Shore Bancshares - 10-Q quarterly report FY

(Exact name of registrant as specified in its charter)

 

INDEX

 

SHORE BANCSHARES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to Condensed Consolidated Financial Statements.

SHORE BANCSHARES, INC.

See accompanying notes to Condensed Consolidated Financial Statements.

SHORE BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

(Dollars in thousands, except per share amounts)

 

 

See accompanying Notes to Condensed Consolidated Financial Statements

SHORE BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

 

See accompanying notes to Condensed Consolidated Financial Statements

Shore Bancshares, Inc.

Notes to Condensed Consolidated Financial Statements

For the Three Months Ended March 31, 2005 and 2004

(Unaudited)

 

There were no antidilutive stock options excluded from the calculation of earnings per share for the three months ended March 31, 2005 and 2004.

 

Information with respect to impaired loans and the related valuation allowance is shown below:

 

Selected financial information by line of business for the three months ended March 31 is included in the following table:

(a)  Amount included in Parent Company relates to services provided to subsidiaries by the Company and rental income.

 

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. Statements that are not historical in nature, including statements that include the words “anticipate,” “estimate,” “should,” expect,” “believe,” “intend,” and similar expressions, are expressions about the Company's confidence,

policies, and strategies, the adequacy of capital levels, and liquidity and are not guarantees of future performance. Such forward-looking statements involve certain risks and uncertainties, including economic conditions, competition in the geographic and business areas in which the Company operates, inflation, fluctuations in interest rates, legislation, and governmental regulation. These risks and uncertainties are described in more detail in Exhibit 99.1 “Risk Factors” to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Actual results may differ materially from such forward-looking statements, and the Company assumes no obligation to update forward-looking statements at any time.

The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of Shore Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes presented in this report, as well as the audited consolidated financial statements and related notes included in the Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2004. Unless the context clearly suggests otherwise, references to the Company in this report are to Shore Bancshares, Inc. and its consolidated subsidiaries.

Shore Bancshares, Inc. is the largest independent financial 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 (“Talbot Bank”), The Centreville National Bank of Maryland located in Centreville, Maryland (“Centreville National Bank”) and The Felton Bank, located in Felton, Delaware (“Felton Bank”) (collectively, the “Banks”). The Banks operate 14 full service branches in Kent, Queen Anne’s, Talbot, Caroline and Dorchester Counties in Maryland and Kent County, Delaware. The Company offers a full range of insurance products and services to its customers through The Avon-Dixon Agency, LLC, Elliott Wilson Insurance, LLC, and Mubell Finance, LLC (collectively, the “Insurance Agency”) and investment advisory services through Wye Financial Services, LLC, all of which are wholly-owned subsidiaries of the Company. The shares of the Company’s common stock are listed on the Nasdaq SmallCap Market under the symbol “SHBI.”

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within the financial statements is, to a significant extent, financial information contained that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning of income, recognizing an expense, recovering an asset or relieving a liability.

The Company believes its most critical accounting policy relates to the allowance for credit losses. The allowance for credit losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable, and (ii) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the loan balance and the value of collateral, present value of future cash flows or values that are observable in the secondary market. Management uses many factors, including economic conditions and trends, the value and adequacy of collateral, the volume and mix of the loan portfolio, and internal loan processes of the Company in determining the inherent loss that may be present in the Company’s loan portfolio. Actual losses could differ significantly from Management’s estimates. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of transactions would be the same, the timing of events that would impact the transactions could change.

Management has significant discretion in making the adjustments inherent in the determination of the provision and allowance for credit losses, including in connection with the valuation of collateral, the borrower’s prospects of repayment, and in establishing allowance factors on the formula allowance and unallocated allowance components of the allowance. The establishment of allowance factors is a continuing exercise, based on Management’s continuing assessment of the totality of all factors, including, but not limited to, as delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of Management, national and local economic trends, concentrations of credit, quality of loan review system and the effect of external factors such as competition and regulatory requirements, and their impact on the portfolio, and allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based upon the same volume and classification of loans. Changes in allowance factors will have a direct impact on the amount of the provision, and a corresponding effect on net income. Errors in Management’s perception and assessment of these factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs.

Three basic components comprise the Company’s allowance for credit losses: (i) a specific allowance; (ii) a formula allowance; and (iii) a nonspecific allowance. Each component is determined based on estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance to loans identified as impaired. An impaired loan may show deficiencies in the borrower’s overall financial condition, payment history, support available from financial guarantors and/or the fair market value of collateral. When a loan is identified as impaired, a specific allowance is established based on the Company’s assessment of the loss that may be associated with the individual loan. The formula allowance is used to estimate the loss on internally risk rated loans, exclusive of those identified as impaired. Loans identified as special mention, substandard, doubtful and loss, as well as impaired, are segregated from performing loans. Remaining loans are then grouped by type (commercial, commercial real estate, construction, home equity or consumer). Each loan type is assigned an allowance factor based on Management’s estimate of the risk, complexity and size of individual loans within a particular category. Classified loans are assigned higher allowance factors than non-rated loans due to Management’s concerns regarding collectibility or Management’s knowledge of particular elements regarding the borrower. Allowance factors grow with the worsening of the internal risk rating. The nonspecific formula is used to estimate the loss of non-classified loans stemming from more global factors such as delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of Management, national and local economic trends, concentrations of credit, quality of loan review system and the effect of external factors such as competition and regulatory requirements. The nonspecific allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance.

Net income for the quarter ended March 31, 2005 was $3,106,000, or diluted earnings per share of $.56, compared to $2,516,000, or diluted earnings per share of $.46, for the first quarter of 2004. Annualized return on average assets was 1.56% for the first three months of 2005, compared to 1.43% for the same period in 2004. Annualized return on average stockholders’ equity was 13.29% and 11.87% for the three months ended March 31, 2005 and 2004, respectively.

Net interest income for the quarter ended March 31, 2005 was $8,277,000, compared to $6,422,000 for the same period last year, representing a 28.9% increase. This increase is attributable primarily to increases in earning assets, mostly loans, and increases in yields on earning assets for the period, which resulted in increased interest income. Total interest income increased by $2,257,000 for the three-month period ended March 31, 2005 when compared to the same period last year. Approximately $966,000 of the increase in the Company’s total interest income represents interest income of Felton Bank, which the Company acquired on April 1, 2004.

The Company’s net interest margin was 4.51% for the three months ended March 31, 2005, which is 56 basis points higher than one year ago. The Company continued to increase its volume of earning assets, which averaged $741,417,000 for the three months ended March 31, 2005, compared to $659,929,000 for the same period in 2004. Approximately $60,699,000 of the growth resulted from the acquisition of Felton Bank. Average loans totaled $593,013,000 for the three-month period ended March 31, 2005, a $107,583,000 increase over the same period in 2004. The yield on earning assets increased 64 basis points from 5.24% to 5.88% for the three-month period ended March 31, 2005 when compared to the same period in 2004.

The overall yield on loans for the three months ended March 31, 2005 was 6.48%, compared to 5.90% for the same period in 2004. The yield on investment securities for the first quarter of 2005 declined to 3.74% from 3.77% for the same period in 2004, and the average balance of investment securities for the first quarter of 2005 decreased by $34,243,000 to $117,138,000 when compared to the first quarter of 2004.

Total interest expense for the three months ended March 31, 2005 was $2,530,000, an increase of $402,000 or 18.9% over the three-month period ended March 31, 2004. An increased volume of interest bearing deposits is the primary reason for the increased expense. The Felton Bank contributed $48,296,000 toward the increased volume of interest bearing liabilities, generating approximately $239,000 in interest expense for the three-month period ended March 31, 2005. Rates paid for certificates of deposit and short-term borrowings increased as a result of higher short-term interest rates and increased competition for deposits. The average balance of interest bearing deposits increased by $58,486,000 for the three months ended March 31, 2005 when compared to the same period in 2004. The overall rate paid for interest bearing deposits increased 8 basis points to 1.68% as a result of higher rates paid for certificates of deposit. For the three months ended March 31, 2005, the average balance of certificates of deposits, including those $100,000 or more, increased by $24,963,000 when compared to the same period last year, and the average rate paid for those certificates of deposit increased 10 basis points to 2.93%. Comparing the first quarter of 2005 to the same period in 2004, interest bearing demand deposits increased by approximately $7,883,000 and money management and savings deposits increased by $25,640,000. In addition to the volume of deposits attributable to the Felton Bank, the Company’s growth was achieved through normal operations.

Loans comprised 78% and 73.6% of total average earning assets at March 31, 2005 and 2004, respectively.

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 quarter of 2005:

(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 35% 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 for the three months ended March 31, 2005 increased by $284,000 when compared to the same period last year to $3,162,000. Approximately $80,000 of this increase relates to noninterest income of Felton Bank and $175,000 relates to an increase in insurance agency commissions. The Company recognized gains on sales of securities of $58,000 during the first three months of 2005, compared to a gain of $16,000 for the same period in 2004.

Total noninterest expense for the first quarter of 2005 was $6,293,000, an increase of $1,080,000 when compared to the same period in 2004. The operation of Felton Bank represented $504,000 of this increase, with the remainder attributable to the overall growth of the Company. For the three months ended March 31, 2005, salaries and benefits expense increased by $861,000, occupancy expense increased by $66,000 and other noninterest expense increased by $153,000, when compared to the same period in 2004.

The effective tax rate for the three months ended March 31, 2005 was 37.5%, compared to 36.8% for the same period last year. Management believes that there have been no changes in tax law or to the Company’s tax structure that are likely to have a future material impact on the Company’s effective tax rate.

Loans, net of unearned income, totaled $596,267,000 at March 31, 2005, an increase of $809,000 since December 31, 2004. Average loans, net of unearned income, increased by $107,583,000 or 22.2% since December 31, 2004 to $593,013,000, compared to an increase of $38,179,000 or 8.5% for the same period last year.

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. Please refer to the discussion above under the caption “Critical Accounting Policies” for an overview of the underlying methodology Management employs on a quarterly basis to maintain the allowance.

The provision for credit losses for the three-month period ended March 31, 2005 was $180,000 compared to $105,000 for the same period in 2004. Despite a decline in nonaccrual loans, Management did not decrease the specific allowance associated with those loans, based on its evaluation of each borrower’s ability to repay and the value of the underlying loan collateral. The increased provision is the result of increases in both the formula allowance and nonspecific allowance components. Growth of the loan portfolio and Management’s assessment of factors used in calculating the nonspecific allowance contributed to the increased provision. The Company continues to maintain strong underwriting guidelines, and Management believes that the local economy remains stable and that collateral values have increased as a result of the strength of the local real estate economy. Each of these factors has had a positive effect on the quality of the Company’s loan portfolio. The Company’s historical charge-off ratios are much lower than those of similarly sized institutions according to the most recent FDIC quarterly banking profile. Net charge-offs were $114,000 for the three-month period ended March 31, 2005, compared to $225,000 for the same period last year. Since December 31, 2004, nonaccrual loans have declined by $353,000 to $1,116,000. Loans past due 90 days and still accruing decreased by $1,823,000 since December 31, 2004, totaling $1,146,000 at March 31, 2005. The decline in loans past due is primarily attributable to a real estate loan which was paid in full during the first quarter of 2005. The Company’s ratio of nonperforming assets, including other real estate owned, remains low. The allowance for credit losses as a percentage of average loans was .80% at March 31, 2005, compared to .81% at March 31, 2004. 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, 2005.

The following table presents a summary of the activity in the allowance for credit losses:

 

Because the Company’s loans are predominately secured by real estate, weaknesses in the local real estate market may have a material adverse effect on collateral values. The Company has a concentration of construction and land development loans. At March 31, 2005, the balance of such loans was $109,836,000 or 18.4% of total outstanding loans, compared to $97,021,000 or 16.3% at December 31, 2004. The Company does not engage in foreign lending activities.

The following table summarizes past due and nonperforming assets of the Company (in thousands):

Investment securities increased by $4,794,000 during the three-month period ended March 31, 2005 when compared to December 31, 2004 to $123,890,000. The yields on bonds purchased during the first quarter of 2005 are similar to the yields on bonds that either matured or were called during this period. The average balance of investment securities was $117,138,000 for the three-months ended March 31, 2005, compared to $151,381,000 for the same period in 2004. The tax equivalent yields on investment securities were 3.74% and 3.77% for the three-month periods ended March 31, 2005 and 2004, respectively.

Total deposits at March 31, 2005 were $678,782,000, compared to $658,672,000 at December 31, 2004. Certificates of deposit of $100,000 or more increased by $7,495,000 during the first quarter of 2005, primarily as a result of increased deposits of one municipal depositor. Since December 31, 2004, money market and savings deposits have increased by $7,173,000 and other certificates of deposit have increased by $7,804,000.

Short-term borrowings at March 31, 2005 and 2004 consisted of securities sold under agreements to repurchase. The Company also had a convertible advance from the Federal Home Loan Bank of Atlanta in the amount of $5,000,000 at March 31, 2005 and 2004. The advance is due in March 2006.

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 correspondent banks. Talbot Bank and Centreville National Bank are also members of the Federal Home Loan Bank of Atlanta to which they have pledged collateral sufficient to permit additional borrowing of up to approximately $59 million at March 31, 2005. Management is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect the Company’s future ability to maintain liquidity at satisfactory levels.

Total stockholders’ equity was $94.6 million at March 31, 2005, which represents an increase of 1.8% since December 31, 2004. Accumulated other comprehensive loss, which consists solely of net unrealized losses on investment securities available for sale, increased by $803,000 during the first quarter of 2005, resulting in accumulated other comprehensive loss of $1,081,000 at March 31, 2005.

Bank 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 Company’s capital ratios as of March 31, 2005 to the minimum regulatory requirements is presented below:

The Company’s principal market risk exposure is to fluctuating interest rates. The Company utilizes a simulation model to quantify the effect that hypothetical plus or minus 200 and 100 basis point changes 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 March 31, 2005 and December 31, 2004, the model produced the following sensitivity profile for net interest income and the fair value capital:

 

Further information regarding market risk and the Company’s objectives and strategies in managing market risk is set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Risk Management”.

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in those rules and forms, and that such information is accumulated and communicated to Management, including the Chief Executive Officer (“CEO”) and the Principal Accounting Officer (“PAO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of March 31, 2005 was carried out under the supervision and with the participation of Management, including the CEO and the PAO. Based on that evaluation, the Company’s management, including the CEO and the PAO, has concluded that the Company’s disclosure controls and procedures are effective.

During the first quarter of 2005, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

On February 25, 2005, the Company issued 11,448 unregistered shares of its common stock, par value $.01 per share (the “Shares”), to The Avon-Dixon Agency, Inc. (“ADA”) as part of the deferred payment (earn-out) required by that certain Asset Purchase Agreement dated December 21, 2001 between the Company and ADA (the “Agreement”). Under the Agreement, the Company purchased substantially all of the assets of ADA and its subsidiaries on May 1, 2002 and agreed to make the deferred payment to ADA, the exact amount of which was to be based on the performance of the purchased assets through December 31, 2004. The Company was required to pay 85.71% of the deferred payment in cash and 14.29% in shares of the Company’s common stock. Based on the performance of the purchased assets, the deferred payment totaled $2,800,000. The Shares represented $400,120 of the deferred payment, based on a per share price of $34.95 calculated by reference to the average of the daily last reported trades in shares of the Company’s common tock during the 60 calendar day period ending on February 14, 2005. The deferred payment was allocated entirely to goodwill. The offer and sale of the Shares to ADA were exempt from registration under Section 4(2) of the Securities Act of 1933, as amended.

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.