Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Unless the context clearly suggests otherwise, references to “the Company”, “we”, “our”, and “us” in the remainder of this report are to Shore Bancshares, Inc. and its consolidated subsidiaries.
Forward-Looking Information
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. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “project,” “projection,” “forecast,” “goal,” “target,” “would,” “aim” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry and management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. The inclusion of these forward-looking statements should not be regarded as a representation by us or any other person that such expectations, estimates and projections will be achieved. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence. 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 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 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.
Introduction
The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes presented elsewhere in this Quarterly Report, as well as the audited consolidated financial statements and related notes included in the 2022 Annual Report.
Shore Bancshares, Inc. is the largest independent financial holding company headquartered on the Eastern Shore of Maryland. It is the parent company of Shore United Bank, N.A. The Bank operates 30 full-service branches in Baltimore County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County, Anne Arundel County and Worcester County in Maryland, Kent County and Sussex County in Delaware and in Accomack County, Virginia. The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank, N.A. The 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. are listed on the NASDAQ Global Select Market under the symbol “SHBI”.
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Shore Bancshares, Inc. maintains an Internet site at www.shorebancshares.com on which it makes available free of charge its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.
The most significant accounting policies that the Company follows are presented in Note 1 of the 2022 Annual Report along with Note 2 of the current period interim financial information. 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 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 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 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. The calculation of expected credit losses is determined using cash flow methodology, and includes considerations of historical experience, current conditions, and reasonable and supportable economic forecasts that may affect collection of the recorded balances. The Company assesses an ACL to groups of loans which share similar risk characteristics or on an individual basis, as deemed appropriate. Changes in the ACL on loans, and as a result, the related provision for credit losses, can materially affect financial results. Although the overall balance is determined based on specific portfolio segments and individually assessed assets, the entire balance is available to absorb credit losses for loans in the portfolio.
The determination of the appropriate level of ACL on loans inherently involves a high degree of subjectivity and requires the Company to make significant judgments concerning credit risks and trends using quantitative and qualitative information, as well as reasonable and supportable forecasts of future economic conditions, all of which may undergo frequent and significant changes. Changes in conditions, including unforeseen events, changes in asset-specific risk characteristics, and other economic factors, both within and outside the Company's control, may indicate the need for an increase or decrease in the ACL on loans. While management makes every effort to utilize the best information available in making its assessment of the ACL estimate, the estimation process is inherently challenging as potential changes in any one factor or input may occur at different rates and/or impact pools of loans in different ways. Further, changes in factors and inputs may also be directionally inconsistent, such that improvement in one factor may offset deterioration in others.
The Company’s management reviews the adequacy of the ACL on loans on at least a quarterly basis. Refer to Note 2, “Adoption of Accounting Standards”, of the interim consolidated financial information for additional detail concerning the determination of the ACL on loans.
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Goodwill
Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Determining fair value is subjective, requiring the use of estimates, assumptions and management judgment. Goodwill is tested at least annually for impairment, usually during the fourth quarter, or on an interim basis if circumstances dictate. Impairment testing requires a qualitative assessment or that the fair value of each of the Company’s reporting units be compared to the carrying amount of its net assets, including goodwill. 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.
OVERVIEW
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
Net Interest Income
Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments. As shown in the table below, tax-equivalent net interest income was $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
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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 $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 $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.
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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 June 30, 2023 and 2022.
For Three Months Ended
For Three Months Ended
June 30, 2023
June 30, 2022
Average
Income(1)/
Yield/
Average
Income(1)/
Yield/
(Dollars in thousands)
Balance
Expense
Rate
Balance
Expense
Rate
Earning assets
Loans (2), (3)
$
2,709,944
$
32,780
4.85
%
$
2,217,139
$
23,490
4.25
%
Investment securities:
Taxable
645,178
3,729
2.32
546,252
2,392
1.75
Tax-exempt
664
6
3.62
—
—
—
Interest-bearing deposits
13,397
170
5.09
426,535
826
0.78
Total earning assets
3,369,183
36,685
4.37
%
3,189,926
26,708
3.36
%
Cash and due from banks
29,923
26,162
Other assets
225,935
218,353
Allowance for credit losses
(28,730)
(15,273)
Total assets
$
3,596,311
$
3,419,168
Interest-bearing liabilities
Demand deposits
$
685,674
3,913
2.29
%
$
644,881
354
0.22
%
Money market and savings deposits
907,068
2,526
1.12
1,019,295
522
0.21
Certificates of deposit $100,000 or more
312,367
2,337
3.00
234,325
337
0.58
Other time deposits
225,495
1,138
2.03
221,714
298
0.54
Interest-bearing deposits
2,130,604
9,914
1.87
2,120,215
1,511
0.29
Advances from FHLB - short-term
261,797
3,449
5.28
—
—
—
Advances from FHLB - long-term
—
—
—
10,075
15
0.60
Subordinated debt
43,185
776
7.21
42,876
527
4.93
Total interest-bearing liabilities
2,435,586
14,139
2.33
%
2,173,166
2,053
0.38
%
Noninterest-bearing deposits
778,058
872,883
Other liabilities
19,442
19,927
Stockholders’ equity
363,225
353,192
Total liabilities and stockholders’ equity
$
3,596,311
$
3,419,168
Net interest spread
$
22,546
2.04
%
$
24,655
2.98
%
Net interest margin
2.68
%
3.10
%
Tax-equivalent adjustment
Loans
$
51
$
38
Investment securities
1
—
Total
$
52
$
38
(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.
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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
For Six Months Ended
June 30, 2023
June 30, 2022
Average
Income(1)/
Yield/
Average
Income(1)/
Yield/
(Dollars in thousands)
Balance
Expense
Rate
Balance
Expense
Rate
Earning assets
Loans (2), (3)
$
2,661,066
$
63,646
4.82
%
$
2,188,236
$
45,614
4.20
%
Investment securities:
Taxable
649,329
7,793
2.42
538,676
4,377
1.64
Tax-exempt
665
15
4.55
—
—
—
Interest-bearing deposits
13,622
333
4.93
506,224
1,080
0.43
Total earning assets
3,324,682
71,787
4.35
%
3,233,136
51,071
3.19
%
Cash and due from banks
29,266
5,569
Other assets
226,989
224,219
Allowance for credit losses
(29,364)
(14,759)
Total assets
$
3,551,573
$
3,448,165
Interest-bearing liabilities
Demand deposits
$
690,258
7,149
2.09
%
$
617,461
582
0.19
%
Money market and savings deposits
955,541
4,899
1.03
1,048,634
1,120
0.22
Certificates of deposit $100,000 or more
277,096
3,413
2.48
260,312
623
0.48
Other time deposits
216,500
1,734
1.62
198,828
544
0.55
Interest-bearing deposits
2,139,395
17,195
1.62
2,125,235
2,869
0.27
Securities sold under retail repurchase agreements and federal funds purchased
—
—
—
1,377
2
0.29
Advances from FHLB - short-term
188,293
4,810
5.15
—
—
—
Advances from FHLB - long-term
—
—
—
10,096
29
0.58
Subordinated debt
43,147
1,532
7.16
42,840
1,046
4.92
Total interest-bearing liabilities
2,370,835
23,537
2.00
%
2,179,548
3,946
0.37
%
Noninterest-bearing deposits
798,994
893,282
Other liabilities
19,539
22,233
Stockholders’ equity
362,205
353,102
Total liabilities and stockholders’ equity
$
3,551,573
$
3,448,165
Net interest spread
$
48,250
2.35
%
$
47,125
2.82
%
Net interest margin
2.93
%
2.94
%
Tax-equivalent adjustment
Loans
$
89
$
77
Investment securities
3
—
Total
$
92
$
77
(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.
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Noninterest Income
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, 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 $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.
Income Taxes
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
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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
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.
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Loans Held for Investment
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
(Dollars in thousands)
Legacy Loans
Severn acquisition
Total Loans
Construction
$
208,230
$
11,998
$
220,228
Residential real estate
824,497
113,654
938,151
Commercial real estate
957,911
172,435
1,130,346
Commercial
104,597
33,714
138,311
Consumer
325,425
614
326,039
Total loans excluding PPP loans
2,420,660
332,415
2,753,075
PPP loans
148
—
148
Total loans
$
2,420,808
$
332,415
$
2,753,223
Allowance for credit losses
(29,014)
Total loans, net
$
2,724,209
December 31, 2022
Loans acquired from
(Dollars in thousands)
Legacy Loans
Severn acquisition
Total Loans
Construction
$
226,908
$
19,411
$
246,319
Residential real estate
680,423
130,074
810,497
Commercial real estate
879,265
186,144
1,065,409
Commercial
111,826
35,843
147,669
Consumer
285,315
711
286,026
Total loans excluding PPP loans
2,183,737
372,183
2,555,920
PPP loans
187
—
187
Total loans
$
2,183,924
$
372,183
$
2,556,107
Allowance for credit losses
(16,643)
Total loans, net
$
2,539,464
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 $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. We do not engage in foreign or subprime lending activities. See Note 5, “Loans and Allowance for Credit Losses”, in the Notes to Consolidated Financial Statements and below under the caption “Allowance for Credit Losses” for additional information.
Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans. Construction loans were $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. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total non-owner occupied commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s non-owner occupied commercial real estate loan portfolio (including construction) has
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increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years. At June 30, 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.
The commercial real estate portfolio (including construction) has increased 94.4% during the prior 36 months. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, as well as strong underwriting criteria with respect to its commercial real estate portfolio. Monitoring practices include periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital or be required to sell/participate portions of loans, which may adversely affect shareholder returns.
Allowance for Credit Losses on Loans
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.
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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
Percentage of net
charge-offs (recoveries)
charge-offs (recoveries)
(annualized) to
(annualized) to
average loans
average loans
Net (charge-offs)
outstanding
Net (charge-offs)
outstanding
(Dollars in thousands)
Average balances
recoveries
during the year
Average balances
recoveries
during the year
Construction
$
228,689
$
4
(0.01)
%
$
253,742
$
4
(0.01)
%
Residential real estate
902,353
3
-
670,999
69
(0.04)
Commercial real estate
1,109,044
—
-
932,782
549
(0.24)
Commercial
138,067
1
-
164,944
(50)
0.12
Consumer
324,454
119
0.07
177,531
1
-
Total
$
2,702,607
$
127
0.01
%
$
2,199,998
$
573
(0.10)
%
Allowance for credit losses at period end as a percentage of total period end loans (1)
1.05
%
0.68
%
Allowance for credit losses at period end as a percentage of total period end loans (2)
1.05
%
0.89
%
Allowance for credit losses at period end as a percentage of average loans (3)
1.07
%
0.70
%
Allowance for credit losses at period end as a percentage of period end nonaccrual loans
833.50
%
574.94
%
(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 $157 thousand and $7.6 million, respectively.
For the Six Months Ended
June 30, 2023
June 30, 2022
Percentage of net
Percentage of net
charge-offs (recoveries)
charge-offs (recoveries)
(annualized) to
(annualized) to
average loans
average loans
Net (charge-offs)
outstanding
Net (charge-offs)
outstanding
(Dollars in thousands)
Average balances
recoveries
during the year
Average balances
recoveries
during the year
Construction
$
238,540
$
7
(0.01)
%
$
253,156
$
7
(0.01)
%
Residential real estate
869,069
34
(0.01)
658,108
115
(0.04)
Commercial real estate
1,094,387
—
-
917,956
699
(0.15)
Commercial
139,975
8
(0.01)
169,525
(74)
0.09
Consumer
312,877
(119)
0.08
169,298
(8)
0.01
Total
$
2,654,848
$
(70)
0.01
%
$
2,168,043
$
739
(0.07)
%
Allowance for credit losses at period end as a percentage of total period end loans (1)
1.05
%
0.68
%
Allowance for credit losses at period end as a percentage of total period end loans (2)
1.05
%
0.89
%
Allowance for credit losses at period end as a percentage of average loans (3)
1.09
%
0.71
%
Allowance for credit losses at period end as a percentage of period end nonaccrual loans
833.50
%
574.94
%
(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.
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Nonperforming Assets
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)
June 30, 2023
December 31, 2022
Nonperforming assets
Nonaccrual loans
$
3,481
$
1,908
Total loans 90 days or more past due and still accruing
1,050
1,841
Other real estate owned
179
197
Total nonperforming assets
$
4,710
$
3,946
As a percent of total loans:
Nonaccrual loans
0.13
%
0.07
%
As a percent of total loans and other real estate owned:
Nonperforming assets
0.17
%
0.15
%
As a percent of total assets:
Nonaccrual loans
0.10
%
0.05
%
Nonperforming assets
0.13
%
0.11
%
Investment Securities
The investment portfolio includes debt and equity securities. Securities are classified as either available for sale or held to maturity. Investment securities available for sale are stated at estimated fair value based on quoted prices. They represent securities which may be sold as part of the asset/liability management strategy or in response to changing interest rates. Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income (loss), a separate component of stockholders’ equity.
Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts and the allowance for credit losses. We have the intent and ability to hold such securities until maturity. 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 $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 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. Our investments in mortgage-backed securities are issued or guaranteed by U.S. Government agencies or government-sponsored agencies.
Deposits
Total deposits at June 30, 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.
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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 $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. Other short-term borrowings may consist of overnight borrowing from correspondent banks or securities sold under agreements to repurchase, primarily with commercial depositors. Short-term advances are defined as those with original maturities of one year or less. 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 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 $18.5 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 $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.
To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets. The Bank has arrangements with other correspondent banks whereby it has $15 million available in federal funds lines of credit and a reverse repurchase agreement available to meet any short-term needs which may not otherwise be funded by the Bank’s portfolio of readily marketable investments that can be converted to cash. The Bank is also a member of the FHLB, which provides another source of liquidity. Through the FHLB, the Bank had 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 $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
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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.
Quantitative measures established by regulation to ensure capital adequacy require the Bank and the Company to maintain minimum ratios of common equity Tier 1, Tier 1, and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1,250%. The Bank and Company are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. The 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.
Tier 1
Common Equity
Tier 1
Total
leverage
Tier 1
risk-based
risk-based
June 30, 2023
ratio
ratio
capital ratio
capital ratio
Shore Bancshares, Inc.
9.09
%
11.04
%
11.72
%
13.69
%
Shore United Bank
9.38
%
12.07
%
12.07
%
13.15
%
Tier 1
Common Equity
Tier 1
Total
leverage
Tier 1
risk-based
risk-based
December 31, 2022
ratio
ratio
capital ratio
capital ratio
Shore Bancshares, Inc.
9.52
%
11.62
%
12.33
%
13.91
%
Shore United Bank
9.92
%
12.82
%
12.82
%
13.47
%
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.