What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-05-16 compared with 2021-11-15 · 166 added, 274 removed, 183 unchanged (71% of the section changed)

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In addition, we cannot assess the impact of each risk and uncertainty on our business or the extent to which any risk or uncertainty, or combination of risks and uncertainties, may cause actual results to differ materially from those contained in any forward-looking statements.

Further, given its ongoing and dynamic nature, it is difficult to predict the full impact of the novel coronavirus (“COVID-19”) outbreak on our business.

The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and how the economy may be fully reopened.

As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

the demand for our products and services may decline, making it difficult to grow assets and income;

if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;

collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

our allowance for loan losses may increase if borrowers experience financial difficulties, which will adversely affect our net income;

the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;

as the result of the decline in the Federal Reserve’s target federal funds rate to near 0%, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;

our cybersecurity risks are increased as the result of an increase in the number of employees working remotely;

and FDIC premiums may increase if the agency experiences additional resolution costs.

If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Quarterly Report on Form 10-Q and other reports and registration statements filed by us with the Securities and Exchange Commission (“SEC”).

For information on the factors that could cause actual results to differ from the expectations stated in the forward- looking statements, see “Risk Factors” under Part I, Item 1A of our 2020 Form 10-K and other reports as filed with the SEC.

For information on the factors that could cause actual results to differ from the expectations stated in the forward- looking statements, see “Risk Factors” under Part I, Item 1A of our 2021 Form 10-K and other reports filed by us with the SEC.

Any forward-looking statement speaks only as of the date of this report, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether because of new information, future developments or otherwise, except as required by law.

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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 22 full-service branches in Baltimore County, Howard County, Kent County, Queen Anne’s County, Talbot County, Caroline County, Dorchester County and Worcester County in Maryland, Kent County, Delaware and Accomack County, Virginia.

The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank.

As discussed in Note 15 to the consolidated financial statements, the Company recently completed its acquisition of Annapolis-based Severn Bancorp, Inc.

The acquisition of Severn will expand the Company’s footprint in the Annapolis and Anne Arundel County market areas, among others, and provide additional banking resources to our customers, including but not limited to, a robust secondary market mortgage banking line of business.

It is the parent company of Shore United Bank, N.A.

The Bank operates 29 full-service branches in Baltimore City, Baltimore County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County, Anne Arundel County and Worcester County in Maryland, Kent County, Delaware and in Accomack County, Virginia.

The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank, N.A.

The shares of common stock of Shore Bancshares, Inc.

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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.

COVID-19 Pandemic

The outbreak of COVID-19 has led to adverse impacts on economic conditions and created uncertainty in financial markets.

Correspondingly, in early March 2020, the Company began preparing for potential disruptions and government limitations of activity in the markets in which we serve.

Our team activated our Business Continuity Program and was able to quickly execute on multiple initiatives to adjust our operations to protect the health and safety of our employees and clients.

Since the beginning of the crisis, we have been in close contact with our clients, assessing the level of impact on their businesses, and providing relief programs according to each client’s specific situation and qualifications.

We have also enhanced awareness of digital banking offerings, expanded services at our drive through locations, and allowed customers to make appointments in the branch for critical services.

The Company’s branches remain open and have taken steps to comply with various government directives regarding “social distancing,” as well as, enhanced cleaning and disinfecting of all surface areas to protect its clients and employees.

Small Business Administration’s Paycheck Protection Program

We established our process for participating in the Small Business Administration’s Paycheck Protection Program (“PPP”) that enabled our clients to utilize this valuable resource beginning in April 2020.

Loans under the PPP are designed to provide assistance for small businesses during the COVID-19 pandemic to help meet the costs associated with payroll, mortgage interest, rent and utilities.

These loans are guaranteed by the SBA and forgiveness of the loans, by the SBA, is granted to the borrower if the borrower uses at least 60% of the funds to cover payroll costs and benefits.

Forgiveness is also based on the small business maintaining or quickly rehiring their employees and maintaining salary levels for their employees.

Loans under the PPP do not require any collateral or personal guarantees, as such, these loans are included in the Company’s commercial loans segment.

The first round of PPP lending resulted in 1,495 loans for $129.0 million, of which 1,447 loans have been forgiven or paid down in the amount of $125.9 million as of September 30, 2021.

The second round of PPP lending which began in 2021, resulted in 959 loans for $67.3 million, of which 597 loans have been forgiven or paid down in the amount of $28.9 million.

As of September 30, 2021, the Company had 410 PPP loans totaling $41.5 million that were outstanding, inclusive of loans issued during both the first and second rounds of the PPP.

This has allowed us to further strengthen and deepen our client relationships, while positively impacting thousands of individuals.

We are also closely monitoring the credit quality of the loan portfolio and monitor lines of credit draws for deviation from normal activity to improve loan performance and reduce credit risk.

Short-term Modifications for Borrowers

In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and the Consolidated Appropriations Act of 2021 (“CAA”), the Company is providing modifications where appropriate, including interest only payments or payment deferrals for clients that could be adversely affected by the COVID-19 pandemic.

Section 4013 of the CARES Act and CAA addressed COVID-19 related modifications and specified that such modifications made on loans that were current as of December 31, 2019 are not TDRs.

In accordance with interagency guidance issued in April 2020 and December 2020, short-term modifications made to borrowers affected by the COVID-19 pandemic and governmental shutdown orders, such as payment deferrals, fee waivers and extensions of repayment terms, do not need to be identified as TDRs if the loans were current at the time a modification plan was implemented.

Since the beginning of the pandemic and through September 30, 2021, the Company had executed principal and/or interest deferrals on outstanding loan balances of $221.1 million.

As of September 30, 2021, the Company had no COVID related loan deferrals remaining.

We are vigilantly monitoring our liquidity position on an ongoing basis.

The Company has several available sources of on and off-balance sheet liquidity.

Currently, the Company has not needed to tap into these available liquidity sources due to payment deferrals by customers, funding of PPP loans, or organic loan growth.

Additional discussion on our liquidity as of the report date is reflected in the “Liquidity and Capital Resources” section of management’s discussion and analysis.

Share Repurchases

The Company currently has a share repurchase program, in which $542 thousand remains available until expirations on December 31, 2021.

The Board of directors and management will re-evaluate the need for an additional stock repurchase program based on the market price of the Company’s stock, capital position, and necessary regulatory approvals.

Dividends and Capital

We currently expect to maintain our quarterly cash dividend based on our strong capital position.

At September 30, 2021, the Bank exceeded all the capital requirements to which it was subject, and based on the most recent notification from its primary federal regulator is considered to be well-capitalized.

There are no conditions or events since that notification that management believes would change the Bank’s classification.

We are closely monitoring our capital position and are taking appropriate steps to ensure our level of capital remains strong.

Our capital, while significant, may deteriorate in future periods due to the impact of the pandemic and limit our ability to pay dividends.

Critical Accounting Policies

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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 and goodwill are critical accounting policies.

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 loans acquired in a business combination, allowance for credit losses and goodwill 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.

Loans Acquired in a Business Combination

Acquired loans are classified as either (i) purchase credit-impaired (“PCI”) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition.

PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments.

When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status.

The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.

On a quarterly basis, we evaluate our estimate of cash flows expected to be collected on PCI loans.

Estimates of cash flows for PCI loans require significant judgment.

Subsequent decreases to the expected cash flows will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses.

Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for loan losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan, or pool(s) of loans.

Disposals of loans, which may include sale of loans to third parties, receipt of payments in full or in part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.

PCI loans are not classified as nonperforming by the Company at the time they are acquired, regardless of whether they had been classified as nonperforming by the previous holder of such loans, and they will not be classified as nonperforming so long as, at quarterly re-estimation periods, we believe we will fully collect the new carrying value of the pools of loans.

The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows.

Purchased performing loans are recorded at fair value, including a credit discount.

The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans.

There is no allowance for loan losses established at the acquisition date for purchased performing loans.

A provision for loan losses may be required for any deterioration in these loans in future periods.

Allowance for Credit Losses

The allowance for credit losses represents management’s estimate of credit losses inherent in the loan portfolio as of the balance sheet date.

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If the fair value of a reporting unit is less than book value, an expense may be required to write down the related goodwill to record an impairment loss.

As of September 30, 2021, the Company had only one banking reporting unit.

As previously noted, the Company acquired Severn Bancorp, Inc.

during the 4 th quarter of 2021.

The Company’s 2021 Annual Report on Form 10-K will also include the critical accounting policies related to its acquisition of Severn.

The Company reported net income of $4.6 million for the third quarter of 2021, or diluted income per common share of $0.39, compared to net income of $3.4 million, or diluted income per common share of $0.27, for the third quarter of 2020.

For the second quarter of 2021, the Company reported net income of $4.0 million, or diluted income per common share of $0.34.

When comparing net income for the third quarter of 2021 to the third quarter of 2020, net income increased $1.2 million, primarily due to increases in net interest income of $2.3 million and noninterest income of $328 thousand, combined with a lower provision for credit losses of $1.2 million.

These improvements to net income were partially offset by an increase in almost all expense line items, adding $2.1 million to noninterest expense.

When comparing the third quarter of 2021 to the second quarter of 2021, the net income increased $586 thousand, due to an increase in net interest income of $1.5 million and lower provision for credit losses of $360 thousand, which was partially offset by an increase in noninterest expense of $1.1 million.

In addition, merger-related expenses were recorded for the second and third quarters of 2021 of $377 thousand and $538 thousand, respectively.

For the first nine months of 2021, the Company reported net income of $12.6 million, or diluted income per common share of $1.08, compared to net income of $11.8 million, or diluted income per common share of $0.95, for the first nine months of 2020.

When comparing net income for the first nine months of 2021 to the first nine months of 2020, net income increased $801 thousand, primarily due to increases in net interest income of $4.7 million and noninterest income of $667 thousand, combined with a lower provision for credit losses of $1.5 million.

These improvements to net income were partially offset by an increase in almost all expense line items, adding $5.5 million to noninterest expense.

In addition, total merger-related expenses for the first nine months were $915 thousand.

As of March 31, 2022, the Company had a banking and mortgage reporting unit.

The Company reported net income of $5.6 million for the first quarter of 2022, or diluted income per common share of $0.28, compared to net income of $4.0 million, or diluted income per common share of $0.34, for the first quarter of 2021.

For the fourth quarter of 2021, the Company reported net income of $2.7 million, or diluted income per common share of $0.16.

Net income, excluding merger related expenses, for the first quarter of 2022 was $6.2 million or $0.31 per diluted common share, compared to net income, excluding merger related expenses, of $7.9 million or $0.46 per diluted common share for the fourth quarter of 2021.

When comparing net income, excluding merger related expenses, for the first quarter of 2022 to the first quarter of 2021, net income increased $2.4 million, primarily due to increases in net interest income of $8.6 million and noninterest income of $3.5 million, partially offset by an increase in noninterest expenses of $9.1 million.

When comparing the first quarter of 2022 to the fourth quarter of 2021, net income, excluding merger related expenses, decreased $1.8 million, due to increases in noninterest expenses of $3.7 million and the cumulative impact of a reversal of the provision for credit losses of $1.7 million in the fourth quarter of 2021 and a provision of $600 thousand in the first quarter of 2022, partially offset by increases in net interest income of $1.8 million and noninterest income of $917 thousand.

Merger-related expenses were recorded for the first quarter of 2022 and the fourth quarter of 2021 of $730 thousand and $7.6 million, respectively.

RESULTS OF OPERATIONS

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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 $15.6 million for the third quarter

of 2021 and $13.3 million for the third quarter of 2020.

Tax-equivalent net interest income was $14.1 million for the second quarter of 2021.

The increase in net interest income when comparing the third quarter of 2021 to the third quarter of 2020 and the second quarter of 2021, was the result of higher interest and fees on loans and income from taxable investment securities, coupled with a decrease in interest expense.

As shown in the table below, tax-equivalent net interest income was $22.5 million for the first quarter of 2022 and $13.8 million for the first quarter of 2021.

Tax-equivalent net interest income was $20.7 million for the fourth quarter of 2021.

The increase in net interest income when comparing the first quarter of 2022 to the first quarter of 2021 and the fourth quarter of 2021, was due to increases in interest and fees on loans and income from taxable investment securities, partially offset by increases in interest expense on interest-bearing deposits and subordinated debt primarily due to the acquisition of Severn.

Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets.

The net interest margin for the third quarter of 2021 was 2.99%, which was a decrease of 18bps when compared to 3.17% for the third quarter of 2020 and an increase of 8bps when compared to 2.91% for the second quarter of 2021.

The decline in net interest margin in the third quarter of 2021 when compared to the third quarter of 2020, was significantly impacted by excess liquidity and the decrease in yields of taxable investment securities.

The increase in net interest margin when compared to the second quarter of 2021, was primarily due to improvement in the yields on earning assets, specifically loans of 14bps, and the continued decrease in rates paid on interest-bearing deposits.

Without excess liquidity of $200 million, the margin for the third quarter of 2021 would have been 3.31%.

The net interest margin for the first quarter of 2022 was 2.78%, which was a decrease of 22bps when compared to 3.00% for the first quarter of 2021 and a decrease of 9bps when compared to 2.87% for the fourth quarter of 2021.

The decline in net interest margin in the first quarter of 2022 when compared to the first quarter of 2021 was significantly impacted by excess liquidity and higher average balances on lower yielding assets, coupled with additional

borrowings resulting from the Severn acquisition.

The decline in net interest margin when compared to the fourth quarter of 2021, was primarily due to a decline in the yields of loans due to lower accretion income and organic loan growth experienced late in the first quarter of 2022.

Without estimated excess liquidity of $400 million, the margin for the first quarter of 2022 would have been 3.07%.

Interest Income

On a tax-equivalent basis, interest income increased $2.0 million, or 13.4%, for the third quarter of 2021 when compared to the third quarter of 2020.

The increase was the result of higher interest and fees on loans and income from investment securities.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $80.6 million and a higher average yield of 13bps, partially impacted by PPP forgiveness in the third quarter of 2021.

The average balance of investment securities increased $198.2 million, providing $588 thousand of additional income, despite a decrease in the average yield of 56bps.

On a tax-equivalent basis, interest income increased $1.4 million, or 8.8%, for the third quarter of 2021 when compared to the second quarter of 2021.

The increase was primarily a result of growth in the average balance in loans of $42.6 million and a higher average yield of 14bps, partially impacted by PPP forgiveness in the third quarter of 2021.

In addition, taxable investment securities were purchased during the third quarter of 2021, resulting in a higher average balance in these securities of $48.1 million and improvement in the average yield of 5bps, which provided $224 thousand of additional income.

On a tax-equivalent basis, interest income increased $9.0 million, or 58.4%, for the first quarter of 2022 when compared to the first quarter of 2021.

The improvement to interest income was the result of increases in interest and fees on loans, income from investment securities and higher rates paid on interest-bearing deposits with other banks.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $684.9 million, coupled with a higher average yield of 17bps, partially impacted by PPP forgiveness and accretion income from the acquired loan portfolio of Severn in the first quarter of 2022.

The average balance of taxable investment securities increased $303.2 million, providing $1.1 million of additional income, despite a decrease in the average yield of 14bps.

On a tax-equivalent basis, interest income increased $1.9 million, or 8.6%, for the first quarter of 2022 when compared to the fourth quarter of 2021.

The increase was primarily a result of growth in the average balance in loans of $248.6 million, or 13.2%.

In addition, the average balance of taxable investment securities increased $62.3 million and the average yield increased 7bps, which provided $322 thousand of additional income.

Interest Expense

Interest expense decreased $309 thousand, or 19.0%, when comparing the third quarter of 2021 to the third quarter of 2020.

The decrease in interest expense from the third quarter of 2020 was a result of the decrease in the average rate paid on interest-bearing deposits of 27bps.

This decrease in interest expense was partially offset by the issuance of subordinated debt late in the third quarter of 2020 which added $211 thousand of additional expense for the third quarter of 2021 when compared to the third quarter of 2020.

Interest expense decreased $116 thousand, or 8.1%, when comparing the third quarter of 2021 to the second quarter of 2021.

The decrease in interest expense on deposits was due to a 6bps decline in the average rate paid on interest-bearing deposits, specifically time deposits.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended September 30, 2021 and 2020.

Interest expense increased $350 thousand, or 22.7%, when comparing the first quarter of 2022 to the first quarter of 2021.

The increase in interest expense from the first quarter of 2021 was the result of increases in expenses on interest-bearing deposits of $174 thousand and both long-term advances from FHLB and subordinated debt for a combined $175 thousand.

Interest expense increased $137 thousand, or 7.8%, when comparing the first quarter of 2022 to the fourth quarter of 2021 primarily due to an increase in interest expense on deposits.

The increase in interest expense on deposits was due to an increase in the average balance of interest-bearing deposits of $284.4 million, or 15.4%, the result of both a full quarter of deposits acquired from Severn and $93.3 million in organic deposit growth during the first quarter of 2022.

The rates paid on interest-bearing deposits decreased slightly to 26bps in the first quarter of 2022 from 27 bps in the fourth quarter of 2021, maintaining a low cost of funds on core deposits.

In addition, the increase in interest expense was impacted by a full quarter of additional long-term advances from the FHLB and, junior subordinated debt acquired from Severn.

For Three Months Ended

September 30, 2021

September 30, 2020

March 31, 2022

March 31, 2021

(Dollars in thousands)

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(4) Interest income on loans includes accreted loan fees, net of costs and accretion of discounts on acquired loans, which are included in the yield calculations.

Net Interest Income

Tax-equivalent net interest income increased $4.7 million, or 12.0%, during the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.

The higher net interest income was due to an increase in interest income of $3.6 million, or 8.1% and a decrease in interest expense on interest-bearing deposits of $1.9 million, or 20.0%.

Despite the improved results, compression in the margin was due to lower yields on total earning assets.

This resulted in a net interest margin of 2.97% for the nine months ended September 30, 2021 compared to 3.35% for the nine months ended September 30, 2020.

Interest Income

On a tax-equivalent basis, interest income increased $3.6 million, or 8.1%, for the nine months ended September 30, 2021 when compared to the nine months ended September 30, 2020.

The increase was primarily due to higher interest and fees

on loans of $2.4 million, or 5.6% and taxable investment securities of $1.3 million, or 60.2%.

The increase in interest and fees on loans was due to a higher average balance of loans of $112.7 million, or 8.4%, which included forgiveness on PPP loans in 2021.

The increase in interest on taxable investment securities was due to a higher average balance in these securities of $158.6 million, or 127.4%, despite the decline in the average yield of such securities of 66bps.

Interest Expense

Interest expense decreased $1.1 million, or 20.0%, when comparing the nine months ended September 30, 2021 to the nine months ended September 30, 2020.

The decrease in interest expense was due to a decline in the rates paid on interest-bearing deposits of 33bps and the elimination of long-term advances from FHLB.

These improvements were partially offset by the addition of subordinated debt, issued in the third quarter of 2020, which added $940 thousand in interest expense when compared to the first nine months of 2020.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the nine months ended September 30, 2021 and 2020.

For Nine Months Ended

September 30, 2021

September 30, 2020

(Dollars in thousands)

Earning assets

Loans (2), (3)

Investment securities:

Interest-bearing deposits

Total earning assets

Cash and due from banks

Allowance for credit losses

Interest-bearing liabilities

Demand deposits

Money market and savings deposits

Certificates of deposit $100,000 or more

Other time deposits

Interest-bearing deposits

Securities sold under retail repurchase agreements and federal funds purchased

Advances from FHLB - long-term

Subordinated debt

Total interest-bearing liabilities

Noninterest-bearing deposits

Other liabilities

Stockholders’ equity

Total liabilities and stockholders’ equity

Net interest spread

Net interest margin

Tax-equivalent adjustment

(1) 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.

(2) Average loan balances include nonaccrual loans.

(3) Interest income on loans includes accreted loan fees, net of costs and accretion of discounts on acquired loans, which are included in the yield calculations.

Noninterest Income

Total noninterest income for the third quarter of 2021 increased $328 thousand, or 12.7%, when compared to the third quarter of 2020.

The increase from the third quarter of 2020 included all lines of business, but predominately service charges on deposit accounts, trust and investment fee income and other debit card interchange fees.

Noninterest income increased $6 thousand, or less than 1%, when compared to the second quarter of 2021 primarily due to higher service charges on deposit accounts, almost entirely offset by the absence of a debit card incentive received in the second quarter of 2021.

Total noninterest income for the nine months ended September 30, 2021, increased $667 thousand, or 8.7%, when compared to the same period in 2020.

The increase in noninterest income primarily consisted of higher trust and investment fee income, deposit related fees and service charges on other bank services, partially off-set by lower gains on securities year over year.

The increase in deposit related fees and other bank service charges has been impacted by the growth in

new accounts and balances of deposits, as well as a return to a more normalized local economy and consumer demand for products and services in 2021.

Total noninterest income for the first quarter of 2022 increased $3.5 million, or 136.4%, when compared to the first quarter of 2021.

The increase from the first quarter of 2021 was across all noninterest income categories but was primarily due to the expenses related to the addition of the mortgage division of $1.9 million, service charges on deposit accounts of $685 thousand, additional rental fee income of $345 thousand and Mid-Maryland Title Company revenue of $323 thousand.

Noninterest income increased $917 thousand, or 17.9%, when compared to the fourth quarter of 2021 primarily due to higher revenue from the mortgage division of $919 thousand, increase in service charges on deposits of $125 thousand, and higher revenue from the Mid-Maryland Title Company of $75 thousand, partially offset by a reduction in other noninterest income primarily related to higher expenses related to retirement funding costs as well as lower other loan fee income.

Noninterest Expense

Total noninterest expense for the third quarter of 2021 increased $2.1 million, or 21.4%, when compared to the third quarter of 2020 and increased $1.1 million, or 9.7%, when compared to the second quarter of 2021.

The increase in noninterest expense when compared to both the third quarter of 2020 and second quarter of 2021 was primarily driven by salary and wages being deferred in the third quarter of 2020 and the second quarter of 2021, the result of originating first and second round PPP loans, combined with additional accruals related to incentive payouts and bonuses for employees.

In addition, increases in employee benefits, furniture and fixtures, and FDIC insurance contributed to the higher expense base in the third quarter of 2021.

Employee benefits increased due to higher supplemental executive retirement plan costs in the third quarter of 2021, while furniture and fixtures increased due to renovations of an existing bank branch.

FDIC insurance premiums have increased due to the growth in deposit accounts in 2021.

Merger-related expenses due to the acquisition of Severn remained a significant variance when comparing the comparative third quarters of 2021 and 2020.

Total noninterest expense for the nine months ended September 30, 2021, increased $5.5 million, or 19.6%, when compared to the same period in 2020.

The increase was mainly the result of the absence of the deferral in salaries and wages due to PPP loan originations in 2020, accruals related to incentive payouts and bonuses, higher data processing costs, FDIC insurance premiums and occupancy costs.

The higher occupancy costs are associated with a new branch lease in Ocean City, Maryland which will open in 2022.

In addition, the Company recorded merger-related expenses of $915 thousand for the first nine months of 2021 due to the acquisition of Severn.

Total noninterest expense, excluding merger-related expenses, for the first quarter of 2022 increased $9.1 million, or 86.7%, when compared to the first quarter of 2021 and increased $3.7 million, or 15.8%, when compared to the fourth quarter of 2021.

The increase in noninterest expense when compared to both the first quarter of 2021 and fourth quarter of 2021 was primarily due to increases in salaries and wages, employee related benefits, occupancy expense, data processing, amortization of intangible assets and legal and professional fees, which were all significantly impacted by adding Severn branches and its operations for a full quarter in 2022.In addition, salaries and wages were impacted by incentive increases which took effect in January of 2022.

Provision for Credit Losses

The provision for credit losses was $290 thousand for the third quarter of 2021, $1.5 million for the third quarter of 2020 and $650 thousand for the second quarter of 2021.

The ratio of the allowance for credit losses to period-end loans was 1.04% at September 30, 2021, 0.95% at December 31, 2020 and 1.02% at June 30, 2021.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% at September 30, 2021, higher than the 1.04% at December 31, 2020 and slightly lower than the 1.09% at June 30, 2021.

The primary driver of the increased percentage of the allowance to total loans, excluding PPP loans, as compared to December 31, 2020, was significant loan originations within segments of the portfolio which carry higher reserves.

The decrease in the percentage of the allowance to total loans, excluding PPP loans, as compared to June 30, 2021, was due slightly reduced pandemic qualitative factors within the allowance model.

The Company reported net recoveries in the third quarter of 2021 of $147 thousand, compared to net recoveries of $187 thousand for the third quarter of 2020 and net recoveries of $125 thousand for the second quarter of 2021.

The provision for credit losses for the nine months ended September 30, 2021, and 2020 was $1.4 million and $2.9 million, respectively, while net recoveries were $272 thousand and net charge-offs were $580 thousand, respectively.

The decrease in the provision for credit losses was the result of lower charge-offs in 2021, overall improved credit quality and a slight reduction in pandemic related qualitative factors.

The ratio of allowance to total loans increased from 0.95% at December 31, 2020, to 1.04% at September 30, 2021.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% at September 30, 2021, higher than the 1.04% at December 31, 2020.

The primary drivers for the increase in the percentage of allowance for credit losses to total loans were significant originations within the construction and consumer loan portfolios, which require a higher level of allowance than certain other segments of the portfolio.

The ratio of annualized net recoveries to average loans was 0.07% for the first nine months of 2021, compared to annualized net charge-offs of 0.06% for the first nine months of 2020.

Management will continue to evaluate the adequacy of the allowance for credit losses as more economic data becomes available and as changes within the Company’s portfolio are known.

The Company reported income tax expense of $1.7 million for the third quarter of 2021, $1.1 million for the third quarter of 2020 and $1.4 million for the second quarter of 2021.

Income tax expense increased when compared to both the third

quarter of 2020 and second quarter of 2021 due to higher pre-tax earnings.

The effective tax rate for the second and third quarters of 2021 was 26.4% and was 25.2% for the third quarter of 2020.

Income tax expense for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020, increased $544 thousand due to higher pre-tax earnings.

The effective tax rate at September 30, 2021 and September 30, 2020 were 26.4% and 25.2%, respectively.

The provision for credit losses was $600 thousand for the first quarter of 2022, $425 thousand for the first quarter of 2021 and $(1.7) million for the fourth quarter of 2021.

The ratio of the allowance for credit losses to period-end loans was 0.67% at March 31, 2022, 0.66% at December 31, 2021 and 0.98% at March 30, 2021.

Excluding PPP loans and acquired loans, the ratio of the allowance for credit losses to period-end loans was 0.92% at March 31, 2022, slightly lower than the 0.93% at December 31, 2021 and lower than the 1.11% at March 31, 2021.

The primary driver of the decreased percentage of the allowance to total loans, excluding PPP loans, as compared to December 31, 2021, was due to further reduced pandemic qualitative factors.

The decrease in the percentage of the allowance to total loans, excluding PPP loans, as compared to March 31, 2021, was also primarily attributed to the Company’s reduction of pandemic related qualitative factors within the allowance model.

The Company reported net recoveries in the first quarter of 2022 of $166 thousand, compared to no net charge offs or recoveries for the first quarter of 2021 and net recoveries of $142 thousand for the fourth quarter of 2021.

Management continually evaluates the adequacy of the allowance for credit losses as changes in the environment and within the portfolio become known.

The Company reported income tax expense of $1.9 million for the first quarter of 2022, $1.4 million for the first quarter of 2021 and $1.3 million for the fourth quarter of 2021.

Income tax expense increased when compared to both the first quarter of 2021 and fourth quarter of 2021 due to higher pre-tax earnings.

The effective tax rate for the first quarter of 2022 was 25.6%, 31.8% for the fourth quarter of 2021, and 26.4% for the first quarter of 2021.

The higher tax rate in the fourth quarter of 2021 was attributed to non-deductible merger-related expenses in the quarter.

ANALYSIS OF FINANCIAL CONDITION

Loans totaled $1.495 billion at September 30, 2021 and $1.454 billion at December 31, 2020, an increase of $40.6 million, or 2.8%.

Excluding PPP loans, the increase in total loans was $121.9 million, or 9.2%, due to significant loan growth late in the second and third quarters of 2021.

The increase in loans, excluding PPP loans, was comprised of increases in consumer loans of $62.8 million, or 199.7%, construction loans of $23.8 million, or 22.3%, residential real estate loans of $17.3 million, or 3.9%, commercial loans of $15.2 million, or 7.2%, and commercial real estate loans of $2.7 million, or less than 1%.

Construction loans included deferred fees, net of deferred costs, of $376 thousand and discounts on acquired loans of $577 thousand at September 30, 2021, compared to deferred costs, net of deferred fees, of $622 thousand and discounts on acquired loans of $754 thousand at December 31, 2020.

Outstanding PPP loans totaled $41.5 million at September 30, 2021 and $122.8 million at December 31, 2020, a decrease of $81.3 million or 66.2%.

Loans Held for Sale

We originate residential mortgage loans for sale on the secondary market, which we have elected to carry at fair value.

At March 31, 2022 and December 31, 2021, the fair value of loans held for sale amounted to $12.9 million and $37.7 million, respectively.

When we sell mortgage loans we make certain representations to the purchaser related to loan ownership, loan compliance and legality, and accurate documentation, among other things.

If a loan is found to be out of compliance with any of the representations subsequent to the date of purchase, we may be required to repurchase the loan or indemnify the purchaser.

Loans Held for Investment

The following tables represent the composition of the Company’s loan portfolio at March 31, 2022 and December 31, 2021.

March 31, 2022

Loans acquired from

(Dollars in thousands)

Severn acquisition

Residential real estate

Commercial real estate

Total loans excluding PPP loans

Allowance for credit losses

Total loans, net

December 31, 2021

Loans acquired from

(Dollars in thousands)

Severn acquisition

Residential real estate

Commercial real estate

Total loans excluding PPP loans

Allowance for credit losses

Total loans, net

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $506.5 million in total loans remained outstanding as of March 31, 2022.

Excluding these loans and legacy PPP loans, total legacy loans increased $111.9 million, or 7.2%, when compared to December 31, 2021.

At March 31, 2022 and December 31, 2021, PPP loans accounted for $14.9 million and $18.4 million of total loans, respectively.

Most of our loans, excluding PPP loans, are secured by real estate and are classified as construction, residential or commercial real estate loans.

The increase in legacy loans, excluding PPP loans, was comprised of increases in consumer loans of $38.3 million, or 30.7%, construction loans of $34.1 million, or 23.5%, commercial real estate loans of $37.8 million, or 5.6%, residential real estate loans of $14.5 million, or 3.1%, partially offset by a decrease in commercial loans of $12.9 million, or 10.0%, at March 31, 2022 compared to December 31, 2021.

At March 31, 2022, the legacy loan portfolio, excluding PPP loans, was comprised of 43.2% commercial real estate, 29.2% residential real estate, 10.8% construction, 9.8% consumer and 7.0% commercial.

That compares to 43.9%, 30.4%, 9.4%, 8.0% and 8.3, respectively, at December 31, 2021.

Outstanding PPP loans totaled $14.9 million at March 31, 2022 and $27.6 million at December 31, 2021, a decrease of $12.7 million or 45.9%.

The decrease was primarily due to forgiveness on first and second round PPP loans originated in 2020 and 2021.

2 unchanged sentences

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 $130.6 million, or 8.7% of total loans, at September 30, 2021 and $106.8 million, or 7.3% of total loans, at December 31, 2020.

Commercial real estate loans were $663.9 million, or 44.4% of total loans, at September 30, 2021, compared to $661.2 million, or 45.5% of total loans, at December 31, 2020.

Construction loans were $258.2 million, or 11.8% of total loans, at March 31, 2022 and $239.4 million, or 11.3% of total loans, at December 31, 2021.

Commercial real estate loans were $928.1 million, or 42.6% of total loans, at March 31, 2022, compared to $896.2 million, or 42.3% of total loans, at December 31, 2021.

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending.

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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 September 30, 2021, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 301.6% of total risk-based capital.

At March 31, 2022, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 291.4% of total risk-based capital.

At such time, construction, land and land development loans represented 79.1% of total risk-based capital.

9 unchanged sentences

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.

The allowance for credit losses was $15.5 million at September 30, 2021, $13.9 million at December 31, 2020 and $15.1 million at June 30, 2021.

There were net recoveries of $147 thousand for the third quarter of 2021, compared to net recoveries of $61 thousand for the fourth quarter of 2020 and net recoveries of $125 thousand for the second quarter of 2021.

The ratio of annualized net recoveries to average loans was 0.04% for the third quarter of 2021, compared to annualized net recoveries of 0.02% for the fourth quarter of 2020 and 0.03% for the second quarter of 2021.

The allowance for credit losses was $14.7 million at March 31, 2022, $13.9 million at December 31, 2021 and $14.3 million at March 31, 2021.

There were net recoveries of $166 thousand for the first quarter of 2022, compared to net recoveries of $142 thousand for the fourth quarter of 2021 and no net charge offs or recoveries for the first quarter of 2021.

The ratio of annualized net recoveries to average loans was 0.03% for the first quarter of 2022, compared to annualized net recoveries of 0.03% for the fourth quarter of 2021 and 0.00% for the first quarter of 2021.

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 1.04% at September 30, 2021 and 0.95% at December 31, 2020.

Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans as 1.07% at September 30, 2021, higher than the 1.04% at December 31, 2020.

The increase in the percentage of the allowance to total loans at September 30, 2021, compared to December 31, 2020, was primarily due to significant loan growth in the second and third quarters of 2021 as previously discussed.

Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at September 30, 2021.

The following tables present a summary of the activity in the allowance for credit losses at or for the three and nine months ended September 30, 2021 and 2020.

For the Three Months Ended September 30,

The allowance for credit losses as a percentage of period-end loans was 0.67% at March 31, 2022 and 0.66% at December 31, 2021.

Excluding PPP loans and acquired loans from Severn and Northwest, the ratio of the allowance for credit losses to period-end loans was 0.92% at March 31, 2022, slightly lower than the 0.93% at December 31, 2021.

The decrease in the percentage of the allowance to total loans, excluding PPP loans and acquired loans, at March 31, 2022 compared to December 31, 2021, was primarily due to the reduction of pandemic

related qualitative factors.

Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at March 31, 2022.

The following table presents a summary of the activity in the allowance for credit losses at or for the three months ended March 31, 2022 and 2021.

For the Three Months Ended

March 31, 2022

March 31, 2021

Percentage of net

9 unchanged sentences

(Dollars in thousands)

Average balances

during the year

Average balances

during the year

3 unchanged sentences

Allowance for credit losses at period end as a percentage of total period end loans (1)

Allowance for credit losses at period end as a percentage of average loans (2)

Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At September 30, 2021, the loan balances used to calculate the ratio include PPP loans of $41.5 million.

Excluding PPP loans, the ratio is 1.07%.

At September 30, 2020, the loan balances used to calculate the ratio included PPP loans of $126.7 million.

Excluding PPP loans, the ratio is 0.98%.

(2) At September 30, 2021, the quarter-to-date average loan balances used to calculate the ratio include PPP loans of $63.9 million.

Excluding PPP loans, the ratio is 1.09%.

At September 30, 2020, the quarter-to-date average loan balances used to calculate the ratio included PPP loans of $125.7 million.

Excluding PPP loans, the ratio is 1.00%.

For the Nine Months Ended September 30,

Percentage of net

charge-offs (recoveries)

(annualized) to

average loans

Net (charge-offs)

(Dollars in thousands)

during the year

Residential real estate

Commercial real estate

Average loans outstanding during the period

Allowance for credit losses at period end as a percentage of total period end loans (2)

1 unchanged sentence

Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At September 30, 2021, the loan balances used to calculate the ratio include PPP loans of $41.5 million.

Excluding PPP loans, the ratio is 1.07%.

At September 30, 2020, the loan balances used to calculate the ratio included PPP loans of $126.7 million.

Excluding PPP loans, the ratio is 0.98%.

(2) At September 30, 2021, the year-to-date average loan balances used to calculate the ratio include PPP loans of $103.9 million.

Excluding PPP loans, the ratio is 1.14%.

At September 30, 2020, the year-to-date average loan balances used to calculate the ratio included PPP loans of $72.2 million.

Excluding PPP loans, the ratio is 1.00%.

(1) At March 31, 2022 and March 31, 2021, these ratios included all loans held for investment, including PPP loans of $14.9 million and $129.1 million, respectively.

(2) At March 31, 2022 and March 31, 2021, these ratios exclude PPP loans, acquired loans and the associated purchase discount mark on the acquired loans from both Severn and Northwest.

(3) At March 31, 2022 and March 31, 2021, these ratios included all loans held for investment, including PPP loans of $18.9 million and $131.9 million, respectively.

Nonperforming Assets and Accruing TDRs

As shown in the following table, nonperforming assets were $4.4 million and $6.3 million at September 30, 2021 and December 31, 2020, respectively.

The balance of nonperforming assets decreased primarily due to a decline in nonaccrual loans of $2.0 million, or 36.6%.

Accruing troubled debt restructurings (“TDRs”) decreased $1.2 million, or 17.8%, over the same time period.

Other real estate owned properties increased to $203 thousand from $0 at December 31, 2020.

The ratio of nonaccrual loans and accruing TDRs to total loans decreased to 0.62% at September 30, 2021 from 0.86% at December 31, 2020.

As shown in the following table, nonperforming assets were $3.9 million and $3.0 million at March 31, 2022 and December 31, 2021, respectively.

The balance of nonperforming assets increased primarily due to an increase in nonaccrual loans of $844 thousand, or 42.1%.

Accruing troubled debt restructurings (“TDRs”) decreased $663 thousand, or 11.7%, over the same time period.

Other real estate owned properties increased to $561 thousand from $532 thousand at December 31, 2021.

The ratio of nonaccrual loans and accruing TDRs to total loans stayed the same at 0.36% at March 31, 2022 and December 31, 2021.

The Company continues to focus on the resolution of its nonperforming and problem assets.

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The reduction of nonperforming and problem assets is and will continue to be a high priority for the Company.

The following table summarizes our nonperforming assets and accruing TDRs at September 30, 2021 and December 31, 2020.

The following table summarizes our nonperforming assets and accruing TDRs at March 31, 2022 and December 31, 2021.

(Dollars in thousands)

September 30, 2021

March 31, 2022

December 31, 2021

22 unchanged sentences

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, a separate component of stockholders’ equity.

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 September 30, 2021, 29.8% of the portfolio of debt securities was classified as available for sale and 70.2% was classified as held to maturity, compared to 68.0% and 32.0% respectively, at December 31, 2020.

We have the intent and ability to hold such securities until maturity.

At March 31, 2022, 21.5% of the portfolio of debt securities were classified as available for sale and 78.5% was classified as held to maturity, compared to 22.6% and 77.4% respectively, at December 31, 2021.

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 $360.2 million at September 30, 2021, a $149.9 million, or 71.3%, increase since December 31, 2020.

The increase was primarily due to the purchases of held to maturity securities of $214.2 million, partially offset by proceeds from maturities and sales of available for sale securities and held to maturity securities of $32.0 million and $29.0 million, respectively, during 2021.

Due to the excess liquidity experienced in 2020 and 2021, the Company strategically purchased short duration held to maturity securities and subordinated debt of other banks which earn significantly higher average yields than interest-bearing deposits with other banks.

As loan demand begins to strengthen, the Company will redeploy proceeds from maturities and paydowns, as well as excess liquidity to fund loan growth.

At September 30, 2021, 82.9% of the securities available for sale were mortgage-backed and 17.1% were U.S.

Government agencies, compared to 83.1% and 16.9%, respectively, at year-end 2020.

At September 30, 2021, 67.6% of the securities held to maturity were mortgage-backed, 27.1% were U.S.

Government agencies and 5.3% were other debt securities, compared to 41.5%, 28.7% and 29.2%, respectively, at year-end 2020.

Investment securities including restricted stock totaled $525.0 million at March 31, 2022, a $2.1 million, or less than 1%, decrease since December 31, 2021.

The decrease was primarily due to proceeds from maturities and principal repayments of available for sale securities of $7.0 million and held to maturity securities of $11.3 million, partially offset by purchases of held to maturity securities of $14.1 million, purchases of restricted securities of $5.7 million and purchases of equity securities of $3 thousand.

At March 31, 2022, 78.2% of the securities available for sale were mortgage-backed, 19.9% were U.S.

Government agencies and 1.9% were corporate bonds, compared to 79.2%, 19.1% and 1.7%, respectively, at year-end 2021.

At March 31, 2022, 74.9% of the securities held to maturity were mortgage-backed, 21.3% were U.S.

Government agencies, 3.7% were subordinated debt instruments and less than 1% were community reinvestment bonds, compared to 74.8%, 21.4%, 3.6% and less than 1%, respectively, at year-end 2021.

Our investments in mortgage-backed securities are issued or guaranteed by U.S.

Government agencies or government-sponsored agencies.

Total deposits at September 30, 2021 amounted to $2.02 billion, an increase of $317.4 million, or 18.7%, when compared to the level at December 31, 2020.

The increase in total deposits consisted of increases in the following categories:

Savings and money market accounts of $193.1 million, checking accounts of $69.6 million, noninterest-bearing deposits of $45.8 million and other time deposits of $8.9 million.

The significant movement within deposit accounts continues to be impacted by direct government stimulus payments to our customers and new account openings.

The decline in fair values on available for sale securities in the first quarter of 2022 was the result of the recent volatility in interest rates and are not indicative of any credit concerns due to the Company holding high quality securities.

Total deposits at March 31, 2022 amounted to $3.07 billion, an increase of $42.3 million, or 1.4%, when compared to the level at December 31, 2021.

The increase in total deposits consisted of an increase in checking accounts of $171.3 million, partially offset by a decrease in savings and money market accounts of $77.9 million and noninterest-bearing deposits of $51.1 million.

Short-Term Borrowings

Short-term borrowings consisted of securities sold under agreements to repurchase, which increased by $2.5 million, or 233.4%, to $3.5 million at September 30, 2021 when compared to December 31, 2020.

Short-term borrowings consisted of securities sold under agreements to repurchase, which decreased by $4.1 million, or 100%, at March 31, 2022 when compared to December 31, 2021.

Securities sold under agreements to repurchase are issued in conjunction with cash management services for commercial depositors.

1 unchanged sentence

Short-term advances are defined as those with original maturities of one year or less.

At September 30, 2021 and December 31, 2020, the Company had no outstanding short-term or long-term advances with FHLB.

At March 31, 2022 and December 31, 2021, the Company had no outstanding short-term advances with FHLB.

Long-Term Debt

The Company occasionally borrows from the FHLB to meet longer term liquidity needs, specifically to fund loan growth when liquidity from deposit growth is not sufficient.

The acquisition of Severn added $10.1 million in long-term FHLB borrowings, which carried an interest rate of 2.19%, and a maturity date of October 2022.

The balance of this debt was $10.1 million at both March 31, 2022 and December 31, 2021.

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.

On August 25, 2020, the Company entered into Subordinated Note Purchase Agreements with certain purchasers pursuant to which the Company issued and sold $25.0 million in aggregate principal amount with an initial interest rate of 5.375% Fixed-to-Floating Rate Subordinated Notes due September 1, 2030.

On October 31, 2021, the Company acquired from the Severn merger, Junior Subordinated Debt Securities due in 2035 (“2035 Debentures”) which had an outstanding principal balance of $20.6 million.

The debt balance of $18.2 million at March 31, 2022 is presented net of a fair value adjustment of $2.4 million at March 31, 2022 and December 31, 2021.

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 increase in cash and cash equivalents was $123.9 million for the first nine months of 2021 compared to an increase of $61.5 million for the first nine months of 2020.

The increase in cash and cash equivalents in 2021 was mainly due to the significant increase in deposits, the direct result of new account openings, government stimulus and significant increases in municipal accounts.

The Company expects these funds to be utilized over the coming months, which may result in deposit balance fluctuations.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $12.6 million for the first three months of 2022 compared to an increase of $40.2 million for the first three months of 2021.

The decrease in cash and cash equivalents in 2022 was mainly due to funding net loan growth of $61.2 million and a purchase of bank owned life insurance of $10 million.

To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets.

1 unchanged sentence

The Bank is also a member of the FHLB, which provides another source of liquidity.

Through the FHLB, the Bank had collateral pledged of approximately $299.2 million and $316.7 million at September 30, 2021 and December 31, 2020, respectively.

Through the FHLB, the Bank had collateral pledged of approximately $283.1 million and $363.9 million at March 31, 2022 and December 31, 2021, respectively.

The Bank has pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB.

Total stockholders’ equity increased $6.6 million to $201.6 million, or 3.4%, at September 30, 2021 when compared to December 31, 2020 primarily due to the current year’s retained earnings, partially offset by dividends paid during the first nine months of 2021 and the change in fair value of available-for-sale securities recorded in accumulated other comprehensive income.

On September 17, 2019, the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (“CBLR”) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act.

The CBLR framework is designed

to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

On April 6, 2020, in a joint statement, the FDIC, Federal Reserve and the Office of Comptroller of the Currency (“OCC”), issued two interim final rules regarding temporary changes to the CBLR framework to implement provisions of the CARES Act.

Under the interim final rules, the community bank leverage ratio was reduced to 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 8%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities.

A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital.

The Company has not opted-in to the CBLR framework.

Under final Federal Reserve 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 Bank.

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 Bank 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 September 30, 2021, the Bank’s capital levels remained characterized as “well-capitalized” under the rules.

The following tables present the applicable capital ratios as of September 30, 2021 and December 31, 2020.

Total stockholders’ equity increased $1.2 million to $351.9 million, or less than 1%, at March 31, 2022 when compared to December 31, 2021 primarily due to the current year’s retained earnings, partially offset by dividends paid during the first three months of 2022 and the change in fair value of available-for-sale securities recorded in accumulated other comprehensive income (loss).

The Bank and Company are subject to various regulatory capital requirements administered by the federal banking agencies.

Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

In July 2013, federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with certain standards that were developed by Basel III and certain provisions of the Dodd-Frank Act.

The final rule currently applies to all depository institutions and bank holding companies and savings and loan holding companies with total consolidated assets of more than $3 billion.

The Company had total consolidated assets of more than $3 billion as of December 31, 2021, due to the acquisition of Severn in the fourth quarter of 2021.

As such, the Company was required to comply with the consolidated capital requirements for the first quarterly report date following the effective date of the business combination as its total assets exceeded $3 billion.

Quantitative measures established by regulation to ensure capital adequacy require the Bank and Company to maintain minimum ratios of common equity Tier 1, Tier 1, and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1,250%.

The Bank and Company are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.

The following tables present the applicable capital ratios as of March 31, 2022 and December 31, 2021.

Common Equity

September 30, 2021

March 31, 2022

capital ratio

Shore Bancshares, Inc.

Shore United Bank

3 unchanged sentences

capital ratio

Shore Bancshares, Inc.

Shore United Bank

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis