UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

(Mark One)

 

 

x

 

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

 

 

 

 

 

 

 

 

 

For the quarterly period ended September 30, 2006

 

 

 

 

 

 

 

 

 

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

 

(I.R.S. Employer

incorporation or organization)

 

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 x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one).

Large accelerated filer x                               Accelerated filer o                               Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
   Yes
o    No x

As of October 20, 2006, there were 125,490,121 shares of registrant’s Common Stock, $2 par value per share, outstanding.

 

 




 

MERCANTILE BANKSHARES CORPORATION
Quarterly Report on Form 10-Q
September 30, 2006

Table of Contents

Part I - Financial Information

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (Unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets

 

 

 

 

Statements of Consolidated Income

 

 

 

 

Statements of Changes in Consolidated Shareholders’ Equity

 

 

 

 

Statements of Consolidated 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 1A.

 

Risk Factors

 

 

 

 

 

 

 

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)

 

 

 

September 30,
2006

 

December 31,
2005

 

September 30,
2005

 

ASSETS

 

 

 

 

 

 

 

Cash and due from banks

 

$

318,184

 

$

369,536

 

$

328,964

 

Interest-bearing deposits in other banks

 

200

 

200

 

200

 

Federal funds sold

 

133,608

 

25,104

 

232,129

 

Total cash and cash equivalents

 

451,992

 

394,840

 

561,293

 

Investment securities available-for-sale (Note 4)

 

3,126,770

 

3,089,628

 

3,048,846

 

Investment securities held-to-maturity (Note 4) - fair value of $14,766 (September 2006), $17,181 (December 2005) and $17,380 (September 2005)

 

14,361

 

16,659

 

16,804

 

Total investment securities

 

3,141,131

 

3,106,287

 

3,065,650

 

Loans held-for-sale

 

1,930

 

26,263

 

42,307

 

Loans:

 

 

 

 

 

 

 

Commercial

 

2,925,300

 

2,957,301

 

2,925,445

 

Commercial real estate

 

4,148,895

 

3,703,297

 

3,638,238

 

Construction

 

1,952,013

 

1,607,095

 

1,543,633

 

Residential real estate

 

1,988,336

 

1,802,373

 

1,778,684

 

Home equity lines

 

476,746

 

505,508

 

520,214

 

Consumer

 

1,043,048

 

1,032,271

 

1,039,845

 

Total loans

 

12,534,338

 

11,607,845

 

11,446,059

 

Less: allowance for loan losses

 

(143,853

)

(156,673

)

(157,176

)

Loans, net

 

12,390,485

 

11,451,172

 

11,288,883

 

Bank premises and equipment, less accumulated depreciation of $152,829 (September 2006), $146,585 (December 2005) and $147,395 (September 2005)

 

142,664

 

137,419

 

146,615

 

Other real estate owned, net

 

67

 

667

 

777

 

Goodwill, net

 

760,347

 

670,028

 

670,306

 

Other intangible assets, net (Note 8)

 

47,818

 

46,653

 

47,485

 

Other assets

 

638,813

 

588,400

 

580,138

 

Total assets

 

$

17,575,247

 

$

16,421,729

 

$

16,403,454

 

COMMITMENTS and CONTINGENCIES (Note 7)

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

$

3,301,554

 

$

3,324,650

 

$

3,329,331

 

Interest-bearing deposits

 

9,473,557

 

8,752,700

 

8,710,575

 

Total deposits

 

12,775,111

 

12,077,350

 

12,039,906

 

Short-term borrowings

 

1,558,710

 

1,237,714

 

1,266,672

 

Accrued expenses and other liabilities

 

188,331

 

169,780

 

165,398

 

Long-term debt

 

659,688

 

742,163

 

780,087

 

Total liabilities

 

15,181,840

 

14,227,007

 

14,252,063

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

Common stock, $2 par value; authorized 200,000,000 shares; issued shares - 125,476,310 (September 2006), 82,165,414 (December 2005) and 82,078,721 (September 2005)

 

250,953

 

164,331

 

164,157

 

Capital surplus

 

667,307

 

676,830

 

669,185

 

Retained earnings

 

1,503,226

 

1,386,405

 

1,343,076

 

Accumulated other comprehensive loss

 

(28,079

)

(32,844

)

(25,027

)

Total shareholders’ equity

 

2,393,407

 

2,194,722

 

2,151,391

 

Total liabilities and shareholders’ equity

 

$

17,575,247

 

$

16,421,729

 

$

16,403,454

 

 

See Notes to Consolidated Financial Statements.

3




MERCANTILE BANKSHARES CORPORATION
STATEMENTS OF CONSOLIDATED INCOME

 

 

 

For the 9 months ended
September 30,

 

For the 3 months ended
September 30,

 

(Dollars in thousands, except per share data)

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

628,369

 

$

508,135

 

$

224,218

 

$

185,714

 

Interest and dividends on investment securities:

 

 

 

 

 

 

 

 

 

Taxable interest income

 

93,323

 

77,052

 

32,393

 

26,686

 

Tax-exempt interest income

 

2,273

 

2,348

 

730

 

839

 

Other investment income

 

1,986

 

1,753

 

660

 

526

 

Total interest and dividends on investment securities

 

97,582

 

81,153

 

33,783

 

28,051

 

Other interest income

 

2,611

 

1,546

 

855

 

760

 

Total interest income

 

728,562

 

590,834

 

258,856

 

214,525

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Interest on deposits

 

175,638

 

95,280

 

68,792

 

38,591

 

Interest on short-term borrowings

 

39,738

 

17,228

 

15,215

 

7,702

 

Interest on long-term debt

 

27,394

 

23,634

 

8,780

 

8,990

 

Total interest expense

 

242,770

 

136,142

 

92,787

 

55,283

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME

 

485,792

 

454,692

 

166,069

 

159,242

 

Provision for credit losses

 

 

1,576

 

 

820

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES

 

485,792

 

453,116

 

166,069

 

158,422

 

 

 

 

 

 

 

 

 

 

 

NONINTEREST INCOME

 

 

 

 

 

 

 

 

 

Investment and wealth management

 

82,582

 

71,505

 

27,596

 

23,668

 

Service charges on deposit accounts

 

33,936

 

32,992

 

12,776

 

11,478

 

Mortgage banking related fees

 

5,042

 

10,329

 

497

 

5,151

 

Investment securities gains (losses)

 

205

 

458

 

218

 

(32

)

Nonmarketable investments

 

13,383

 

13,683

 

1,150

 

4,190

 

Other income

 

49,693

 

52,042

 

17,530

 

18,619

 

Total noninterest income

 

184,841

 

181,009

 

59,767

 

63,074

 

 

 

 

 

 

 

 

 

 

 

NONINTEREST EXPENSES

 

 

 

 

 

 

 

 

 

Salaries

 

147,755

 

148,482

 

51,424

 

51,748

 

Employee benefits

 

42,538

 

35,490

 

13,511

 

11,637

 

Net occupancy expense of bank premises

 

23,991

 

20,918

 

8,289

 

7,139

 

Furniture and equipment expenses

 

24,752

 

23,168

 

8,353

 

7,965

 

Communications and supplies

 

12,083

 

11,992

 

3,796

 

3,933

 

Other expenses

 

77,447

 

72,398

 

27,056

 

25,960

 

Total noninterest expenses

 

328,566

 

312,448

 

112,429

 

108,382

 

Income before income taxes

 

342,067

 

321,677

 

113,407

 

113,114

 

Applicable income taxes

 

126,643

 

120,221

 

41,834

 

42,158

 

 

 

 

 

 

 

 

 

 

 

NET INCOME

 

$

215,424

 

$

201,456

 

$

71,573

 

$

70,956

 

 

 

 

 

 

 

 

 

 

 

NET INCOME PER SHARE OF COMMON STOCK (Note 3):

 

 

 

 

 

 

 

 

 

Basic

 

$

1.74

 

$

1.67

 

$

0.57

 

$

0.58

 

Diluted

 

$

1.73

 

$

1.65

 

$

0.57

 

$

0.57

 

DIVIDENDS PAID PER COMMON SHARE

 

$

0.82

 

$

0.74

 

$

0.28

 

$

0.25

 

 

See Notes to Consolidated Financial Statements.

4




MERCANTILE BANKSHARES CORPORATION
STATEMENTS OF CHANGES IN CONSOLIDATED SHAREHOLDERS’ EQUITY

 

 

 

For the 9 months ended September 30, 2006 and 2005

 

(Dollars in thousands, except per share data)

 

 

 

Total

 

Common
Stock

 

Capital
Surplus

 

Retained
Earnings

 

Accumulated 
Other
Comprehensive
Income (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, DECEMBER 31, 2004

 

$

1,917,683

 

$

158,601

 

$

530,705

 

$

1,231,102

 

$

(2,725

)

Net income

 

201,456

 

 

 

 

 

201,456

 

 

 

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

 

(22,302

)

 

 

 

 

 

 

(22,302

)

Comprehensive income (Note 9)

 

179,154

 

 

 

 

 

 

 

 

 

Cash dividends paid:

 

 

 

 

 

 

 

 

 

 

 

Common stock ($0.74 per share)

 

(89,017

)

 

 

 

 

(89,017

)

 

 

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 82,444 shares for dividend reinvestment and stock purchase plan

 

4,098

 

165

 

3,933

 

 

 

 

 

Issuance of 17,550 shares for employee stock purchase dividend reinvestment plan

 

873

 

35

 

838

 

 

 

 

 

Stock options

 

 

 

 

 

 

 

 

 

 

 

Issuance of 181,808 shares

 

3,664

 

364

 

3,300

 

 

 

 

 

Expense

 

2,519

 

 

 

2,519

 

 

 

 

 

Stock awards

 

 

 

 

 

 

 

 

 

 

 

Issuance of 41,823 shares

 

2,211

 

84

 

2,127

 

 

 

 

 

Deferred compensation

 

(2,242

)

 

 

 

 

(2,242

)

 

 

Expense

 

1,972

 

 

 

 

 

1,972

 

 

 

Directors’ deferred compensation plan

 

 

 

 

 

 

 

 

 

 

 

Issuance of 10,182 shares

 

439

 

19

 

420

 

 

 

 

 

Contribution

 

520

 

 

 

520

 

 

 

 

 

Dividend

 

 

 

 

195

 

(195

)

 

 

BALANCE, SEPTEMBER 30, 2005

 

$

2,151,391

 

$

164,157

 

$

669,185

 

$

1,343,076

 

$

(25,027

)

BALANCE, DECEMBER 31, 2005

 

$

2,194,722

 

$

164,331

 

$

676,830

 

$

1,386,405

 

$

(32,844

)

Net income

 

215,424

 

 

 

 

 

215,424

 

 

 

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

 

4,765

 

 

 

 

 

 

 

4,765

 

Comprehensive income (Note 9)

 

220,189

 

 

 

 

 

 

 

 

 

Cash dividends paid

 

 

 

 

 

 

 

 

 

 

 

Common stock ($0.82 per share)

 

(101,556

)

 

 

 

 

(101,556

)

 

 

Issuance of 1,833,757 shares in connection with bank acquisition

 

63,140

 

3,668

 

59,472

 

 

 

 

 

Fair value of 138,066 converted options related to employee stock option plan of acquired bank

 

1,605

 

 

 

1,605

 

 

 

 

 

Issuance of 134,274 shares for dividend reinvestment and stock purchase plan

 

4,706

 

268

 

4,438

 

 

 

 

 

Issuance of 26,505 shares for employee stock purchase dividend reinvestment plan

 

996

 

53

 

943

 

 

 

 

 

Stock options

 

 

 

 

 

 

 

 

 

 

 

Issuance of 107,767 shares

 

1,975

 

216

 

1,759

 

 

 

 

 

Expense

 

2,219

 

 

 

2,219

 

 

 

 

 

Stock awards and units

 

 

 

 

 

 

 

 

 

 

 

Issuance of 157,243 shares

 

189

 

314

 

(125

)

 

 

 

 

Repurchase of 38,471 shares for tax settlement

 

(1,477

)

(77

)

(1,400

)

 

 

 

 

Expense

 

5,748

 

 

 

5,748

 

 

 

 

 

Directors’ deferred compensation plan

 

 

 

 

 

 

 

 

 

 

 

Issuance of 4,995 shares

 

192

 

10

 

182

 

 

 

 

 

Contribution

 

841

 

 

 

841

 

 

 

 

 

Dividend

 

 

 

 

253

 

(253

)

 

 

Adjustment for adoption of SFAS No. 123R

 

 

 

 

(3,206

)

3,206

 

 

 

Issuance of 41,084,826 shares for a 3-for-2 stock split

 

(82

)

82,170

 

(82,252

)

 

 

 

 

BALANCE, SEPTEMBER 30, 2006

 

$

2,393,407

 

$

250,953

 

$

667,307

 

$

1,503,226

 

$

(28,079

)

See Notes to Consolidated Financial Statements.

5




MERCANTILE BANKSHARES CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS

 

 

 

For the 9 months ended September 30,

 

Increase (decrease) in cash and cash equivalents
(Dollars in thousands)

 

 

 

2006

 

2005

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

215,424

 

$

201,456

 

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

 

 

 

 

 

Provision for credit losses

 

 

1,576

 

Depreciation

 

11,857

 

11,581

 

Amortization of other intangible assets

 

7,064

 

6,482

 

Tax benefit from the issuance of stock-based awards

 

115

 

83

 

Write-downs of other real estate owned

 

 

1

 

Gains on sales of other real estate owned

 

(7

)

(153

)

Gains on sales of investments securities

 

(205

)

(458

)

Gains on sales of premises

 

(103

)

(4,341

)

Net (increase) decrease in assets:

 

 

 

 

 

Loans held-for-sale

 

25,568

 

(31,307

)

Interest receivable

 

(11,975

)

(9,332

)

Nonmarketable investments

 

(8,964

)

11,912

 

Other assets

 

(13,246

)

(80

)

Net increase (decrease) in liabilities:

 

 

 

 

 

Interest payable

 

19,359

 

13,710

 

Other liabilities

 

(15,502

)

(11,871

)

Net cash provided by operating activities

 

229,385

 

189,259

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Proceeds from maturities of investment securities held-to-maturity

 

2,298

 

3,372

 

Proceeds from maturities of investment securities available-for-sale

 

705,128

 

655,641

 

Proceeds from sales of investment securities available-for-sale

 

101,670

 

121,207

 

Purchases of investment securities available-for-sale

 

(723,014

)

(782,084

)

Net increase in customer loans

 

(511,661

)

(551,290

)

Proceeds from sales of other real estate owned

 

2,241

 

273

 

Capital expenditures

 

(16,117

)

(12,878

)

Proceeds from sales of premises

 

536

 

7,981

 

Proceeds from sale of interest in Ltd Partnership

 

6,705

 

 

Business acquisitions (net of cash received)

 

(61,251

)

(78,655

)

Business acquisitions contingent consideration

 

(8,806

)

 

Purchase of nonmarketable investments

 

(12,112

)

(57,105

)

Net cash used in investing activities

 

(514,383

)

(693,538

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Net (decrease) increase in noninterest-bearing deposits

 

(118,812

)

172,450

 

Net increase in interest-bearing deposits

 

383,457

 

442,943

 

Net increase in short-term borrowings

 

266,837

 

369,109

 

Repayment of long-term debt

 

(95,362

)

(84,659

)

Tax benefit from the issuance of stock-based awards

 

1,040

 

530

 

Excess tax benefit related to stock-based awards

 

346

 

447

 

Proceeds from issuance of shares

 

7,677

 

8,635

 

Repurchase of common shares

 

(1,477

)

 

Dividends paid

 

(101,556

)

(89,017

)

Net cash provided by financing activities

 

342,150

 

820,438

 

Net increase in cash and cash equivalents

 

57,152

 

316,159

 

Cash and cash equivalents at beginning of period

 

394,840

 

245,134

 

Cash and cash equivalents at end of period

 

$

451,992

 

$

561,293

 

SUPPLEMENTAL INFORMATION

 

 

 

 

 

Cash payments for interest

 

$

222,237

 

$

121,081

 

Cash payments for income taxes

 

135,974

 

133,745

 

 

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 purposes of comparability, certain prior period amounts have been reclassified to conform to 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 Bankshares’ Annual Report on Form 10-K for more detail.

On January 10, 2006, Bankshares announced a three-for-two stock split on its common stock payable in the form of a stock dividend on January 27, 2006 to stockholders of record as of the close of business on January 20, 2006.  For comparative purposes, certain share, average share and per share amounts have been restated.

2.  Business Combinations / Restructuring

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

On July 17, 2006, Bankshares completed its acquisition of James Monroe Bancorp, Inc. (“James Monroe”), an Arlington, Virginia-based commercial bank.  James Monroe was merged into Mercantile-Safe Deposit & Trust Company (“MSD&T”).  At the time of the acquisition, James Monroe operated six full-service branches and a loan production office located in Northern Virginia and suburban Washington, D.C.  The total consideration paid to James Monroe shareholders in connection with the acquisition was $71.4 million in cash and 1.8 million shares of Bankshares’ common stock.  The results of James Monroe’s operations have been included in Bankshares’ financial results subsequent to July 17, 2006.  The assets and liabilities of James Monroe were recorded on the Consolidated Balance Sheet at their respective fair values.  The fair values have been determined as of July 17, 2006 and are subject to refinement, as further information becomes available.  The transaction resulted in total assets acquired of $552 million, including $414 million in gross loans; and liabilities assumed of $507 million, including $434 million in total deposits.  Additionally, Bankshares preliminarily recorded $87.0 million of goodwill.  Intangible assets subject to amortization are being amortized on an accelerated basis.

Bankshares’ exit costs, referred to herein as “merger-related” costs, are defined to include those costs for branch closings and related severance, combining operations such as systems conversions, and printing and 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 $0.7 million for the three month period ended September 30, 2006.  The costs associated with these activities are included in noninterest expense.  Merger-related expenses incurred to date consisted largely of expenses for systems conversion costs.  Bankshares will incur additional merger-related expenses of $1.5 million during the fourth quarter of 2006 and the first quarter of 2007 as systems conversions, branch closings and integration of operations continue and these expenses will be recorded when incurred.

7




3.  Earnings per Share

Basic earnings per share (“EPS”) are computed by dividing income available to common shareholders by weighted average common shares outstanding.  Diluted EPS are computed using the same components as basic EPS with the denominator adjusted for the dilutive effect of weighted average common shares from the various share-based compensation plans.  The following tables provide reconciliations between the computation of basic EPS and diluted EPS for the nine and three months ended September 30, 2006 and 2005, respectively.

 

 

 

For the 9 months ended September 30,

 

 

 

2006

 

2005

 

(In thousands, except per share data)

 

 

 

Net
Income

 

Weighted
Average
Common
Shares

 

EPS

 

Net
Income

 

Weighted
Average
Common
Shares

 

EPS

 

Basic EPS

 

$

215,424

 

123,678

 

$

1.74

 

$

201,456

 

120,818

 

$

1.67

 

Dilutive effect of :

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

760

 

 

 

 

 

635

 

 

 

Restricted stock awards and units

 

 

 

109

 

 

 

 

 

113

 

 

 

Vested directors’ deferred compensation plan shares

 

 

 

295

 

 

 

 

 

258

 

 

 

Diluted EPS

 

$

215,424

 

124,842

 

$

1.73

 

$

201,456

 

121,824

 

$

1.65

 

 

 

 

For the 3 months ended September 30,

 

 

 

2006

 

2005

 

(In thousands, except per share data)

 

 

 

Net
Income

 

Weighted
Average
Common
Shares

 

EPS

 

Net
Income

 

Weighted
Average
Common
Shares

 

EPS

 

Basic EPS

 

$

71,573

 

124,750

 

$

0.57

 

$

70,956

 

122,797

 

$

0.58

 

Dilutive effect of :

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

742

 

 

 

 

 

776

 

 

 

Restricted stock awards and units

 

 

 

100

 

 

 

 

 

116

 

 

 

Vested directors’ deferred compensation plan shares

 

 

 

301

 

 

 

 

 

264

 

 

 

Diluted EPS

 

$

71,573

 

125,893

 

$

$0.57

 

$

70,956

 

123,953

 

$

0.57

 

 

Antidilutive weighted average common shares from the various share-based compensation plans excluded from the computation of diluted earnings per share were 430,857 and 666,503 for the nine months and three months ended September 30, 2006.  There were no antidilutive weighted average common shares excluded from the computation of diluted earnings per share for the nine months and three months ended September 30, 2005.

8




4.  Investment Securities

At September 30, 2006 and December 31, 2005, securities with an amortized cost of $1.5 billion and $1.3 billion, respectively, were pledged as collateral for repurchase transactions and certain deposits as required by regulatory guidelines.  The following table shows the amortized cost and fair value of investment securities at September 30, 2006 and December 31, 2005.

 

 

 

September 30, 2006

 

December 31, 2005

 

(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

 

$

14,361

 

$

425

 

$

20

 

$

14,766

 

$

16,659

 

$

541

 

$

19

 

$

17,181

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury

 

$

409,137

 

$

512

 

$

2,041

 

$

407,608

 

$

434,893

 

$

223

 

$

3,080

 

$

432,036

 

U.S. Government agencies

 

928,550

 

240

 

7,996

 

920,794

 

992,040

 

29

 

12,761

 

979,308

 

Mortgage-backed securities

 

1,710,596

 

2,116

 

37,791

 

1,674,921

 

1,581,845

 

685

 

38,269

 

1,544,261

 

States and political subdivisions

 

61,542

 

255

 

127

 

61,670

 

70,017

 

306

 

188

 

70,135

 

Other bonds, notes and debentures

 

11,678

 

 

129

 

11,549

 

19,083

 

 

215

 

18,868

 

Total bonds

 

3,121,503

 

3,123

 

48,084

 

3,076,542

 

3,097,878

 

1,243

 

54,513

 

3,044,608

 

Other investments

 

49,597

 

1,118

 

487

 

50,228

 

43,980

 

1,236

 

196

 

45,020

 

Total

 

$

3,171,100

 

$

4,241

 

$

48,571

 

$

3,126,770

 

$

3,141,858

 

$

2,479

 

$

54,709

 

$

3,089,628

 

 

The following table shows the unrealized gross losses and fair value of securities in the securities available-for-sale portfolio at September 30, 2006, by length of time that individual securities in each category have been in a continuous loss position.

 

 

 

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

 

$

94

 

$

229,867

 

$

1,947

 

$

177,741

 

$

2,041

 

$

407,608

 

U.S. Government agencies

 

709

 

331,626

 

7,287

 

589,168

 

7,996

 

920,794

 

Mortgage-backed securities

 

2,632

 

610,473

 

35,159

 

1,064,448

 

37,791

 

1,674,921

 

States and political subdivisions

 

29

 

45,862

 

98

 

15,808

 

127

 

61,670

 

Other bonds, notes and debentures

 

29

 

5,497

 

100

 

6,052

 

129

 

11,549

 

Total bonds

 

3,493

 

1,223,325

 

44,591

 

1,853,217

 

48,084

 

3,076,542

 

Other investments

 

181

 

35,934

 

306

 

14,294

 

487

 

50,228

 

Total

 

$

3,674

 

$

1,259,259

 

$

44,897

 

$

1,867,511

 

$

48,571

 

$

3,126,770

 

 

At September 30, 2006, there were $1.9 billion of individual securities that had unrealized losses for a period greater than 12 months.  At September 30, 2006, these securities had an unrealized loss of $44.9 million of which approximately 57% 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 until the value recovers or they mature.

9




5.  Allowance for Loan Losses and Reserve for Unfunded Commitments

During the first quarter of 2006, Bankshares refined the model used for determining certain components of the allowance for loan losses. The model refinement did not have a material impact on Bankshares’ recorded allowance for loan losses. Additionally, Bankshares reclassified a portion of the allowance for loan losses to a reserve for unfunded lending commitments reflected in other liabilities in the consolidated balance sheet.  As a result of the refinement of the modeling process for the allowance for loan losses, Bankshares was able specifically to identify risk inherent in unfunded commitments and make the reclassification noted above.  As no model data existed for previous years, prior period data has not been reclassified for comparability.

Bankshares reclassified $14.0 million and $1.9 million in the first and third quarters of 2006, respectively, of the allowance for loan losses to the reserve for unfunded commitments.  The third quarter reclassification resulted from a refinement in the manner in which the required reserves for unfunded commitments were calculated.  The acquired allowance from James Monroe was approximately $4.0 million.

The allowance for loan losses and reserve for unfunded commitments is presented below.

 

 

For the 9 months ended September 30,

 

For the 3 months ended September 30,

 

(Dollars in thousands)

 

 

 

2006

 

2005

 

2006

 

2005

 

Allowance for Loan Losses

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

156,673

 

$

149,002

 

$

142,860

 

$

157,101

 

Allowance of acquired bank

 

3,985

 

7,086

 

3,985

 

 

Provision for credit losses

 

(990

)

1,576

 

 

820

 

Transfer to reserve for unfunded commitments

 

(15,824

)

 

(1,856

)

 

Total

 

143,844

 

157,664

 

144,989

 

157,921

 

Charge-offs

 

(4,137

)

(4,825

)

(1,909

)

(1,710

)

Recoveries

 

4,146

 

4,337

 

773

 

965

 

Net recoveries (charge-offs)

 

9

 

(488

)

(1,136

)

(745

)

Balance, end of period

 

$

143,853

 

$

157,176

 

$

143,853

 

$

157,176

 

 

 

 

 

 

 

 

 

 

 

Reserve for Unfunded Commitments

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

 

$

 

$

14,958

 

$

 

Provision for credit losses

 

990

 

 

 

 

Transfer from allowance for loan losses

 

15,824

 

 

1,856

 

 

Balance, end of period

 

$

16,814

 

$

 

$

16,814

 

$

 

 

6.  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 September 30, 2006, December 31, 2005 and September 30, 2005 is shown in the following table.  See Bankshares’ Annual Report on Form 10-K for more detail.

10




 

(Dollars in thousands)

 

 

 

September 30,
2006

 

December 31,
2005

 

September 30,
2005

 

Impaired loans with a specific valuation allowance

 

$

2,488

 

$

11,512

 

$

15,579

 

All other impaired loans

 

30,293

 

9,086

 

9,103

 

Total impaired loans

 

$

32,781

 

$

20,598

 

$

24,682

 

 

 

 

 

 

 

 

 

Specific allowance for loan losses applicable to impaired loans

 

$

1,755

 

$

4,150

 

$

8,671

 

General allowance for loan losses applicable to other than impaired loans

 

142,098

 

152,523

 

148,505

 

Total allowance for loan losses

 

$

143,853

 

$

156,673

 

$

157,176

 

 

 

 

 

 

 

 

 

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

 

$

106

 

$

128

 

$

114

 

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

 

$

23,970

 

$

26,703

 

$

27,332

 

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

 

$

30

 

$

14

 

$

61

 

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

 

$

27,016

 

$

24,817

 

$

26,223

 

 

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.

There were no loans associated with the James Monroe acquisition that were 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.”  As part of the Community Bank of Northern Virginia (“CBNV”) acquisition, two commercial real estate loans totaling $4.9 million were within the scope of SOP 03-3.  One of the loans was subsequently paid in full and the remaining loan is deemed to be immaterial for purposes of the required disclosures.

7.  Commitments and Contingencies

Bankshares is a party to financial instruments that are not recorded 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 $5.1 billion at September 30, 2006, $4.8 billion at December 31, 2005, and $4.6 billion at September 30, 2005.

Letters of credit are commitments issued to guarantee the performance of a customer to a third party.  Outstanding letters of credit were $575.8 million at September 30, 2006, $540.6 million at December 31, 2005 and $506.8 million at September 30, 2005.  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 September 30, 2006, December 31, 2005, and September 30, 2005 had a carrying value of $2.5 million, $2.7 million and $2.5 million, respectively.

11




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 $278.7 million, $249.8 million and $237.2 million at September 30, 2006, December 31, 2005 and September 30, 2005, respectively.  The loss reserve for potential losses on loans originated and sold in the secondary market was $100.2 thousand and $60.7 thousand at September 30, 2006 and December 31, 2005, respectively.  The mortgage subsidiary also has originated and sold loans with recourse in the event of foreclosure on the underlying real estate.

Bankshares has committed to invest funds in third-party private equity investments.  At September 30, 2006, December 31, 2005 and September 30, 2005, $31.1 million, $26.6 million and $28.1 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 any, arising from pending litigation matters, will have a material adverse effect on the consolidated financial position, earnings 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.

8.  Goodwill and Other Intangible Assets

Goodwill, net, totaled $760.3 million at September 30, 2006 and $670.0 million at December 31, 2005.  In the third quarter of 2006, Bankshares preliminarily recorded $87.0 million in goodwill in connection with the James Monroe acquisition.  In the first quarter of 2006, there was an increase in goodwill of $8.8 million related to a contingent payment made to the management of Boyd Watterson Asset Management as they met the performance conditions outlined in the merger agreement.

The following table discloses the gross carrying amount and accumulated amortization of intangible assets subject to amortization at September 30, 2006 and December 31, 2005.

 

 

September 30, 2006

 

December 31, 2005

 

(Dollars in thousands)

 

 

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net
amount

 

Gross
carrying
amount

 

Accumulated
amortization

 

Net
amount

 

Core deposits

 

$

62,842

 

$

(25,444

)

$

37,398

 

$

54,509

 

$

(20,790

)

$

33,719

 

Mortgage servicing

 

2,848

 

(1,461

)

1,387

 

2,902

 

(1,145

)

1,757

 

Customer lists and other

 

17,795

 

(8,762

)

9,033

 

17,845

 

(6,668

)

11,177

 

Total

 

$

83,485

 

$

(35,667

)

$

47,818

 

$

75,256

 

$

(28,603

)

$

46,653

 

 

In connection with the James Monroe acquisition, Bankshares preliminarily recorded $8.3 million in core deposit intangibles.  The core deposit intangible from James Monroe is being amortized on an accelerated basis.

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.

 

12




 

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 September 30, 2006.  Future amortization expense may be significantly different depending upon changes in the mortgage-servicing portfolio, mortgage interest rates and market conditions.

 

(Dollars in thousands)

 

 

 

 

 

Core
Deposits

 

Mortgage
Servicing

 

Customer 
Lists
and Other

 

Total

 

Nine months ended September 30, 2006 (actual)

 

 

 

$

4,654

 

$

251

 

$

2,159

 

$

7,064

 

Three months ended December 31, 2006 (estimated)

 

 

 

1,680

 

59

 

562

 

2,301

 

Twelve months ended December 31, 2006 (estimated)

 

 

 

$

6,334

 

$

310

 

$

2,721

 

$

9,365

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimate for years ended December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

$

6,517

 

$

232

 

$

2,454

 

$

9,203

 

 

 

2008

 

5,423

 

215

 

1,617

 

7,255

 

 

 

2009

 

5,272

 

215

 

641

 

6,128

 

 

 

2010

 

5,272

 

215

 

505

 

5,992

 

 

9.  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 nine months and three months ended September 30, 2006 and 2005, respectively.  Total comprehensive income is included in the Statements of Changes in Consolidated Shareholders’ Equity.

 

 

 

For the 9 months ended September 30,

 

 

 

2006

 

2005

 

(Dollars in thousands)

 

 

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Net Income

 

 

 

 

 

$

215,424

 

 

 

 

 

$

201,456

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising

 

 

 

 

 

 

 

 

 

 

 

 

 

during the period

 

8,105

 

(3,216

)

4,889

 

(35,258

)

13,234

 

(22,024

)

Reclassification adjustment for (gains) losses included in net income

 

(205

)

81

 

(124

)

(458

)

180

 

(278

)

Total other comprehensive income

 

7,900

 

(3,135

)

4,765

 

(35,716

)

13,414

 

(22,302

)

Total comprehensive income

 

 

 

 

 

$

220,189

 

 

 

 

 

$

179,154

 

 

 

 

 

For the 3 months ended September 30,

 

 

 

2006

 

2005

 

(Dollars in thousands)

 

 

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Pretax
Amount

 

Tax
(Expense)
Benefit

 

Net
Amount

 

Net Income

 

 

 

 

 

$

71,573

 

 

 

 

 

$

70,956

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

34,202

 

(12,947

)

21,255

 

(22,781

)

8,459

 

(14,322

)

Reclassification adjustment for (gains) losses included in net income

 

(218

)

86

 

(132

)

32

 

(13

)

19

 

Total other comprehensive income

 

33,984

 

(12,861

)

21,123

 

(22,749

)

8,446

 

(14,303

)

Total comprehensive income

 

 

 

 

 

$

92,696

 

 

 

 

 

$

56,653

 

 

13




 

10.  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 September 30, 2006, Bankshares and each of its bank affiliates exceeded all capital adequacy requirements to be considered well capitalized.

Actual capital amounts and ratios are presented in the following table for Bankshares and its affiliates.  The September 30, 2006 MSD&T capital ratios reflect the James Monroe acquisition.

 

September 30, 2006
(Dollars in thousands)

 

 

 

Tier I
Capital

 

Total
Risk-Based
Capital

 

Net
Risk-Weighted
Assets

 

Adjusted
Average
Total Assets

 

Tier I
Capital
Ratio

 

Total
Capital
Ratio

 

Leverage
Ratio

 

Bankshares

 

$

1,639,229

 

$

2,099,107

 

$

13,713,845

 

$

16,413,550

 

11.95

%

15.31

%

9.99

%

Annapolis Banking & Trust

 

44,251

 

51,524

 

347,132

 

483,250

 

12.75

 

14.84

 

9.16

 

Citizens National Bank

 

108,741

 

156,454

 

1,213,369

 

1,338,333

 

8.96

 

12.89

 

8.13

 

Farmers & Mechanics Bank

 

168,335

 

229,463

 

1,370,064

 

1,687,145

 

12.29

 

16.75

 

9.98

 

Marshall National Bank & Trust

 

13,957

 

20,423

 

144,576

 

185,805

 

9.65

 

14.13

 

7.51

 

Mercantile County Bank

 

82,794

 

119,526

 

753,143

 

955,397

 

10.99

 

15.87

 

8.67

 

Mercantile Eastern Shore Bank

 

55,070

 

86,472

 

479,466

 

614,010

 

11.49

 

18.04

 

8.97

 

Mercantile Peninsula Bank

 

150,847

 

222,454

 

1,405,887

 

1,783,333

 

10.73

 

15.82

 

8.46

 

Mercantile-Safe Deposit & Trust Company

 

617,697

 

738,896

 

6,302,877

 

7,583,480

 

9.80

 

11.72

 

8.15

 

Mercantile Southern Maryland Bank

 

95,858

 

132,791

 

697,608

 

1,000,486

 

13.74

 

19.04

 

9.58

 

National Bank of Fredericksburg

 

39,402

 

50,261

 

395,730

 

477,679

 

9.96

 

12.70

 

8.25

 

Westminster Union Bank

 

70,671

 

101,193

 

524,157

 

822,105

 

13.48

 

19.31

 

8.60

 

 

December 31, 2005
(Dollars in thousands)

 

 

 

Tier I
Capital

 

Total
Risk-Based
Capital

 

Net
Risk-Weighted
Assets

 

Adjusted
Average
Total Assets

 

Tier I
Capital
Ratio

 

Total
Capital
Ratio

 

Leverage
Ratio

 

Bankshares

 

$

1,518,454

 

$

1,975,313

 

$

12,848,926

 

$

15,471,385

 

11.82

%

15.37

%

9.81

%

Annapolis Banking & Trust

 

43,148

 

50,382

 

331,167

 

484,567

 

13.03

 

15.21

 

8.90

 

Citizens National Bank

 

103,600

 

151,903

 

1,139,217

 

1,281,737