UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------------- FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 2002 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission file number 0-22345 ------- SHORE BANCSHARES, INC. ---------------------- (Exact name of registrant as specified in its charter) Maryland 52-1974638 - -------------------------------------- ------------------ (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 18 East Dover Street, Easton, Maryland 21601 - --------------------------------------- --------------------- (Address of Principal Executive Offices) (Zip Code) (410) 822-1400 -------------- Registrant's Telephone Number, Including Area Code N/A -------------------------- Former name, former address and former fiscal year, if changed since last report Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes X . No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of May 1, 2002, registrant had 5,371,615 issued and outstanding shares of common stock.
<TABLE> <CAPTION> INDEX Part I. Item 1. Financial Statements Page <S> <C> <C> Condensed Consolidated Balance Sheets - March 31, 2002 (unaudited) and December 31, 2001 2 Condensed Consolidated Statements of Income - For the three months ended March 31, 2002 and 2001 (unaudited) 3 Condensed Consolidated Statements of Changes in Stockholders' Equity - For the three months ended March 31, 2002 and 2001 (unaudited) 4 Condensed Consolidated Statements of Cash Flows - For the three months ended March 31, 2002 and 2001 (unaudited) 5 Notes to Condensed Consolidated Financial Statements (unaudited) 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-13 Item 3. Quantitative and Qualitative Disclosures about Market Risk 13 Part II. Item 6. Exhibits and Reports on Form 8-K 14 </TABLE>
<TABLE> <CAPTION> Part I Item 1. Financial Statements SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) March 31, December 31, ASSETS: 2002 2001 - ------- --------------- ---------------- (unaudited) <S> <C> <C> Cash and due from banks $ 10,040 $ 17,424 Interest bearing deposits with other banks 6,918 14,179 Federal funds sold 36,211 20,035 Investment securities: Held-to-maturity, at amortized cost (fair value of $11,528, $11,042, respectively) 11,422 10,896 Available for sale, at fair value 117,099 114,932 Loans, less allowance for credit losses ($4,298, $4,189, respectively) 404,687 388,516 Bank premise and equipment, net 7,231 7,224 Accrued interest receivable on loans and investment securities 3,652 3,321 Investment in unconsolidated subsidiary 1,126 1,126 Goodwill and other intangible assets 1,473 1,475 Deferred income taxes 988 681 Other real estate owned 56 56 Other assets 3,107 2,538 --------- --------- TOTAL ASSETS $604,010 $582,403 ========= ========= LIABILITIES: - ------------ Deposits: Noninterest bearing demand $ 62,741 $ 65,305 NOW and Super NOW 98,470 91,288 Certificates of deposit $100,000 or more 71,895 75,096 Other time and savings 271,331 255,781 --------- --------- Total Deposits 504,437 487,470 Accrued interest payable 668 785 Short term borrowings 20,485 17,054 Long term debt 5,000 5,000 Other liabilities 2,014 1,124 --------- --------- TOTAL LIABILITIES 532,604 511,433 --------- --------- STOCKHOLDERS' EQUITY: - --------------------- Common Stock, Par Value $.01; authorized 35,000,000 shares; issued and outstanding: March 31, 2002 5,331,995 December 31, 2001 5,332,947 53 53 Surplus 23,020 23,039 Retained earnings 48,352 47,412 Accumulated other comprehensive income (loss) (19) 466 --------- --------- TOTAL STOCKHOLDERS' EQUITY 71,406 70,970 --------- --------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $604,010 $582,403 ========= ========= See accompanying notes to Condensed Consolidated Financial Statements. </TABLE> -2-
<TABLE> <CAPTION> SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands, except per share amounts) For the three Months Ended March 31, 2002 2001 ---------------- ---------------- INTEREST INCOME <S> <C> <C> Loans, including fees $7,030 $8,063 Interest and dividends on investment securities Taxable 1,516 1,549 Tax-exempt 106 115 Other interest income 153 414 ------ ------ Total interest income 8,805 10,141 ------ ------ INTEREST EXPENSE Certificates of deposit, $100,000 or more 761 1,150 Other deposits 2,429 3,274 Other interest 114 261 ------ ------ Total interest expense 3,304 4,685 ------ ------ NET INTEREST INCOME 5,501 5,456 PROVISION FOR CREDIT LOSSES 132 57 ------ ------ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 5,369 5,399 ------ ------ NONINTEREST INCOME Service charges on deposit accounts 465 460 Loss on sale of securities - (1) Other noninterest income 218 146 ------ ------ Total noninterest income 683 605 ------ ------ NONINTEREST EXPENSE Salaries and employee benefits 1,840 1,745 Expenses of premises and fixed assets 369 354 Other noninterest expense 1,078 1,089 ------ ------ Total noninterest expense 3,287 3,188 ------ ------ INCOME BEFORE TAXES ON INCOME 2,765 2,816 Federal and State income taxes 1,025 1,015 ------ ------ NET INCOME $1,740 $1,801 ====== ====== Diluted earnings per common share $ .32 $ .34 Basic earnings per common share $ .33 $ .34 See accompanying notes to Condensed Consolidated Financial Statements. -3- </TABLE>
<TABLE> <CAPTION> SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (Dollars in thousands) Accumulated other Total Common Retained Comprehensive Stockholders' Stock Surplus Earnings Income(loss) Equity ----------- ----------- --------- ------------------- ------------- <S> <C> <C> <C> <C> <C> <C> Balances, January 1, 2002 $53 $23,039 $47,412 $466 $70,970 Comprehensive income: - - 1,740 - 1,740 Net income - - - Other comprehensive income, net of tax: Unrealized loss on available for sale securities - - - (485) (485) ------- Total comprehensive income 1,255 Stock repurchased and retired - (21) - - (21) Exercise of stock options - 2 - - 2 Cash dividends paid $0.15 per share - - (800) - (800) ---- ------- ------- ----- ------- Balances, March 31, 2002 $53 $23,020 $48,352 $ (19) $71,406 ==== ======= ======= ===== ======= Balances, January 1, 2001 $53 $22,924 $42,601 $(554) $65,024 Comprehensive income: Net income - - 1,801 - 1,801 Other comprehensive income, net of tax: Unrealized gain on available for sale securities - - - 806 806 ------- Total comprehensive income 2,607 ------- Shares issued - 44 - - 44 Cash dividends paid $0.15 per share - - (799) - (799) ---- ------- ------- ----- ------- Balances, March 31, 2001 $53 $22,968 $43,603 $ 252 $66,876 ==== ======= ======= ===== ======= </TABLE> See accompanying Notes to Condensed Consolidated Financial Statements. -4-
<TABLE> <CAPTION> SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) For the Three Months Ended March 31, 2002 2001 --------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: <S> <C> <C> Net Income $ 1,740 $ 1,801 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 263 221 Discount accretion on debt securities (29) (88) Discount accretion on matured debt securities 8 18 Provision for credit losses, net 109 18 Loss on sale of securities - 1 Net changes in: Accrued interest receivable (331) (29) Other assets (569) (546) Accrued interest payable on deposits (117) (12) Accrued expenses 890 588 --------- ---------- Net cash provided by operating activities 1,964 1,972 --------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities and principal payments of securities available for sale 14,377 26,494 Proceeds from sale of investment securities available for sale - 1,999 Purchase of securities available for sale (17,438) (24,527) Proceeds from maturities and principal payments of securities held to maturity 164 7,408 Purchase of securities held to maturity (693) - Net (increase) decrease in loans (16,280) 5,600 Purchase of bank premises and equipment (142) (383) Proceeds from sale of premises and equipment - (96) --------- ---------- Net cash (used) provided in investing activities (20,012) 16,495 --------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand, NOW, money market and savings deposits 21,051 (8,152) Net increase (decrease) in certificates of deposit (4,084) 9,225 Net increase in securities sold under agreement to repurchase 3,431 1,698 Proceeds from issuance of common stock 2 44 Repurchase of common stock (21) - Dividends paid (800) (799) --------- ---------- Net cash provided by financing activities 19,579 2,016 - --------- ---------- NET INCREASE IN CASH AND CASH EQUIVALENTS 1,531 20,483 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 51,638 39,715 --------- ---------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 53,169 $ 60,198 ========= ========== </TABLE> See accompanying notes to Condensed Consolidated Financial Statements -5-
Shore Bancshares, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) 1) The consolidated financial statements include the accounts of Shore Bancshares, Inc. ("the Company") and its subsidiaries, The Talbot Bank of Easton, Maryland ("Talbot Bank") and The Centreville National Bank of Maryland ("Centreville National Bank"), collectively referred to as the "Banks," with all significant intercompany transactions eliminated. The consolidated financial statements conform to accounting principles generally accepted in the United States of America and to prevailing practices within the banking industry. The accompanying interim financial statements are unaudited; however, in the opinion of management all adjustments necessary to present fairly the financial position at March 31, 2002, the results of operations for the three-month period ended March 31, 2002 and 2001, and cash flows for the three-month period ended March 31, 2002 and 2001 have been included. All such adjustments are of a normal recurring nature. The results of operations for the three-month period ended March 31, 2002 are not necessarily indicative of the results to be expected for the full year. This quarterly report on Form 10-Q should be read in conjunction with the Company's annual report on Form 10-K. 2) Year to date basic earnings per share is derived by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the first quarter of 5,332,941 shares for 2002 and 5,324,373 shares for 2001. The diluted earnings per share calculation is arrived at by dividing net income by the weighted average number of shares. The diluted earnings per share calculation is derived by dividing net income by the weighted average number of shares outstanding, adjusted for the dilutive effect of outstanding options and warrants. Considering the effect of these common stock equivalents, the adjusted average shares for the three months ended March 31, 2002 and 2001 were 5,390,859 and 5,366,485, respectively. 3) Under the provisions of Statements of Financial Accounting Standards (SFAS) Nos. 114 and 118, "Accounting by Creditors for Impairment of a Loan," a loan is considered impaired if it is probable that the Company will not collect all principal and interest payments according to the loan's contracted terms. The impairment of a loan is measured at the present value of expected future cash flows using the loan's effective interest rate, or at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loans principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Information with respect to impaired loans and the related valuation allowance is shown below: <TABLE> <CAPTION> March 31, December 31, (Dollars in thousands) 2002 2001 - ------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> Impaired loans with valuation allowance $ 976 $ 561 Impaired loans with no valuation allowance 530 382 ------ ------ Total impaired loans $1,506 $ 943 ====== ====== Allowance for credit losses applicable to impaired loans $ 150 $ 76 Allowance for credit losses applicable to other than impaired loans 4,148 4,113 ------ ------ Total allowance for credit losses $4,298 $4,189 ====== ====== Interest income on impaired loans recorded on the cash basis $ 11 $ 19 ====== ====== </TABLE> Impaired loans do not include groups of smaller balance homogenous loans such as residential mortgage and consumer installment loans that are evaluated collectively for impairment. Reserves for probable credit losses related to these loans are based upon historical loss ratios and are included in the allowance for credit losses. -6-
4) In the normal course of business, to meet the financial needs of its customers, the Banks are parties to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. At March 31, 2002, total commitments to extend credit were approximately $111,642,000. Outstanding letters of credit were approximately $5,674,000 at March 31, 2002. 5) In July 2001, the Financial Accounting Standards Board issued Statement No. 141(Statement 141), "Business Combinations," and Statement No. 142 (Statement 142), "Goodwill and Other Intangible Assets." Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also specifies the criteria for intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill. Statement 142 requires goodwill and intangible assets with indefinite lives to no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires intangible assets with definite useful lives to be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with the FASB's Statement No. 121 (Statement 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company adopted the provisions of Statement 141 effective July 1, 2001and Statement 142 effective January 1, 2002. As of the date of adoption, the Company had unamortized goodwill in the amount of $1,440,000, which was subject to the transition provisions of Statements 141 and 142. Amortization expense related to goodwill was approximately $140,000 for the year ended December 31, 2001. There was no amortization expense related to goodwill for the three months ended March 31, 2002. 6) On December 21, 2001, the Company reached an agreement to acquire certain assets of The Avon-Dixon Agency, Inc., a full service insurance agency, and its subsidiaries, all located in Easton, Maryland. The transaction was completed on May 1, 2002, enabling the Company to offer a full range of insurance products and services to its customers. -7-
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Shore Bancshares, Inc. (the "Company") is the largest independent bank holding company located on the Eastern Shore of Maryland. It is the parent company of The Talbot Bank of Easton, Maryland located in Easton, Maryland, and The Centreville National Bank of Maryland (collectively, the "Banks") located in Centreville, Maryland. The Banks operate 11 full service branches in Kent, Queen Anne's, Talbot, Caroline and Dorchester Counties. During April 2001 the Company obtained a listing under the NASDAQ Small Cap Market, trading under the symbol "SHBI." On May 1, 2002 the Company completed its acquisition of certain assets and the assumption of certain liabilities of the Avon-Dixon Agency, Inc., a full service insurance agency, and its subsidiaries, all located in Easton, Maryland. The Company will offer a full range of insurance products and services to its customers through three new wholly-owned subsidiaries, The Avon-Dixon Agency, LLC, Elliott Wilson Insurance, LLC, and Mubell Finance, LLC, all of which are Maryland limited liability companies. The following discussion is designed to provide a better understanding of the financial position of the Company and should be read in conjunction with the December 31, 2001 audited Consolidated Financial Statements and Notes. Forward-Looking Information Portions of this Quarterly Report on Form 10-Q contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about the Company's confidence, policies, and strategies, the adequacy of capital levels, and liquidity. Such forward-looking statements involve certain risks and uncertainties, including economic conditions, competition in the geographic and business areas in which the Company and its affiliates operate, inflation, fluctuations in interest rates, legislation, and governmental regulation. These risks and uncertainties are described in more detail in the Company's Form 10-K, under the heading "Risk Factors." Actual results may differ materially from such forward looking statements, and the Company assumes no obligation to update forward-looking statements at any time. RESULTS OF OPERATIONS Overview Net income for the first quarter of 2002 was $1,740,000, a decrease of 3.4% when compared to the first quarter of 2001. On a per share basis, diluted earnings were $ .32, compared to $ .34 for the same period last year. Return on average assets was 1.18% for the first quarter of 2002, compared to 1.31% for the same period in 2001. Return on average stockholders' equity was 9.72% and 10.90% for the three months ended March 31, 2002 and 2001, respectively. Net Interest Income Net interest income totaled $5,501,000 for the first quarter of 2002, representing a $45,000 increase over the same period last year. Total interest income decreased $1,336,000 or 13.2%, totaling $8,805,000 for the first quarter of 2002 compared to the same period last year. Total interest expense for the quarter ended March 31, 2002 was $3,304,000, a decrease of $1,381,000 or 29.5% over last year. The interest rate environment during the first quarter of 2002 was stable. In contrast, during the first quarter of 2001 the Federal Reserve Board decreased short-term interest rates by 150 basis points. This continued throughout 2001, with the Federal Reserve Board making a total of eleven rate cuts which resulted in a decline in short term rates for the year of 475 basis points. The rate paid for federal funds sold declined from 6.50% on January 1, 2001 to 1.75% on December 31, 2001. Correspondingly, the New York Prime rate, the index most commonly used to price loans, fell from 9.50% at January 1, 2001 to 4.75% at December 31, 2001. -8-
Although the Company did not experience a decline in net interest income, its net interest margin declined by 25 basis points. The increased volume of earning assets was not sufficient to overcome the declining yields earned on those assets. The overall yield on loans for the three months ended March 31, 2002 was 7.17%, compared to 8.64% for the corresponding period in 2001. The average balance of loans increased $20,758,000 totaling $400,064,000 for the three months ended March 31, 2002. The yield on investment securities declined from 6.24% for the first quarter of 2001 to 5.45% for the same period in 2002, while the average balance of investment securities grew from $112,148,000 to $125,330,000 for the three months ended March 31, 2001 and 2002, respectively. Interest and fees on loans decreased $1,033,000 due to a lower overall yield on loans for the three-month period ended March 31, 2002 when compared to the same period in 2001. Interest on investment securities declined $42,000 due to a decline in the average yield on those securities, and interest on federal funds sold and interest bearing deposits decreased $262,000 due to a decline in the overall yield earned, despite a $6,056,000 increase in volume. The overall rate earned on federal funds sold was 1.75% for the three months ended March 31, 2002, compared to 5.58% for the same period last year. Interest expense decreased primarily as a result of lower rates paid for interest bearing deposits. The average balance of interest-bearing deposits increased $23,656,000, with $19,400,000 of that increase occurring in savings account vehicles. The average rate paid for NOW, savings and money market accounts declined 134 basis points for the period ended March 31, 2002 compared to the same period in 2001. The overall rate paid for certificates of deposit declined 112 basis points for the period ended March 31, 2002 compared to the same period in 2001. See the Analysis of Interest Rates and Interest Differentials below for further details. Loans comprised 71.3% and 72.7% of total average earning assets at March 31, 2002 and 2001, respectively. 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 through the first three months of the year. <TABLE> <CAPTION> March 31, 2002 March 31, 2001 -------------- -------------- Average Income Yield Average Income Yield (Dollars in thousands) Balance Expense Rate Balance Expense Rate - ----------------------------------------------------------------------------------------------------------------------------- Earning Assets <S> <C> <C> <C> <C> <C> <C> Investment securities $125,330 $1,684 5.45% $112,148 $ 1,725 6.24% Loans 400,064 7,074 7.17% 379,306 8,077 8.64% Interest bearing deposits 13,119 53 1.65% 2,978 37 4.97% Federal funds sold 22,927 99 1.75% 27,012 377 5.58% -------- ------ ----- -------- ------- ----- Total earning assets 561,440 8,910 6.44% 521,444 10,216 7.94% Noninterest earning assets 27,055 27,392 -------- -------- Total Assets 588,495 548,836 ======== ======== Interest bearing liabilities Interest bearing deposits 429,212 3,190 3.01% 406,556 4,424 4.41% Short term borrowing 17,377 52 1.21% 17,349 180 4.22% Long term debt 5,000 62 5.04% 5,000 81 6.55% -------- ------ ----- -------- ------- ----- Total interest bearing liabilities 451,589 3,304 2.07% 428,905 4,685 4.43% Noninterest bearing liabilities 65,301 53,849 Stockholders' equity 71,605 66,082 -------- -------- Total liabilities and stockholders' equity $588,495 $548,836 ======== ======== Net interest spread $5,606 3.47% $ 5,531 3.51% ====== ======= Net interest margin 4.05% 4.30% </TABLE> -9-
(1) All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate exclusive of the alternative minimum tax rate of 34% and nondeductible interest expense. (2) Average loan balances include nonaccrual loans. (3) Interest income on loans includes amortized loan fees, net of costs, for each loan category and yield calculations are stated to include all. Noninterest Income Total noninterest income increased 12.9% in the first quarter of 2002 when compared to the same period in 2001. This increase is due to increased ATM service charges and income from the sale of nondeposit products, such as mutual funds and annuities. Noninterest Expense Total noninterest expense, excluding income taxes and the provision for credit loan losses, increased 3.1% for the quarter ended March 31, 2002 from the comparable period in 2001. This increase is due to general increases in salaries and employee benefit costs for the period. Income Taxes The effective tax rate for the quarter ended March 31, 2002 was 37.0%, compared to 36.0% for the same period last year. There have been no significant changes in tax law or to the Company's tax structure which would impact the effective tax rate. Analysis of Financial Condition Loans Loans, net of unearned income, totaled $408,985,000 at March 31, 2002, an increase of $16,280,000 or 4.1% since December 31, 2001. The increase is primarily attributable to an increase in loans secured by real estate during the quarter. Average loans, net of unearned income, increased $20,758,000 or 5.5% for the quarter ended March 31, 2001 totaling $400,064,000, compared to $379,306,000 for the same period last year. Allowance for Credit Losses The Company has established an allowance for credit losses, which is increased by provisions charged against earnings and recoveries of previously charged-off debts. The allowance is decreased by current period charge-off of uncollectible debts. Management evaluates the adequacy of the allowance for credit losses on a quarterly basis and adjusts the provision for credit losses based upon this analysis. The evaluation of the adequacy of the allowance for credit losses is based on a risk rating system of individual loans, as well as on a collective evaluation of smaller balance homogenous loans based on factors such as past credit loss experience, local economic trends, nonperforming and problem loans, and other factors which may impact collectibility. A loan is placed on nonaccrual when it is specifically determined to be impaired and principal and interest is delinquent for 90 days or more. The provision for credit losses for the three-month periods ended March 31, 2002 and 2001 was $132,000 and $57,000, respectively. The Company had net charge-offs of $23 thousand for the first quarter of 2002, compared to net charge-offs of $39 thousand for the same period last year. Management adjusts the allowance for credit losses through the provision based on its evaluation and analysis of the adequacy of the allowance, including consideration of general economic conditions, growth of the loan portfolio, current trends in delinquencies and nonperforming assets, as well as past credit loss experience. Nonaccrual loans increased $563,000 during the first quarter of 2002. The increase was attributable to loans secured by real estate for which specific allocations within the allowance for credit losses have been made or charge-offs taken for amounts considered uncollectible. The allowance for credit losses as a percentage of average loans was 1.07% and 1.11% as of March 31, 2002 and 2001, respectively. Based on Management's quarterly evaluation of the adequacy of the allowance for credit losses, it believes that the allowance for credit losses and the related provision are adequate at March 31, 2002. -10-
The following table presents a summary of the activity in the allowance for credit losses: <TABLE> <CAPTION> Three Months Ended March 31, (Dollars in thousands) 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> Allowance balance - beginning of year $ 4,189 $ 4,199 Charge-offs: Commercial and other - 16 Real estate 25 3 Consumer 23 34 -------- -------- Totals 48 53 -------- -------- Recoveries: Commercial 3 3 Real estate 2 - Consumer 20 11 -------- -------- Totals 25 14 -------- -------- Net charge-offs: 23 39 Provision for credit losses 132 57 -------- -------- Allowance balance-ending $ 4,298 $ 4,217 ======== ======== Average loans outstanding during period $400,159 $379,306 ======== ======== Net charge-offs (annualized) as a percentage of average loans outstanding during period .02% .04% ======== ======== Allowance for credit losses at period end as a percentage of average loans 1.07% 1.11% ======== ======== </TABLE> -11-
Because the Company's loans are predominately real estate secured, weaknesses in the local real estate market may have an adverse effect on collateral values. The Company does not have any concentrations of loans in any particular industry, nor does it engage in foreign lending activities Nonperforming Assets The following table summarizes past due and nonperforming assets of the Company (in thousands): March 31, December 31, Nonperforming Assets: 2002 2001 -------- ------------ Nonaccrual loans $1,506 $ 943 Other real estate owned 56 56 ------ ------ 1,562 999 Past due loans 923 1,532 ------ ------ Total nonperforming and past due loans $2,485 $2,531 ====== ====== Investment Securities Investment securities increased $2,693,000 during the first quarter of 2002 when compared to December 31, 2001. Bond yields began to increase during the first quarter of 2002, but not enough to replace the yields on bonds which matured or were called during the same period. The average balance of investment securities was $125,330,000 for the first quarter of 2002, compared to $112,148,000 for the same period in 2001. The tax equivalent yield on investment securities was 5.45% and 6.24% for the three months ended March 31, 2002 and 2001, respectively. Deposits Total deposits at March 31, 2002 were $504,437,000, compared to $487,470,000 at December 31, 2001. Due to the lower rates offered for certificates of deposit, much of the deposit growth was in savings account balances. Certificates of deposit of $100,000 or more declined slightly during the first quarter as the result of a temporary shift into NOW and SuperNOW accounts of a municipal depositor. Other time and savings accounts increased $15,550,000 during the three-month period ended March 31, 2002 when compared to December 31, 2001. Borrowed Funds Short term borrowings at March 31, 2002 and 2001 consisted of securities sold under agreements to repurchase. The Company also has a convertible advance from the Federal Home Loan Bank of Atlanta in the amount $5,000,000 at March 31, 2002 and 2001. The advance is due in March 2006 and has a one-time call provision in 2004. Liquidity and Capital Resources The Company derives liquidity through increased customer deposits, maturities in the investment portfolio, loan repayments and income from earning assets. To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term funds markets through arrangements with its correspondent banks. The Banks are also members of the Federal Home Loan Bank of Atlanta, which provides another source of liquidity. There are no known trends or demands, commitments, events or uncertainties that Management is aware of which will materially affect the Company's ability to maintain liquidity at satisfactory levels. -12-
Total stockholders' equity was $71.4 million at March 31, 2002, which is 6.8% higher than one year ago. Accumulated other comprehensive losses, which consists solely of net unrealized losses on investment securities available for sale, increased $485,000, resulting in an accumulated other comprehensive loss of $19,000 at March 31, 2002. Bank and Company regulatory agencies have adopted various capital standards for financial institutions, including risk-based capital standards. The primary objectives of the risk-based capital framework are to provide a more consistent system for comparing capital positions of financial institutions and to take into account the different risks among financial institutions' assets and off-balance sheet items. Risk-based capital standards have been supplemented with requirements for a minimum Tier 1 capital to assets ratio (leverage ratio). In addition, regulatory agencies consider the published capital levels as minimum levels and may require a financial institution to maintain capital at higher levels. A comparison of the capital as of March 31, 2002 for the Company with the minimum requirements is presented below: Minimum Actual Requirements ------ ------------ Tier 1 risk-based capital 16.78% 4.00% Total risk-based capital 17.83% 8.00% Leverage ratio 11.87% 4.00% Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company's principal market risk exposure is to interest rates. The Company utilizes a simulation model to quantify the effect a hypothetical plus or minus 200 basis point change in rates would have on net interest income and the fair value of capital. The model takes into consideration the effect of call features of investments as well as repayments of loans in periods of declining rates. When actual changes in interest rates occur, the changes in interest earning assets and interest bearing liabilities may differ from the assumptions used in the model. As of December 31, 2001, the model produced the following sensitivity profile for net interest income and the fair value capital: <TABLE> <CAPTION> Immediate Change in Rates +200 Basis Points -200 Basis Points Policy Limit - ---------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> % Change in net interest income (.43)% (2.8%) +25% - % Change in fair value of capital (.16%) (4.4%) +15% - </TABLE> -13-
For more information about market risk, see "Management's Discussion and Analysis of Financial Condition and Results of Operation." Part II Item 6. Exhibits and Reports on Form 8-K. a) Exhibits 3.1 Shore Bancshares, Inc. Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 3.2 Shore Bancshares, Inc. Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 10.1 Form of Employment Agreement with W. Moorhead Vermilye (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 10.2 Form of Employment Agreement with Daniel T. Cannon (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 21 Subsidiaries of Shore Bancshares, Inc. (incorporated by reference to Exhibit 21 of Shore Bancshares, Inc.'s Annual Report on Form 10-K filed on April 1, 2002). 99.1 1998 Employee Stock Purchase Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on From S-8 filed on September 25, 1998 (Registration No. 333-64317)). 99.2 1998 Sock Option Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed on September 25, 1998 (Registration No. 333-64319)). 99.3 Talbot Bancshares, Inc. Employee Stock Option Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed on May 4, 2001 (Registration No. 333-60214)). b) Reports on Form 8-K. On May 1, 2002, the Company filed a Current Report on Form 8-K to report the acquisition of certain assets and assumption of certain liabilities of The Avon Dixon Agency, Inc. and its subsidiaries. Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Shore Bancshares, Inc. Date: May 14, 2002 By: /s/ W. Moorhead Vermilye -------------------------------------- W. Moorhead Vermilye President Date: May 14, 2002 By: /s/ Susan E. Leaverton -------------------------------------- Susan E. Leaverton, CPA Treasurer/Principal Accounting Officer -14-