SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 ------------------------------ FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED June 30, 1997 ------------------------------ SHORE BANCSHARES, INC. 109 North Commerce Street Post Office Box 400 Centreville, Maryland 21617-0400 Telephone: (410) 758-1600 IRS Employer Identification Number: 52-1974638 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 the number of shares of outstanding of each of the issuer's classes of common stock as of the latest practicable date. As of August 8, 1997, there were 1,007,424
SHORE BANCSHARES, INC. FORM 10-Q INDEX PART I FINANCIAL INFORMATION - ----------------------------- Item 1. Financial Statements (Unaudited) Balance Sheets -- June 30, 1997 and December 31, 1996 Statements of Income -- Three months ended June 30, 1997 and 1996 and the six months ended June 30, 1997 and 1996. Statements of Cash Flows -- Six months ended June 30, 1997 and 1996 and the twelve months ended December 31, 1996 Notes to Financial Statements -- June 30, 1997 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II OTHER INFORMATION - -------------------------- Item 1. Legal Proceedings Item 2. Changes in Securities Item 3. Defaults upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES - ----------
PART 1 FINANCIAL INFORMATION
Item 1. Financial Information CONSOLIDATED BALANCE SHEETS SHORE BANCSHARES, INC. <TABLE> <CAPTION> June 30, December 31, Dollars in thousands 1997 1996 (Unaudited) ----------------- ----------------- <S><C> ASSETS Cash and due from banks $ 6,463 $ 4,873 Federal funds sold 4,754 5,390 Securities (Note 2) Held to Maturity 32,712 32,462 Available for Sale 8,715 11,191 Loans, less allowance for credit losses (Note 3) 107,093 87,389 Premises and fixed assets 2,895 2,153 Other real estate owned 63 - Investments in unconsolidated subsidiaries 1,118 1,114 Accrued interest receivable 1,376 1,385 Net deferred tax assets and other assets 4,058 942 TOTAL ASSETS $ 169,247 $ 146,899 ================= ================= LIABILITIES Deposits Non-interest bearing demand $ 16,856 $ 16,381 Interest bearing transaction 16,872 16,172 Savings and money market 40,682 31,799 Time, $100,000 or more 14,111 16,680 Other time 56,995 43,134 ----------------- ----------------- Total deposits 145,516 124,166 ----------------- ----------------- Accrued interest payable 180 158 Other liabilities 949 479 ----------------- ----------------- 1,129 637 ----------------- ----------------- Total liabilities 146,645 124,803 ----------------- ----------------- COMMITMENTS EQUITY CAPITAL Common stock, par value $.01; authorized 10,000,000 shares, issued and outstanding 1,007,424 shares 10 10 Surplus 10,064 10,064 Retained earnings 12,609 12,087 Net unrealized holding gains (losses) on available for sale securities (81) (65) ----------------- ----------------- Total stockholders' equity 22,602 22,096 ----------------- ----------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 169,247 $ 146,899 ================= ================= </TABLE> See Notes to Financial Statements
CONSOLIDATED STATEMENTS OF INCOME SHORE BANCSHARES, INC. <TABLE> <CAPTION> (UNAUDITED) Quarter Six Months Quarter Six Months Dollars in thousands except per share data Ended Ended Ended Ended June 30, June 30, June 30, June 30, 1997 1997 1996 1996 ---------------------------------------------------------------------- <S><C> INTEREST INCOME Interest and fee income on loans $ 2,439 $ 4,400 $ 2,065 $ 4,025 Interest and dividends on investment securities Taxable securities 556 1,083 445 845 Tax-exempt securities 105 212 106 217 Interest on federal funds sold 45 136 74 173 ---------------------------------------------------------------------- Total interest income 3,145 5,831 2,690 5,260 ---------------------------------------------------------------------- INTEREST EXPENSE Interest on certificates of deposit of $100,000 or more 200 410 162 330 Interest on other deposits 1,187 2,124 922 1,851 Interest on federal funds purchased - - - - ---------------------------------------------------------------------- Total interest expense 1,387 2,534 1,084 2,181 ---------------------------------------------------------------------- NET INTEREST INCOME 1,758 3,297 1,606 3,079 Provision for credit losses (Note 7) - - - - ---------------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 1,758 3,297 1,606 3,079 ---------------------------------------------------------------------- NONINTEREST INCOME Service charges on deposit accounts 168 329 169 314 Other noninterest income 33 61 30 64 Gains (losses) on securities 4 8 204 204 ---------------------------------------------------------------------- Total noninterest income 205 398 403 582 ---------------------------------------------------------------------- NONINTEREST EXPENSE Salaries and employee benefits 546 1,058 465 933 Expenses of premises and fixed assets 114 265 127 270 Other noninterest expense 466 852 300 701 ---------------------------------------------------------------------- Total noninterest expense 1,126 2,175 892 1,904 ---------------------------------------------------------------------- INCOME BEFORE TAXES 838 1,521 1,117 1,757 Applicable income taxes 295 536 344 570 ---------------------------------------------------------------------- NET INCOME $ 543 $ 985 $ 773 $ 1,187 ====================================================================== Net Income Per Share $ 0.54 $ 0.98 $ 0.77 $ 1.18 Number of Shares Outstanding 1,007,424 1,007,424 1,007,424 1,007,424 </TABLE> See Notes to the Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOW SHORE BANCSHARES, INC. (UNAUDITED) <TABLE> <CAPTION> Six Months Year Six Months Ended Ended Ended June 30, December 31, June 30, 1997 1996 1996 ------------------------------------------------------ <S><C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 985 $ 2,308 $ 1,187 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 102 296 130 Equity in net earnings of unconsolidated subsidiaries (26) Provision for credit losses, net (91) 25 (17) Deferred income tax benefits 60 - Net (gains) losses on disposal of assets (8) (205) (204) Changes in assets and liabilities: (Increase) decrease in accrued interest receivable 9 (49) (56) (Increase) decrease in other assets (853) 34 113 Increase (decrease) in interest payable 22 7 (10) Increase (decrease) in other liabilities 82 (141) (38) --------------------------------------------------------- Net cash provided by operating activities 248 2,309 1,105 --------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale or maturities of held-to-maturity securities 3,055 11,529 7,215 Proceeds from sale or maturities of available-for-sale securities 9,257 957 751 (Purchases) of held-to-maturity securities (3,294) (11,034) (4,882) (Purchases) of available-for-securities (5,645) (7,988) (2,960) Net (increase) decrease in loans 693 (1,963) (2,122) Purchase of premises and equipment (690) (211) (127) Proceeds from sale of premises and equipment 7 Investment in unconsolidated subsidary - (15) Purchase of Kent S&L Assoc, net of cash acquired (2,799) Acquire other real estate - - - Proceeds from sales of other real estate 118 --------------------------------------------------------- Net cash provided by (used in) investing activities 577 (8,600) (2,125) --------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in demand, interest- bearing transaction, and savings deposits 2,772 2,928 3,560 Net increase (decrease) in time deposits (2,180) 4,758 (1,169) Cash dividends paid (463) (926) (353) --------------------------------------------------------- Net cash provided by (used in) financing activities 129 6,760 2,038 --------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 954 469 1,018 Cash and cash equivalents, beginning 10,263 9,794 9,794 --------------------------------------------------------- Cash and cash equivalents, ending $ 11,217 $ 10,263 $ 10,812 ========================================================= Supplementary cash flow information: Interest paid $ 2,511 $ 4,469 $ 2,197 Income taxes paid $ 282 $ 1,100 473 </TABLE> All dollar amounts in thousands
Note 1 - Financial Information The unaudited interium consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interium financial information and with the instructions to Form 10Q. In the opinion of management, all necessary adjustments have been made for a fair presentation of financial position and results of operations for the periods presented. Operating results for the six month period ended June 30, 1997 are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. For further information, refer to the audited consolidated financial statements and footnotes included in the 1996 Annual Report to Shareholders and Form 10.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SECURITIES (UNAUDITED) <TABLE> <CAPTION> June 30, 1997 December 31, 1996 ---------------------------------------------- ------------------------------------------- Held-to-Maturity Available-for-Sale Held-to-Maturity Available-for-Sale Amortized Fair Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value Cost Value ---------------------------------------------- ------------------------------------------- <S><C> U.S. Treasury securities $ 5,960 $ 5,955 $ 9,434 $ 9,458 U.S. Government agency and corporation obligations issued by U.S. Government sponsored agencies $ 23,892 $ 23,872 99 100 $ 23,035 $ 23,057 Securities issued by states and political subdivisions in the U.S. a. General obligations 8,288 8,380 8,892 9,030 b. Revenue obligations 505 521 505 527 Mortgage-backed securities 27 30 423 429 30 34 Equity Securities a. Investments in Mutual Funds 1,291 1,163 1,000 870 b. Other equity securites with readily determinable fair values c. All other equity securities 1,068 1,068 863 863 --------------------------------------------- -------------------------------------------- TOTAL SECURITIES $ 32,712 $ 32,803 $ 8,841 $ 8,715 $ 32,462 $ 32,648 $ 11,297 $ 11,191 ============================================= ============================================ PLEDGED SECURITIES $ 13,784 $ 19,566 ========= ======== </TABLE> All dollar amounts in thousands
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE - 3 LOANS AND LEASE FINANCING RECEIVABLES (UNAUDITED) <TABLE> <CAPTION> June 30, December 31 1997 1996 ------------------- ----------------- <S><C> Loans secured by real estate a. Construction and land development $ 3,052 $ 3,264 b. Secured by farmland (including farm residential and other improvements) 4,559 3,877 c. Secured by 1-4 family residential properties 1. Revolving, open end loans 1,223 984 2. All others (a) Secured by first liens 70,098 52,793 (b) Secured by junior liens 3,474 2,836 d. Secured by multi-family (5 or more) residential properties e. Secured by nonfarm nonresidential properties 11,199 10,908 Loans to depository institutions a. In commercial banks in the U. S. b. To other depository institutions in the U. S. c. To banks in foreign countries Loans to finance agricultural production and other loans to farmers 1,645 1,410 Commercial and industrial loans a. To U. S. addressees (domicile) 6,785 6,329 Acceptances of other banks Loans to individuals for household, family, and other personal expenditures (includes purchased paper) a. Credit card and related plans 68 75 b. Other 6,560 6,555 Loans to foreign governments and official institutions (including foreign central banks) Obligations (other than securities) of states and political subdivisions in the U. S. 20 27 Other loans a. Loans for purchasing or carrying securities (secured and unsecured) b. All other loans 28 48 Less any unearned income on loans 191 212 ---------------- ---------------- Total loans and leases, net of unearned income 108,520 88,892 Less allowance for loan and lease losses 1,427 1,503 ---------------- ---------------- Total loans and leases, net of unearned income and allowance for loan and lease losses $ 107,093 $ 87,389 ================ ================ </TABLE> All dollar amounts in thousands
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE - 4 CHARGE OFFS AND RECOVERIES AND CHANGE IN ALLOWANCE FOR LOAN AND LEASE LOSSES (UNAUDITED) <TABLE> <CAPTION> I. CHARGE-OFFS AND RECOVERIES ON LOANS AND LEASES June 30, 1997 December 31, 1996 Charge-offs Recoveries Charge-offs Recoveries ------------------------------- --------------------------------- <S><C> 1. Real estate loans $ 22 $ - $ 10 $ 10 2. Installment loans 70 16 63 26 3. Credit cards and related plans 4. Commercial (time and demand) and all other loans 17 2 5 67 ------------------------------- -------------------------------- 6. Total $ 109 $ 18 $ 78 $ 103 =============================== ================================ II. CHANGES IN ALLOWANCE FOR LOAN AND LEASE LOSSES 1. Balance at end of previous period $ 1,503 $ 1,478 2. Recoveries 18 103 3. Charge-offs (109) (78) 4. Provision for loan and lease losses - - 5. Adjustments 15 ----------------- --------------- 6. Balance at end of current period $ 1,427 $ 1,503 ================= =============== 7. Net charge-offs $ 91 $ 25 8. Average daily loan balance 98,925 87,803 9. Ratio-net of charge-offs to average loans outstanding 0.09% 0.03% </TABLE> All dollar amounts in thousands
<TABLE> <CAPTION> Average Balances, Yields and Rates YTD 6/30/97 YTD 6/30/96 Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate <S><C> ASSETS Interest Earning assets: Money market investments: Federal funds sold 5,158,390 136,148 5.32% 6,477,367 172,558 5.36% Investment Securities: U.S. Treasury securities and obligations of U.S. government agencies 32,007,965 1,017,137 6.41% 25,978,694 788,304 6.10% Obligations of States and political subdivisions 8,400,276 321,106 7.71% 8,574,774 329,216 7.72% Taxable Municipals 512,815 20,242 7.96% 512,815 20,242 7.94% All other investment securities 2,417,445 36,685 3.06% 1,089,602 27,728 5.12% Federal Reserve Bank stock 302,250 9,068 6.05% 302,250 9,068 6.03% -------------------------------------------- ------------------------------------- Total investment securities 43,640,751 1,404,238 6.49% 36,458,135 1,174,558 6.48% Loans - net of unearned income Commercial loans 9,271,536 485,915 10.57% 10,767,525 562,730 10.51% Installment loans 5,209,275 260,686 10.09% 4,921,390 245,842 10.05% Mortgage loans 84,443,987 3,653,432 8.72% 72,114,153 3,216,006 8.97% -------------------------------------------- ------------------------------------- Total loans 98,924,798 4,400,033 8.97% 87,803,068 4,024,578 9.22% -------------------------------------------- ------------------------------------- TOTAL INTEREST EARNING ASSETS 147,723,939 5,940,419 8.11% 130,738,570 5,371,694 8.26% Cash and due from banks 3,897,486 3,465,795 Other assets 7,520,827 5,404,000 Allowance for loan and lease losses (1,469,286) (1,463,392) -------------------------------------------- ------------------------------------- TOTAL ASSETS 157,672,966 138,144,973 ============================================ ===================================== LIABILITIES Interest-bearing liabilities Federal funds purchased - - 0.00% - - 0.00% Super NOW accounts 16,371,886 243,319 3.00% 15,650,592 239,506 3.08% Money market deposit accounts 20,225,294 334,063 3.33% 18,325,032 308,410 3.38% Time, $100,000 or more 14,231,866 374,028 5.30% 10,848,770 294,022 5.45% Other time deposits 37,439,886 965,186 5.20% 29,596,587 781,212 5.31% IRA deposits 14,440,251 380,247 5.31% 14,566,547 361,833 5.00% Savings deposits 15,349,455 236,788 3.11% 12,354,343 196,684 3.20% -------------------------------------------- ------------------------------------- TOTAL INT-BEARING LIABILITIES 118,058,638 2,533,631 4.33% 101,341,871 2,181,667 4.33% Demand deposits 15,491,419 14,814,783 Other liabilities 1,703,749 729,056 -------------------------------------------- ------------------------------------- Total liabilities 135,253,806 116,885,710 Stockholders' equity 22,419,160 21,259,263 -------------------------------------------- ------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 157,672,966 138,144,973 ============================================ ===================================== Net interest income & interest rate spread 3,406,788 3.78% 3,190,027 3.93% Net interest income as a % of earning assets 4.63% 4.89% ============================================ ===================================== </TABLE> 1. All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate of 34%, exclusive of the alternative minimum tax rate and non deductible interest expense. 2. Loan fee income is included in interest income for each loan catagory and yields are stated to include all. 3. Balances of nonaccrual loans and related income have been included for computational purposes.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion is designed to provide a better understanding of the financial position of Shore Bancshares, Inc., and should be read in conjunction with the December 31, 1996 audited consolidated financial statements and notes. ORGANIZATIONAL BACKGROUND On July 1, 1996, Shore Bancshares, Inc. (the Company) commenced operations as the parent company of its sole subsidiary, The Centreville National Bank of Maryland (the Bank) which has conducted the business of banking since 1876. Since the Bank is the primary possession of the Company, the assets and liabilites of the Company are made up almost entirely of the assets and liabilites of the Bank. The same is true for the income and expense of the Company. All data for the periods on and after July 1996 is presented in this analysis in consolidated form and is compared to like data for the Bank for prior years, restated to reflect the exchange of shares of Bank common stock for Company shares. RESULTS OF OPERATIONS OVERVIEW The Company reported $985 thousand in net income for the six months ended June 30, 1997 or $.98 per share compared to the six months ended June 30, 1996 net income of $1,187 thousand or $1.18 per share. Net interest income for June 30, 1997 increased $218 thousand over the prior year. Net income as June 30, 1996 includes non-interest income of $204 thousand which was a gain on sale of investment securities. In addition the current period absorbed additional non-interest expense associated with the merger of Kent Savings and Loan Association (Kent.) NET INTEREST INCOME and NET INTEREST MARGIN Net interest income is the principal source of earnings for a banking company. It represents the difference between interest and fees earned on the loan and investment portfolios and the interest paid on deposits. The quarter ended June 30, 1997 has been characterized by stable interest rates. Because deposits and loans and other investments reprice at different rates and as a result of changes in volume and balance sheet growth resulting from the Kent purchase, the Bank's net interest income, on a fully tax-equivalent basis, increased in the first six months of 1997 compared to the same period in 1996. Net interest income (on a tax equivalent basis) for June 30, 1997 increased by $218 thousand or 7.0% compared to the six months ended June 30, 1996. Interest rate spread is the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities (deposits). Interest rate spread for the six months ended June 30, 1997, 1997 and 1996 was 3.78%, and 3.93%, respectively. Interest rate spread in 1997 decreased by .15% as a result of decreased in yield on earning assets of .15% and no change in yield of interest bearing liabilities. Yield on deposits remained at the same level in the first six months of 1997 compared to the same period in 1996. The decrease in asset yield is attributed to mortgage Page 1
loan yield decreasing as a result of rate decreases on some loan products and a lower yielding portfolio purchased from Kent. A decrease in net interest margin was also reflected. Net interest margin is calculated as tax equivalent net interest income divided by average earning assets and represents the Company's net yield on its earning assets. As of June 30, 1997, the net interest margin decreased to 4.63% from 4.89% as of June 30, 1996. See the table 1 titled "Average Balances, Yields and Rates" for additional information. Management and the Board of Directors monitor interest rates on a regular basis to assess the Company's competitive position and to maintain a reasonable and profitable interest rate spread. The Company also considers the maturity distribution of loans, investments, and deposits and its effect on net interest income as interest rates rise and fall over time. PROVISION and ALLOWANCE FOR CREDIT LOSSES For the quarter ended June 30, 1997 and 1996, the Bank recorded net charge offs of $91 thousand and $17 thousand, respectively compared to net recoveries of $25 thousand for the year ended December 31, 1996. Internal loan review, in particular, has been effective in identifying problem credits and in achieving timely recognition of potential and actual losses within the loan portfolio. Improved overall credit quality and increased collection efforts have also contributed to the immaterial amount of net charge offs in the first half of 1997 and net recoveries in 1996. Gross charge offs as of June 30, 1997 amounted to $109 thousand, $30 thousand for the same period in 1996 and $78 thousand for the year ended 1996, the majority of which were installment loans. Efforts to collect charged off loans continue, but successes are rare as evidenced by the relatively low amount of recoveries, totaling only $18 thousand in 1997 $30 thousand for the same six months in 1996 and $103 thousand for the year ended 1996. The provision for credit losses has followed the same general trend as the amount of charge offs. No provision for credit losses was charged to expense in 1997 or 1996. The allowance for credit losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Management's quarterly evaluation of the adequacy of the allowance is based on analysis of the loan portfolio and its known and inherent risks, assessment of current economic conditions, diversification and size of the portfolio, adequacy of the collateral, past and anticipated loss experience and the amount of non-performing loans. The allowance for credit losses has remained relatively unchanged despite the increase in outstanding loan balances. The allowance for credit losses of $1.4 million as of June 30, 1997 represents 1.3% of gross loans. As of December 31, 1996 and June 30, 1996, the $1.5 million allowance for credit losses reflected 1.7% and 1.6%, respectively, of gross loans. The reduction in percentage of allowance to outstanding loans reflects improvements in credit quality achieved through better credit underwriting and more aggressive collection efforts and is futher evidenced by lower past due loan totals. In management's opinion, the allowance for credit losses is adequate as of June 30, 1997. See Notes 3 and 4 in the Notes to Financial Statements. Page 2
NON-INTEREST INCOME AND EXPENSE As of June 30, 1997 non-interest income reflects $184 thousand decrease compared to June 30, 1996 as a result of $204 thousand the gain on sale of investment securities reflected as of June 30, 1996. Non-interest expense increased $271 thousand or 14.2% as of the same period last year. The increase reflects the cost of additional staff and overhead of the Kent Branch aquired in the purchase of Kent Savings and Loan Association. In addition, the second quarter of 1997 includes the costs of the merger. Amortization of intangibles also increased as goodwill from the merger is amortized over 15 years. In the first six months of 1997 costs have been added as the Company has invested in additional marketing programs and staff training programs. INVESTMENT SECURITIES Investment securities classified as available-for-sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the asset/liability management strategy. Available-for-sale securities are carried at market value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity net of income taxes. Investment securities classified as held-to-maturity are those that management has both the positive intent and ability to hold to maturity, and are reported at amortized cost. The Company does not currently follow a strategy of making securities purchases with a view to near-term sales, and, therefore, does not own trading securities. The Company manages the investment portfolios within policies which seek to achieve desired levels of liquidity, manage interest rate sensitivity risk, meet earnings objectives, and provide required collateral support for deposit activities. Total investment securities amounted to $41.4 million and $43.6 million as of June 30 1997 and December 31, 1996, respectively. The decreased level of investments in securities resulted primarily from the use of funds from matured or called securities for the purchase of Kent Savings and Loan Association. The Company manages its investment portfolios within policies which seek to achieve desired levels of liquidity, manage interest rate sensitivity risk, meet earnings objectives and provide required collateral support for deposit activities. Excluding the U.S. Government and U.S. Government sponsored agencies, the Company had no concentrations of investment securities from any single issues that exceeded 10% of stockholders' equity. LOAN PORTFOLIO The Bank is actively engaged in originating loans to customers in Queen Anne's, Caroline and Talbot Counties. The Company has policies and procedures designed to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for credit losses. These policies, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan and the experience of the Page 3
lending officer. Note 3 "Summary of Loan Portfolio" presents the composition of the Company's loan portfolio by significant concentration. The Company had no loan concentrations exceeding 10% of total loans which are not otherwise disclosed. The Company's policy is to make the majority of its loan commitments in the market area it serves. This tends to reduce risk because management is familiar with the credit histories of loan applicants and has an in-depth knowledge of the risk to which a given credit is subject. The Company had no foreign loans in its portfolio as of June 30, 1997. It is the policy of the Bank to place a loan in non-accrual status whenever there is substantial doubt about the ability of a borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan and the overall economic situation of the borrower when making a non-accrual decision. Non-accrual loans are closely monitored by management . A non-accruing loan is restored to current status when the prospects of future contractual payments are no longer in doubt. At December 31, 1996 and June 30, 1997, $872 thousand and $826 million, respectively, of non-accrual loans were secured by collateral with an estimated value of $1.8 million as of December 31, 1996 and $1.8 million as of June 30, 1997. At June 30, 1997, the Bank had $3.1 million in loans on the watch list for which payments were current, but the borrowers have the potential for experiencing financial difficulties. These loans are subject to on going management attention and their classifications are reviewed regularly. DEPOSITS Deposit liabilities reflected 1% growth in the first half of 1997 in addition to the increase attributed to the Kent Savings and Loan Association aquisition. Savings, money market and NOW account deposits continue to be the main source of deposit growth, although non-interest bearing demand deposits have exhibited growth. The Company continues to experience strong competition from other commercial banks, credit unions, the stock market and mutual funds. The Company has no foreign banking offices. LIQUIDITY MANAGEMENT Liquidity describes the ability of Shore Bancshares, Inc. and its subsidiary, The Centreville National Bank of Maryland to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet borrowing and deposit withdrawal requirements of the customers of the Bank and to fund current and planned expenditures. The Company maintains its asset liquidity position internally through short term investments, the maturity distribution of the investment portfolio, loan repayments and income from earning assets. A substantial portion of the investment portfolio contains readily marketable securities that could be converted to cash immediately. Refer to Note 2 in the Consolidated Financial Statements for a table refelecting the Bank's security portfolio's estimated fair value. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. Other sources, not currently in use, are available through borrowings from the Federal Reserve Bank, the Federal Home Loan Bank and from lines of credit approved at correspondent banks. The purchase of Kent on April 1, 1997 reflects the use of Page 4
funds primarily from Federal Funds which had been accumulated through investment security maturities and calls. During 1997, the Bank has met liquidity needs for daily operations and to fund increased loan demand through the use of funds from matured investment securities and by selling $2.9 million in U.S. Treasury and Government Securities. Management knows of no trend or event which will have a material impact on the Bank's ability to maintain liquidity at satisfactory levels. CAPITAL RESOURCES AND ADEQUACY Total stockholders' equity increased $506 thousand or 2.3% in 1997 to $22.6 million at the end of the June 1997 from $22.1 million at December 31, 1996. Earnings of $985 thousand was the primary contributor to this increase. The change in unrealized gain (loss) on investments classified as available for sale accounted for a $16 thousand reduction and dividends paid reduced stockholders' equity $463 thousand. One measure of capital adequacy is the leverage capital ratio which is calculated by dividing average total assets for the most recent quarter into Tier 1 capital. The regulatory minimum for this ratio is 3%. The primary capital ratio for the year ended December 31, 1996 was 14.9% and the six months ended June 30, 1997 and 1996 of 12.1% and 15.4% respectively. Another measure of capital adequacy is the risk based capital ratio or the ratio of total capital to risk adjusted assets. Total capital is composed of both core capital (Tier 1) and supplemental capital (Tier 2) including adjustments for off balance sheet items such as letters of credit and taking into account the different degrees of risk among various assets. Regulators require a minimum total risk based capital ratio of 8%. The Bank's ratio at December 31, 1996 of 28.2%, and the six months ended June 30, 1997 and 1996 of 23.5% and 27.5% respectively. According to FDIC capital guidelines, the Bank is considered to be "Well Capitalized." Building and technological improvements are expected to continue in 1997. Intentions are to begin renovations at the Commerce street location during 1997, cost estimates available at this time anticipate a cost of close to $1 million which includes improvements, furniture and equipment. On December 5, 1996 the Bank entered into an agreement to acquire Kent Savings and Loan Association, F.A.(Kent Savings) of Chestertown, Maryland. The merger transaction was accounted for as a purchase. Under the terms of the agreement, the Bank will pay approximately $5,100,000 for all of the outstanding shares of Kent Savings resulting in 2.1 million in goodwill to be amortized over 15 years. The Kent Savings shareholders met on March 17, 1997 and approved the merger. The effective date of the merger was April 1, 1997. Management knows of no other trend or event which will have a material impact on capital. Page 5
PART 2 OTHER INFORMATION
Item 1. Legal Proceedings None Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders The following matters were submitted to and approved by stockholders, through the solicitation of proxies or otherwise, at the Annual Meeting of Stockholders held on April 15, 1997: a) The following persons were elected to serve as directors of the Company for one year terms: For Against Abstain --- ------- ------- Sydney G. Ashley 726,155 3,760 0 J. Robert Barton 727,915 2,000 0 David C. Bryan 727,915 2,000 0 Daniel T. Cannon 727,915 2,000 0 B. Vance Carmean, Jr. 727,915 2,000 0 Mark M. Freestate 727,915 2,000 0 Neil R. LeCompte 727,595 2,320 0 Jerry F. Pierson 727,915 2,000 0 William Maurice Sanger 726,187 3,728 0 Walter E. Schmidt 727,915 2,000 0 b) Ratification of the Board of Directors' selection of Stegman and Company, P.A. to serve as the independent public accountants to examine the financial statements of the Company and its subsidiary for the year ending December 31, 1997. Votes cast were 729,915 for ratification, 0 against ratification and 0 abstaining. Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - None (b) No reports on Form 8K was filed during the second quarter of 1997.
SIGNATURES Pursuant to the requirements of Section 13 of the Securities and Exchange Act of 1934, the Bank has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: August 12, 1997 SHORE BANCSHARES, INC. ------------------------------ CAROL I. BROWNAWELL Executive Vice President and Chief Financial Officer