

Write-downs of other real estate owned

 

1

 

 

Gains on sales of other real estate owned

 

(153

)

(13

)

Gains on sales of investments securities

 

(513

)

(535

)

Gains on sales of premises

 

(4,541

)

(963

)

Loans held-for-sale

 

(5,754

)

14,178

 

Net (increase) decrease in assets:

 

 

 

 

 

Interest receivable

 

(444

)

3,954

 

Nonmarketable investments

 

(6,683

)

(4,519

)

Other assets

 

(4,472

)

1,598

 

Net increase (decrease) in liabilities:

 

 

 

 

 

Interest payable

 

3,591

 

(1,125

)

Other liabilities

 

(27,333

)

(15,066

)

Net cash provided by operating activities

 

96,766

 

126,173

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Proceeds from maturities of investment securities held-to-maturity

 

2,120

 

3,913

 

Proceeds from maturities of investment securities available-for-sale

 

425,262

 

532,465

 

Proceeds from sales of investment securities available-for-sale

 

89,878

 

42,055

 

Purchases of investment securities held-to-maturity

 

 

(5,195

)

Purchases of investment securities available-for-sale

 

(408,727

)

(514,304

)

Net increase in customer loans

 

(465,812

)

(493,705

)

Proceeds from sales of other real estate owned

 

273

 

75

 

Capital expenditures

 

(10,189

)

(5,403

)

Proceeds from sales of premises

 

5,893

 

2,594

 

Business acquisitions (net of cash received)

 

(78,655

)

 

Purchase of nonmarketable investments

 

(3,926

)

(2,956

)

Net cash used in investing activities

 

(443,883

)

(440,461

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Net increase in noninterest-bearing deposits

 

136,463

 

292,521

 

Net increase in interest-bearing deposits

 

268,181

 

88,620

 

Net increase in short-term borrowings

 

295,219

 

82,858

 

Repayment of long-term debt

 

(67,212

)

(231

)

Proceeds from issuance of shares

 

5,226

 

7,090

 

Repurchase of common shares

 

 

(44,110

)

Dividends paid

 

(57,897

)

(53,957

)

Net cash provided by financing activities

 

579,980

 

372,791

 

Net increase in cash and cash equivalents

 

232,863

 

58,503

 

Cash and cash equivalents at beginning of period

 

245,134

 

362,701

 

Cash and cash equivalents at end of period

 

$

477,997

 

$

421,204

 

SUPPLEMENTAL INFORMATION

 

 

 

 

 

Cash payments for interest

 

$

75,916

 

$

55,125

 

Cash payments for income taxes

 

91,109

 

64,245

 

 

See notes to consolidated financial statements

 

6



 

MERCANTILE BANKSHARES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Basis of Presentation

 

The consolidated financial statements, which include the accounts of Mercantile Bankshares Corporation (“Bankshares”) (Nasdaq: MRBK) and all of its affiliates, are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practice within the banking industry.  In the opinion of management, the consolidated financial statements include all adjustments necessary for a fair presentation of the interim period.  These adjustments are of a normal nature and include adjustments to eliminate all significant intercompany transactions.  In view of the changing conditions in the national economy, the effect of actions taken by regulatory authorities and normal seasonal factors, the results for the interim period are not necessarily indicative of annual performance.  For comparability, certain prior period amounts have been reclassified to conform with current period presentation.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities in the financial statements, and the disclosure of revenue and expenses during the reporting period.  These assumptions are based on information available as of the date of the financial statements and could differ from actual results.  See Annual Report on Form 10-K for more detail.

 

2. Business Combinations / Restructuring

 

The following provides information concerning acquisitions and restructurings. Acquisitions are accounted for as purchases with the results of their operations subsequent to the acquisition date included in Bankshares’ Statements of Consolidated Income.

 

On May 18, 2005, Bankshares completed its acquisition of Community Bank of Northern Virginia (“CBNV”), a bank headquartered in Sterling, Virginia, which was merged into Mercantile-Safe Deposit & Trust Company.  CBNV operated fourteen branch offices in the Northern Virginia metropolitan market at the time of the acquisition. The primary reason for the merger with CBNV was to expand Bankshares’ distribution network in Northern Virginia, a higher growth market. The total consideration paid to CBNV shareholders in connection with the acquisition was $82.9 million in cash and 2.4 million shares of Bankshares’ common stock.  CBNV transactions have been included in Bankshares’ financial results subsequent to May 18, 2005.  The assets and liabilities of CBNV were recorded on the Consolidated Balance Sheet at their respective fair values. The fair values have been determined as of June 30, 2005 and are subject to refinement, as further information becomes available. The transaction resulted in total assets acquired as of May 18, 2005 of $888.2 million, including $671.0 million of loans and leases; liabilities assumed were $842.3 million, including $626.9 million of deposits. Additionally, Bankshares had recorded $159.7 million of goodwill and $4.8 million of core deposit intangible. Intangible assets subjected to amortization are being amortized on a straight-line basis. The weighted average amortization period for the newly-acquired core deposit intangible is nine years.

 

Bankshares’ exit costs, referred to herein as “merger-related” costs, are defined to include those costs for its branch closings and related severance, combining operations such as systems conversions, and printing/mailing costs incurred by Bankshares prior to and after the merger date and are included in Bankshares’ results of operations.  Bankshares expensed merger-related costs totaling $302.0 thousand and $44.1 thousand for the six and three-month periods ended June 30, 2005, respectively. The costs associated with these activities are included in noninterest expenses. Merger-related expenses incurred year to date consisted largely of expenses for systems conversion costs. Bankshares will incur additional merger-related expenses in the third and fourth quarter as systems conversions, branch closings and integration of operations continue and these expenses will be reflected when incurred.

 

In the second quarter of 2005, Bankshares consolidated Fidelity Bank into Farmers & Mechanics Bank. The consolidation of these banks allows the surviving bank to serve its local customers with greater scale and expertise. Also, in the second quarter of 2005, Mercantile Potomac Bank merged into Mercantile-Safe Deposit and Trust Company. This combination allows Bankshares to provide the resources necessary for greater expansion into the Washington, D.C. and Northern Virginia markets.

 

In 2004, Bankshares initiated a significant reorganization within its Banking network.  In a move designed to create banks of sufficient size and depth to compete more effectively today and in the future, Bankshares combined 11 affiliate banks to create four new organizations, all with a more prominent Mercantile identity. This reorganization has enabled Bankshares to operate more effectively and efficiently in the face of increased competitive and regulatory pressures.  Fewer, larger banks allow better leverage of our branch network, reduce administrative and operational redundancies and increase the breadth and depth of expertise within our banks. All banks that were combined are geographically contiguous, share increasingly common market dynamics and offer the opportunity to create scale efficiencies. In 2004, Bankshares accrued approximately $2.3 million in restructuring charges due to this reorganization. At June 30, 2005, $0.9 million remains to be paid.

 

7



 

3. Earnings Per Share

 

Basic earnings per share (“EPS”) is computed by dividing income available to common shareholders by weighted average common shares outstanding.  Diluted EPS is computed using the same components as basic EPS with the denominator adjusted for the dilutive effect of stock awards.  The following tables provide reconciliation between the computation of basic EPS and diluted EPS for the six months and quarters ended June 30, 2005 and 2004, respectively.

 

 

 

For the 6 months ended June 30,

 

 

 

2005

 

2004

 

(In thousands, except per share data)

 

Net
Income

 

Weighted Average
Common Shares

 

EPS

 

Net
Income

 

Weighted Average
Common Shares

 

EPS

 

Basic EPS

 

$

130,500

 

79,875

 

$

1.63

 

$

112,010

 

79,422

 

$

1.41

 

Dilutive effect of stock options and restricted stock awards

 

 

 

476

 

 

 

 

 

510

 

 

 

Vested directors deferred compensation plan shares

 

 

 

170

 

 

 

 

 

75

 

 

 

Diluted EPS

 

$

130,500

 

80,521

 

$

1.62

 

$

112,010

 

80,007

 

$

1.40

 

 

 

 

For the 3 months ended June 30,

 

 

 

2005

 

2004

 

(In thousands, except per share data)

 

Net
Income

 

Weighted Average
Common Shares

 

EPS

 

Net
Income

 

Weighted Average
Common Shares

 

EPS

 

Basic EPS

 

$

67,873

 

80,514

 

$

0.84

 

$

56,313

 

79,119

 

$

0.71

 

Dilutive effect of stock options and restricted stock awards

 

 

 

475

 

 

 

 

 

483

 

 

 

Vested directors deferred compensation plan shares

 

 

 

172

 

 

 

 

 

149

 

 

 

Diluted EPS

 

$

67,873

 

81,161

 

$

0.84

 

$

56,313

 

79,751

 

$

0.71

 

 

Antidilutive options and awards excluded from the computation of diluted earnings per share were 209,974 and 445,909 for the six months ended June 30, 2005 and 2004, respectively, and 312,322 and 593,500 for the second quarter of 2005 and 2004, respectively.

 

4. Investment Securities

 

At June 30, 2005 and December 31, 2004, securities with an amortized cost of $1.3 billion and $1.1 billion, respectively, were pledged as collateral for certain deposits as required by regulatory guidelines. The following table shows amortized cost and fair value of investment securities at June 30, 2005 and December 31, 2004.

 

 

 

June 30, 2005

 

December 31, 2004

 

(Dollars in thousands)

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Investment securities held-to-maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

States and political subdivisions

 

$

18,056

 

$

743

 

$

11

 

$

18,788

 

$

20,176

 

$

921

 

$

3

 

$

21,094

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

475,206

 

$

873

 

$

1,725

 

$

474,354

 

$

605,505

 

$

4,534

 

$

980

 

$

609,059

 

U.S. Government agencies

 

924,286

 

1,498

 

7,716

 

918,068

 

853,930

 

3,742

 

4,699

 

852,973

 

Mortgage-backed securities

 

1,436,562

 

2,263

 

14,592

 

1,424,233

 

1,326,056

 

4,372

 

13,127

 

1,317,301

 

States and political subdivisions

 

78,028

 

890

 

50

 

78,868

 

61,984

 

917

 

31

 

62,870

 

Other investments

 

63,266

 

1,626

 

140

 

64,752

 

65,323

 

1,294

 

126

 

66,491

 

Total

 

$

2,977,348

 

$

7,150

 

$

24,223

 

$

2,960,275

 

$

2,912,798

 

$

14,859

 

$

18,963

 

$

2,908,694

 

 

The following table shows the unrealized gross losses and fair value of securities in the securities available-for-sale portfolio at June 30, 2005, by length of time that individual securities in each category have been in a continuous loss position.

 

8



 

 

 

Less than 12 Months

 

12 months or more

 

Total

 

(Dollars in thousands)

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

U.S. Treasury

 

$

1,620

 

$

471,370

 

$

105

 

$

2,984

 

$

1,725

 

$

474,354

 

U.S. Government agencies

 

7,042

 

892,179

 

674

 

25,889

 

7,716

 

918,068

 

States and political subdivisions

 

59

 

78,768

 

2

 

100

 

61

 

78,868

 

Mortgage-backed securities

 

5,884

 

1,137,052

 

8,708

 

287,181

 

14,592

 

1,424,233

 

Other investments

 

140

 

64,752

 

 

 

140

 

64,752

 

Total bonds

 

$

14,745

 

$

2,644,121

 

$

9,489

 

$

316,154

 

$

24,234

 

$

2,960,275

 

 

At June 30, 2005, there were $316.2 million of individual securities that had unrealized losses for a period greater than 12 months. At June 30, 2005, these securities had an unrealized loss of $9.5 million of which 91.8% were mortgage-backed securities. Management has assessed the impairment of these securities and determined that the impairment is temporary. All principal and interest payments on available-for-sale debt securities in an unrealized loss position for greater than 12 months are expected to be collected given the high credit quality of the U.S. government agency debt securities and Bankshares’ ability and intent to hold the securities. Because the declines in fair value were due to changes in market interest rates, not in estimated cash flows, no other-than-temporary impairment was recorded at June 30, 2005.

 

5. Impaired Loans

 

When scheduled principal or interest payments are past due 90 days or more at quarter-end on any loan, the accrual of interest income is discontinued and subsequent receipts on these loans are recorded as a reduction of principal, and interest income is recorded only once principal recovery is reasonably assured. Previously accrued but uncollected interest on these loans is charged against interest income. Generally, a loan may be restored to accruing status when all past due principal, interest and late charges have been paid and the bank expects repayment of the remaining contractual principal and interest on a timely basis.

 

Under Statements of Financial Accounting Standards (SFAS) Nos. 114 and 118, “Accounting by Creditors for Impairment of a Loan-an amendment of FASB Statements Nos. 5 and 15,” a loan is considered impaired, based on current information and events, if it is probable that Bankshares will not collect all principal and interest payments according to the contractual terms of the loan agreement. The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the repayment is expected to be provided predominantly by the underlying collateral. Information with respect to impaired loans and the related valuation allowance (if the measure of the impaired loan is less than the recorded investment) at June 30, 2005, December 31, 2004 and June 30, 2004 is shown below.  See Annual Report on Form 10-K for more detail.

 

(Dollars in thousands)

 

June 30,
2005

 

December 31,
2004

 

June 30,
2004

 

Impaired loans with a specific valuation allowance

 

$

16,460

 

$

18,365

 

$

24,864

 

All other impaired loans

 

8,746

 

9,113

 

12,160

 

Total impaired loans

 

$

25,206

 

$

27,478

 

$

37,024

 

 

 

 

 

 

 

 

 

Specific allowance for loan losses applicable to impaired loans

 

$

10,225

 

$

10,611

 

$

14,497

 

General allowance for loan losses applicable to other than impaired loans

 

146,876

 

138,391

 

143,934

 

Total allowance for loan losses

 

$

157,101

 

$

149,002

 

$

158,431

 

 

 

 

 

 

 

 

 

Year-to-date interest income on impaired loans recorded on the cash basis

 

$

53

 

$

379

 

$

212

 

Year-to-date average recorded investment in impaired loans during the period

 

$

27,887

 

$

39,025

 

$

41,116

 

Quarter-to-date interest income on impaired loans recorded on the cash basis

 

$

30

 

$

79

 

$

109

 

Quarter-to-date average recorded investment in impaired loans during the period

 

$

26,993

 

$

35,583

 

$

39,752

 

 

Note: Impaired loans do not include large groups of smaller balance homogeneous loans that are evaluated collectively for impairment (e.g., residential mortgages and consumer installment loans).  The allowance for loan losses related to these loans is included in the general allowance for loan losses applicable to other than impaired loans.

 

9



 

On May 18, 2005, Bankshares acquired approximately $671.0 million in loans as part of the CBNV acquisition. At acquisition, CBNV had $7.4 million in an allowance for loan losses of which $7.1 million was carried over to Bankshares in accordance with SFAS 141, “Business Combinations,” for those loans that do not fall within the scope of the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” Under SOP 03-3, Bankshares determined that certain loans acquired at the CBNV acquisition displayed evidence of deterioration of credit quality since their origination for which it was probable that all contractual payments would not be collected. Bankshares determined two commercial real estate loans totaling $4.9 million were within the scope of SOP 03-3. The carrying value and accretable yields of these loans as of June 30, 2005 are shown below.

 

(Dollars in thousands)

 

June 30,
2005

 

Commercial real estate

 

$

4,865

 

Total contractual balance

 

$

4,865

 

 

 

 

 

Carrying amount

 

$

3,500

 

 

 

 

Accretable yield

 

Balance at May 18, 2005

 

$

 

Addition - due to acquisition

 

680

 

Accretion

 

(46

)

Balance at June 30, 2005

 

$

634

 

 

6. Commitments & Contingencies

 

Bankshares is a party to financial instruments that are not reflected in the balance sheet, which include commitments to extend credit and standby letters of credit. Various commitments to extend credit (lines of credit) are made in the normal course of banking business. Letters of credit are issued for the benefit of customers by affiliated banks. These commitments are subject to loan underwriting standards and geographic boundaries consistent with Bankshares’ loans outstanding. Bankshares’ lending activities are concentrated in Maryland, Delaware and Virginia.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Total commitments to extend credit were $4.7 billion at June 30, 2005, $4.2 billion at December 31, 2004, and $3.9 billion at June 30, 2004.

 

Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Outstanding letters of credit were $438.3 million at June 30, 2005, $379.8 million at December 31, 2004 and $320.9 million at June 30, 2004.  Fees received for issuing letters of credit are deferred and amortized over the life of the commitment.  The unamortized fees on letters of credit at June 30, 2005, December 31, 2004, and June 30, 2004 had a carrying value of $1.5 million, $1.3 million and $1.2 million, respectively.

 

Bankshares’ mortgage banking subsidiary is a Fannie Mae Delegated Underwriting and Servicing lender and has a loss sharing arrangement for loans originated on behalf of and sold to Fannie Mae.  The unamortized principal balance of the underlying loans totaled $225.8 million, $190.7 million and $183.9 million at June 30, 2005, December 31, 2004 and June 30, 2004, respectively.  A minimal loss reserve has been established for potential losses on loans originated and sold in the secondary market at June 30, 2005.  The mortgage subsidiary also has originated and sold loans with recourse in the event of foreclosure on the underlying real estate.  The unamortized amount of principal balance of loans sold with recourse totaled $1.3 million at June 30, 2005, $1.7 million at December 31, 2004 and $2.0 million at June 30, 2004.  These mortgages are generally in good standing, are well-collateralized and no loss has ensued and no future loss is expected.

 

Bankshares has committed to invest funds in third-party private equity investments. At June 30, 2005, December 31, 2004 and June 30, 2004, $30.0 million, $28.9 million and $18.7 million, respectively, remained unfunded.

 

In the ordinary course of business, Bankshares and its subsidiaries are involved in a number of pending and threatened legal actions and proceedings. In certain of these actions and proceedings, claims for substantial monetary damages are asserted against Bankshares and its subsidiaries. In view of the inherent difficulty of predicting the outcome of such matters, Bankshares cannot state what the eventual outcome of pending matters will be. However, based on current knowledge, management does not believe that liabilities, if

 

10



 

any, arising from pending litigation matters, will have a material adverse effect on the consolidated financial position or liquidity of Bankshares. If payment associated with a claim becomes probable and the cost can be reasonably estimated, a contingent liability would be established based on information currently available, advice of counsel and available insurance coverage.

 

Between 2001 and 2003, on behalf of either individual plaintiffs or a putative class of plaintiffs, eight separate actions were filed in state and federal court against Community Bank of Northern Virginia (“CBNV”) and other defendants challenging the validity of second mortgage loans the defendants made to the plaintiffs.  All of the cases were either filed in or removed to the federal district court for the Western District of Pennsylvania.  In June 2003, the parties to the various actions informed the court that they had reached an agreement in principle to settle the various actions.  On July 17, 2003, the court conditionally certified a class for settlement purposes, preliminarily approved the class settlement, and directed the issuance of notice to the class.

 

Thereafter, certain plaintiffs opted out of the proposed settlement and challenged the validity of the settlement in the district court.  The district court denied their arguments and approved the settlement.  These “opt out” plaintiffs appealed the district court’s approval of the settlement to the Third Circuit Court of Appeals.  The Third Circuit heard oral argument on February 17, 2005 and has not yet issued its decision. Certain individuals who were excluded from the settlement class have filed two actions on behalf of a putative class of plaintiffs alleging claims similar to those raised in the initial filing.  These actions recently were consolidated in the Western District of Pennsylvania.  Bankshares believes these actions are without merit and intends to defend the actions vigorously.

 

The contingency, which is estimable and probable, was incorporated in determining the fair value of the liability assumed at the acquisition of CBNV.

 

7. Goodwill and Other Intangible Assets

 

Bankshares’ Consolidated Balance Sheet included goodwill of $667.5 million at June 30, 2005 and $507.8 million at December 31, 2004. In 2005, Bankshares recorded $159.7 million in goodwill and $4.8 million in estimated core deposit intangible in connection with the CBNV acquisition, which was allocated to Bankshares’ banking segment. The core deposit intangible from CBNV is being amortized over a weighted average remaining useful life of nine years.

 

The following table discloses the gross carrying amount and accumulated amortization of intangible assets subject to amortization at June 30, 2005 and December 31, 2004.

 

 

 

June 30, 2005

 

December 31, 2004

 

(Dollars in thousands)

 

Gross carrying
amount

 

Accumulated
amortization

 

Net
amount

 

Gross carrying
amount

 

Accumulated
amortization

 

Net
amount

 

Core deposits

 

$

54,660

 

$

(17,828

)

$

36,832

 

$

49,881

 

$

(15,014

)

$

34,867

 

Mortgage servicing

 

2,445

 

(1,156

)

1,289

 

1,370

 

(1,013

)

357

 

Customer lists and other

 

17,010

 

(5,301

)

11,709

 

17,010

 

(4,008

)

13,002

 

Total

 

$

74,115

 

$

(24,285

)

$

49,830

 

$

68,261

 

$

(20,035

)

$

48,226

 

 

Identifiable intangible assets are amortized based on estimated lives of up to 15 years. Management reviews other intangible assets for impairment yearly, or whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. For those intangible assets subject to amortization, impairment is indicated if the sum of undiscounted estimated future net cash flows is less than the carrying amount of the asset. Impairment is recognized by writing down the carrying value or adjusting the estimated life of the asset. Any impairment recognized in a valuation account is reflected in the income statement in the corresponding period.

 

The following table shows the current period and estimated future amortization expense for amortized intangible assets. The projections of amortization expense shown for mortgage servicing rights are based on asset balances and the interest rate environment as of June 30, 2005. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.

 

11



 

The following table shows the current period and estimated future amortization expense for amortized intangible assets.

 

(Dollars in thousands)

 

Core
deposits

 

Mortgage
servicing

 

Customer lists
and other

 

Total

 

Six months ended June 30, 2005 (actual)

 

$

2,814

 

$

136

 

$

1,301

 

$

4,251

 

Six months ended December 31, 2005 (estimated)

 

2,974

 

201

 

1,293

 

4,468

 

Twelve months ended December 31, 2005 (estimated)

 

5,788

 

337

 

2,594

 

8,719

 

 

 

 

 

 

 

 

 

 

 

 

Estimate for year ended December 31,

2006

 

5,950

 

259

 

2,343

 

8,552

 

 

 

2007

 

5,691

 

210

 

2,149

 

8,050

 

 

 

2008

 

4,827

 

192

 

1,968

 

6,987

 

 

 

2009

 

4,502

 

187

 

1,028

 

5,717

 

 

8. Comprehensive Income

 

The following table summarizes the market value change and related tax effect of unrealized gains (losses) on securities available-for-sale for the six months ended June 30, 2005 and 2004.  The net amount is included in accumulated other comprehensive income (loss) in the Statements of Changes in Consolidated Shareholders’ Equity.

 

 

 

For the 6 months ended June 30,

 

 

 

2005

 

2004

 

(Dollars in thousands)

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Net Income

 

 

 

 

 

$

130,500

 

 

 

 

 

$

112,010

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

(12,454

)

4,766

 

(7,688

)

(48,260

)

17,998

 

(30,262

)

Reclassification adjustment for (gains) losses included in net income

 

(513

)

203

 

(310

)

(535

)

212

 

(323

)

Total other comprehensive income

 

(12,967

)

4,969

 

(7,998

)

(48,795

)

18,210

 

(30,585

)

Total comprehensive income

 

 

 

 

 

$

122,502

 

 

 

 

 

$

81,425

 

 

 

 

For the 3 months ended June 30,

 

 

 

2005

 

2004

 

(Dollars in thousands)

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Net Income

 

 

 

 

 

$

67,873

 

 

 

 

 

$

56,313

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

19,767

 

(7,265

)

12,502

 

(67,503

)

25,019

 

(42,484

)

Reclassification adjustment for (gains) losses included in net income

 

(99

)

39

 

(60

)

(590

)

233

 

(357

)

Total other comprehensive income

 

19,668

 

(7,226

)

12,442

 

(68,093

)

25,252

 

(42,841

)

Total comprehensive income

 

 

 

 

 

$

80,315

 

 

 

 

 

$

13,472

 

 

12



 

9. Capital Adequacy

 

Bankshares and its bank affiliates are subject to various regulatory capital adequacy requirements administered by federal and state banking agencies.  These requirements include maintaining certain capital ratios above minimum levels.  These capital ratios include tier I capital and total risk-based capital as percentages of net risk-weighted assets and tier I capital as a percentage of adjusted average total assets (leverage ratio).  The minimum ratios for capital adequacy purposes are 4.00%, 8.00% and 4.00%, for the tier I capital, total capital and leverage ratios, respectively.  To be categorized as well capitalized, a bank must maintain minimum ratios of 6.00%, 10.00% and 5.00%, for its tier I capital, total capital and leverage ratios, respectively.  As of June 30, 2005, Bankshares and all of its bank affiliates exceeded all capital adequacy requirements to be considered well capitalized.

 

Capital ratios and the amounts used to calculate them are presented in the following table for Bankshares and Mercantile-Safe Deposit & Trust Company (MSD&T), the lead bank, as of June 30, 2005 and December 31, 2004. The June 30, 2005 MSD&T capital ratios reflect the impact of the consolidation of Mercantile Potomac Bank into MSD&T and the acquisition of CBNV.

 

 

 

June 30, 2005

 

December 31, 2004

 

(Dollars in thousands)

 

Bankshares

 

MSD&T

 

Bankshares

 

MSD&T

 

Tier I capital

 

$

1,422,079

 

$

468,540

 

$

1,370,112

 

$

411,587

 

Total risk-based capital

 

1,882,496

 

580,685

 

1,802,520

 

459,812

 

Net risk-weighted assets

 

12,373,131

 

5,575,052

 

11,109,137

 

3,847,161

 

Adjusted average total assets

 

14,438,084

 

5,963,921

 

13,674,386

 

4,504,451

 

 

 

 

 

 

 

 

 

 

 

Tier I capital ratio

 

11.49

%

8.40

%

12.33

%

10.70

%

Total capital ratio

 

15.21

%

10.42

%

16.23

%

11.95

%

Leverage ratio

 

9.85

%

7.86

%

10.02

%

9.14

%

 

Bankshares has an ongoing share repurchase program.  Purchases may be made from time to time, subject to regulatory requirements, in open market or in privately negotiated transactions. Purchased shares are retired. At June 30, 2005, there were 476,327 shares remaining available for repurchase under the plan.

 

10. Segment Reporting

 

Operating segments as defined by SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information are components of an enterprise with separate financial information.  The component engages in business activities from which it derives revenues and incurs expenses and whose operating results management relies on for decision-making and performance assessment. Bankshares has two reportable segments – Banking and Investment and Wealth Management (“IWM”).

 

The following tables present selected segment information for the three and six months ended June 30, 2005 and 2004. The components in the “Other” column consist of amounts for the nonbank affiliates, unallocated corporate expenses including income taxes and intercompany eliminations. Certain expense amounts such as operations overhead have been reclassified in order to provide for full cost absorption. These reclassifications are shown on the “Adjustments” line.  Results of the CBNV acquisition have been included in the “Banking” column from its acquisition date in the second quarter of 2005.

 

 

 

For the 6 months ended June 30, 2005

 

For the 6 months ended June 30, 2004

 

(Dollars in thousands)

 

Banking

 

IWM

 

Other

 

Total

 

Banking

 

IWM

 

Other

 

Total

 

Net interest income

 

$

295,666

 

$

 

$

(216

)

$

295,450

 

$

263,740

 

$

 

$

149

 

$

263,889

 

Provision for loan losses

 

(756

)

 

 

(756

)

(4,779

)

 

 

(4,779

)

Noninterest income

 

62,479

 

47,841

 

7,615

 

117,935

 

56,154

 

45,229

 

2,897

 

104,280

 

Noninterest expenses

 

(164,620

)

(35,303

)

(4,143

)

(204,066

)

(152,764

)

(33,809

)

(180

)

(186,753

)

Adjustments

 

8,100

 

(1,443

)

(6,657

)

 

8,386

 

(1,926

)

(6,460

)

 

Income (loss) before income taxes

 

200,869

 

11,095

 

(3,401

)

208,563

 

170,737

 

9,494

 

(3,594

)

176,637

 

Income tax (expense) benefit

 

(69,923

)

(4,438

)

(3,702

)

(78,063

)

(59,982

)

(3,797

)

(848

)

(64,627

)

Net income (loss)

 

$

130,946

 

$

6,657

 

$

(7,103

)

$

130,500

 

$

110,755

 

$

5,697

 

$

(4,442

)

$

112,010

 

Average loans

 

$

10,608,029

 

 

 

$

399

 

$

10,608,428

 

$

9,480,967

 

 

 

$

192

 

$

9,481,159

 

Average earning assets

 

13,516,688

 

 

 

16,125

 

13,532,813

 

12,494,449

 

 

 

23,950

 

12,518,399

 

Average assets

 

14,718,009

 

 

 

154,924

 

14,872,933

 

13,227,398

 

 

 

550,019

 

13,777,417

 

Average deposits

 

11,188,466

 

 

 

(190,934

)

10,997,532

 

10,299,390

 

 

 

(66,939

)

10,232,451

 

Average equity

 

1,852,056

 

 

 

144,388

 

1,996,444

 

1,383,980

 

 

 

464,858

 

1,848,838

 

 

13



 

 

 

For the 3 months ended June 30, 2005

 

For the 3 months ended June 30, 2004

 

(Dollars in thousands)

 

Banking

 

IWM

 

Other

 

Total

 

Banking

 

IWM

 

Other

 

Total

 

Net interest income

 

$

152,572

 

$

 

$

(205

)

$

152,367

 

$

133,395

 

$

 

$

89

 

$

133,484

 

Provision for loan losses

 

 

 

 

 

(2,353

)

 

 

(2,353

)

Noninterest income

 

32,988

 

23,528

 

3,550

 

60,066

 

29,059

 

22,847

 

(780

)

51,126

 

Noninterest expenses

 

(84,169

)

(18,457

)

(1,287

)

(103,913

)

(77,237

)

(16,430

)

300

 

(93,367

)

Adjustments

 

4,171

 

(234

)

(3,937

)

 

5,155

 

(1,130

)

(4,025

)

 

Income (loss) before income taxes

 

105,562

 

4,837

 

(1,879

)

108,520

 

88,019

 

5,287

 

(4,416

)

88,890

 

Income tax (expense) benefit

 

(36,876

)

(1,932

)

(1,839

)

(40,647

)

(30,936

)

(2,114

)

473

 

(32,577

)

Net income (loss)

 

$

68,686

 

$

2,905

 

$

(3,718

)

$

67,873

 

$

57,083

 

$

3,173

 

$

(3,943

)

$

56,313

 

Average loans

 

$

10,898,888

 

 

 

$

375

 

$

10,899,263

 

$

9,623,698

 

 

 

$

186

 

$

9,623,884

 

Average earning assets

 

13,830,457

 

 

 

10,534

 

13,840,991

 

12,640,594

 

 

 

28,080

 

12,668,674

 

Average assets

 

15,083,362

 

 

 

150,209

 

15,233,571

 

13,385,094

 

 

 

554,091

 

13,939,185

 

Average deposits

 

11,470,481

 

 

 

(197,261

)

11,273,220

 

10,459,934

 

 

 

(61,677

)

10,398,257

 

Average equity

 

1,898,013

 

 

 

144,091

 

2,042,104

 

1,394,812

 

 

 

456,949

 

1,851,761

 

 

11. Derivative Instruments and Hedging Activities

 

FASB Statement No. 133 (SFAS No. 133), Accounting for Derivative Instruments and Hedging Activities, FASB Statement No. 138 (SFAS No. 138), Accounting for Certain Derivative Instruments and Certain Hedging Activities – an amendment to FASB Statement No. 133 and FASB Statement No. 149 (SFAS No. 149), Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities (collectively referred to as “derivatives”), establishes accounting and reporting standards for derivative instruments and for hedging activities. Bankshares maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.  Currently, derivative instruments that are used as part of the interest rate risk management strategy have been restricted to interest rate swaps.  Interest rate swaps generally involve the exchange of fixed-rate and variable-rate interest payments between two parties, based on a common notional principal amount and maturity date. As of June 30, 2005, Bankshares had interest rate swaps to convert a portion of its nonprepayable fixed-rate debt to floating-rate debt.  Bankshares also arranges interest rate swaps, caps and swaptions for commercial loan customers through its capital markets group.  Derivative transactions done with loan customers are hedged by means of an off-setting derivative trade with a third party.  In this way, Bankshares manages the market risk arising from capital markets related derivative activity.

 

The fair value of derivative instruments relating to hedging activities recorded in other assets was $12.8 million (notional $327.4 million) and $7.1 million (notional $294.5 million) at June 30, 2005 and December 31, 2004, respectively.  The fair value of derivative instruments relating to hedging activities recorded in other liabilities was $8.1 million (notional $158.6 million) and $6.8 million (notional $136.0 million) at June 30, 2005 and December 31, 2004, respectively.

 

Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded as other noninterest income in the results of operations. For all hedge relationships, ineffectiveness resulting from differences between the changes in fair values or cash flows of the hedged item and changes in fair value of the derivative are recognized as other noninterest income in the results of operations. The net interest settlement on derivatives designated as fair value or cash flow hedges is treated as an adjustment of the interest income or interest expense of the hedged assets or liabilities. The fair-value hedges of nonprepayable fixed-rate debt were effective for the reported periods. The impact of the hedges decreased interest expense $2.8 million in the first half of 2005 and $5.7 million for the same period in 2004.

 

14



 

The following tables summarize the gross position of derivatives relating to hedging activities at June 30, 2005 and December 31, 2004.

 

 

 

June 30, 2005

 

December 31, 2004

 

(Dollars in thousands)

 

Notional or
Contractual
Amount

 

Credit
Risk
Amount (1)

 

Estimated
Net
Fair Value

 

Notional or
Contractual
Amount

 

Credit
Risk
Amount (1)

 

Estimated
Net
Fair Value

 

Asset/Liability Management Hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Contracts:

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

$

350,000

 

$

8,220

 

$

3,605

 

$

350,000

 

$

6,297

 

$

(143

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer Accommodations

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Contracts:

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

$

124,178