Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2019
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.)
28969 Information Lane, Easton, Maryland
21601
(Address of Principal Executive Offices)
(Zip Code)
(410) 763‑7800
Registrant’s Telephone Number, Including Area Code
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
SHBI
NASDAQ
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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b‑2 of the Exchange Act.
Large accelerated filer
Accelerated filer
☑
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Act). Yes ◻ 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: 12,779,072 shares of common stock outstanding as of July 31, 2019.
INDEX
Page
Part I. Financial Information
3
Item 1. Financial Statements
Consolidated Balance Sheets –June 30, 2019 (unaudited) and December 31, 2018
Consolidated Statements of Income For the three and six months ended June 30, 2019 and 2018 (unaudited)
4
Consolidated Statements of Comprehensive Income For the three and six months ended June 30, 2019 and 2018 (unaudited)
5
Consolidated Statements of Changes in Stockholders’ Equity For the three and six months ended June 30, 2019 and 2018 (unaudited)
6
Consolidated Statements of Cash Flows For the six months ended June 30, 2019 and 2018 (unaudited)
7
Notes to Consolidated Financial Statements (unaudited)
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
35
Item 3. Quantitative and Qualitative Disclosures about Market Risk
47
Item 4. Controls and Procedures
Part II. Other Information
48
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Exhibit Index
49
Signatures
50
2
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
June 30,
December 31,
2019
2018
ASSETS
(Unaudited)
Cash and due from banks
$
18,541
16,294
Interest-bearing deposits with other banks
20,739
50,931
Cash and cash equivalents
39,280
67,225
Investment securities:
Available-for-sale, at fair value
145,410
154,432
Held to maturity, at amortized cost - fair value of $5,887 (2019) and $6,000 (2018)
5,905
6,043
Equity securities, at fair value
1,325
1,269
Restricted securities
5,095
6,476
Loans
1,240,295
1,195,355
Less: allowance for credit losses
(10,305)
(10,343)
Loans, net
1,229,990
1,185,012
Premises and equipment, net
22,710
22,711
Goodwill
17,518
Other intangible assets, net
2,540
2,857
Other real estate owned, net
524
1,222
Right-of-use assets
3,663
—
Other assets
14,602
17,678
Assets of discontinued operations
633
TOTAL ASSETS
1,488,562
1,483,076
LIABILITIES
Deposits:
Noninterest-bearing
346,916
330,466
Interest-bearing
902,084
881,875
Total deposits
1,249,000
1,212,341
Short-term borrowings
25,508
60,812
Long-term borrowings
15,000
Lease liabilities
Other liabilities
4,084
8,415
Liabilities of discontinued operations
3,323
TOTAL LIABILITIES
1,297,255
1,299,891
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share; shares authorized - 35,000,000; shares issued and outstanding - 12,779,072 (2019) and 12,749,497 (2018)
128
127
Additional paid in capital
65,376
65,434
Retained earnings
125,996
120,574
Accumulated other comprehensive loss
(193)
(2,950)
TOTAL STOCKHOLDERS' EQUITY
191,307
183,185
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
See accompanying notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
For Three Months Ended
For Six Months Ended
INTEREST INCOME
Interest and fees on loans
13,749
12,631
27,248
24,675
Interest and dividends on investment securities:
Taxable
887
982
1,885
2,003
Interest on deposits with other banks
113
61
276
99
Total interest income
14,749
13,674
29,409
26,777
INTEREST EXPENSE
Interest on deposits
2,204
580
4,151
1,128
Interest on short-term borrowings
145
461
358
687
Interest on long-term borrowings
107
213
Total interest expense
2,456
1,041
4,722
1,815
NET INTEREST INCOME
12,293
12,633
24,687
24,962
Provision for credit losses
200
418
300
907
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
12,093
12,215
24,387
24,055
NONINTEREST INCOME
Service charges on deposit accounts
1,028
947
1,962
1,852
Trust and investment fee income
385
414
757
814
Other noninterest income
1,196
935
2,078
1,770
Total noninterest income
2,609
2,296
4,797
4,436
NONINTEREST EXPENSE
Salaries and wages
3,792
4,101
7,558
8,327
Employee benefits
1,068
1,045
2,322
2,221
Occupancy expense
668
650
1,359
1,327
Furniture and equipment expense
295
247
558
502
Data processing
919
689
1,829
1,557
Directors' fees
116
152
202
266
Amortization of other intangible assets
155
228
317
327
FDIC insurance premium expense
181
214
386
419
Other real estate owned expenses, net
60
293
(41)
Legal and professional fees
559
487
1,160
Other noninterest expenses
1,172
1,035
2,344
2,465
Total noninterest expense
8,985
8,853
18,328
18,305
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
5,717
5,658
10,856
10,186
Income tax expense
1,489
1,466
2,800
2,532
Income from continuing operations
4,228
4,192
8,056
7,654
(Loss) income from discontinued operations before income taxes
(4)
269
(103)
1,048
Income tax (benefit) expense
70
(25)
253
(Loss) income from discontinued operations
199
(78)
795
NET INCOME
4,224
4,391
7,978
8,449
Earnings per common share - Basic
0.33
0.63
0.60
0.01
(0.01)
0.06
Net income
0.34
0.62
0.66
Earnings per common share - Diluted
Dividends paid per common share
0.10
0.08
0.20
0.15
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
Other comprehensive income (loss):
Unrealized holding gains (losses) on available-for-sale-securities
1,797
(550)
3,780
(3,416)
Tax effect
(492)
149
(1,033)
942
Amortization of unrealized loss on securities transferred from available-for-sale to held-to-maturity
14
15
(1)
(2)
(5)
Total other comprehensive income (loss)
1,311
(395)
2,757
(2,464)
Comprehensive income
5,535
3,996
10,735
5,985
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
For the Three and Six months Ended June 30, 2019 and 2018
Accumulated
Additional
Other
Total
Common
Paid in
Retained
Comprehensive
Stockholders’
Stock
Capital
Earnings
Income(Loss)
Equity
Balances, January 1, 2019
Net Income
3,754
Other comprehensive income
1,446
Stock-based compensation
63
Exercise of options and vesting of restricted stock, net of
shares surrendered
1
(89)
(88)
Cash dividends declared
(1,278)
Balances, March 31, 2019
65,408
123,050
(1,504)
187,082
(32)
Balances, June 30, 2019
Balances, January 1, 2018
65,256
99,662
(1,309)
163,736
4,058
Other comprehensive (loss)
(2,069)
143
(891)
Balances, March 31, 2018
65,399
102,829
(3,378)
164,977
Cumulative effect adjustment (ASU 2016-01)
(6)
163
(1,021)
Balances, June 30, 2018
65,562
106,193
(3,767)
168,115
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of acquisition accounting estimates
(262)
(310)
Depreciation and amortization
1,198
1,030
Net amortization of securities
262
339
Stock-based compensation expense
31
306
Deferred income tax expense
233
Losses (gains) on sales and valuation adjustments on other real estate owned
287
(55)
Fair value adjustment on equity securities
13
Net changes in:
Accrued interest receivable
(326)
473
2,644
(4,532)
Accrued interest payable
(383)
(7,485)
(52)
Net cash provided by operating activities
7,328
CASH FLOWS FROM INVESTING ACTIVITES:
Proceeds from maturities and principal payments of investment securities available for sale
12,542
16,979
Proceeds from maturities and principal payments of investment securities held to maturity
150
91
Purchases of equity securities
(15)
(7)
Net change in loans
(45,130)
(63,740)
Purchases of premises and equipment
(545)
(798)
Proceeds from sales of other real estate owned
411
280
Net redemption of restricted securities
1,381
Net cash (used in) investing activities
(31,206)
(47,195)
CASH FLOWS FROM FINANCING ACTIVITIES:
Noninterest-bearing deposits
16,450
(1,688)
Interest-bearing deposits
20,323
(25,881)
(35,304)
81,007
Common stock dividends paid
(2,556)
(1,912)
Repurchase of shares for tax withholding on exercised options and vested restricted stock
Net cash (used in) provided by financing activities
(1,175)
51,526
Net (decrease) increase in cash and cash equivalents
(27,945)
11,659
Cash and cash equivalents at beginning of period
31,820
Cash and cash equivalents at end of period
43,479
Supplemental cash flows information:
Interest paid
5,219
1,726
Income taxes paid
9,669
2,825
Lease liabilities arising from right-of-use assets
3,877
Unrealized gain (loss) on securities available for sale
Amortization of unrealized loss on securities transferred from available for sale to held to maturity
Shore Bancshares, Inc.
Notes to Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2019 and 2018
Note 1 – Basis of Presentation
The consolidated financial statements include the accounts of Shore Bancshares, Inc. and its subsidiaries with all significant intercompany transactions eliminated. The consolidated financial statements conform to accounting principles generally accepted in the United States of America (“GAAP”) 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 consolidated financial position at June 30, 2019, the consolidated results of income and comprehensive income for the three and six months ended June 30, 2019 and 2018, and changes in stockholders’ equity and cash flows for the six months ended June 30, 2019 and 2018, have been included. All such adjustments are of a normal recurring nature. The amounts as of December 31, 2018 were derived from the 2018 audited financial statements. The results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of the results to be expected for any other interim period or for the full year. This Quarterly Report on Form 10-Q should be read in conjunction with the Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2018. For purposes of comparability, certain immaterial reclassifications have been made to amounts previously reported to conform with the current period presentation.
When used in these notes, the term “the Company” refers to Shore Bancshares, Inc. and, unless the context requires otherwise, its consolidated subsidiary.
Recent Accounting Standards
ASU No. 2016-13 - In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Based on FASB’s July 17, 2019 meeting, an exposure draft is expected that, once finalized, could change implementation dates for many companies. The Company believes this ASU will have a significant impact on our consolidated financial statements and the method in which we calculate our credit losses, primarily on loans and held to maturity securities. At this time, the Company has established a project management team which meets periodically to discuss and assign roles and responsibilities, key tasks to complete, and a general time line to be followed for implementation. The team has been working with an advisory consultant and has purchased a vendor model for implementation. Historical data has been collected and uploaded to the new model and the team is in the process of finalizing the methodologies that will be utilized. The team is currently running a parallel simulation to its current incurred loss impairment model. The Company is continuing to evaluate the extent of the potential impact of this standard and continues to keep current on evolving interpretations and industry practices via webcasts, publications, conferences, and peer bank meetings.
ASU No. 2017-04 – In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”. The amendments in this ASU simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public business entities that are U.S.
Securities and Exchange Commission (SEC) filers should adopt the amendments in this ASU for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The guidance is not expected to have a significant impact on the Company’s financial positions, results of operations or disclosures.
ASU No. 2018-13 – In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Early adoption is permitted. As ASU No. 2018-13 only revises disclosure requirements, it will not have a material impact on the Company’s Consolidated Financial Statements.
ASU No. 2019-04 – In April 2019, the FASB issued ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments.” This ASU clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement including improvements resulting from various TRG Meetings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-04 will have on its (consolidated) financial statements.
ASU No. 2019-05 - In May 2019, the FASB issued ASU 2019-05, “Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief.” The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with changes in fair value flowing through earnings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments should be applied on a modified-retrospective basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-04 will have on its (consolidated) financial statements.
9
Note 2 – Sale of Subsidiary
Avon-Dixon Agency Sale
On December 31, 2018, the Company completed the sale of the specific assets and activities related to its insurance agency, Avon-Dixon Agency, LLC (“Avon-Dixon”) to Avon-Dixon, an Alera Group Agency, LLC (“Alera”). Also, on this date the Company discontinued the operations of its premium finance company, Mubell Finance, LLC (“Mubell”). Together, Avon-Dixon and Mubell companies are referred to as the “Insurance Subsidiaries”. The Insurance Subsidiaries represented the Company’s insurance products and services segment, the activities of which related to originating, servicing and underwriting retail insurance policies. Assets sold to Alera included various intangible assets and a 40% interest in segregated portfolio of Eastern Re. LTD., a specialty reinsurance company. Mubell, along with certain other assets and liabilities that will be sold or settled separately within one year, is classified as discontinued operations in the accompanying Consolidated Balance Sheets and Consolidated Statements of Income.
The specific assets acquired by Alera include, among other things, the insurance origination offices, insurance expirations, workforce and system procedures, trade names and goodwill. Alera has assumed certain obligations and liabilities of the Company under the acquired leases, and with respect to the employment of transferred employees. The Company received a $25.2 million cash payment, upon the closing of the transaction.
The following table summarizes the calculation of the net gain on disposal of discontinued operations.
($ in thousands)
Year Ended December 31, 2018
Proceeds from the transaction
29,276
Compensation expense related to the transaction
2,588
Broker fees
Other transaction costs
594
Net cash proceeds
25,159
Net assets sold
(12,423)
Net gain on disposal
12,736
The following tables present the financial information of discontinued operations as of the dates and for the periods indicated:
625
Accrued expenses and other liabilities
10
For the Three Months Ended
For the Six Months Ended
Noninterest income
Insurance agency commissions
2,151
4,845
All other income
93
188
2,244
5,033
Noninterest expense
(3)
1,282
28
2,529
324
665
105
209
Furniture and equipment
Amortization of intangible assets
11
23
18
71
34
207
465
1,975
118
3,985
Note 3 – Earnings Per Share
Basic earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period, adjusted for the dilutive effect of potential common stock equivalents (stock-based awards). The following table provides information relating to the calculation of earnings per common share:
(In thousands, except per share data)
Net income from continuing operations
Net (loss) income from discontinued operations
Weighted average shares outstanding - Basic
12,779
12,744
12,774
12,730
Dilutive effect of common stock equivalents-options
Weighted average shares outstanding - Diluted
12,784
12,757
12,743
Basic earnings per common share
Diluted earnings per common share
There were no weighted average common stock equivalents excluded from the calculation of diluted earnings per share for the three and six months ended June 30, 2019 and 2018.
Note 4 – Investment Securities
The following tables provide information on the amortized cost and estimated fair values of debt securities.
Gross
Estimated
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available-for-sale securities:
June 30, 2019
U.S. Government agencies
34,125
110
34,019
Mortgage-backed
111,520
361
490
111,391
145,645
365
600
December 31, 2018
34,285
651
33,636
124,162
115
3,481
120,796
158,447
117
4,132
Held-to-maturity securities:
1,504
1,514
States and political subdivisions
1,401
1,406
Other Debt securities
3,000
33
2,967
5,887
1,642
25
1,617
1,415
32
2,968
57
6,000
The Company adopted ASU 2016-01 effective January 1, 2018 and equity securities with an aggregate fair value of $1.3 million at June 30, 2019 and December 31, 2018 are presented separately on the balance sheet. The fair value adjustment recorded through earnings totaled $41 for the six months ended June 30, 2019 and $(13) thousand for six months ended June 30, 2018, respectively.
The following tables provide information about gross unrealized losses and fair value by length of time that the individual securities have been in a continuous unrealized loss position at June 30, 2019 and December 31, 2018.
Less than
More than
12 Months
30,018
59,065
89,083
Other debt securities
12
1,079
32,362
641
33,441
13,981
261
99,904
3,220
113,885
15,060
271
132,266
3,861
147,326
4,585
All of the securities with unrealized losses in the portfolio have modest duration risk, low credit risk, and minimal losses when compared to total amortized cost. The unrealized losses on debt securities that exist are the result of market changes in interest rates since original purchase. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost bases, which may be at maturity for debt securities, the Company considers the unrealized losses to be temporary. There were forty-six available-for-sale securities and two held-to-maturity securities in an unrealized loss position at June 30, 2019.
The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at June 30, 2019.
Available for sale
Held to maturity
Fair Value
Due in one year or less
5,996
5,978
500
503
Due after one year through five years
28,874
28,780
400
401
Due after five years through ten years
59,748
59,787
3,501
3,469
Due after ten years
51,027
50,865
The maturity dates for debt securities are determined using contractual maturity dates.
Note 5 – Loans and Allowance for Credit Losses
The Company makes residential mortgage, commercial and consumer loans to customers primarily in Talbot County, Queen Anne’s County, Kent County, Caroline County, Dorchester County, Baltimore County and Howard County in Maryland, Kent County, Delaware and Accomack County, Virginia. The following table provides information about the principal classes of the loan portfolio at June 30, 2019 and December 31, 2018.
Construction
134,145
127,572
Residential real estate
430,020
429,560
Commercial real estate
559,568
523,427
Commercial
108,615
107,522
Consumer
7,947
7,274
Total loans
Allowance for credit losses
Total loans, net
Loans are stated at their principal amount outstanding net of any purchase premiums/discounts, deferred fees and costs. Loans included deferred costs, net of deferred fees, of $1.2 million and discounts on acquired loans of $1.3 million at June 30, 2019. Loans included deferred costs, net of deferred fees, of $789 thousand and discounts on acquired loans of $1.4 million at December 31, 2018. At June 30, 2019 and December 31, 2018, included in total loans were $86.9 million and $92.8 million in loans, respectively, acquired as part of the NWBI branch acquisition. Interest income on loans is accrued at the contractual rate based on the principal amount outstanding. Fees charged and costs capitalized for originating loans are being amortized substantially on the interest method over the term of the loan. A loan is placed on nonaccrual (i.e., interest income is no longer accrued) when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more, unless the loan is well secured and in the process of collection. Any unpaid interest previously accrued on those loans is reversed from income.
Interest payments received on nonaccrual loans are applied as a reduction of the loan principal balance unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
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 contractual terms when due. 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. 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. Generally, the Company measures impairment on such loans by reference to the fair value of the collateral. Once the amount of impairment has been determined, the uncollectible portion is charged off. Loan payments received on nonaccrual impaired loans are generally applied to the outstanding principal balance. In certain circumstances, income may be recognized on a cash basis. Generally, interest income is not recognized on impaired loans unless the likelihood of further loss is remote. The allowance for credit losses may include specific reserves related to impaired loans. Specific reserves remain until charge offs are made. 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 on historical loss ratios and are included in the formula portion of the allowance for credit losses. See additional discussion under the caption “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
A loan is considered a troubled debt restructuring (“TDR”) if a borrower is experiencing financial difficulties and a creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Loans are identified to be restructured when signs of impairment arise such as borrower interest rate reduction request, slowness to pay, or when an inability to repay becomes evident. The terms being offered are evaluated to determine if they are more liberal than those that would be indicated by policy or industry standards for similar, untroubled credits. In those situations where the terms or the interest rates are considered to be more favorable than industry standards or the current underwriting guidelines of the Company’s banking subsidiary, Shore United Bank (the “Bank”), the loan is classified as a TDR. All loans designated as TDRs are considered impaired loans and may be on either accrual or nonaccrual status. In instances where the loan has been placed on nonaccrual status, six consecutive months of timely payments are required prior to returning the loan to accrual status.
All loans classified as TDRs which are restructured and accrue interest under revised terms require a full and comprehensive review of the borrower’s financial condition, capacity for repayment, realistic assessment of collateral values, and the assessment of risk entered into any workout agreement. Current financial information on the borrower, guarantor, and underlying collateral is analyzed to determine if it supports the ultimate collection of principal and interest. For commercial loans, the cash flows are analyzed, both for the underlying project and globally. For consumer loans, updated salary, credit history and cash flow information is obtained. Current market conditions are also considered. Following a full analysis, the determination of the appropriate loan structure is made.
In the normal course of banking business, risks related to specific loan categories are as follows:
Construction loans – Construction loans are offered primarily to builders and individuals to finance the construction of single-family dwellings. In addition, the Bank periodically finances the construction of commercial projects. Credit risk factors include the borrower’s ability to successfully complete the construction on time and within budget, changing market conditions which could affect the value and marketability of projects, changes in the borrower’s ability or willingness to repay the loan and potentially rising interest rates which can impact both the borrower’s ability to repay and the collateral value.
Residential real estate – Residential real estate loans are typically made to consumers and are secured by residential real estate. Credit risk arises from the borrower’s continuing financial stability, which can be adversely impacted by job loss, divorce, illness, or personal bankruptcy, among other factors. Also impacting credit risk would be a shortfall in the value of the residential real estate in relation to the outstanding loan balance in the event of a default or subsequent liquidation of the real estate collateral.
Commercial real estate – Commercial real estate loans consist of both loans secured by owner occupied properties and nonowner occupied properties where an established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of occupancy and cash flow. These loans are subject to adverse changes in the local economy and commercial real estate markets. Credit risk associated with owner occupied properties arises from the borrower’s financial stability and the ability of the borrower and the business to repay the loan. Nonowner occupied properties carry the risk of a tenant’s deteriorating credit strength, lease expirations in soft markets and sustained vacancies which can adversely impact cash flow.
Commercial – Commercial loans are secured or unsecured loans for business purposes. Loans are typically secured by accounts receivable, inventory, equipment and/or other assets of the business. Credit risk arises from the successful operation of the business which may be affected by competition, rising interest rates, regulatory changes and adverse conditions in the local and regional economy.
Consumer – Consumer loans include home equity loans and lines, installment loans and personal lines of credit. Credit risk is similar to residential real estate loans above as it is subject to the borrower’s continuing financial stability and the value of the collateral securing the loan.
The following tables include impairment information relating to loans and the allowance for credit losses as of June 30, 2019 and December 31, 2018.
Residential
real estate
Loans individually evaluated for impairment
1,494
6,761
13,794
311
22,360
Loans collectively evaluated for impairment
132,651
423,259
545,774
108,304
1,217,935
Allowance for credit losses allocated to:
230
272
661
2,291
1,925
3,095
2,050
283
9,644
Total allowance
2,443
2,155
3,367
2,057
10,305
2,893
8,553
13,532
340
25,318
124,679
421,007
509,895
107,182
1,170,037
320
301
104
36
761
2,342
2,052
2,973
1,913
302
9,582
2,662
2,353
3,077
1,949
10,343
The following tables provide information on impaired loans and any related allowance by loan class as of June 30, 2019 and December 31, 2018. The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken and interest paid on nonaccrual loans that has been applied to principal.
Recorded
Unpaid
investment
Quarter-to-date
Average
Interest
principal
with no
with an
Related
average recorded
recorded
balance
allowance
Impaired nonaccrual loans:
1,581
1,449
1,515
2,153
3,035
2,549
2,730
3,034
10,949
8,956
9,613
9,466
425
314
319
15,990
11,505
3,087
406
14,172
14,972
Impaired accruing TDRs:
45
4,212
1,228
2,984
4,219
4,263
81
3,511
2,822
3,516
3,533
66
7,768
4,095
3,673
255
7,782
7,844
Total impaired loans:
1,626
1,562
2,201
7,247
3,777
6,949
7,297
14,460
11,778
2,016
13,129
12,999
23,758
15,600
6,760
21,954
22,816
16
June 30, 2018
income
recognized
3,219
2,715
2,982
2,987
4,281
2,605
1,590
10,029
9,307
67
1,853
1,286
445
332
344
17,974
12,039
4,616
541
6,757
6,121
51
291
1,634
4,454
1,440
3,014
183
4,839
4,565
46
4,158
2,872
37
4,541
4,596
41
8,663
2,777
5,886
220
9,671
10,795
100
3,270
178
3,273
4,621
8,735
4,045
4,508
6,429
6,069
14,187
10,593
2,939
6,394
5,882
26,637
14,816
10,502
16,428
16,916
17
The following tables provide a roll-forward for TDRs as of June 30, 2019 and June 30, 2018.
1/1/2019
6/30/2019
TDR
New
Disbursements
Charge-
Reclassifications/
Balance
TDRs
(Payments)
offs
Transfer In/(Out)
Payoffs
Allowance
For six months ended
Accruing TDRs
(45)
(197)
(647)
(698)
Nonaccrual TDRs
2,798
(1,346)
(9)
3,118
(1,355)
1,760
159
11,781
(2,053)
9,528
1/1/2018
6/30/2018
3,972
(379)
(2,600)
987
4,536
(42)
(154)
(237)
4,103
4,818
(69)
(219)
4,530
13,326
(117)
(3,056)
9,620
2,878
(40)
2,838
392
154
83
337
333
29
3,298
(44)
3,408
421
16,624
(161)
13,028
The following tables provide information on TDRs that defaulted within twelve months of restructuring during the six months ended June 30, 2019 and June 30, 2018. There were no defaults during the three months ended June 30, 2019 and 2018. Generally, a loan is considered in default when principal or interest is past due 90 days or more, the loan is placed on nonaccrual, the loan is charged off, or there is a transfer to OREO or repossessed assets.
Number of
contracts
TDRs that subsequently defaulted:
379
533
Management uses risk ratings as part of its monitoring of the credit quality in the Company’s loan portfolio. Loans that are identified as special mention, substandard or doubtful are adversely rated. These loans and the pass/watch loans are assigned higher qualitative factors than favorably rated loans in the calculation of the formula portion of the allowance for credit losses. At June 30, 2019, there were no nonaccrual loans classified as special mention or doubtful and $14.6 million of nonaccrual loans were classified as substandard. Similarly, at December 31, 2018, there were no nonaccrual loans classified as special mention or doubtful and $16.7 million of nonaccrual loans were classified as substandard.
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The following tables provide information on loan risk ratings as of June 30, 2019 and December 31, 2018.
Special
Pass/Performing
Pass/Watch
Mention
Substandard
Doubtful
104,892
25,633
1,467
390,307
32,098
3,878
3,737
426,909
111,664
5,749
15,246
88,611
19,335
345
7,528
416
1,018,247
189,146
12,104
20,798
93,977
30,735
2,860
386,553
33,739
3,769
5,499
389,219
113,873
4,515
15,820
90,777
15,727
642
376
6,805
466
967,331
194,540
8,926
24,558
The following tables provide information on the aging of the loan portfolio as of June 30, 2019 and December 31, 2018.
Accruing
30‑59 days
60‑89 days
Greater than
Current
past due
90 days
Nonaccrual
132,478
218
423,119
3,088
1,112
4,352
545,125
1,657
2,225
278
4,160
10,283
107,534
471
290
770
7,925
21
22
1,216,181
5,217
3,866
439
9,522
14,592
Percent of total loans
98.1
%
0.4
0.3
0.7
1.2
100.0
124,535
195
2,842
423,732
1,384
206
139
1,729
4,099
512,252
1,548
1,801
9,374
107,089
7,238
30
1,174,846
1,945
3,854
16,655
98.3
0.2
0.1
1.4
20
The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three and six months ended June 30, 2019 and June 30, 2018. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.
For three months ended
Allowance for credit losses:
Beginning Balance
2,657
2,433
3,057
2,009
10,418
Charge-offs
(300)
(81)
(23)
(407)
Recoveries
77
94
Net charge-offs
(297)
(21)
(313)
Provision
(215)
52
42
Ending Balance
2,541
2,359
2,643
2,027
217
9,787
(126)
(14)
(181)
73
97
(116)
(84)
(241)
194
299
120
2,593
2,150
2,845
2,210
323
10,121
(423)
(162)
(29)
(617)
279
(412)
(10)
(27)
(338)
(223)
2,460
2,284
2,594
2,241
9,781
(179)
(24)
(708)
86
141
(364)
(93)
(104)
(567)
497
Foreclosure Proceedings
Consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure totaled $961 thousand as of June 30, 2019 and $949 as of December 31, 2018, respectively. There were no residential real estate properties included in the balance of other real estate owned at June 30, 2019 and December 31, 2018.
All accruing TDRs were in compliance with their modified terms. Both performing and non-performing TDRs had no further commitments associated with them as of June 30, 2019 and December 31, 2018.
Note 6 – Leases
On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and consistent with such elections did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. As stated in the Company’s 2018 Form 10-K, the implementation of the new standard resulted in recognition of right-of-use assets and lease liabilities totaling $3.8 million at the date of adoption, which are related to the Company’s lease of premises used in operations.
Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company’s right to use
the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.
The Company’s long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably certain of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.
The following tables present information about the Company’s leases:
Weighted average remaining lease term
11.55
years
Weighted average discount rate
3.49
For the three months ended
For the six months ended
Lease cost (in thousands)
Operating lease cost
294
Short-term lease cost
Total lease cost
Cash paid for amounts included in the measurement of lease liabilities
144
A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows:
As of
Lease payments due (in thousands)
Six months ending December 31, 2019
289
Twelve months ending December 31, 2020
480
Twelve months ending December 31, 2021
417
Twelve months ending December 31, 2022
404
Twelve months ending December 31, 2023
381
Twelve months ending December 31, 2024
371
Thereafter
2,156
Total undiscounted cash flows
4,498
Discount
835
Note 7 – Goodwill and Other Intangibles
The following table provides information on the significant components of goodwill and other acquired intangible assets at June 30, 2019 and December 31, 2018.
Weighted
Net
Carrying
Impairment
Remaining Life
Amount
Charges
Amortization
(in years)
19,728
(1,543)
(667)
Other intangible assets
Amortizable
Core deposit intangible
3,954
(1,414)
6.5
Total other intangible assets
(1,097)
7.2
The aggregate amortization expense included in continuing operations was $317 thousand for June 30, 2019 and $350 thousand for June 30, 2018.
At June 30, 2019, estimated future remaining amortization for amortizing intangibles within the years ending December 31, is as follows:
AmortizationExpense
288
2020
2021
2022
389
2023
2024
246
Total amortizing intangible assets
24
Note 8 – Other Assets
The Company had the following other assets at June 30, 2019 and December 31, 2018 excluding discontinued operations.
3,671
3,345
Deferred income taxes
2,912
4,182
Prepaid expenses
1,186
1,067
Cash surrender value on life insurance
3,752
3,726
Income taxes receivable
781
2,300
5,358
The following table provides information on significant components of the Company’s deferred tax assets and liabilities as of June 30, 2019 and December 31, 2018.
Deferred tax assets:
2,815
2,797
Reserve for off-balance sheet commitments
Net operating loss carry forward
Write-downs of other real estate owned
273
Nonaccrual loan interest
260
Unrealized losses on available-for-sale securities
72
1,105
Unrealized losses on available-for-sale securities transferred to held to maturity
464
Total deferred tax assets
3,863
5,052
Deferred tax liabilities:
Depreciation
238
Amortization on loans FMV adjustment
Acquisition accounting adjustments
Deferred capital gain on branch sale
197
121
125
Total deferred tax liabilities
951
870
Net deferred tax assets
Note 9 – Other Liabilities
The Company had the following other liabilities at June 30, 2019 and December 31, 2018 excluding discontinued operations.
221
604
Other accounts payable
1,616
3,213
Deferred compensation liability
962
1,040
Income taxes payable
3,454
1,285
Note 10 - Stock-Based Compensation
At the 2016 annual meeting, stockholders approved the Shore Bancshares, Inc. 2016 Stock and Incentive Plan (“2016 Equity Plan”), replacing the Shore Bancshares, Inc. 2006 Stock and Incentive Plan (“2006 Equity Plan”), which expired on that date. The Company may issue shares of common stock or grant other equity-based awards pursuant to the 2016 Equity Plan. Stock-based awards granted to date generally are time-based, vest in equal installments on each anniversary of the grant date and range over a one- to five-year period of time, and, in the case of stock options, expire 10 years from the grant date. As part of the 2016 Equity Plan, a performance equity incentive award program, known as the “Long-term incentive plan” allows participating officers of the Company to earn incentive awards of performance share/restricted stock units if certain pre-determined targets are achieved at the end of a three-year performance cycle. Stock-based compensation expense based on the grant date fair value is recognized ratably over the requisite service period for all awards and reflects forfeitures as they occur. The 2016 Equity Plan originally reserved 750,000 shares of common stock for grant, and 636,465 shares remained available for grant at June 30, 2019.
The following tables provide information on stock-based compensation expense for the three and six months ended June 30, 2019 and 2018.
Excess tax benefits related to stock-based compensation
146
Unrecognized stock-based compensation expense
677
Weighted average period unrecognized expense is expected to be recognized
1.0
The following table summarizes restricted stock award activity for the Company under the 2016 Equity Plan for the six months ended June 30, 2019 and 2018.
Six Months Ended June 30, 2019
Weighted Average
Grant Date
Shares
Nonvested at beginning of period
Granted
15,702
15.36
Vested
Cancelled
Nonvested at end of period
The fair value of restricted stock awards that vested during the first six months of 2019 and 2018 was $0 and $133 thousand, respectively.
Restricted stock units (RSUs) are similar to restricted stock, except the recipient does not receive the stock immediately, but instead receives it upon the terms and conditions of the Company’s long-term incentive plans which are subject to performance milestones achieved at the end of a three-year period. Each RSU cliff vests at the end of the three-year period and entitles the recipient to receive one share of common stock on a specified issuance date. The recipient does not have any stockholder rights, including voting rights, with respect to the shares underlying awarded RSUs until the recipient becomes the holder of those shares.
26
In the second quarter of 2019, the Long-Term Incentive Plan culminating December 31, 2020 was terminated by the Board’s Compensation Committee and all outstanding RSUs were forfeited as presented in the table below. To replace this compensation incentive plan, the Compensation Committee elected to institute individual Supplemental Executive Retirement Plans (“SERPs”) which will be executed in the beginning of 2020, with the exception of three SERPs which began on July 19, 2019 for Lloyd L. Beatty, Jr., President and Chief Executive Officer, Edward C. Allen, Executive Vice President and Chief Financial Officer and Donna J. Stevens, Executive Vice President and Chief Operating Officer. These individuals also forfeited their RSUs in the LTI culminating December 31, 2019. More information about these SERP agreements can be found in Footnote 15 – Subsequent Events.
During 2017, the Company entered into a long-term incentive plan agreement with officers of the Company and its subsidiaries to award RSUs based on a performance metric to be achieved as of December 31, 2019. Assuming the performance metric is achieved, these awards will cliff vest on this date, in which the final number of common shares to be issued will be determined. The range of RSUs which could potentially be awarded at the end of the performance cycle is between 6,178 shares and 24,726 shares, assuming a certain performance metric is met. The table below presents management’s evaluation of the probable number of common stock awards to be issued at the end of the performance cycle.
During 2016, the Company entered into a long-term incentive plan agreement with officers of the Company and its subsidiaries to award RSUs based on a performance metric to be achieved as of December 31, 2018. Based on the results for the year ended December 31, 2018, 15,577 shares were vested.
The following table summarizes restricted stock units activity based on management’s evaluation of the probable number of common stock awards to be issued at the end of the performance cycle for the Company under the 2016 Equity Plan for the six months ended June 30, 2019.
Outstanding at beginning of period
38,562
14.69
(15,577)
11.68
Forfeited
(16,807)
16.78
Outstanding at end of period
6,178
16.57
The fair value of restricted stock units that vested during the first six months of 2019 and 2018 was $237 thousand and $695 thousand.
The following table summarizes stock option activity for the Company under the 2016 Equity Plan for the six months ended June 30, 2019 and 2018.
Exercise Price
27,249
9.68
Exercised
(15,578)
10.01
Expired/Cancelled
11,671
9.25
Exercisable at end of period
There were no stock options granted during the three and six months ended June 30, 2019 and June 30, 2018. The Company estimates the fair value of options using the Black-Scholes valuation model with weighted average assumptions for
27
dividend yield, expected volatility, risk-free interest rate and expected lives (in years). The expected dividend yield is calculated by dividing the total expected annual dividend payout by the average stock price. The expected volatility is based on historical volatility of the underlying securities. The risk-free interest rate is based on the Federal Reserve Bank’s constant maturities daily interest rate in effect at grant date. The expected contract life of the options represents the period of time that the Company expects the awards to be outstanding based on historical experience with similar awards.
At the end of the second quarter of 2019, the aggregate intrinsic value of the options outstanding under the 2016 Equity Plan was $83 thousand based on the $16.34 market value per share of the Company’s common stock at June 30, 2019. Similarly, the aggregate intrinsic value of the options exercisable was $83 thousand at June 30, 2019. The intrinsic value on options exercised during the six months ended June 30, 2019 was $72 thousand based on the $14.66 market value per share of the Company’s common stock at January 15, 2019. The intrinsic value on options exercised in 2018 was $365 thousand based on the $17.92 market value per share of the Company’s common stock at January 31, 2018. At June 30, 2019, the weighted average remaining contract life of options outstanding and exercisable was 5.3 years.
Note 11 – Accumulated Other Comprehensive Income
The Company records unrealized holding gains (losses), net of tax, on investment securities available for sale as accumulated other comprehensive income (loss), a separate component of stockholders’ equity. The following table provides information on the changes in the components of accumulated other comprehensive income (loss) for the six months ended June 30, 2019 and 2018.
Unrealized gains
(losses) on securities
transferred from
gains (losses) on
Available-for-sale
other
available for sale
to
comprehensive
securities
Held-to-maturity
(loss)
Balance, December 31, 2018
(2,918)
2,747
Balance, June 30, 2019
(171)
(22)
Balance, December 31, 2017
(1,255)
(54)
(2,474)
(3,723)
Note 12 – Fair Value Measurements
Accounting guidance under GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This accounting guidance also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, loans held for sale and other real estate owned (foreclosed assets). These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
Under fair value accounting guidance, assets and liabilities are grouped at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine their fair values. These hierarchy levels are:
Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.
Level 2 inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
Below is a discussion on the Company’s assets measured at fair value on a recurring basis.
Investment Securities Available for Sale
Fair value measurement for investment securities available for sale is based on quoted prices from an independent pricing service. The fair value measurements consider observable data that may include present value of future cash flows, prepayment assumptions, credit loss assumptions and other factors. The Company classifies its investments in U.S. Treasury securities, if any, as Level 1 in the fair value hierarchy, and it classifies its investments in U.S. Government agencies securities and mortgage-backed securities issued or guaranteed by U.S. Government sponsored entities as Level 2.
Equity Securities
Fair value measurement for equity securities is based on quoted market prices retrieved by the Company via on-line resources. Although these securities have readily available fair market values, the Company determined that they should be classified as level 2 investments in the fair value hierarchy due to not being considered traded in a highly active market.
The tables below present the recorded amount of assets measured at fair value on a recurring basis at June 30, 2019 and December 31, 2018. No assets were transferred from one hierarchy level to another during the first six months of 2019 or 2018.
Significant
Quoted
Observable
Unobservable
Prices
Inputs
(Level 1)
(Level 2)
(Level 3)
Securities available for sale:
146,735
155,701
Below is a discussion on the Company’s assets measured at fair value on a nonrecurring basis.
Impaired Loans
Loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts according to the contractual terms of the loan agreement when due. Loan impairment is measured using the present value of expected cash flows, the loan’s observable market price or the fair value of the collateral (less selling costs) if the loans are collateral dependent and these are considered Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of business equipment, inventory and accounts receivable, discounted on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those techniques applied in prior periods.
Other Real Estate Owned (Foreclosed Assets)
Foreclosed assets are adjusted for fair value upon transfer of loans to foreclosed assets establishing a new cost basis. Subsequently, foreclosed assets are carried at the lower of carrying value and fair value. The estimated fair value for foreclosed assets included in Level 3 are determined by independent market based appraisals and other available market information, less costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of the collateral deteriorates subsequent to the initial recognition, the Company records the foreclosed
asset as a non-recurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods.
The tables below present the recorded amount of assets measured at fair value on a nonrecurring basis at June 30, 2019 and December 31, 2018.
Quantitative Information about Level 3 Fair Value Measurements
Valuation Technique
Unobservable Input
Range
Nonrecurring measurements:
Impaired loans
1,994
Appraisal of collateral
Appraisal adjustments
0% - 17%
Liquidation expense
0% - 10%
4,105
Discounted cash flow analysis
Discount rate
4% - 7.25%
Other real estate owned
15% - 40%
5% - 10%
3,839
5,902
Fair value is generally determined through independent appraisals of the underlying collateral (impaired loans and OREO) or discounted cash flow analyses (impaired loans), which generally include various level III inputs which are not identifiable.
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
The carrying amounts and estimated fair values of the Company’s financial instruments not carried at fair value on the Company’s Consolidated Balance Sheets are presented in the following table. Fair values for June 30, 2019 and December 31, 2018 were estimated using an exit price notion.
Financial assets
Level 1 inputs
Level 2 inputs
Investment securities held to maturity
Level 3 inputs
1,222,190
1,150,418
Financial liabilities
Noninterest-bearing demand
Checking plus interest
232,123
239,809
Money market
239,942
232,613
Savings
142,497
148,723
Club
1,142
387
Brokered Deposits
19,998
19,997
22,084
22,075
Certificates of deposit, $100,000 or more
117,855
117,968
97,905
96,435
Other time
148,527
148,125
140,354
136,292
15,021
15,012
Note 13 – Financial Instruments with Off-Balance Sheet Risk
In the normal course of business, to meet the financial needs of its customers, the Bank is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Letters of credit and other commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the letters of credit and commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements.
The following table provides information on commitments outstanding at June 30, 2019 and December 31, 2018.
Commitments to extend credit
223,777
210,463
Letters of credit
5,967
6,917
229,744
217,380
Note 14 – Revenue Recognition
On January 1, 2018, the Company adopted ASU No. 2014-09 “Revenue from Contracts with Customers” (Topic 606) and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.
Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees and merchant income. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided.
Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or at the end of the month through a direct charge to customers’ accounts.
Trust and Investment Fee Income
Trust and investment fee income are primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end through a direct charge to customers’ accounts. The Company does not earn performance-based incentives.
Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered.
Other Noninterest Income
Other noninterest income consists of: fees, exchange, other service charges, safety deposit box rental fees, and other miscellaneous revenue streams. Fees and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The
Company determined that rentals and renewals of safe deposit boxes will be recognized on a monthly basis consistent with the duration of the performance obligation.
The following presents noninterest income from continuing operations, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and six months ended June 30, 2019 and 2018.
Noninterest Income
In-scope of Topic 606:
1,146
915
1,986
1,725
Noninterest Income (in-scope of Topic 606)
2,559
2,276
4,705
Noninterest Income (out-of-scope of Topic 606)
92
Total Noninterest Income
Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of June 30, 2019 and December 31, 2018, the Company did not have any significant contract balances.
Note 15 – Subsequent Events
On July 19, 2019, the Company entered into individual SERPs for the following Named Executive Officers: Lloyd L. Beatty, Jr. President and Chief Executive Officer, Edward C. Allen, Executive Vice President and Chief Financial Officer and Donna J. Stevens, Executive Vice President and Chief Operating Officer. Also, on this day the Bank purchased $14 million in BOLI which will be used to fund contributions to these SERPs in future years. These SERPs were created to replace the 2019 and 2020 Long-term Incentive Plans in which these officers forfeited their rights to receive shares of the Company’s common stock. More information and copies of these agreements were filed on July 25, 2019 in the form of a Current Report on 8-K and have been included as exhibits herein for reference.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Unless the context clearly suggests otherwise, references to “the Company”, “we”, “our”, and “us” in the remainder of this report are to Shore Bancshares, Inc. and its consolidated subsidiaries.
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. 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 our 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 we operate, inflation, fluctuations in interest rates, legislation, and governmental regulation. These risks and uncertainties are described in detail in the section of the periodic reports that Shore Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) entitled “Risk Factors” (see Item 1A of Part II of this report and Item 1A of Part I of the Annual Report of Shore Bancshares, Inc. on Form 10‑K for the year ended December 31, 2018 (the “2018 Annual Report”)). Actual results may differ materially from such forward-looking statements, and we assume no obligation to update forward-looking statements at any time except as required by law.
Introduction
The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited 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 2018 Annual Report.
Shore Bancshares, Inc. is the largest independent financial holding company headquartered on the Eastern Shore of Maryland. It is the parent company of Shore United Bank. The Bank operates 21 full service branches in Baltimore County, Howard County, Kent County, Queen Anne’s County, Talbot County, Caroline County and Dorchester County in Maryland, Kent County, Delaware and Accomack County, Virginia. The Company engages in the trust services business through the trust department at Shore United Bank under the trade name Wye Financial & Trust.
The shares of common stock of Shore Bancshares, Inc. are listed on the NASDAQ Global Select Market under the symbol “SHBI”.
Shore Bancshares, Inc. maintains an Internet site at www.shorebancshares.com on which it makes available free of charge its Annual Report on Form 10‑K, Quarterly Reports on Form 10‑Q, Current Reports on Form 8‑K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. 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. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility.
The fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices, collateral value or are provided by other third-party sources, when available.
The most significant accounting policies that the Company follows are presented in Note 1 of the 2018 Annual Report. These policies, along with the disclosures presented in the notes to the financial statements and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for credit losses, goodwill and other intangible assets, deferred tax assets, and fair value are critical accounting policies. These policies are considered critical because they relate to accounting areas that require the most subjective or complex judgments, and, as such, could be most subject to revision as new information becomes available.
The allowance for credit losses represents management’s estimate of credit losses inherent in the loan portfolio as of the balance sheet date. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheets. Note 1 of the 2018 Annual Report describes the methodology used to determine the allowance for credit losses. A discussion of the factors driving changes in the amount of the allowance for credit losses is included in the Asset Quality - Provision for Credit Losses and Risk Management section below.
Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability. Goodwill and other intangible assets are required to be recorded at fair value at inception. Determining fair value is subjective, requiring the use of estimates, assumptions and management judgment. Goodwill and other intangible assets with indefinite lives are tested at least annually for impairment, usually during the first quarter, or on an interim basis if circumstances dictate. Intangible assets that have finite lives are amortized over their estimated useful lives and also are subject to impairment testing. Impairment testing requires that the fair value of each of the Company’s reporting units be compared to the carrying amount of its net assets, including goodwill. At the present time the Company only has one reporting unit, the Bank. If the fair value of the Bank is less than book value, an expense may be required to write down the related goodwill or purchased intangibles to record an impairment loss.
Deferred tax assets and liabilities are determined by applying the applicable federal and state income tax rates to cumulative temporary differences. These temporary differences represent differences between financial statement carrying amounts and the corresponding tax bases of certain assets and liabilities. Deferred taxes result from such temporary differences. A valuation allowance, if needed, reduces deferred tax assets to the expected amount most likely to be realized. Realization of deferred tax assets is dependent on the generation of a sufficient level of future taxable income, recoverable taxes paid in prior years and tax planning strategies. The Company evaluates all positive and negative evidence before determining if a valuation allowance is deemed necessary regarding the realization of deferred tax assets.
The Company measures certain financial assets and liabilities at fair value, with the measurements made on a recurring or nonrecurring basis. Significant financial instruments measured at fair value on a recurring basis are investment securities. Impaired loans and other real estate owned are significant financial instruments measured at fair value on a nonrecurring basis. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In determining fair value, the Company is required to maximize the use of observable inputs and minimize the use of unobservable inputs, reducing subjectivity.
OVERVIEW
The Company reported net income of $4.2 million for the second quarter of 2019, or diluted income per common share of $0.33, compared to net income of $4.4 million, or diluted income per common share of $0.34, for the second quarter of 2018. For the first quarter of 2019, the Company reported net income of $3.8 million, or diluted income per common share of $0.29. Net income from continuing operations for the second quarter of 2019 was $4.2 million or $0.33 per diluted common share, compared to net income from continuing operations of $4.2 million or $0.33 per diluted common share for the second quarter of 2018, and net income from continuing operations of $3.9 million or $0.30 per diluted common share for the first quarter of 2019. When comparing net income from continuing operations for the second quarter of 2019 to the second quarter of 2018, the primary reasons for slightly improved results were an increase in noninterest income and a reduction in provision for credit losses, almost entirely offset by increases in interest expense and noninterest expense. When comparing net income from continuing operations for the second quarter of 2019 to the first quarter of 2019, the improved results were primarily attributable to increases in interest income and noninterest income as well as a reduction in noninterest expense, partially offset by higher interest expense and higher provision for credit losses.
For the first six months of 2019, the Company reported net income of $8.0 million, or diluted income per common share of $0.62, compared to net income of $8.4 million, or diluted income per common share of $0.66, for the first six months of 2018. Net income from continuing operations for the first six months of 2019 was $8.1 million, or 0.63 per diluted common share, compared to net income from continuing operations of $7.7 million or $0.60 per diluted common share for the first six months of 2018. When comparing net income from continuing operations for the first six months of 2019 to the first six months of 2018, the improved results were due to higher noninterest income coupled with a reduction to the provision for credit losses, partially offset by an increase in interest expense and noninterest expense.
RESULTS OF OPERATIONS
Net Interest Income
Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments. As shown in the table below, tax-equivalent net interest income was $12.3 million for the second quarter of 2019 and $12.6 million for the second quarter of 2018. Tax-equivalent net interest income was $12.4 million for the first quarter of 2019. The decrease in net interest income for the second quarter of 2019 when compared to the second quarter of 2018 and first quarter of 2019 was primarily due to an increase in interest expense, primarily interest on deposits of $1.6 million, or 280.0%, and $257 thousand, or 13.2%, respectively. These increases in interest expense for the second quarter of 2019 were partially offset by higher interest income and fees on loans when compared to the second quarter of 2018 and the first quarter of 2019 of $1.1 million, or 8.9%, and $257 thousand, or 1.9%, respectively. Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets. The net interest margin for the second quarter of 2019 was 3.54%, which is a decrease of 25 basis points (bps) when compared to 3.79% for the second quarter of 2018 and a decrease of 7bps when compared to the first quarter of 2019 of 3.61%.
Interest Income
On a tax-equivalent basis, interest income increased $1.1 million, or 7.9%, for the second quarter of 2019 when compared to the second quarter of 2018. The increase was due to a $1.1 million, or 8.9%, increase in interest income and fees on loans, primarily the result of the increase in the average balance of loans of $79.9 million, or 7.0%. The average yield on loans increased 8bps from the comparable quarter in 2018. Interest on interest-bearing deposits with other banks increased $52 thousand, or 85.2% due to increased average yield on these deposits of 65bps. Interest on investment securities decreased $95 thousand, or 9.7%, due to a decrease in the average balance of investment securities of $26.6 million, or 14.3% which was used to fund loan growth between the comparable quarters.
On a tax-equivalent basis, interest income increased $96 thousand, or 0.7%, for the second quarter of 2019 when compared to the first quarter of 2019. The increase was primarily due to an increase in interest income and fees on loans of $257 thousand, primarily the result of an increase in the average balance on loans of $19.3 million. Partially offsetting the increase in interest income and fees on loans, was reduced income on taxable investment securities and interest-bearing deposits with other banks of $111 thousand and $50 thousand, respectively. Both interest-bearing deposits with other
banks and taxable investment securities were impacted by lower average balances of $9.5 million and $5.1 million, with the addition of a decrease in the yield for taxable investment securities of 23bps.
Interest Expense
Interest expense increased $1.4 million, or 135.9%, when comparing the second quarter of 2019 to the second quarter of 2018. The increase in interest expense was due to an increase in the rates paid on interest-bearing deposits of 72bps, which equated to $1.6 million in additional interest expense. The addition of long-term borrowings resulted in additional interest expense of $107 thousand, partially offset by a decrease in the average balance of short-term borrowings of $70.4 million, or 76.6%. The average balance of interest-bearing deposits increased $54.7 million, or 6.5% which was a positive transition from higher rates paid on short-term borrowings and a more sustainable approach for funding long-term loan growth. The average balance of noninterest-bearing deposits increased $17.4 million, or 5.4% between the comparable quarters.
Interest expense increased $190 thousand, or 8.4%, when comparing the second quarter of 2019 to the first quarter of 2019. The increase in interest expense was due to an increase in the average balance of interest-bearing deposits of $9.7 million, or 1.1%, coupled with higher rates paid on these deposits of 10bps. This increase provided the opportunity for the Company to pay-down short-term borrowings resulting in a decrease in the average balance of $11.4 million, or 34.6%. The average balance of noninterest-bearing deposits increased $8.6 million, or 2.6% when compared to the first quarter of 2019.
38
The following tables presents the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended June 30, 2019 and 2018.
Income(1)/
Yield/
Expense
Rate
Earning assets
Loans (2), (3)
1,221,215
13,790
4.53
1,141,296
12,659
4.45
159,878
2.22
186,453
2.11
18,325
2.47
13,301
1.82
Total earning assets
1,399,418
14,790
4.24
1,341,050
13,702
4.10
17,225
16,905
61,906
78,185
(10,456)
(10,193)
Total assets
1,468,093
1,425,947
Interest-bearing liabilities
Demand deposits
234,775
382
0.65
204,068
108
0.21
Money market and savings deposits
385,272
803
0.84
381,047
0.13
20,866
131
2.52
10,684
1.96
Certificates of deposit $100,000 or more
107,549
413
1.54
96,873
129
0.54
Other time deposits
145,900
475
1.31
146,946
164
0.45
894,362
0.99
839,618
0.27
21,557
2.70
91,980
2.01
Long-term debt
2.86
Total interest-bearing liabilities
930,919
1.06
931,598
0.44
339,589
322,172
8,484
5,697
Stockholders’ equity
189,101
166,480
Total liabilities and stockholders’ equity
Net interest spread
12,334
3.18
12,661
3.66
Net interest margin
3.54
3.79
Tax-equivalent adjustment
All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%, exclusive of nondeductible interest expense.
Average loan balances include nonaccrual loans.
Interest income on loans includes amortized loan fees, net of costs, and accretion of discounts on acquired loans, which are included in the yield calculations.
Tax-equivalent net interest income decreased $256 thousand, or 1.0%, during the six months ended June 30, 2019 compared to the six months ended June 30, 2018. The decrease in net interest income was primarily due to an increase in interest expense on interest-bearing deposits of $3.0 million, or 268.0%, partially offset by an increase in interest income from earning assets of $2.7 million, or 9.9%. This resulted in a net interest margin of 3.57% for the six months ended June 30, 2019 compared to 3.80% for the six months ended June 30, 2018.
On a tax-equivalent basis, interest income increased $2.7 million, or 9.9%, for the six months ended June 30, 2019 when compared to the six months ended June 30, 2018. The increase was primarily due to a $2.6 million, or 10.5%, increase in interest income and fees on loans. The average balance on loans increased $87.8 million, or 7.8%, while the yield on these loans expanded 11bps. In addition, interest income from interest-bearing deposits with other banks increased $177
39
thousand, or 178.8%, primarily due to a 70bps increase in yield on these deposits. This was partially offset by a decrease in interest income on investment securities of $118 thousand, or 5.9%, primarily due to a decrease in the average balance in these investments of $29.4 million, or 15.3%, which was used to fund loan growth between the comparable periods.
Interest expense increased $2.9 million, or 160.2%, when comparing the six months ended June 30, 2019 to the six months ended June 30, 2018. The increase in interest expense was due to the increase in the average balance of interest-bearing deposits of $43.8 million, or 5.2%, and the average rate paid on these deposits of 67bps. This added $3.0 million in additional interest expense when comparing the first six months of 2019 to the first six months of 2018. The addition of long-term borrowings of $15.0 million was offset by a decrease in the average balance of short-term borrowings of $47.1 million which decreased the dependence on outside funding sources which carry a higher rate than core deposits.
The following tables presents the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the six months ended June 30, 2019 and 2018.
1,211,618
27,323
4.55
1,123,852
24,731
4.44
162,429
2.34
191,839
2.09
23,039
2.42
11,536
1.72
1,397,086
29,484
4.26
1,327,227
26,833
4.08
17,211
16,646
60,340
77,266
(10,423)
(10,081)
1,464,214
1,411,058
237,271
741
210,403
0.22
384,508
1,610
380,969
244
21,470
2.44
5,372
103,067
714
1.40
99,387
0.52
143,226
826
1.16
149,619
0.46
889,542
0.94
845,750
27,239
2.65
74,381
1.86
931,781
1.02
920,131
0.40
335,334
319,434
10,051
5,715
187,048
165,778
24,762
3.24
25,018
3.68
3.57
3.80
75
56
40
Total noninterest income from continuing operations for the second quarter of 2019 increased $313 thousand, or 13.6%, when compared to the second quarter of 2018. The increase from the second quarter of 2018 was mainly due to increases in other fees on bank services of $259 thousand, service charges on deposit accounts of $81 thousand, other loan fee income of $26 thousand and a change in the fair value of equity securities of $51 thousand, partially offset by a decrease in trust and investment fee income of $29 thousand. Noninterest income from continuing operations increased $421 thousand, or 19.2%, when compared to the first quarter of 2019 mainly due to other fees and bank services of $288 thousand, service charges on deposit accounts of $94 thousand, other loan fee income of $29 thousand and trust and investment fee income of $13 thousand. The increase in fee income in the second quarter of 2019 when compared to the second quarter of 2018 and the first quarter of 2019 was primarily due to certain one-time fees received in the second quarter of 2019 as a one-time occurrence.
Total noninterest income from continuing operations for the six months ended June 30, 2019 increased $361 thousand, or 8.1%, when compared to the same period in 2018. The increase in noninterest income primarily consists of increases in other fees on bank services of $311 thousand, service charges on deposit accounts of $110 thousand, other loan fee income of $40 thousand, and a change in the fair value of equity securities of $54 thousand, partially offset by a decrease in trust and investment income of $57 thousand.
Noninterest Expense
Total noninterest expense from continuing operations for the second quarter of 2019 increased $132 thousand, or 1.5%, when compared to the second quarter of 2018. The increase in noninterest expense for the second quarter of 2019 compared to the second quarter of 2018 was primarily due to higher expense related to data processing of $230 thousand, other real estate owned expense, net of $55 thousand, furniture and equipment expense of $48 thousand and legal and professional fees of $72 thousand, partially offset by a decrease in salaries and wages of $309 thousand. The higher data processing fees were the result of a new contract with our core service provider which occurred in the third quarter of 2018. The decrease in salaries and wages was due to the termination of the 2020 Long-term Incentive Plan and the absence of the former president of the Bank’s salary for an entire quarter. The decrease in total noninterest expenses from continuing operations when compared to the first quarter of 2019 was primarily due to lower employee benefit costs of $186 thousand and lower other real estate owned expense, net of $173 thousand.
Total noninterest expense from continuing operations for the six months ended June 30, 2019 increased $23 thousand, or 0.01%, when compared to the same period in 2018. Despite the minimal increase in total noninterest expenses from continuing operations, several expense line items experienced significant variances. The significant increases in noninterest expenses were the following: Other real estate owned expenses, net of $334 thousand, data processing fees of $272 thousand, legal and professional fees of $225 thousand, and employee benefits of $101 thousand. The significant decreases in noninterest expense were the following: Salaries and wages of $769 thousand, other noninterest expenses of $121 thousand and $64 thousand in directors’ fees.
Provision for Credit Losses
The provision for credit losses was $200 thousand for the second quarter of 2019, $418 thousand for the second quarter of 2018 and $100 thousand for the first quarter of 2019. The lower level of provision for credit losses when comparing the second quarter of 2019 to the second quarter of 2018 was due to lower loan growth in the second quarter of 2019. The higher level of provision for credit losses when comparing the second quarter of 2019 to the first quarter of 2019 was due to the absence of recoveries experienced in the first quarter of 2019 of $185 thousand. Net charge-offs were $313 thousand for the second quarter of 2019, $84 thousand for the second quarter of 2018 and $25 thousand for the first quarter of 2019. The increase in net charge-offs in the second quarter of 2019 when compared to the second quarter of 2018 and the first quarter of 2019, was primarily due to the sale of real estate securing specific loans at a foreclosure auction, which resulted in additional charge-offs during the second quarter of 2019. Total nonperforming assets at June 30, 2019 increased $5.4 million when compared to June 30, 2018, which was due to a nonaccrual loan added late in the fourth quarter of 2018, in which the Company does not anticipate any further losses. Total nonperforming assets when compared to the first quarter of 2019 decreased $891 thousand, the result of decreases in nonaccrual loans of $768 thousand and other real estate owned
of $455 thousand, partially offset by an increase in loans 90 days past due and still accruing of $392 thousand. The ratio of annualized net charge-offs to average loans was 0.10% for the second quarter of 2019, 0.03% for the second quarter of 2018 and 0.01% for the first quarter of 2019.
The provision for credit losses for the six months ended June 30, 2019 and 2018 was $300 thousand and $907 thousand, respectively, while net charge-offs were $338 thousand and $567 thousand, respectively. The decrease in provision for credit losses was the result of improved overall credit quality exclusive of one large nonaccrual loan with an outstanding loan balance of $7.5 million added late in the fourth quarter of 2018. Additionally, the decrease in provision for credit losses for the first six months of 2019 when compared to the first six months of 2018 was impacted by lower loan growth and lower net charge-offs in 2019. The ratio of annualized net charge-offs to average loans was 0.06% for the first six months of June 30, 2019 and 0.10% for the same period in 2018.
Income Taxes
The Company reported income tax expense from continuing operations of $1.5 million for the second quarter of 2019 and 2018 and $1.3 million for the first quarter of 2019. Income tax expense remained flat when compared to the second quarter of 2018 due to a minimal change in pre-tax earnings. Income tax expense increased $178 thousand when compared to the first quarter of 2019 due to improved pre-tax earnings for the Company. The effective tax rate on continuing operations was 26.0% for the second quarter of 2019, 25.9% for the second quarter of 2018 and 25.5% for the first quarter of 2019. Income taxes from continuing operations for the six months ended June 30, 2019 increased $268 thousand or 10.6%, due to an increase in net income.
ANALYSIS OF FINANCIAL CONDITION
Loans totaled $1.240 billion at June 30, 2019 and $1.195 billion at December 31, 2018, an increase of $44.9 million, or 3.8%. The increase was primarily due to organic growth of $36.1 million in commercial real estate loans, $6.6 million in construction loans and $1.1 million in commercial loans. Loans included deferred costs, net of deferred fees, of $1.2 million and discounts on acquired loans of $1.3 million at June 30, 2019, compared to $789 thousand and $1.4 million, respectively, at December 31, 2018. We do not engage in foreign or subprime lending activities. See Note 5, “Loans and Allowance for Credit Losses”, in the Notes to Consolidated Financial Statements and below under the caption “Allowance for Credit Losses” for additional information.
Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans. Construction loans were $134.1 million, or 10.8% of total loans, at June 30, 2019 and $127.6 million, or 10.7% of total loans at December 31, 2018. Commercial real estate loans were $559.6 million, or 45.1% of total loans, at June 30, 2019, compared to $523.4 million, or 43.8% of total loans, at December 31, 2018.
The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total non-owner occupied commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s non-owner occupied commercial real estate loan portfolio (including construction) has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years. At June 30, 2019, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 299.9% of total risk-based capital. At such time, construction, land and land development loans represented 84.2% of total risk-based capital.
The commercial real estate portfolio (including construction) has increased 99.4% during the prior 36 months. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, as well as strong underwriting criteria with respect to its commercial real estate portfolio. Monitoring practices include periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital or be required to sell/participate portions of loans, which may adversely affect shareholder returns.
Allowance for Credit Losses
We have established an allowance for credit losses, which is increased by provisions charged against earnings and recoveries of previously charged-off loans and is decreased by current period charge-offs of uncollectible loans. Management evaluates the adequacy of the allowance for credit losses at least quarterly and adjusts the provision for credit losses based on this analysis. The evaluation of the adequacy of the allowance for credit losses is based primarily on a risk rating system of individual loans, as well as on a collective evaluation of smaller balance homogenous loans, each grouped by loan type. Each loan type is assigned allowance factors based on criteria such as past credit loss experience, local economic and industry trends, and other measures which may impact collectability. Please refer to the discussion above under the caption “Critical Accounting Policies” for an overview of the underlying methodology management employs to maintain the allowance.
Net charge-offs were $313 thousand for the second quarter of 2019, $84 thousand for the second quarter of 2018 and $25 thousand for the first quarter of 2019. Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming loans to enable the Company to continue to improve its overall credit quality. The allowance for credit losses as a percentage of period-end loans was 0.83% at June 30, 2019, and 0.87% at June 30, 2018 and December 31, 2018. Management believes that the provision for credit losses and the resulting allowance was adequate to provide for probable losses inherent in our loan portfolio at June 30, 2019.
43
The following table presents a summary of the activity in the allowance for credit losses at or for the three and six months ended June 30, 2019 and 2018.
At or for Three Months Ended
At or for Six Months Ended
Allowance balance - beginning of period
Charge-offs:
Recoveries:
Totals
Allowance balance - end of period
Average loans outstanding during the period
Net charge-offs (annualized) as a percentage of average loans outstanding during the period
0.03
Allowance for credit losses at period end as a percentage of total period end loans
0.83
0.87
Nonperforming Assets and Accruing TDRs
As shown in the following table, nonperforming assets decreased $2.5 million to $15.6 million at June 30, 2019 from $18.0 million at December 31, 2018, primarily due to a decrease in nonaccrual loans of $2.1 million, or 12.4%. Accruing TDRs decreased $895 thousand to $7.8 million at June 30, 2019 from $8.7 million at December 31, 2018. Additionally, other real estate owned decreased $698 thousand, or 57.1% when compared to December 31, 2018. The decrease in nonaccrual loans was due to two residential relationships in which the collateral was sold by the borrower and the loans were subsequently paid off. One of these relationships required a charge-off of $123 thousand. The decrease in accruing TDRs was due to normal payments and one payoff of $197 thousand. The ratio of nonaccrual loans and accruing TDRs to total loans decreased to 1.80% at June 30, 2019 from 2.12% at December 31, 2018.
The Company continues to focus on the resolution of its nonperforming and problem assets. The efforts to accomplish this goal include frequently contacting borrowers until the delinquency is cured or until an acceptable payment plan has been agreed upon; obtaining updated appraisals; provisioning for credit losses; charging-off loans; transferring loans to other real estate owned; aggressively marketing other real estate owned. The reduction of nonperforming and problem assets is and will continue to be a high priority for the Company.
44
The following table summarizes our nonperforming assets and accruing TDRs at June 30, 2019 and December 31, 2018.
Nonperforming assets
Nonaccrual loans
Total nonaccrual loans
Loans 90 days or more past due and still accruing
Total loans 90 days or more past due and still accruing
Total nonperforming assets
15,555
18,016
Total accruing TDRs
Total nonperforming assets and accruing TDRs
23,323
As a percent of total loans:
1.18
1.39
0.72
Nonaccrual loans and accruing TDRs
1.80
2.12
As a percent of total loans and other real estate owned:
1.25
1.51
Nonperforming assets and accruing TDRs
1.88
2.23
As a percent of total assets:
0.98
1.12
1.04
1.21
0.58
1.56
Investment Securities
The investment portfolio is comprised of debt securities that are classified either available for sale or held to maturity. Investment securities available for sale are stated at estimated fair value based on quoted prices. They represent securities which may be sold as part of the asset/liability management strategy or in response to changing interest rates. Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income (loss), a separate component of stockholders’ equity.
Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts. We have the intent and current ability to hold such securities until maturity. At June 30, 2019, 96.1% of the portfolio was classified as available for sale and 3.9% as held to maturity, compared to 96.3% and 3.7% at December 31, 2018. With the exception of municipal securities, our general practice is to classify all newly-purchased debt securities as available for sale. See Note 4 - Investment Securities, in the Notes to Consolidated Financial Statements for additional details on the composition of our investment portfolio.
Investment securities including restricted stock totaled $157.7 million at June 30, 2019, a $10.5 million, or 6.2%, decrease since December 31, 2018. The decrease was due to the roll-off of investment securities, the proceeds of which were redeployed to fund loan growth during the first six months of 2019. At June 30, 2019, 76.6% of the securities available for sale were mortgage-backed and 23.4% were U.S. Government agencies, compared to 78.2% and 21.8%, respectively, at year-end 2018. Our investments in mortgage-backed securities are issued or guaranteed by U.S. Government agencies or government-sponsored agencies.
Deposits
Total deposits at June 30, 2019 totaled $1.2 billion, an increase of $36.7 million, or 3.0% when compared to the level at December 31, 2018. The increase in total deposits primarily consisted of increases in time deposits greater than $100 thousand of $20.0 million, noninterest-bearing deposits of $16.5 million, other time deposits of $8.9 million and savings and money market accounts of $1.1 million, partially offset by decreases in interest bearing checking deposits of $7.7 million and brokered deposits of $2.1 million. The Company has continued its efforts in 2019 to focus on growing core deposits as an alternative to short-term borrowings for funding loan growth.
Short-Term Borrowings
Short-term borrowings decreased by $35.3 million, or 58.1%, to $25.5 million at June 30, 2019 when compared to December 31, 2018. The decrease in short-term borrowings was the result of utilizing cash received from the sale of the Company’s former insurance subsidiary on December 31, 2018 as well as growth in core deposits. Short-term borrowings generally consist of securities sold under agreements to repurchase, which are issued in conjunction with cash management services for commercial depositors, overnight borrowings from correspondent banks and short-term advances from the Federal Home Loan Bank (the “FHLB”). Short-term advances are defined as those with original maturities of one year or less. At June 30, 2019 and December 31, 2018, short-term borrowings consisted of borrowings from the FHLB and repurchase agreements.
Long-Term Debt
The Company uses long-term borrowings to meet longer term liquidity needs, specifically to fund loan growth when liquidity from deposit growth is not sufficient. The Company had $15.0 million outstanding at June 30, 2019 and December 31, 2018. The $15.0 million in fixed rate long-term borrowings from the FHLB carries an interest rate of 2.82% and will mature in April 2020.
Liquidity and Capital Resources
We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets. As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $27.9 million for the first six months of 2019 compared to an increase of $11.7 million for the first six months of 2018. The increase in cash and cash equivalents in 2018 was mainly due to short-term borrowings.
To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets. The Bank has arrangements with other corresponding banks whereby it has $15 million available in federal funds lines of credit and a reverse repurchase agreement available to meet any short-term needs which may not otherwise be funded by the Bank’s portfolio of readily marketable investments that can be converted to cash. The Bank is also a member of the FHLB, which provides another source of liquidity. Through the FHLB, the Bank had credit availability of approximately $212.9 million and $154.7 million at June 30, 2019 and December 31, 2018, respectively. The Bank has
pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB. Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our future ability to maintain liquidity at satisfactory levels.
Total stockholders’ equity increased $8.1 million to $191.3 million at June 30, 2019 when compared to December 31, 2018 primarily due to current year’s earnings.
Basel III
Under final FRB and FDIC approved rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks minimum requirements increased for both the quantity and quality of capital held by the Company. The Basel III capital standards substantially revised the risk based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the definitions and the components of Tier 1 capital and Total Capital, the method of evaluating risk-weighted assets, institutions of a capital conservation buffer, and other matters affecting regulatory capital ratios. Strict eligibility criteria for regulatory capital instruments were also implemented under the rules.
The phase-in period for the final rules became effective for the Company on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, which was fully phased in on January 1, 2019. As of June 30, 2019, the Bank’s capital levels remained characterized as “well-capitalized” under the new rules
The following tables present the applicable capital ratios as of June 30, 2019 and December 31, 2018.
Tier 1
Common Equity
leverage
risk-based
ratio
capital ratio
Shore United Bank
10.29
12.11
12.98
9.79
11.84
12.73
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Our primary market risk is interest rate fluctuation and management has procedures in place to evaluate and mitigate this risk. This risk and these procedures are discussed in Item 7 of Part II of the 2018 Annual Report under the caption “Market Risk Management and Interest Sensitivity”. Management believes that there have been no material changes in our market risks, the procedures used to evaluate and mitigate these risks, or our actual and simulated sensitivity positions since December 31, 2018.
Item 4. Controls and Procedures.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that Shore Bancshares, Inc. files 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 Shore Bancshares, Inc.’s principal executive officer (“PEO”) and its 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, controls 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 and procedures as of June 30, 2019 was carried out under the supervision and with the participation of management, including the PEO and the PAO. Based on that evaluation, the Company’s management, including the PEO and the PAO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level at June 30, 2019.
There was no change in our internal control over financial reporting during the second quarter of 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
From time to time the Company may become involved in legal proceedings. At the present time, there are no proceedings which the Company believes will have a material adverse impact on the financial condition or earnings of the Company.
The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the 2018 Annual Report. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed in our 2018 Annual Report.
None.
None
Not Applicable
Item 6. Exhibits.
The exhibits filed or furnished with this quarterly report are shown on the Exhibit List that follows the signatures to this report, which list is incorporated herein by reference.
EXHIBIT INDEX
ExhibitNumber
Description
10.1
Supplemental Executive Retirement Plan for Lloyd L. Beatty, Jr. (Incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on July 25, 2019).
10.2
Supplemental Executive Retirement Plan for Edward C. Allen (Incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed on July 25, 2019).
10.3
Supplemental Executive Retirement Plan for Donna J. Stevens (Incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed on July 25, 2019).
31.1
Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).
31.2
Certifications of the Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).
Certification pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith).
101
Interactive Data File
101.INS
XBRL Instance Document (filed herewith)
101.SCH
XBRL Taxonomy Extension Schema (filed herewith)
101.CAL
XBRL Taxonomy Extension Calculation Linkbase (filed herewith)
101.DEF
XBRL Taxonomy Extension Definition Linkbase (filed herewith)
101.LAB
XBRL Taxonomy Extension Label Linkbase (filed herewith)
101.PRE
XBRL Taxonomy Extension Presentation Linkbase (filed herewith)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: August 9, 2019
By:
/s/ Lloyd L. Beatty, Jr.
Lloyd L. Beatty, Jr.
President & Chief Executive Officer
(Principal Executive Officer)
/s/ Edward C. Allen
Edward C. Allen
Executive Vice President & Chief Financial Officer
(Principal Accounting Officer)