What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-08-14 compared with 2023-05-15 · 196 added, 111 removed, 204 unchanged (60% of the section changed)

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Forward-Looking Information

This Quarterly Report on Form 10-Q contains forward-looking statements.

This Quarterly Report on Form 10-Q (“Quarterly Report”) contains forward-looking statements.

These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance.

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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.

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”).

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 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 2022 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.

Any forward-looking statement speaks only as of the date of this Quarterly 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.

The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated.

This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes presented elsewhere in this report, as well as the audited consolidated financial statements and related notes included in the 2022 Annual Report.

This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes presented elsewhere in this Quarterly Report, as well as the audited consolidated financial statements and related notes included in the 2022 Annual Report.

Shore Bancshares, Inc.

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

The Company also engages in title work for real estate transactions through Mid-MD Title.

The Company also engages in title work for real estate transactions through Mid-Maryland Title Company, Inc.

(“Title Company”).

As a result of the acquisition of TCFC, which was effective July 1, 2023, the Bank now operates 43 full-service branches in the above locations as well as Calvert County, St Mary’s County, and Charles County in Maryland and Fredericksburg City and Spotsylvania County in Virginia.

The shares of common stock of Shore Bancshares, Inc.

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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 the allowance for credit losses on loans 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 relating to the allowance for credit losses on loans 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.

Allowance for Credit Losses on Losses

Allowance for Credit Losses on Loans

The Company adopted ASU No.

2026-13, “Financial Instruments – Credit Losses (Topic 326)”, as amended, on January 1, 2023 and in accordance with ASC 326, has recorded an allowance for credit losses (“ACL”) on loans carried at amortized cost.

The ACL represents management’s best estimate of expected lifetime credit losses within the Company's loan portfolio as of the balance sheet date.

The allowance for credit losses is established through a provision for credit losses and is increased by recoveries of loans previously charged off.

The ACL represents management’s estimate of expected lifetime credit losses within the Company's loan portfolio as of the balance sheet date.

The ACL is established through a provision for credit losses and is increased by recoveries of loans previously charged off.

Loan losses are charged against the allowance when management's assessments confirm that the Company will not collect the full amortized cost basis of a loan.

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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.

The Company reported net income of $6.5 million for the first quarter of 2023, or diluted income per common share of $0.32, compared to net income of $5.6 million, or diluted income per common share of $0.28, for the first quarter of 2022.

For the fourth quarter of 2022, the Company reported net income of $8.4 million, or diluted income per common share of $0.42.

Net income, excluding merger related expenses, for the first quarter of 2023 was $7.0 million or $0.35 per diluted common share, compared to net income, excluding merger related expenses, of $9.1 million or $0.46 per diluted common share for the fourth quarter of 2022 and net income, excluding merger-related expenses, of $6.2 million or $0.31per diluted common share for the first quarter of 2022.

When comparing net income, excluding merger related expenses, for the first quarter of 2023 to the first quarter of 2022, net income increased $803 thousand, primarily due to increases in net interest income of $3.2 million, partially offset by a decrease in noninterest income of $712 thousand, coupled with increases in both noninterest expense of $600 thousand and provision for credit losses of $613 thousand.

When comparing the first quarter of 2023 to the fourth quarter of 2022, net income, excluding merger related expenses, decreased $2.2 million, due to decreases in net interest income of $1.3 million and noninterest income of $528 thousand, coupled with increases in in noninterest expense of $169 thousand and provision for credit losses of $763 thousand.

Merger-related expenses recorded for the first quarter of 2023 and the fourth quarter of 2022 were $691 thousand and $967 thousand, respectively.

The Company reported net income of $4.0 million for the second quarter of 2023, or diluted income per common share of $0.20, compared to net income of $7.5 million, or diluted income per common share of $0.38, for the second quarter of 2022.

For the first quarter of 2023, the Company reported net income of $6.5 million, or diluted income per common share of $0.32.

Net income, excluding merger related expenses, for the second quarter of 2023 was $4.9 million or $0.25 per diluted common share, compared to net income, excluding merger related expenses, of $7.0 million or $0.35 per diluted common share for the first quarter of 2023 and net income, excluding merger related expenses, of $7.7 million or $0.39 per diluted common share for the second quarter of 2022.

When comparing net income, excluding merger related expenses, for the second quarter of 2023 to the second quarter of 2022, net income decreased $2.8 million, primarily due to decreases in net interest income of $2.1 million and noninterest income of $539 thousand, coupled with increases in both noninterest expense of $558 thousand and provision for credit losses of $467 thousand.

When comparing the second quarter of 2023 to the first quarter of 2023, excluding merger related expenses, net income decreased $1.9 million, due to decreases in net interest income of $3.2 million and noninterest income of $40 thousand, coupled with an increase in noninterest expense of $209 thousand, partially offset by a decrease in provision for credit losses of $546 thousand.

Merger related expenses recorded for the second quarter of 2023 and the first quarter of 2023 were $1.2 million and $691 thousand, respectively.

For the first six months of 2023, the Company reported net income of $10.5 million, or diluted income per common share of $0.53, compared to net income of $13.1 million, or diluted income per common share of $0.66, for the first six months of 2022.

When comparing net income for the first six months of 2023 to the first six months of 2022, the decrease in net income was primarily due to a decrease in noninterest income of $1.3 million and an increase in noninterest expense of $2.1 million, partially offset by an increase in net interest income of $1.1 million.

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 $25.7 million for the first quarter of 2023 and $22.5 million for the first quarter of 2022.

Tax-equivalent net interest income was $26.9 million for the fourth quarter of 2022.

The increase in net interest income when comparing the first quarter of 2023 to the first quarter of 2022 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 FHLB short-term borrowings.

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

The net interest margin for the first quarter of 2023 was 3.18% which was an increase of 42bps when compared to 2.76% for the first quarter of 2022 and a decrease of 17bps when compared to 3.35% for the fourth quarter of 2022.

The improvement in net interest margin in the first quarter of 2023 when compared to the first quarter of 2022 was primarily due to significantly higher volume of interest earning assets as well as improved yields on such interest earning assets.

The decrease in net interest margin when compared to the fourth quarter of 2022 was primarily due to the increase in the average balance of FHLB short-term borrowings of $106.6 million and an increases rate of 98bps, resulting in $1.3 million in interest expense.

Interest Income

On a tax-equivalent basis, interest income increased $10.7 million, or 44.1%, for the first quarter of 2023 when compared to the first quarter of 2022.

As shown in the table below, tax-equivalent net interest income was $22.5 million for the second quarter of 2023 and $24.7 million for the second quarter of 2022.

Tax-equivalent net interest income was $25.7 million for the first quarter of 2023.

The decrease in net interest income when comparing the second quarter of 2023 to the second quarter of 2022 was due to increases in interest expense on interest-bearing deposits and FHLB short-term borrowings.

The Company’s net interest margin decreased to 2.68% for the second quarter of 2023 from 3.18% for the first quarter of 2023 and decreased compared to 3.10% for the second quarter of 2022.

The decrease in the net interest margin when compared to the first quarter of 2023 and the second quarter of 2022 was primarily due to increased funding costs as rates on deposits and borrowings increased at a faster pace than yields on loans as well as a change in the overall mix of interest-bearing liabilities.

The average balance of FHLB short -term borrowings increased from $114.0 million in the first quarter of 2023 to $261.8 million in the second quarter of 2023.

In addition, the migration of deposits from lower rate to higher rate accounts, specifically reciprocal deposits, contributed to the decrease in margins.

The modest increase in average loan yields during the second quarter of 2023 to 4.85% from 4.79% in the first quarter of 2023 was due to a change in the overall mix of loans with more loans onboarded from lower yielding consumer mortgages than higher yielding commercial portfolios.

Average consumer mortgage loans have increased from 33.0% of average loans in the fourth quarter of 2022 to 34.9% of average loans in the second quarter of 2023.

Management intends to significantly decrease consumer mortgage

portfolio production in the second half of 2023 and emphasize the mortgage loan production of saleable loans.

In addition, management intends to reduce the annualized growth rate on all loans to between 4%-6% in the second half of 2023.

I nterest Income

On a tax-equivalent basis, interest income increased $10.0 million, or 37.4%, for the second quarter of 2023 when compared to the second quarter of 2022.

The improvement to interest income was the result of increases in 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 $492.8 million coupled with an increase in the average yield of 60bps.

The average balance of taxable investment securities increased $122.5 million, providing $2.1 million of additional income.

On a tax-equivalent basis, interest income increased $2.8 million, or 8.6%, for the first quarter of 2023 when compared to the fourth quarter of 2022.

The primary driver for the increase in interest income growth in the average balance of $144.3 million, or 5.8% coupled with a higher average yield of 34bps.

The average balance of taxable investment securities increased $98.9 million and the average yield increased, providing $1.3 million of additional income.

On a tax-equivalent basis, interest income increased $1.6 million, or 4.5%, for the second quarter of 2023 when compared to the first quarter of 2023.

The primary driver for the increase in interest income was growth in the average balance of loans of $98.3 million, or 3.8%, coupled with a higher average yield of 6bps.

Interest Expense

Interest expense increased $7.5 million, or 396.1%, when comparing the first quarter of 2023 to the first quarter of 2022.

The increase in interest expense from the first quarter of 2022 was the result of increases in expenses on interest-bearing deposits of $5.9 million and FHLB short-term borrowings of $1.4 million, primarily a result of an increase in the average balance of FHLB short term borrowings of $114.0 million.

Interest expense increased $4.1 million, or 76.1%, when comparing the first quarter of 2023 to the fourth quarter of 2022 primarily due to increases in rates paid on interest-bearing liabilities.

These interest-bearing liabilities included increases in interest bearing deposits of 52bps and FHLB short-term borrowings of 98bps.

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 March 31, 2023 and 2022.

Interest expense increased $12.1 million, or 589.0%, when comparing the second quarter of 2023 to the second quarter of 2022.

The increase in interest expense from the second quarter of 2022 was due to increases in expenses on interest-bearing deposits of $8.4 million and FHLB short-term borrowings of $3.4 million, primarily a result of an increase in the rates paid on interest-bearing deposits and an increase in the average balance of FHLB short-term borrowings of $261.2 million.

Interest expense increased $4.7 million, or 50.5%, when comparing the second quarter of 2023 to the first quarter of 2023 primarily due to increases in rates paid on interest-bearing liabilities.

These interest-bearing liabilities included increases in the rate on interest-bearing deposits of 50bps and FHLB short-term borrowings of 44bps.

For Three Months Ended

March 31, 2023

March 31, 2022

June 30, 2023

June 30, 2022

(Dollars in thousands)

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Interest-bearing deposits

Advances from FHLB - short-term

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

Investment securities

(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.

Net Interest Income

Tax-equivalent net interest income increased $1.1 million, or 2.4%, during the six months ended June 30, 2023 compared to the six months ended June 30, 2022.

The increase in net interest income was primarily due to an increase in total interest income of $20.7 million, or 40.6%, with interest and fees on loans driving an increase of $18.0 million, or 39.6%.

The improvement of interest and fees on loans was primarily due to the increase in the average balance of loans of $472.8 million, or 21.6%.

Interest on investment securities increased $3.4 million, or 78.0%, primarily due to an increase in the average balance of $110.7 million, or 20.5%.

Total interest expense increased $19.6 million, or 496.5%, primarily due to a 135bps increase in rates paid on interest-bearing deposits.

In addition, an increase in the average balance of FHLB short-term borrowings of $188.3 million, or 100%, increased interest expense by $4.8 million.

Interest Income

On a tax-equivalent basis, interest income increased $20.7 million, or 40.6%, for the six months ended June 30, 2023 when compared to the six months ended June 30, 2022.

The increase was primarily due to higher interest and fees on loans of $18.0 million, or 39.5%, and increased interest income on taxable investment securities of $3.4 million, or 78.0%.

The increase in interest and fees on loans was due to a higher average balance of loans of $472.8 million, or 21.6%, and the increase in interest on taxable investment securities was due to a higher average balance in these securities of $110.7 million, or 20.5%.

Interest Expense

Total interest expense increased $19.6 million, or 496.5%, primarily due to a 135bps increase in rates paid on interest-bearing deposits.

In addition, an increase in the average balance of FHLB short term borrowings of $188.3 million, or 100%, increased interest expense by $4.8 million.

For Six Months Ended

June 30, 2023

June 30, 2022

(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

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Noninterest Income

Total noninterest income for the first quarter of 2023 decreased $712 thousand, or 11.8%, when compared to the first quarter of 2022.

The decrease from the first quarter of 2022 was primarily due to decreases in revenue associated with the mortgage division of $890 thousand, revenue from Mid-Maryland Title Company, Inc.

of $186 thousand and service charges on deposit accounts of $146 thousand partially offset by increases in interchange credits of $174 thousand, and other fees on bank services of $336 thousand.

Noninterest income decreased $528 thousand, or 9.0%, when compared to the fourth quarter of 2022 primarily due to a decrease in revenue associated with the mortgage division of $590 thousand and in service charges on deposit accounts $133 thousand.

Declines in noninterest income from the mortgage division are primarily attributable to the general rise in interest rates that continue to put pressure on the mortgage market, resulting in declines in home loan sales and home loan refinances.

Total noninterest income for the second quarter of 2023 decreased $40 thousand from $5.33 million to $5.29 million compared to the first quarter of 2023 and decreased $539 thousand, or 9.2%, when compared to $5.83 million in the second quarter of 2022.

The decrease compared to the first quarter of 2023 was primarily due to decreases in other loan and fee income, rental income and trust and investment fee income, partially offset by increases in interchange credits, mortgage banking revenue, service charges on deposit accounts, and revenue from the Title Company.

The decrease in noninterest income when compared to the second quarter of 2022 was primarily due to decreases in revenue from the Title Company, service charges on deposit accounts and revenue associated with mortgage banking, partially offset by increases in interchange credits and other fees on bank services .

Total noninterest income for the six months ended June 30, 2023 decreased $1.3 million, or 10.5%, when compared to the same period in 2022.

The decrease in noninterest income consisted of revenue associated with the mortgage division, title company revenue and service charges on deposit accounts, partially offset by an increase interchange credits and other noninterest income.

Noninterest Expense

Total noninterest expense for the first quarter of 2023, excluding merger-related expenses, increased $600 thousand, or 3.1%, when compared to the first quarter of 2022 and increased $169 thousand, or less than 1.0%, when compared to the fourth quarter of 2022.

The increase in noninterest expense when compared to the first quarter of 2022 was primarily due to other noninterest expenses, employee related benefits, data processing, legal and professional fees and furniture and equipment expense partially offset by decreases in salary expense due to deferred salaries based on loan originations in the first quarter of 2023.

The increase in noninterest expense when compared to the fourth quarter of 2022 was primarily due to increases in employee benefits and legal and professional fees offset by decreases in salaries due to an increase in deferred salaries based on loan originations in the fourth quarter of 2022.

Total noninterest expense, excluding merger related expenses, for the second quarter of 2023 increased $209 thousand to $20.4 million, or 1.0%, when compared to the first quarter of 2023 expense of $20.2 million and increased $558 thousand, or 2.8%, when compared to the second quarter of 2022 expense of $19.9 million.

The increase in noninterest expense when compared to the first quarter of 2023 was primarily due to increases in FDIC insurance premiums, salaries and wages and legal and professional fees partially offset by decreases in employee related benefits.

The increase from the second quarter of 2022 was primarily due to increases in FDIC insurance premiums, legal and professional fees and employee related benefits partially offset by decreases in other loan expense.

Total noninterest expense, excluding merger related expenses, for the six months ended June 30, 2023 increased $1.2 million, or 2.9%, when compared to the same period in 2022.

The increase was primarily the result of an increase in employee benefits, occupancy expense, other intangibles, data processing costs, other noninterest expenses, and FDIC insurance premiums due to recent volatility in the banking industry and additional legal and professional fees related to a larger overall organization.

Provision for Credit Losses

The provision for credit losses was $1.2 million for the first quarter of 2023, $600 thousand for the first quarter of 2022 and $450 thousand for the fourth quarter of 2022.

The increase in the provision for credit losses during the first quarter of 2022 as compared to the prior quarters was primarily a result of new loan growth of $112.6 million.

The ratio of the allowance for credit losses to period-end loans was 1.07% at March 31, 2023, 0.65% at December 31, 2022 and 0.67% at March 31, 2022.

The Company reported net charge offs in the first quarter of 2023 of $20 thousand, compared to net recoveries of $166 thousand for the first quarter of 2022 and net charge offs of $84 thousand for the fourth quarter of 2022.

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

The provision for the three months ended March 31, 2023 was comprised of $1.05 million related to the allowance for credit losses on loans and $163 thousand for the allowance for credit losses on held to maturity securities.

The Company reported income tax expense of $2.4 million for the first quarter of 2023, $1.9 million for the first quarter of 2022 and $2.9 million for the fourth quarter of 2022.

Income tax expense increased when compared to the first quarter of 2022 due to higher pre-tax earnings and decreased compared to the fourth quarter of 2022 due to lower pre-tax earnings.

The effective tax rate for the first quarter of 2023 was 27.4%, 26.0% for the fourth quarter of 2022, and 25.6% for the first quarter of 2022.

The higher effective tax rate in the first quarter of 2023 was the result of non-deductible merger related expenses.

The provision for credit losses was $667 thousand for the three months ended June 30, 2023.

The comparable amounts were $1.2 million and $200 thousand for the three months ended March 31, 2023, and June 30, 2022, respectively.

The provision for the second quarter of 2023 reflected the strong growth in total loans compared to the first quarter of 2023 and declined slightly based on the composition of growth and the Company’s evaluation of factors used in developing its estimate.

The increase in the provision when compared to the second quarter of 2022 was primarily a result of higher reserves required by the Company’s CECL allowance model as compared to the incurred loss model utilized in 2022.

Net charge-offs for the second quarter of 2023 were $50 thousand, compared to net charge-offs of $20 thousand for the first quarter of 2023 and net recoveries of $573 thousand for the second quarter of 2022.

The provision for credit losses for the six months ended June 30, 2023 and 2022 was $1.9 million and $800 thousand, respectively.

The increase in the provision for credit losses was the result of loan growth during the first six months of 2023 outpacing loan growth during the first six months of 2022 by $51.7 million as well as higher levels of reserves required by the Company’s CECL allowance model as compared to the incurred loss methodology utilized in 2022.

The Company reported income tax expense of $1.5 million for the second quarter of 2023, $2.7 million for the second quarter of 2022 and $2.4 million for the first quarter of 2023.

Income tax expense decreased when compared to the second quarter of 2022 and the first quarter of 2023 due to lower pre-tax earnings.

The effective tax rate for the second quarter of 2023 was 27.1%, 27.4% for the first quarter of 2023, and 26.2% for the second quarter of 2022.

Income tax expense was $3.9 million for the six months ended June 30, 2023, and $4.6 million for the six months ended June 30, 2022.

The effective

tax rate was 27.3% for the six months ended June 30, 2023, and 25.9% for the six months ended June 30, 2022.

The higher rate for the six months period in 2023 was due to an increase in merger-related nondeductible expenses and apportionment of earnings in states with higher tax rates.

ANALYSIS OF FINANCIAL CONDITION

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, 2023 and December 31, 2022, the fair value of loans held for sale amounted to $3.5 million and $4.2 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.

The Bank originates residential mortgage loans for sale on the secondary market, which are recorded at fair value.

At June 30, 2023 and December 31, 2022, the fair value of loans held for sale amounted to $6.8 million and $4.2 million, respectively.

The Bank makes certain representations to purchasers in the sale of the mortgage loans related to loan ownership, loan compliance and legality, and accurate documentation.

If a loan is found to be out of compliance with any of the representations subsequent to the date of purchase, the Bank 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, 2023 and December 31, 2022.

March 31, 2023

The following tables represent the composition of the Company’s loan portfolio at June 30, 2023 and December 31, 2022.

June 30, 2023

Loans acquired from

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Total loans, net

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $342.8 million in total loans remained outstanding as of March 31, 2023.

Excluding these loans and legacy PPP loans, total legacy loans increased $142.0 million, or 6.5%, when compared to December 31, 2022.

At March 31, 2023 and December 31, 2022, PPP loans accounted for $167 thousand and $187 thousand of total legacy loans, respectively.

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $332.4 million in total loans remained outstanding as of June 30, 2023.

Excluding these loans and PPP loans, total legacy loans increased $236.9 million, or 10.8%, when compared to December 31, 2022.

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 residential real estate loans of $68.5 million, or 10.1%, consumer loans of $28.8 million, or 10.1%, commercial real estate loans of $40.7 million or 4.6%, construction loans of $10.5 million, or 4.6%, partially offset by a decrease in commercial loans of $6.4 million, or 5.7%, at March 31, 2023 compared to December 31, 2022.

At March 31, 2023, the legacy loan portfolio, excluding PPP loans, was comprised of 39.6% commercial real estate, 32.2% residential real estate, 13.5% consumer, 10.2% construction and 4.5% commercial.

The increase in legacy loans, excluding PPP loans, was comprised of increases in residential real estate loans of $144.1 million, or 21.2%, consumer loans of $40.1 million, or 14.1% and commercial real estate loans of $78.6 million or 8.9%, partially offset by decreases in construction loans of $18.7 million, or 8.2%, and commercial loans of $7.2 million, or 6.5%, at June 30, 2023 compared to December 31, 2022.

At June 30, 2023, the legacy loan portfolio, excluding PPP loans, was comprised of 39.6% commercial real estate, 34.1% residential real estate, 13.4% consumer, 8.6% construction and 4.3% commercial.

That compares to 40.3%, 31.2%, 13.1%, 10.4% and 5.1%, respectively, at December 31, 2022.

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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 $250.4 million, or 9.4% of total loans, at March 31, 2023 and $246.3 million, or 9.6% of total loans, at December 31, 2022.

Commercial real estate loans were $1.10 billion, or 41.1% of total loans, at March 31, 2023, compared to $1.07 billion, or 41.7% of total loans, at December 31, 2022.

Construction loans were $220.2 million, or 8.0% of total loans, at June 30, 2023 and $246.3 million, or 9.6% of total loans, at December 31, 2022.

Commercial real estate loans were $1.13 billion, or 41.1% of total loans, at June 30, 2023, compared to $1.07 billion, or 41.7% of total loans, at December 31, 2022.

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

land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital;

or (2) total non-owner occupied commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s non-owner occupied commercial real estate loan portfolio (including construction) has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk.

Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital;

increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk.

Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital.

The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years.

At March 31, 2023, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 290.9% of total risk-based capital.

At June 30, 2023, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 287.5% of total risk-based capital.

At such time, construction, land and land development loans represented 60.9% of total risk-based capital.

4 unchanged sentences

Allowance for Credit Losses on Loans

The allowance for credit losses was $28.5 million at March 31, 2023, $16.6 million at December 31, 2022 and $14.7 million at March 31, 2022.

There were net charge-offs of $20 thousand for the first quarter of 2022, compared to net charge-offs of $84 thousand for the fourth quarter of 2022 and net recoveries of $166 thousand for the first quarter of 2022.

The ratio of annualized net charge-offs to average loans was 0.00% for the first quarter of 2023, compared to annualized net charge-offs of 0.01% for the fourth quarter of 2022 and annualized net recoveries of 0.03% for the first quarter of 2022.

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 1.07% at March 31, 2023 and 0.65% at December 31, 2022.

The following tables present a summary of the activity in the allowance for credit losses at or for the three months ended March 31, 2023 and 2022.

March 31, 2023

March 31, 2022

The allowance for credit losses was $29.0 million at June 30, 2023, $16.6 million at December 31, 2022 and $15.5 million at June 30, 2022.

There were net charge-offs of $50 thousand for the second quarter of 2023, compared to net charge-offs of $20 thousand for the first quarter of 2023 and net recoveries of $573 thousand for the second quarter of 2022.

The ratio of annualized net charge-offs to average loans was 0.01% for the second quarter of 2023, compared to annualized net charge-offs of 0.00% for the first quarter of 2023 and annualized net recoveries of 0.10% for the second quarter of 2022.

Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming loans to enable the Company to maintain overall credit quality.

The allowance for credit losses on loans as a percentage of period-end loans was 1.05% at June 30, 2023 and 0.65% at December 31, 2022.

The following tables present a summary of the activity in the allowance for credit losses at or for the three and six months ended June 30, 2023 and 2022.

For the Three Months Ended

June 30, 2023

June 30, 2022

Percentage of net

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

(1) At March 31, 2023 and March 31, 2022, these ratios included all loans held for investment, including PPP loans of $167 thousand and $14.9 million, respectively.

(1) At June 30, 2023 and June 30, 2022, these ratios included all loans held for investment, including PPP loans of $148 thousand and $1.7 million, respectively.

(2) For 2023, this ratio excludes only PPP loans given the Company’s adoption of the CECL standard.

For periods in 2022, this ratio excludes PPP loans and loans acquired in the Severn and Northwest acquisition.

(3) At March 31, 2023 and March 31, 2022, these ratios included all loans held for investment, including average PPP loans of $176 thousand and $18.9 million, respectively.

For periods in 2022, this ratio excludes PPP loans and loans acquired in the Severn and Northwest branch acquisitions.

(3) At June 30, 2023 and June 30, 2022, these ratios included all loans held for investment, including average PPP loans of $157 thousand and $7.6 million, respectively.

For the Six Months Ended

June 30, 2023

June 30, 2022

Percentage of net

charge-offs (recoveries)

(annualized) to

average loans

Net (charge-offs)

(Dollars in thousands)

Average balances

during the year

Average balances

during the year

Residential real estate

Commercial real estate

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 total period end loans (2)

Allowance for credit losses at period end as a percentage of average loans (3)

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

(1) At June 30, 2023 and June 30, 2022, these ratios included all loans held for investment, including PPP loans of $148 thousand and $1.7 million, respectively.

(2) For 2023, this ratio excludes only PPP loans given the Company’s adoption of the CECL standard.

For periods in 2022, this ratio excludes PPP loans and loans acquired in the Severn and Northwest branch acquisitions.

(3) At June 30, 2023 and June 30, 2022, these ratios included all loans held for investment, including average PPP loans of $166 thousand and $13.0 million, respectively.

Nonperforming Assets

As shown in the following table, nonperforming assets were $2.7 million at March 31, 2023 and $3.9 million at December 31, 2022.

The balance of nonperforming asset decreased primarily due to a decrease in total loans 90 days or more past due and still accruing of $1.2 million, or 66.8%.

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

The efforts to accomplish this goal include frequently contacting borrowers until the delinquency is cured or until an acceptable payment plan has been agreed upon;

obtaining updated appraisals;

provisioning for credit losses;

charging-off loans;

transferring loans to other real estate owned;

aggressively marketing other real estate owned.

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

The following table summarizes our nonperforming assets at March 31, 2023 and December 31, 2022.

As shown in the following table, nonperforming assets were $4.7 million at June 30, 2023 and $3.9 million at December 31, 2022.

The balance of nonperforming assets increased primarily due to an increase in total nonaccrual loans of $1.6 million, or 82.4%.

The following table summarizes our nonperforming assets at June 30, 2023 and December 31, 2022.

(Dollars in thousands)

March 31, 2023

June 30, 2023

December 31, 2022

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Investment Securities

The investment portfolio is comprised of debt and equity securities.

The investment portfolio includes debt and equity securities.

Securities are classified as either available for sale or held to maturity.

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

At March 31, 2023, 14.2% of the portfolio of debt securities was classified as available for sale and 85.8% was classified as held to maturity, compared to 14.5% and 85.5% respectively, at December 31, 2022.

At June 30, 2023, 12.7% of the portfolio of debt securities was classified as available for sale and 87.3% was classified as held to maturity, compared to 14.5% and 85.5% respectively, at December 31, 2022.

See Note 3 – “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 $647.0 million at March 31, 2023, an $8.5 million, or 1.3%, decrease since December 31, 2022.

At March 31, 2023, 75.3% of the securities available for sale were mortgage-backed, 22.5% were U.S.

Investment securities, including restricted stock, totaled $637.5 million at June 30, 2023, a $18.0 million, or 2.7%, decrease since December 31, 2022.

At June 30, 2023, 74.5% of the securities available for sale were mortgage-backed, 23.1% were U.S.

Government agencies and 2.3% were corporate bonds, compared to 76.0%, 21.7% and 2.3%, respectively, at year-end 2022.

At March 31, 2023, 70.2% of the securities held to maturity were mortgage-backed, 27.5% were U.S.

At June 30, 2023, 69.8% of the securities held to maturity were mortgage-backed, 27.9% were U.S.

Government agencies, 2.0% were subordinated debt instruments and less than 1% were community reinvestment bonds, compared to 70.4%, 27.2%, 2.1% and less than 1%, respectively, at year-end 2022.

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Government agencies or government-sponsored agencies.

Total deposits at March 31, 2023 amounted to $2.99 billion, a decrease of $15.2 million, or less than 1%, when compared to the level at December 31, 2022.

The decrease in total deposits consisted of a decrease in money market and savings accounts of $58.2 million and $53.3 million in noninterest bearing deposits partially offset by an increase in time deposits of $64.2 million and an increase in interest bearing checking accounts of $32.0 million.

Total estimated uninsured deposits amounted to $839.4 million and $871.5 million at March 31, 2023 and December 31, 2022, respectively.

Total deposits at June 30, 2023 amounted to $2.94 billion, a decrease of $72.3 million, or 2.4%, when compared to the level at December 31, 2022.

The decrease in total deposits consisted of a decrease in money market and savings accounts of $157.3 million and $83.1 million in noninterest bearing deposits partially offset by an increase in total time deposits of $168.0 million.

The decrease in money market and savings accounts was mainly due to competitive market pressures for these products.

The decrease in noninterest bearing deposits were mainly due to a shift to higher yielding accounts.

Total estimated uninsured deposits were $503.5 million or 17.1% of total deposits at June 30, 2023 and $671.1 million or 22.3% of total deposits at December 31, 2022.

Short-Term Borrowings

The Company had $131.5 million of short-term borrowings consisting of short-term advances with the FHLB as of March 31, 2023, compared to short-term borrowings consisting of advances with the FHLB of $40.0 million at December 31, 2022.

The Company had $276.0 million of short-term borrowings consisting of short-term advances with the FHLB as of June 30, 2023, compared to short-term borrowings consisting of advances with the FHLB of $40.0 million at December 31, 2022.

This increase was due to funding needs as a result of the decrease in deposits and the increase in loans.

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

At March 31, 2023 and December 31, 2022, the Company had no securities sold under agreements to repurchase or overnight borrowings from correspondent banks.

At June 30, 2023 and December 31, 2022, the Company had no securities sold under agreements to repurchase or overnight borrowings from correspondent banks.

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.

There were no long-term borrowings from the FHLB outstanding at March 31, 2023 and December 31, 2022.

There were no long-term borrowings from the FHLB outstanding at June 30, 2023 and December 31, 2022.

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% of Fixed-to-Floating Rate Subordinated Notes due September 1, 2030.

As a result of the Severn merger, the Company acquired Junior Subordinated Debt Securities due in 2035 which had an outstanding principal balance of $20.6 million.

The debt balance of $18.4 million at March 31, 2023 and December 31, 2022 was presented net of a fair value adjustment of $2.2 million.

The debt balance of $18.5 million at June 30, 2023 and $18.4 million at December 31, 2022 was presented net of a fair value adjustment of $2.1 million and $2.2 million, respectively.

Liquidity and Capital Resources

We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $17.8 million for the first three months of 2023 compared to a decrease of $12.6 million for the first three months of 2022.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $9.7 million for the first six months of 2023 compared to a decrease of $180.6 million for the first six months of 2022.

The decrease in cash and cash equivalents in 2023 was mainly due to funding net loan growth of $196.2 million.

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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 $283.5 million and $298.9 million at March 31, 2023 and December 31, 2022, respectively.

Through the FHLB, the Bank had available lendable collateral of approximately $264.4 million and $298.9 million at June 30, 2023 and December 31, 2022, 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 decreased $2.6 million, or less than 1%, to $361.6 million at March 31, 2023 when compared to December 31, 2022 primarily due to a Day 1 CECL adjustment of ($7.8) million, partially offset by current year earnings of $6.5 million and a decrease in unrealized losses on available for sale securities of $860 thousand.

Total stockholders’ equity decreased $1.1 million, or less than 1%, to $363.1 million at June 30, 2023 when compared to December 31, 2022 primarily due to a $7.8 million CECL adjustment in the first quarter of 2023 and dividends paid of $4.8 million, partially offset by $10.5 million in current year earnings.

The Bank and the 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.

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.

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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 Bank and the Company were deemed “well capitalized” under applicable regulatory capital requirements at March 31, 2023.

The following tables present the applicable capital ratios for the Company and the Bank as of March 31, 2023 and December 31, 2022.

The Bank and the Company were deemed “well capitalized” under applicable regulatory capital requirements at June 30, 2023.

The following tables present the applicable capital ratios for the Company and the Bank as of June 30, 2023 and December 31, 2022.

Common Equity

March 31, 2023

June 30, 2023

capital ratio

9 unchanged sentences

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