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United States
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from
    
    
    
    toCommission file number
    
    0-5127
 Mercantile Bankshares Corporation  Maryland
    
    52-0898572State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization
    
    Identification No.)
 Two Hopkins Plaza, P. O. Box 1477, Baltimore, Maryland 21203
(Address of principal executive offices) Registrants telephone number, including area code (410) 237-5900 Securities registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registeredNone
    
    None
 Securities registered pursuant to Section 12(g) of the Act: Common Stock ($2 par value)
(Title of class) Stock Purchase Rights
(Title of class) 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 ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2)
Yes X No ___




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At June 30, 2003, the last business day of registrants most recently completed
second fiscal quarter, the aggregate market value of shares of common stock
held by non-affiliates of registrant (including fiduciary accounts administered
by affiliates) was $2,718,819,545 based on the last sale price on the Nasdaq
National Market on June 30, 2003. As of February 27, 2004, 79,895,736 shares of common stock were outstanding. Documents Incorporated by Reference: Part III  Definitive Proxy
Statement of Registrant to be filed with the Securities and Exchange Commission
under Regulation 14A within 120 days after the end of the Registrants fiscal
year covered by this Annual Report on Form 10-K. 2




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PART I ITEM 1. BUSINESS General Mercantile Bankshares Corporation was incorporated under the laws of
Maryland on May 27, 1969. It is a financial holding company and a bank holding
company registered under the Bank Holding Company Act of 1956. Mercantile
Bankshares Corporation along with its consolidated subsidiaries is referred to
in this report as Bankshares, we or Registrant. Bankshares, with $13.7 billion in assets for the year ended December 31,
2003, is a regional multibank holding company with headquarters in Baltimore,
Maryland. It is comprised of Mercantile-Safe Deposit and Trust Company
(MSD&T) and 19 community banks (each a Community Bank) and a mortgage
banking company. Sixteen banks are located in Maryland, three are in Virginia
and one is in southern Delaware. Bankshares largest bank, MSD&T, represents
approximately 33% of total assets and operates 24 offices in Maryland, one
office in Washington, D.C., and one commercial office in Pennsylvania. On August 12, 2003, Bankshares acquired F&M Bancorp (F&M) for a mix of
cash and stock for total consideration of $558.1 million. On the date of
purchase, F&M had total loans of $1.4 billion, total assets of $2.2 billion and
total deposits of $1.7 billion. In late October, certain assets and
liabilities from F&M were allocated to MSD&T and certain Community Banks whose
market places overlapped with F&M. Nearly all of Bankshares substantial trust operations and specialized
corporate banking services are provided by MSD&T. Bankshares places particular emphasis on long-term customer relationships
by providing value-added services through its extensive Community Bank network.
Each Community Bank has its own name, management team and board of directors.
Perhaps most importantly, each bank has strong historical ties to the families
and businesses in the community it serves. Through its association with
Bankshares, each bank is able to provide its customers with the sophisticated
banking services and financial resources of a major banking organization. Bankshares directly owns all of the outstanding stock of MSD&T and the 19
Community Banks and directly or indirectly owns all of the outstanding stock of
certain other affiliates. For purposes of segment reporting, three operating
components have been identified. They are the banking division of the lead
bank, MSD&T; the Investment and Wealth Management Division of MSD&T; and the 19
Community Banks. The principal components of our banking and non-banking
network are listed below. 3




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Lead Bank and Affiliates Mercantile-Safe Deposit and Trust Company
    
    Baltimore, MarylandMercantile Mortgage CorporationMercantile Agency, Inc.Mercantile Capital Advisors, Inc.Mercantile Securities, Inc.Mercantile/Cleveland, LLCPeremel & Co., Inc.**Boyd Watterson Asset Management, LLC*MBC Agency, Inc.Mercantile Life Insurance CompanyMBC Realty,
LLC
   * 100% interest in Boyd Watterson was acquired on February 28, 2003 ** Bankshares acquired a 100% interest in Peremel on March 31, 2003 Community Banks The Annapolis Banking and Trust Company
    
    Annapolis, MarylandBank of Southern Maryland
    
    LaPlata, MarylandCalvert Bank and Trust Company
    
    Prince Frederick, MarylandThe Chestertown Bank of Maryland
    
    Chestertown, MarylandThe Citizens National Bank
    
    Laurel, MarylandCounty Banking & Trust Company
    
    Elkton, MarylandFarmers & Mechanics Bank
    
    Frederick, MarylandThe Fidelity Bank
    
    Hagerstown, MarylandThe First National Bank of St. Marys
    
    Leonardtown, MarylandThe Forest Hill State Bank
    
    Bel Air, MarylandPeninsula Bank
    
    Princess Anne, MarylandThe Peoples Bank of Maryland
    
    Denton, MarylandPotomac Valley Bank
    
    Gaithersburg, MarylandSt. Michaels Bank
    
    St. Michaels, MarylandWestminster Union Bank
    
    Westminster, MarylandBaltimore Trust Company
    
    Selbyville, DelawareFarmers & Merchants Bank  Eastern Shore
    
    Onley, VirginiaThe National Bank of Fredericksburg
    
    Fredericksburg, VirginiaMarshall National Bank and Trust Company
    
    Marshall, Virginia
 4




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For segment reporting information, see Footnote 15 to the financial
statements in Item 8 hereof, and information under the heading Segment
Reporting in the sections captioned Analysis of Operating Results for 2003 to
2002 and Review of Earnings and Balance Sheet for 2002 to 2001, in Item 7
hereof. Bankshares periodically reviews and considers possible acquisitions of
banks and other entities performing related activities and discusses such
possible acquisitions with managements of the subject companies, and such
acquisitions, which may be material, may be made from time to time.
Acquisitions are normally subject to regulatory approval. Consumer Banking Services Personal Banking MSD&T and all of the Community Banks offer numerous services to meet the
checking, savings, investment and credit needs of the individuals in their
communities. Personal banking services include Individual Retirement Accounts,
certificates of deposit and various checking and savings plans, including an
indexed money market account. The banks offer home equity loans and lines of
credit, as well as installment loans, to meet a variety of borrowing needs. The Community Bank network provides customers with no-fee access to 235
ATMs, and customers can perform many routine transactions at any of the 227
bank offices. For added convenience, substantially all Bankshares affiliates
provide customers with toll-free telephone access to a centralized Customer
Service Center and a voice-response account information system. Banking
Twenty-Four Online® enables customers to access their personal accounts online
to verify account balances, track recent account activity and perform selected
transactions. Recently, online banking was enhanced with bill payment
capabilities. Banking Twenty-Four offers sole proprietors similar and
specifically tailored capabilities to meet their small business needs. Home Mortgages Residential mortgages are provided through Mercantile Mortgage LLC, a
joint venture between Mercantile Mortgage Corporation (Mercantile Mortgage),
a subsidiary of MSD&T, and Wells Fargo Ventures LLC. A wide variety of
competitively priced fixed- and variable-rate products are available, including
jumbo loans. Residential mortgage loans also are available through the
Community Banks. Risks associated with residential mortgage lending include interest rate
risk, which is mitigated through the sale of the majority of all conforming
fixed-rate loans, and default risk by the borrower, which is lessened through
underwriting procedures and credit quality standards, among other things. 5




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Commercial Banking Services Lending General Commercial Lending With their local knowledge and focus, our Community Banks are well-suited
to meet the traditional credit needs of businesses in their market areas. Each
bank works closely with customers to extend credit for general business
purposes, such as working capital, plant expansion or equipment purchases, and
for financing industrial and commercial real estate. Where appropriate, the
banks employ government guarantee programs, such as those available from the
Small Business Administration. In addition to supplying credit to the businesses in its own market area,
MSD&T works in collaboration with other Community Banks when their customers
credit needs exceed the Community Banks lending limit or when there is a more
specialized commercial banking need. Specialized Lending When local commercial customers do not qualify for traditional financing,
the Asset-Based Lending Group at MSD&T can help them convert the value of their
accounts receivable, inventory and equipment into cash for operations. MSD&T
lenders also work with the other Community Banks to arrange more sophisticated
financing in the areas of acquisitions and management buyouts. Real Estate Lending The Real Estate Group at MSD&T provides land acquisition and development,
construction and interim financing to commercial real estate investors and
developers. The Community Banks also provide such lending to their customers
in their markets. Credits exceeding a predetermined threshold are made in
collaboration with the Real Estate Lending Group. Mercantile Mortgage makes loans for land acquisition, development and
construction of single-family and multifamily housing. Mercantile Mortgage also provides permanent financing for multifamily
projects as one of the nations few Fannie Mae Delegated Underwriting and
Servicing lenders. Permanent financing for multifamily projects and long-term,
nonrecourse financing for commercial real estate are provided through Columbia
National Real Estate Finance LLC, a subsidiary of Mercantile Mortgage.
Columbia National is a Freddie Mac Program Plus Seller Servicer. It has
correspondent relationships with approximately 12 life insurance companies and
services a loan portfolio in excess of $5.3 billion. Managing Credit Risk Much of the fundamental business of Bankshares is based on understanding,
measuring and controlling credit risk. Credit risk includes both general
risks, which are part of the lending process, and specific risk relating to
each borrower. With respect to commercial lending, losses as a percentage of
outstanding loans can vary widely from period to period and are particularly
sensitive to changing economic conditions. MSD&T and each Community Bank
carefully evaluate the credit risk presented by a customer and often require
collateral support as well as personal guarantees of the borrower. Bankshares
and each 6




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Community Bank often have the benefit of long-standing customer relationships,
which management believes is a key component to managing credit risk. The type
of collateral support varies, but includes accounts receivable, inventory,
land, buildings, equipment, income-generating commercial properties and
residential real estate, among other things. The evaluation of specific risk is a basic function of the underwriting
and loan administration in each of our Community Banks, involving analysis of
the borrowers ability to service debt as well as the value of pledged
collateral. Bankshares has established a centralized independent loan review function
charged with regularly reviewing the loan portfolio and identifying changes in
the economy or in a borrowers circumstances that may affect the ability to
repay debt or the value of pledged collateral. On a regular basis senior
management, through the establishment of a Credit Quality Committee, monitors
the degree of risk in the loan portfolio. In addition, lenders assign a grade
to each commercial loan based on a number of factors, including the borrowers
capacity to service the debt and the presence and value of the collateral for
the loan. The independent loan review function evaluates on a regular basis
the grade assigned to certain loans and analyzes the impact on the allowance
for loan losses. Cash Management Centered at MSD&T, Cash Management Services helps business customers of
all Community Banks collect, transfer and invest their cash. Through a variety
of electronic payment and account management tools, Cash Management also
enables customers to monitor cash flows conveniently and efficiently.
Nonprofit institutions such as unions, charities and philanthropic
organizations also use Cash Management services. Private Equity Bankshares, in partnership with MSD&T, began a focused private equity
investment initiative in 2000 as an alternative use of capital with the
objectives of generating long-term returns and developing additional long-term
client relationships with emerging companies in Bankshares footprint. The
primary investments are capital commitments to private equity limited
partnerships located or seeking investment opportunities within Bankshares
geographic trade area and, to a lesser extent, direct investments in privately
held companies within the region. The private equity funds include small- and
middle-market buyout funds, mezzanine funds and late-stage venture funds where
the target investments of the funds are or would likely be, in time, potential
Bankshares customers. For more information on private equity
investments see Footnote No. 9 of the financial statements. 7




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Investment And Wealth Management Services Bankshares offers investment and wealth management services through MSD&T
and continues building on a 140-year tradition of providing investment and
wealth management services to private individuals, family groups and
institutions. Today, Bankshares provides a range of wealth management services. An open
architecture platform gives clients access to proprietary investment management
in addition to carefully selected outside managers. Both the open architecture
platform and proprietary investment management offer clients a comprehensive
approach to equity and fixed-income investments complemented by alternative
investments. Bankshares proprietary investment platform includes both
separate account management and mutual funds, including the Mercantile Dow
Jones U.S. Portfolio Funds, based on the Dow Jones Portfolio Indexes.
Investment and wealth management services are available throughout the
Community Bank network, Cleveland-based Boyd Watterson Asset Management LLC
(Boyd Watterson) and Baltimore-based Peremel & Company, Inc. (Peremel).
Peremel fills an important niche by offering brokerage capabilities and account
services. At December 31, 2003, Bankshares had $22 billion of discretionary
assets under management and $46 billion of assets under administration. Private Wealth Management When managing a clients assets as part of an investment management or
trustee relationship, Bankshares focuses on consistent investment performance
and an asset allocation that is individually designed to meet each clients
risk/return parameters and investment objectives. Professional investors,
working in partnership with our clients, provide access to the Mercantile
funds, separately managed accounts, nonproprietary mutual funds and a variety
of alternative investments. With the acquisition of Peremel, our clients have
access to full-service brokerage capabilities. MSD&T provides a wide range of
fiduciary and client administrative services, including trust administration,
protection and continuity of trust structures, estate settlement, estate advice
and planning, tax advice and planning and charitable giving programs. MSD&T
also acts in a custodial capacity for its clients, providing safekeeping of
assets, transaction execution, income collection, preparation of tax returns
and record keeping. Family Office Designed to service the unique needs of families with substantial means,
the Family Office team works with more than 85 families whose total assets
approach $5 billion. The Family Office is comprised of professionals including
CFAs, CFPs and attorneys. The group integrates the full range of services
required to manage its clients complex, multigenerational financial
circumstances. MSD&T offers family governance, family education and
philanthropic advisory programs in addition to the normal services associated
with Family Offices, such as investment management, trust structuring and
administration, tax planning, estate planning, closely held business planning,
credit, and charitable giving and administration. 8




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The team of specialists within Family Office also provides guidance in
sophisticated, nontraditional investment strategies, such as private equity,
real estate and hedge fund investing. Private Banking The Private Banking Group provides one point of contact for its clients
deposit and credit needs, ensuring that these services are delivered within an
overall asset management plan. Private bankers can coordinate cash flows,
arrange investment of short- and long-term funds and structure credit
arrangements to meet short- to long-term needs. Institutional Asset Management Bankshares, through its Community Banks and Boyd Watterson, works to
provide businesses and charitable organizations with sophisticated investment
management and administrative services for their employee retirement plans,
profit sharing plans and endowments. Clients include state and local
government entities, corporations, unions, charitable organizations and
military institutions. For example, MSD&T is trustee for a group trust that
focuses on commercial real estate investments for Taft-Hartley pension plans.
MSD&T also can help nonprofit organizations, such as charitable and
philanthropic groups, with annual giving and capital campaigns, pooled income
funds, gift annuities and charitable remainder trusts. Bankshares offers
corporations 401(k) programs tailored to their specific needs. Insurance Activities Keller Stonebraker, an independent, wholly owned subsidiary of Farmers &
Mechanics Bank, arranges a full line of consumer and commercial business
insurance products through offices in Hagerstown and Cumberland, Maryland, and
Keyser, West Virginia. Consumer insurance products include annuities,
homeowners, automobile, life and personal umbrellas. Commercial products
include property and casualty packages, workers compensation, bonds,
professional liability, umbrella, and 401(k) and other benefit plans. Potomac Basin Group Associates, Inc.,
  Beltsville, Maryland, operates as an independent wholly owned subsidiary of
  Farmers & Mechanics Bank and is an
  independent insurance agency specializing in corporate employee benefit plans
  through its offices in Beltsville and Ellicott City, Maryland. Other Nonbanking Affiliates Mercantile Agency, Inc. acts as agent in the sale of fixed-rate annuities
and offers variable-rate annuities with Mercantile Securities, Inc. Mercantile Securities, Inc. is a general securities broker-dealer that
facilitates purchases by bank customers of shares of the Mercantile family of
funds and other securities and variable-rate annuities. Peremel & Co., Inc. is a general securities broker-dealer that offers
discount and online brokerage services. 9




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MBC Agency, Inc. provides as agent, under group policies, credit life
insurance in connection with extensions of credit by MSD&T and the Community
Banks. Mercantile Life Insurance Company reinsures the insurance provided by
MBC Agency, Inc. Mercantile Capital Advisors, Inc. is a registered investment adviser that
provides investment advisory and administrative services to investment
companies, including the Mercantile family of funds. Statistical Information The statistical information required in this Item 1 is set forth in Item
6, 7 and 8 of this Annual Report on Form 10-K, as follows: Disclosure Required by Guide
          3
        
        Reference to Caption in Item
          6 or 7, or Note in Item 8(I)
        
        Distribution of Assets,Liabilities and StockholderEquity; Interest Rates andInterest Differentials
        
        
        
        Analysis of Interest Rates andInterest Differentials (Item 7)Rate/Volume Analysis (Item 7)Nonperforming Assets (Item 7)(II)
        
        Investment Portfolio
        
        
        
        Bond Investment Portfolio (Item 7)Notes to Financial Statement, Note 3 Investment Securities(III)
        
        Loan Portfolio
        
        
        
        Year-End Loan Data (Item 6)Loan Maturity Schedule (Item 7)Interest Rate Risk (Item 7)Nonperforming Assets (Item 7)(IV)
        
        Summary of Loan LossExperience
        
        
        
        Allowance for Loan Losses (Item 7)Credit Risk Analysis (Item 7)Allocation of Allowance for LoanLosses (Item 7)(V)
        
        Deposits
        
        
        
        Analysis of Interest Rates andInterest Differentials (Item 7)Notes to Financial Statements,Note 6  Deposits(VI)
        
        Return on Equityand Assets
        
        
        
        Return on Equity and Assets (Item 6)(VII)
        
        Short-Term Borrowings
        
        
        
        Notes to Financial Statements,Note 7
 10




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Employees At December 31, 2003, Bankshares and its affiliates had approximately
1,068 officers and 2,497 other employees. Of these, MSD&T employed 536
officers and 681 other employees and the Community Banks had 529 officers and
1,794 other employees. Competition The banking business, in all of its phases, is highly competitive. Within
their service areas, MSD&T and the 19 Community Banks compete with commercial
banks (including local banks and branches or affiliates of other larger banks),
savings and loan associations and credit unions for loans and deposits, and
with insurance companies and other financial institutions for various types of
loans. There is also competition for commercial and retail banking business
from banks and financial institutions located outside our service areas.
Interstate banking is now an established part of the competitive environment. Bankshares is a financial holding company and is the largest independent
bank holding company headquartered in Maryland. MSD&T is the sixth largest
commercial bank in the state. During 2003, Bankshares also competed with
Maryland-based bank subsidiaries of the third, fourth, ninth, thirteenth, and
nineteenth largest bank holding companies in the United States as well as
banking subsidiaries of other non-Maryland bank holding companies. Measured in
terms of assets under management and administration, MSD&T believes it is one
of the largest trust institutions in the southeastern United States. MSD&T and
its subsidiaries (i.e., Boyd Watterson & Mercantile Capital Advisers, Inc.)
compete for various classes of fiduciary and investment advisory business with
other banks and trust companies, insurance companies, investment counseling
firms, mutual funds and others. Mercantile Mortgage is one of many competitors in its area of activity.
MBC Agency, Inc. is limited to providing life, health and accident insurance in
connection with credit extended by MSD&T and the Community Banks. Mercantile
Agency, Inc. commenced business in 1996 and is a small competitor in its area. The 19 other Community Banks ranged in asset size from $108 million to
$1.527 billion, at December 31, 2003. They face competition in their own local
service areas as well as from the larger competitors mentioned above. Supervision and Regulation Bankshares Bankshares, as a registered bank holding company, is subject to regulation
and examination by the Board of Governors of the Federal Reserve System (the
Federal Reserve Board) under the Bank Holding Company Act of 1956, as amended
(the BHC Act) and is required to file with the Federal Reserve Board
quarterly and annual reports and such additional information as the Federal
Reserve Board may require pursuant to the BHC Act. Among other provisions, the
BHC Act and regulations promulgated thereunder 11




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require prior approval of the Federal Reserve Board of the acquisition by
Bankshares of more than 5% of any class of the voting shares of any bank. The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act of 1999 (the GLB
Act) was adopted on November 12, 1999 and amended several of the federal
banking laws, including the BHC Act and the Banking Act of 1933 (generally
known as Glass-Steagall), that affect Bankshares and its subsidiaries. Prior
to the adoption of the GLB Act, the activities of bank holding companies and
their subsidiaries were restricted to banking, the business of managing and
controlling banks, and other activities that the Federal Reserve Board had
determined were so closely related to banking or managing or controlling banks
as to be a proper incident thereto. In particular, Glass-Steagall and the BHC
Act imposed important restrictions on the ability of bank holding companies or
their subsidiaries to engage in the securities or insurance business. The GLB Act repealed the provisions of Glass-Steagall and restrictions in
the BHC Act that limited affiliations among, and overlapping business
activities between the banking business and, respectively, the securities and
insurance industries. With the adoption of the GLB Act, a bank holding company
that makes an effective election to become a financial holding company may,
within a holding company system, (a) engage in banking, managing or controlling
banks; (b) perform certain servicing activities for subsidiaries; and (c)
engage in any activity, or acquire and retain the shares of any company engaged
in any activity that is either (i) financial in nature or incidental to such
financial activity, as determined by the Federal Reserve Board in consultation
with the Secretary of the Treasury or (ii) complementary to a financial
activity and that does not pose a substantial risk to the safety and soundness
of depository institutions or the financial system generally, as determined by
the Federal Reserve Board. Activities that are financial in nature include
activities specified in the GLB Act and those activities that the Federal
Reserve Board had determined, by order or regulation in effect prior to
enactment of the GLB Act, to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. Thus, a financial
holding company may engage in a full range of banking, securities and insurance
activities, including securities and insurance underwriting, as well as, with
certain restrictions, merchant banking activities. The election to become a financial holding company is only available to
bank holding companies whose bank and thrift subsidiaries are well capitalized,
well managed, and have satisfactory Community Reinvestment Act ratings. With
exceptions for insurance underwriting, merchant banking and real estate
investment and development, the GLB Act also permits comparable expansion of
national bank activities by banks meeting similar criteria, together with
certain additional firewall and other requirements, through financial
subsidiaries of national banks. Similarly, as a matter of Federal law, but
still subject to State law, the GLB Act greatly expands the potential financial
activities of subsidiaries of State banks. Bankshares filed an election and,
on December 20, 2002, became a financial holding company. The GLB Act also imposed a general scheme of functional regulation with
respect to the activities of bank holding companies and their bank and nonbank
subsidiaries to ensure that banking activities are regulated by bank
regulators, securities activities are regulated by securities regulators, and
insurance activities are regulated by insurance regulators, although the
Federal Reserve Board retains its role as the 12




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umbrella supervisor for bank holding companies. Consequently, various
securities activities of bank subsidiaries of Bankshares are now subject to
regulation by the Securities and Exchange Commission. The functional
regulation of the securities brokerage activities of banks is not yet fully
implemented. As a result of the functional regulation imposed by the GLB Act,
Bankshares bank subsidiaries have moved certain securities activities that
have become subject to Securities and Exchange Commission regulation into
separate securities subsidiaries or affiliates. For example, in 2001 MSD&T
formed two new subsidiaries to engage in securities activities: Mercantile
Capital Advisors, Inc., a registered investment adviser that advises the
Mercantile family of mutual funds and certain other institutional accounts; and
Mercantile Securities, Inc. a registered broker-dealer that facilitates the
purchase of shares of mutual funds by bank customers and may engage in certain
other potential activities. (Hopkins Plaza Securities, Inc. changed its name
to Mercantile Securities, Inc. effective December 1, 2003). The GLB Act also implements a number of requirements designed to protect
the privacy of customer information. A financial institution must inform its
customers at the outset of the customer relationship, and at least annually
thereafter, of the institutions privacy policies and procedures with respect
to the customers nonpublic personal financial information. With certain
exceptions, an institution may not provide any nonpublic personal information
to unaffiliated third parties unless the customer has been informed that such
information may be so provided and the customer has been given the opportunity
to opt out. Furthermore, the GLB Act limits a financial institutions use of a
customers account information for marketing purposes and imposes criminal
penalties for the use of fraudulent or deceptive means to obtain personal
customer financial information. The GLB Act permits states to adopt more
rigorous laws with respect to privacy of customer information. The Fair Credit Reporting Act and the Fair and Accurate Transactions Act
of 2003. The Fair Credit Reporting Act (FCRA), among other provisions,
restricts any bank from sharing with its affiliates certain information
relating to its individual customers creditworthiness and certain other
matters unless the information consists solely of transactions or experiences
(Transaction or Experience Information) between the customer and the bank or
the bank notifies the customer that Transaction or Experience Information may
be shared and gives the customer the opportunity to opt out. FCRA preempts
state laws that purport to restrict further such information sharing among
affiliated institutions. The Fair and Accurate Transactions Act of 2003 (the
FACT Act), which was signed into law on December 4, 2003, extends the
preemption of state law restrictions on affiliate information sharing that is
permitted by FCRA and amends FCRA in various respects, including to enhance the
ability of consumers to combat identity theft, increase the accuracy of
consumer credit reports, and allow consumers to exercise greater control over
the type and amount of marketing solicitations that they receive. The new
marketing restrictions, with some exceptions, would prevent banks from using
Transaction or Experience Information received from an affiliate for marketing
to a consumer unless the consumer was given notice and an opportunity to opt
out. The FACT Act also restricts the sharing of certain types of consumer
medical information among affiliates. These new restrictions on sharing or
using information shared among affiliates must be implemented by regulations 13




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which have not yet been issued. However, the FACT Act requires regulations
implementing the new provisions on sharing of sensitive medical information
among affiliates to be finalized by June 4, 2004, and to become effective on
the later of 90 days after the regulations are issued in final form or the
effective date specified in such regulations. The FACT Act also specifies that
the regulations implementing the restrictions on use of information obtained
from an affiliate for marketing purposes must be final no later than September
4, 2004, and effective no later than six months after the regulations are
issued in final form (i.e., possibly as late as March 4, 2005). More
generally, the Federal Reserve Board and the Federal Trade Commission have
issued joint final rules establishing December 1, 2004 as the effective date
for many of the provisions of the FACT Act that will require significant
changes to affected companies business practices. The USA PATRIOT ACT. Congress adopted the USA PATRIOT ACT (the Patriot
Act) on October 26, 2001 in response to the terrorist attacks that occurred on
September 11, 2001. Under the Patriot Act, banks are required to maintain and
prepare additional records and reports that are designed to assist the
governments efforts to combat terrorism. The Patriot Act includes sweeping
anti-money laundering and financial transparency laws and required additional
regulations, including, among other things, standards for verifying client
identification when opening an account and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering. Other Regulatory Matters. It is Federal Reserve Board policy that a bank
holding company should serve as a source of financial and managerial strength
for, and commit resources to support each, of its subsidiary banks even in
circumstances in which it might not do so (or may not legally be required or
financially able to do so) absent such a policy. In addition, there are
numerous federal and state laws and regulations which regulate the activities
of Bankshares and its bank subsidiaries, including requirements and limitations
relating to capital and reserve requirements, permissible investments and lines
of business, transactions with officers, directors and affiliates, loan limits,
consumer protection laws, privacy of financial information, predatory lending,
fair lending, mergers and acquisitions, issuances of securities, dividend
payments, inter-affiliate liabilities, extensions of credit and branch banking.
The laws and regulations to which Bankshares is subject are constantly under
review by Congress, regulatory agencies and state legislatures. Information
regarding capital requirements for bank holding companies and tables reflecting
Banksharess regulatory capital position at December 31, 2003 can be found in
Footnote 10 to the financial statements. Bankshares is a separate and distinct legal entity from its subsidiaries.
It receives substantially all of its revenue from dividends from its
subsidiaries. These dividends are the principal source of funds to pay
dividends on the holding companys common stock and interest on its debt. The
payment of dividends by a subsidiary is subject to federal law restrictions as
well as to the laws of the subsidiarys state of incorporation. Also, a parent
companys right to participate in a distribution of assets upon a subsidiarys
liquidation or reorganization is subject to the prior claims of the
subsidiarys creditors. 14




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##### 



Changes in control of Bankshares and its Community Banks are regulated
under the BHC Act, the Change in Bank Control Act of 1978 and various state
laws. Further, the BHC Act and the Federal Reserve Boards regulations limit the
ability of bank subsidiaries of bank holding companies to engage in certain
tie-in arrangements with bank holding companies and their nonbank subsidiaries
in connection with any extension of credit or provision of any property or
services, subject to various exceptions. Community Banks All Community Banks, with the exception of The Citizens National Bank,
Baltimore Trust Company, Farmers & Merchants Bank  Eastern Shore, The First
National Bank of St. Marys, The National Bank of Fredericksburg and Marshall
National Bank and Trust Company are Maryland banks, subject to the banking laws
of Maryland and to regulation by the Commissioner of Financial Regulation of
Maryland, who is required by statute to make at least one examination in each
calendar year (or at 18-month intervals if the Commissioner determines that an
examination is unnecessary in a particular calendar year). Their deposits are
insured by, and they are subject to certain provisions of Federal law and
regulations and examination by, the Federal Deposit Insurance Corporation (the
FDIC). In addition, The Annapolis Banking and Trust Company, The Forest Hill
State Bank and St. Michaels Bank and Farmers & Mechanics Bank are members of
the Federal Reserve System, and are thereby subject to regulation by the
Federal Reserve Board. The Citizens National Bank, The First National Bank of St. Marys, The
National Bank of Fredericksburg and Marshall National Bank and Trust Company
are national banks subject to regulation and regular examination by the office
of the Comptroller of the Currency in addition to regulation and examination by
the FDIC, which insures their deposits. Farmers & Merchants Bank  Eastern Shore is a Virginia bank, subject to
the banking laws of Virginia and to regulation by its State Corporation
Commission, which is required by statute to make at least one examination in
every three-year period. Its deposits are insured by, and it is subject to
certain provisions of Federal law and regulation and examination by the FDIC. Baltimore Trust Company is a Delaware bank, subject to the banking laws of
Delaware and to regulation by the Delaware State Bank Commissioner, who is
required by statute to make periodic examinations. Its deposits are insured
by, and it is subject to certain provisions of Federal law and regulation and
examination by the FDIC. Bankshares and its affiliates are subject to the provisions of Section 23A
of the Federal Reserve Act, which limit the amount of loans or extensions of
credit to, and investments in, Bankshares and its nonbank affiliates by MSD&T
and the Community Banks, and Section 23B of the Federal Reserve Act, which
requires that transactions between MSD&T or the Community Banks and Bankshares
and its nonbank affiliates be on terms and under circumstances that are
substantially the same as with non-affiliates. Under the federal banking laws,
the federal regulatory agencies have broad power to take prompt corrective
action if a 15




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##### 



depository institution fails to maintain certain capital levels and there are
circumstances under which Community Banks could be responsible to the FDIC for
losses incurred by it with respect to other Community Banks. Other Affiliates As affiliates of Bankshares, the nonbank affiliates are subject to
examination by the Federal Reserve Board and, as affiliates of the Community
Banks, they are subject to examination by the FDIC, the Commissioner of
Financial Regulation of Maryland and the office of the Comptroller of the
Currency, as the case may be. In addition, MBC Agency, Inc., Mercantile Life
Insurance Company and Mercantile Agency, Inc. are subject to licensing and
regulation by state insurance authorities. Mercantile Capital Advisors, Inc.,
Mercantile Securities, Inc., Boyd Watterson and Peremel, are subject to
regulation by the Securities and Exchange Commission and state securities law
authorities, and Mercantile Securities, Inc. and Peremel are also subject to
regulation by the National Association of Securities Dealers, Inc. Retail
sales of insurance and securities products by Mercantile Agency, Inc. and
Mercantile Securities, Inc. are also subject to the requirements of the
Interagency Statement on Retail Sales of Nondeposit Investment Products
promulgated in 1994 by the FDIC, the Federal Reserve Board, the Comptroller of
the Currency and the Office of Thrift Supervision. Effects of Monetary Policy All commercial banking operations are affected by the Federal Reserve
Systems conduct of monetary policy and its policies change from time to time
based on changing circumstances. The Federal Reserve effectively controls
national supply of bank credit in order to achieve economic results deemed
appropriate by its Federal Reserve Board, including efforts to combat
unemployment, recession or inflationary pressures. Among the instruments of
monetary policy used to implement these objectives are open market operations
in the purchase and sale of U.S. Government securities, changes in the
discount rate charged on bank borrowings and changes in reserve requirements
against bank deposits. These means are used in varying combinations to
influence the general level of interest rates and the general availability of
credit. More specifically, actions by the Federal Reserve Board influence the
levels of interest rates paid on deposits and other bank funding sources and
charged on bank loans as well as the level of availability of bank funds with
which loans and investments can be made. 16




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##### 



Cautionary Statement This Annual Report on Form 10-K contains forward-looking statements,
within the meaning of and pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. A forward-looking statement
encompasses any estimate, prediction, opinion or statement of belief contained
in this report, and the underlying management assumptions. These
forward-looking statements include such words as believes, expects,
anticipates, intends and similar expressions. Examples of forward-looking
statements in this Annual Report on Form 10-K are statements concerning
competitive conditions, effects of monetary policy, the potential impact of
legislation, identification of trends, loan growth, customer borrowing trends,
anticipated level of interest rates, business strategies and services,
continuation or development of specified lending and other activities, credit
quality, predictions or assessments related to determination and adequacy of
loan loss allowances, monitored loans, internal controls, tax accounting,
importance and effects of capital levels, effects of asset sensitivity and
interest rates, earnings simulation model projections, efforts to mitigate
market and liquidity risks, dividend payments and impact of FASB
pronouncements. These statements are based on current expectations and
assessments of potential developments affecting market conditions, interest
rates and other economic conditions, and results may ultimately vary from the
statements made in this report. The following factors, among others, could
cause actual results to differ materially from the anticipated results or other
expectations expressed in the forward-looking statements: (1) the interest rate
environment may further compress margins and adversely affect net interest
income; (2) results may be adversely affected by continued diversification of
assets and adverse changes to credit quality; (3) economic slowdown could
adversely affect credit quality and loan originations; (4) loan growth may not
improve to a degree that would help offset continuing pressure on net interest
margin; (5) adverse governmental or regulatory policies may be enacted; (6) the
expected growth opportunities or cost savings from our merger with F&M Bancorp
may not be fully realized or may take longer to realize than expected; (7)
F&Ms actual earnings may not be as strong as projected; (8) declines in equity
and bond markets may adversely affect IWM revenues; and (9) the inability to
manage adequately the spread between yields on earning assets and cost of funds
could adversely affect results. Website Access To Information Bankshares annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and all amendments to those reports may be accessed
through Bankshares website as soon as reasonably practicable after such
material is electronically filed with the Securities and Exchange Commission.
Bankshares website is www.mercantile.com. 17




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##### 



ITEM 2. PROPERTIES The main offices of Bankshares and MSD&T are located in a 21-story
building at Two Hopkins Plaza in Baltimore owned by MBC Realty, LLC, a
wholly-owned subsidiary of Bankshares. At December 31, 2003, these offices
occupied approximately 163,000 square feet. At December 31, 2003, MSD&T also
occupied approximately 132,000 square feet of leased space in a building
located in Linthicum, Maryland, in which its operations and certain other
departments are located, and a 7,000 square foot call center facility in
Federalsburg, Maryland. The Linthicum and Federalsburg properties are owned by
MBC Realty, LLC. Of the 26 banking and bank-related offices occupied by MSD&T,
seven are owned in fee, seven are owned subject to ground leases and 12 are
leased with aggregate annual rentals of approximately $1,646,000, not including
rentals for the main office and adjacent premises owned by MBC Realty, LLC. Of the 201 banking offices, 106 are owned in fee, 24 are owned subject to
ground leases and 71 are leased, with aggregate annual rentals of approximately
$6,634,000 as of December 31, 2003. ITEM 3. LEGAL PROCEEDINGS There was no matter which is required to be disclosed in this Item 3
pursuant to the instructions contained in the form for this Report. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted during the fourth quarter of the fiscal year
covered by this Report to a vote of security holders which is required to be
disclosed pursuant to the instructions contained in the form for this Report. 18




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##### 



SPECIAL ITEM: EXECUTIVE OFFICERS OF THE REGISTRANT On October 22, 2003 Bankshares formed a holding company management
committee comprised of the individuals listed below: Name
    
    Position
    
    AgeEdward J. Kelly, III
    
    Chairman, President and Chief Executive Officer
    
    
    50Alexander T. Mason
    
    Vice Chairman, Bankshares
    
    
    52J. Marshall Reid (1)
    
    President and Chief Operating Officer, MSD&T
    
    
    58Kenneth A. Bourne, Jr.
    
    Executive Vice President, MSD&T
    
    
    61Peter W. Floeckher, Jr.
    
    Executive Vice President, Bankshares
    
    
    54John J. Pileggi
    
    Chief Executive Officer, Investment
and Wealth Management
    
    
    44Terry L. Troupe
    
    Chief Financial Officer, Bankshares
    
    
    56John L. Unger
    
    General Counsel, Bankshares
    
    
    50Michael M. Paese
    
    Chief Administrative Officer, Bankshares
    
    
    36Deborah A. Kakaris
    
    Executive Vice President, MSD&T
    
    
    40Frank K. Turner
    
    Executive Vice President, MSD&T
    
    
    48Priscilla S. Hoblitzell
    
    Senior Vice President, Bankshares
    
    
    43
 No family relationships, as defined by the rules and regulations of the
Securities and Exchange Commission, exist among any of the Executive Officers.
All officers are elected annually by the Board of Directors and hold office at
the pleasure of the Board. Effective March 1, 2001, Mr. Kelly became President and Chief Executive of
Bankshares and Chairman of the Board and Chief Executive Officer of
Mercantile-Safe Deposit and Trust Company. In addition, effective March 1, 2003
Mr. Kelly became Chairman of Bankshares. Mr. Kelly served as Managing Director,
Head of Global Financial Institutions, and as Co-Head of Investment Banking
Client Management of J. P. Morgan, Chase & Co. during January, 2001. Prior
thereto, he was a Managing Director of J. P. Morgan & Co. Incorporated and held
the following additional positions with that Company: Head, Global Financial
Institutions from February, 2000 through December, 2000; Co-Head, Global
Financial Institutions and Head, Latin America Investment Banking from
December, 1997 through February, 2000; Member, Global Investment Banking
Committee from December, 1997 through December, 2000; and Co-Head, Financial
Institutions (Americas) from February, 1996 through December, 1997. Mr. Mason joined Bankshares in November, 2003, and is Vice Chairman of
Bankshares and is Bankshares Chief Risk Officer. Prior to joining Bankshares, he was Vice Chairman of Deutsche Bank
in the Americas and Managing Director of 19




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##### 



Deutsche Bank Securities. He also served as chief operating officer of the
firms Global Corporate Finance Department and headed up the firms Global
Industry Group practice. Mr. Reid was elected President and Chief Operating Officer of MSD&T in
September, 1997. He joined MSD&T as a Senior Vice President in 1993 and served
as an Executive Vice President from 1994 until September, 1997. Mr. Bourne has been an Executive Vice President of MSD&T since 1989. He
joined the bank as a trainee in 1970. Mr. Floeckher was appointed Executive Vice President and Head of the
Affiliates for Bankshares in November, 2003. He served as President and Chief
Executive Officer of Citizens National Bank from 1995 until November, 2003.
Mr. Floeckher is responsible for oversight of the 19 Community Banks, which
includes risk management, compliance and enhanced performance through
coordinated sharing of best practices. Mr. Pileggi joined Mercantile in 2001 as head of Mercantile Capital
Advisors, Inc. and Mercantile Securities, Inc. Appointed Chief Executive
Officer of Investment & Wealth Management in September, 2003, Mr. Pileggi has
more than 20 years experience in retail and institutional financial services,
including hedge funds and private equity. Mr. Troupe has been Chief Financial Officer of Bankshares and MSD&T, and
Treasurer of Bankshares, since September, 1996. He was Vice President and
Chief Financial Officer of IREX Corporation, a specialty mechanical insulation
contractor and distributor, from May, 1993 to May, 1996. Prior thereto, Mr.
Troupe was Vice Chairman of Meridian Bankcorp, Inc. Mr. Unger became General Counsel on March 23, 2002 and was elected
Secretary of Bankshares and MSD&T July 1, 2002. Prior to joining Bankshares,
Mr. Unger was General Counsel to IMI Resort Holdings, Inc., a privately held
real estate company in Greenville, South Carolina. Mr. Paese
was named Chief Administrative Officer of Bankshares in November, 2003. He
joined MSD&T as a Senior Vice President in January, 2003.  Before
joining Mercantile, Mr. Paese was Senior Counsel to the Financial
Services Committee of the U.S. House of Representatives (minority).
Mr. Paese advised the Committee on legal and policy issues
relating to U.S. capital markets and corporate governance. Prior
thereto, Mr. Paese was Vice President in equity capital markets,
at J.P. Morgan & Co. Incorporated. Prior thereto, Mr. Paese
was an associate at Davis, Polk & Wardwell. Mrs. Kakaris has been an Executive Vice President of MSD&T since 2002.
She is responsible for Operations and Technology Services. Mrs. Kakaris joined
the bank in 1988 and served as a Senior Vice President from 1997 until March,
2002. Mr. Turner is an Executive Vice President of Bankshares and MSD&T. Mr.
Turner began his banking career with Mercantile in 1978. He is currently
responsible for the syndicated lending, correspondent banking and private
equity groups. Ms. Hoblitzell joined Bankshares as a Senior Vice President in April,
2003. Prior to joining Bankshares, she was self-employed. Prior thereto, Ms.
Hoblitzell was a Vice President at Goldman, Sachs & Co. 20




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##### 



PART II ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS For information regarding market prices, dividends on Bankshares common
stock, and the number of Bankshares stockholders, see the information set forth
under the captions Dividends and Recent Common Stock Prices in Item 7 of
this Annual Report on Form 10-K. In December, 2003 one director of Bankshares received an aggregate of 377
shares of Bankshares common stock, at fair market value, in lieu of a cash
retainer fee, under the Bankshares Retainer Plan for Non Employee Directors.
The shares issuable under the Plan have not been registered under the
Securities Act of 1933 in reliance on applicable exemptions. The only
potential Plan participants are outside directors, currently 17 in number. The
maximum number of shares (450,000) issuable over ten years under the Plan is
less than 1% of the total shares outstanding. Bankshares common stock is
actively traded on the Nasdaq National Market. 21




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##### 



ITEM 6. SELECTED FINANCIAL DATA Five-Year Statistical Summary Years Ended December 31,(Dollars in thousands)
    
    2003
    
        2002
    
        2001
    
        2000
    
        1999AVERAGE BALANCE SHEET STATISTICSLoans:Commercial
    
    $
    4,795,334
    
    
    $
    4,283,322
    
    
    $
    3,978,335
    
    
    $
    3,534,898
    
    
    $
    3,094,713Construction
    
    
    929,939
    
    
    
    733,237
    
    
    
    795,931
    
    
    
    738,393
    
    
    
    606,771Residential real estate
    
    
    1,171,194
    
    
    
    1,072,297
    
    
    
    1,059,798
    
    
    
    950,531
    
    
    
    874,947Consumer
    
    
    1,192,515
    
    
    
    999,988
    
    
    
    998,792
    
    
    
    945,810
    
    
    
    800,936Total loans
    
    
    8,088,982
    
    
    
    7,088,844
    
    
    
    6,832,856
    
    
    
    6,169,632
    
    
    
    5,377,367Federal funds sold, et al
    
    
    250,462
    
    
    
    178,624
    
    
    
    141,245
    
    
    
    29,434
    
    
    
    15,762Securities:U.S. Government obligations
    
    
    1,731,032
    
    
    
    2,089,004
    
    
    
    1,705,543
    
    
    
    1,628,477
    
    
    
    1,807,264States and political subdivisions
    
    
    69,888
    
    
    
    38,799
    
    
    
    40,359
    
    
    
    25,170
    
    
    
    12,024Mortgage-backed securities
    
    
    927,235
    
    
    
    216,391
    
    
    
    48,203
    
    
    
    21,252
    
    
    
    2,916Other investments*
    
    
    124,009
    
    
    
    23,578
    
    
    
    22,299
    
    
    
    19,505
    
    
    
    20,557Total securities
    
    
    2,852,164
    
    
    
    2,367,772
    
    
    
    1,816,404
    
    
    
    1,694,404
    
    
    
    1,842,761Total earning assets
    
    $
    11,191,608
    
    
    $
    9,635,240
    
    
    $
    8,790,505
    
    
    $
    7,893,470
    
    
    $
    7,235,890Deposits:Noninterest-bearing deposits
    
    $
    2,269,720
    
    
    $
    1,856,706
    
    
    $
    1,618,838
    
    
    $
    1,438,578
    
    
    $
    1,334,282Savings deposits**
    
    
    3,597,185
    
    
    
    2,936,197
    
    
    
    2,471,674
    
    
    
    2,345,808
    
    
    
    2,375,075Time deposits
    
    
    3,124,949
    
    
    
    2,839,507
    
    
    
    2,958,158
    
    
    
    2,412,468
    
    
    
    2,186,868Total deposits
    
    $
    8,991,854
    
    
    $
    7,632,410
    
    
    $
    7,048,670
    
    
    $
    6,196,854
    
    
    $
    5,896,225Borrowed funds:Short-term borrowings
    
    $
    851,348
    
    
    $
    845,938
    
    
    $
    744,907
    
    
    $
    860,241
    
    
    $
    594,106Long-term debt
    
    
    517,386
    
    
    
    279,471
    
    
    
    117,823
    
    
    
    87,679
    
    
    
    70,836Total borrowed funds
    
    $
    1,368,734
    
    
    $
    1,125,409
    
    
    $
    862,730
    
    
    $
    947,920
    
    
    $
    664,942AVERAGE RATES ***Loans:Commercial
    
    
    5.77
    %
    
    
    6.51
    %
    
    
    7.99
    %
    
    
    9.14
    %
    
    
    8.58
    %Construction
    
    
    5.41
    
    
    
    6.09
    
    
    
    7.96
    
    
    
    9.66
    
    
    
    9.03Residential real estate
    
    
    6.46
    
    
    
    7.30
    
    
    
    7.94
    
    
    
    7.98
    
    
    
    7.96Consumer
    
    
    6.25
    
    
    
    7.12
    
    
    
    8.28
    
    
    
    8.70
    
    
    
    8.50Total loans
    
    
    5.90
    
    
    
    6.67
    
    
    
    8.02
    
    
    
    8.96
    
    
    
    8.52Federal funds sold, et al
    
    
    1.56
    
    
    
    2.92
    
    
    
    4.38
    
    
    
    6.31
    
    
    
    4.95Securities:U.S. Government obligations
    
    
    4.25
    
    
    
    4.67
    
    
    
    5.48
    
    
    
    5.67
    
    
    
    5.65States and political subdivisions
    
    
    6.50
    
    
    
    8.08
    
    
    
    8.17
    
    
    
    8.26
    
    
    
    7.98Mortgage-backed securities
    
    
    3.90
    
    
    
    5.59
    
    
    
    7.47
    
    
    
    7.48
    
    
    
    5.69Other investments*
    
    
    6.33
    
    
    
    5.99
    
    
    
    7.48
    
    
    
    8.51
    
    
    
    9.44Total securities
    
    
    4.29
    
    
    
    4.83
    
    
    
    5.62
    
    
    
    5.77
    
    
    
    5.70Composite rate earned
    
    
    5.39
    %
    
    
    6.15
    %
    
    
    7.46
    %
    
    
    8.26
    %
    
    
    7.79
    %Deposits:Savings deposits**
    
    
    .46
    %
    
    
    .87
    %
    
    
    1.62
    %
    
    
    2.06
    %
    
    
    2.04
    %Time deposits
    
    
    2.45
    
    
    
    3.42
    
    
    
    5.40
    
    
    
    5.56
    
    
    
    5.01Total interest-bearing deposits
    
    
    1.39
    
    
    
    2.12
    
    
    
    3.68
    
    
    
    3.83
    
    
    
    3.46Borrowed funds:Short-term borrowings
    
    
    .66
    
    
    
    1.33
    
    
    
    3.37
    
    
    
    5.66
    
    
    
    4.59Long-term debt
    
    
    3.57
    
    
    
    3.85
    
    
    
    5.69
    
    
    
    6.79
    
    
    
    6.80Total borrowed funds
    
    
    1.76
    
    
    
    1.96
    
    
    
    3.69
    
    
    
    5.77
    
    
    
    4.83Composite rate paid
    
    
    1.45
    %
    
    
    2.10
    %
    
    
    3.68
    %
    
    
    4.16
    %
    
    
    3.64
    %
 * Includes interest-bearing deposits in other banks.
 ** Includes savings, checking plus interest and money market deposit accounts.
*** Presented on a tax-equivalent basis. 22




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##### 



Years Ended December 31,(Dollars in thousands)
    
    2003
    
        2002
    
        2001
    
        2000
    
        1999RETURN ON EQUITY AND ASSETSAverage total assets
    
    $
    11,971,581
    
    
    $
    10,123,457
    
    
    $
    9,227,202
    
    
    $
    8,299,316
    
    
    $
    7,628,660Average shareholders equity
    
    $
    1,497,145
    
    
    $
    1,257,967
    
    
    $
    1,197,058
    
    
    $
    1,054,071
    
    
    $
    971,837Return on average total assets
    
    
    1.64
    %
    
    
    1.88
    %
    
    
    1.96
    %
    
    
    2.11
    %
    
    
    2.07
    %Return on average shareholders equity
    
    
    13.15
    %
    
    
    15.12
    %

    
    
    15.15
    %
    
    
    16.62
    %
    
    
    16.23
    %Average shareholders equity as a percent
of average total assets
    
    
    12.51
    %
    
    
    12.43
    %
    
    
    12.97
    %
    
    
    12.70
    %
    
    
    12.74
    %Dividends paid per share as a percent
of basic net income per share
    
    
    47.8
    %
    
    
    43.1
    %
    
    
    42.8
    %
    
    
    40.3
    %
    
    
    41.4
    %SOURCE OF INCOMECommercial loans
    
    
    35.2
    %
    
    
    37.7
    %
    
    
    39.4
    %
    
    
    41.3
    %
    
    
    38.5
    %Construction loans
    
    
    6.3
    
    
    
    5.9
    
    
    
    7.9
    
    
    
    9.2
    
    
    
    7.9Residential real estate loans
    
    
    9.8
    
    
    
    10.7
    
    
    
    10.6
    
    
    
    9.8
    
    
    
    10.2Consumer loans
    
    
    9.6
    
    
    
    9.8
    
    
    
    10.4
    
    
    
    10.7
    
    
    
    10.0Federal funds sold, et al
    
    
    .5
    
    
    
    .7
    
    
    
    .8
    
    
    
    .2
    
    
    
    .1Securities
    
    
    15.8
    
    
    
    15.5
    
    
    
    12.6
    
    
    
    12.5
    
    
    
    15.4Total interest income
    
    
    77.2
    
    
    
    80.3
    
    
    
    81.7
    
    
    
    83.7
    
    
    
    82.1Investment and wealth management
    
    
    10.2
    
    
    
    9.4
    
    
    
    8.7
    
    
    
    9.1
    
    
    
    9.5Other income
    
    
    12.6
    
    
    
    10.3
    
    
    
    9.6
    
    
    
    7.2
    
    
    
    8.4Total income
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %NET INTEREST INCOME(Tax-equivalent)Interest earned:Loans
    
    $
    477,276
    
    
    $
    473,120
    
    
    $
    547,970
    
    
    $
    552,548
    
    
    $
    457,936Federal funds sold, et al
    
    
    3,901
    
    
    
    5,213
    
    
    
    6,190
    
    
    
    1,857
    
    
    
    781Taxable securities
    
    
    117,615
    
    
    
    111,111
    
    
    
    98,732
    
    
    
    95,625
    
    
    
    104,144Tax-exempt securities
    
    
    4,543
    
    
    
    3,135
    
    
    
    3,298
    
    
    
    2,080
    
    
    
    959Total interest income
    
    
    603,335
    
    
    
    592,579
    
    
    
    656,190
    
    
    
    652,110
    
    
    
    563,820Interest paid:Savings deposits
    
    
    16,520
    
    
    
    25,536
    
    
    
    39,993
    
    
    
    48,362
    
    
    
    48,442Time deposits
    
    
    76,670
    
    
    
    97,033
    
    
    
    159,710
    
    
    
    134,086
    
    
    
    109,555Total interest-bearing deposits
    
    
    93,190
    
    
    
    122,569
    
    
    
    199,703
    
    
    
    182,448
    
    
    
    157,997Short-term borrowings
    
    
    5,604
    
    
    
    11,259
    
    
    
    25,120
    
    
    
    48,711
    
    
    
    27,267Long-term debt
    
    
    18,451
    
    
    
    10,754
    
    
    
    6,702
    
    
    
    5,951
    
    
    
    4,818Total interest expense
    
    
    117,245
    
    
    
    144,582
    
    
    
    231,525
    
    
    
    237,110
    
    
    
    190,082Net interest income
    
    $
    486,090
    
    
    $
    447,997
    
    
    $
    424,665
    
    
    $
    415,000
    
    
    $
    373,738
 23




---



##### 



Five-Year Selected Financial Data Years Ended December 31,(Dollars in thousands, except per share data)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999NET INTEREST INCOME
    
    $
    479,330
    
    
    $
    441,804
    
    
    $
    418,241
    
    
    $
    409,385
    
    
    $
    369,086NET INCOME
    
    $
    196,814
    
    
    $
    190,238
    
    
    $
    181,295
    
    
    $
    175,230
    
    
    $
    157,737NET INCOME PER SHARE OF COMMON STOCKBasic
    
    $
    2.70
    
    
    $
    2.74
    
    
    $
    2.57
    
    
    $
    2.53
    
    
    $
    2.27Diluted
    
    $
    2.68
    
    
    $
    2.72
    
    
    $
    2.55
    
    
    $
    2.51
    
    
    $
    2.25TOTAL ASSETS
    
    $
    13,695,472
    
    
    $
    10,790,376
    
    
    $
    9,928,786
    
    
    $
    8,938,030
    
    
    $
    7,895,024LONG-TERM DEBT
    
    $
    647,722
    
    
    $
    287,214
    
    
    $
    269,437
    
    
    $
    92,547
    
    
    $
    82,683PROVISION FOR LOAN LOSSES
    
    $
    12,105
    
    
    $
    16,378
    
    
    $
    13,434
    
    
    $
    17,231
    
    
    $
    12,056PER SHARE CASH DIVIDENDSCommon
    
    $
    1.29
    
    
    $
    1.18
    
    
    $
    1.10
    
    
    $
    1.02
    
    
    $
    .94CASH DIVIDENDS DECLARED AND PAIDOn common stock
    
    $
    95,842
    
    
    $
    81,909
    
    
    $
    77,597
    
    
    $
    70,641
    
    
    $
    65,113YEAR-END LOAN DATACommercial
    
    $
    2,577,021
    
    
    $
    2,300,956
    
    
    $
    2,228,750
    
    
    $
    2,215,039
    
    
    $
    1,984,358Commercial real estate
    
    
    2,738,832
    
    
    
    2,016,307
    
    
    
    1,819,268
    
    
    
    1,409,987
    
    
    
    1,220,100Construction
    
    
    1,064,021
    
    
    
    810,985
    
    
    
    652,486
    
    
    
    824,752
    
    
    
    650,745Residential real estate
    
    
    1,335,375
    
    
    
    1,066,694
    
    
    
    1,060,519
    
    
    
    1,086,674
    
    
    
    878,900Consumer
    
    
    1,067,360
    
    
    
    775,673
    
    
    
    801,474
    
    
    
    832,206
    
    
    
    707,359Home equity lines
    
    
    415,500
    
    
    
    239,232
    
    
    
    189,867
    
    
    
    168,944
    
    
    
    147,560Lease financing
    
    
    74,051
    
    
    
    102,180
    
    
    
    153,882
    
    
    
    155,692
    
    
    
    123,108Total loans
    
    
    9,272,160
    
    
    
    7,312,027
    
    
    
    6,906,246
    
    
    
    6,693,294
    
    
    
    5,712,130Less: Allowance for loan losses
    
    
    (155,337
    )
    
    
    (138,601
    )
    
    
    (141,463
    )
    
    
    (138,612
    )
    
    
    (117,997
    )Loans, net
    
    $
    9,116,823
    
    
    $
    7,173,426
    
    
    $
    6,764,783
    
    
    $
    6,554,682
    
    
    $
    5,594,133
 Five-Year Summary of Consolidated Income Years Ended December 31,(Dollars in thousands)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999INTEREST INCOMEInterest and fees on loans
    
    $
    472,379
    
    
    $
    468,298
    
    
    $
    543,020
    
    
    $
    547,942
    
    
    $
    453,825Interest and dividends on securities
    
    
    120,235
    
    
    
    112,860
    
    
    
    100,538
    
    
    
    96,687
    
    
    
    104,556Other interest income
    
    
    3,961
    
    
    
    5,228
    
    
    
    6,208
    
    
    
    1,866
    
    
    
    787Total interest income
    
    
    596,575
    
    
    
    586,386
    
    
    
    649,766
    
    
    
    646,495
    
    
    
    559,168INTEREST EXPENSEInterest on deposits
    
    
    93,190
    
    
    
    122,569
    
    
    
    199,703
    
    
    
    182,448
    
    
    
    157,997Interest on short-term borrowings
    
    
    5,604
    
    
    
    11,259
    
    
    
    25,120
    
    
    
    48,711
    
    
    
    27,267Interest on long-term debt
    
    
    18,451
    
    
    
    10,754
    
    
    
    6,702
    
    
    
    5,951
    
    
    
    4,818Total interest expense
    
    
    117,245
    
    
    
    144,582
    
    
    
    231,525
    
    
    
    237,110
    
    
    
    190,082NET INTEREST INCOME
    
    
    479,330
    
    
    
    441,804
    
    
    
    418,241
    
    
    
    409,385
    
    
    
    369,086Provision for loan losses
    
    
    12,105
    
    
    
    16,378
    
    
    
    13,434
    
    
    
    17,231
    
    
    
    12,056NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
    
    
    467,225
    
    
    
    425,426
    
    
    
    404,807
    
    
    
    392,154
    
    
    
    357,030NONINTEREST INCOMEInvestment and wealth management
    
    
    78,933
    
    
    
    68,435
    
    
    
    69,331
    
    
    
    69,850
    
    
    
    65,036Service charges on deposit accounts
    
    
    36,912
    
    
    
    31,454
    
    
    
    28,085
    
    
    
    24,346
    
    
    
    23,043Other income
    
    
    60,746
    
    
    
    43,861
    
    
    
    48,074
    
    
    
    31,345
    
    
    
    33,912Total noninterest income
    
    
    176,591
    
    
    
    143,750
    
    
    
    145,490
    
    
    
    125,541
    
    
    
    121,991NONINTEREST EXPENSESalaries and employee benefits
    
    
    198,043
    
    
    
    165,371
    
    
    
    152,887
    
    
    
    140,391
    
    
    
    134,665Net occupancy and equipment
    
    
    52,366
    
    
    
    40,368
    
    
    
    38,448
    
    
    
    34,607
    
    
    
    32,959Amortization of goodwill
    
    
    
    
    
    
    
    
    
    
    9,072
    
    
    
    5,213
    
    
    
    3,832Other expenses
    
    
    87,038
    
    
    
    66,869
    
    
    
    63,552
    
    
    
    63,294
    
    
    
    58,964Total noninterest expenses
    
    
    337,447
    
    
    
    272,608
    
    
    
    263,959
    
    
    
    243,505
    
    
    
    230,420Income before income taxes
    
    
    306,369
    
    
    
    296,568
    
    
    
    286,338
    
    
    
    274,190
    
    
    
    248,601Applicable income taxes
    
    
    109,555
    
    
    
    106,330
    
    
    
    105,043
    
    
    
    98,960
    
    
    
    90,864NET INCOME
    
    $
    196,814
    
    
    $
    190,238
    
    
    $
    181,295
    
    
    $
    175,230
    
    
    $
    157,737
 24




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##### 



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS I. EXECUTIVE OVERVIEW Mercantile Bankshares Corporation (Bankshares) recorded its 28th
consecutive year of increased net income in 2003. Net income for Bankshares
was $196.8 million for the year ended December 31, 2003 compared to $190.2
million for the year 2002. However, diluted net income per common share for
2003 decreased by 1% to $2.68 compared to $2.72 for 2002 due largely to the
higher adjusted weighted average shares outstanding for 2003. The most
noteworthy factors affecting 2003 earnings were the acquisition of F&M Bancorp
(F&M), the continuing repositioning of the Investment & Wealth Management
(IWM) Division of the lead bank, Mercantile-Safe Deposit and Trust Company
(MSD&T), and the downward pressure put on earnings by a lower net interest
margin compared to the year earlier. On August 12, 2003, Bankshares completed its acquisition of F&M Bancorp, a
bank holding company headquartered in Frederick, Maryland. On the date of
purchase, F&M had total loans of $1.4 billion, total investment securities of
$638.0 million, total earning assets of $2.0 billion, and total deposits of
$1.7 billion. There were 10.4 million shares issued in connection with the
acquisition, which was accounted for as a purchase and resulted in total
consideration paid of $558.1 million (including the cash component). F&M is
the second largest affiliate bank in the organization behind only MSD&T in
total assets. The results of operations and balances for F&M are included in
the consolidated financial statements from the merger date forward. Bankshares
recorded $400.3 million of goodwill, $36.0 million of core deposit intangible,
$5.8 million of client relationship intangibles and $1.1 million in other
identified intangible assets. The weighted average amortization period for
newly acquired core deposit intangible is nine years, and the client
relationship and other identified intangibles range from three to fifteen
years. Investment and wealth management revenues benefited from rising equity
market values and the inclusion of revenues from Boyd Watterson Asset
Management LLC, an investment management firm and Peremel & Company, Inc., a
directed and discount brokerage company, acquired on March 1, 2003 and April 1,
2003, respectively. In the aggregate, these companies were purchased for
approximately $29 million in cash. The Boyd Watterson acquisition has a
potential additional contingent payment of up to $8.6 million based upon
performance, among other factors. The contingent payment will be recorded,
assuming specific metrics are met, and become payable three years from the
acquisition date. Bankshares recorded approximately $10.1 million of
identified intangibles, mostly client relationships, as a result of these
acquisitions. These intangibles are amortized on a straight-line basis over a
range of three to eight years. Goodwill recorded on these transactions totaled
approximately $18.0 million at December 31, 2003. A generally sluggish economy, decreases in long-term interest rates, and
Bankshares net asset sensitive position combined to drive the net interest
margin 31 basis points lower for the year 2003 than for the year 25




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##### 



2002. The net interest margin was 4.34% for 2003 compared to 4.65% for 2002.
Approximately two-thirds, or 20 basis points, of the decline is attributable to
the lower benefit derived from noninterest-bearing sources of funding, such as
demand deposit accounts and shareholders equity. On a tax-equivalent basis,
net interest income was reduced by nearly $30 million as a result of the margin
compression. Management does not anticipate any significant change in the level
of interest rates in 2004 and is looking for improved loan growth to help
offset the continuing pressure on the net interest margin in the current low
interest rate environment. Although certain statistical performance measures declined slightly from
the prior year, 2003 proved to be another year of relatively solid performance,
as indicated by the standard industry measures of return on average assets
(ROA) and return on average shareholders equity (ROE). The 2003 ROA was 1.64%,
compared to 1.88% for the year ended December 31, 2002. Bankshares 2003 ROE
decreased to 13.15%, compared to the 15.12% reported for 2002. Average assets
increased by 18% to $12.0 billion, average deposits increased by 18% to $9.0
billion and average loans increased by 14% to $8.1 billion for the year ended
December 31, 2003, compared to the prior year. Approximately one-half of the
respective increases in the year 2003 average balances are attributable to F&M.
Bankshares also reports net operating earnings, defined as GAAP (Generally
Accepted Accounting Principles) earnings excluding the amortization of
intangible assets associated with purchase accounting for business
combinations; securities gains and losses; and other significant gains, losses
or expenses (such as those associated with integrating acquired entities
operations into Bankshares). Net operating earnings totaled $200.3 million for
the year 2003, an increase of 5% over the $190.9 million for 2002. Diluted net
operating earnings per share for 2003 were $2.73 compared with $2.72 for last
year. A reconciliation of GAAP basis net income to net operating earnings can
be found in Footnote No. 22 of the financial statements. Average shareholders equity to average assets remained strong at 12.51%,
increasing slightly from 12.43% for 2002. In 2003, 5,500 shares were
repurchased under Bankshares buyback plan in open market purchases. Bankshares
was not an active acquirer during 2003 mainly due to the restrictions in place
associated with our acquisition of F&M. The buyback plan retired 1,384,200
shares through open market purchases made during 2002. Management believes that reporting several key measures based on tangible
assets (total assets less intangible assets) and tangible equity (total equity
less intangible assets) is important, as this is the basis for measuring the
adequacy of capital for regulatory purposes. For the year 2003, return on
average tangible assets was 1.71%, compared to 1.91% for the year 2002. The
ratio of average tangible equity to average tangible assets for 2003 was 10.34%
compared to 11.45% for 2002. The decline in average tangible equity to average
tangible assets was largely attributable to the use of $124.1 million of cash
(or 25% of the consideration paid) instead of issuing only shares to acquire
F&M. For the reconciliation of GAAP to non-GAAP measures, see Footnote No. 22
of the financial statements. 26




---



##### 



The remaining sections of Managements Discussion and Analysis of
Financial Condition and Results of Operations will provide a more detailed
explanation of the important trends and material changes in components of our
financial statements. The discussion suggests that sustaining future earnings
growth comparable to our experience in past years will require, among other
things, efficient generation of loan growth in a competitive market, while
maintaining an adequate spread between yields on earning assets and the cost of
funds. Our degree of success in meeting these goals depends on unpredictable
factors such as possible changes in prevailing interest rates, the mix of
deposits, credit quality and general economic conditions. This discussion and
analysis should be read in conjunction with the consolidated financial
statements and other financial information presented in this report. ()
    
    
    ()
 ()
    
    
    ()
 27




---



##### 



Critical Accounting Policies and Related Estimates Set forth below is a discussion of the accounting policies and related
estimates that management believes are the most critical to understanding
Bankshares consolidated financial statements, financial condition and results
of operations, and which involve complex management judgments, uncertainties
and/or estimates. Information regarding Bankshares other accounting policies
is included in Footnote No. 1 of the financial statements. Allowance for Loan Losses Arriving at an appropriate level of allowance for loan losses involves a
high degree of judgment. Bankshares allowance for loan losses provides for
probable losses based on evaluations of known and inherent risks in the loan
portfolio. Management uses historical information to assess the adequacy of the
allowance for loan losses as well as information about the prevailing economic
and business environment among other things. For a full discussion of
Bankshares methodology for assessing the adequacy of the allowance for loan
losses, see Allowance for Loan Losses below and Footnote No. 1 of the
financial statements. Loans on Nonaccrual Status or Deemed to Be Impaired A loan asset will be classified and placed into nonaccrual status when the
principal or interest payments on any loan (e.g.,
commercial, mortgage and construction loans) is past due 90 days or more at the
end of a calendar quarter and/or the payment in full of principal or interest
is not expected. Consumer installment loans are charged-off when they become
90 days past due. Additionally, a loan may be put on nonaccrual status sooner
than 90 days, if in managements judgment, the loan or portions thereof are
deemed uncollectible. Bankshares ceases to accrue interest income on such
loans. Subsequent receipts on nonaccrual loans are recorded as a reduction of
principal, and interest income is recorded only once principal recovery is
reasonably assured. 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. 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. 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 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. A majority of Bankshares
impaired loans are measured by reference to the fair value of the collateral. Income Taxes Bankshares recognizes deferred income tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryovers, and
tax credits. Deferred tax assets are subject to managements 28




---



##### 



judgment, based on available evidence, that future realization is more likely
than not. If management determines that Bankshares may be unable to realize
all or part of net deferred tax assets in the future, then Bankshares would be
required to record a valuation allowance against such deferred tax asset. In
such an event, a direct charge to income tax expense may be required to reduce
the recorded value of the net deferred tax asset to the expected realizable
amount. Although management has determined that a valuation allowance is not
currently required, no assurance can be given that one will not be required in
the future. For more information regarding Bankshares accounting for income
taxes, see Footnote No. 11 of the financial statements. Valuation of Goodwill/Intangible Assets and Analysis for Impairment Bankshares has increased its market share, in part, through the
acquisition of entire financial institutions accounted for under the business
combinations method of accounting, as well as from the purchase of other
financial institutions branches (not the entire institution). For acquisitions
under the purchase method, Bankshares is required to record assets acquired and
liabilities assumed at their fair value, which is an estimate determined by the
use of internal or other valuation techniques. See Footnote No. 19 of the
financial statements for further information on the accounting for goodwill and
other intangible assets. II. ANALYSIS OF OPERATING RESULTS FOR 2003 TO 2002 Segment Reporting Bankshares has identified three distinct business segments for which
financial information is segregated for use in assessing performance and
allocating resources when reporting to the Board of Directors. This
segmentation is consistent with the reporting structure put in place at the
time Bankshares was formed. At that time the organization consisted of: a
lead bank, MSD&T, with two business segmentsBanking and IWM; and a Community
Bank segment, which has been built through acquisitions and continued operation
of independent charters. This latter segment consists of the group of 19
community banks (collectively, the Community Banks). Mortgage banking
activities are not viewed as a separate business line and, accordingly, are
included in the MSD&T Banking Division. A schedule disclosing the details of
these operating segments can be found in Footnote No. 15 of the financial
statements. Segment financial information is subjective and, unlike financial
accounting, is not necessarily based on GAAP. As a result, the financial
information of the reporting segments is not necessarily comparable with
similar information reported by others and may not be comparable with
Bankshares consolidated results. Certain expense amounts, such as operations
overhead, have been reclassified from internal financial reporting in order to
provide for proper allocation of costs in the reported data. Community Banks The addition of F&M during 2003 had a significant impact on nearly every
line of the consolidated balance sheet and statement of consolidated income as
well as the performance of the Community Bank segment as set forth below. Net
income for the Community Banks for 2003 increased 16% to $139.1 29




---



##### 



million, compared to $119.6 million for 2002. Net interest income for the
Community Banks increased 13% to $336.3 million for 2003 from $297.9 million
for 2002. The growth in net interest income in 2003 was attributable to a 22%
increase in average earning assets, which offset a 37 basis point decline in
the net interest margin from 5.05% to 4.68%. F&M contributed over 50% to the
growth in the Community Banks average earning assets. Farmers & Mechanics Affiliate
Selected Balance Sheet Data Proformaimpact of openingbalance on averagesAt
    
    for the 12 months ended(Dollars in thousands)
    
    August 12, 2003
    
    December 31, 2003Investment securities available-for-sale
    
    $
    637,962
    
    
    $
    248,193Loans:Commercial
    
    
    176,689
    
    
    
    68,739Construction
    
    
    114,982
    
    
    
    44,733Residential real estate
    
    
    824,232
    
    
    
    320,660Consumer
    
    
    248,625
    
    
    
    96,725Lease financing
    
    
    
    
    
    
    Total loans
    
    
    1,364,528
    
    
    
    530,857Less: allowance for loan losses
    
    
    (13,205
    )
    
    
    (5,137
    )Loans, net
    
    
    1,351,323
    
    
    
    525,720Total assets
    
    
    2,174,932
    
    
    
    846,138Deposits:Noninterest-bearing deposits
    
    
    301,024
    
    
    
    117,111Interest-bearing deposits
    
    
    1,395,758
    
    
    
    543,007Total deposits
    
    
    1,696,782
    
    
    
    660,118
 As a reflection of the overall improvement in the Community Banks credit
quality trends, the Community Banks recorded a reversal of $1.1 million in the
provision for loan losses for 2003 as compared to a provision for loan losses
of $4.6 million in 2002. Average assets for the Community Banks increased 23% to $7.7 billion in 2003.
Increases of 24% and 22% were recorded in the investment and loan portfolios,
respectively. Average deposits for the Community Banks increased 22% to $6.2
billion in 2003. More than half of the growth in the Community Banks average
balances was due to F&M. At December 31, 2003, 63.9% of average total loans were held by the Community
Banks, compared to 60.0% in 2002. Commercial loans, including commercial
mortgages, accounted for 52.4% of the Community Banks average total loans,
slightly higher than the 51.5% for 2002. These loans increased 24% from the
2002 average. Construction and consumer loans accounted for approximately the
same portion of Community Bank loans in 2003 as in 2002, at 5.7% and 21.5%,
respectively. Construction loans increased 30




---



##### 



35%, while consumer loans increased 22%, from 2002 levels. Residential real
estate loans, which were 20.4% and 22.0% of average total loans for 2003 and
2002, respectively, increased 13%. The Community Banks provided 68.4% of the average total deposit base of
Bankshares, up from the 66.2% at 2002. The Community Banks generated 72.9% of
average noninterest-bearing deposits in 2003, slightly higher than 72.0% in
2002. For 2003, 66.8% of average interest-bearing deposits were at the
Community Banks, increasing from the 64.3% for 2002. MSD&T Banking MSD&T Banking recorded net income of $61.0 million in 2003, compared to
$64.1 million in 2002. Net interest income for MSD&T decreased 3% in 2003 to
$141.8 million from $146.2 million in 2002. Although average earning assets
increased 4%, it was not enough to offset the decline in the net interest
margin from 3.81% to 3.54%. Due to continuing credit quality issues within MSD&Ts commercial loan
portfolio, MSD&T recorded a provision for loan losses of $13.2 million, an
increase of 13% over the $11.7 million recorded in 2002. The allowance as a
percent of loans was 1.96% in 2003 compared to 1.72% in 2002. Average total assets for MSD&T increased 6% to $4.4 billion in 2003 from $4.1
billion in 2002. Average investments and loans increased only 2% and 3%,
respectively, while federal funds sold and other assets accounted for the
balance of the increase in average assets. Average deposits grew at a much
higher rate of 13%. At the end of 2003 commercial loans, at 71.4%, was the largest sector of
MSD&Ts average total loans, decreasing from 73.7% for 2002. MSD&Ts
construction loans comprised 21.8% of MSD&Ts average total loans, up from
18.2% for 2002. Construction loans, which increased 23% over 2002, was the only
MSD&T loan category to experience any growth during 2003. Residential real
estate and consumer loans were 4.0% and 2.8% of the average total loan
portfolio, respectively, which were relatively the same proportions to total
loans as in 2002. IWM The net income for IWM was $5.1 million in 2003, versus $12.1 million in 2002.
Pretax profit margins were 10.8% and 29.6% for 2003 and 2002, respectively. At December 31, 2003, assets under administration by the IWM were
$46.0 billion, an increase of $10.0 billion from the prior year. At their
respective dates of acquisition Boyd Watterson Asset Management LLC and Peremel
and Company, Inc. contributed approximately $3.6 billion and $0.6 billion, 31




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##### 



respectively, to the increase in assets under administration. Bankshares had
investment management responsibility for $21.8 billion, up 41% from the prior
year. Revenues increased 15.7% to $78.6 million in 2003. Increased sales, the
inclusion of Boyd Watterson Asset Management LLC and Peremel & Company, Inc.
for 10 and 9 months of the year, respectively, and the increase in the equity
markets beginning in April all contributed to the revenue increase and the
growth in assets under management. Expense growth associated with a full year of investments in people and new
product capabilities exceeded the increase in revenues. Additionally, expenses
for 2003 included $3.6 million of severance and $0.5 million paid to terminate
a technology equipment lease, both of which were related to the ongoing
repositioning of IWMs capabilities and its infrastructure. In 2002, severance
expense for IWM totaled $1.7 million. Substantial progress was made in repositioning the investment and wealth
management business. New capabilities were added, including three registered
hedge fund of funds, an expanded brokerage capability through Peremel &
Company, Inc., an open architecture investment management platform, a 401(k)
program and the introduction of the Mercantile Dow Jones U.S.
Portfolio Funds.
Distribution through the Community Banks grew with the introduction of an asset
allocation platform. 32




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##### 



ANALYSIS OF INTEREST RATES AND INTEREST DIFFERENTIALS The following table presents the distribution of the average consolidated
balance sheets, interest income/expense and annualized yields earned and rates
paid. 2003
    
    2002
    
    2001Average
    
    Income*/
    
    Yield*/
    
    Average
    
    Income*/
    
    Yield*/
    
    Average
    
    Income*/
    
    Yield*/(Dollars in thousands)
    
    Balance**
    
    Expense
    
    Rate
    
    Balance**
    
    Expense
    
    Rate
    
    Balance**
    
    Expense
    
    RateEarning assetsLoans:Commercial
    
    $
    4,795,334
    
    
    $
    276,788
    
    
    
    5.77
    %
    
    $
    4,283,322
    
    
    $
    278,995
    
    
    
    6.51
    %
    
    $
    3,978,335
    
    
    $
    317,769
    
    
    
    7.99
    %Construction
    
    
    929,939
    
    
    
    50,324
    
    
    
    5.41
    
    
    
    733,237
    
    
    
    44,667
    
    
    
    6.09
    
    
    
    795,931
    
    
    
    63,359
    
    
    
    7.96Residential real estate
    
    
    1,171,194
    
    
    
    75,651
    
    
    
    6.46
    
    
    
    1,072,297
    
    
    
    78,233
    
    
    
    7.30
    
    
    
    1,059,798
    
    
    
    84,102
    
    
    
    7.94Consumer
    
    
    1,192,515
    
    
    
    74,513
    
    
    
    6.25
    
    
    
    999,988
    
    
    
    71,225
    
    
    
    7.12
    
    
    
    998,792
    
    
    
    82,740
    
    
    
    8.28Total loans
    
    
    8,088,982
    
    
    
    477,276
    
    
    
    5.90
    
    
    
    7,088,844
    
    
    
    473,120
    
    
    
    6.67
    
    
    
    6,832,856
    
    
    
    547,970
    
    
    
    8.02Federal funds sold, et al
    
    
    250,462
    
    
    
    3,901
    
    
    
    1.56
    
    
    
    178,624
    
    
    
    5,213
    
    
    
    2.92
    
    
    
    141,245
    
    
    
    6,190
    
    
    
    4.38Securities:Taxable securities
U.S. Treasury securities
    
    
    1,021,513
    
    
    
    41,233
    
    
    
    4.04
    
    
    
    1,478,387
    
    
    
    67,531
    
    
    
    4.57
    
    
    
    1,366,245
    
    
    
    73,653
    
    
    
    5.39U.S. Agency securities
    
    
    709,519
    
    
    
    32,399
    
    
    
    4.57
    
    
    
    610,617
    
    
    
    30,072
    
    
    
    4.92
    
    
    
    339,298
    
    
    
    19,812
    
    
    
    5.84Mortgage-backed securities
    
    
    927,235
    
    
    
    36,135
    
    
    
    3.90
    
    
    
    216,391
    
    
    
    12,096
    
    
    
    5.59
    
    
    
    48,203
    
    
    
    3,599
    
    
    
    7.47Other stocks and bonds
    
    
    114,924
    
    
    
    7,788
    
    
    
    6.78
    
    
    
    23,220
    
    
    
    1,397
    
    
    
    6.02
    
    
    
    21,934
    
    
    
    1,650
    
    
    
    7.52Tax-exempt securitiesStates and political subdivisions
    
    
    69,888
    
    
    
    4,543
    
    
    
    6.50
    
    
    
    38,799
    
    
    
    3,135
    
    
    
    8.08
    
    
    
    40,359
    
    
    
    3,298
    
    
    
    8.17Total securities
    
    
    2,843,079
    
    
    
    122,098
    
    
    
    4.29
    
    
    
    2,367,414
    
    
    
    114,231
    
    
    
    4.83
    
    
    
    1,816,039
    
    
    
    102,012
    
    
    
    5.62Interest-bearing deposits in other banks
    
    
    9,085
    
    
    
    60
    
    
    
    .66
    
    
    
    358
    
    
    
    15
    
    
    
    4.12
    
    
    
    365
    
    
    
    18
    
    
    
    4.98Total earning assets
    
    
    11,191,608
    
    
    
    603,335
    
    
    
    5.39
    
    
    
    9,635,240
    
    
    
    592,579
    
    
    
    6.15
    
    
    
    8,790,505
    
    
    
    656,190
    
    
    
    7.46Cash and due from banks
    
    
    266,173
    
    
    
    
    
    
    
    
    
    
    
    227,034
    
    
    
    
    
    
    
    
    
    
    
    215,852Bank premises and equipment, net
    
    
    118,071
    
    
    
    
    
    
    
    
    
    
    
    101,660
    
    
    
    
    
    
    
    
    
    
    
    102,993Other assets
    
    
    543,341
    
    
    
    
    
    
    
    
    
    
    
    300,422
    
    
    
    
    
    
    
    
    
    
    
    260,333Less: allowance for loan losses
    
    
    (147,612
    )
    
    
    
    
    
    
    
    
    
    
    (140,899
    )
    
    
    
    
    
    
    
    
    
    
    (142,481
    )Total assets
    
    $
    11,971,581
    
    
    
    
    
    
    
    
    
    
    $
    10,123,457
    
    
    
    
    
    
    
    
    
    
    $
    9,227,202Interest-bearing liabilitiesDeposits:Savings
    
    $
    1,168,074
    
    
    
    4,702
    
    
    
    .40
    
    
    $
    966,283
    
    
    
    8,405
    
    
    
    .87
    
    
    $
    853,911
    
    
    
    12,899
    
    
    
    1.51Checking plus interest accounts
    
    
    1,071,877
    
    
    
    2,061
    
    
    
    .19
    
    
    
    873,497
    
    
    
    2,908
    
    
    
    .33
    
    
    
    771,186
    
    
    
    5,255
    
    
    
    .68Money market
    
    
    1,357,234
    
    
    
    9,757
    
    
    
    .72
    
    
    
    1,096,417
    
    
    
    14,223
    
    
    
    1.30
    
    
    
    846,577
    
    
    
    21,839
    
    
    
    2.58Time deposits $100,000 and over
    
    
    1,272,327
    
    
    
    29,464
    
    
    
    2.32
    
    
    
    1,080,347
    
    
    
    34,671
    
    
    
    3.21
    
    
    
    1,145,569
    
    
    
    62,350
    
    
    
    5.44Other time deposits
    
    
    1,852,622
    
    
    
    47,206
    
    
    
    2.55
    
    
    
    1,759,160
    
    
    
    62,362
    
    
    
    3.54
    
    
    
    1,812,589
    
    
    
    97,360
    
    
    
    5.37Total interest-bearing deposits
    
    
    6,722,134
    
    
    
    93,190
    
    
    
    1.39
    
    
    
    5,775,704
    
    
    
    122,569
    
    
    
    2.12
    
    
    
    5,429,832
    
    
    
    199,703
    
    
    
    3.68Short-term borrowings
    
    
    851,348
    
    
    
    5,604
    
    
    
    .66
    
    
    
    845,938
    
    
    
    11,259
    
    
    
    1.33
    
    
    
    744,907
    
    
    
    25,120
    
    
    
    3.37Long-term debt
    
    
    517,386
    
    
    
    18,451
    
    
    
    3.57
    
    
    
    279,471
    
    
    
    10,754
    
    
    
    3.85
    
    
    
    117,823
    
    
    
    6,702
    
    
    
    5.69Total interest-bearing funds
    
    
    8,090,868
    
    
    
    117,245
    
    
    
    1.45
    
    
    
    6,901,113
    
    
    
    144,582
    
    
    
    2.10
    
    
    
    6,292,562
    
    
    
    231,525
    
    
    
    3.68Noninterest-bearing deposits
    
    
    2,269,720
    
    
    
    
    
    
    
    
    
    
    
    1,856,706
    
    
    
    
    
    
    
    
    
    
    
    1,618,838Other liabilities and accrued expenses
    
    
    113,848
    
    
    
    
    
    
    
    
    
    
    
    107,671
    
    
    
    
    
    
    
    
    
    
    
    118,744Total liabilities
    
    
    10,474,436
    
    
    
    
    
    
    
    
    
    
    
    8,865,490
    
    
    
    
    
    
    
    
    
    
    
    8,030,144Shareholders equity
    
    
    1,497,145
    
    
    
    
    
    
    
    
    
    
    
    1,257,967
    
    
    
    
    
    
    
    
    
    
    
    1,197,058Total liabilities & shareholders equity
    
    $
    11,971,581
    
    
    
    
    
    
    
    
    
    
    $
    10,123,457
    
    
    
    
    
    
    
    
    
    
    $
    9,227,202Net interest rate spread
    
    
    
    
    
    $
    486,090
    
    
    
    3.94
    %
    
    
    
    
    
    $
    447,997
    
    
    
    4.05
    %
    
    
    
    
    
    $
    424,665
    
    
    
    3.78
    %Effect of noninterest-bearing funds
    
    
    
    
    
    
    
    
    
    
    .40
    
    
    
    
    
    
    
    
    
    
    
    .60
    
    
    
    
    
    
    
    
    
    
    
    1.05Net interest margin on earning assets
    
    
    
    
    
    
    
    
    
    
    4.34
    %
    
    
    
    
    
    
    
    
    
    
    4.65
    %
    
    
    
    
    
    
    
    
    
    
    4.83
    %Tax-equivalent adjustment included in:Loan income
    
    
    
    
    
    $
    4,897
    
    
    
    
    
    
    
    
    
    
    $
    4,822
    
    
    
    
    
    
    
    
    
    
    $
    4,950Investment securities income
    
    
    
    
    
    
    1,863
    
    
    
    
    
    
    
    
    
    
    
    1,371
    
    
    
    
    
    
    
    
    
    
    
    1,474Total
    
    
    
    
    
    $
    6,760
    
    
    
    
    
    
    
    
    
    
    $
    6,193
    
    
    
    
    
    
    
    
    
    
    $
    6,424
   *
    
    Presented on a tax-equivalent basis using the statutory federal corporate
income tax rate of 35%.**
    
    Average investment securities are reported at amortized cost and exclude
pretax unrealized gains (losses) on securities available-for-sale. Nonaccrual
loans are included in average loans. 33




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##### 



Net Interest Income Net interest income represents the largest source of Bankshares revenue. It is
affected by both changes in the level of interest rates and changes in the
amount and composition of interest-earning assets and interest-bearing
liabilities. Interest rate risk represents one of the more significant risks
facing financial institutions like Bankshares. See additional discussion under
the caption Interest Rate Risk, below. It is measured in terms of the effect
changes in market interest rates have on net interest income. Bankshares is
asset sensitive, with assets repricing more quickly than liabilities in
response to changes in interest rates. In a falling rate environment,
Bankshares net interest margin (net interest income expressed as a percent of
average earning assets) compresses, causing net interest income to slow. Net
interest income, on a fully tax-equivalent basis, was $486.1 million for 2003.
This represents an increase of 9%, or $38.1 million, over the prior years
$448.0 million. In 2002, fully tax-equivalent net interest income increased by
$23.3 million, or 6%, over 2001. As previously noted, net interest income is
affected by changes in the volume of earning assets and the net interest margin
earned thereon. The Rate/Volume Analysis table below presents further details
supporting this discussion. Average earning assets increased by $1.6 billion, or 16%, in 2003, with
approximately 50% of this increase attributable to the F&M acquisition. Average
total loans grew $1.0 billion, or 14%, during 2003. As with earning assets,
approximately 50% of this growth relates to the F&M acquisition. Despite the
sluggish economy, organic loan growth was fairly consistent throughout the
year. While average total loans grew by $256.0 million, or 4%, during 2002,
substantially all of the growth occurred during the first half of the year.
Average securities, the other major component of earning assets, increased by
$475.7 million, or 20%, in 2003 compared to an increase of $551.4 million, or
30%, in the prior year. The F&M acquisition accounted for slightly less than
50% of the increase in 2003. The slowing in the growth of the investment
portfolio is attributable to the improved loan growth rate and a slowing in the
deposit growth rate, especially in the fourth quarter of 2003. See III.
Analysis of Financial Condition below for a more in-depth discussion of
balance sheet trends. The overall growth in average earning assets added $67.9
million to net interest income in 2003. Offsetting the increase in net interest income from the growth in average
earning assets was a 31 basis point decline in the net interest margin from
4.65% in 2002 to 4.34% in 2003. The decline in the net interest margin reduced
net interest income by $29.9 million. The net interest margin declined for the
third straight year. The net interest spread also declined by 11 basis points
to 3.94% in 2003 from 4.05% in 2002. The net interest spread is the difference
between the yield earned on total earning assets and the rate paid on total
interest-bearing liabilities. In response to the slowing economy, the Board of Governors of the Federal
Reserve System (the Federal Reserve Board) began taking action in 2001 to
reduce short-term interest rates. They reduced short-term 34




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##### 



rates by 475 basis points in 2001, followed by 50 basis points in 2002 and 25
basis points in 2003. The net interest margin declined by 43 basis points in
2001, primarily as a result of the unprecedented drop in the level of
short-term interest rates. Since 2001, the margin has continued to decline,
not because of the additional short-term rate reductions, but due to a decline
in intermediate and long-term interest rates. The impact of the decline in
these rates is reflected in the benefit Bankshares derives from its
noninterest-bearing sources of funding earning assets. Such benefit declined
by 45 basis points in 2002 and 20 basis points in 2003, a combined decline of
65 basis points over the two-year period. Approximately 28% of the funding of
average earning assets is derived from noninterest-bearing sources. The 11 basis point decline in the spread during 2003 is attributable to
the difficulty of further reducing the rate paid on managed-rate deposits
(savings, checking plus interest and money market accounts) and remaining
competitive in the marketplace. The average yield on earning assets declined 76
basis points to 5.39% in 2003. In comparison, the average rate paid on
interest-bearing funds declined only 65 basis points to 1.45% in 2003, from
2.10% in 2002. MSD&Ts net interest margin decreased 27 basis points, from 3.81% in 2002
to 3.54% in 2003. The Community Banks net interest margin decreased 37 basis
points, from 5.05% in 2002 to 4.68% in 2003. Over the two-year period ended
December 31, 2003, MSD&Ts net interest margin declined 50 basis points
compared to a decline of 53 basis points for the Community Banks. The Community
Banks account for most of Bankshares residential real estate and consumer loan
portfolios. These portfolios were most affected by the refinancing triggered by
the drop in intermediate and long-term rates. As a result, the net interest
margin contracted to a greater extent at the Community Banks than at MSD&T. Understanding the trend of the net interest margin during 2003 is
important when assessing the outlook for the net interest margin in the year
ahead. The net interest margin was 4.57% for the first quarter of 2003, up 2
basis points from the fourth quarter of 2002. During the second quarter of
2003, the margin dropped 19 basis points, followed by an additional 19 basis
point decline in the third quarter. During this six-month period, intermediate
and long-term interest rates declined, triggering a surge in consumer and
mortgage loan refinancing. During the fourth quarter of 2003, intermediate and
long-term rates increased from their low levels, slowing the pace of
refinancing and improving yields on new consumer and mortgage loans.
Bankshares net interest margin improved 9 basis points to 4.28% for the fourth
quarter of 2003. Looking forward to 2004, management does not anticipate an
increase in short-term interest rates or overall interest rates from where they
were at the close of 2003. Normally, this stable scenario would result in a
downward movement in the net interest margin as fixed-rate loans and
investments mature and are replaced by loans and investments at lower current
yields. However, with some signs of an improving economy beginning to emerge,
management anticipates the net interest margin will remain stable, as improving
loan growth should result in earning assets more heavily weighted toward higher
yielding loans compared to investment 35




---



##### 



securities. For additional information regarding interest rate sensitivity,
see the discussion in the Interest Rate Risk section below. ()
    
    
    ()
 36




---



##### 



RATE/VOLUME ANALYSIS A rate/volume analysis, which demonstrates changes in tax-equivalent
interest income and expense for significant assets and liabilities, appears
below. The calculation of rate and volume variances is based on a procedure
established for banks by the Securities and Exchange Commission. Year Ended December 31,2003 vs. 2002
    
    2002 vs. 2001Due to variances in
    
    Due to variances in(Dollars in thousands)
    
    Total
    
    Rates
    
    Volumes(4)
    
    Total
    
    Rates
    
    Volumes(4)Interest earned on:Loans:Commercial (1)
    
    $
    (2,207
    )
    
    $
    (35,557
    )
    
    $
    33,350
    
    
    $
    (38,774
    )
    
    $
    (63,135
    )
    
    $
    24,361Construction (2)
    
    
    5,657
    
    
    
    (6,326
    )
    
    
    11,983
    
    
    
    (18,692
    )
    
    
    (13,701
    )
    
    
    (4,991
    )Residential real estate
    
    
    (2,582
    )
    
    
    (9,797
    )
    
    
    7,215
    
    
    
    (5,869
    )
    
    
    (6,861
    )
    
    
    992Consumer
    
    
    3,288
    
    
    
    (10,425
    )
    
    
    13,713
    
    
    
    (11,515
    )
    
    
    (11,614
    )
    
    
    99Taxable securities (3)
    
    
    6,459
    
    
    
    (14,751
    )
    
    
    21,210
    
    
    
    12,382
    
    
    
    (18,357
    )
    
    
    30,739Tax-exempt securities (3)
    
    
    1,408
    
    
    
    (1,104
    )
    
    
    2,512
    
    
    
    (163
    )
    
    
    (36
    )
    
    
    (127
    )Federal funds sold, et al
    
    
    (1,312
    )
    
    
    (3,409
    )
    
    
    2,097
    
    
    
    (977
    )
    
    
    (2,615
    )
    
    
    1,638Interest-bearing deposits in other banks
    
    
    45
    
    
    
    (321
    )
    
    
    366
    
    
    
    (3
    )
    
    
    (3
    )
    
    
    Total interest income
    
    
    10,756
    
    
    
    (81,690
    )
    
    
    92,446
    
    
    
    (63,611
    )
    
    
    (116,322
    )
    
    
    52,711Interest paid on:Savings deposits
    
    
    (3,703
    )
    
    
    (5,458
    )
    
    
    1,755
    
    
    
    (4,494
    )
    
    
    (6,191
    )
    
    
    1,697Checking plus interest deposits
    
    
    (847
    )
    
    
    (1,507
    )
    
    
    660
    
    
    
    (2,347
    )
    
    
    (3,044
    )
    
    
    697Money market accounts
    
    
    (4,466
    )
    
    
    (7,849
    )
    
    
    3,383
    
    
    
    (7,616
    )
    
    
    (14,061
    )
    
    
    6,445Certificates of deposit $100,000 and over
    
    
    (5,207
    )
    
    
    (11,368
    )
    
    
    6,161
    
    
    
    (27,679
    )
    
    
    (24,129
    )
    
    
    (3,550
    )Other time deposits
    
    
    (15,156
    )
    
    
    (18,469
    )
    
    
    3,313
    
    
    
    (34,998
    )
    
    
    (32,128
    )
    
    
    (2,870
    )Short-term borrowings
    
    
    (5,655
    )
    
    
    (5,727
    )
    
    
    72
    
    
    
    (13,861
    )
    
    
    (17,268
    )
    
    
    3,407Long-term debt
    
    
    7,697
    
    
    
    (1,458
    )
    
    
    9,155
    
    
    
    4,052
    
    
    
    (5,143
    )
    
    
    9,195Total interest expense
    
    
    (27,337
    )
    
    
    (51,836
    )
    
    
    24,499
    
    
    
    (86,943
    )
    
    
    (101,964
    )
    
    
    15,021Net interest earned
    
    $
    38,093
    
    
    $
    (29,854
    )
    
    $
    67,947
    
    
    $
    23,332
    
    
    $
    (14,358
    )
    
    $
    37,690
  (1)
    
    Tax-equivalent adjustments of $3.6 million for 2003, $3.6 million for 2002
and $4.1 million for 2001 are included in the calculation of commercial loan
rate variances.(2)
    
    Tax-equivalent adjustments of $1.3 million for 2003, $1.2 million for 2002
and $867 thousand for 2001 are included in the calculation of construction loan
rate variances.(3)
    
    Tax-equivalent adjustments of $1.9 million for 2003, $1.4 million for
2002 and $1.5 million for 2001 are included in the calculation of
investment securities rate variances.(4)
    
    Changes attributable to mix (rate and volume) are included in volume
variance. Interest Income Fully tax-equivalent interest income amounted to $603.3 million in 2003, an
increase of $10.7 million, or 2%, from $592.6 million in 2002. This compares
favorably to the $63.6 million, or 10% decrease in 2002 from 2001. The slight
increase in 2003 was due to a decline in market interest rates, resulting in an
$81.7 million reduction in interest income, offset by $92.4 million in
additional interest income generated by the growth in earning assets primarily
due to the addition of F&M. During 2002, the $116.3 million reduction 37




---



##### 



in interest income resulted from the lower yield on earning assets and was only
partially offset by the $52.7 million increase derived from the growth in
earning assets. At year-end 2003, the prime rate was 4.00%, compared to 4.25% and 4.75% at
year-end 2002 and 2001, respectively. The average prime rate was 4.12% for
2003, compared to 4.72% for 2002, a decline of 60 basis points. The yield on
average total loans in 2003 was 5.90%, a 77 basis point decline from 6.67% in
2002. The commercial and construction loan portfolios are the most sensitive to
changes in short-term interest rates, while the residential real estate and
consumer loan portfolios are mostly affected by long-term rates. The yield on
the consumer loan portfolio declined 87 basis points and the residential real
estate portfolio declined by 84 basis points. The commercial and construction
loan portfolios declined by 74 and 68 basis points, respectively. These
declines reflected the Federal Reserve Boards 50 basis point reduction in
short-term rates during the fourth quarter of 2002 and 25 basis point reduction
at the end of the second quarter of 2003. The yield on investment securities, at 4.29% in 2003, declined 54 basis
points from 4.83% in 2002. The yield on the portfolio decreased 79 basis points
in 2002 from 5.62% in 2001. More than offsetting the negative impact on
interest income from reinvesting at lower yields has been the increasing size
and changing mix of the portfolio. During 2003 Bankshares followed a strategy
begun in 2002 to shift from U.S. Treasury to higher yielding U.S. agency
securities and mortgage-backed securities. This has resulted in a mix of 27%,
25% and 41%, respectively, at December 31, 2003. The other 7% of the investment
securities was comprised of 3% municipals and 4% other investments at year end. Interest Expense Total interest expense in
2003 was $117.2 million, a decrease of $27.4 million
from $144.6 million in 2002. The decrease in interest expense for 2003 was
attributable to a decrease in the rate paid on total interest-bearing funds of
65 basis points, which was partially offset by a 17% growth in average
balances. Total interest expense in 2002 was $86.9 million less than the $231.5
million reported in 2001. With the combination of interest rates at record low
levels and slowing deposit inflows, management does not anticipate that it will
be able to significantly reduce the rate paid on managed-rate deposits
(savings, checking plus interest and money market accounts). See managements
discussion under Interest Rate Risk below for further information regarding
Bankshares exposure to changes in interest rates. The rate paid on average total interest-bearing deposits was 1.39% in
2003, a decline of 73 basis points from 2.12% for the prior year. The rate paid
on savings, checking plus interest and money market accounts declined 47 basis
points, 14 basis points and 58 basis points, respectively. Certificates of
deposit-$100,000 and over declined 89 basis points, while the rate paid on
other time deposits decreased 99 basis points in 2003. 38




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##### 



The most interest rate sensitive source of funds is short-term borrowings.
This category is comprised of federal funds purchased, securities sold under
agreement to repurchase and commercial paper. The duration of these funds is
very short, with most repricing daily. Reflecting the rate environment, the
rate paid on short-term borrowings declined 67 basis points to 0.66% in 2003,
after having decreased by 204 basis points in 2002 to 1.33%. The rate paid on
long-term debt declined 28 basis points in 2003, following a decline of 184
basis points in the prior year. The decline is primarily related to the $200
million of 10-year debt issued by MSD&T in the fourth quarter of 2001. These
notes, which were issued at a fixed rate of 5.70%, were converted to a floating
rate through an interest rate swap. The notes reprice quarterly and carried an
effective cost of 2.18% during 2003. Additionally, Bankshares issued $300
million of subordinated debt in April 2003. The notes were issued at a fixed
rate of 4.65%. Subsequently, $150 million of this debt was converted to a
floating rate through interest rate swaps. The effect of the swap lowered the
cost on the $300 million debt to 3.96% during 2003. NONINTEREST INCOME A schedule of noninterest income over the past three years is presented below: Year Ended December 31,
        
        % Change(Dollars in thousands)
        
        2003
        
        2002
        
        2001
        
        2003/2002
        
        2002/2001Investment and wealth
            management
        
        $
        78,933
        
        
        $
        68,435
        
        
        $
        69,331
        
        
        
        15.3
        %
        
        
        (1.3
        )%Service charges on
            deposit accounts
        
        
        36,912
        
        
        
        31,454
        
        
        
        28,085
        
        
        
        17.4
        
        
        
        12.0Mortgage banking
            related feesCommercial
        
        
        6,645
        
        
        
        5,609
        
        
        
        7,319
        
        
        
        18.5
        
        
        
        (23.4
        )Residential
        
        
        4,466
        
        
        
        4,336
        
        
        
        5,263
        
        
        
        3.0
        
        
        
        (17.6
        )Total mortgage banking
            related fees
        
        
        11,111
        
        
        
        9,945
        
        
        
        12,582
        
        
        
        11.7
        
        
        
        (21.0
        )Investment securities
            gains
        
        
        7,137
        
        
        
        846
        
        
        
        4,248
        
        
        
        743.6
        
        
        
        (80.1
        )Other incomeElectronic banking fees
        
        
        16,814
        
        
        
        15,076
        
        
        
        13,956
        
        
        
        11.5
        
        
        
        8.0Charges and fees
            on loans
        
        
        9,549
        
        
        
        8,440
        
        
        
        6,372
        
        
        
        13.1
        
        
        
        32.5Insurance
        
        
        4,656
        
        
        
        1,141
        
        
        
        1,327
        
        
        
        308.1
        
        
        
        (14.0
        )Bank-owned life insurance
        
        
        2,003
        
        
        
        869
        
        
        
        
        
        
        
        130.5
        
        
        
        100.0All other fees
        
        
        9,476
        
        
        
        7,544
        
        
        
        9,589
        
        
        
        25.6
        
        
        
        (21.3
        )Total other income
        
        
        42,498
        
        
        
        33,070
        
        
        
        31,244
        
        
        
        28.5
        
        
        
        5.8Total
        
        $
        176,591
        
        
        $
        143,750
        
        
        $
        145,490
        
        
        
        22.8
        %
        
        
        (1.2
        )%
 Noninterest Income Noninterest income for 2003 increased by $32.8 million, or 23%, to $176.6
million compared to $143.8 million for 2002. The table above shows the major
components of noninterest income. Investment and Wealth Management revenue
represents the largest source of noninterest income at 45%. Improvement in IWM
revenue came principally from the inclusion of Boyd Watterson Asset Management
LLC and Peremel & Company, Inc., which were acquired on March 1, 2003 and April
1, 2003, respectively. Together, these acquisitions added $8.2 million in
revenues. The improved performance in equity markets that began in the second
quarter of 2003 had a positive impact on IWM revenues, mostly in the second
half 39




---



##### 



of the year. Approximately 35% of IWMs managed assets is invested in
equities. Between December 31, 2002 and December 31, 2003, major equity indices
rose sharply. The S&P 500 index was up 26%, the Dow Jones Industrial Average
was up 25% and the Nasdaq was up 50%. Higher revenues also reflected increased
new sales across both mutual funds and separately managed accounts. For 2004,
revenues will benefit from a full year of Boyd Watterson and Peremel.
Additional growth will depend on continued new sales and increased
distribution, equity and bond market conditions and further acquisitions, if
any. See the discussion under Segment Reporting above for additional
information relating to IWM. Service charges on deposit accounts increased in line with the growth in
core consumer and commercial deposit balances. This growth is a result not
only of the F&M acquisition, but also of significant growth in Bankshares
deposits excluding F&M. The $5.5 million, or 17%, growth in service charge
income is almost equally divided between the F&M acquisition and core deposit
growth. Additionally, a reduction in waivers of nonsufficient funds and
overdraft charges increased these fees $2.9 million, or 20%. Commercial account
analysis fees increased $600 thousand, or 12%, primarily due to reduced earning
credits on these accounts as a result of lower interest rates during 2003. Mortgage banking fees increased by $1.2 million to $11.1 million in 2003.
Bankshares mortgage banking revenue is comprised of loan origination fees,
which is the largest category at 55% of total mortgage banking fees; servicing
fees; and net gain on the sales of mortgage loans. Mercantile Mortgage
Corporations commercial loan origination and servicing fees increased by a
combined $1.0 million due to the activities of its subsidiary, Columbia
National Real Estate Financing LLC. Commercial mortgages are sold in the
secondary market with rights to servicing retained. Residential mortgage
banking fees increased by $0.2 million due to activities conducted by F&M and
by Mercantile Mortgage Corporation through its joint venture with Wells Fargo
Ventures LLC (WFV). Mercantile Mortgage Corporation owns a 49.9% stake in
Mercantile Mortgage LLC, which has originated retail mortgages since April
2002. Bankshares reports its share of the net profits from the joint venture as
mortgage banking fees. The financial risk for Bankshares is the initial
capital contribution to the venture, which is minimal. As the primary
beneficiary and managing partner, WFV is responsible for consolidating the
joint venture in its financial statements. Either party may terminate the
joint venture with 60 days notice. Residential mortgages are sold in the
secondary market with rights to servicing released. During 2004, F&Ms
residential mortgage business will be integrated into the joint venture.
Historically, MSD&T has utilized the joint venture to underwrite and close
residential mortgages on its behalf. As a result of the F&M integration, the
joint venture will be offering this service to several of the Community Banks. Investment securities gains mostly represent sales of equity securities,
with the balance related to the continued restructuring of the investment
securities bond portfolios held in available-for-sale portfolios. These gains
were generated as part of a repositioning of the balance sheet for interest
rate changes that adjust portfolio yields and duration. 40




---



##### 



Other income includes several categories. Electronic banking fees consist
of merchant card processing fees, foreign ATM fees and debit card fees. These
fees increased to $16.8 million, up 12% from 2002. Charges and fees on loans
consist of letters of credit fees, late fees and other assessed loan fees.
Sixty percent of the increase in this category is attributable to F&M. Letters
of credit fees decreased $1.1 million. This decrease was more than offset by an
18% increase in late fees of $490 thousand and a 60% increase, or $1.7 million
in other loan fees. Insurance revenues are derived from fee income related to
the sale and servicing of insurance products. The $3.5 million increase is due
primarily to F&M, which operates two wholly owned subsidiaries, Keller
Stonebraker Insurance, Inc. and Potomac Basin Group Associates, Inc. These
insurance agencies provide a full line of consumer and commercial products.
Consumer products include annuities, homeowners, automobile, life and personal
umbrella insurance products. Commercial products include property and casualty
packages, workers compensation, bonds, professional liability
and 401(k) and
other benefit plans. Bankshares invested $50.0 million in bank-owned life
insurance (BOLI) during the third quarter of 2002. The Company invested in
BOLI to provide funding for future employee benefit costs. Executive and middle
management employees are insured under the plan. Income, which reflects
changes in the cash surrender value, was $1.1 million higher than in 2002 due
to a full years earnings for 2003 compared to less than one-half years
earnings in 2002. BOLI investment income is exempt from federal and state
income tax, and related costs of the insurance are not tax deductible. The BOLI
is invested primarily in high grade corporate and government bonds and
mortgage-backed securities. All other income consists of revenues from various
sources, such as safe deposit box rent, travelers checks, money orders and
bill collection fees. 41




---



##### 



NONINTEREST EXPENSES A schedule of noninterest expenses over the past three years is presented
below: Year Ended December 31,
    
    % Change(Dollars in thousands)
    
    2003
    
    2002
    
    2001
    
    2003/2002
    
    2002/2001Salaries
    
    $
    160,326
    
    
    $
    133,200
    
    
    $
    123,712
    
    
    
    20.4
    %
    
    
    7.7
    %Employee benefits
    
    
    37,717
    
    
    
    32,171
    
    
    
    29,175
    
    
    
    17.2
    
    
    
    10.3Net occupancy expense of bank premises
    
    
    20,756
    
    
    
    15,904
    
    
    
    14,440
    
    
    
    30.5
    
    
    
    10.1Furniture and equipment expense
    
    
    31,610
    
    
    
    24,464
    
    
    
    24,008
    
    
    
    29.2
    
    
    
    1.9Communication and supplies
    
    
    15,188
    
    
    
    13,375
    
    
    
    13,086
    
    
    
    13.6
    
    
    
    2.2Other expensesProfessional services
  
  
  19,500
  
  
  
  11,221
  
  
  
  9,479
  
  
  
  73.8
  
  
  
  18.4Advertising and promotional expense
    
    
    9,155
    
    
    
    6,872
    
    
    
    6,818
    
    
    
    33.2
    
    
    
    .8Electronic banking expense
    
    
    7,657
    
    
    
    6,937
    
    
    
    7,000
    
    
    
    10.4
    
    
    
    (.9
    )Amortization of intangible assets
    
    
    4,943
    
    
    
    1,972
    
    
    
    2,082
    
    
    
    150.7
    
    
    
    (5.3
    )All other expenses
    
    
    30,595
    
    
    
    26,492
    
    
    
    25,087
    
    
    
    15.5
    
    
    
    5.6Total other expenses
    
    
    71,850
    
    
    
    53,494
    
    
    
    50,466
    
    
    
    34.3
    
    
    
    6.0Noninterest expenses
        before amortization of good will
    
    337,447
    
    
    272,608
    
    
    
    254,887
    
    
    
    23.8
    
    
    
    7.0Amortization of goodwill
    
    
    
    
    
    
    
    
    
    
    9,072
    
    
    
    
    
    
    
    (100.0
    )Total
    
    $
    337,447
    
    
    $
    272,608
    
    
    $
    263,959
    
    
    
    23.8
    %
    
    
    3.3
    %
 Noninterest Expenses Noninterest expenses
increased $64.8 million, or 24%, from the 2002
level. The table above shows the major components of noninterest expenses.
The principal reason for the year-over-year increase in each noninterest
expense category was the inclusion of F&M, Boyd Watterson Asset Management LLC
and Peremel & Company, Inc. In 2003, $8.0 million was recorded in pretax
merger-related expenses related to the F&M acquisition. There were no
merger-related expenses recognized in 2002. For further information regarding
the various categories that merger-related expenses affected, see Footnote No.
2 of the financial statements. Controlling costs and maintaining operational efficiencies remain primary
objectives for Bankshares. A key measure that is closely monitored is
Bankshares overall efficiency ratio. It is computed by dividing noninterest
expenses by the sum of net interest income on a tax-equivalent basis and
noninterest income. Bankshares efficiency ratio was 50.9%
compared to 46.1%
for the years ended December 31, 2003 and 2002, respectively. About half of the
increase in the efficiency ratio for 2003 compared to 2002 was due to the
significant investments in IWM during 2003. The other half of the increase was
due to the decline in Bankshares net interest margin for 2003. On a non-GAAP
basis, the operating efficiency ratio excludes amortization expense for
intangibles, nonoperating income and expenses, such as securities gains and
losses and merger-related expenses. Bankshares operating efficiency ratio was
49.5%, compared to 45.8% 42




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##### 



for the years ended December 31, 2003 and 2002, respectively. For the
reconciliation of GAAP to non-GAAP measures, see Footnote No. 22 of the
financial statements. Employee-related expenses, which include salaries, benefits and incentive
compensation, is the largest component at 59% of noninterest expenses. F&M
accounts for a substantial portion of the $32.7 million increase in employee
related expenses for 2003 compared to 2002. The operational merger of F&M took
place in the fourth quarter of 2003. Management expects employee-related
expenses associated with F&M to diminish as head-count and other targeted cost
saves are realized. Additionally, there were approximately $0.7 million in
pre-operational merger-related staff costs and approximately $3.6 million in
severance expense, of which $0.8 million relates to the accelerated vesting of
restricted stock awards for employees in IWM whose employment was terminated.
Higher commissions, incentive compensation and normal merit increases also
contributed to the increase in employee-related expenses. An increase of $4.3
million, or 58% over the prior year, in commissions and incentive compensation
is tied directly to Bankshares revenue and overall performance. Stock-based
compensation expense, which is included in salary expense, increased due to
stock options and restricted stock awards granted under Bankshares Omnibus
Stock Plan. Bankshares has expensed the cost of stock options when granted in
accordance with the fair value provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. For
further information regarding stock-based compensation plans, see Footnote No.
14 of the financial statements. Net occupancy expense, which includes depreciation, rents, maintenance and
utilities, increased due to the net additional 39 branch locations as well as
the three corporate offices related to F&M, Boyd Watterson Asset Management LLC
and Peremel & Company, Inc. Additionally, $1.2 million relating to terminating
certain Community Bank lease agreements, generally higher rental payments and
an increase in expenses associated with improvements are reflected in the
increase to net occupancy expense. Furniture and equipment expenses include premises depreciation, rental and
maintenance expense associated with the upkeep and improvement of hardware and
computer software. Pretax merger-related expenses associated with cancellation
of equipment maintenance contracts were $372 thousand. IWM expenditures
increased by $3.2 million, of which $525 thousand related to the termination of
a technology equipment contract. Also adding to the increase is furniture and
equipment expense primarily related to F&M. Professional services, communications and supplies and marketing expenses
increased $12.4 million, or 39%. Pretax merger-related expenses contributed
$4.8 million, or approximately one-third, of this increase. Merger-related
professional expenses included services rendered to implement system
conversions, consolidation and branch closings, employee benefits and tax
consulting. Communications and supplies and 43




---



##### 



marketing merger-related expenses relate to the increase in the supplies needed
for additional branch office locations, including brochures and operational
supplies, as well as increased customer information mailings and disclosures. Other expenses consist of travel and membership, amortization, licensing
and insurance, sundry losses and other operational expenses. Travel and
membership increased to $7.2 million, or 30%, in 2003 from $5.5 million in
2002. Amortization of other identifiable intangibles increased to $4.9 million
in 2003 from $2.0 million in 2002. Licensing and insurance increased to $5.1
million, or 38%, in 2003 from $3.7 million in 2002. Increases in these three
categories are mostly attributable to the increased activities relating to the
acquisition of F&M. Other expenses include armored couriers service, credit and
debit card charges, check clearing and processing charges and other
miscellaneous charges. These expenses for 2003 were $22.9 million, up 16% from
$19.8 million in 2002. Management expects 2004 expenses to
increase modestly due to the incremental increase on a linked quarter
basis offsetting some savings from the integration of F&M. In
particular, Bankshares expects to make additional investments in
regulatory and compliance infrastructure and incur increased
operating expenses associated with the planned opening of de
novo branches in Washington, D.C., and Northern Virginia. 44




---



##### 



III. ANALYSIS OF FINANCIAL CONDITION BOND INVESTMENT PORTFOLIO The following summary shows the maturity distribution and average
tax-equivalent yields for the bond investment portfolio at December 31, 2003. Within 1
    
    1-5
    
    5-10
    
    After 10(Dollars in thousands)
    
    Year
    
    Years
    
    Years
    
    Years
    
    TotalSecurities available-for-sale (1)U.S. Treasury and otherU.S. Government agenciesFair Value
    
    $
    567,873
    
    
    $
    1,042,734
    
    
    $
    28,666
    
    
    $
    92
    
    
    $
    1,639,365Yield
    
    
    4.47
    %
    
    
    3.71
    %
    
    
    5.02
    %
    
    
    7.54
    %
    
    
    3.99
    %States and political subdivisionsFair Value
    
    $
    9,399
    
    
    $
    19,726
    
    
    $
    41,368
    
    
    $
    9,377
    
    
    $
    79,870Yield
    
    
    1.23
    %
    
    
    2.76
    %
    
    
    5.04
    %
    
    
    6.00
    %
    
    
    4.14
    %Mortgage-backed securities (2)Fair Value
    
    $
    44,856
    
    
    $
    873,536
    
    
    $
    305,044
    
    
    $
    60,194
    
    
    $
    1,283,630Yield
    
    
    3.81
    %
    
    
    3.93
    %
    
    
    4.45
    %
    
    
    4.18
    %
    
    
    4.06
    %Other bonds, notes and debenturesFair Value
    
    $
    
    
    
    $
    6,083
    
    
    $
    
    
    
    $
    
    
    
    $
    6,083Yield
    
    
    
    %
    
    
    4.04
    %
    
    
    
    %
    
    
    
    %
    
    
    4.04
    %Asset-backed securities (2)Fair Value
    
    $
    6,584
    
    
    $
    22,092
    
    
    $
    
    
    
    $
    
    
    
    $
    28,676Yield
    
    
    3.51
    %
    
    
    3.09
    %
    
    
    
    %
    
    
    
    %
    
    
    3.19
    %Total securities available-for-saleFair Value
    
    $
    628,712
    
    
    $
    1,964,171
    
    
    $
    375,078
    
    
    $
    69,663
    
    
    $
    3,037,624Yield
    
    
    4.36
    %
    
    
    3.79
    %
    
    
    4.56
    %
    
    
    4.43
    %
    
    
    4.02
    %Securities held-to-maturityStates and political subdivisionsAmortized cost
    
    $
    4,179
    
    
    $
    13,390
    
    
    $
    8,057
    
    
    $
    2,587
    
    
    $
    28,213Yield
    
    
    7.28
    %
    
    
    6.63
    %
    
    
    7.56
    %
    
    
    7.86
    %
    
    
    7.11
    %
   (1)
    
    Investment securities available-for-sale are presented at estimated fair
value. Yields on such securities are based on amortized cost.(2)
    
    Maturities are reflected based on projected maturities at time of
purchase. Actual maturities will vary as a result of the level of loan
prepayments in the underlying mortgage pools. Investment Securities Bankshares investment securities portfolio is structured to serve both as
a source of liquidity and as a key component in the overall management of
interest rate risk. At December 31, 2003, the total investment securities
portfolio was $3.2 billion, an increase of $533.3 million, or 20%, from $2.6
billion at December 31, 2002. The portfolio consists of short-term and
intermediate-term U.S. Treasury and U.S. agency obligations, adjustable-rate
mortgage-backed securities (ARMs) and intermediate average life agency
collateralized mortgage obligations (CMOs). More than 98% of the total
investment portfolio is classified as available-for-sale. 45




---



##### 



As part of a new investment portfolio strategy designed to maintain a core
amount of liquidity and to increase portfolio yields in a low interest rate
environment, Bankshares increased its holdings of mortgage-backed securities
over the course of 2003. Mortgage-backed securities were purchased for the
investment portfolio because they have short or intermediate-term durations and
represent a stable source of cash-flows. As a result of this new program and
the F&M acquisition, mortgage-backed securities rose $935.3 million to $1.3
billion during 2003. Similarly, the proportion of mortgage-backed securities
to total available-for-sale securities increased from 13% in 2002 to 41% over
the same period in 2003. In the available-for-sale portfolio, U.S. Treasury
obligations decreased $576.1 million, or 41%, in 2003 while U.S. agency
obligations increased by $66.0 million, or 9%. At year-end 2003, the average maturity of the bond component of the
available-for-sale portfolio was 3.0 years, a 0.6 year increase from year-end
2002. The market value of the bond investment portfolio as of December 31,
2003, was 101% of amortized cost, compared to 104% at December 31, 2002. At
December 31, 2003, $2.2 billion of these investments had unrealized gains of
$47.3 million, and the remaining $796 million of these investment securities
had unrealized losses of $12.4 million. More information on the investment
portfolio is provided in the table above and in Footnote No. 3 of the financial
statements. () Loans Total loans averaged $8.1 billion for the year ended December 31, 2003, an
increase of 14% over the average of $7.1 billion for the year ended December
31, 2002. The F&M acquisition accounted for approximately 50% of Bankshares
loan growth in 2003. Average loans increased in all categories in 2003:
commercial (including industrial, financial, agricultural, leases and
commercial mortgages), residential real estate, consumer and construction. In
2003 average commercial loans grew 12%, and average residential real estate
loans grew 9%, while average consumer loans increased 19% over 2002. An average
balance of $930 million in construction loans reflected an increase of 27%
compared to an average balance of $733 million in 2002. At December 31, 2003,
commercial, industrial and agricultural loans constituted the largest portion,
at 58%, of the total loan portfolio, a slight decline from 60% at December
31, 2002. 46




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##### 



Average loan growth, at 22% for the Community Banks reflects the F&M
acquisition. MSD&Ts growth, at 3% in 2003 remained well below historical
levels. The Community Banks have a higher concentration in the residential
real estate and consumer portfolios than MSD&T. The Community Banks have
remained focused on relationships in local markets and management believes this
allows the Community Banks management to tailor loan products and services to
their individual communities. MSD&T is focused more on commercial and
construction loans. The leasing portfolio at MSD&T decreased by $28.1 million,
or 28%, to $74.1 million at December 31, 2003 from $102.2 million one year ago.
Because of the dynamics of the equipment leasing business, and the risk
inherent therein, management decided in the fourth quarter of 2001 to
discontinue marketing this product line. As noted above, commercial real estate
experienced growth in 2003, both in absolute terms (11%) and as a portion of
total loans. A large percentage of the commercial real estate mortgages and
construction loan balances outstanding at December 31, 2003, were for
owner-occupied properties. Although it recognizes the risks associated with
some types of real estate loans, Bankshares believes it is consistent with
sound banking practice to continue to extend real estate credits to carefully
selected customers. Bankshares historical charge-off experience for real
estate loans compares favorably with loss experience in other portfolio
segments. For further comparative information on the components of the loan
portfolio, see the Five-Year Selected Financial Data table. COMPOSITION OF EARNING ASSETS Average Balances(Dollars in thousands)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Loans
    
    $
    8,088,982
    
    
    
    72.3
    %
    
    $
    7,088,844
    
    
    
    73.6
    %
    
    $
    6,832,856
    
    
    
    77.7
    %
    
    $
    6,169,632
    
    
    
    78.2
    %
    
    $
    5,377,367
    
    
    
    74.3
    %Investment securities*
    
    
    2,852,164
    
    
    
    25.5
    
    
    
    2,367,772
    
    
    
    24.6
    
    
    
    1,816,404
    
    
    
    20.7
    
    
    
    1,694,404
    
    
    
    21.4
    
    
    
    1,842,761
    
    
    
    25.5Federal funds sold, et al
    
    
    250,462
    
    
    
    2.2
    
    
    
    178,624
    
    
    
    1.8
    
    
    
    141,245
    
    
    
    1.6
    
    
    
    29,434
    
    
    
    .4
    
    
    
    15,762
    
    
    
    .2Total
    
    $
    11,191,608
    
    
    
    100.0
    %
    
    $
    9,635,240
    
    
    
    100.0
    %
    
    $
    8,790,505
    
    
    
    100.0
    %
    
    $
    7,893,470
    
    
    
    100.0
    %
    
    $
    7,235,890
    
    
    
    100.0
    %
  *
    
    Includes interest-bearing deposits in other banks. DEPOSIT MIX Average Balances(Dollars in thousands)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Noninterest-bearing deposits
    
    $
    2,269,720
    
    
    
    25.2
    %
    
    $
    1,856,706
    
    
    
    24.3
    %
    
    $
    1,618,838
    
    
    
    23.0
    %
    
    $
    1,438,578
    
    
    
    23.2
    %
    
    $
    1,334,282
    
    
    
    22.6
    %Interest-bearing deposits:Savings
    
    
    1,168,074
    
    
    
    13.0
    
    
    
    966,283
    
    
    
    12.7
    
    
    
    853,911
    
    
    
    12.2
    
    
    
    854,035
    
    
    
    13.8
    
    
    
    887,624
    
    
    
    15.1Checking plus interest
    
    
    1,071,877
    
    
    
    11.9
    
    
    
    873,497
    
    
    
    11.4
    
    
    
    771,186
    
    
    
    10.9
    
    
    
    718,669
    
    
    
    11.6
    
    
    
    696,862
    
    
    
    11.8Money market
    
    
    1,357,234
    
    
    
    15.1
    
    
    
    1,096,417
    
    
    
    14.4
    
    
    
    846,577
    
    
    
    12.0
    
    
    
    773,104
    
    
    
    12.5
    
    
    
    790,589
    
    
    
    13.4Certificates of deposit
        -
$100,000 and over
    
    
    1,272,327
    
    
    
    14.2
    
    
    
    1,080,347
    
    
    
    14.2
    
    
    
    1,145,569
    
    
    
    16.2
    
    
    
    852,495
    
    
    
    13.7
    
    
    
    714,600
    
    
    
    12.1Other time deposits
    
    
    1,852,622
    
    
    
    20.6
    
    
    
    1,759,160
    
    
    
    23.0
    
    
    
    1,812,589
    
    
    
    25.7
    
    
    
    1,559,973
    
    
    
    25.2
    
    
    
    1,472,268
    
    
    
    25.0Total
    
    $
    8,991,854
    
    
    
    100.0
    %
    
    $
    7,632,410
    
    
    
    100.0
    %
    
    $
    7,048,670
    
    
    
    100.0
    %
    
    $
    6,196,854
    
    
    
    100.0
    %
    
    $
    5,896,225
    
    
    
    100.0
    %
 47




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##### 



Sources of Funds Bankshares primary source of funding for its investing and lending activities
comes from deposits gathered by the 227 branches of its banking affiliates.
Raising core deposits through the branch system is a high priority for
Bankshares. Average total deposits in 2003 were $9.0 billion, representing an
increase of $1.4 billion, or 18%, over the prior year average of $7.6 billion.
The F&M acquisition accounted for approximately 50% of this growth. For the
year ended December 31, 2003, 80.3% of the funding for average earning assets
was derived from deposits, while this ratio was 79.2% for the year ended
December 31, 2002. Bankshares continues to promote its cash management services
to its commercial customers in order to maintain and expand this key source of
funding. In 2003, interest-bearing deposits represented 74.8% of average total deposits
and were $6.7 billion, reflecting growth of 16%. In 2003, the combination of
savings, checking plus interest and money market accounts increased 23% on
average. The move to these deposit products, particularly money market
accounts, reflected customers shift to more conservative investments, given
the uncertainties about the economy and the equities market. Also, the drop in
yield on money market mutual funds has made these products more competitive.
Certificates of deposit and other time deposits have increased 10% on average
in 2003 over 2002. Although deposits are Bankshares primary source of funding, advances from
the Federal Home Loan Bank (FHLB), other secured borrowings, as well as
federal funds purchased, provide additional funding. In 2003, the growth in
average total deposits, at 18%, was able to support most, but not
all, of the 16% increase in average
earning assets, resulting in a slight increase in short-term borrowing needs.
Short-term borrowings, which consist mainly of securities sold under repurchase
agreements, federal funds purchased and commercial paper, averaged
$851 million
during 2003, a slight increase over the 2002 level. During 2003, $8.6 million was repaid on previously existing long-term
debt. Bankshares issued $300 million in subordinated debt in 2003, as an
additional means of funding. Of this amount, $124.1 million was used to
pay the cash portion of the consideration relating to the acquisition
of F&M. The balance was invested in the Community Banks as
subordinated debt as part of a capital restructuring initiative. For a more in-depth discussion of the impact of this
issuance, see Interest Rate Risk below. Another key source of funding is shareholders equity. Bankshares has
consistently maintained a capital to asset ratio higher than its peers, as
reported in data furnished by our regulators. Shareholders equity averaged
$1.5 billion during 2003, which represented an increase of $239.2 million, or
19%, over the prior years average. For a more in-depth discussion of
shareholders equity and capital adequacy, see Capital Resources and Adequacy
below and Footnote No. 10 of the financial statements. 48




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##### 



RISK MANAGEMENT Bankshares has established an integrated risk management structure in
which senior management regularly identifies, measures and manages risks. The
Chief Risk Officer coordinates and directs the work of several standing
committees charged with managing the risks Bankshares faces (see below) and
provides regular reports to the Audit Committee. These committees are:  
    
    The Asset and Liability Committee (ALCO) which, as described in more detail
below, manages interest rate risk, market risk and liquidity risk.  
    
    The Credit Quality Committee: (1) oversees the establishment of consistent
credit quality standard policies; (2) monitors the functioning of the newly
established loan review function; and (3) along with the CEO and CFO,
determines the allowance for loan and lease loss reserves and related issues.  
    
    The Compliance Committee establishes global compliance guidelines and ensures
strict compliance with all relevant regulatory and statutory requirements for
Bankshares and its affiliates.  
    
    The Disclosure Committee, comprised of senior representatives of all of
Bankshares business lines, reviews Bankshares periodic disclosures and ensures
compliance with the requirements of the U.S. securities laws and best
practices.  
    
    The Technology and Operations Committee evaluates on an ongoing basis
operational risk and technology risk to Bankshares. Credit Risk Analysis Bankshares loans and commitments are substantially to borrowers located
in our immediate region. Bankshares has restricted its participation in
multibank credits where Bankshares is not the managing or agent bank. Central
to the operation of a sound and successful financial institution is the
balanced management of asset growth and credit quality. Responsibility for loan
underwriting and monitoring is clearly fixed on key management personnel in
each of our affiliates and, ultimately, on the board of directors of each
affiliate. These responsibilities are supported at the holding company level by
appropriate underwriting guidelines and effective ongoing loan review. In
addition, Bankshares has set an internal limit for each affiliate bank, that is
well below the regulatory limit, on the maximum amount of credit that may be
extended to a single borrower. 49




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##### 



() ALLOWANCE FOR LOAN LOSSES Year Ended December 31,(Dollars in thousands)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Allowance balance  beginning
    
    $
    138,601
    
    
    $
    141,463
    
    
    $
    138,612
    
    
    $
    117,997
    
    
    $
    112,423Allowance of acquired banks
    
    
    13,205
    
    
    
    
    
    
    
    
    
    
    
    5,868
    
    
    
    Charge-offs:Commercial
    
    
    (5,765
    )
    
    
    (13,864
    )
    
    
    (3,799
    )
    
    
    (2,875
    )
    
    
    (3,733
    )Construction
    
    
    (170
    )
    
    
    
    
    
    
    (90
    )
    
    
    (11
    )
    
    
    (305
    )Residential real estate
    
    
    (246
    )
    
    
    (251
    )
    
    
    (104
    )
    
    
    (322
    )
    
    
    (676
    )Consumer
    
    
    (4,367
    )
    
    
    (3,306
    )
    
    
    (3,507
    )
    
    
    (2,998
    )
    
    
    (2,614
    )Lease financing
    
    
    (1,776
    )
    
    
    (4,800
    )
    
    
    (5,828
    )
    
    
    
    
    
    
    (2,000
    )Total
    
    
    (12,324
    )
    
    
    (22,221
    )
    
    
    (13,328
    )
    
    
    (6,206
    )
    
    
    (9,328
    )Recoveries:Commercial
    
    
    1,203
    
    
    
    847
    
    
    
    795
    
    
    
    1,963
    
    
    
    1,337Construction
    
    
    136
    
    
    
    226
    
    
    
    78
    
    
    
    177
    
    
    
    24Residential real estate
    
    
    125
    
    
    
    128
    
    
    
    147
    
    
    
    144
    
    
    
    280Consumer
    
    
    1,970
    
    
    
    1,570
    
    
    
    1,725
    
    
    
    1,438
    
    
    
    1,205Lease financing
    
    
    316
    
    
    
    210
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    3,750
    
    
    
    2,981
    
    
    
    2,745
    
    
    
    3,722
    
    
    
    2,846Net charge-offs
    
    
    (8,574
    )
    
    
    (19,240
    )
    
    
    (10,583
    )
    
    
    (2,484
    )
    
    
    (6,482
    )Provision for loan losses
    
    
    12,105
    
    
    
    16,378
    
    
    
    13,434
    
    
    
    17,231
    
    
    
    12,056Allowance balance  ending
    
    $
    155,337
    
    
    $
    138,601
    
    
    $
    141,463
    
    
    $
    138,612
    
    
    $
    117,997Average loans
    
    $
    8,088,982
    
    
    $
    7,088,844
    
    
    $
    6,832,856
    
    
    $
    6,169,632
    
    
    $
    5,377,367Percent of net charge-offs to average loans
    
    
    .11
    %
    
    
    .27
    %
    
    
    .15
    %
    
    
    .04
    %
    
    
    .12
    %Period-end loans
    
    $
    9,272,160
    
    
    $
    7,312,027
    
    
    $
    6,906,246
    
    
    $
    6,693,294
    
    
    $
    5,712,130Percent of allowance for loan losses
to period-end loans
    
    
    1.68
    %
    
    
    1.90
    %
    
    
    2.05
    %
    
    
    2.07
    %
    
    
    2.07
    %
 The allowance for loan losses has been allocated to the various categories of loans. This allocation does not limit the amount of the allowance available to absorb losses from any type of loan and should not be viewed as an indicator of the specific amount or specific loan categories in which future charge-offs may ultimately occur. The tables below present this allocation at the dates shown. For a historical analysis of the allowance for loan losses, see the Allowance for Loan Losses table above. 50




---



##### 



ALLOCATION OF ALLOWANCE FOR LOAN LOSSES Allowance amount allocated as of December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999% of
    
    
    
    
    
    % of
    
    
    
    
    
    % of
    
    
    
    
    
    % of
    
    
    
    
    
    % ofTotal
    
    
    
    
    
    Total
    
    
    
    
    
    Total
    
    
    
    
    
    Total
    
    
    
    
    
    Total(Dollars in thousands)
    
    Amount
    
    Allowance
    
    Amount
    
    Allowance
    
    Amount
    
    Allowance
    
    Amount
    
    Allowance
    
    Amount
    
    AllowanceAllowance amount allocated to:Commercial
    
    $
    120,316
    
    
    
    77.5
    %
    
    $
    109,386
    
    
    
    78.9
    %
    
    $
    79,253
    
    
    
    56.0
    %
    
    $
    55,400
    
    
    
    40.0
    %
    
    $
    45,300
    
    
    
    38.4
    %Construction
    
    
    10,806
    
    
    
    7.0
    
    
    
    9,644
    
    
    
    7.0
    
    
    
    7,124
    
    
    
    5.0
    
    
    
    18,000
    
    
    
    13.0
    
    
    
    12,600
    
    
    
    10.7Residential real estate
    
    
    7,263
    
    
    
    4.7
    
    
    
    3,645
    
    
    
    2.6
    
    
    
    2,866
    
    
    
    2.0
    
    
    
    9,700
    
    
    
    7.0
    
    
    
    9,900
    
    
    
    8.4Consumer
    
    
    14,447
    
    
    
    9.3
    
    
    
    6,565
    
    
    
    4.7
    
    
    
    6,149
    
    
    
    4.3
    
    
    
    5,500
    
    
    
    4.0
    
    
    
    4,800
    
    
    
    4.1Lease financing
    
    
    2,505
    
    
    
    1.6
    
    
    
    9,361
    
    
    
    6.8
    
    
    
    26,594
    
    
    
    18.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Allowance amount not allocated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,477
    
    
    
    13.8
    
    
    
    50,012
    
    
    
    36.1
    
    
    
    45,397
    
    
    
    38.5Total
    
    $
    155,337
    
    
    
    100.0
    %
    
    $
    138,601
    
    
    
    100.0
    %
    
    $
    141,463
    
    
    
    100.0
    %
    
    $
    138,612
    
    
    
    100.0
    %
    
    $
    117,997
    
    
    
    100.0
    %
 The table below presents the percentage distribution of loan amounts in each
category, at the date shown. COMPOSITION OF LOAN PORTFOLIO December 31,(Dollars in thousands)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Commercial
    
    
    57.3
    %
    
    
    59.0
    %
    
    
    58.6
    %
    
    
    54.2
    %
    
    
    56.1
    %Construction
    
    
    11.5
    
    
    
    11.1
    
    
    
    9.4
    
    
    
    12.3
    
    
    
    11.4Residential real estate
    
    
    14.4
    
    
    
    14.6
    
    
    
    15.4
    
    
    
    16.3
    
    
    
    15.4Consumer
    
    
    16.0
    
    
    
    13.9
    
    
    
    14.4
    
    
    
    14.9
    
    
    
    15.0Lease financing
    
    
    .8
    
    
    
    1.4
    
    
    
    2.2
    
    
    
    2.3
    
    
    
    2.1Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 Allowance for Loan Losses The allowance for loan losses and the provision for loan losses charged to
expense are based on credit loss experience and estimated inherent losses in
the current portfolio, which includes evaluation of impaired loans as required
by SFAS No. 114, Accounting by Creditors for Impairment of a Loan and SFAS
No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosure. Also incorporated in determination of the allowance is SFAS
No. 5, Accounting for Contingencies; the recent guidance contained in the
Securities and Exchange Commissions SAB No. 102, Loan Loss Allowance
Methodology and Documentation; and the Federal Financial Institutions
Examination Councils Policy Statement on Allowance for Loan and Lease Losses
Methodologies and Documentation for Banks and Savings Institutions. An
allowance for loan losses is maintained sufficient to absorb losses in the loan
portfolio. The allowance is a function of specific loan allowances, general
loan allowances based on historic loan loss experience and current trends and,
lastly, allowances based on existing economic conditions that affect the
collectibility of the loan portfolio. These can include, but are not limited
to, exposure to an industry experiencing problems, changes in the nature or
volume of the portfolio, 51




---



##### 



delinquency and nonaccrual trends. The portfolio review and the calculation of
the allowance is performed by management at each affiliate bank based on its
knowledge of its loans and risk factors prevailing in its market. Other risk
factors are reviewed by Bankshares Credit Quality Committee to determine their
impact on the allowance for loan losses, with final evaluation done at the
holding company. Each affiliates reserve is dedicated to that affiliate only and is not
available to absorb losses from another affiliate. The level and adequacy of
the allowance is evaluated quarterly by Bankshares Credit Quality Committee.
All loan loss reserves are subject to annual regulatory examinations and
determination as to their methodology and adequacy. Management believes that
the allowance for loan losses is at an adequate level to absorb losses inherent
in the portfolio. The specific allowance is based on analysis of the loan portfolio by each
affiliate bank. Each loan with an outstanding balance in excess of a specified
threshold that is either on nonaccrual status or on the Watchlist will be
evaluated. The Watchlist represents loans identified and closely followed by
management. They possess certain qualities or characteristics that may lead to
collection and loss issues. Monitored loans, which are included in the
Watchlist, display characteristics suggesting they may be classified as
nonperforming loans in the near feature. The identified loans are evaluated for
potential loss by analyzing current collateral values or present value of cash
flows, as well as the capacity of the guarantor, as applicable. The specific
allowance resulting from this review increased 184% to $14.9 million from $5.3
million at December 31, 2003 and 2002, respectively. The largest portion of
this component is from MSD&Ts portfolio, at 100% and 87%, for 2003 and 2002,
respectively. The specific reserve increased primarily due to several
commercial loans at MSD&T that moved to nonaccrual status during 2003. The general allowance calculation, which is also completed on a quarterly
basis, begins with segmentation of the remaining portfolio according to loan
types as presented in external reports. Historical loss factors are maintained,
providing the starting point of the analysis. Historical loss factors are
applied to all non-Watchlist loans. Management is currently utilizing the past
five-year loss history specific to each major segment to perform the
allocation. As to Watchlist loans, loss factors are applied based on the
severity of the loan grade. Historical loss factors are adjusted to reflect the
point in time that management initially identified a potential impairment loss
in such risk-rated loans as opposed to when such loss is actually taken as a
charge-off against the allowance. This adjustment is necessary as Bankshares
practice has generally been to work with its borrowers through their economic
difficulties. Accordingly, historical losses may tend to lag the national and
regional economic cycles. Those loss factors are applied to all loans within
the same risk rating. Qualitative factors that may cause credit losses to
deviate from average historical experience are then developed. These include
but are not limited to: changes in the volume and severity of past due loans;
changes in the volume of Watchlist loans and nonaccruals; concentrations in a
specific industry or geographic location; administrative risk concerns that
include changes in the loan review and loan grading system; changes in lending
policies and procedures (which include underwriting, 52




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##### 



collection, charge-off and recovery practices); changes in management or the
staff of any previously mentioned areas; and current economic conditions and
indicators. Managements judgment and experience are key to this process. These
factors are revised to address current conditions in the portfolio. The general
allowance was $140.4 million and $133.3 million at December 31, 2003 and 2002,
respectively. Increases in the general allowance can be attributed to the
ongoing refinement of the methodology in quantifying risk segments and
estimation techniques used in the calculation. The increase in allocation to
the commercial loan portfolio is related to the F&M acquisition and the trend
in nonperformers at MSD&T. The increases in the residential real estate and
consumer allocations are related to the F&M acquisition. The decline in the
allocation to the lease financing portfolio is a result of the charge-offs and
workout of problems within that portfolio identified in 2001. Allocation of a
portion of the allowance does not preclude its availability to absorb losses in
other categories. The allowance for loan losses as a percent of loans was 1.68% at December
31, 2003, compared to 1.90% at December 31, 2002. The allowance for loan losses
as a percent of loans declined from December 31, 2002 to December 31, 2003,
principally as a result of the F&M acquisition. F&Ms loan portfolio is more
heavily weighted towards consumer and residential real estate loans. Potential
losses in these portfolios are more predictable and quantifiable, generally
resulting in a lower required allowance. F&Ms allowance at date of merger was
less than 1% of loans outstanding. Reflecting this and overall credit quality
trends, the allowance within the Community Banks, as a percentage of
loans outstanding declined from 2.01% at December 31, 2002 to 1.54% at December
31, 2003. In contrast, the allowance as a percentage of loans for MSD&T
increased from 1.72% at December 31, 2002 to 1.96% at December 31, 2003. This
increase is attributable to the additional specific allowance allocation at
MSD&T. During 2003 the provision for loan loss expense was $12.1 million,
compared to $16.4 million in 2002. The provision at MSD&T was $13.2 million for
2003, an increase of 13% over the $11.7 million provided in 2002. The Community
Banks recorded a reversal in their aggregate allowance of $1.1 million in 2003,
compared to a provision of $4.6 million in 2002. The shift in the provisioning
reflects the overall credit quality trends within the two business segments. Net charge-offs decreased to $8.6 million during 2003, compared to $19.2
million during 2002. The commercial portfolio represented the largest net
charge-off amount for 2003 at $4.6 million, or 53% of total net charge-offs.
Net charge-offs as a percentage of average loans were .11%, .27% and .15% for
the years ended December 31, 2003, 2002 and 2001, respectively. Intensive collection efforts continue after a loan is charged-off in order
to maximize the recovery of amounts previously charged-off. Recoveries as a
percent of loans charged-off were 30.4% in 2003, 13.4% in 2002 and 20.6% in
2001. In 2003, recoveries increased 26% over 2002, and charge-offs decreased
45%, symptomatic of the economy stabilizing and showing some signs of
improvement. Recoveries in a given 53




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##### 



year may not relate to loans charged-off in that year. Further details related
to the allowance for loan losses are shown in the tables above and in Footnote
No. 4 of the financial statements. NONPERFORMING ASSETS A five-year comparison of nonperforming assets is presented below: December 31,(Dollars in thousands)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Nonaccrual loans (1)Commercial
    
    $
    43,932
    
    
    $
    25,260
    
    
    $
    23,284
    
    
    $
    22,736
    
    
    $
    11,076Construction
    
    
    651
    
    
    
    1,365
    
    
    
    2,201
    
    
    
    3,394
    
    
    
    2,581Residential real estate
    
    
    3,721
    
    
    
    2,479
    
    
    
    2,251
    
    
    
    3,123
    
    
    
    3,373Consumer
    
    
    1,224
    
    
    
    261
    
    
    
    408
    
    
    
    249
    
    
    
    258Lease financing
    
    
    824
    
    
    
    4,006
    
    
    
    4,775
    
    
    
    863
    
    
    
    1,841Total
    
    
    50,352
    
    
    
    33,371
    
    
    
    32,919
    
    
    
    30,365
    
    
    
    19,129Renegotiated loans (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loans contractually past due 90 days or more
and still accruing interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total nonperforming loans
    
    
    50,352
    
    
    
    33,371
    
    
    
    32,919
    
    
    
    30,365
    
    
    
    19,129Other real estate owned
    
    
    191
    
    
    
    132
    
    
    
    181
    
    
    
    1,005
    
    
    
    1,663Total nonperforming assets
    
    $
    50,543
    
    
    $
    33,503
    
    
    $
    33,100
    
    
    $
    31,370
    
    
    $
    20,792Nonperforming loans as a percent of
period-end loans
    
    
    .54
    %
    
    
    .46
    %
    
    
    .48
    %
    
    
    .45
    %
    
    
    .33
    %Nonperforming assets as a percent of
period-end loans and other real estate owned
    
    
    .55
    %
    
    
    .46
    %
    
    
    .48
    %
    
    
    .47
    %
    
    
    .36
    %
 (1) Aggregate gross interest income of $4.1 million and $2.8 million in 2003
and 2002, respectively, on nonaccrual and renegotiated loans would have been
recorded if these loans had been accruing on their original terms throughout
the period or since origination if held for part of the period. The amount of
interest income on the nonaccrual and renegotiated loans that was recorded
totaled $2.1 million and $641 thousand in 2003 and 2002, respectively. Note: Management was monitoring loans estimated to aggregate $28.4 million
at December 31, 2003 and $24.9 million at December 31, 2002 that were not
classified as nonaccrual or renegotiated loans. These loans had characteristics
which indicated they might result in such classification in the future. Nonperforming Assets Nonperforming assets consist of nonaccrual loans, renegotiated loans and
other real estate owned (i.e., real estate acquired in foreclosure or in lieu
of foreclosure). With respect to nonaccrual loans, our policy is that,
regardless of the value of the underlying collateral and/or guarantees, no
interest is accrued on the entire balance once either principal or interest
payments on any loan become 90 days past due at the end of a calendar quarter.
All accrued and uncollected interest on such loans is eliminated from the
income statement and is recognized only as collected. If a loan is impaired and
has a specific loss allocation based on an analysis under SFAS No. 114,
Accounting by Creditors for Impairment of a Loanan amendment of FASB
Statements No. 5 and 15, all payments are then applied against the loans
principal. A loan may be put on nonaccrual status sooner than this standard if,
in managements judgment, such action is warranted. 54




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##### 



Nonperforming assets (nonaccrual loans and other real estate owned) as a
percent of period-end loans and other real estate owned was .55% at December 31, 2003, compared to .46% in the preceding year. At year-end 2003,
nonperforming assets were $50.5 million, compared to $33.5 million in 2002.
Nonperforming loans totaled $50.4 million at December 31, 2003, compared to $33.4
million at December 31, 2002. Nonperforming loans increased in three categories
of the portfolio: commercial and industrial, residential real estate and
consumer. The largest dollar increase in nonperforming loans was $18.7 million
in the commercial and industrial category, which accounted for 87.3% of
nonperforming loans at December 31, 2003. MSD&Ts nonperforming loans were
$37.5 million at December 31, 2003, representing 74.6% of Bankshares total
nonperforming loans. The increase is primarily related to three large loan
relationships that migrated from monitored to nonaccrual status during the
year. MSD&Ts nonperforming loans amounted to $22.1 million at December 31,
2002. Nonperforming loans at the Community Banks were $12.8 million at
December 31, 2003, relatively unchanged from $11.3 million at December 31,
2002. The level of monitored loans, or loans with characteristics suggesting
that they may be classified as nonperforming in the near future, increased
during the year. At December 31, 2003, monitored loans were $28.4 million,
compared to $24.9 million a year before. Two loans at MSD&T contributed $19.8
million to the current total. These loans are secured by two commercial
aircraft, which are leased to a regional commercial airline. A long-time
customer of MSD&T holds a controlling interest in the airline. In light of the
prevailing conditions in the commercial airline industry, management has
included these loans in the monitored status. The balance of the portfolio
also was examined for additional exposure to this industry and it was
determined to be minimal. This exposure was factored into the general reserve
allocation for commercial loans. Other real estate owned was $191 thousand at December 31, 2003 compared to
$132 thousand at December 31, 2002. These properties generally are sold within
a short period. Therefore, regardless of the amount, the properties generally
will have changed from year to year. Other real estate owned is carried at the
lower of cost or fair market value. Refer to the data in the Nonperforming
Assets chart above, which shows the changes in the amounts of various
categories of nonperforming assets over the last five years and sets forth the
relationship between nonperforming loans and total loans. 55




---



##### 



INTEREST RATE SENSITIVITY ANALYSIS (STATIC
    GAP) Low/Falling Interest Rate Scenario At December 31, 2003Over
    
    
    
    
    
    Over
    
    Over3 months
    
        1 year
    
        1 year
    
        5 years andWithin
    
    through
    
    cumulative
    
    through
    
    nonsensitive(Dollars in thousands)
    
        3 months
    
        1 year
    
    total
    
        5 years
    
    funds
    
    TotalEarning AssetsLoans
    
    $
    4,986,658
    
    
    $
    1,067,341
    
    
    $
    6,053,999
    
    
    $
    2,462,977
    
    
    $
    755,184
    
    
    $
    9,272,160Investment securities (1)
    
    
    206,374
    
    
    
    373,753
    
    
    
    580,127
    
    
    
    1,654,685
    
    
    
    952,702
    
    
    
    3,187,514Other earning assets
    
    
    41,161
    
    
    
    
    
    
    
    41,161
    
    
    
    
    
    
    
    
    
    
    
    41,161Total earning assets
    
    
    5,234,193
    
    
    
    1,441,094
    
    
    
    6,675,287
    
    
    
    4,117,662
    
    
    
    1,707,886
    
    
    
    12,500,835Interest-Bearing LiabilitiesManaged-rate deposits (2)Savings
    
    
    268,133
    
    
    
    
    
    
    
    268,133
    
    
    
    1,074,353
    
    
    
    
    
    
    
    1,342,486Checking plus interest
    
    
    189,616
    
    
    
    
    
    
    
    189,616
    
    
    
    1,074,493
    
    
    
    
    
    
    
    1,264,109Money market
    
    
    438,403
    
    
    
    
    
    
    
    438,403
    
    
    
    1,183,130
    
    
    
    
    
    
    
    1,621,533Time deposits
    
    
    954,783
    
    
    
    1,236,649
    
    
    
    2,191,432
    
    
    
    1,077,810
    
    
    
    14,462
    
    
    
    3,283,704Short-term borrowings
    
    
    809,021
    
    
    
    
    
    
    
    809,021
    
    
    
    
    
    
    
    
    
    
    
    809,021Long-term debt
    
    
    348,956
    
    
    
    7,500
    
    
    
    356,456
    
    
    
    98,940
    
    
    
    192,326
    
    
    
    647,722Total interest-bearing liabilities
    
    
    3,008,912
    
    
    
    1,244,149
    
    
    
    4,253,061
    
    
    
    4,508,726
    
    
    
    206,788
    
    
    
    8,968,575Gap
    
    $
    2,225,281
    
    
    $
    196,945
    
    
    $
    2,422,226
    
    
    $
    (391,064
    )
    
    $
    1,501,098
    
    
    $
    3,532,260Cumulative gap
    
    $
    2,225,281
    
    
    $
    2,422,226
    
    
    
    
    
    
    $
    2,031,162
    
    
    $
    3,532,260Cumulative gap as a percent of
earning assets
    
    
    17.80
    %
    
    
    19.38
    %
    
    
    
    
    
    
    16.25
    %
    
    
    28.26
    %Cumulative rate-sensitive assets/
cumulative rate-sensitive liabilities
    
    
    173.96
    %
    
    
    156.95
    %
    
    
    
    
    
    
    123.18
    %
    
    
    139.38
    %
 (1) Includes interest-bearing deposits in other banks. (2) Reflects behavior experience in a declining rate environment, which often
differs from legal withdrawal provisions. LOAN MATURITY SCHEDULE The following table illustrates loan diversity by maturity distribution for
commercial and construction loans as of December 31, 2003. Over 11 year
    
    through
    
    Over 5(Dollars in thousands)
    
    or less
    
    5 years
    
    years
    
    TotalCommercial
    
    $
    2,352,449
    
    
    $
    2,439,793
    
    
    $
    597,662
    
    
    $
    5,389,904Construction
    
    
    416,419
    
    
    
    580,565
    
    
    
    67,037
    
    
    
    1,064,021Total
    
    $
    2,768,868
    
    
    $
    3,020,358
    
    
    $
    664,699
    
    
    $
    6,453,925
 Of the $3.7 billion loans maturing after one year, $1.6 billion, or 42.1%,
have fixed interest rates and $2.1 billion, or 57.9%, have variable interest
rates. 56




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##### 



EARNINGS SIMULATION MODEL PROJECTIONS The following table summarizes the effect a positive 100 and 200 basis
point change and a negative 50 basis point change in interest rates would have
on Bankshares net interest income over the next 12 months. Calculated increase / (decrease) inprojected net interest incomeChange in interest rates
    
    As of December 31,(basis points)
    
    2003
    
    2002+200
    
    
    4.6
    %
    
    
    3.0
    %+100
    
    
    2.4
    %
    
    
    1.6
    %-50
    
    
    (2.1)
    %
    
    
    (2.2)
    %
 Interest Rate Risk The objective of interest rate risk management is to contain the risks
associated with interest rate fluctuations. The process involves identification
and management of the sensitivity of net interest income to changing interest
rates and other market factors. Managing to mitigate interest rate risk,
however, is not an exact science. Not only does the interval between repricing
of assets and liabilities change from day to day as the assets and liabilities
change, but also for some assets and liabilities, contractual maturity and the
actual cash flows experienced are not the same. For example, residential
mortgages and mortgage-backed securities may have contractual maturities well
in excess of five years, but depending on the interest rate carried by the
specific mortgages and the then currently prevailing rate of interest, such
mortgages and securities may be prepaid much more rapidly. Similarly, savings,
checking plus interest and money market deposits may be withdrawn on seven days
notice. While these contracts are extremely short, it has been Bankshares
experience that these funding pools, when considered as a whole, have a
multiyear duration. The Interest Rate Sensitivity Analysis (Static Gap) table
above reflects the expected contractual cash flows or maturities of assets and
liabilities, along with the scheduled opportunity to reset interest rates in a
downward rate environment. As the table reflects at December 31, 2003,
Bankshares is asset sensitive since more assets than liabilities are subject to
repricing within the next 12 months. The data in this table would suggest that
net interest income should tend to increase in a rising interest rate
environment and decrease in a declining rate environment. The absolute change
in the repricing of products varies greatly. As noted in the discussion of net
interest income, changes in short-term interest rates by the Federal Reserve
Board result in an almost similar change in the yield on Bankshares
prime-rate-based loans. In contrast, the repricing characteristics of certain
managed-rate deposits, primarily savings, checking plus interest and money
market accounts, have proven to be much less sensitive during the current
declining rate environment than they were in prior rate cycles. The current
experience has been factored into the table. Because of the limitations of the Static Gap analysis, management
primarily utilizes an earnings simulation model to monitor Bankshares risk
exposure associated with interest rate fluctuations. The model provides
management with the tools to reflect more reasonably how specific loan,
investment, deposit and debt 57




---



##### 



products will respond to changes in market interest rates. This model projects
the effects on net income based on factors such as changes in interest rates,
the shape of the yield curve and interest rate relationships. As seen in the
Earnings Simulation Model Projections table above, within a one-year horizon,
the model forecasts that, compared to the net interest income projection under
stable rates, net interest income would increase by 2.4% and 4.6% if interest
rates increased by 100 and 200 basis points, respectively, and that net
interest income would decrease by 2.1% if interest rates decreased by 50 basis
points. Given the current low level of interest rates, Bankshares is limiting
its modeling to the 50 basis point decline in future interest rates. These
results are not necessarily indicative of future actual results, nor do they
take into account certain actions that management may undertake in response to
future changes in interest rates. The Federal Reserve Boards 75 basis point reduction in short-term
interest rates over the two-year period ended December 31, 2003, continued to
compress the net interest margin. Beginning in 2002, management started taking
actions to reduce the magnitude of Bankshares risk related to further interest
rate reductions or the compression in spreads from a sustained low interest
rate environment. These actions included expanding and repositioning the
investment portfolio and adding an indexed money market account. This product
is more rate sensitive than the traditional money market product. Management
took advantage of the lower rate environment to secure long-term funding
through the issuance in April 2003 of $300 million in subordinated notes at
Bankshares. The notes carried a fixed rate of 4.65%, of which $150 million was
swapped to a floating rate as a fair value hedge. This resulted in an increase
in the amount of liabilities that reprice within the three-month time frame.
Management will continue to pursue any combination of these strategies as long
as interest rates remain low and the economy and customer borrowing needs
remain subdued. Despite these efforts, the increase in sensitivity from that
reported at December 31, 2002 is a function of the current low rate
environment. It reflects the inability to reduce rates on managed deposits to
match a drop in interest rates. It also reflects Bankshares strong capital
position. At times, Bankshares efforts to mitigate its exposure to changes in
interest rates have resulted in loan pricing policies that have not coincided
with its commercial customers preferences. As a result, MSD&T entered into a
master agreement with another bank for the purpose of making interest rate
swaps and similar interest rate protection arrangements in connection with
commercial loans made to MSD&Ts customers. This arrangement enables MSD&Ts
customers to eliminate potential volatility of interest rates and associated
risks. MSD&T will only enter into specific interest rate protection
arrangements under the master agreement with respect to which it has approved a
corresponding credit facility with the customer, and as to which the customer
is entering into a corresponding interest rate protection arrangement with
MSD&T. Management does not anticipate that these arrangements will expose
Bankshares to any risk beyond the normal credit risks undertaken with any
lending arrangement. As of December 31, 2003, one customer had entered into
such an arrangement. This swap agreement has not had a material impact on the
financial performance of Bankshares. Management anticipates that should
interest rates reverse course and 58




---



##### 



begin to rise, customer interest in this option will increase. As a matter of
policy, Bankshares does not use highly leveraged derivative instruments for
interest rate risk management. Market Risk Market risk is defined as the constraint imposed by lower market values of
assets and liabilities as interest rates and equity markets fluctuate. Changes
in market values also impact the fee income earned by IWM, where a significant
portion of the fee schedule is tied to current asset values under management or
administration. Bankshares has designated substantially all of its investment
portfolio as available-for-sale and in accordance with financial reporting
standards, this portfolio is reported at fair value. Changes in fair value, net
of tax, are reflected as a component of shareholders equity. Bankshares
maintenance of capital ratios well above regulatory requirements (see Capital
Resources and Adequacy, below) provides management with the flexibility to
utilize the available-for-sale portfolio for liquidity and interest rate risk
management needs, even during a period when valuations are depressed.
Maintaining a fairly short duration in the portfolio also mitigates market
risk. Liquidity Risk Liquidity risk is the possibility that Bankshares will not be able to fund
present and future financial obligations. The objective of liquidity management
is to maintain the ability to meet commitments to fund loans, purchase
securities and repay deposits and other liabilities in accordance with their
terms. Core deposits and the available-for-sale investment portfolio are key
elements in meeting this objective. For the year ended December 31, 2003, core
deposits, total deposits less certificates of deposit  $100,000 and over,
averaged $7.7 billion. This represents a 17% increase over the $6.6 billion
average balance for 2002. The percentage of average loans funded by core
deposits improved to 95.4% in 2003 from 92.4% in 2002. Although not viewed as
core deposits, a substantial portion of short-term borrowings, comprised of
securities sold under agreements to repurchase and commercial paper, originate
from core deposit relationships tied to the overnight cash management program
offered to customers. By limiting the maturity of securities and maintaining a conservative
investment posture, management can rely on the investment portfolio to help
meet any short-term funding needs. U.S. Treasury and agency securities averaged
$1.7 billion in 2003, a 17% decrease from the average of $2.1 billion the prior
year. These securities provide the greatest liquidity and represented 15% of
average earning assets for 2003, compared to 22% in 2002. In addition to these
sources, Bankshares has access to national markets for certificates of deposit,
commercial paper and debt financing. Should it need to supplement further its
liquidity, Bankshares has $1.8 billion in lines with the FHLB and back-up
commercial paper lines of $40 million with commercial banks. Under covenants
related to its 6.72% and 6.80% unsecured senior notes, Bankshares is required
to obtain approval from these note holders if it incrementally borrows in
excess of $150 million. Increases in borrowings as a result of businesses
acquired do not count towards the incremental borrowing amount. Bankshares has
rarely had a need to access this source of funding and would not expect its
need to exceed this threshold in the near term. 59




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##### 



(Bar Chart)
    
    (Bar Chart)


Capital Resources and Adequacy

Maintenance of exceptional capital strength has long been a guiding
principle of Bankshares. Ample capital is necessary to sustain growth, to
provide a measure of protection against unanticipated declines in asset values
and to safeguard the funds of depositors. Capital also provides a source of
funds to meet loan demand and enables Bankshares to manage its assets and
liabilities effectively.

Shareholders equity increased 39% to $1.8 billion at year-end 2003 from
$1.3 billion at year-end 2002. The increase can be attributed to the
acquisition of F&M and earnings growth offset by increased cash dividend
payments. Book value per share was $23.08 at December 31, 2003, compared to
$19.24 at December 31, 2002. The ratio of average equity to average assets was
12.51% in 2003 and 12.43% in 2002, ranking Bankshares among the most strongly
capitalized banks in the industry. Excluding intangible assets, average tangible equity
to average tangible assets was 10.34% in 2003 and 11.45% in 2002. The ratio in
2003 was lower than in 2002 due to $124.1 million of the consideration for the
F&M acquisition being paid in cash. The ratio was also negatively impacted by
the increased dividends paid.

While maintaining exceptional capital strength and financing growth of the
corporation, Bankshares also has pursued a share repurchase program. Through
December 2003, the Board of Directors authorized the repurchase of up to
16,000,000 shares with 14,523,700 shares of common stock repurchased under
these programs. At December 31, 2003, there remained 1,476,300 shares of common
stock authorized for repurchase. The share repurchase program has supported
managements strategy to enhance shareholder value. Management has repurchased
shares in open market transactions and returned capital to shareholders in the
form of dividends during periods when capital accumulates at a rate in excess
of that required to support the growth of earning assets. See Footnote No.10 of
the financial statements and the Statements of Changes in Consolidated
Shareholders Equity below for details related to the share repurchase
program.

60



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##### 



Various bank regulatory agencies have implemented stringent capital
guidelines, which are directly related to a banks risk-based capital ratios.
By regulatory definition, a well-capitalized institution, such as Bankshares,
faces fewer regulatory constraints on its operations than institutions
classified at the other end of the spectrum as critically undercapitalized. For
instance, only well-capitalized banks can accept brokered deposits without
advance regulatory approval. In addition, FDIC deposit insurance premium rates
are significantly lower for banks with higher capital levels, compared to
poorly capitalized banks. The Risk-Based Capital Ratios graph above shows
that Bankshares has maintained capital levels well in excess of the regulatory
minimum over each of the last five years. For a further discussion of the
regulatory capital requirements that apply to Bankshares, see Footnote No. 10
of the financial statements. Bank regulatory agencies also impose certain
restrictions on transactions among and between subsidiaries of bank holding
companies, including extensions of credit, transfers of assets and payments of
dividends. Historically, the dividend restrictions have not limited dividend
payments at Bankshares, and it is not anticipated that they will have a
constraining effect in the future. In addition to dividend restrictions,
capital requirements are also affected by off-balance sheet risks. These
include such items as letters of credit and commitments to extend credit. Refer
to Footnote No. 9 of the financial statements for information regarding
Bankshares commitments. DIVIDENDS 2003
    
    2002Quarter
    
    4th
    
    3rd
    
    2nd
    
    1st
    
    4th
    
    3rd
    
    2nd
    
    1stCommon dividends
    
    
    .33
    
    
    
    .33
    
    
    
    .33
    
    
    
    .30
    
    
    
    .30
    
    
    
    .30
    
    
    
    .30
    
    
    
    .28
 Bankshares has paid quarterly cash dividends on its common stock since
September 1970 when such stock was first issued. Bankshares intends to consider
quarterly payment of dividends on its common stock, but such payment is
necessarily dependent on many factors, including the future earnings and
financial requirements of Bankshares and its affiliates. For the 27th consecutive year, the annual dividend paid on common stock
exceeded the prior years level. Effective with the June 2003 dividend, the
quarterly cash dividend was increased 10% to $.33 from $.30 per share. Over the
last five years, dividends have increased at a compound growth rate of 8.4%.
Management will periodically evaluate the dividend rate in light of Bankshares
capital strength, profitability and conditions prevailing in the economy in
general and the banking industry in particular. The annual dividends paid per
common share were $1.29 in 2003 and $1.18 in 2002. Total cash dividends paid
were $95.8 million in 2003 and $81.9 million in 2002. The Dividends table
above presents quarterly dividends paid over the last two years. 61




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##### 



RECENT COMMON STOCK PRICES
Market Prices* 2003
    
    2002Quarter
    
    4th
    
    3rd
    
    2nd
    
    1st
    
    4th
    
    3rd
    
    2nd
    
    1stHigh
    
    
    45.95
    
    
    
    42.49
    
    
    
    41.30
    
    
    
    40.47
    
    
    
    40.39
    
    
    
    41.40
    
    
    
    44.80
    
    
    
    45.36Low
    
    
    39.76
    
    
    
    38.91
    
    
    
    33.90
    
    
    
    30.16
    
    
    
    32.60
    
    
    
    32.07
    
    
    
    38.89
    
    
    
    41.80
 * The stock of Mercantile Bankshares Corporation is traded on the Nasdaq
National Market under the symbol MRBK. The quotations represent actual
transactions. As of February 27, 2004, there were 10,508 shareholders of record. OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS Off-Balance Sheet Arrangements Bankshares consolidates majority-owned subsidiaries that it controls.
Other affiliates, including certain joint ventures in which there is less than
20% ownership, are generally carried at lower of cost or fair market value.
Bankshares does not dispose of troubled loans or problem assets by means of
unconsolidated special purpose entities. Bankshares mortgage banking subsidiary, as a Fannie Mae Delegated
Underwriting and Servicing lender, has a loss sharing arrangement for loans
originated on behalf of and sold to Fannie Mae. In the ordinary course of
business, Bankshares routinely originates and sells mortgage loans on the
secondary market. Typically these loans are sold under forward commitments on a
servicing released basis. Refer to Footnote No. 9 of the financial statements for
additional information regarding commitments relating to mortgage banking. Contractual Obligations and Other Commitments Through the normal course of business, Bankshares enters into certain
contractual obligations and other commitments. Such obligations generally
relate to funding operations through debt arrangements as well as leases of
premises and equipment. These commitments for 2004 include budgeted requests
for approximately $31.6 million of capital expenditures spread relatively
evenly between improvements to existing banking offices and replacement of
furniture, equipment and technology. While these items have been included in
the budget for 2004, they are subject to a review and approval process prior to
funding. For further information on commitments, see Footnotes No. 5, 8 and 9
of the financial statements. As a financial services provider, Bankshares routinely enters into
commitments to extend credit, including loan commitments, standby letters of
credit and financial guarantees. While contractual obligations represent future
cash requirements of Bankshares, a significant portion of commitments to extend
credit are likely to expire without being drawn upon. Such commitments are
subject to the same credit policies and approval processes accorded to loans
made by Bankshares. Additionally, Bankshares has committed to invest funds in
third-party private equity investments. 62




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The table below summarizes significant contractual obligations and commitments: Long-term
    
    Operating(Dollars in thousands)
    
    debt
    
    leases
    
    Total2004
    
    $
    7,969
    
    
    $
    12,157
    
    
    $
    20,1262005
    
    
    6,382
    
    
    
    10,867
    
    
    
    17,2492006
    
    
    66,733
    
    
    
    9,498
    
    
    
    76,2312007
    
    
    5,333
    
    
    
    8,843
    
    
    
    14,1762008
    
    
    22,038
    
    
    
    5,106
    
    
    
    27,144Thereafter
    
    
    539,267
    
    
    
    24,693
    
    
    
    563,960Total
    
    $
    647,722
    
    
    $
    71,164
    
    
    $
    718,886Other commitmentsCommitments to extend credit
    
    
    
    
    
    
    
    
    
    $
    3,608,700Standby letters of credit and financial guarantees
    
    
    
    
    
    
    
    
    
    
    281,400Unfunded third-party private equity investments
    
    
    
    
    
    
    
    
    
    
    16,102
 RECENT FASB PRONOUNCEMENTS On January 17, 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46, Consolidation of Variable Interest Entities an
interpretation of ARB No. 51 (FIN 46). The FASB has deferred the
implementation of FIN 46 for all public entities to the first reporting period
ending after December 15, 2003. This deferral applies to all variable interest
entities both financial and nonfinancial in nature. Bankshares is currently in
the process of evaluating the impact of FIN 46. This Interpretation does not
have a material impact on Bankshares financial statements. In April 2003, FASB issued SFAS No. 149, Amendment of Statement No.133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. In particular, SFAS No. 149 clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a
derivative and when a derivative contains a financing component that warrants
special reporting in the statement of cash flows. This Statement is generally
effective for contracts entered into or modified after June 30, 2003 and did
not have a material impact on Bankshares financial statements. In May 2003, FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
This Statement does not have a material impact on Bankshares financial
statements. In December 2003, FASB issued SFAS No. 132 revised 2003, Employers
Disclosures about Pensions and Other Postretirement Benefitsan amendment of
FASB Statements No. 87, 88, and 106. The revised SFAS No. 132 does not change
the measurement or recognition of prior statements, but requires additional 63




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disclosure to those in the original SFAS No. 132. The revised SFAS No. 132
retains the disclosures required by the original SFAS No. 132 and additionally
requires disclosures including describing the type of plan assets, investment
strategy, measurement dates, plan obligations, cash flows and components of net
periodic benefit cost recognized. This revised Statement will have no impact on
Bankshares financial statements. See Footnote No 13 of the financial
statements for required disclosure. In December 2003, 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, which addresses the accounting for
differences between contractual cash flows and expected cash flows for loans
acquired in a transfer when those differences are attributable at least in part
to credit quality. It includes such loans acquired in purchase business
combinations where there is evidence of deterioration in credit quality since
origination. This SOP requires the difference between expected cash flows and
the purchase price to be accreted as an adjustment to yield over the life of
the acquired loans; the difference between contractual cash flows an expected
cash flows is not subject to accretion. This SOP would represent a change from
current practice where the allowance for loan losses is carried over in
purchase accounting. The SOP is effective for loans acquired beginning after
December 15, 2004. Bankshares is currently evaluating the impact it will have
on operations and financial statements. REVIEW OF EARNINGS AND BALANCE SHEET FOR 2002 TO 2001 Performance & Operating Analysis Net income in 2002 was $190.2 million, compared with $181.3 million in
2001, a 5% increase. Diluted net income per common share was $2.72 in 2002
compared with $2.55 in 2001, an increase of 7%. Excluding goodwill
amortization, 2001 net income and diluted net income per common share would
have increased by $8.9 million or $0.12, respectively. Return on average assets
was 1.88%, and return on average equity was 15.12% in 2002 compared with 1.96%
and 15.15%, respectively, in 2001. Average assets increased 10% to $10.1
billion, average deposits increased 8% to $7.6 billion and average loans
increased 4% to $7.1 billion for the year ended December 31, 2002 compared with
the prior year. Net interest income on a fully tax-equivalent basis, was $448.0 million in
2002, compared with $424.7 million in 2001. Net interest income was affected
by both changes in the level of interest rates and changes in the amount and
composition of interest-earning assets and interest-bearing liabilities. In
the fourth quarter of 2002 the Federal Reserve Board reduced short-term rates
by 50 basis points. Bankshares is asset sensitive, and in the falling rate
environment, the net interest margin (net interest income expressed as a
percent of average earning assets) tends to compress, and growth in net
interest income tends to slow. Even though Bankshares was able to improve the
net interest rate spread, the net interest margin declined to 4.65% in 2002
from 4.83% in 2001, primarily due to the reduced benefit derived from
noninterest-bearing funds. This benefit fell from 105 basis points for 2001 to
60 basis points for 2002. 64




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##### 



Noninterest income decreased by 1% to $143.8 million in 2002 from $145.5
million in 2001, largely due to a $3.4 million decrease reported on gains on
the sale of equity securities held in the available-for-sale portfolio.
Additionally, a decrease in IWM revenue of $896 thousand was primarily due to
declines in equity market valuations during 2002. Mortgage banking related fees
for 2002 were down $2.6 million due to lower volumes in commercial mortgage
loan origination and the outsourcing of the retail mortgage origination
business. Other noninterest income, including service charges on deposit
accounts, remained strong, increasing by $5.2 million in 2002 compared to 2001. Noninterest expenses totaled $272.6 million in 2002, compared with $264.0
million in 2001, an increase of $8.6 million, or 3%. After excluding the
amortization of goodwill in 2001, total noninterest expenses for 2002 increased
by $17.7 million, or 7%, over the 2001 total of $254.9 million. More than 70%
($12.5 million) of the increase is attributable to the increase in salaries and
benefits. Contributing to this overall increase were: $2.5 million in incentive
compensation; $1.8 million in stock option and restricted stock award expense;
$1.7 million in severance costs, mostly associated with the IWM reorganization;
$1.5 million in pension costs, mainly due to lower returns on plan assets; and
$1.4 million in health insurance costs. Net occupancy expense increased by $1.5 million during 2002 due mainly to
higher rental rates, higher insurance costs and improvements to branch
facilities. Bankshares also continued to expand its use of its headquarters
building, thereby reducing the number of outside tenants. Higher software maintenance and rental costs accounted for most of the
$456 thousand increase in 2002 furniture and equipment expenses. Increases in
professional fees of $1.7 million; charitable contributions of $1.3 million;
and debit card processing fees of $333 thousand accounted for the remainder of
the increase in 2002 noninterest expense. Segment Reporting Community Banks Net income in 2002 was $119.6 million, compared with $98.5 million in 2001, a
21% increase. Discontinuing the amortization of goodwill accounted for 8% of
the increase. Excluding goodwill amortization expense, net income would have
been $106.4 for 2001. For the year ended December 31, 2002, average assets
increased 11% to $6.3 billion, average deposits increased 10% to $5.1 billion
and average loans increased 7% to $4.3 billion. The Community Banks provided
66% of the average total deposit base and 60% of the average loan base of
Bankshares in 2002, reflecting a slight increase in both proportions compared
with 2001. Net interest income on a fully tax-equivalent basis was $301.5 million in 2002,
compared with $282.0 million in 2001. The increase in net interest income was
attributable to a 10% increase in average earning 65




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##### 



assets, which offset a 12 basis point decline in the net interest margin. The
net interest margin declined to 5.05% in 2002 from 5.17% in 2001. Noninterest income increased to $50.0 million in 2002 from $46.3 million in
2001, largely due to a $2.5 million, or 10%, increase in service charges on
deposits and loan related fees. Additionally, other income consisting of
revenues from electronic banking and merchant card processing, safe deposit box
rent, travelers checks, money orders and bill collection increased by $1.0
million, or 5%, from the 2001 levels. Noninterest expense totaled $151.3 million in 2002, compared with $145.4
million in 2001, an increase of $5.9 million, or 4%. After excluding the
amortization of goodwill in 2001, total noninterest expenses for 2002 increased
by $13.8 million, or 10%, over the 2001 total of $137.5 million. The increase
was primarily related to increases in salaries and employee benefit expense of
$5.5 million. Normal merit increases and incentive compensation contributed to
this increase. In addition, occupancy and equipment expenses increased $6.0
million due to higher rent and facility and technology maintenance cost. MSD&T Banking Net income in 2002 was $64.1 million compared with $63.3 million in 2001, a 1%
increase. Average assets increased 10% to $4.1 billion, average deposits
increased 4% to $2.7 billion and average loans decreased marginally, remaining
at $2.8 billion for the year ended December 31, 2002 compared to the prior
year. MSD&T Banking provided 34% of the average total deposit base and 40% of
the average loan base of Bankshares in 2002. Net interest income on a fully tax-equivalent basis was $148.9 million in 2002,
compared with $143.6 million in 2001. This increase in net interest income was
attributable to a 10% increase in average earning assets, consisting mainly of
a 61% growth in average investment securities to $848 million. This was offset
by a 23 basis point decline in the net interest margin. The net interest margin
declined to 3.81% in 2002 from 4.04% in 2001. The growth in the average
investment securities reflects the investment of the proceeds from the issuance
of $200 million of unsecured senior notes late in November 2001. Noninterest income decreased slightly to $40.2 million or less than 1% from
$40.3 million in 2001, largely due to a $2.7 million, or 22%, decrease in
mortgage banking fees. This decrease was attributable to lower commercial loan
originations as well as the outsourcing of retail mortgage originations. All
other noninterest income increased $2.6 million, or 9%, from the 2001 levels. Noninterest expense totaled $89.9 million in 2002, compared with $86.1 million
in 2001, an increase of $3.8 million, or 4%. After excluding the amortization
of goodwill in 2001, total noninterest expense for 2002 increased by $5.0
million, or 6%, over the 2001 total of $84.9 million. The increase was
primarily 66




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##### 



related to salaries and employee benefit expense increases totaling $3.8
million. Normal merit increases and incentive compensation contributed to this
increase. IWM Net income in 2002 was $12.1 million, compared with $16.3 million in 2001, a
26% decrease. Pretax profit margins were 29.6% and 39.4% for 2002 and 2001,
respectively. These declines reflected decreasing equity market values and
ongoing reorganization costs for the division. Assets under administration by
IWM decreased by 7% to $36.0 billion for the year ended December 31, 2002
compared to the prior year. Investment and wealth management fee income decreased to $68.0 million, or 2%,
in 2002 from $69.0 million in 2001. Revenues from IWM represented the largest
source of Bankshares noninterest income at 48%. Noninterest expense totaled $45.6 million in 2002, compared with $40.5 million
in 2001, an increase of $5.1 million, or 13%. The increase was related to an
increase of $3.2 million in salaries and employee benefit expenses.
Approximately half of the salary expense increase in 2002 was related to
severance costs associated with the reorganization of IWM. Credit Quality Measures Provision for loan losses was $16.4 million in 2002, compared to $13.4
million in 2001. Net charge-offs in 2002 were $19.2 million, or .27% of
average total loans, compared with $10.6 million, or .15%, in 2001. The
allowance for loan losses was $138.6 million, or 1.90% of total loans at
December 31, 2002, compared with $141.5 million, or 2.05%, at December 31,
2001. At December 31, 2002, total nonperforming assets were $33.5 million, or
..46% of period-end loans and other real estate owned, compared with $33.1 million, or .48%, at December 31,
2001. The 2002 increase was primarily in the commercial portfolio. Capital Ratios The ratio of average shareholders equity to average total assets remained
strong at 12.43% at December 31, 2002 and 12.97% at December 31, 2001.
Bankshares total risk-based capital ratio at December 31, 2002 was 16.29% and
its Tier I capital ratio was 15.00%, exceeding the minimum regulatory
guidelines of 8% and 4%, respectively. Bankshares leverage ratios were 11.20%
and 11.60% at December 31, 2002 and 2001, respectively, exceeding the minimum
regulatory guideline of 4%. As of December 31, 2002, all of Bankshares bank
affiliates exceeded all capital adequacy requirements to be considered
well-capitalized. For additional information on Bankshares risk-based
capital ratio see Footnote No. 10 of the financial statements. 67




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##### 



ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item 7A is set forth under the captions
Risk Management, Interest Rate Risk, Interest Rate Sensitivity Analysis
(Static Gap) and Earnings Simulation Model Projections in Item 7. 68




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##### 



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements Statement of Responsibility Management of Mercantile Bankshares Corporation (Bankshares) is
responsible for the preparation and fair presentation of the financial
statements and other financial information contained in this report. The
accompanying consolidated financial statements were prepared in conformity with
accounting principles generally accepted in the United States of America and
include, as necessary, best estimates and judgments by management. Other
financial information contained in this annual report is presented on a basis
consistent with the consolidated financial statements. Management understands and recognizes the importance of safeguarding
Bankshares assets. In connection with this, management believes that
Bankshares maintains a system of internal controls that is adequate to ensure
that transactions are properly authorized, that its assets are safeguarded
against unauthorized acquisition, use or disposition, and that its financial
records are reliable. Bankshares maintains systems of controls that it believes
are reasonably designed to provide management with timely and accurate
information about Bankshares operations. The system of internal controls
includes, but is not limited to, maintaining internal audit, legal and
compliance departments, establishing formal written policies, procedures and
codes of conduct, training personnel and segregating key duties and functions,
where appropriate. The Audit Committee of the Board of Directors participates in reviewing
the adequacy of the system of internal controls and financial reporting. The
Audit Committee consists of directors who are independent from Bankshares. They
meet regularly with management, the internal auditors and the independent
auditors to review the scope of their work and findings. There are inherent limitations in the effectiveness of any system of
internal controls, including the possibility of human error and circumvention
or overriding of controls. Accordingly, even effective internal controls can
provide only reasonable assurance with respect to financial statement
preparation. Further, because of changes in conditions, the effectiveness of
internal controls may vary over time. The independent accounting firm of PricewaterhouseCoopers LLP (PwC) has
performed an audit of Bankshares financial statements. As part of the audit,
management believes it has made available to PwC all of the financial records,
related data and minutes of shareholders and directors meetings that PwC
believed were necessary in order to render their independent audit report. As
part of its audit, PwC obtains specific representations from management of
Bankshares. Management believes that all representations made to PwC during its
audit were valid and accurate. A copy of the independent auditors report
follows. /s/ Ned Kelly
Edward J. Kelly III
President and Chief Executive Officer /s/ Terry L. Troupe
Terry L. Troupe
Chief Financial Officer 69




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##### 



Report of Independent Auditors To the Board of Directors and
Shareholders of Mercantile Bankshares Corporation In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income and of changes in shareholders
equity and of cash flows present fairly, in all material respects, the
financial position of Mercantile Bankshares Corporation and its subsidiaries
(the Company) at December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America. These financial statements are the
responsibility of the Companys management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion. /s/ PricewaterhouseCoopers LLP Baltimore, Maryland
January 27, 2004 70




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##### 



Consolidated Balance Sheets December 31,(Dollars in thousands, except per share data)
    
    2003
    
    2002ASSETSCash and due from banks
    
    $
    321,882
    
    
    $
    281,130Interest-bearing deposits in other banks
    
    
    14,583
    
    
    
    358Federal funds sold
    
    
    26,236
    
    
    
    264,293Total cash and cash equivalents
    
    
    362,701
    
    
    
    545,781Investment securities available-for-sale (1), (3)
    
    
    3,123,514
    
    
    
    2,586,192Investment securities held-to-maturity (1), (3)
    
    
    49,417
    
    
    
    53,391Loans held-for-sale (1)
    
    
    14,925
    
    
    
    Loans (4)
    
    
    9,272,160
    
    
    
    7,312,027Less: allowance for loan losses (1), (4)
    
    
    (155,337
    )
    
    
    (138,601
    )Loans, net
    
    
    9,116,823
    
    
    
    7,173,426Bank premises and equipment, net (1), (5)
    
    
    140,922
    
    
    
    102,428Other real estate owned, net (1)
    
    
    191
    
    
    
    132Goodwill, net (1)
    
    
    522,173
    
    
    
    102,705Other intangible assets, net (19)
    
    
    56,223
    
    
    
    7,530Other assets
    
    
    308,583
    
    
    
    218,791Total assets
    
    $
    13,695,472
    
    
    $
    10,790,376LIABILITIESDeposits:Noninterest-bearing deposits
    
    $
    2,750,721
    
    
    $
    2,086,745Interest-bearing deposits
    
    
    7,511,832
    
    
    
    6,174,195Total deposits
    
    
    10,262,553
    
    
    
    8,260,940Short-term borrowings (7)
    
    
    809,021
    
    
    
    823,385Accrued expenses and other liabilities
    
    
    134,735
    
    
    
    94,479Long-term debt (8)
    
    
    647,722
    
    
    
    287,214Total liabilities
    
    
    11,854,031
    
    
    
    9,466,018COMMITMENTS AND CONTINGENCIES(5), (9)SHAREHOLDERS EQUITYPreferred stock, no par value; authorized 2,000,000 shares; issued and outstanding  NoneCommon stock, $2 par value; authorized 130,000,000 shares; issued shares - 79,772,705 (2003)
and 68,836,092 (2002); restricted shares - 101,932 (2003) and 76,250 (2002)
    
    
    159,545
    
    
    
    137,672Capital surplus
    
    
    548,664
    
    
    
    120,577Retained earnings
    
    
    1,110,748
    
    
    
    1,010,248Accumulated other comprehensive income (loss)
    
    
    22,484
    
    
    
    55,861Total shareholders equity
    
    
    1,841,441
    
    
    
    1,324,358Total liabilities and shareholders equity
    
    $
    13,695,472
    
    
    $
    10,790,376
 See Notes to Consolidated
Financial Statements. 71




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##### 



Statements of Consolidated Income FOR THE YEARS ENDED DECEMBER 31,(Dollars in thousands, except per share data)
    
    2003
    
    2002
    
    2001INTEREST INCOMEInterest and fees on loans (1)
    
    $
    472,379
    
    
    $
    468,298
    
    
    $
    543,020Interest and dividends on investment securities:Taxable interest income
    
    
    109,767
    
    
    
    109,699
    
    
    
    97,064Tax-exempt interest income
    
    
    2,746
    
    
    
    1,895
    
    
    
    1,993Dividends
    
    
    754
    
    
    
    1,055
    
    
    
    1,283Other investment income
    
    
    6,968
    
    
    
    211
    
    
    
    198Total interest and dividends on investment securities
    
    
    120,235
    
    
    
    112,860
    
    
    
    100,538Other interest income
    
    
    3,961
    
    
    
    5,228
    
    
    
    6,208Total interest income
    
    
    596,575
    
    
    
    586,386
    
    
    
    649,766INTEREST EXPENSEInterest on deposits (6)
    
    
    93,190
    
    
    
    122,569
    
    
    
    199,703Interest on short-term borrowings
    
    
    5,604
    
    
    
    11,259
    
    
    
    25,120Interest on long-term debt
    
    
    18,451
    
    
    
    10,754
    
    
    
    6,702Total interest expense
    
    
    117,245
    
    
    
    144,582
    
    
    
    231,525NET INTEREST INCOME
    
    
    479,330
    
    
    
    441,804
    
    
    
    418,241Provision for loan losses (1),(4)
    
    
    12,105
    
    
    
    16,378
    
    
    
    13,434NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    
    
    467,225
    
    
    
    425,426
    
    
    
    404,807NONINTEREST INCOMEInvestment and wealth management (1)
    
    
    78,933
    
    
    
    68,435
    
    
    
    69,331Service charges on deposit accounts
    
    
    36,912
    
    
    
    31,454
    
    
    
    28,085Mortgage banking related fees
    
    
    11,111
    
    
    
    9,945
    
    
    
    12,582Investment securities gains and (losses) (3)
    
    
    7,137
    
    
    
    846
    
    
    
    4,248Other income
    
    
    42,498
    
    
    
    33,070
    
    
    
    31,244Total noninterest income
    
    
    176,591
    
    
    
    143,750
    
    
    
    145,490NONINTEREST EXPENSESSalaries
    
    
    160,326
    
    
    
    133,200
    
    
    
    123,712Employee benefits (13)
    
    
    37,717
    
    
    
    32,171
    
    
    
    29,175Net occupancy expense of bank premises (1),(5)
    
    
    20,756
    
    
    
    15,904
    
    
    
    14,440Furniture and equipment expenses (1),(5)
    
    
    31,610
    
    
    
    24,464
    
    
    
    24,008Communications and supplies
    
    
    15,188
    
    
    
    13,375
    
    
    
    13,086Amortization of goodwill
    
    
    
    
    
    
    
    
    
    
    9,072Other expenses
    
    
    71,850
    
    
    
    53,494
    
    
    
    50,466Total noninterest expenses
    
    
    337,447
    
    
    
    272,608
    
    
    
    263,959Income before income taxes
    
    
    306,369
    
    
    
    296,568
    
    
    
    286,338Applicable income taxes (1),(11)
    
    
    109,555
    
    
    
    106,330
    
    
    
    105,043NET INCOME
    
    $
    196,814
    
    
    $
    190,238
    
    
    $
    181,295NET INCOME PER SHARE OF COMMON STOCK(10):Basic
    
    $
    2.70
    
    
    $
    2.74
    
    
    $
    2.57Diluted
    
    $
    2.68
    
    
    $
    2.72
    
    
    $
    2.55DIVIDENDS PAID PER COMMON SHARE
    
    $
    1.29
    
    
    $
    1.18
    
    
    $
    1.10
 See notes to consolidated financial statements. 72




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##### 



Statements of Changes in Consolidated Shareholders Equity FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accumulated OtherCommon
    
    Capital
    
    Retained
    
    Comprehensive(Dollars in thousands, except per share data)
    
    Total
    
    Stock
    
    Surplus
    
    Earnings
    
    Income (Loss)BALANCE, DECEMBER 31, 2000
    
    $
    1,173,301
    
    
    $
    142,198
    
    
    $
    214,454
    
    
    $
    800,781
    
    
    $
    15,868Net income
    
    
    181,295
    
    
    
    
    
    
    
    
    
    
    
    181,295Unrealized gains (losses) on securities available-for-sale,
net of reclassification adjustment, net of taxes
    
    
    10,361
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,361Comprehensive income
    
    
    191,656Cash dividends paid:Common stock ($1.10 per share)
    
    
    (77,597
    )
    
    
    
    
    
    
    
    
    
    
    (77,597
    )Issuance of 108,094 shares for dividend reinvestment and
stock purchase plan
    
    
    4,139
    
    
    
    216
    
    
    
    3,923Issuance of 23,754 shares for employee stock purchase
dividend reinvestment plan
    
    
    933
    
    
    
    47
    
    
    
    886Issuance of 139,612 shares for employee stock option plan
    
    
    2,324
    
    
    
    279
    
    
    
    2,045Purchase of 1,594,500 shares under stock repurchase plan
    
    
    (65,572
    )
    
    
    (3,189
    )
    
    
    (62,383
    )Vested stock options
    
    
    1,022
    
    
    
    
    
    
    
    1,022
    
    
    
    
    
    
    
    BALANCE, DECEMBER 31, 2001
    
    
    1,230,206
    
    
    
    139,551
    
    
    
    159,947
    
    
    
    904,479
    
    
    
    26,229Net income
    
    
    190,238
    
    
    
    
    
    
    
    
    
    
    
    190,238Unrealized gains (losses) on securities available-for-sale,
net of reclassification adjustment, net of taxes
    
    
    29,632
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,632Comprehensive income
    
    
    219,870Cash dividends paid:Common stock ($1.18 per share)
    
    
    (81,909
    )
    
    
    
    
    
    
    
    
    
    
    (81,909
    )Issuance of 107,680 shares for dividend reinvestment and
stock purchase plan
    
    
    3,872
    
    
    
    215
    
    
    
    3,657Issuance of 23,231 shares for employee stock purchase
dividend reinvestment plan
    
    
    921
    
    
    
    46
    
    
    
    875Issuance of 237,421 shares for employee stock option plan
    
    
    3,994
    
    
    
    475
    
    
    
    3,519Issuance of 76,250 shares for restricted stock awards
    
    
    3,430
    
    
    
    153
    
    
    
    3,277Deferred compensation  restricted stock awards
    
    
    (2,560
    )
    
    
    
    
    
    
    
    
    
    
    (2,560
    )Purchase of 1,384,200 shares under stock repurchase plan
    
    
    (53,953
    )
    
    
    (2,768
    )
    
    
    (51,185
    )Vested stock options
    
    
    487
    
    
    
    
    
    
    
    487
    
    
    
    
    
    
    
    BALANCE, DECEMBER 31, 2002
    
    
    1,324,358
    
    
    
    137,672
    
    
    
    120,577
    
    
    
    1,010,248
    
    
    
    55,861Net income
    
    
    196,814
    
    
    
    
    
    
    
    
    
    
    
    196,814Unrealized gains (losses) on securities available-for-sale,
net of reclassification adjustment, net of taxes
    
    
    (33,377
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33,377
    )Comprehensive income
    
    
    163,437Cash dividends paid:Common stock ($1.29 per share)
    
    
    (95,842
    )
    
    
    
    
    
    
    
    
    
    
    (95,842
    )Issuance of 10,379,710 shares for bank acquisition
    
    
    428,059
    
    
    
    20,759
    
    
    
    407,300Fair value of 322,528 options related to
employee stock option plan of acquired bank
    
    
    5,944
    
    
    
    
    
    
    
    5,944Issuance of 124,268 shares for dividend reinvestment and
stock purchase plan
    
    
    4,696
    
    
    
    248
    
    
    
    4,448Issuance of 23,737 shares for employee stock purchase
dividend reinvestment plan
    
    
    929
    
    
    
    47
    
    
    
    882Issuance of 312,466 shares for employee stock option plan
    
    
    5,744
    
    
    
    625
    
    
    
    5,119Issuance of 101,932 shares for restricted stock awards
    
    
    3,611
    
    
    
    205
    
    
    
    3,406Deferred compensation  restricted stock awards
    
    
    (472
    )
    
    
    
    
    
    
    
    
    
    
    (472
    )Purchase of 5,500 shares under stock repurchase plan
    
    
    (212
    )
    
    
    (11
    )
    
    
    (201
    )Vested stock options (14)
    
    
    1,189
    
    
    
    
    
    
    
    1,189
    
    
    
    
    
    
    
    BALANCE, DECEMBER 31, 2003(10)
    
    $
    1,841,441
    
    
    $
    159,545
    
    
    $
    548,664
    
    
    $
    1,110,748
    
    
    $
    22,484
 See notes to consolidated financial statements. 73




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##### 



Statements of Consolidated Cash Flows
Increase (decrease) in cash and cash equivalents FOR THE YEARS ENDED DECEMBER 31,(Dollars in thousands)
    
    2003
    
    2002
    
    2001CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    196,814
    
    
    $
    190,238
    
    
    $
    181,295Adjustments to reconcile net income to net cash provided by operating activities:Provision for loan losses
    
    
    12,105
    
    
    
    16,378
    
    
    
    13,434Depreciation and amortization
    
    
    14,251
    
    
    
    13,071
    
    
    
    12,456Amortization of goodwill
    
    
    
    
    
    
    
    
    
    
    9,072Amortization of other intangible assets
    
    
    4,943
    
    
    
    1,972
    
    
    
    2,082Provision for deferred taxes (benefits)
    
    
    (9 678
    )
    
    
    11,093
    
    
    
    14,723Investment securities (gains) and losses
    
    
    (7,137
    )
    
    
    (846
    )
    
    
    (4,248
    )Write-downs (income) of investments in private equity funds
    
    
    (243
    )
    
    
    2,167
    
    
    
    1,063Write-downs of other real estate owned
    
    
    7
    
    
    
    54
    
    
    
    50Gains on sales of other real estate owned
    
    
    (366
    )
    
    
    (51
    )
    
    
    (272
    )Gains on sales of buildings
    
    
    (228
    )
    
    
    (456
    )
    
    
    (801
    )Net (increase) decrease in assets:Interest receivable
    
    
    4,741
    
    
    
    1,792
    
    
    
    1,039Other receivables
    
    
    (12,928
    )
    
    
    (678
    )
    
    
    902Bank owned life insurance
    
    
    (2,003
    )
    
    
    (869
    )
    
    
    Other assets
    
    
    (19,034
    )
    
    
    (16,437
    )
    
    
    (20,434
    )Loans held-for-sale
    
    
    31,096
    
    
    
    137,950
    
    
    
    (131,355
    )Net increase (decrease) in liabilities:Interest payable
    
    
    24,132
    
    
    
    (8,637
    )
    
    
    (2,257
    )Accrued expenses
    
    
    (49,669
    )
    
    
    (5,221
    )
    
    
    (1,305
    )Taxes payable
    
    
    10,640
    
    
    
    (5,896
    )
    
    
    19,438Net cash provided by operating activities
    
    
    197,443
    
    
    
    335,624
    
    
    
    94,882CASH FLOWS FROM INVESTING ACTIVITIES:Proceeds from maturities of investment securities held-to-maturity
    
    
    15,149
    
    
    
    3,553
    
    
    
    3,870Proceeds from maturities of investment securities available-for-sale
    
    
    961,583
    
    
    
    568,491
    
    
    
    642,747Proceeds from sales of investment securities available-for-sale
    
    
    572,615
    
    
    
    79,293
    
    
    
    4,248Purchases of investment securities held-to-maturity
    
    
    (2,590
    )
    
    
    (4,425
    )
    
    
    (5,386
    )Purchases of investment securities available-for-sale
    
    
    (1,488,190
    )
    
    
    (822,769
    )
    
    
    (1,237,534
    )Net increase in customer loans
    
    
    (663,922
    )
    
    
    (425,202
    )
    
    
    (224,062
    )Proceeds from sales of other real estate owned
    
    
    959
    
    
    
    227
    
    
    
    1,573Capital expenditures
    
    
    (17,355
    )
    
    
    (14,723
    )
    
    
    (12,828
    )Proceeds from sales of buildings
    
    
    602
    
    
    
    975
    
    
    
    2,047Purchase of bank owned life insurance
    
    
    
    
    
    
    (50,000
    )
    
    
    Business acquisitions
    
    
    (154,139
    )
    
    
    
    
    
    
    (7,000
    )Cash from acquired bank
    
    
    70,450
    
    
    
    
    
    
    
    Other investing activity
    
    
    (4,507
    )
    
    
    (87,906
    )
    
    
    (1,476
    )Net cash used in investing activities
    
    
    (709,345
    )
    
    
    (752,486
    )
    
    
    (833,801
    )CASH FLOWS FROM FINANCING ACTIVITIES:Net increase (decrease) in noninterest-bearing deposits
    
    
    367,640
    
    
    
    202,867
    
    
    
    290,375Net increase (decrease) in checking plus interest and savings accounts
    
    
    146,789
    
    
    
    608,722
    
    
    
    357,833Net increase (decrease) in certificates of deposit
    
    
    (204,910
    )
    
    
    1,978
    
    
    
    2,623Net increase (decrease) in short-term borrowings
    
    
    (187,374
    )
    
    
    (29,893
    )
    
    
    71,810Proceeds from issuance of long-term debt
    
    
    300,000
    
    
    
    
    
    
    
    200,000Repayment of long-term debt
    
    
    (8,638
    )
    
    
    (8,300
    )
    
    
    (8,347
    )Proceeds from issuance of shares
    
    
    11,369
    
    
    
    8,784
    
    
    
    7,396Repurchase of common shares
    
    
    (212
    )
    
    
    (53,953
    )
    
    
    (65,572
    )Dividends paid
    
    
    (95,842
    )
    
    
    (81,909
    )
    
    
    (77,597
    )Net cash provided by financing activities
    
    
    328,822
    
    
    
    648,296
    
    
    
    778,521Net increase (decrease) in cash and cash equivalents
    
    
    (183,080
    )
    
    
    231,434
    
    
    
    39,602Cash and cash equivalents at beginning of period
    
    
    545,781
    
    
    
    314,347
    
    
    
    274,745Cash and cash equivalents at end of period
    
    $
    362,701
    
    
    $
    545,781
    
    
    $
    314,347
 See notes to consolidated financial statements. 74




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##### 



Notes to Consolidated Financial Statements 1. SIGNIFICANT ACCOUNTING POLICIES A. Basis of Presentation The consolidated financial statements, which include the accounts of
Mercantile Bankshares Corporation (Bankshares) 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. All significant intercompany transactions have been eliminated. For
purposes of 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 at the date of
the financial statements, and the disclosure of revenues and expenses during
the reporting period. These estimates and assumptions, such as the accounting
for loan losses, depreciation and pension obligations, are based on information
available as of the date of the financial statements and could differ from
actual results. Assets (other than cash deposits) held for others under fiduciary and
agency relationships are not included in the accompanying balance sheets since
they are not assets of Bankshares or its affiliates. Acquisitions accounted for
as purchases are included in the financial statements from the respective dates
of affiliation. B. Investment Securities Investments are classified as either held-to-maturity or
available-for-sale. Investment securities classified as held-to-maturity
are acquired with the intent and ability to hold until maturity and are carried
at cost, adjusted for amortization of premiums and accretion of discounts.
Amortization and accretion are computed by methods that approximate level yield
adjusted for the effects of prepayments on the underlying investments.
Investment securities classified as available-for-sale are acquired to be
held for indefinite periods of time and may be sold in response to changes in
interest rates and/or prepayment risk or for liquidity management purposes.
These securities are carried at fair value, and any unrealized appreciation or
depreciation in the market value of available-for-sale securities is reported
as accumulated other comprehensive income, a separate component of
shareholders equity, net of applicable taxes. Realized gains and losses are
recognized on a specific identification trade date basis. Amortized cost is
used to compute gains or losses on the sales of securities, which are reported
in the Statement of Consolidated Income. An assessment is made at the end of each quarter to determine whether there
have been any events or economic circumstances to indicate that a security is
impaired on an other-than-temporary basis. An other-than-temporary impairment
may develop if, based on all available evidence, the carrying amount of the 75




---



##### 



investment is not recoverable within a reasonable period of time. Factors
considered in making this assessment include among others, the intent and
ability to hold the investment for a period of time sufficient for a recovery
in value; external credit ratings and recent downgrades; market price
fluctuations due to factors other than interest rates; and the probability of
collection of contractual cash flows. Securities on which there is an
unrealized loss that is deemed to be other-than-temporary are written down to
fair value and the adjustment is recorded as a realized loss. C. Loans Interest income on loans is accrued at the contractual rate on the
principal amount outstanding. Loan origination and commitment fees, direct loan
acquisition and origination costs, when significant, are deferred and accreted
to interest income over the life of the loan or over the commitment period.
Loans held-for-sale in conjunction with the mortgage banking business are
carried at the lower of aggregate cost or fair value. Fees related to loans
held-for-sale are recognized as a component of mortgage banking income upon the
sale of the loan. 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. Under Statements of Financial Accounting Standards (SFAS) Nos. 114 and
118, Accounting by Creditors for Impairment of a Loan-an amendment of FASB
Statements No. 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. 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 allowance for loan losses
applicable to other than impaired loans. 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. A majority of Bankshares impaired loans are measured by reference
to the fair value of the collateral. D. Allowance for Loan Losses The allowance for loan losses is maintained at a level considered by
management to be adequate to absorb inherent losses in the loan portfolio.
Managements assessment includes the systematic evaluation of several factors:
current economic conditions and their impact on specific borrowers and industry
groups; 76




---



##### 



the level of classified and nonperforming loans; the historical loss experience
by loan type; the results of regulatory examinations; and, in specific cases,
the estimated value of underlying collateral. The assessments of economic
conditions, results of regulatory examinations and other risk elements are
determined primarily by management at each affiliate and reviewed by
Bankshares. The allowance is increased by the loan loss provision charged to operating
expenses and reduced by loan charge-offs, net of recoveries. The provision for
loan losses is based on a continuing review of the loan portfolios, past loss
experience and current economic conditions which may affect borrowers ability
to pay. E. Loans Held-for-Sale Bankshares enters into commitments to sell loans which it has originated.
Generally, these loans are held for a short term. Amounts reported are at the
lower of cost or fair value. Fair value was deemed equal to the carrying
amounts because loans are originated for sale only after obtaining investor
commitment to offset changes in market rates in the near term. The
determination of any write-down to market value includes consideration of all
open positions and outstanding commitments from investors. Declines in the
market value of loans held-for-sale are recorded as a charge in mortgage
banking related fees. Sales of loans are recorded when the proceeds are
received and any difference between the proceeds and the carrying amount is
recorded as gain or loss in mortgage banking related fees. F. Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are computed using
both the straight-line and accelerated methods over the estimated useful lives
of the properties. Expenditures for repairs and maintenance are charged to
operating expenses as incurred. Expenditures for improvements which extend the
life of an asset are capitalized and depreciated over the assets remaining
useful life. Gains or losses realized on the disposition of properties are
reflected in consolidated income. G. Other Real Estate Owned Other real estate owned consists primarily of real estate obtained through
foreclosure or acceptance of deeds in lieu of foreclosure. Other real estate
owned is held for sale and is stated at the lower of cost or fair value. H. Goodwill and Intangible Assets Goodwill is the excess of the cost of Bankshares investment over its
equity in the net assets of purchased businesses. Amortization of goodwill was
discontinued in 2002, in accordance with SFAS No. 142, Goodwill and Other
Intangible Assets, which requires that goodwill be reviewed at least annually
for 77




---



##### 



impairment. Prior to 2002, goodwill was being amortized on a straight-line
basis over a 15-year period from the respective acquisition dates. Intangible assets consist mainly of deposit intangibles and customer list
intangibles which are being amortized on a straight-line basis over an original
life of between 3 and 15 years. Bankshares reviews its intangible assets
periodically for other-than-temporary impairment. If such impairment is
indicated, impairment is recognized by accelerating the amortization of the
asset to the extent the carrying value exceeds the estimated fair value.
Accumulated amortization for total intangible assets was $13.0 million and $7.9
million at year-end 2003 and 2002, respectively. Bankshares recognizes as assets the right to service mortgage loans for others.
Market quotes were used to determine the fair value of the mortgage servicing
rights at the date of the sale. The capitalized mortgage servicing rights are
amortized in proportionate amounts over the estimated period of net servicing
income. Bankshares analyzes the capitalized mortgage servicing rights for
impairment using a discounted cash flow analysis. A valuation allowance is
established through a charge to earnings if the amount of unamortized mortgage
servicing rights exceeds fair value. I. Stock Options and Restricted Stock Awards Bankshares stock-based compensation plans are accounted for in accordance
with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation.
Under this standard, compensation cost for options is determined based on the
fair value of each option and the number of options that are granted and
expected to vest. Compensation expense for restricted stock awards is based on
the closing market value of Bankshares stock on the date an award is granted. J. Income Taxes Income taxes are recorded in accordance with SFAS No. 109, Accounting for
Income Taxes. The asset and liability approach underlying SFAS No. 109
requires the recognition of deferred tax liabilities and assets for the
expected future tax consequences of temporary differences between the carrying
amounts and tax bases of Bankshares assets and liabilities. Deferred taxes are
determined using enacted tax rates in effect for the year in which the
temporary difference is expected to reverse. To the extent tax rates or laws
change, deferred tax assets and liabilities are adjusted in the period that the
tax change is enacted. Income tax expense includes: deferred tax expense,
which represents the net change in the deferred tax asset or liability balance
during the year plus any change in a valuation allowance; and current tax
expense, which represents the aggregate amount of tax currently payable to or
receivable from tax authorities. 78




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##### 



K. Earnings Per Share Basic and diluted earnings per share (EPS) amounts are computed in
accordance with the provisions of SFAS No. 128, Earnings Per Share. Basic EPS
is computed by dividing income available to common shareholders by weighted
average common shares outstanding during the period. Diluted EPS is computed
using the same components as in basic EPS with the denominator adjusted for the
dilutive effect of stock options and restricted stock awards. L. Cash Flows For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks, interest-bearing deposits in other banks, federal
funds sold and securities purchased under resale agreements. Generally, federal
funds are purchased and sold for one-day periods; securities purchased/sold
under resale agreements are purchased/sold for periods of one to sixty days. M. Derivatives and Hedging Activities Derivatives are recognized on the balance sheet at their fair value.
Bankshares has entered into derivative contracts that are classified as
interest rate swaps. On the date that the derivative contracts were entered
into, they were designated as a hedge of the fair value of a recognized asset
or liability. Changes in the fair value of a derivative that is highly
effective as a fair-value hedge, along with changes in the fair value of the
hedged asset or liability that are attributable to the hedged risk, are
recorded in current period earnings. The relationship between hedging instruments and hedged items is formally
documented, as well as the risk management objective and strategy for
undertaking the hedge transactions. This process includes linking the
fair-value hedges to specific assets and liabilities on the balance sheet. Both
at inception and on an ongoing basis, an assessment is made as to whether the
derivatives used in hedging transactions have been highly effective in
offsetting changes in the fair value of hedged items, and whether those
derivatives may be expected to remain highly effective in future periods. N. Third-Party Private Equity Investments Bankshares invests funds in third-party private equity investments. These
investments are included in other assets and are carried at the lower of cost
or fair value. Bankshares proportionate share of income or loss is included in
other income. 2. BUSINESS COMBINATIONS The following provides information concerning acquisitions completed
during the three years ended December 31, 2003. These acquisitions were
accounted for as purchases. The results of operations of these acquisitions
subsequent to the acquisition dates are included in Bankshares Statements of
Consolidated Income. Individually, the results of operations of these
acquisitions prior to the acquisition dates were not material to Bankshares
results of operations. 79




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##### 



In March and April 2003, Bankshares acquired in separate transactions,
Boyd Watterson Asset Management LLC (BW), an investment management firm, and
Peremel & Company, Inc. (Peremel), a directed and discount brokerage company.
In the aggregate, the companies were purchased for approximately $29 million
in cash. The BW acquisition has a potential additional contingent payment of
up to $8.6 million which, if paid, will be recorded as goodwill. The
contingent payment will be recorded assuming certain metrics are met and become
payable three years from the acquisition date. Bankshares finalized and
recorded approximately $10.1 million of identified intangibles, mostly client
relationships, as a result of these acquisitions. These intangibles are being
amortized on a straight-line basis over a range of three to eight years.
Goodwill recorded on these transactions totaled approximately $18.0 million at
December 31, 2003. On August 12, 2003, Bankshares completed its acquisition of F&M Bancorp
(F&M), a bank holding company headquartered in Frederick, Maryland. The
total consideration paid to F&M shareholders in connection with the acquisition
was $124.1 million in cash and 10.4 million shares of Bankshares common stock.
F&M transactions have been included in Bankshares financial results since
August 13, 2003. Acquired assets on August 12, 2003 totaled $2.2 billion,
including $1.4 billion of loans and leases; liabilities assumed were $2.0
billion, including $1.7 billion of deposits. As of December 31, 2003,
Bankshares recorded $400.3 million of goodwill, $36.0 million of core deposit
intangible, $5.8 million of mostly client relationship intangibles (relating to
the two insurance subsidiaries) and $1.1 million in a trademark intangible. The
weighted average amortization period for the newly-acquired core deposit
intangible is nine years, and the client relationship identified intangible
ranges from three to fifteen years. On October 24, 2003, certain assets and
liabilities of F&M were transferred to other Bankshares affiliates in order to
align customers accounts with the Bankshares affiliate serving the geographic
area where those customers reside. F&M, newly acquired in a business combination, falls under the guidance of
the Emerging Issues Task Force (EITF) in EITF Issue No. 95-3, Recognition of
Liability in Connection with a Purchase Business Combination. EITF Issue No.
95-3 requires an entity to recognize a liability for an exit cost on the date
that the entity commits itself to an exit plan. Exit costs are defined to
include those costs recorded by F&M prior to the merger date and therefore are
not included in Bankshares results of operations. Prior to August 12, 2003,
F&M recorded exit costs of $33.6 million relating to severance, systems
conversion, branch consolidation and costs associated with terminating
contracts (including leases). As of December 31, 2003, $21.1 million of these
exit costs were paid. 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, integration planning
consultants fees and marketing consultants fees incurred by Bankshares prior
to and after the 80




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##### 



merger date and are included in Bankshares results of operations. Bankshares
expensed merger-related costs totaling $8.0 million and $0 for the years ended
December 31, 2003 and 2002, respectively. The costs associated with these
activities are included in noninterest expenses. Merger-related expenses
incurred for the period ended December 31, 2003 consisted largely of expenses
for professional services rendered and marketing in connection with the merger
integration plan.
The table below shows the components of the pretax merger-related expenses. December 31,(Dollars in thousands)
    
    2003Salaries & benefits
    
    $
    722Net occupancy expense of bank premises
    
    
    1,197Furniture and equipment expenses
    
    
    372Professional services
    
    
    3,528Communications and supplies
    
    
    336Advertising and promotional expense
    
    
    959All other expenses
    
    
    900Total
    
    $
    8,014
 The following table provides information concerning the purchase price of F&M
Bancorp, balance sheet allocations, exit costs associated with the acquisition
and allocation of total intangible assets as of August 12, 2003. (Dollars in thousands)Purchase price

less tangible equity of F&M
    
    
    
    
    
    $
    396,222Fair value

purchase accounting adjustmentsFinancial

assets (net of taxes)
        $
    
        1,067Premises and

equipment (net of taxes)
    
    
        (3,243
        )Financial

liabilities (net of taxes)
    
    
    10,666Total fair

value purchase accounting adjustments
(net of taxes)
    
    
    
    
    
    
    8,490Exit cost

purchase accounting adjustmentsPersonnel and

employee terminations benefits
    
    
    14,610Occupancy and

equipment
    
    
    2,977Contract

cancellations
    
    
    9,284Other
    
    
    6,739Total pre-tax

costs
    
    
    33,610Income

taxes
    
    
        (12,061
        )Total

after-tax exit cost purchase accounting adjustments
    
    
    
    
    
    
    21,549Total adjusted

purchase price
    
    
    
    
    
    
    426,261Core deposit

intangible (net of taxes)
    
    
    
    
    
    
    21,783Other

identifiable intangibles (net of taxes)
    
    
    
    
    
    
    4,171Goodwill
    
    
    
    
    
    $
    400,307
 81




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##### 



3. INVESTMENT SECURITIES The amortized cost and fair value of investment securities at December 31, 2003
and 2002 were as follows: 2003
    
    2002Gross
    
    Gross
    
    
    
    
    
    
    
    
    
    Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    Fair
    
    Amortized
    
    Unrealized
    
    Unrealized
    
    Fair(Dollars in thousands)
    
    Cost
    
    Gains
    
    Losses
    
    Value
    
    Cost
    
    Gains
    
    Losses
    
    ValueSecurities held-to-maturityStates and political subdivisions
    
    $
    28,213
    
    
    $
    1,905
    
    
    $
    3
    
    
    $
    30,115
    
    
    $
    38,299
    
    
    $
    2,852
    
    
    $
    1
    
    
    $
    41,150Other investments
    
    
    21,204
    
    
    
    
    
    
    
    
    
    
    
    21,204
    
    
    
    15,092
    
    
    
    
    
    
    
    
    
    
    
    15,092Total
    
    $
    49,417
    
    
    $
    1,905
    
    
    $
    3
    
    
    $
    51,319
    
    
    $
    53,391
    
    
    $
    2,852
    
    
    $
    1
    
    
    $
    56,242Securities available-for-saleU.S. Treasury
    
    $
    823,356
    
    
    $
    22,437
    
    
    $
    39
    
    
    $
    845,754
    
    
    $
    1,375,703
    
    
    $
    46,187
    
    
    $
    
    
    
    $
    1,421,890U.S. Government agencies
    
    
    778,916
    
    
    
    15,096
    
    
    
    401
    
    
    
    793,611
    
    
    
    695,970
    
    
    
    31,659
    
    
    
    2
    
    
    
    727,627States and political subdivisions
    
    
    77,897
    
    
    
    2,073
    
    
    
    100
    
    
    
    79,870
    
    
    
    549
    
    
    
    28
    
    
    
    
    
    
    
    577Mortgage-backed securities
    
    
    1,288,109
    
    
    
    7,352
    
    
    
    11,831
    
    
    
    1,283,630
    
    
    
    341,806
    
    
    
    6,666
    
    
    
    149
    
    
    
    348,323Other bonds, notes and debentures
    
    
    34,440
    
    
    
    319
    
    
    
    
    
    
    
    34,759
    
    
    
    2,460
    
    
    
    151
    
    
    
    
    
    
    
    2,611Total bonds
    
    
    3,002,718
    
    
    
    47,277
    
    
    
    12,371
    
    
    
    3,037,624
    
    
    
    2,416,488
    
    
    
    84,691
    
    
    
    151
    
    
    
    2,501,028Other investments
    
    
    84,508
    
    
    
    1,382
    
    
    
    
    
    
    
    85,890
    
    
    
    80,222
    
    
    
    4,942
    
    
    
    
    
    
    
    85,164Total
    
    $
    3,087,226
    
    
    $
    48,659
    
    
    $
    12,371
    
    
    $
    3,123,514
    
    
    $
    2,496,710
    
    
    $
    89,633
    
    
    $
    151
    
    
    $
    2,586,192
 The amortized cost and fair value of the bond investment portfolio by
contractual maturity at December 31, 2003 and 2002 are shown below: 2003
    
    2002Amortized
    
    Fair
    
    Amortized
    
    Fair(Dollars in thousands)
    
    Cost
    
    Value
    
    Cost
    
    ValueSecurities held-to-maturityWithin 1 year
    
    $
    4,179
    
    
    $
    4,245
    
    
    $
    3,568
    
    
    $
    3,6281-5 years
    
    
    13,390
    
    
    
    14,114
    
    
    
    16,103
    
    
    
    17,1425-10 years
    
    
    8,057
    
    
    
    8,861
    
    
    
    10,918
    
    
    
    11,938After 10 years
    
    
    2,587
    
    
    
    2,895
    
    
    
    7,710
    
    
    
    8,442Total
    
    $
    28,213
    
    
    $
    30,115
    
    
    $
    38,299
    
    
    $
    41,150Securities available-for-saleWithin 1 year
    
    $
    620,663
    
    
    $
    628,712
    
    
    $
    629,085
    
    
    $
    639,2391-5 years
    
    
    1,940,913
    
    
    
    1,964,171
    
    
    
    1,571,674
    
    
    
    1,642,5155-10 years
    
    
    372,736
    
    
    
    375,078
    
    
    
    215,470
    
    
    
    219,010After 10 years
    
    
    68,406
    
    
    
    69,663
    
    
    
    259
    
    
    
    264Total
    
    $
    3,002,718
    
    
    $
    3,037,624
    
    
    $
    2,416,488
    
    
    $
    2,501,028
 At December 31, 2003 and 2002, no single issue of investment securities
exceeded 10% of shareholders equity. At December 31, 2003 and 2002, securities
with an amortized cost of $1.2 billion and $1.0 billion, respectively, were
pledged as collateral for certain deposits as required or permitted by law. At
December 31, 2003 there were $94 thousand of individual securities that had
unrealized losses for a period greater than one year. At year end 2003, these
securities had an unrealized loss of $2 thousand. 82




---



##### 



The gross realized gains and losses on debt and nondebt securities for 2003,
2002 and 2001 were as follows: 2003
    
    2002
    
    2001Gross
    
    Gross
    
    Gross
    
    Gross
    
    Gross
    
    GrossRealized
    
    Realized
    
    Realized
    
    Realized
    
    Realized
    
    Realized(Dollars in thousands)
    
    Gains
    
    Losses
    
    Gains
    
    Losses
    
    Gains
    
    LossesSecurities available-for-saleDebt
    
    $
    
    
    
    $
    985
    
    
    $
    1
    
    
    $
    679
    
    
    $
    
    
    
    $
    67Nondebt
    
    
    8,122
    
    
    
    
    
    
    
    1,524
    
    
    
    
    
    
    
    4,315
    
    
    
    Total
    
    $
    8,122
    
    
    $
    985
    
    
    $
    1,525
    
    
    $
    679
    
    
    $
    4,315
    
    
    $
    67
 4. LOANS AND ALLOWANCE FOR LOAN LOSSES Loans at December 31, 2003 and 2002 were as follows: (Dollars in thousands)
    
    2003
    
    2002Commercial
    
    $
    5,315,853
    
    
    $
    4,317,263Construction
    
    
    1,064,021
    
    
    
    810,985Residential real estate
    
    
    1,335,375
    
    
    
    1,066,694Consumer
    
    
    1,482,860
    
    
    
    1,014,905Lease financing
    
    
    74,051
    
    
    
    102,180Total
    
    $
    9,272,160
    
    
    $
    7,312,027
 At December 31, 2003 and 2002, $50.4 million and $33.4 million, respectively,
were considered nonaccrual loans (loans in which interest income is recognized
only as collected). Interest income on nonaccrual loans that would have been
recorded if accruing was $4.1 million and $2.8 million in 2003 and 2002,
respectively. Interest income on nonaccrual loans that was recorded totaled
$2.1 million and $641 thousand in 2003 and 2002, respectively. See Note 1C for
an explanation of the nonaccrual loan policy. The changes in the allowance for loan losses follow: (Dollars in thousands)
    
    2003
    
    2002
    
    2001Allowance balance at beginning of year
    
    $
    138,601
    
    
    $
    141,463
    
    
    $
    138,612Allowance of acquired bank
    
    
    13,205
    
    
    
    
    
    
    
    Charge-offs
    
    
    (12,324
    )
    
    
    (22,221
    )
    
    
    (13,328
    )Recoveries
    
    
    3,750
    
    
    
    2,981
    
    
    
    2,745Provision for loan losses
    
    
    12,105
    
    
    
    16,378
    
    
    
    13,434Allowance balance at end of year
    
    $
    155,337
    
    
    $
    138,601
    
    
    $
    141,463
 83




---



##### 



Information with respect to impaired loans and the related valuation allowance
(if the measure of the impaired loan is less than the recorded investment) as
of December 31, 2003 and 2002 is shown below. Refer to Note 1C for an expanded
discussion on impaired loans. (Dollars in thousands)
    
    2003
    
    2002Impaired loans with a specific valuation allowance
    
    $
    26,715
    
    
    $
    13,751All other impaired loans
    
    
    18,692
    
    
    
    16,813Total impaired loans
    
    $
    45,407
    
    
    $
    30,564Specific allowance for loan losses applicable to impaired loans
    
    $
    14,925
    
    
    $
    5,251General allowance for loan losses applicable to other than impaired loans
    
    
    140,412
    
    
    
    133,350Total allowance for loan losses
    
    $
    155,337
    
    
    $
    138,601Year-to-date interest income on impaired loans recorded on the cash basis
    
    $
    443
    
    
    $
    563Year-to-date average recorded investment in impaired loans during the period
    
    $
    31,241
    
    
    $
    53,777
 5. BANK PREMISES AND EQUIPMENT Bank premises and equipment at December 31, 2003 and 2002 consisted of the
following: (Dollars in thousands)
    
    2003
    
    2002Land
    
    $
    29,370
    
    
    $
    21,010Building and leasehold improvements
    
    
    158,928
    
    
    
    121,180Equipment
    
    
    105,395
    
    
    
    79,904Total bank premises and equipment
    
    
    293,693
    
    
    
    222,094Accumulated depreciation and amortization
    
    
    (152,771
    )
    
    
    (119,666
    )Bank premises and equipment, net
    
    $
    140,922
    
    
    $
    102,428
 Bankshares bank affiliates conduct a part of their branch banking operations
from leased facilities. Generally, the initial terms of the leases range from a
period of 1 to 15 years. Most of the leases contain options for renewal at the
fair rental value for periods of 1 to 20 years. In addition to minimum rentals,
certain leases have escalation clauses based on various price indices and
include provisions for additional payments to cover taxes, insurance and
maintenance. Total rental expense for 2003, 2002 and 2001 was: (Dollars in thousands)
    
    2003
    
    2002
    
    2001Bank premises*
    
    $
    8,807
    
    
    $
    6,092
    
    
    $
    5,949Equipment / software expense
    
    
    5,984
    
    
    
    4,456
    
    
    
    4,730Total rental expense
    
    $
    14,791
    
    
    $
    10,548
    
    
    $
    10,679
  *
    
    Amounts do not reflect offset for rental income. At December 31, 2003, the aggregate minimum rental commitments under
noncancelable operating leases were as follows: 2004-$12.2 million; 2005-$10.9
million; 2006-$9.5 million; 2007-$8.8 million; 2008-$5.1 million;
thereafter-$24.7 million. 84




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##### 



6. DEPOSITS Included in time deposits are certificates of deposit issued in
denominations of $100,000 and over, which totaled $1.3 billion and $1.1 billion
at December 31, 2003 and 2002, respectively. At December 31, 2003, the amount
outstanding and maturity distribution of certificates of deposit issued in
amounts of $100,000 and over are presented in the following table: MaturingOver 1
    
    Over 2
    
    Over 3
    
    Over 41 year
    
    through
    
    through
    
    through
    
    through
    
    Over(Dollars in thousands)
    
    Total
    
    or less
    
    2 years
    
    3 years
    
    4 years
    
    5 years
    
    5 yearsCertificates of deposit$100,000 and over
    
    $
    1,296,148
    
    
    $
    987,720
    
    
    $
    123,064
    
    
    $
    51,699
    
    
    $
    76,065
    
    
    $
    55,168
    
    
    $
    2,432
 Interest on deposits for the years ended December 31, 2003, 2002 and 2001
consisted of the following: (Dollars in thousands)
    
    2003
    
    2002
    
    2001Savings
    
    $
    4,702
    
    
    $
    8,405
    
    
    $
    12,899Checking plus interest
    
    
    2,061
    
    
    
    2,908
    
    
    
    5,255Money market
    
    
    9,757
    
    
    
    14,223
    
    
    
    21,839Time  $100,000 and over
    
    
    29,464
    
    
    
    34,671
    
    
    
    62,350Other time
    
    
    47,206
    
    
    
    62,362
    
    
    
    97,360Total interest on deposits
    
    $
    93,190
    
    
    $
    122,569
    
    
    $
    199,7037. SHORT-TERM BORROWINGS
 The following table provides selected information on Bankshares
short-term borrowings and applicable weighted average interest rates at
December 31, 2003 and 2002: Year-end
    
    During Year2003(Dollars in thousands)
    
    Amount
    
    Rate
    
    Highest
    
    Average
    
    RateFederal funds purchased and securitiessold under repurchase agreements
    
    $
    618,141
    
    
    
    .57
    %
    
    $
    777,450
    
    
    $
    627,839
    
    
    
    .71
    %Commercial paper
    
    
    190,880
    
    
    
    .30
    
    
    
    261,032
    
    
    
    222,714
    
    
    
    .49Other short-term borrowings
    
    
    
    
    
    
    
    
    
    
    1,720
    
    
    
    795
    
    
    
    2.22Total
    
    $
    809,021
    
    
    
    .51
    %
    
    
    
    
    
    $
    851,348
    
    
    
    .66
    %
 2002 (Dollars in thousands)Federal funds purchased and securitiessold under repurchase agreements
    
    $
    564,616
    
    
    
    .88
    %
    
    $
    777,798
    
    
    $
    578,547
    
    
    
    1.35
    %Commercial paper
    
    
    258,769
    
    
    
    .60
    
    
    
    270,495
    
    
    
    229,994
    
    
    
    1.19Other short-term borrowings
    
    
    
    
    
    
    
    
    
    
    50,000
    
    
    
    37,397
    
    
    
    1.90Total
    
    $
    823,385
    
    
    
    .79
    %
    
    
    
    
    
    $
    845,938
    
    
    
    1.33
    %
 Other short-term borrowings consist of borrowings from the Federal Home
Loan Bank. During 2003 and 2002, commercial paper borrowings were partially
supported by back-up lines of credit of $40.0 million. Unused lines of credit
at December 31, 2003 and 2002 were $40.0 million. These lines of credit are
paid for quarterly, semiannually or annually on a fee basis of .09% to .10%. 85




---



##### 



8. LONG-TERM DEBT Long-term debt at December 31, 2003 and 2002 consisted of the following: (Dollars in thousands)
    
    2003
    
    20022.00% Federal Home Loan Bank borrowing
    
    $
    41
    
    
    $
    2.00% Federal Home Loan Bank borrowing
    
    
    38
    
    
    
    4.24% Federal Home Loan Bank borrowing
    
    
    15,877
    
    
    
    4.39% Federal Home Loan Bank borrowing
    
    
    26,186
    
    
    
    4.75% Federal Home Loan Bank borrowing
    
    
    10,748
    
    
    
    5.09% Federal Home Loan Bank borrowing
    
    
    5,229
    
    
    
    5.32% Federal Home Loan Bank borrowing
    
    
    5,305
    
    
    
    5.44% Federal Home Loan Bank borrowing
    
    
    5,327
    
    
    
    5.51% Federal Home Loan Bank borrowing
    
    
    10,000
    
    
    
    10,0005.55% Federal Home Loan Bank borrowing
    
    
    10,845
    
    
    
    5.71% Federal Home Loan Bank borrowing
    
    
    7,500
    
    
    
    7,5006.12% Federal Home Loan Bank borrowing
    
    
    626
    
    
    
    6.19% Federal Home Loan Bank borrowing
    
    
    1,187
    
    
    
    6.56% Federal Home Loan Bank borrowing
    
    
    582
    
    
    
    6.95% Federal Home Loan Bank borrowing
    
    
    641
    
    
    
    4.625% Unsecured subordinated notesBook value
    
    
    299,284
    
    
    
    Interest rate swap adjustment
    
    
    (7,960
    )
    
    
    Adjusted balance
    
    
    291,324
    
    
    
    5.70% Unsecured senior notes
Book value
    
    
    199,672
    
    
    
    199,641Interest rate swap adjustment
    
    
    6,594
    
    
    
    11,673Adjusted balance
    
    
    206,266
    
    
    
    211,3146.72% Unsecured senior notes
    
    
    35,000
    
    
    
    35,0006.80% Unsecured senior notes
    
    
    15,000
    
    
    
    15,0006.94% Unsecured senior notes
    
    
    
    
    
    
    8,400Total
    
    $
    647,722
    
    
    $
    287,214
 The 2.00% Federal Home Loan Bank borrowings are due on November 23, 2015.
Principal and interest are payable monthly on the 1st, until maturity. The 2.00% Federal Home Loan Bank borrowings are due on February 29, 2016.
Principal and interest are payable monthly on the 1st, until maturity. The 4.24% Federal Home Loan Bank borrowings are due on May 10, 2012.
Interest is payable quarterly on February 10, May 10, August 10 and November
10, until maturity. The 4.39% Federal Home Loan Bank borrowings are due on March 13, 2006.
Interest is payable quarterly on March 15, June 15, September 15 and December
15, until maturity. The 4.75% Federal Home Loan Bank borrowings are due on September 14, 2011.
Interest is payable quarterly on March 15, June 15, September 15 and December
15, until maturity. The 5.09% Federal Home Loan Bank borrowings are due on September 7, 2005.
Interest is payable monthly on the 2nd, until maturity. The 5.32% Federal Home Loan Bank borrowings are due on September 7, 2006.
Interest is payable monthly on the 1st, until maturity. The 5.44% Federal Home Loan Bank borrowings are due on September 7, 2007.
Interest is payable monthly on the 1st, until maturity. The 5.51% Federal Home Loan Bank borrowings are due on June 23, 2008.
Interest is payable quarterly on March 23, June 23, September 23 and December
23, until maturity. 86




---



##### 



The 5.55% Federal Home Loan Bank borrowings are due on August 6, 2008.
Interest is payable quarterly on February 6, May 6, August 6 and November 6,
until maturity. The 5.71% Federal Home Loan Bank borrowings are due on September 28, 2004.
Interest is payable quarterly on March 28, June 28, September 28 and December
28, until maturity. The 6.12% Federal Home Loan Bank borrowings are due on December 15, 2005.
Principal and interest are payable monthly on the 1st, until maturity. The 6.19% Federal Home Loan Bank borrowings are due on March 4, 2008.
Interest is payable monthly on the 1st, until maturity. The 6.56% Federal Home Loan Bank borrowings are due on December 20, 2006.
Principal and interest are payable monthly on the 1st, until maturity. The 6.95% Federal Home Loan Bank borrowings are due on June 29, 2005.
Interest is payable monthly on the 1st, until maturity. The 4.625% subordinated notes are due on April 15, 2013. Interest is
payable semiannually on April 15 and October 15, until maturity. The debt has a
face value of $300 million, with an amortized discount of $716 thousand based
on an effective rate of 4.65%. $150 million of these fixed-rate notes were
converted to floating rates through interest rate swaps. These swaps were
designed as a hedge of the fair value of the debt; therefore, the debt has been
adjusted to reflect the change in the fair value of the swap. The 5.70% senior notes are due on November 15, 2011. Interest is payable
semiannually on May 15 and November 15, until maturity. The debt has a face
value of $200 million, with an amortized discount of $328 thousand based on an
effective rate of 5.725%. These fixed-rate notes were converted to floating
rates through an interest rate swap. This swap was designed as a hedge of the
fair value of the debt; therefore, the debt has been adjusted to reflect the
change in the fair value of the swap. The 6.72% senior notes are due on April 30, 2006. Interest is payable
semiannually on April 30 and October 30, until maturity. The 6.80% senior notes are due on April 30, 2009. Interest is payable
semiannually on April 30 and October 30, until maturity. The annual maturities on all long-term debt over the next five years are:
2004  $8.0 million; 2005  $6.4 million; 2006  $66.7 million; 2007  $5.3
million; 2008  $22.0 million. 9. COMMITMENTS 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 $3.6 billion at December 31, 2003 and $3.0 billion at December 31,
2002. Standby letters of credit are commitments issued to guarantee the
performance of a customer to a third party. Outstanding letters of credit were
$281.4 million at December 31, 2003 and $241.1 million at 87




---



##### 



December 31, 2002. In accordance with FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, the fees received for issuing letters of
credit are deferred and amortized over the life of the commitment. The fees on
letters of credit at December 31, 2003 had a carrying value of $970 thousand
representing unamortized fees. Bankshares mortgage banking subsidiary, as a Fannie Mae Delegated
Underwriting and Servicing lender, 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 $149.4 million at December 31, 2003.
No allowance has been established for possible losses since there have been no
losses recognized during the six-year history of the arrangement and none is
expected as of December 31, 2003. 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 $2.3 million at December 31, 2003. 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 December 31, 2003 and 2002, $16.1 million and $15.2 million,
respectively, remained unfunded. 10. SHAREHOLDERS EQUITY The Board of Directors has the authority to classify and reclassify any
unissued shares of preferred stock by fixing the preferences, rights, voting
powers (which may include separate class voting on certain matters),
restrictions and qualifications, dividends, times and prices of redemption and
conversion rights. Bankshares has a Dividend Reinvestment and Stock Purchase Plan. The Plan
allows shareholders to automatically invest their cash dividends in Bankshares
stock at a price which is 5% less than the market price on the dividend payment
date. Plan participants also may make additional cash payments to purchase
stock through the Plan at the market price. The number of shares of common
stock that remain available for issuance under the Plan is 467,703 shares.
Bankshares reserves the right to amend, modify, suspend or terminate the Plan
at any time at its discretion. Bankshares has an Employee Stock Purchase Plan. The Plan allows employees
(other than executive officers of Bankshares) to purchase stock through payroll
deduction and dividend reinvestment at the then current market price for
employee purchases and at 95% of market for dividend reinvestment. The number
of shares of common stock which remain available for issuance under the Plan is
764,827 shares. Bankshares reserves the right to amend, modify, suspend or
terminate the Plan at any time at its discretion. 88




---



##### 



The Board of Directors has approved plans authorizing Bankshares to
purchase shares of its common stock. Purchases may be made from time to time,
subject to regulatory requirements, in the open market or in privately
negotiated transactions. Purchased shares will be used from time to time for
corporate purposes including issuance under Bankshares dividend reinvestment
plans and stock-based compensation plans. The number of shares remaining
available for purchase under the plans was 1,476,328 shares at December 31,
2003. Pursuant to a Shareholders Protection Rights Agreement adopted in June
1999, each share of outstanding common stock carries a right, initially for the
purchase of 1/1,000 of a share of preferred stock at an exercise price of $150
(subject to adjustment). The rights, which do not carry voting or dividend
rights, may be redeemed by Bankshares at $.01 per right. The rights expire on
September 29, 2009 unless sooner exercised, exchanged or redeemed. The rights
will not become exercisable and will not trade separately from the common stock
until the tenth business day (or such other date as the Board of Directors
selects) after commencement of a tender or exchange offer for, or announcement
of the acquisition by a person or group of, 10% or more of the outstanding
common stock. Upon exercisability of the rights after acquisition by a person
or group (acquiring person) of 10% or more of the outstanding common stock or
upon certain business combinations or other defined transactions involving
Bankshares, each right (except rights of the acquiring person, which become
void) will entitle its holder to acquire common stock (or at Bankshares
discretion, preferred stock) of Bankshares, or common stock of the acquiring
entity in a business combination or other defined transaction, with a value of
twice the then current exercise price of the right. In certain such cases,
Bankshares may exchange one share of common stock (or at Bankshares
discretion, 1/1,000 of a share of preferred stock) for each right which has not
become void. The Board of Directors has classified 1,600,000 shares of
preferred stock as Class A Preferred Stock for potential issuance on exercise
of rights. Cash dividends paid to Bankshares by its consolidated subsidiaries for the
years ended 2003, 2002 and 2001 were $310.8 million, $135.7 million and $126.9
million, respectively. In aggregate, our affiliate banks have $409.4 million
of capital beyond the level necessary to maintain well-capitalized status at
December 31, 2003. The amount of dividends that Bankshares bank and nonbank
affiliates could have paid to the holding company without approval from bank
regulators at December 31, 2003 was $343.3 million. Earnings Per Share Basic earnings per share (EPS) is computed by dividing income available
to common shareholders by weighted average common shares outstanding, which
were 72,892,409 for 2003, 69,545,591 for 2002 and 70,573,594 for 2001. Diluted
EPS is computed using the same components as in basic EPS with the denominator
adjusted for the dilutive effect of stock options and restricted stock awards.
The adjusted weighted average shares were 73,421,487 for 2003, 70,067,292 for
2002 and 71,199,340 for 2001. 89




---



##### 



The following tables provide a reconciliation between the computation of basic
EPS and diluted EPS for the years ended December 31, 2003, 2002 and 2001: Net
    
    Weighted Average2003(In thousands, except per share data)
    
    Income
    
    Common Shares
    
    EPSBasic EPS
    
    $
    196,814
    
    
    
    72,892
    
    
    $
    2.70Dilutive effect of stock options and restricted stock awards
    
    
    
    
    
    
    529Diluted EPS
    
    $
    196,814
    
    
    
    73,421
    
    
    $
    2.68
 Net
    
    Weighted Average2002 (In thousands, except per share data)
    
    Income
    
    Common Shares
    
    EPSBasic EPS
    
    $
    190,238
    
    
    
    69,546
    
    
    $
    2.74Dilutive effect of stock options and restricted stock awards
    
    
    
    
    
    
    521Diluted EPS
    
    $
    190,238
    
    
    
    70,067
    
    
    $
    2.72
 Net
    
    Weighted Average2001 (In thousands, except per share data)
    
    Income
    
    Common Shares
    
    EPSBasic EPS
    
    $
    181,295
    
    
    
    70,574
    
    
    $
    2.57Dilutive effect of stock options and restricted stock awards
    
    
    
    
    
    
    625Diluted EPS
    
    $
    181,295
    
    
    
    71,199
    
    
    $
    2.55
 Comprehensive Income The two major components of comprehensive income are net income and other
comprehensive income. Other comprehensive income includes such items as net
unrealized gains and losses on securities available-for-sale. The following
table summarizes the related tax effect of unrealized gains (losses) on
securities available-for-sale for each of the three years in the period ended
December 31, 2003. The net amount is included in Accumulated Other
Comprehensive Income (Loss) in the Statements of Changes in Consolidated
Shareholders Equity above. 2003
    
    2002
    
    2001Tax
    
    
    
    
    
    
    
    
    
    Tax
    
    
    
    
    
    
    
    
    
    TaxPretax
    
    (Expense)
    
    Net
    
    Pretax
    
    (Expense)
    
    Net
    
    Pretax
    
    (Expense)
    
    Net(Dollars in thousands)
    
    Amount
    
    Benefit
    
    Amount
    
    Amount
    
    Benefit
    
    Amount
    
    Amount
    
    Benefit
    
    AmountUnrealized gains (losses) onsecurities available-for-sale:Unrealized holding gains (losses)
arising during the period
    
    $
    (46,059
    )
    
    $
    16,996
    
    
    $
    (29,063
    )
    
    $
    47,512
    
    
    $
    (17,369
    )
    
    $
    30,143
    
    
    $
    21,601
    
    
    $
    (8,672
    )
    
    $
    12,929Reclassification adjustmentfor (gains) losses includedin net income
    
    
    (7,137
    )
    
    
    2,823
    
    
    
    (4,314
    )
    
    
    (846
    )
    
    
    335
    
    
    
    (511
    )
    
    
    (4,248
    )
    
    
    1,680
    
    
    
    (2,568
    )Total
    
    $
    (53,196
    )
    
    $
    19,819
    
    
    $
    (33,377
    )
    
    $
    46,666
    
    
    $
    (17,034
    )
    
    $
    29,632
    
    
    $
    17,353
    
    
    $
    (6,992
    )
    
    $
    10,361
 90




---



##### 



Capital Adequacy Bankshares and its bank affiliates are subject to various regulatory
capital requirements administered by the federal and state banking agencies.
Failure to meet minimum capital requirements can initiate certain
mandatoryand possibly additional discretionaryactions by regulators that,
if undertaken, could have a direct material effect on Bankshares financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, Bankshares and its bank affiliates must meet specific
capital guidelines that involve quantitative measures of Bankshares assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. Bankshares capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy
require Bankshares and its bank affiliates to maintain at least the minimum
amounts and ratios (set forth in the table below) of Tier I capital (as defined
in the regulations) to risk-weighted assets (as defined). Management believes
that, as of December 31, 2003, Bankshares and its bank affiliates exceeded all
capital adequacy requirements to which they are subject. As of December 31, 2003, the most recent notification from the primary
regulators for each of Bankshares affiliate banking institutions categorized
them as well-capitalized under the prompt corrective action regulations. To be
categorized as well-capitalized, a bank must maintain certain capital ratios
above minimum levels, as set forth in the table below. These capital ratios
include Tier I capital and total risk-based capital as percents of net
risk-weighted assets and Tier I capital as a percent of adjusted average total
assets (leverage ratio). There are no conditions or events since the last
notifications that management believes have changed the affiliate banks
category. 91




---



##### 



Actual capital amounts and ratios are also presented in the table below
for Bankshares and Mercantile-Safe Deposit and Trust Company (MSD&T), the
lead bank. No deduction from capital is required for interest rate risk. Minimum Ratio to beMinimum Ratio
    
    Well-capitalized Underfor Capital
    
    Prompt CorrectiveAdequacy Purposes
    
    Action Provisions(Dollars in thousands)
    
    Bankshares
    
    MSD&T
    
    Bankshares
    
    MSD&T
    
    Bankshares
    
    MSD&TAs of December 31, 2003Tier I capital
    
    $
    1,248,492
    
    
    $
    396,186Total risk-based capital
    
    
    1,666,064
    
    
    
    440,479Net risk-weighted assets
    
    
    10,020,487
    
    
    
    3,529,223Adjusted average total assets
    
    
    13,011,399
    
    
    
    4,353,713Tier I capital ratio
    
    
    12.46
    %
    
    
    11.23
    %
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    (1
    )
    
    
    6.00
    %Total capital ratio
    
    
    16.63
    %
    
    
    12.48
    %
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    (1
    )
    
    
    10.00
    %Leverage ratio
    
    
    9.60
    %
    
    
    9.10
    %
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    (1
    )
    
    
    5.00
    %As of December 31, 2002
Tier I capital
    
    $
    1,151,831
    
    
    $
    430,375Total risk-based capital
    
    
    1,250,550
    
    
    
    473,185Net risk-weighted assets
    
    
    7,677,476
    
    
    
    3,407,691Adjusted average total assets
    
    
    10,281,071
    
    
    
    4,246,480Tier I capital ratio
    
    
    15.00
    %
    
    
    12.63
    %
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    (1
    )
    
    
    6.00
    %Total capital ratio
    
    
    16.29
    %
    
    
    13.89
    %
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    (1
    )
    
    
    10.00
    %Leverage ratio
    
    
    11.20
    %
    
    
    10.13
    %
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    (1
    )
    
    
    5.00
    %
  (1)
    
    Bankshares is not subject to this requirement. 11. INCOME TAXES Applicable income taxes on net income for 2003, 2002 and 2001 consisted of the
following: 2003
    
    2002
    
    2001(Dollars in thousands)
    
    Federal
    
    State
    
    Total
    
    Federal
    
    State
    
    Total
    
    Federal
    
    State
    
    TotalCurrent tax expense
    
    $
    108,555
    
    
    $
    10,678
    
    
    $
    119,233
    
    
    $
    90,308
    
    
    $
    4,929
    
    
    $
    95,237
    
    
    $
    88,436
    
    
    $
    1,884
    
    
    $
    90,320Deferred tax expense
    
    
    (8,142
    )
    
    
    (1,536
    )
    
    
    (9,678
    )
    
    
    9,159
    
    
    
    1,934
    
    
    
    11,093
    
    
    
    12,082
    
    
    
    2,641
    
    
    
    14,723Total
    
    $
    100,413
    
    
    $
    9,142
    
    
    $
    109,555
    
    
    $
    99,467
    
    
    $
    6,863
    
    
    $
    106,330
    
    
    $
    100,518
    
    
    $
    4,525
    
    
    $
    105,043
 92




---



##### 



Significant components of Bankshares deferred tax assets and liabilities as of
December 31, 2003 and 2002 were as follows: (Dollars in thousands)
    
    2003
    
    2002Deferred tax assets:Allowance for loan losses
    
    $
    59,183
    
    
    $
    52,659Write-down of other real estate owned
    
    
    114
    
    
    
    112Deferred income
    
    
    45,446
    
    
    
    38,468Other
    
    
    1,187
    
    
    
    Total deferred tax assets
    
    
    105,930
    
    
    
    91,239Deferred tax liabilities:Purchase accounting adjustments
    
    
    12,868
    
    
    
    1,108Net unrealized gains on securities available-for-sale
    
    
    13,804
    
    
    
    33,623Depreciation
    
    
    69,643
    
    
    
    70,200Accrued employee benefits
    
    
    10,705
    
    
    
    4,939Prepaid items
    
    
    152
    
    
    
    152Other
    
    
    
    
    
    
    196Total deferred tax liabilities
    
    
    107,172
    
    
    
    110,218Net deferred tax assets / (liabilities)
    
    $
    (1,242
    )
    
    $
    (18,979
    )
 A valuation allowance has not been established against Bankshares deferred tax
assets since management has determined that it is more likely than not that
all such tax assets will be realized in the future. A reconciliation between actual tax
    expense and taxes computed at the statutory federal rate of 35% for each of
    the three years in the period ended December 31, 2003 follows: 2003
    
    2002
    
    2001% of
    
    
    
    
    
    % of
    
    
    
    
    
    % ofPretax
    
    
    
    
    
    Pretax
    
    
    
    
    
    Pretax(Dollars in thousand)
    
    Amount
    
    income
    
    Amount
    
    income
    
    Amount
    
    incomeTax computed at statutory rate
    
    $
    107,229
    
    
    
    35.0
    %
    
    $
    103,799
    
    
    
    35.0
    %
    
    $
    100,218
    
    
    
    35.0
    %Increases (decreases) in tax resulting from:Tax advantaged income
    
    
    (3,581
    )
    
    
    (1.2
    )
    
    
    (3,243
    )
    
    
    (1.1
    )
    
    
    (3,345
    )
    
    
    (1.2
    )State income taxes, net of federal
income tax benefit
    
    
    5,942
    
    
    
    1.9
    
    
    
    4,461
    
    
    
    1.5
    
    
    
    2,941
    
    
    
    1.0Nondeductible goodwill amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,044
    
    
    
    1.1Other, net
    
    
    (35
    )
    
    
    
    

    
    
    1,313
    
    
    
    0.5
    
    
    
    2,185
    
    
    
    0.8Actual tax expense
    
    $
    109,555
    
    
    
    35.7
    %
    
    $
    106,330
    
    
    
    35.9
    %
    
    $
    105,043
    
    
    
    36.7
    %
 93




---



##### 



12. RELATED PARTY TRANSACTIONS In the normal course of banking business, loans are made to officers and
directors of Bankshares and its affiliates, as well as to their related
interests. In the opinion of management, these loans are consistent with sound
banking practices, are within regulatory lending limitations and do not involve
more than the normal risk of collectibility. At December 31, 2003 and 2002,
loans to executive officers and directors of Bankshares and its principal
affiliates, including loans to their related interests, totaled $98.4 million
and $64.3 million, respectively. During 2003, loan additions and loan deletions
were $148.7 million and $114.6 million, respectively. 13. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Bankshares sponsors qualified and nonqualified pension plans and other
postretirement benefit plans for its employees. With regard to the pension
plans, there is no additional minimum pension liability required to be
recognized. Included in the other postretirement benefit plans are health care
and life insurance. All Bankshares affiliates have adopted the same health care
and life insurance plans, except for one affiliate which has separate benefit
plans. Employees were eligible for company-paid health care benefits if their
age plus length of service was equal to at least 65 as of December 31, 1990.
Employees may become eligible for company-paid life insurance benefits if they
qualify for retirement while working for Bankshares. The following table provides a reconciliation of the changes in the plans
benefit obligations and fair value of assets for each of the two years in the
period ended December 31, 2003: Pension Benefits2003
    
    2002
    
    Other Benefits(Dollars in thousands)
    
    Qualified
    
    Nonqualified
    
    Total
    
    Qualified
    
    Nonqualified
    
    Total
    
    2003
    
    2002Change in Benefit ObligationBenefit obligation at beginning of year
    
    $
    155,160
    
    
    $
    5,986
    
    
    $
    161,146
    
    
    $
    144,043
    
    
    $
    4,217
    
    
    $
    148,260
    
    
    $
    13,044
    
    
    $
    11,482Service cost
    
    
    4,563
    
    
    
    404
    
    
    
    4,967
    
    
    
    4,058
    
    
    
    390
    
    
    
    4,448
    
    
    
    205
    
    
    
    182Interest cost
    
    
    9,993
    
    
    
    314
    
    
    
    10,307
    
    
    
    9,731
    
    
    
    332
    
    
    
    10,063
    
    
    
    854
    
    
    
    939Amendments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Actuarial (gain) loss
    
    
    8,244
    
    
    
    39
    
    
    
    8,283
    
    
    
    5,213
    
    
    
    1,074
    
    
    
    6,287
    
    
    
    2,010
    
    
    
    1,805Acquisition
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Benefits paid
    
    
    (9,856
    )
    
    
    (183
    )
    
    
    (10,039
    )
    
    
    (7,885
    )
    
    
    (27
    )
    
    
    (7,912
    )
    
    
    (1,063
    )
    
    
    (1,364
    )Benefit obligation at end of year
    
    
    168,104
    
    
    
    6,560
    
    
    
    174,664
    
    
    
    155,160
    
    
    
    5,986
    
    
    
    161,146
    
    
    
    15,050
    
    
    
    13,044Change in Plan AssetsFair value of plan assets at beginning of
year
    
    
    153,935
    
    
    
    
    
    
    
    153,935
    
    
    
    155,285
    
    
    
    
    
    
    
    155,285
    
    
    
    
    
    
    
    Actual return on plan assets
    
    
    33,431
    
    
    
    
    
    
    
    33,431
    
    
    
    (13,589
    )
    
    
    
    
    
    
    (13,589
    )
    
    
    
    
    
    
    Acquisition
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Employer contribution
    
    
    19,750
    
    
    
    183
    
    
    
    19,933
    
    
    
    20,124
    
    
    
    27
    
    
    
    20,151
    
    
    
    1,063
    
    
    
    1,364Plan participants contributions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,476
    
    
    
    1,126Benefits paid
    
    
    (9,856
    )
    
    
    (183
    )
    
    
    (10,039
    )
    
    
    (7,885
    )
    
    
    (27
    )
    
    
    (7,912
    )
    
    
    (2,539
    )
    
    
    (2,490
    )Fair value of plan assets at end of year
    
    
    197,260
    
    
    
    
    
    
    
    197,260
    
    
    
    153,935
    
    
    
    
    
    
    
    153,935
    
    
    
    
    
    
    
    Funded status
    
    
    29,156
    
    
    
    (6,560
    )
    
    
    22,596
    
    
    
    (1,225
    )
    
    
    (5,986
    )
    
    
    (7,211
    )
    
    
    (15,050
    )
    
    
    (13,044
    )Unrecognized net actuarial (gain) loss
    
    
    27,083
    
    
    
    2,016
    
    
    
    29,099
    
    
    
    42,296
    
    
    
    2,009
    
    
    
    44,305
    
    
    
    4,963
    
    
    
    3,106Unrecognized prior service cost
    
    
    5,655
    
    
    
    189
    
    
    
    5,844
    
    
    
    6,434
    
    
    
    212
    
    
    
    6,646
    
    
    
    
    
    
    
    Unrecognized transition (assets)/obligation
    
    
    
    
    
    
    94
    
    
    
    94
    
    
    
    
    
    
    
    193
    
    
    
    193
    
    
    
    
    
    
    
    Prepaid (accrued) benefit cost
    
    $
    61,894
    
    
    $
    (4,261
    )
    
    $
    57,633
    
    
    $
    47,505
    
    
    $
    (3,572
    )
    
    $
    43,933
    
    
    $
    (10,087
    )
    
    $
    (9,938
    )
 94




---



##### 



Amounts recognized in the consolidated balance sheets consist of: Pension Benefits2003
    
    2002
    
    Other Benefits(Dollars in thousands)
    
    Qualified
    
    Nonqualified
    
    Total
    
    Qualified
    
    Nonqualified
    
    Total
    
    2003
    
    2002Prepaid benefit cost
    
    $
    61,894
    
    
    $
    
    
    
    $
    61,894
    
    
    $
    47,505
    
    
    $
    
    
    
    $
    47,505
    
    
    $
    
    
    
    $
    Accrued benefit cost
    
    
    
    
    
    
    (4,261
    )
    
    
    (4,261
    )
    
    
    
    
    
    
    (3,572
    )
    
    
    (3,572
    )
    
    
    (10,087
    )
    
    
    (9,938
    )Intangible assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accumulated other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    61,894
    
    
    $
    (4,261
    )
    
    $
    57,633
    
    
    $
    47,505
    
    
    $
    (3,572
    )
    
    $
    43,933
    
    
    $
    (10,087
    )
    
    $
    (9,938
    )
 The following is a comparison of the projected and accumulated benefit
obligation to the fair value of assets for the pension plans: Pension Benefits at December 31,2003
    
    2002Qualified
    
    Nonqualified
    
    Total
    
    Qualified
    
    Nonqualified
    
    TotalProjected benefit obligation
    
    $
    168,104
    
    
    $
    6,560
    
    
    $
    174,664
    
    
    $
    155,160
    
    
    $
    5,986
    
    
    $
    161,146Accumulated benefit obligation
    
    
    160,926
    
    
    
    5,968
    
    
    
    166,894
    
    
    
    147,402
    
    
    
    5,459
    
    
    
    152,861Fair value of assets
    
    
    197,260
    
    
    
    
    
    
    
    197,260
    
    
    
    153,935
    
    
    
    
    
    
    
    153,935
 The components of net periodic benefit cost for the pension plans for 2003,
2002 and 2001 follow: Pension Benefits2003
    
    2002
    
    2001(Dollars in thousands)
    
    Qualified
    
    Nonqualified
    
    Total
    
    Qualified
    
    Nonqualified
    
    Total
    
    Qualified
    
    Nonqualified
    
    TotalService cost
    
    $
    4,563
    
    
    $
    404
    
    
    $
    4,967
    
    
    $
    4,058
    
    
    $
    390
    
    
    $
    4,448
    
    
    $
    3,650
    
    
    $
    223
    
    
    $
    3,873Interest cost
    
    
    9,993
    
    
    
    314
    
    
    
    10,307
    
    
    
    9,731
    
    
    
    332
    
    
    
    10,063
    
    
    
    9,236
    
    
    
    243
    
    
    
    9,479Expected return on plan assets
    
    
    (12,395
    )
    
    
    
    
    
    
    (12,395
    )
    
    
    (12,158
    )
    
    
    
    
    
    
    (12,158
    )
    
    
    (11,582
    )
    
    
    
    
    
    
    (11,582
    )Amortization of prior service cost
    
    
    779
    
    
    
    23
    
    
    
    802
    
    
    
    996
    
    
    
    23
    
    
    
    1,019
    
    
    
    819
    
    
    
    15
    
    
    
    834Recognized net actuarial (gain) loss
    
    
    2,421
    
    
    
    32
    
    
    
    2,453
    
    
    
    
    
    
    
    94
    
    
    
    94
    
    
    
    
    
    
    
    36
    
    
    
    36Amortization of transition asset
    
    
    
    
    
    
    99
    
    
    
    99
    
    
    
    
    
    
    
    99
    
    
    
    99
    
    
    
    (692
    )
    
    
    99
    
    
    
    (593
    )Net periodic benefit cost
    
    $
    5,361
    
    
    $
    872
    
    
    $
    6,233
    
    
    $
    2,627
    
    
    $
    938
    
    
    $
    3,565
    
    
    $
    1,431
    
    
    $
    616
    
    
    $
    2,047
 The components of net periodic benefit cost for the other postretirement
benefit plans for 2003, 2002 and 2001 follow: Other Benefits(Dollars in thousands)
    
    2003
    
    2002
    
    2001Service cost
    
    $
    205
    
    
    $
    182
    
    
    $
    171Interest cost
    
    
    854
    
    
    
    939
    
    
    
    872Expected return on plan assets
    
    
    
    
    
    
    
    
    
    
    Amortization of prior service cost
    
    
    
    
    
    
    
    
    
    
    Recognized net actuarial (gain) loss
    
    
    153
    
    
    
    324
    
    
    
    16Amortization of transition asset
    
    
    
    
    
    
    
    
    
    
    Net periodic benefit cost
    
    $
    1,212
    
    
    $
    1,445
    
    
    $
    1,059
 There was no increase in the minimum liability included in other comprehensive
income relating to pension benefits and other postretirement benefits for 2003
and 2002. 95




---



##### 



The weighted average assumptions used to determine the benefit obligation
are shown in the following table: Pension Benefits
    
    Other BenefitsAs of December 31,
    
    2003
    
    2002
    
    2003
    
    2002Discount rate
    
    
    6.25
    %
    
    
    6.50
    %
    
    
    6.25
    %
    
    
    6.50
    %Rate of compensation increase
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.00
    %
 The weighted average assumptions used to determine the net periodic benefit
cost are shown in the following table: Pension Benefits
    
    Other BenefitsAs of December 31,
    
    2003
    
    2002
    
    2003
    
    2002Discount rate
    
    
    6.50
    %
    
    
    7.00
    %
    
    
    6.50
    %
    
    
    7.00
    %Expected long-term return on plan assets
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    N/A
    
    
    
    N/ARate of compensation increase
    
    
    4.00
    %
    
    
    4.50
    %
    
    
    4.00
    %
    
    
    4.50
    %
 In determining pension expense for the qualified pension plan, a long-term
return on assets of 8% was assumed. This return consists of an average return
of 10% on equity securities and 5% on debt securities. Assumed health care cost trend rates are shown in the following table: As of December 31,
    
    2003
    
    2002Health care cost trend rate assumed for next year
    
    
    10.0
    %
    
    
    4.5
    %Rate to which the cost trend rate is assumed to decline (the ultimate
trend rate)
    
    
    5.0
    %
    
    
    4.5
    %Year that the rate reaches the ultimate trend rate
    
    
    2009
    
    
    
    2003
 For measurement purposes, a 10% annual rate of increase in the per capita cost
of covered health care benefits was assumed for 2004 and assumed to decrease by
1% per annum until the annual rate reaches 5% and to remain level thereafter.
This rate represents Bankshares portion of the annual rate of increase.
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A 1% change in assumed health care cost
trend rates would have the following effects: 1% Increase
    
    1% DecreaseEffect on total of service and interest cost components
    
    $
    65
    
    
    $
    (58
    )Effect on postretirement benefit obligation
    
    
    921
    
    
    
    (825
    )
 Pension Plan Assets Bankshares qualified pension plan weighted average asset allocations by
category are as follows: Plan Assetsat December 31Asset category
    
    2003
    
    2002Equity securities
    
    
    68
    %
    
    
    49
    %Debt securities
    
    
    30
    
    
    
    50Cash
    
    
    2
    
    
    
    1Total
    
    
    100
    %
    
    
    100
    %
 96




---



##### 



The return objectives for the qualified pension plan are: (1) provide a
growing and predictable income stream from year to year; (2) achieve an annual
return at least equal to the 8% actuarial assumption rate; (3) preserve the
capital value of the pension plan; and (4) achieve growth of capital with
comparable pension funds. Asset allocation targets are between 30% to 50% in debt securities and 50%
to 70% in equity securities. At December 31, 2003, assets of the qualified
pension plan consisted of 68% equity securities, 30% debt securities, and 2%
cash. One final objective of the qualified pension plan is to maintain the fair
value of plan assets greater than the plan benefit obligations. At December 31,
2003, the fair value of plan assets was 117% of benefit obligations. The qualified pension plan has no investments in Bankshares common stock as of
December 31, 2003 and 2002. Cash Flows
Generally, Bankshares has made cash contributions to the pension plan in
amounts equal to the maximum permitted by Employee Retirement Income Securities
Act guidelines. Under those guidelines, Bankshares could contribute up to
approximately $20 million to the pension plan during 2004. The following
benefit payments, which reflect expected future service, as appropriate, are to
be paid: Pension BenefitsOtherQualified
    
    Nonqualified
    
    Total
    
    benefits2004
    
    $
    8,634
    
    
    $
    205
    
    
    $
    8,839
    
    
    $
    1,1692005
    
    
    8,937
    
    
    
    215
    
    
    
    9,152
    
    
    
    1,1312006
    
    
    9,422
    
    
    
    225
    
    
    
    9,647
    
    
    
    1,1092007
    
    
    9,954
    
    
    
    235
    
    
    
    10,189
    
    
    
    1,0962008
    
    
    10,663
    
    
    
    245
    
    
    
    10,908
    
    
    
    1,106Years 2009-2014
    
    
    64,074
    
    
    
    1,350
    
    
    
    65,424
    
    
    
    4,830
 14. STOCK PLANS Omnibus Stock Plan (1989) The Omnibus Stock Plan adopted in 1989 permitted the grant of stock
options and other stock incentives to key employees of Bankshares and its
affiliates. The 1989 Plan provided for the issuance of up to 2,902,500 shares
of Bankshares authorized but unissued common stock. Options outstanding were
granted at market value and include both stock options which become exercisable
cumulatively at the rate of 25% a year and those which are exercisable
immediately on grant. If certain levels of earnings per share of Bankshares and 97




---



##### 



net income of affiliates are not achieved, all or a portion of those options
which become exercisable at the rate of 25% a year are forfeited and become
available for future grants. All options will terminate 10 years from date of
grant if not exercised. No further grants will be made under the 1989 Plan. 1999 Omnibus Stock Plan The 1999 Omnibus Stock Plan permits the grant of stock options and other
stock incentives, including restricted stock awards, to key employees of
Bankshares and its affiliates. The 1999 Plan provides for the issuance of up to
3,000,000 shares of Bankshares authorized but unissued common stock. Options
outstanding were granted at market value and include both performance-based and
nonperformance-based options. Options become exercisable ratably over three or
four years. If certain levels of earnings per share of Bankshares and net
income of affiliates are not achieved, all or a portion of the
performance-based options are forfeited and become available for future grants.
All options will terminate 10 years from date of grant if not exercised.
Restricted stock awards outstanding were granted at market value and vest
ratably over three years or in total at the end of a specified three-year
period. The table below summarizes activity under the Omnibus Stock Plan and the 1999
Omnibus Stock Plan during the three years ended December 31, 2003: As of December 31,Options issued
    
    Weighted average
    
    Options
    
    Weighted averageand outstanding
    
    exercise price
    
    exercisable
    
    exercise priceBalance, December 31, 2000
    
    
    1,836,584
    
    
    $
    20.904Granted
    
    
    131,500
    
    
    
    39.546Terminated / forfeited
    
    
    (220,934
    )
    
    
    27.350Exercised
    
    
    (143,935
    )
    
    
    17.311Balance, December 31, 2001
    
    
    1,603,215
    
    
    
    21.868
    
    
    
    905,000
    
    
    $
    17.575Granted
    
    
    160,250
    
    
    
    44.996Terminated / forfeited
    
    
    (221,407
    )
    
    
    25.360Exercised
    
    
    (238,969
    )
    
    
    17.587Balance, December 31, 2002
    
    
    1,303,089
    
    
    
    24.903
    
    
    
    729,522
    
    
    
    18.767Granted
    
    
    421,350
    
    
    
    35.653Options (at fair value) related to option
plan of acquired bank
    
    
    322,528
    
    
    
    20.929Terminated / forfeited
    
    
    (202,811
    )
    
    
    28.269Exercised
    
    
    (332,725
    )
    
    
    19.387Balance, December 31, 2003
    
    
    1,511,431
    
    
    
    27.814
    
    
    
    899,039
    
    
    
    21.983
 98




---



##### 



The following table provides selected information on stock options outstanding
and exercisable at December 31, 2003: Options Outstanding
    
    Options ExercisableWeighted averageremaining
    
    Weighted
    
    
    
    WeightedNumber
    
    contractual
    
    average
    
    Number
    
    averageExercise Prices
    
    outstanding
    
    life (years)
    
    exercise price
    
    exercisable
    
    exercise price$10.500 - $18.630
    
    
    375,080
    
    
    
    1.82
    
    
    $
    14.920
    
    
    
    375,080
    
    
    $
    14.920$19.550 - $25.740
    
    
    520,788
    
    
    
    6.37
    
    
    
    24.540
    
    
    
    451,325
    
    
    
    24.416$34.610 - $39.250
    
    
    416,125
    
    
    
    8.97
    
    
    
    35.476
    
    
    
    15,400
    
    
    
    37.789$42.650 - $45.170
    
    
    199,438
    
    
    
    8.44
    
    
    
    44.628
    
    
    
    57,234
    
    
    
    44.839
 The weighted average fair value of options granted during 2003, 2002 and 2001
was $6.82, $11.10 and $8.35, respectively. Compensation expense associated with
the options granted and expected to vest for 2003, 2002 and 2001 were $2.0
million, $1.2 million and $482 thousand, respectively. The weighted average fair value of options granted is estimated as of the
grant date using the Black-Scholes option pricing model. The following weighted
average assumptions were used as inputs to the Black-Scholes model for grants
in 2003, 2002 and 2001, respectively:  
    
    Dividend yield of 3.37%, 2.49% and 2.71%  
    
    Volatility of 26.20%, 26.41% and 26.72%  
    
    Risk-free interest rate of 3.28%, 4.55% and 4.88%  
    
    Expected term of 5.4, 5.4 and 3.8 years The number of restricted stock awards granted in 2003 and 2002 was 101,932 and
76,250, respectively. There were no restricted stock awards granted during
2001. Total compensation expense associated with the restricted stock awards
for 2003, 2002 and 2001 was $3.0 million, $872 thousand and $0, respectively.
Compensation expense is recognized on a straight-line basis over a three-year
vesting period. Due to the separation of personnel from IWM, restricted stock
expense of $0.8 million was accelerated into the year 2003 that otherwise would
have been recognized over future periods. Compensation costs for stock options and restricted stock awards are
included in salary expense. Another form of stock-based compensation is
phantom stock, which is used for Bankshares directors deferred compensation
plan. The compensation cost for the phantom stock, which fluctuates with
changes in 99




---



##### 



Bankshares stock price, is included in other expenses. Stock-based
compensation amounts for 2003, 2002 and 2001 are summarized in the following
table: December 31,(Dollars in thousands)
    
    2003
    
    2002
    
    2001Stock options expense
    
    $
    2,045
    
    
    $
    1,189
    
    
    $
    482Restricted stock awards expense
    
    
    2,986
    
    
    
    872
    
    
    
    Subtotal included in salaries expense
    
    
    5,031
    
    
    
    2,061
    
    
    
    482Phantom stock expense
    
    
    1,581
    
    
    
    (371
    )
    
    
    (601
    )Total stock-based compensation expense
    
    $
    6,612
    
    
    $
    1,690
    
    
    $
    (119
    )
 15. SEGMENT REPORTING Operating segments are defined as components of an enterprise about which
separate financial information is available that management relies on for
decision making and performance assessment. Bankshares has three reportable
segments: its 19 Community Banks, MSD&T Banking and IWM. The Community Banks
operate in smaller geographic areas than MSD&T, which operates in a large
metropolitan area. The accounting policies of the segments are the same as
those described in Footnote No. 1 of the financial statements. However, the
segment data reflect intersegment transactions and balances. The following tables present selected segment information for the years
ended December 31, 2003, 2002 and 2001. The components in the Other column
consist of amounts for the nonbank affiliates and intercompany eliminations.
Certain expense amounts such as operations overhead have been reclassified from
internal financial reporting in order to provide for full cost absorption.
These reclassifications are shown in the Adjustments line. Goodwill
amortization charges for the Community Banks were $0 for 2003 and 2002,
respectively, and $7.9 million for 2001. Goodwill amortization charges for
MSD&T Banking were $0 for 2003 and 2002, respectively, and $1.2 million for
2001. F&M is included in the column Community Banks whereas Boyd Watterson
Asset Management LLC and Peremel & Company, Inc. are included in the column
IWM. Banking2003(Dollars in thousands)
    
    IWM
    
    MSD&T
    
    Community
    
    Other
    
    TotalNet interest income
    
    $
    
    
    
    $
    141,842
    
    
    $
    336,286
    
    
    $
    1,202
    
    
    $
    479,330Provision for loan losses
    
    
    
    
    
    
    (13,249
    )
    
    
    1,144
    
    
    
    
    
    
    
    (12,105
    )Noninterest income
    
    
    78,608
    
    
    
    42,073
    
    
    
    70,536
    
    
    
    (14,626
    )
    
    
    176,591Noninterest expenses
    
    
    (66,633
    )
    
    
    (94,799
    )
    
    
    (185,898
    )
    
    
    9,883
    
    
    
    (337,447
    )Adjustments
    
    
    (3,483
    )
    
    
    19,421
    
    
    
    (9,480
    )
    
    
    (6,458
    )
    
    
    -Income (loss) before income taxes
    
    
    8,492
    
    
    
    95,288
    
    
    
    212,588
    
    
    
    (9,999
    )
    
    
    306,369Income tax (expense) benefit
    
    
    (3,397
    )
    
    
    (34,274
    )
    
    
    (73,469
    )
    
    
    1,585
    
    
    
    (109,555
    )Net income (loss)
    
    $
    5,095
    
    
    $
    61,014
    
    
    $
    139,119
    
    
    $
    (8,414
    )
    
    $
    196,814Average assets
    
    
    
    
    
    $
    4,391,805
    
    
    $
    7,667,609
    
    
    $
        (87,833)
    
    
        $
    11,971,581Average equity
    
    
    
    
    
    
    450,897
    
    
    
    858,580
    
    
    
    187,668
    
    
    
    1,497,145
 100




---



##### 



Banking2002 (Dollars in thousands)
        
        IWM
        
        MSD&T
        
        Community
        
        Other
        
        TotalNet interest income
        
        $
        
        
        
        $
        146,249
        
        
        $
        297,882
        
        
        $
        (2,327
        )
        
        $
        441,804Provision for loan
            losses
        
        
        
        
        
        
        (11,735
        )
        
        
        (4,643
        )
        
        
        
        
        
        
        (16,378
        )Noninterest income
        
        
        67,965
        
        
        
        40,174
        
        
        
        49,950
        
        
        
        (14,339
        )
        
        
        143,750Noninterest expenses
        
        
        (45,617
        )
        
        
        (89,927
        )
        
        
        (151,346
        )
        
        
        14,282
        
        
        
        (272,608
        )Adjustments
        
        
        (2,219
        )
        
        
        15,491
        
        
        
        (8,419
        )
        
        
        (4,853
        )
        
        
        Income (loss) before
            income taxes
        
        
        20,129
        
        
        
        100,252
        
        
        
        183,424
        
        
        
        (7,237
        )
        
        
        296,568Income tax (expense) benefit
        
        
        (8,052
        )
        
        
        (36,160
        )
        
        
        (63,782
        )
        
        
        1,664
        
        
        
        (106,330
        )Net income (loss)
        
        $
        12,077
        
        
        $
        64,092
        
        
        $
        119,642
        
        
        $
        (5,573
        )
        
        $
        190,238Average assets
        
        
        
        
        
        $
        4,138,932
        
        
        $
        6,252,720
        
        
        $
        (268,195
        )
        
        $
        10,123,457Average equity
        
        
        
        
        
        
        435,308
        
        
        
        786,474
        
        
        
        36,185
        
        
        
        1,257,967
 Banking2001 (Dollars in thousands)
        
        IWM
        
        MSD&T
        
        Community
        
        Other
        
        TotalNet interest income
        
        $
        
        
        
        $
        140,764
        
        
        $
        278,421
        
        
        $
        (944
        )
        
        $
        418,241Provision for loan
            losses
        
        
        
        
        
        
        (7,238
        )
        
        
        (6,196
        )
        
        
        
        
        
        
        (13,434
        )Noninterest income
        
        
        69,046
        
        
        
        40,314
        
        
        
        46,343
        
        
        
        (10,213
        )
        
        
        145,490Noninterest expenses
        
        
        (40,469
        )
        
        
        (86,150
        )
        
        
        (145,436
        )
        
        
        8,096
        
        
        
        (263,959
        )Adjustments
        
        
        (1,363
        )
        
        
        11,634
        
        
        
        (17,968
        )
        
        
        7,697
        
        
        
        Income (loss) before
            income taxes
        
        
        27,214
        
        
        
        99,324
        
        
        
        155,164
        
        
        
        4,636
        
        
        
        286,338Income tax (expense) benefit
        
        
        (10,886
        )
        
        
        (36,061
        )
        
        
        (56,678
        )
        
        
        (1,418
        )
        
        
        (105,043
        )Net income (loss)
        
        $
        16,328
        
        
        $
        63,263
        
        
        $
        98,486
        
        
        $
        3,218
        
        
        $
        181,295Average assets
        
        
        
        
        
        $
        3,746,151
        
        
        $
        5,657,733
        
        
        $
        (176,682
        )
        
        $
        9,227,202Average equity
        
        
        
        
        
        
        410,425
        
        
        
        674,869
        
        
        
        111,764
        
        
        
        1,197,058
 16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of the unaudited quarterly results of operations: Three months ended2003(Dollars in thousands, except per share data)
    
    Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31Net interest income
    
    $
    133,249
    
    
    $
    122,232
    
    
    $
    112,723
    
    
    $
    111,126Provision for loan losses
    
    
    3,033
    
    
    
    3,005
    
    
    
    3,051
    
    
    
    3,016Net income
    
    
    50,645
    
    
    
    47,173
    
    
    
    50,010
    
    
    
    48,986Per share of common stock:Basic
    
    
    .64
    
    
    
    .64
    
    
    
    .73
    
    
    
    .71Diluted
    
    
    .63
    
    
    
    .63
    
    
    
    .72
    
    
    
    .71
 Three months ended2002 (Dollars in thousands, except per share data)
    
    Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31Net interest income
    
    $
    112,277
    
    
    $
    111,914
    
    
    $
    110,425
    
    
    $
    107,188Provision for loan losses
    
    
    4,935
    
    
    
    3,244
    
    
    
    5,116
    
    
    
    3,083Net income
    
    
    48,503
    
    
    
    48,615
    
    
    
    46,945
    
    
    
    46,175Per share of common stock:Basic
    
    
    .70
    
    
    
    .70
    
    
    
    .67
    
    
    
    .66Diluted
    
    
    .70
    
    
    
    .69
    
    
    
    .67
    
    
    
    .66
 101




---



##### 



17. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of Bankshares financial instruments at December 31,
2003 and 2002 were as follows: 2003
    
    2002Book
    
    Fair
    
    Book
    
    Fair(Dollars in thousands)
    
    Value
    
    Value
    
    Value
    
    ValueAssetsCash and short-term investments
    
    $
    362,701
    
    
    $
    362,701
    
    
    $
    545,781
    
    
    $
    545,781Investment securities
    
    
    3,172,931
    
    
    
    3,174,833
    
    
    
    2,564,583
    
    
    
    2,567,434Loans held-for-sale
    
    
    14,925
    
    
    
    14,925
    
    
    
    
    
    
    
    Loans
    
    
    9,272,160
    
    
    
    9,272,709
    
    
    
    7,312,027
    
    
    
    7,377,495Less: allowance for loan losses
    
    
    (155,337
    )
    
    
    
    
    
    
    (138,601
    )Loans, net
    
    
    9,116,823
    
    
    
    
    
    
    
    7,173,426Interest rate swaps
    
    
    6,594
    
    
    
    6,594
    
    
    
    11,424
    
    
    
    11,424Total financial assets
    
    $
    12,673,974
    
    
    $
    12,831,762
    
    
    $
    10,295,214
    
    
    $
    10,502,134LiabilitiesDeposits
    
    $
    10,262,553
    
    
    $
    10,269,135
    
    
    $
    8,260,940
    
    
    $
    8,284,730Short-term borrowings
    
    
    809,021
    
    
    
    809,021
    
    
    
    823,385
    
    
    
    823,385Long-term debt
    
    
    647,722
    
    
    
    641,110
    
    
    
    287,214
    
    
    
    301,451Interest rate swaps
    
    
    7,960
    
    
    
    7,960
    
    
    
    
    
    
    
    Total financial liabilities
    
    $
    11,727,256
    
    
    $
    11,727,226
    
    
    $
    9,371,539
    
    
    $
    9,409,566
 The following methods and assumptions were used to estimate the fair value
disclosures for financial instruments as of December 31, 2003 and 2002: Cash and Short-Term Investments The amounts reported in the balance sheet approximate the fair values of
these assets. Short-term investments include interest-bearing deposits in other
banks and federal funds sold. Investment Securities Fair values of investment securities are based on quoted market prices. Loans Held-for-Sale Loans held-for-sale are at book value which approximates fair value. Loans The fair value of loans is estimated using discounted cash flow analyses
based on contractual repayment schedules and discount rates which are believed
to reflect current credit quality and other related factors. These factors
provide for the effect of interest over time, as well as losses expected over
the life of the loan portfolio and recovery of other operating expenses. Deposits The fair value of demand deposits, savings accounts and money market
deposits is the amount payable on demand at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated using a 102




---



##### 



discounted cash flow calculation that applies interest rates and remaining
maturities for currently offered certificates of deposit. Short-Term Borrowings The amounts reported in the balance sheet approximate the fair values because
of the short duration of those instruments. Long-Term Debt The fair value of the long-term debt associated with the interest rate
swaps is based on quoted market prices. For all other long-term debt, fair value
is estimated by discounting the future cash flows using estimates of rates
currently available to Bankshares and its affiliates for debt with similar
terms and remaining maturities. Interest Rate Swaps The fair value of existing agreements is based on quoted market prices. Limitations The valuation techniques employed above involve uncertainties and are
affected by assumptions used and by judgments regarding prepayments, credit
risk, future loss experience, discount rates, cash flows and other factors.
Therefore, derived fair values cannot be substantiated by comparison to
independent markets or to other financial institutions. The reported fair
values do not necessarily represent what Bankshares would realize in immediate
sales or other dispositions. Changes in assumptions could significantly affect
the reported fair values. 18. DERIVATIVE INSTRUMENTS AND 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.
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. Bankshares has entered into interest rate swaps to convert
fixed-rate loans made to borrowers to floating-rate loans and convert its
nonprepayable fixed-rate debt to floating-rate debt. The fair value of derivative instruments recorded in other assets was $6.6
million (notional $203.1 million) and $11.4 million (notional $203.2 million)
at December 31, 2003 and 2002, respectively. The fair value of derivative
instruments recorded in other liabilities was $8.0 million (notional $150.0
million) and $0 at December 31, 2003 and 2002, respectively. For 2003,
Bankshares recognized a net gain of $70 thousand which represented the
ineffective portion of the fair-value hedge of fixed-rate loans made to
borrowers. For 2002, Bankshares recognized a net loss of $40 thousand. The
impact of the hedge decreased interest income $167 thousand and $151 thousand
in 2003 and 2002, respectively. The fair-value hedges of 103




---



##### 



nonprepayable fixed-rate debt were effective, and the impact of the hedges
decreased interest expense $8.5 million and $5.9 million in 2003 and 2002,
respectively. The following summarizes the gross position of derivatives at December 31, 2003
and 2002: Weighted AverageNumber
        
        Notional
        
        Years to
        
        
        
        
        
        
        
        
        
        FairDecember 31, 2003(Dollars in thousands)
        
        of contracts
        
        amount
        
        Maturity
        
        Fixed rate
        
        Variable Rate
        
        valueGross Position Summary:Pay fixed/receive
            variable interest rate swaps (1)
        
        
        1
        
        
        $
        3,108
        
        
        
        .33
        
        
        
        9.38
        %
        
        
        4.00
        %
        
        $
        (64
        )Receive fixed/pay
            variable interest rate swaps (2)
        
        
        3
        
        
        
        350,000
        
        
        
        8.44
        
        
        
        5.21
        %
        
        
        1.98
        %
        
        
        (1,366
        )Gross off balance
            sheet position
        
        
        4
        
        
        $
        353,108
        
        
        
        8.37
        
        
        
        
        
        
        
        
        
        
        $
        (1,430
        )Weighted AverageNumber
        
        Notional
        
        Years to
        
        
        
        
        
        
        
        
        
        FairDecember 31, 2002(Dollars in thousands)
        
        of contracts
        
        amount
        
        Maturity
        
        Fixed rate
        
        Variable Rate
        
        valueGross Position Summary:Pay fixed/receive
            variable interest rate swaps (1)
        
        
        1
        
        
        $
        3,174
        
        
        
        1.33
        
        
        
        9.38
        %
        
        
        4.25
        %
        
        $
        (249
        )Receive fixed/pay
            variable interest rate swaps (2)
        
        
        1
        
        
        
        200,000
        
        
        
        8.88
        
        
        
        5.70
        %
        
        
        2.28
        %
        
        
        11,673Gross off balance
            sheet position
        
        
        2
        
        
        $
        203,174
        
        
        
        8.76
        
        
        
        
        
        
        
        
        
        
        $
        11,424
  (1)
      
      Hedges fixed-rate commercial loan.(2)
      
      Hedges fixed-rate long-term debt. 19. INTANGIBLE ASSETS The following table discloses the gross carrying amount and accumulated
amortization of intangible assets subject to amortization at December 31, 2003
and December 31, 2002: December 31, 2003
    
    December 31, 2002Gross carrying
    
    Accumulated
    
    Net
    
    Gross carrying
    
    Accumulated
    
    Net(Dollars in thousands)
    
    amount
    
    amortization
    
    amount
    
    Amount
    
    amortization
    
    amountDeposit intangibles
    
    $
    49,881
    
    
    $
    (9,546
    )
    
    $
    40,335
    
    
    $
    13,846
    
    
    $
    (6,581
    )
    
    $
    7,265Mortgage servicing rights
    
    
    2,351
    
    
    
    (1,790
    )
    
    
    561
    
    
    
    1,543
    
    
    
    (1,282
    )
    
    
    261Customer lists and other
    
    
    17,010
    
    
    
    (1,683
    )
    
    
    15,327
    
    
    
    50
    
    
    
    (46
    )
    
    
    4Total
    
    $
    69,242
    
    
    $
    (13,019
    )
    
    $
    56,223
    
    
    $
    15,439
    
    
    $
    (7,909
    )
    
    $
    7,530
 The projections of amortization expense shown for mortgage servicing
rights are based on asset balances and the interest rate environment as of
December 31, 2003. Future amortization expense may be significantly different
depending on changes in the mortgage servicing portfolio, mortgage interest
rates and market conditions. Identifiable intangible assets are amortized based on useful lives of up
to 15 years. Bankshares recorded an estimated $36.0 million of core deposit
intangibles in connection with the F&M acquisition. Management reviews
identifiable intangible assets for impairment yearly (except mortgage servicing
rights, which are reviewed monthly), 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 flow is less than the carrying
amount of the asset. 104




---



##### 



Impairment is recognized by accelerating the write off of the asset to the
extent that the carrying value exceeds the estimated fair value. The following table shows the current period and estimated future amortization
expense for amortized intangible assets: MortgageDeposit
    
    servicing
    
    Customer lists(Dollars in thousands)
    
    
    
    
    
    intangibles
    
    intangibles
    
    and other
    
    TotalYear ended December 31, 2003
    
    
    
    
    
    $
    3,012
    
    
    $
    286
    
    
    $
    1,645
    
    
    $
    4,943Estimate for year ended December 31,
    
    
    2004
    
    
    
    5,467
    
    
    
    410
    
    
    
    2,326
    
    
    
    8,2032005
    
    
    
    5,467
    
    
    
    151
    
    
    
    2,326
    
    
    
    7,9442006
    
    
    
    5,467
    
    
    
    
    
    
    
    2,083
    
    
    
    7,5502007
    
    
    
    5,321
    
    
    
    
    
    
    
    1,890
    
    
    
    7,2112008
    
    
    
    4,605
    
    
    
    
    
    
    
    1,708
    
    
    
    6,313
 The following table discloses the gross carrying amount and accumulated
amortization of goodwill at December 31, 2003 and December 31, 2002 by segment: December 31, 2003
        
        December 31, 2002Gross carrying
        
        Accumulated
        
        Net
        
        Gross carrying
        
        Accumulated
        
        Net(Dollars in thousands)
        
        amount
        
        amortization
        
        amount
        
        amount
        
        amortization
        
        amountIWM
        
        **$**
        **18,061**
        
        
        **$**
        ****
        
        
        **$**
        **18,061**
        
        
        $
        
        
        
        $
        
        
        
        $
        Banking:MSD&T
        
        
        **19,445**
        
        
        
        **( 5,595**
        **)**
        
        
        **13,850**
        
        
        
        19,445
        
        
        
        ( 5,595
        )
        
        
        13,850Community
        
        
        **524,448**
        
        
        
        **(34,186**
        **)**
        
        
        **490,262**
        
        
        
        123,041
        
        
        
        (34,186
        )
        
        
        88,855****
        
        
        
        ****
        
        
        
        ****Total
        
        **$**
        **561,954**
        
        
        $
        **(39,781**
        **)**
        
        **$**
        **522,173**
        
        
        $
        142,486
        
        
        $
        (39,781
        )
        
        $
        102,705
 20. ACCOUNTING CHANGES In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Additionally, it further clarifies the criteria for the
initial recognition and measurement of intangible assets separate from
goodwill. SFAS No. 142 is effective for fiscal years beginning after December
15, 2001 and prescribes the accounting for goodwill and intangible assets
subsequent to initial recognition. The provisions of SFAS No. 142 discontinue
the amortization of goodwill and intangible assets with indefinite lives.
Instead, these assets will be subject to at least an annual impairment review,
and more frequently if certain impairment indicators are in evidence. SFAS No.
142 also requires that reporting units be identified for the purpose of
assessing potential future impairments of goodwill. 105




---



##### 



Bankshares adopted SFAS No. 142 on January 1, 2002. In preparing for its
adoption of SFAS No. 142, Bankshares determined its reporting units and the
amounts of goodwill and intangible assets to be allocated to those reporting
units. Bankshares determined that any reclassifications between goodwill and
intangible assets or any changes in the useful lives of intangible assets were
unnecessary. Application of the nonamortization provisions of the statement
resulted in additional net income of $8.4 million for the year ended December
31, 2002. SFAS No. 142 requires that goodwill be tested annually for impairment
using a two-step process. The first step is to identify potential impairment
and the second step is to measure the amount of the impairment loss, if any.
No impairment charges for goodwill impacted either the 2003 or 2002 financial
statements. The following table presents a reconciliation of reported net income and
earnings per share to amounts adjusted to exclude goodwill amortization, net of
tax, for 2003, 2002 and 2001. (Dollars in thousands, except per share data)
    
    2003
    
    2002
    
    2001Net IncomeReported
    
    $
    196,814
    
    
    $
    190,238
    
    
    $
    181,295Add: goodwill amortization
    
    
    
    
    
    
    
    
    
    
    8,924Adjusted
    
    $
    196,814
    
    
    $
    190,238
    
    
    $
    190,219Basic Earnings Per ShareReported
    
    $
    2.70
    
    
    $
    2.74
    
    
    $
    2.57Add: goodwill amortization
    
    
    
    
    
    
    
    
    
    
    .13Adjusted
    
    $
    2.70
    
    
    $
    2.74
    
    
    $
    2.70Diluted Earnings Per ShareReported
    
    $
    2.68
    
    
    $
    2.72
    
    
    $
    2.55Add: goodwill amortization
    
    
    
    
    
    
    
    
    
    
    .12Adjusted
    
    $
    2.68
    
    
    $
    2.72
    
    
    $
    2.67
 106




---



##### 



21. MERCANTILE BANKSHARES CORPORATION (PARENT CORPORATION ONLY)
FINANCIAL INFORMATION BALANCE SHEET December 31,(Dollars in thousands, except per share data)
    
    2003
    
    2002| |AssetsCash
    
    $
    13,597
    
    
    $
    3,950Interest-bearing deposits with bank affiliates
    
    
    56,000
    
    
    
    37,000Securities purchased under resale agreements with bank affiliates
    
    
    60,880
    
    
    
    128,769Cash and cash equivalents
    
    
    130,477
    
    
    
    169,719Investment in bank affiliates
    
    
    1,369,101
    
    
    
    1,315,369Investment in bank-related affiliates
    
    
    22,341
    
    
    
    20,198Loans and advances to affiliates
    
    
    359,520
    
    
    
    58,320Investment securities available-for-sale
    
    
    19,610
    
    
    
    6,017Goodwill, net
    
    
    400,307
    
    
    
    Other assets
    
    
    101,925
    
    
    
    89,183Total
    
    $
    2,403,281
    
    
    $
    1,658,806Liabilities and Shareholders EquityLiabilities:Commercial paper
    
    $
    190,880
    
    
    $
    258,768Accounts payable and other liabilities
    
    
    29,636
    
    
    
    17,280Long-term debt
    
    
    341,324
    
    
    
    58,400Total Liabilities
    
    
    561,840
    
    
    
    334,448Shareholders Equity:Preferred stock, no par value; authorized 2,000,000 shares;
issued and outstanding  NoneCommon stock, $2 par
            value; authorized 130,000,000 shares; issued 79,772,705 shares in
            2003 and 68,836,092 shares in 2002
    
    
    159,545
    
    
    
    137,672Capital surplus
    
    
    548,664
    
    
    
    120,577Retained earnings
    
    
    1,110,748
    
    
    
    1,010,248Accumulated other comprehensive income (loss)
    
    
    22,484
    
    
    
    55,861Total shareholders equity
    
    
    1,841,441
    
    
    
    1,324,358Total
    
    $
    2,403,281
    
    
    $
    1,658,806
 107




---



##### 



STATEMENT
          OF INCOME(Dollars in thousands)For the Years Ended December 31,
        
        2003
        
        2002
        
        2001IncomeDividends from bank
            affiliates
        
        $
        309,980
        
        
        $
        134,838
        
        
        $
        125,981Dividends from bank-related
            affiliates
        
        
        863
        
        
        
        905
        
        
        
        952Interest on interest-bearing
            deposits with bank affiliates
        
        
        1,460
        
        
        
        819
        
        
        
        2,855Interest on securities
            purchased under resale agreements with bank affiliates
        
        
        526
        
        
        
        1,224
        
        
        
        2,787Interest on loans
            to affiliates
        
        
        5,920
        
        
        
        2,383
        
        
        
        5,598Other income
        
        
        6,215
        
        
        
        198
        
        
        
        3,268Total income
        
        
        324,964
        
        
        
        140,367
        
        
        
        141,441ExpensesInterest on short-term
            borrowings
        
        
        1,099
        
        
        
        2,732
        
        
        
        7,635Interest on long-term
            debt
        
        
        12,128
        
        
        
        4,243
        
        
        
        4,819Amortization expense
        
        
        
        
        
        
        
        
        
        
        6,793Other Expenses
        
        
        6,042
        
        
        
        2,269
        
        
        
        982Total expenses
        
        
        19,269
        
        
        
        9,244
        
        
        
        20,229Income before income
            tax benefit and equity in undistributed net income of affiliates
        
        
        305,695
        
        
        
        131,123
        
        
        
        121,212Income tax (benefit)
        
        
        (1,959
        )
        
        
        (310
        )
        
        
        2,272307,654
        
        
        
        131,433
        
        
        
        118,940Equity in undistributed
            net income of:Bank affiliates
        
        
        (110,984
        )
        
        
        58,269
        
        
        
        61,589Bank-related affiliates
        
        
        144
        
        
        
        536
        
        
        
        766Net Income
        
        $
        196,814
        
        
        $
        190,238
        
        
        $
        181,295
 108




---



##### 



STATEMENT OF CASH FLOWS (Dollars in thousands)Increase (decrease) in cash and cash equivalentsFor the Years Ended December 31,
        
        2003
        
        2002
        
        2001Cash Flows from
            Operating ActivitiesNet Income
        
        $
        196,814
        
        
        $
        190,238
        
        
        $
        181,295Adjustments to reconcile
            net income to net cash provided by operating activities:Equity in undistributed
            net income of affiliates
        
        
        110,840
        
        
        
        (58,805
        )
        
        
        (62,355
        )Amortization expense
        
        
        
        
        
        
        
        
        
        
        6,793Investment securities
            gains
        
        
        (380
        )
        
        
        
        
        
        
        (3,138
        )Net (increase) decrease
            in other assets
        
        
        (6,390
        )
        
        
        (83,772
        )
        
        
        799Net increase (decrease) in
            liabilities:Interest payable
        
        
        3,377
        
        
        
        
        
        
        
        Accrued expenses
        
        
        2,424
        
        
        
        (582
        )
        
        
        (2,377
        )Taxes payable
        
        
        (1,615
        )
        
        
        (15,065
        )
        
        
        21,757Net cash provided
            by operating activities
        
        
        305,070
        
        
        
        32,014
        
        
        
        142,774Cash Flows from
            Investing ActivitiesNet (increase) decrease
            in loans to affiliates
        
        
        (299,115
        )
        
        
        74,445
        
        
        
        (180
        )Proceeds from sales
            of investment securities available-for-sale
        
        
        2,380
        
        
        
        500
        
        
        
        3,138Purchases of investment
            securities available-for-sale
        
        
        (14,995
        )
        
        
        (1,000
        )
        
        
        Investment in affiliates
        
        
        (171,609
        )
        
        
        
        
        
        
        (150
        )Net cash provided
            by (used in) investing activities
        
        
        (483,339
        )
        
        
        73,945
        
        
        
        2,808Cash Flows from
            Financing ActivitiesNet increase (decrease) in
            commercial paper
        
        
        (67,888
        )
        
        
        14,017
        
        
        
        46,806Proceeds from issuance
            of long-term debt
        
        
        300,000
        
        
        
        
        
        
        
        Repayment of long-term
            debt
        
        
        (8,400
        )
        
        
        (8,300
        )
        
        
        (8,300
        )Proceeds from issuance
            of shares
        
        
        11,369
        
        
        
        8,784
        
        
        
        7,396Repurchase of common
            shares
        
        
        (212
        )
        
        
        (53,953
        )
        
        
        (65,572
        )Dividends paid
        
        
        (95,842
        )
        
        
        (81,909
        )
        
        
        (77,597
        )Net cash used in
            financing activities
        
        
        139,027
        
        
        
        (121,361
        )
        
        
        (97,267
        )Net increase (decrease) in
            cash and cash equivalents
        
        
        (39,242
        )
        
        
        (15,402
        )
        
        
        48,315Cash and cash equivalents
            at beginning of year
        
        
        169,719
        
        
        
        185,121
        
        
        
        136,806Cash and cash equivalents
            at end of year
        
        $
        130,477
        
        
        $
        169,719
        
        
        $
        185,121
 109




---



##### 



22. NON-GAAP RECONCILIATION (Unaudited) For the Twelve Months Ended
      
      For the Quarter EndedDecember 31,
      
      December 31,(Dollars in thousands,
          except per share data)
      
      
      2003
      
      
      
      2002
      
      
      
      2003
      
      
      
      2002
 (1) The net interest margin and efficiency ratios are presented on a fully tax-equivalent (FTE) and annualized basis. The FTE
basis adjusts for the tax-favored status of income from certain loans and investments. Management believes this measure to be the preferred industry measurement of net interest income
and provides a relevant comparison between taxable and nontaxable investments. Net interest income (GAAP basis)
    
    $
    479,330
    
    
    $
    441,804
    
    
    $
    133,249
    
    
    $
    112,277Tax-equivalent adjustment
    
    
    6,760
    
    
    
    6,193
    
    
    
    1,881
    
    
    
    1,586Net interest income  tax-equivalent
    
    $
    486,090
    
    
    $
    447,997
    
    
    $
    135,130
    
    
    $
    113,863
 (2) Bankshares presents return on average assets, return on average tangible assets, return on average equity, and return on average tangible equity. Management excludes the balance of intangible assets and their related amortization expense from its calculation of return on average tangible assets, return on average tangible equity and
average tangible equity to average tangible assets. This adjustment allows management to review the core operating results and core capital position of Bankshares. This is consistent with the
treatment by bank regulatory agencies which exclude goodwill from their calculation of risk-based capital ratios. Return on average assets
          (GAAP basis)
      
      
      1.64
      %
      
      
      1.88
      %
      
      
      1.47
      %
      
      
      1.84
      %Impact of excluding
          average intangible assets and amortization
      
      
      .07
      
      
      
      .03
      
      
      
      .10
      
      
      
      .02Return on average tangible
          assets
      
      
      1.71
      %
      
      
      1.91
      %
      
      
      1.57
      %
      
      
      1.86
      %Return on average equity
          (GAAP basis)
      
      
      13.15
      %
      
      
      15.12
      %
      
      
      11.09
      %
      
      
      15.10
      %Impact of excluding
          average intangible assets and amortization
      
      
      3.40
      
      
      
      1.57
      
      
      
      5.40
      
      
      
      1.52Return on average tangible
          equity
      
      
      16.55
      %
      
      
      16.69
      %
      
      
      16.49
      %
      
      
      16.62
      %Average equity to average
          assets (GAAP basis)
      
      
      12.51
      %
      
      
      12.43
      %
      
      
      13.26
      %
      
      
      12.16
      %Impact of excluding
          average intangible assets and amortization
      
      
      (2.17
      )
      
      
      (.98
      )
      
      
      (3.75
      )
      
      
      (.93
      )Average tangible equity
          to average tangible assets
      
      
      10.34
      %
      
      
      11.45
      %
      
      
      9.51
      %
      
      
      11.23
      %
 When computing the efficiency ratio and net operating earnings, management excludes the amortization of intangible assets, merger-related expenses and gains and losses from sales of
investment securities because of the uncertainty as to timing and amount of gain or loss to be recognized. (3) The efficiency ratio is measured by dividing noninterest expenses by the sum of net interest income on an FTE basis and noninterest income. Efficiency
            ratio (GAAP basis)
        
        50.92
        %
        
        
        46.07
        %
        
        
        54.47
        %
        
        
        46.39
        %Impact of excluding:
        Securities gains and (losses)
        
        .56
        
        
        
        .06
        
        
        
        .04
        
        
        
        Amortization of deposit intangibles
        
        (.45
        )
        
        
        (.28
        )
        
        
        (.60
        )
        
        
        (.25
        )Amortization of other intangibles
        
        (.29
        )
        
        
        (.05
        )
        
        
        (.40
        )
        
        
        (.03
        )Merger-related expenses
        
        (1.24
        )
        
        
        
        
        
        
        (2.59
        )
        
        
        Operating
            efficiency ratio
        
        49.50
        %
        
        
        45.80
        %
        
        
        50.92
        %
        
        
        46.11
        %
 110
      (4)
    
    Management presents net operating earnings and diluted net operating earnings per share in order to assess the core operating results of Bankshares. Net income
            (GAAP basis)
        $
        196,814
        
        
        $
        190,238
        
        
        $
        50,645
        
        
        $
        48,503Less:
            Securities (gains) and losses, net of tax
        
        (4,314
        )
        
        
        (511
        )
        
        
        (74
        )
        
        
        Plus:
        Amortization of deposit intangibles, net of tax
        
        1,821
        
        
        
        1,017
        
        
        
        670
        
        
        
        221Amortization of other intangibles, net of tax
        
        1,167
        
        
        
        175
        
        
        
        446
        
        
        
        27Merger-related expenses, net of tax
        
        4,844
        
        
        
        
        
        
        
        2,847
        
        
        
        Net operating
            earnings
        $
        200,332
        
        
        $
        190,919
        
        
        $
        54,534
        
        
        $
        48,751Diluted
            net income per share (GAAP basis)
        $
        2.68
        
        
        $
        2.72
        
        
        $
        .63
        
        
        $
        .70Less:
            Securities (gains) and losses, net of tax
        
        (.06
        )
        
        
        (.01
        )
        
        
        
        
        
        
        Plus:
        Amortization of deposit intangibles, net of tax
        
        .02
        
        
        
        .01
        
        
        
        .01
        
        
        
        Amortization of other intangibles, net of tax
        
        .02
        
        
        
        
        
        
        
        .01
        
        
        
        Merger-related expenses, net of tax
        
        .07
        
        
        
        
        
        
        
        .04
        
        
        
        Diluted
            net operating earnings per share
        $
        2.73
        
        
        $
        2.72
        
        
        $
        .69
        
        
        $
        .70
 111
      ITEM 9.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
 There was no matter which is required to be disclosed in this Item 9
pursuant to the instructions contained in the form for this Report. ITEM 9A.
      
      CONTROLS AND PROCEDURES We have carried out an evaluation, under the supervision and with the
participation of our management including our principal executive officer and
principal financial officer, of the effectiveness of the design and operation
of our disclosure controls and procedures, as that term is defined in Rule
13a-15(e) under the Securities and Exchange Act of 1934, as amended. Based on
that evaluation, our principal executive officer and principal financial
officer concluded that as of December 31, 2003, which is the end of the period
covered by this Annual Report on Form 10-K, our disclosure controls and
procedures are effective. There have been no changes in our internal controls over financial
reporting in the fiscal quarter ended December 31, 2003 that have materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting. PART III ITEM 10.
    
    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 Bankshares has adopted a code of ethics that applies to its chief
executive officer, chief financial officer, and controller. The code of ethics
has been filed as an exhibit to this Annual Report on Form 10-K. The text of
the code is posted on Bankshares website at www.mercantile.com. Bankshares
will provide to any person, without charge, upon request a copy of the code of
ethics. Requests for a copy of the code of ethics can be made in writing to:
Mercantile Bankshares Corporation, P.O. Box 1477, Baltimore, MD 21203, Attn:
Investor Relations. Any future amendments to, or waivers from, the provisions
of the code of ethics that require disclosure under applicable rules of the
Securities and Exchange Commission will be disclosed in Item 10 of a current
report on Form 8-K The information required by this Item 10 with respect to the Executive
Officers of Registrant appears in Part I of this Annual Report on Form 10-K. The remaining information required by this Item 10 is incorporated by
reference to the definitive proxy statement of Registrant to be filed with the
Securities and Exchange Commission under Regulation 14A not later than 120 days
after the end of the fiscal year covered by this Annual Report on Form 10-K. 112
      ITEM 11.
    
    EXECUTIVE COMPENSATION
 The information required by this Item 11 is incorporated by reference to
the definitive proxy statement of Registrant to be filed with the Securities
and Exchange Commission under Regulation 14A not later than 120 days after the
end of the fiscal year covered by this Annual Report on Form 10-K.  ITEM
          12.
      
      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
        OWNERS AND MANAGEMENT The information
    required by this Item 12 is incorporated by reference to the definitive
    proxy statement of Registrant to be filed with the Securities and Exchange
    Commission under Regulation 14A not later than 120 days after the
    end of the fiscal year covered by this Annual Report on Form 10-K. ITEM 13.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 The information required by this Item 13 is incorporated by reference to
the definitive proxy statement of Registrant to be filed with the Securities
and Exchange Commission under Regulation 14A not later than 120 days after the
end of the fiscal year covered by this Annual Report on Form 10-K. ITEM
          14.
      
      PRINCIPAL ACCOUNTANT FEES AND SERVICES
 The information required by this Item 14 is incorporated by reference to
the definitive proxy statement of Registrant to be filed with the Securities
and Exchange Commission under Regulation 14A not later than 120 days after the
end of the fiscal year covered by this Annual Report on Form 10-K. PART IV ITEM 15.
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
  (a)
    
    The following documents are filed or furnished as part of this report,
except as indicated.  (1)
    
    The financial statements filed herewith are listed in the accompanying
Index to Financial Statements.(2)
    
    Financial Statement Schedules are omitted because of the absence of the
conditions under which they are required or because the information called
for is included in the Consolidated Financial Statements or notes thereto. 113
      (3)
    
    Exhibits filed or furnished herewith or incorporated by reference herein
are set forth in the following table prepared in accordance with Item 601
of Regulation S-K. Exhibit Table  (2)
    
    Agreement and Plan of Merger, dated as of March 13, 2003, between Registrant and F&M Bancorp (Incorporated by reference to Registrants Registration Statement on Form S-4, No. 333-104793, Exhibit 2)(3)
    
    Charter and by-laws A.
      (1)
      
      Articles of Incorporation effective May 27, 1969 (Incorporated
        by reference to Registrants Registration Statement on Form S-1,
        No. 2-39545, Exhibit 3-A(1)).(2)
      
      Articles of Amendment effective June 6, 1969 (Incorporated by reference
        to Registrants Registration Statement on Form S-1, No. 2-39545,
        Exhibit 3-A)(2)).(3)
      
      Articles Supplementary effective August 28, 1970 (Incorporated
        by reference to Registrants Registration Statement on Form S-1,
        No. 2-39545, Exhibit 3-A)(3)).(4)
      
      Articles of Amendment effective December 14, 1970 (Incorporated
        by reference to Registrants Registration Statement on Form S-1,
        No. 2-39545, Exhibit 3-A(4)).(5)
      
      Articles Supplementary effective May 10, 1971 (Incorporated by
        reference to Registrants Registration Statement on Form S-1,
        No. 2-39545, Exhibit 3-A(5)).(6)
      
      Articles Supplementary effective July 30, 1971 (Incorporated by
        reference to Registrants Registration Statement on Form S-1,
        No. 2-41379, Exhibit 3-A(6)).(7)
      
      Articles of Amendment effective May 8, 1986 (Incorporated by reference
        to Registrants Annual Report on Form 10-K for the year ended December 31,
        1993, Exhibit 3-A(7), Commission File No. 0-5127).(8)
      
      Articles of Amendment effective April 27, 1988 (Incorporated by
        reference to Registrants Annual Report on Form 10-K for the year
        ended December 31, 1993, Exhibit 3-A(8), Commission File No.
        0-5127).(9)
      
      Articles Supplementary effective September 13, 1989 (Incorporated
        by reference to Registrants Form 8-K filed September 27, 1989, Exhibit B
        attached to Exhibit 4-A, Commission File No. 0-5127). 114
      (10)
    
    Articles Supplementary effective January 3, 1990
(Incorporated by reference to Registrants Form 8-K filed January 9,
1990, Exhibit B attached to Exhibit 4-A, Commission File No.
0-5127).(11)
    
    Articles of Amendment effective April 26, 1990 (Incorporated
by reference to Registrants Annual Report on Form 10-K for the year
ended December 31, 1990, Exhibit 3-A(11), Commission File No.
0-5127).(12)
    
    Articles of Amendment effective April 30, 1997 (Incorporated
by reference to Registrants Registration Statement on Form S-4, No.
333-43651, Exhibit 3(i)(L)).(13)
    
    Articles Supplementary effective June 9, 1999 (Incorporated
by reference to Registrants Registration Statement on Form S-8, No.
333-90307, Exhibit 4.1.M).(14)
    
    Articles Supplementary effective September 30, 1999
(Incorporated by reference to Registrants Registration Statement on
Form S-8, No. 333-90307, Exhibit 4.1.N).(15)
    
    Certificate of Correction
effective July 3, 2002, concerning Articles of
Amendment effective May 8, 1986 (incorporated by
reference to Registrants Quarterly Report for the
quarter ended September 30, 2002, Exhibit 3A(15),
Commission File No. 0-5127).(16)
    
    Certificate of Correction effective July 3, 2002, concerning
Articles of Amendment effective April 26, 1990 (incorporated by
reference to Registrants Quarterly Report for the quarter ended
September 30, 2002, Exhibit 3A(16), Commission File No. 0-5127).  B.
    
    By-Laws of the Registrant, as amended to date.
(Filed herewith).  (4)
    
    Instruments defining the rights of security holders, including
indentures, Charter and by-laws: See Item 15(a)(3) above.  A.
    
    Rights Agreement dated as of June 8, 1999
between Registrant and the Rights Agent, including Form of
Rights Certificate and Articles Supplementary (Incorporated
by reference to Form 8-K of Registrant filed June 11, 1999,
Exhibit 4, Commission File No. 0-5127, and to Form 8-A of
Registrant filed June 11, 1999, Exhibits 1, 2 and 3,
Commission File No. 0-5127).B.
    
    Indenture between Registrant and JP Morgan
Chase Bank, as Trustee, dated as of April 15, 2003, relating
to Subordinated Notes due 2013 (Incorporated by reference to
Registrants Registration Statement on Form S-4, No.
333-105238, Exhibit 4.1). 115
      C.
    
    Form of 4.625% Subordinated Note due 2013,
Series B (Incorporated by reference to Registrants
Registration Statement on Form S-4, No. 333-105238, Exhibit
4.2).  (10)
    
    Material contracts  A.
    
    Mercantile Bankshares Corporation and
Affiliates Annual Incentive Compensation Plan, as amended
through March 10, 1998 (Incorporated by reference to
Registrants Annual Report on Form 10-K for the year ended
December 31, 1997, Exhibit 10 A, Commission File No. 0-5127).B.
    
    Dividend Reinvestment and Stock Purchase Plan
of Mercantile Bankshares Corporation (Incorporated by
reference to the Plan text included in Registrants
Registration Statement on Form S-3, No. 33-44376).C.
    
    Deferred Compensation Agreement, including
supplemental pension and thrift plan arrangements, dated
September 30, 1982, between Mercantile-Safe Deposit and Trust
Company and H. Furlong Baldwin, as amended by Agreements
dated as of October 24, 1983, March 13, 1984, January 1,
1987, December 8, 1987 and January 1, 1989 (Incorporated by
reference to Registrants Annual Report on Form 10-K for the
year ended December 31, 1989, Exhibit 10 E, Commission File
No. 0-5127), as amended by Agreement dated February 1, 1997
(Incorporated by reference to Registrants Annual Report on
Form 10-K for the year ended December 31, 1996, Exhibit 10 D,
Commission File No. 0-5127), as amended by Agreement dated
February 22, 2001 (Incorporated by reference to Registrants
Annual Report on Form 10-K for the year ended December 31,
2000, Exhibit 10 D, Commission File No. 0-5127).D.
    
    Mercantile Bankshares Corporation and
Participating Affiliates Unfunded Deferred Compensation Plan
for Directors, as amended through January 1, 1984
(Incorporated by reference to Registrants Annual Report on
Form 10-K for the year ended December 31, 1989, Exhibit 10 G,
Commission File No. 0-5127), as amended and restated by
amendment effective December 31, 1995 (Incorporated by
reference to Registrants Annual Report on Form 10-K for the
year ended December 31, 1995, Exhibit 10 F, Commission File
No. 0-5127).E.
    
    Mercantile Bankshares Corporation Employee
Stock Purchase Dividend Reinvestment Plan dated February 13,
1995 (Incorporated by reference to Registrants Annual Report
on Form 10-K for the year ended December 31, 1994, Exhibit 10
I, Commission File No. 0-5127).F.
    
    Mercantile Bankshares Corporation (1989)
Omnibus Stock Plan (Incorporated by reference to Registrants
Quarterly Report on Form 10-Q for the period ended September
30, 1997, Exhibit 10 K, Commission File No. 0-5127). 116
      G.
    
    Mercantile Bankshares Corporation 1999 Omnibus
Stock Plan (Incorporated by reference to Registrants
Registration Statement on Form S-8, No. 333-90307, Exhibit
4.4).H.
    
    Mercantile Bankshares Corporation and
Participating Affiliates Supplemental Cash Balance Executive
Retirement Plan, dated April 27, 1994, effective January 1,
1994 (Incorporated by reference to Registrants Annual Report
on Form 10-K for year ended December 31, 1994, Exhibit 10 R,
Commission File No. 0-5127).I.
    
    Mercantile Bankshares Corporation and
Participating Affiliates Supplemental 401(k) Executive
Retirement Plan, dated December 13, 1994, effective January
1, 1995 (Incorporated by reference to Registrants Annual
Report on Form 10-K for the year ended December 31, 1994,
Exhibit 10 S, Commission File No. 0-5127).J.
    
    Mercantile Bankshares Corporation Option
Agreement with H. Furlong Baldwin (dated August 22, 1995),
with respect to 120,000 shares after a stock dividend paid in
1997, and as to which the Net Operating Income is that of
Mercantile-Safe Deposit and Trust Company (Incorporated by
reference to Registrants Annual Report on Form 10-K for the
year ended December 31, 1995, Exhibit 10 Q, Commission File
No. 0-5127).K.
    
    Mercantile Bankshares Corporation Retainer
Stock Plan For Non-Employee Directors dated March 12, 1996
(Incorporated by reference to Registrants Annual Report on
Form 10-K for the year ended December 31, 1995, Exhibit 10 R,
Commission File No. 0-5127).L.
    
    Mercantile Bankshares Corporation Option
Agreement with J. Marshall Reid, dated August 21, 1995
(Incorporated by reference to Registrants Annual Report on
Form 10-K for the year ended December 31, 1998, Exhibit 10 R,
Commission File No. 0-5127).M.
    
    Mercantile Bankshares Corporation Option
Agreement with Jack E. Steil, dated August 21, 1995
(Incorporated by reference to Registrants Annual Report on
Form 10-K for the year ended December 31, 1998, Exhibit 10 S,
Commission File No. 0-5127).N.
    
    Mercantile Bankshares Corporation Option
Agreement with Terry L. Troupe, dated September 10, 1996
(Incorporated by reference to Registrants Annual Report on
Form 10-K for the year ended December 31, 1999, Exhibit 10 S,
Commission File No. 0-5127).O.
    
    Agreement dated February 2, 2001, among
Mercantile Bankshares Corporation, Mercantile-Safe Deposit
and Trust Company and H. Furlong Baldwin (Incorporated by
reference to Form 8-K of Registrant filed February 13, 2001,
Exhibit 10 T, Commission File No. 0-5127). 117
      P.
    
    Executive Employment Agreement dated February
2, 2001, among Mercantile Bankshares Corporation,
Mercantile-Safe Deposit and Trust Company and Edward J.
Kelly, III (Incorporated by reference to Form 8-K of
Registrant filed February 13, 2001, Exhibit 10 U, Commission
File No. 0-5127), as amended by Agreement effective February
21, 2002 (Incorporated by reference to Registrants annual
report on Form 10-K for the year ended December 31, 2001
Exhibit 10R, Commission File No. 0-5127).Q.
    
    Executive Severance Agreement dated February 2,
2001, among Mercantile Bankshares Corporation,
Mercantile-Safe Deposit and Trust Company and Edward J.
Kelly, III (Incorporated by reference to Form 8-K of
Registrant filed February 13, 2001, Exhibit 10 V, Commission
File No. 0-5127), as amended by Agreement effective February
21, 2002 (Incorporated by Reference to Registrants Annual
Report on Form 10-K, for the year ended December 31, 2001,
Exhibit 10S, Commission File No. 5127).R.
    
    Supplemental Retirement Agreement dated
February 2, 2001, among Mercantile Bankshares Corporation,
Mercantile-Safe Deposit and Trust Company and Edward J.
Kelly, III (Incorporated by reference to Form 8-K of
Registrant filed February 13, 2001, Exhibit 10 W, Commission
File No. 0-5127).S.
    
    Mercantile Bankshares Corporation Option
Agreement with Edward J. Kelly, III, dated March 2, 2001
(Incorporated by reference to Registrants Annual Report on
Form 10-K for the year ended December 31, 2000, Exhibit 10 X,
Commission File No. 0-5127).T.
    
    Schedule and Form of Mercantile Bankshares
Corporation Option Agreements entered into in 2000 with J.
Marshall Reid (40,000 shares), Jack E. Steil (40,000 shares)
and Terry L. Troupe (20,000 shares) (Incorporated by
reference to Registrants Annual Report on Form 10-K for the
year ended December 31, 2000, Exhibit 10 Y, Commission File
No. 0-5127).U.
    
    Executive Employment Agreement effective
February 1, 2002, among Mercantile Bankshares Corporation,
Mercantile-Safe Deposit and Trust Company and Wallace
Mathai-Davis (incorporated by reference to Registrants
Annual Report on Form 10-K for the year ended December 31,
2001, Exhibit 10W, Commission File No. 0-5127).V.
    
    Executive Severance Agreement effective
February 1, 2002, among Mercantile Bankshares Corporation,
Mercantile-Safe Deposit and Trust Company and Wallace
Mathai-Davis (incorporated by reference to Registrants
Annual Report on Form 10-K for the year ended December 31,
2001, Exhibit 10X, Commission File No. 0-5127). 118
      Y.
    
    Executive Employment Agreement dated March 19,
2002, among Mercantile Bankshares Corporation,
Mercantile-Safe Deposit and Trust Company and John L. Unger
(incorporated by reference to Registrants Form 8-K filed
April 3, 2002 Exhibit 10Y, Commission File No. 0-5127).Z.
    
    Executive Severance Agreement dated March 19,
2002, among Mercantile Bankshares Corporation,
Mercantile-Safe Deposit and Trust Company and John L. Unger
(incorporated by reference to Registrants Form 8-K April 3,
2002, Exhibit 10Z, Commission File No. 0-5127).AA.
    
    Mercantile Bankshares Corporation Option
Agreement with Edward J. Kelly, III, dated May 7, 2002
(incorporated by reference to Registrants Quarterly Report
for the quarter ended June 30, 2002, Exhibit 10AA, Commission
File No. 0-5127).BB.
    
    Mercantile Bankshares Corporation Option
Agreement with J. Marshall Reid, dated May 7, 2002
(incorporated by reference to Registrants Quarterly Report
for the quarter ended June 30, 2002, Exhibit 10BB, Commission
File No. 0-5127).CC.
    
    Mercantile Bankshares Corporation Option
Agreement with Jack E. Steil, dated May 7, 2002 (incorporated
by reference to Registrants Quarterly Report for the quarter
ended June 30, 2002, Exhibit 10CC, Commission File No.
0-5127).DD.
    
    Mercantile Bankshares Corporation Option
Agreement with John L. Unger, dated May 7, 2002 (incorporated
by reference to Registrants Quarterly Report for the quarter
ended June 30, 2002, Exhibit 10DD, Commission File No.
0-5127).EE.
    
    Mercantile Bankshares Corporation Option
Agreement with Terry L. Troupe, dated May 7, 2002
(incorporated by reference to Registrants Quarterly Report
for the quarter ended June 30, 2002, Exhibit 10EE, Commission
File No. 0-5127).FF.
    
    Mercantile Bankshares Corporation Restricted
Stock Agreement with Edward J. Kelly, III, dated April 29,
2002 (incorporated by reference to Registrants Quarterly
Report for the quarter ended June 30, 2002, Exhibit 10FF,
Commission File No. 0-5127).GG.
    
    Mercantile Bankshares Corporation Restricted
Stock Agreement with Wallace Mathai-Davis, dated April 29,
2002 (incorporated by reference to Registrants Quarterly
Report for the quarter ended June 30, 2002, Exhibit 10GG,
Commission File No. 0-5127).HH.
    
    Mercantile Bankshares Corporation Restricted
Stock Agreement with J. Marshall Reid, dated April 29, 2002
(incorporated by reference to Registrants Quarterly Report
for the quarter ended June 30, 2002, Exhibit 10HH, Commission
File No. 0-5127).II.
    
    Mercantile Bankshares Corporation Restricted
Stock Agreement with Jack E. Steil, dated April 29, 2002
(incorporated by reference to Registrants Quarterly 119
      Report for the quarter ended June 30, 2002, Exhibit 10II,
        Commission File No. 0-5127).JJ.
      
      Mercantile Bankshares Corporation Severance Agreement with Jack E. Steil,
        dated December 31, 2002 (Incorporated by reference to Registrants
        Annual Report on Form 10-K for the year ended December 31, 2002,
        Exhibit 10JJ, Commission File No. 0-5127).KK.
      
      Agreement dated February 25, 2003, among Mercantile Bankshares
        Corporation, Mercantile-Safe Deposit and Trust Company and H. Furlong
        Baldwin (Incorporated by reference to Registrants Annual Report
        on Form 10-K for the year ended December 31, 2002, Exhibit 10KK,
        Commission File No. 0-5127).LL.
      
      F&M Bancorp Restated 1983 Incentive Stock Option Plan (Incorporated
        by reference to Registrants Registration Statement on Form S-8,
        No. 333-108123, Exhibit 4.4).MM.
      
      F&M Bancorp 1995 Stock Option Plan (Incorporated by reference to
        Registrants Registration Statement on Form S-8, No. 333-108123,
        Exhibit 4.5).NN.
      
      F&M Bancorp 1999 Employee Stock Option Plan (Incorporated by reference
        to Registrants Registration Statement on Form S-8, No. 333-108123,
        Exhibit 4.6).OO.
      
      F&M Bancorp 1999 Stock Option Plan for Non-Employee Directors (Incorporated
        by reference to Registrants Registration Statement on Form S-8,
        No. 333-108123, Exhibit 4.7)PP.
      
      Patapsco Valley Bancshares, Inc. Incentive Stock Option Plan (Incorporated
        by reference to Registrants Registration Statement on Form S-8,
        No. 333-108123, Exhibit 4.8).QQ.
      
      Patapsco Valley Bancshares, Inc. Directors Stock Option Plan (Incorporated
        by reference to Registrants Registration Statement on Form S-8,
        No. 333-108123, Exhibit 4.9).RR.
      
      Pataspco Valley Bancshares, Inc. Employee Stock Purchase Plan (Incorporated
        by reference to Registrants Registration Statement on Form S-8,
        No. 333-108123, Exhibit 4.10).SS.
      
      Monocracy Bancshares, Inc. 1994 Stock Incentive Plan (Incorporated by
        reference to Registrants Registration Statement on Form S-8,
        No. 333-108123, Exhibit 4.11).TT.
      
      Monocracy Bancshares, Inc. 1997 Independent Directors Stock Option
        Plan (Incorporated by reference to Registrants Registration Statement
        on Form S-8, No. 333-108123, Exhibit 4.12).UU.
      
      Executive Employment Agreement dated as of February 1, 2002 by
        and between Mercantile-Safe Deposit and Trust Company and John J. Pileggi
        (filed herewith). 120
      VV.
    
    Executive Severance Agreement dated as of
February 1, 2002 by and between Mercantile-Safe Deposit and
Trust Company and John J. Pileggi (filed herewith).WW.
    
    Executive Employment Agreement dated as of
January 13, 2003 by and between Mercantile-Safe Deposit and
Trust Company and Michael M. Paese (filed herewith).XX.
    
    Executive Severance Agreement dated as of March 10, 2004
by and between Mercantile Bankshares Corporation and Peter W.
Floeckher, Jr. (filed herewith).YY.
    
    Executive Severance Agreement dated as of March 10, 2004
by and among Mercantile Bankshares Corporation, Mercantile-Safe
Deposit and Trust Company and Deborah A. Kakaris (filed herewith).ZZ.
    
    Executive Severance Agreement dated as of March 10, 2004
by and between Mercantile Bankshares Corporation and Priscilla S.
Hoblitzell (filed herewith).  (14)
    
    Code of Ethics (filed herewith).(21)
    
    Subsidiaries of the Registrant (filed herewith).(23)
    
    Consent of Independent Accountants (filed herewith).(24)
    
    Power of Attorney dated March 9, 2004 (filed herewith).(31)
    
    Certifications pursuant to Section 302 of the Sarbanes Oxley Act of 2002  A.
    
    Certification of the Chief Executive Officer of Mercantile Bankshares
Corporation
(filed herewith).B.
    
    Certification of the Chief Financial Officer of Mercantile Bankshares
Corporation
(filed herewith).  (32)
    
    Certifications pursuant to Section 906 of the Sarbanes Oxley Act of 2002  A.
    
    Certificate of the Chief Executive Officer of
Mercantile Bankshares Corporation (furnished herewith).B.
    
    Certificate of the Chief Financial Officer of
Mercantile Bankshares Corporation (furnished herewith).  (b)
    
    Reports on Form 8-K.Report on Form 8-K, filed October 22, 2003, Item 5Report on Form 8-K, filed October 22, 2003, Item 5Report on Form 8-K, filed October 27, 2003, Items 7 and 9Report on Form 8-K, filed December 10, 2003, Items 5 and 9 121
      INDEX TO FINANCIAL STATEMENTS The Report of Independent Accountants on the Consolidated Financial
Statements of Mercantile Bankshares Corporation and affiliates and related
notes is included in Item 8 of this Annual Report on Form 10-K. Consolidated Financial Statements and related notes are included in Item 8 of
this Annual Report on Form 10-K, as follows: Consolidated Balance Sheets, December 31, 2003 and 2002 Statement of Consolidated Income for the years ended December 31, 2003,
2002, and 2001 Statement of Consolidated Cash Flows for the years ended December 31, 2003,
2002 and 2001 Statement of Changes in Consolidated Stockholders Equity for the years
ended December 31, 2003, 2002 and 2001 Notes to Consolidated Financial Statements 122
      SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. MERCANTILE
            BANKSHARES CORPORATIONBy:
        /s/ Edward
            J. Kelly, III
        March 9, 2004Edward
            J. Kelly, III
            President and Chief Executive Officer
 Pursuant
    to the requirements of the Securities Act of 1934, this report has been signed
    below by the following persons on behalf of the Registrant and in the capacities
    and on the dates indicated: Principal
          Executive Officer/s/
          Edward J. Kelly, III
      March 9, 2004Edward J. Kelly, III
          President and Chief Executive Officer  Principal
            Financial Officer/s/
            Terry L. Troupe
        March 9, 2004Terry L. Troupe
            Chief Financial Officer
 Principal
          Accounting Officer/s/
          William T. Skinner, Jr.
      March 9, 2004William T. Skinner, Jr.
          Controller 123
      A majority of the Board of Directors: Cynthia A. Archer, R. Carl Benna, Richard O. Berndt, Howard B. Bowen, William
R. Brody, Eddie C. Brown, George L. Bunting, Jr., Anthony W. Deering, Darrell
D. Friedman, Freeman A Hrabowski, Robert A. Kinsley, Morton P. Plant, Christian
H. Poindexter, Clayton S. Rose, James L. Shea and Donald L. Shepard. By:
        /s/ Edward
            J. Kelly, III
        March 9, 2004Edward
            J. Kelly, III
            For Himself and as Attorney-in-Fact
 124