Shore Bancshares - 10-Q quarterly report FY

For the Quarterly Period Ended September 30, 2005

For the transition period from ________ to ________

(Exact name of registrant as specified in its charter)

Registrant’s Telephone Number, Including Area Code

Former name, former address and former fiscal year, if changed since last report.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 5,546,494 issued and outstanding shares of common stock as of November 1, 2005.

 

 

 

SHORE BANCSHARES, INC.

(Dollars in thousands, except per share amounts)

See accompanying notes to Condensed Consolidated Financial Statements.

 

SHORE BANCSHARES, INC.

(Dollars in thousands, except per share amounts)

See accompanying notes to Condensed Consolidated Financial Statements.

 

 

SHORE BANCSHARES, INC.

(Dollars in thousands, except per share amounts)

See accompanying Notes to Condensed Consolidated Financial Statements

 

SHORE BANCSHARES, INC.

(Dollars in thousands)

See accompanying notes to Condensed Consolidated Financial Statements

 

Shore Bancshares, Inc.

For the Nine Month Periods Ended September 30, 2005 and 2004

(Unaudited)

 

As of September 30, 2005 and 2004, there were 4,000 shares excluded from the diluted earnings per share computations because the option price exceeded the average market price and therefore, their effect would be anti-dilutive.

 

 

 

 

 

Through the Insurance Products and Services business, the Company provides a full range of insurance products and services to businesses and consumers in the Company’s market areas. Products include property and casualty, life, marine, individual health and long-term care insurance. Pension and profit sharing plans and retirement plans for executives and employees are available to suit the needs of individual businesses.

Selected financial information by line of business for the nine months ended September 30 is included in the following table:

 

 

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 Management’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 Shore Bancshares, Inc. and its subsidiaries operate, 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 Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2004. Actual results may differ materially from such forward-looking statements, and Management 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 the Company 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 elsewhere in this report, as well as the audited consolidated financial statements and related notes included in the Company’s Annual Report 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” and collectively with Talbot Bank and Centreville National Bank, the “Banks”). The Banks operate 16 full service branches in Kent, Queen Anne’s, Talbot, Caroline and Dorchester Counties in Maryland and in Kent County, Delaware. During the third quarter of 2005, Centreville National Bank established a trust department and now offers various fiduciary services to the Company’s customers. The Company additionally 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 Capital 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 requires us to make estimates, assumptions, and judgments that affect the reported amount of assets, liabilities, revenues and expenses. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.

 

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 September 30, 2005 was $3,142,000, or diluted earnings per share of $.56, compared to $2,935,000, or diluted earnings per share of $.53, for the third quarter of 2004. Net income for the nine months ended September 30, 2005 was $9,749,000, a $1,698,000 increase over the same period in 2004. On a per share basis, diluted earnings for the nine months ended September 30, 2005 were $1.75, compared to $1.46 for the same period last year. Annualized return on average assets was 1.59% for the nine months ended September 30, 2005, compared to 1.39% for the same period in 2004. Annualized return on average stockholders’ equity was 13.06% and 11.85% for the nine months ended September 30, 2005 and 2004, respectively.

Net interest income for the three- and nine-month periods ended September 30, 2005 was $9,065,000 and $26,072,000, respectively, an increase of $1,361,000, or 17.7%, and $4,859,000, or 22.9%, respectively, when compared to the same periods last year. These increases are attributable to a $35,664,000 increase in average earning assets, concentrated in loans, and an overall increase in yields on earning assets. Total interest income increased by $2,255,000 and $6,657,000 for the three- and nine-month periods ended September 30, 2005, respectively, when compared to the same periods last year.

 

The Company’s net interest margin was 4.65% for the nine months ended September 30, 2005, which is 67 basis points higher than the net interest margin for the same period last year. The Company continued to increase its volume of earning assets, which averaged $755,586,000 for the nine months ended September 30, 2005, compared to $719,922,000 for the same period in 2004. Average loans totaled $602,836,000 for the nine-month period ended September 30, 2005, a $58,691,000 increase over the same period in 2004. This growth was funded with maturities in the investment portfolio and increased customer deposits. The yield on earning assets for the nine-month period ended September 30, 2005 increased 93 basis points to 6.14% from 5.21% for the same period last year. Increasing short term interest rates and a shift in the mix of earning assets from investment securities, which have lower overall yields than loans, to loans is the reason for this increase.

The overall yield on loans for the nine months ended September 30, 2005 was 6.77%, compared to 5.84% for the same period in 2004. The yield on investment securities for the first nine months of 2005 increased slightly to 3.80% from 3.67% for the same period in 2004, and the average balance of investment securities for the nine-month period ended September 30, 2005 decreased by $26,605,000 to $120,979,000 when compared to the same period in 2004. Investment portfolio maturities during the first nine months of 2005 were used primarily to fund loan growth, so growth in the overall portfolio yield has been small.

Total interest expense for the three and nine months ended September 30, 2005 was $3,171,000 and $8,461,000, respectively, an increase of $894,000 and $1,798,000, respectively, over the same periods in 2004. The increase in interest expense resulted primarily from an increased volume of interest bearing deposits during the period and increases in the rates paid on interest bearing liabilities. The market for deposits is very competitive and the Company has responded by offering higher overall rates for deposits, especially time deposits. The average balance of interest bearing deposits increased by $24,137,000 for the nine months ended September 30, 2005 when compared to the same period in 2004. The overall rate paid for interest bearing deposits increased 30 basis points to 1.83% as a result of higher rates paid for certificates of deposit. 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. For the nine months ended September 30, 2005, the average balance of certificates of deposits, including those $100,000 or more, increased by $9,854,000 when compared to the same period last year, and the average rate paid for those certificates of deposit increased 71 basis points to 3.32%. Comparing the first nine months of 2005 to the same period in 2004, average interest bearing demand deposits increased by approximately $905,000 and average money management and savings deposits increased by $6,717,000.

Loans comprised 79.8% and 75.6% of total average earning assets for the nine-months ended September 30, 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 nine months of 2005:

 

Noninterest income declined $156,000 in the third quarter of 2005 when compared to the same period in 2004. The primary reason for the decline is a reduction in insurance agency commissions. During the third quarter of 2004 the Insurance Agency recognized a one-time commission of approximately $135,000, which contributed to the decline in insurance agency commissions when compared to 2005. Also, the Company converted its billing system during the third quarter of 2005 and customers are now billed directly by the insurance company providing coverage. Under this converted system, the Company receives commission income after the insurance company completes the billing process. The effect of this new system is that commission income is now recognized later than it was recognized a year ago. Service charges on deposit accounts continue to grow as a result of enhanced product offerings to customers. For the nine-month period ended September 30, 2005, noninterest income increased $514,000 as a result of a $266,000 increased service charges on deposit accounts, a gain on sale of securities of $57,000 and increased income from mortgage originations and sales of investment products.

 

Total noninterest expense for the three-month period ended September 30, 2005 was $6,393,000, compared to $5,684,000 for the same period last year. For the nine months ended September 30, 2005, total noninterest expense was $18,765,000, an increase of $2,282,000 over the same period last year. Increases in salaries and benefits expense for the quarter ($446,000) and nine months ($1,513,000) relate to an increase in the number of employees, an increase in incentive compensation cost and overall salary and benefit cost increases for the year. Increases in premises and equipment expense for the quarter ($101,000) and nine months ($229,000) as well as other noninterest expense for the quarter ($162,000) and nine months ($540,000) relate to the operation of new branch facilities opened in 2004, a new branch facility opening in the fourth quarter of 2005, and overall growth of the Company, including the start-up costs associated with the establishment of Centreville National Bank’s trust department, which began operations during the third quarter of 2005.

 

 

 

The effective tax rate for the three- and nine-month periods ended September 30, 2005 was 37.3% and 37.0%, respectively, compared to 35.8% and 36.1%, respectively, for the same periods last year. Management believes that there have been no changes in applicable tax laws 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 $611,839,000 at September 30, 2005, an increase of $16,381,000 since December 31, 2004. The growth in loans since year end is attributable to an increase in real estate mortgage loans of $20,512,000 or 4.3%. Average loans, net of unearned income, totaled $602,836,000 for the nine months ended September 30, 2005, a $58,691,000 increase when compared to the same period last year. The Company's market demand for loans remained strong through the third quarter of 2005.

 

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. An overview of the methodology employed by Management on a quarterly basis to maintain the allowance is found above under the caption “Critical Accounting Policies”.

The provision for credit losses for the three- and nine-month periods ended September 30, 2005 was $220,000 and $580,000, respectively, compared to $165,000 and $370,000, respectively, for the same periods of 2004. The Company has experienced a decline in nonaccrual and past due loans since December 31, 2004; however, the specific allowance associated with those loans has increased slightly as a result of Management’s 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 appreciated 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 $99,000 and $292,000 for the three- and nine-month periods ended September 30, 2005, respectively, compared to $95,000 and $454,000, respectively, for the same periods in 2004. Since December 31, 2004, nonaccrual loans have declined by $585,000 to $884,000. Loans past due 90 days and still accruing decreased by $2,310,000 since December 31, 2004, totaling $659,000 at September 30, 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 to total loans, including other real estate owned, remains low. The allowance for credit losses as a percentage of average loans was .83% at September 30, 2005 and .85% at December 31, 2004. Based on its quarterly evaluation of the adequacy of the allowance for credit losses, Management believes that the allowance for credit losses and the related provision are adequate at September 30, 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 markets relevant to the Company may have a material adverse effect on collateral values. The Company has a concentration of construction and land development loans in its market areas. At September 30, 2005, the balance of such loans was $127,249,000 or 20.8% 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 totaled $126,764,000 at September 30, 2005, an increase of $7,668,000 when compared to December 31, 2004. The tax equivalent yield on investment securities for the nine-month period ended September 30, 2005 increased to 3.80% from 3.67% for the same period last year. This slight increase was the result of yields on bonds purchased during the nine-month period ended September 30, 2005 that were higher than those on bonds that matured during the period.

 

Total deposits at September 30, 2005 were $701,971,000, an increase of $43,299,000 when compared to total deposits at December 31, 2004. Noninterest bearing demand account balances increased approximately $7,867,000, certificates of deposit $100,000 or more increased $14,526,000, and other time deposits increased $22,329,000 during the first nine months of 2005 when compared to the same period last year, while NOW and SuperNOW accounts declined $1,418,000.

 

Short-term borrowings at September 30, 2005 were $29,832,000 and consisted of securities sold under agreements to repurchase and federal funds purchased. At December 31, 2004, short-term borrowings were $27,106,000 and 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 September 30, 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 $80 million at September 30, 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 $99.7 million at September 30, 2005, which represents an increase of 7.2% since December 31, 2004. Accumulated other comprehensive loss, which consists solely of net unrealized losses on investment securities available for sale, increased by $554,000 during the first nine months of 2005, resulting in accumulated other comprehensive loss of $832,000 at September 30, 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 September 30, 2005 to the minimum regulatory requirements is presented below:

 

 

The Company’s objectives and strategies in managing market risk have not materially changed since December 31, 2004 and are discussed in detail 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 September 30, 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 third 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.

 

 

 

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.