What changed in this filing

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Item 1. Financial Statements

2023-05-15 compared with 2022-11-14 · 385 added, 538 removed, 596 unchanged (61% of the section changed)

2 unchanged sentences

CONSOLIDATED BALANCE SHEETS

September 30,

(In thousands, except share and per share data)

3 unchanged sentences

Investment securities:

Available-for-sale, at fair value

Held to maturity, at amortized cost - fair value of $ 501,145 (2022) and $ 401,524 (2021)

Available-for-sale, at fair value (amortized cost of $ 92,754 (2023) and $ 95,999 (2022))

Held to maturity, net of allowance for credit losses of $ 163 (2023) (fair value of $ 491,116 (2023) and $ 494,627 (2022))

Equity securities, at fair value

1 unchanged sentence

Loans held for sale, at fair value

Loans held for investment

Loans held for investment ($ 9,526 (2023) and $ 8,437 (2022), at fair value)

allowance for credit losses

8 unchanged sentences

Total deposits

Securities sold under retail repurchase agreements

Advances from FHLB - long-term

Advances from FHLB - short-term

Subordinated debt

10 unchanged sentences

Retained earnings

Accumulated other comprehensive (loss) income

Accumulated other comprehensive loss

TOTAL STOCKHOLDERS' EQUITY

4 unchanged sentences

For Three Months Ended

For Nine Months Ended

September 30,

(In thousands, except per share data)

2 unchanged sentences

Interest and dividends on taxable investment securities

Interest and dividends on tax-exempt investment securities

Interest on deposits with other banks

39 unchanged sentences

For Three Months Ended

For Nine Months Ended

September 30,

(In thousands)

Other comprehensive (loss):

Other comprehensive income (loss):

Investment securities:

Unrealized holding (losses) on available-for-sale-securities

Total other comprehensive (loss)

Unrealized holding gains/(losses) on available-for-sale-securities

Total other comprehensive income (loss)

Comprehensive income

2 unchanged sentences

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

For the Three and Nine Months Ended September 30, 2022 and 2021

For the Three Months Ended March 31, 2023 and 2022

Comprehensive

1 unchanged sentence

(In thousands)

Income (loss)

Balances, January 1, 2023

Other comprehensive (loss)

Cumulative effect adjustment due to the adoption of ASC 326, net of tax

Other comprehensive income

Common shares issued for employee stock purchase plan

2 unchanged sentences

Balances, March 31, 2023

Other comprehensive (loss)

Common shares issued for employee stock purchase plan

Stock-based compensation

Cash dividends declared

Balances, June 30, 2022

Other comprehensive (loss)

Common shares issued for employee stock purchase plan

Stock-based compensation

Cash dividends declared

Balances, September 30, 2022

SHORE BANCSHARES, INC.

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

For the Three and Nine Months Ended September 30, 2022 and 2021

Comprehensive

1 unchanged sentence

(In thousands)

Income (Loss)

Balances, January 1, 2022

Other comprehensive (loss)

Retirement of common stock

Common shares issued for employee stock purchase plan

Stock-based compensation

1 unchanged sentence

Balances, March 31, 2022

Other comprehensive (loss)

Stock-based compensation

Cash dividends declared

Balances, June 30, 2021

Other comprehensive (loss)

Stock-based compensation

Exercise of options, net of shares surrendered

Cash dividends declared

Balances, September 30, 2021

See accompanying notes to Consolidated Financial Statements.

1 unchanged sentence

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

For Nine Months Ended

September 30,

For Three Months Ended

(In thousands)

11 unchanged sentences

Deferred income tax expense (benefit)

(Gains) on sales and calls of securities

(Gains) on valuation adjustments on mortgage servicing rights

Losses on sales and disposals of premises and equipment

(Gains) loss on valuation adjustments on mortgage servicing rights

Valuation adjustments on premises transferred to held for sale

Losses on sales and valuation adjustments on other real estate owned

Fair value adjustments on loans held for investments, at fair value

Fair value adjustment on equity securities

10 unchanged sentences

Purchases of equity securities

Net (purchase) of restricted securities

Purchase of restricted securities

Net change in loans

2 unchanged sentences

Improvements to other real estate owned

Net redemption of restricted securities

Redemption of restricted securities

Purchases of bank owned life insurance

6 unchanged sentences

Common stock dividends paid

Retirement of common stock

Issuance of common stock

Net cash (used in) provided by financing activities

Net (decrease) increase in cash and cash equivalents

Net cash provided by financing activities

Net (decrease) in cash and cash equivalents

Cash and cash equivalents at beginning of period

6 unchanged sentences

Recognition (remeasurement of) lease liabilities arising from right-of-use assets

Transfer of premises to held for sale (included in other assets)

Transfers from loans to other real estate owned

Unrealized (loss) on securities available for sale

Unrealized gain (loss) on securities available for sale

See accompanying notes to Consolidated Financial Statements.

1 unchanged sentence

Notes to Consolidated Financial Statements

For the Three and Nine Months Ended September 30, 2022 and 2021

For the Three Months Ended March 31, 2023 and 2022

Note 1 – Basis of Presentation

3 unchanged sentences

The accompanying interim financial statements are unaudited;

however, in the opinion of management all adjustments necessary to present fairly the consolidated financial position at September 30, 2022, the consolidated results of income and comprehensive income for the three and nine months ended September 30, 2022 and 2021, changes in stockholders’ equity for the three and nine months ended September 30, 2022 and 2021 and cash flows for the nine months ended September 30, 2022 and 2021, have been included.

however, in the opinion of management all adjustments necessary to present fairly the consolidated financial position at March 31, 2023, the consolidated results of income and comprehensive income for the three months ended March 31, 2023 and 2022, changes in stockholders’ equity for the three months ended March 31, 2023 and 2022 and cash flows for the three months ended March 31, 2023 and 2022, have been included.

All such adjustments were of a normal recurring nature.

The amounts as of December 31, 2022 were derived from the 2022 audited financial statements.

The results of operations for the three and nine months ended September 30, 2022 are not necessarily indicative of the results to be expected for any other interim period or for the full year.

The results of operations for the three months ended March 31, 2023 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.

3 unchanged sentences

and, unless the context requires otherwise, its consolidated subsidiaries, Shore United Bank, N.A.

(the “Bank”).

Recent Accounting Standards and Other Authoritative Guidance

2016-13 – In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03.

These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters.

Smaller reporting companies who file with the U.S.

Securities and Exchange Commission (SEC) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022.

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 timeline 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 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.

The Company has completed the external validation of the new model.

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119.

SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses;

(2) development, governance, and documentation of a systematic methodology;

(3) documenting the results of a systematic methodology;

and (4) validating a systematic methodology.

2022-02 – In March 2022, the (FASB) issued (ASU) No.

2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model.

The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancing’s and restructurings made with borrowers experiencing financial difficulty.

In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures.

The amendments in this ASU should be applied prospectively, except for the transition method related to the recognition and measurement of troubled debt restructurings (TDR), an entity has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption.

For entities that have adopted ASU 2016-13, ASU 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.

For entities that have not yet adopted ASU 2016-13, the effective dates for ASU 2022-02 are the same as the effective dates in ASU 2016-13.

Early adoption is permitted if an entity has adopted ASU 2016-13.

An entity may elect to early adopt the amendments about TDRs and related disclosure enhancements separately from the amendments related to vintage disclosures.

The Company is currently assessing the impact that ASU 2022-02 will have on its consolidated financial statements.

(the “Bank”) and Mid-Maryland Title Company, Inc.

(the “Title Company”).

Pending Recent Accounting Standards

2022-03 - In June 2022, the (FASB) issued (ASU) No.

5 unchanged sentences

The Company does not expect the adoption of ASU 2022-03 to have a material impact on its consolidated financial statements.

2020-04 – In March 2020, the (FASB) issued (ASU) No.

2020-04 “Reference Rate Reform (Topic 848):

Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform.

The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Inter-bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued.

It is intended to help stakeholders during the global market-wide reference rate transition period.

The guidance is effective for all entities as of March 12, 2020 through December 31, 2022.

Subsequently, in January 2021, the (FASB) issued (ASU) No.

2021-01 “Reference Rate Reform (Topic 848):

Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition.

The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition.

An entity may elect to apply ASU No.

2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued.

An entity may elect to apply ASU No.

2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020.

At present, the Bank has limited exposure to LIBOR based pricing.

LIBOR based loans only comprise 18 loans or 3.3 % of the loan portfolio.

The Bank is confident it can successfully negotiate a migration to the Secured Overnight Financing Rate (“SOFR”) between now and the implementation date.

The Bank will notify customers within 120 days prior to migration to SOFR.

The Bank acknowledges the replacement rate will be more volatile based on different countries migrating to different indexes and limited liquidity to support the rate.

The Bank further acknowledges the volatility will be greatly influenced by the support provided by the Federal Reserve.

Note 2 – Business Combination

On October 31, 2021 (“Acquisition Date”), the Company completed the acquisition of Severn Bancorp, Inc.

(“Severn”), a Maryland charted commercial bank, in accordance with the definitive agreement that was entered into on March 3, 2021, by and among the Company and Severn.

The Company acquired Severn to access deposits and deploy excess capital into a high growth market, while also enhancing scale to drive efficiency and profitability.

Additionally, this transaction creates a competitive position in the Columbia/Baltimore/Towson MSA, while filling in our current market footprint.

In connection with the completion of the merger, former Severn shareholders received 0.6207 shares of Shore common stock and $ 1.59 in cash for each share of Severn common stock.

Based on the $ 18.48 per share closing price of the Company’s common stock on October 29, 2021 and including the fair value of options converted or cashed-out, the total transaction value was approximately $ 169.8 million.

Upon completion of the acquisition, Shore shareholders owned approximately 59.6 % of the combined company, and former Severn shareholders owned approximately 40.4 %.

As of October 31, 2021, Severn, headquartered in Annapolis, MD, had more than $ 1.1 billion in assets and operated 7 full-service community banking offices throughout Anne Arundel County, Maryland.

The acquisition of Severn was accounted for as a business combination using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at estimated fair values on the Acquisition Date.

The provisional amount of goodwill recognized as of the Acquisition Date was approximately $ 45.9 million.

The Company will continue to keep the measurement of goodwill open for any additional adjustments to the fair value of certain accounts, for example loans, that may arise during the Company’s final review procedures of any updated information.

If considered necessary, any subsequent adjustments to the fair value of assets acquired and liabilities assumed, identifiable intangible assets, or other purchase accounting adjustments will result in adjustments to goodwill within the first 12 months following the Acquisition Date.

The goodwill is not expected to be deductible for tax purposes.

As a result of the integration of the operations of Severn, it is not practicable to determine revenue or net income included in the Company’s consolidated operating results relating to Severn since the date of acquisition, as Severn’s results cannot be separately identified.

Comparative pro-forma financial statements for the prior year period were not presented, as adjustments to those statements would not be indicative of what would have occurred had the acquisition taken place on January 1, 2021.

In particular, adjustments that would have been necessary to be made to record the loans at fair value, the provision of credit losses or the core deposit intangible would not be practical to estimate.

The consideration paid for Severn’s common equity and outstanding stock options and the provisional fair values of acquired identifiable assets and assumed identifiable liabilities were as follows:

(In thousands, except per share data)

Purchase Price Consideration:

Fair value of common shares issued ( 8,053,088 shares) based on Shore Bancshares, Inc.

share price of $ 18.48

Cash consideration

Cash paid for cash-out Severn stock options

Cash for fractional shares

Total purchase price

Identifiable assets:

Cash and cash equivalents

Total securities

Loans held for sale

Loans, net (1)

Premises and equipment, net

Other real estate owned

Core deposit intangible asset

Other assets (1)

Total identifiable assets

Identifiable liabilities:

Other liabilities

Total identifiable liabilities

Provisional fair value of net assets acquired including identifiable intangible assets

Provisional resulting goodwill (1)

(1) Includes the effect of measurement period adjustments recorded in the first quarter of 2022 and reconciled in the table below.

The following table details the changes in fair value of net assets acquired and liabilities assumed from the amounts reported for the year ended December 31, 2021 (dollars in thousands).

Goodwill at December 31, 2021

Effect of adjustments to:

Goodwill at September 30, 2022

The adjustment to goodwill made during the first quarter of 2022 was related to the fair value of certain acquired loans, net of the related deferred tax impact which was determined to be higher than their acquisition date fair values.

Acquired loans

The following table outlines the contractually required payments receivable, cash flows we expected to receive, and the accretable yield for all Severn purchased credit-impaired (PCI) loans as of the acquisition date.

Contractually required payments receivable

Nonaccretable difference

Cash flows expected to be collected

Accretable yield

The Company recorded all loans acquired at the estimated fair value on the acquisition date with no carryover of the related allowance for loan losses.

The Company determined the net discounted value of cash flows on gross loans totaling $ 593.3 million, including 1,306 performing loans and 162 PCI loans.

The valuation took into consideration the loans’ underlying characteristics, including account types, remaining terms, annual interest rates, interest types, past delinquencies, timing of principal and interest payments, current market rates, loan-to-loan value ratios, loss exposures, and remaining balances.

These performing loans were segregated into pools based on loan and payment type.

The effect of the valuation process was a total net discount of $ 8.7 million at acquisition.

Note 2 – Adoption of Accounting Standards

On January 1, 2023, the Company adopted Accounting Standards Updates (ASU) 2016-13 “Financial Instruments – Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments,” ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,” ASU 2019-05, “Financial Instruments – Credit Losses (Topic 326):

Targeted Transition Relief,” ASU 2019-10, “Financial instruments – Credit losses (Topic 326), Derivatives and hedging (Topic 815), and Leases (Topic 842) – Effective dates,” ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2020-02, “Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842),” ASU 2020-03, “Codification Improvements to Financial Instruments” and ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326) – Troubled Debt Restructurings and Vintage Disclosures” (collectively, ASC 326).

The significant impacts of adopting these standards and related updates to the Company’s accounting policies are discussed below.

ASC 326 requires entities to estimate an allowance for credit losses (ACL) on certain types of financial instruments measured at amortized cost using a current expected credit losses (CECL) methodology, replacing the incurred loss methodology from prior GAAP.

It also applies to unfunded commitments to extend credit, including loan commitments, standby letters of credit, and other similar instruments.

The impairment model for available-for-sale debt securities was modified and ASC 326 also provided for a simplified accounting model for purchased financial assets with credit

deterioration since their origination.

Additionally, the measurement principles for modifications of loans to borrowers experiencing financial difficulty were modified, including how the ACL is measured for such loans.

The amendments of ASC 326, upon adoption, were applied on a modified retrospective basis, by recording an increase in the reported balance of loans and the allowance for credit losses on loans, an increase in the liability for credit losses on commitments to extend credit and reducing total equity of both the Company and the Bank.

As a result of adopting ASC 326, the Company recorded a decrease to opening retained earnings, net of taxes, of approximately $ 7.8 million.

ASC 326 also replaced the Company’s previous accounting policies for purchased credit-impaired (PCI) loans and troubled-debt restructurings (TDRs).

With the adoption of ASC 326, loans previously designated as PCI loans were designated as purchased loans with credit deterioration (PCD loans).

The Company adopted ASC 326 using the prospective transition approach for PCD loans that were previously identified as PCI and accounted for under ASC 310-30.

On January 1, 2023, the Corporation’s PCD loans were adjusted to reflect the addition of expected credit losses to the amortized cost basis of the loans and a corresponding increase to the ACL.

The remaining noncredit discount, which represents the difference between the adjusted amortized cost basis and the outstanding principal balance on PCD loans, will be accreted into interest income over the estimated remaining lives of the loans using the effective interest rate method.

The evaluation of the ACL will include PCD loans together with other loans that share similar risk characteristics, rather than using the separate pools that were used under PCI accounting, unless the loans are specifically identified for individual evaluation under our CECL methodology.

The adoption of ASC 326 also replaced previous TDR accounting guidance, and the evaluation of the ACL will include loans previously designated as TDRs together with other loans that share similar risk characteristics, unless the loans are specifically identified for individual evaluation under our CECL methodology.

The following table shows the impact of the Company's adoption of ASC 326 on loans, the allowance for credit losses, and the Company’s reserve for unfunded commitments:

January 1, 2023

As Reported Under

(Dollars in thousands)

Total Loans, gross

Allowance for credit losses

Total loans, net

Reserve for Unfunded Commitments

The following accounting policies have been updated in connection with the adoption of ASC 326 and apply to periods beginning after December 31, 2022.

Accounting policies applying to prior periods are described in the 2022 Annual Report, as discussed above.

Investments in Debt Securities

Investments in debt securities are classified as either held to maturity, available for sale, or trading, based on management’s intent.

Currently, the Company has classified its debt securities within the available for sale and held to maturity classifications.

Debt securities purchased with the positive intent and ability to hold to maturity are classified as held to maturity and are recorded at amortized cost, net of any ACL.

Debt securities not classified as held to maturity are classified as available for sale and are carried at estimated fair value with the corresponding unrealized gains and losses recognized in other comprehensive income (loss).

Gains or losses are recognized in net income on the trade date using the amortized cost of the specific security sold.

Purchase premiums are recognized in interest income using the effective interest rate method over the period from purchase to maturity or, for callable securities, the earliest call date, and purchase discounts are recognized in the same manner from purchase to maturity.

The Company has elected to exclude accrued interest receivable from the amortized cost basis and fair value of its held to maturity and available for sale debt securities and has included such accrued interest of $ 1.8 million at March 31, 2023 within the other assets line item of the Consolidated Balance Sheets.

The Company estimates an ACL for held to maturity debt securities on a collective basis by major security type and standard credit rating.

Certain securities in our held to maturity securities portfolio are either explicitly or implicitly guaranteed by the U.S.

government, are highly rated by major rating agencies and have a long history of no credit losses.

With respect to these securities, we consider the risk of credit loss to be zero and, therefore, we do not record an ACL.

The estimate of an ACL on our held to maturity securities that are not guaranteed by the U.S.

government considers historical credit loss information and severity of loss in the event of default and leverages external data.

No ACL is recorded on accrued interest receivable and amounts written-off are reversed by an adjustment to interest income.

An ACL on held to maturity debt securities that do not share common risk characteristics with our collective portfolio are individually measured based on net realizable value, or the difference between the discounted value of the expected future cash flows and the recorded amortized cost basis of the security.

For debt securities available for sale, impairment is recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis.

If, however, the Company does not intend to sell the security and it is not more-likely-than-not that the Company will be required to sell the security before recovery, the Company evaluates unrealized losses to determine whether a decline in fair value below amortized cost basis is a result of a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security, or other factors such as changes in market interest rates.

If a credit loss exists, an allowance for credit losses is recorded that reflects the amount of the impairment related to credit losses, limited by the amount by which the specific security’s amortized cost basis exceeds its fair value.

Changes in the allowance for credit losses are recorded in net income in the period of change and are included in provision for credit losses.

Changes in the fair value of debt securities available for sale not resulting from credit losses are recorded in other comprehensive income (loss).

The Company regularly reviews unrealized losses in its investments in securities and cash flows expected to be collected from impaired securities based on criteria including the extent to which market value is below amortized cost, the financial health of and specific prospects for the issuer, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.

Loans Held for Investment

The Company’s recorded investment in loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally is reported at the unpaid principal balances adjusted for charges-offs, unearned discounts, any deferred fees or costs on originated loans, and the allowance for credit losses.

The Company has elected to exclude accrued interest receivable from the amortized cost basis of its loans held for investment and has included such accrued interest of $ 6.2 million at March 31, 2023 within the other assets line item of the Consolidated Balance Sheets.

Interest on loans is recorded to interest income based on the contractual rates and the amount of outstanding principal of the loans.

Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield using the level-yield method.

Loans acquired in a business combination are recorded at estimated fair value on the date of acquisition.

In the case of loans that have experienced more than insignificant deterioration in credit quality since origination as of the acquisition date, the loan’s amortized cost basis is increased above estimated fair value by the amount of expected credit losses as of the acquisition date, and a corresponding allowance for credit losses is also recorded.

Any remaining non-credit discount or premium for such purchased loans with credit deterioration (PCD loans) and any fair value discount or premium for non-PCD loans is accreted or amortized as an adjustment to yield over the estimated lives of the loans using the level-yield method.

A loan’s past due status is based on the contractual due date of the most delinquent payment due.

Loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain.

Any accrued interest receivable on loans placed on nonaccrual status is reversed by an adjustment to interest

Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest.

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.

A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.

In the ordinary course of business, the Company has entered into commitments to extend credit and standby letters of credit.

Such financial instruments are recorded in the Consolidated Balance Sheets when they are funded.

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 non-owner 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.

Non-owner 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 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.

ACL on Loans Held for Investment

An ACL is estimated on loans held for investment, excluding loans carried at fair value.

The ACL on loans is established through charges to earnings in the form of a provision for credit losses.

Loan losses are charged against the ACL for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when management believes that the collectability of the principal is unlikely.

Subsequent recoveries, if any, are credited to the allowance.

The allowance represents management’s current estimate of expected credit losses over the contractual term of loans held for investment, and is recorded at an amount that, in management’s judgment, reduces the recorded investment in loans to the net amount expected to be collected.

No ACL is recorded on accrued interest receivable and amounts written-off are reversed by an adjustment to interest income.

Management’s judgment in determining the level of the allowance is based

on evaluations of historical loan losses, current conditions and reasonable and supportable forecasts relevant to the collectability of loans.

The methodology for estimating the amount reported in the ACL is the sum of two main components, an allowance assessed on a collective basis for pools of loans that share similar risk characteristics and an allowance assessed on individual loans that do not share similar risk characteristics with other loans .

Loans that share common risk characteristics are evaluated collectively using a cash flow approach.

The discounted cash flow approach used by the Company utilizes loan-level cash flow projections and pool-level assumptions.

For loans that do not share risk characteristics with other loans, the ACL is measured based on the net realizable value, that is, the difference between the discounted value of the expected future cash flows and the amortized cost basis of the loan.

When a loan is collateral-dependent and the repayment is expected to be provided substantially through the operation or sale of the collateral, the ACL is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral.

Cash flow projections and estimated expected losses on loans which share common risk characteristics are based in part on forecasts of the national unemployment rate that are reasonable and supportable over a twelve month period and incorporated into the estimate of expected credit losses using a statistical regression analysis.

For periods beyond those for which reasonable and supportable forecasts are available, projections are based on a reversion of the national unemployment rate from the last forecast to a historical average level over the following twelve months.

Management’s estimate of the allowance for credit losses on loans that are collectively evaluated also includes a qualitative assessment of available information relevant to assessing collectability that is not captured in the quantitative loss estimation process.

Factors considered by management include changes in general market, economic and business conditions;

the nature and volume of the loan portfolio;

the volume and severity of delinquencies and adversely classified loan balances and the value of underlying collateral;

and other factors as deemed necessary and appropriate.

This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

Reserve for Unfunded Commitments

The Company records a reserve, reported in other liabilities, for expected credit losses on commitments to extend credit that are not unconditionally cancelable by the Company.

The reserve for unfunded commitments is measured based on the principles utilized in estimating the allowance for credit losses on loans and an estimate of the amount of unfunded commitments expected to be advanced.

Changes in the reserve for unfunded commitments are recorded through the provision for credit losses.

During the three months ended March 31, 2023, the Company recorded no provision for credit losses associated with its unfunded commitments.

Note 3 – Earnings Per Share

3 unchanged sentences

For the Three Months Ended

For the Nine Months Ended

September 30,

(In thousands, except per share data)

Weighted average shares outstanding - Basic

Weighted average shares outstanding - Basic and Diluted

Earnings per common share - Basic and Diluted

There were no weighted average common stock equivalents excluded from the calculation of diluted earnings per share for the three and nine months September 30, 2021.

There were no potentially dilutive shares outstanding during the three and nine months ended September 30, 2022.

There were no weighted average common stock equivalents excluded from the calculation of diluted earnings per share for the three months March 31, 2022.

There were no potentially dilutive shares outstanding during the three months ended March 31, 2023.

Note 4 – Investment Securities

On January 1, 2023, the Company adopted ASC 326, which made changes to accounting for available for sale debt securities whereby credit losses should be presented as an allowance, rather than as a write-down when management does not intend to sell and does not believe that it is more likely than not they will be required to sell prior to maturity.

In addition, ASC 326 requires an allowance for credit losses to be recorded on held to maturity debt securities measured at amortized cost.

All securities information presented as of March 31, 2023 is in accordance with ASC 326.

All securities information presented as of December 31, 2022 or a prior date is presented in accordance with previously applicable GAAP.

For further discussion on the Corporation’s accounting policies and policy elections related to the accounting standard update refer to Note 2.

The following table summarizes the activity in the ACL on held-to-maturity securities:

Three Months ended

(Dollars in thousands)

March 31, 2023

Balance, beginning of period

Other debt securities, provision for credit losses

Balance, end of period

The ACL for held-to-maturity securities was initially determined to be immaterial as of the date of adoption of ASC 326.

Upon re-estimation in the current period, ACL was recorded based on the results of our calculation as of March 31, 2023.

The following tables provide information on the amortized cost and estimated fair values of debt securities.

1 unchanged sentence

Available-for-sale securities:

September 30, 2022

March 31, 2023

Government agencies

5 unchanged sentences

Other debt securities

No available for sale securities were sold during the three and nine months ended September 30, 2022 and 2021.

No available for sale securities were sold during the three months ended March 31, 2023 and 2022.

(Dollars in thousands)

Held-to-maturity securities:

September 30, 2022

March 31, 2023

Government agencies

7 unchanged sentences

Other debt securities

Equity securities with an aggregate fair value of $ 1.2 million at September 30, 2022 and $ 1.4 million at December 31, 2021 are presented separately on the balance sheet.

The fair value adjustment recorded through earnings totaled $( 145 ) thousand for the nine months ended September 30, 2022 and $( 24 ) thousand for the nine months ended September 30, 2021, 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 September 30, 2022 and December 31, 2021.

Equity securities with an aggregate fair value of $ 1.3 million at March 31, 2023 and $ 1.2 million at December 31, 2022 are presented separately on the balance sheet.

The fair value adjustment recorded through earnings totaled $ 17 thousand for the three months ended March 31, 2023 and $( 70 ) thousand for the three months ended March 31, 2022, respectively.

Credit Quality Information

The Company monitors the credit quality of held-to-maturity securities through credit ratings provided by Standard & Poor’s Rating Services and Moody’s Investor Services.

Credit ratings express opinions about the credit quality of a security, and are updated at each quarter end.

Investment grade securities are rated BBB- or higher by S&P and Baa3 or higher by Moody’s and are generally considered by the rating agencies and market participants to be of low credit risk.

Conversely, securities rated below investment grade, which are labeled as speculative grade by the rating agencies, are considered to have distinctively higher credit risk than investment grade securities.

There were no speculative grade held-to-maturity securities at March 31, 2023 or December 31, 2022.

Held-to-maturity securities that are not rated are agency mortgage-backed securities sponsored by US government agencies, as well as direct obligations of the agencies, with the remainder being sub-debt of other banks.

The following table shows the amortized cost of held-to-maturity securities based on their lowest publicly available credit rating as of March 31, 2023.

March 31, 2023

Investment Grade

(Dollars in thousands)

September 30, 2022

Available-for-sale securities:

Government agencies

Mortgage-backed

States and political subdivisions

Other debt securities

Held-to-maturity securities:

Total Held-to Maturity Securities

(Dollars in thousands)

March 31, 2023

Available-for-sale securities:

Government agencies

Mortgage-backed

States and political subdivisions

Other debt securities

4 unchanged sentences

Mortgage-backed

Other debt securities

Held-to-maturity securities:

1 unchanged sentence

Mortgage-backed

States and political subdivisions

Other debt securities

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 and are not related to credit concerns.

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 basis, which may be at maturity for debt securities, the Company considers the unrealized losses to be temporary.

There were one hundred twelve available-for-sale securities and one hundred ninety held-to-maturity securities in an unrealized loss position at September 30, 2022.

The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at September 30, 2022.

There were one hundred fifteen available-for-sale debt securities with a fair value below the amortized cost basis, totaling $ 11.2 million of aggregate fair value as of March 31, 2023.

The Company concluded that a credit loss does not exist in its available-for-sale securities portfolio as of March 31, 2023, and no impairment loss has been recognized based on the fact that (1) changes in fair value were caused primarily by fluctuations in interest rates, (2) securities with unrealized losses had generally high credit quality, (3) the Company intends to hold these investments in debt securities to maturity and it is more-likely-than-not the Company will not be required to sell these investments before a recovery of its investment, and (4) issuers have continued to make timely payments of principal and interest.

Additionally, the Company’s mortgage-back securities are issued by either US government agencies or US government sponsored enterprises.

Collectively, these entities provide a guarantee, which is either explicitly or implicitly supported by the full faith and credit of the US government, that investors in such mortgage-backed securities will receive timely principal and interest payments.

All held-to-maturity and available for sale securities were current with no securities past due or on nonaccrual as of March 31, 2023.

The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at March 31, 2023.

Available for sale

7 unchanged sentences

Note 5 – Loans and Allowance for Credit Losses

The Company makes residential mortgage, commercial and consumer loans to customers primarily in Anne Arundel County, Baltimore City, Baltimore County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County and Worcester County in Maryland, Kent and Sussex County, Delaware and in Accomack County, Virginia.

The following table provides information about the principal classes of the loan portfolio at September 30, 2022 and December 31, 2021.

On January 1, 2023, the Company adopted ASC 326.

The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables.

For further discussion on the most significant accounting policies that the Company follows see Note 2 – Adoption of Accounting Standards and Note 1 of the Company’s Annual Report on Form 10-K.

All loan information presented as of March 31, 2023 is in accordance with ASC 326.

All loan information presented as of December 31, 2022, or a prior date is presented in accordance with previously applicable GAAP.

The Company makes residential mortgage, commercial and consumer loans to customers primarily in Anne Arundel County, Baltimore County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County and Worcester County in Maryland, Kent and Sussex County, Delaware and in Accomack County, Virginia.

The following table provides information about the principal classes of the loan portfolio at March 31, 2023 and December 31, 2022.

(Dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

4 unchanged sentences

Loans are stated at their principal amount outstanding net of any purchase premiums/discounts, deferred fees and costs.

Included in loans were deferred costs, net of fees, of $ 967 thousand and $ 1.2 million at September 30, 2022 and December 31, 2021.

At September 30, 2022 and December 31, 2021, included in total loans were $ 24.7 million and $ 39.9 million in loans, respectively, net of discounts on acquired loans of $ 332 thousand and $ 516 thousand, respectively, as part of the Northwest Bancshares, Inc.

branch acquisition in 2017.

At September 30, 2022 and December 31, 2021, included in total loans were $ 407.8 million and $ 553.0 million in loans, acquired as part of the acquisition of Severn.

These balances were presented net of the related discount which totaled $ 7.3 million and $ 8.4 million at September 30, 2022 and December 31, 2021, respectively.

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.

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.

A loan is considered a 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 Bank’s current underwriting guidelines 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.

During 2021 and 2020, the Company participated in the Small Business Administration’s Paycheck Protection Program (PPP).

As of September 30, 2022, the Company held PPP loans with a total outstanding balance of $ 291 thousand, inclusive of loans issued pre-merger and those acquired from Severn, which are included in the commercial loan segment in the table above.

As of December 31, 2021, the Company held PPP loans with a total outstanding balance of $ 27.6 million, of which $ 9.2 million was acquired from Severn, which are included in the commercial loan segment in the table above.

The decrease is due to repayment and forgiveness received as of September 30, 2022.

As compensation for originating the loans, the Company received lender processing fees from the SBA, which were deferred, along with the related loan origination costs.

These net fees are being accreted to interest income over the remaining contractual lives of the loans.

Upon forgiveness of a PPP loan and repayment by the SBA, which may be prior to the loan’s maturity, the remainder of any unrecognized net fees are recognized as interest income.

The following tables provide information about all loans acquired from Severn.

September 30, 2022

Acquired Loans -

Included in loans were deferred costs, net of fees, of $ 1.7 million and $ 1.4 million at March 31, 2023 and December 31, 2022.

At March 31, 2023 and December 31, 2022, included in total loans were $ 342.8 million and $ 372.2 million in loans, acquired as part of the acquisition of Severn Bancorp, Inc.

(“Severn”), effective October 31, 2021.

These balances were presented net of the related discount which totaled $ 6.0 million and $ 6.7 million at March 31, 2023 and December 31, 2022, respectively.

At March 31, 2023, the Bank was servicing $ 349.8 million in loans for the Federal National Mortgage Association and $ 74.9 million in loans for Freddie Mac.

The following table provides information on nonaccrual loans by loan class as of March 31, 2023.

Loans past due

90 days or more

allowance for

(Dollars in thousands)

Credit Impaired

Outstanding principal balance

Carrying amount

March 31, 2023

Nonaccrual loans:

Residential real estate

Commercial real estate

Interest income

The overall quality of the Bank’s loan portfolio is primarily assessed using the Bank’s risk-grading scale.

This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans.

Credit quality indicators are adjusted based on management’s judgment during the quarterly review process.

Loans are graded on a scale of one to ten.

Ratings 1 thru 6 – Pass - Ratings 1 thru 6 have asset risks ranging from excellent-low to adequate.

The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks.

Rating 7 – Special Mention - These credits have potential weaknesses due to economic conditions, less than adequate earnings performance or other factors which require the lending officer to direct more than normal attention to the credit.

Financing alternatives may be limited and/or command higher risk interest rates.

Special mention loan relationships are reviewed at least quarterly.

Rating 8 – Substandard - Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged.

Substandard loans are the first adversely classified loans on the Bank's watchlist.

These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.

They are characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard.

The loans may have a delinquent history or combination of weak collateral, weak guarantor or operating losses.

When a loan is assigned to this category the Bank may estimate a specific reserve in the loan loss allowance analysis and/or place the loan on nonaccrual.

These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies.

These relationships will be reviewed at least quarterly.

Rating 9 – Doubtful - Doubtful assets have many of the same characteristics of substandard with the exception that the Bank has determined that loss is not only possible but is probable.

The amount of loss is not discernible due to factors such as merger, acquisition, or liquidation;

a capital injection;

a pledge of additional collateral;

the sale of assets;

or alternative refinancing plans.

Credits receiving a doubtful classification are required to be on nonaccrual.

These relationships will be reviewed at least quarterly.

Rating 10 – Loss – Loss assets are uncollectible or of little value.

The following table provides information on loan risk ratings as of March 31, 2023.

Term Loans by Origination Year

(Dollars in thousands)

March 31, 2023

Gross Charge-offs

Residential real estate

Special Mention

Gross Charge-offs

Commercial real estate

Special Mention

Gross Charge-offs

Special Mention

Gross Charge-offs

Special Mention

Gross Charge-offs

Total loans by risk category

Total gross charge-offs

The following tables provide information on the aging of the loan portfolio as of March 31, 2023 and December 31, 2022.

90 days or more

(Dollars in thousands)

March 31, 2023

Residential real estate

Commercial real estate

Percent of total loans

(1) Includes loans measured at fair value of $ 9.5 million at March 31, 2023.

90 days or more

(Dollars in thousands)

December 31, 2022

Residential real estate

Commercial real estate

Percent of total loans

(1) Includes loans measured at fair value of $ 8.4 million at December 31, 2022.

The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three months ended March 31, 2023 and March 31, 2022.

Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.

(Dollars in thousands)

For three months ended

March 31, 2023

Allowance for credit losses:

Beginning Balance

Impact of ASC326 Adoption

Charge-offs (1)

Net (charge-offs) recoveries

Ending Balance

(1) Gross charge-offs of commercial loans for the three months ended March 31, 2023 included $ 107 of demand deposit overdrafts.

(Dollars in thousands)

For three months ended

March 31, 2022

Allowance for credit losses:

Beginning Balance

Net (charge-offs) recoveries

Ending Balance

There were no modifications to loans for borrowers experiencing financial difficulty (“BEFD”) during the three months ending March 31, 2023.

Foreclosure Proceedings

There were $ 39 thousand of consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure as of March 31, 2023 and $ 263 thousand as of December 31, 2022, respectively.

There were no residential real estate properties included in the balance of other real estate owned at March 31, 2023 and 1 residential real estate property totaling $ 18 thousand at December 31, 2022.

Prior to the adoption of ASC 326

The following table provides information about all loans acquired from Severn as of December 31, 2022.

December 31, 2022

Acquired Loans -

8 unchanged sentences

The following table presents a summary of the change in the accretable yield on PCI loans acquired from Severn.

For the Nine Months Ended

For the Three Months Ended

(Dollars in thousands)

September 30, 2022

March 31, 2022

Accretable yield, beginning of period

2 unchanged sentences

Accretable yield, end of period

At September 30, 2022, the Bank was servicing $ 346.9 million in loans for the Federal National Mortgage Association and $ 74.5 million in loans for the Federal Home Loan Mortgage Corporation.