SHORE BANCSHARES INC 10-Q

Item 1. Financial Statements. SHORE BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) September 30, 2023 December 31, 2022 ASSETS (Unaudited) Cash and due from banks $ 68,097 $ 37,661 Interest-bearing deposits with other banks 40,612 17,838 Cash and cash equivalents 108,709 55,499 Investment securities: Available-for-sale, at fair value (amortized cost of $ 93,052 (2023) and $ 95,999 (2022)) 79,143 83,587 Held to maturity, net of allowance for credit losses of $ 126 (2023) (fair value of $ 445,652 (2023) and $ 494,627 (2022)) 523,051 559,455 Equity securities, at fair value 5,434 1,233 Restricted securities, at cost 13,361 11,169 Loans held for sale, at fair value 14,725 4,248 Loans held for investment ($ 9,302 (2023) and $ 8,437 (2022), at fair value) 4,617,719 2,556,107 Less: allowance for credit losses ( 57,051 ) ( 16,643 ) Loans, net 4,560,668 2,539,464 Premises and equipment, net 81,149 51,488 Goodwill 63,266 63,266 Core deposit intangible, net 50,685 5,547 Other real estate owned, net 179 197 Mortgage servicing rights, at fair value 5,890 5,275 Right-of-use assets 12,741 9,629 Cash surrender value on life insurance 100,950 59,218 Accrued interest receivable 15,683 9,384 Deferred income taxes 48,699 7,357 Other assets 24,392 11,260 TOTAL ASSETS $ 5,708,725 $ 3,477,276 LIABILITIES Deposits: Noninterest-bearing $ 1,211,401 $ 862,015 Interest-bearing 3,897,343 2,147,769 Total deposits 5,108,744 3,009,784 Advances from FHLB - short-term — 40,000 Guaranteed preferred beneficial interest in junior subordinated debentures ("TRUPS") 29,079 18,398 Subordinated debt 42,956 24,674 Total borrowings 72,035 83,072 Lease liabilities 13,082 9,908 Other liabilities 9,933 10,227 TOTAL LIABILITIES 5,203,794 3,112,991 STOCKHOLDERS' EQUITY Common stock, par value $ .01 per share; shares authorized - 35,000,000 ; shares issued and outstanding - 33,136,182 (2023) and 19,864,956 (2022) 331 199 Additional paid in capital 355,575 201,494 Retained earnings 159,134 171,613 Accumulated other comprehensive loss ( 10,109 ) ( 9,021 ) TOTAL STOCKHOLDERS' EQUITY 504,931 364,285 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,708,725 $ 3,477,276 See accompanying notes to Consolidated Financial Statements. 3 Table of Contents SHORE BANCSHARES, INC. CONSOLIDATED STATEMENTS OF (LOSS)/INCOME (Unaudited) For Three Months Ended September 30, For Nine Months Ended September 30, (In thousands, except per share data) 2023 2022 2023 2022 INTEREST INCOME Interest and fees on loans $ 64,869 $ 25,924 $ 128,424 $ 71,458 Interest and dividends on taxable investment securities 5,047 3,186 12,840 7,562 Interest and dividends on tax-exempt investment securities 27 — 41 — Interest on federal funds sold 92 — 92 — Interest on deposits with other banks 1,213 1,466 1,546 2,546 Total interest income 71,248 30,576 142,943 81,566 INTEREST EXPENSE Interest on deposits 23,473 2,561 40,668 5,429 Interest on short-term borrowings 692 — 5,501 2 Interest on long-term borrowings 1,461 700 2,992 1,776 Total interest expense 25,626 3,261 49,161 7,207 NET INTEREST INCOME 45,622 27,315 93,782 74,359 Provision for credit losses 28,176 675 30,056 1,475 NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 17,446 26,640 63,726 72,884 NONINTEREST INCOME Service charges on deposit accounts 1,505 1,509 3,981 4,306 Trust and investment fee income 1,933 421 2,764 1,383 Loss on sales and calls of investment securities ( 2,166 ) — ( 2,166 ) — Interchange credits 1,557 1,241 4,081 3,532 Mortgage-banking revenue 1,377 680 3,408 3,643 Title Company revenue 89 397 412 1,146 Bargain purchase gain 12,169 — 12,169 — Other noninterest income 1,873 1,096 4,317 3,214 Total noninterest income 18,337 5,344 28,966 17,224 NONINTEREST EXPENSE Salaries and wages 14,183 8,562 31,822 27,022 Employee benefits 3,607 2,191 8,968 7,122 Occupancy expense 2,245 1,496 5,463 4,548 Furniture and equipment expense 750 533 1,761 1,370 Data processing 2,485 1,759 6,022 5,034 Directors' fees 295 217 730 617 Amortization of core deposit intangible 2,634 499 3,510 1,528 FDIC insurance premium expense 618 339 1,747 1,111 Other real estate owned expenses, net 2 1 2 52 Legal and professional fees 1,217 756 2,926 2,204 Merger-related expenses 14,866 159 16,754 1,130 Other noninterest expenses 4,256 2,387 9,956 7,585 Total noninterest expense 47,158 18,899 89,661 59,323 (Loss)/income before income taxes ( 11,375 ) 13,085 3,031 30,785 Income tax (benefit) expense ( 4,991 ) 3,427 ( 1,060 ) 8,016 NET (LOSS) INCOME $ ( 6,384 ) $ 9,658 $ 4,091 $ 22,769 Basic and diluted net (loss) income per common share $ ( 0.19 ) $ 0.49 $ 0.17 $ 1.15 Dividends paid per common share $ 0.12 $ 0.12 $ 0.36 $ 0.36 See accompanying notes to Consolidated Financial Statements. 4 Table of Contents SHORE BANCSHARES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)/INCOME (Unaudited) For Three Months Ended September 30, For Nine Months Ended September 30, (In thousands) 2023 2022 2023 2022 Net (loss) income $ ( 6,384 ) $ 9,658 $ 4,091 $ 22,769 Other comprehensive loss: Investment securities: Unrealized holding losses on available-for-sale-securities ( 2,132 ) ( 4,307 ) ( 1,498 ) ( 13,533 ) Tax effect 584 1,177 410 3,696 Total other comprehensive loss ( 1,548 ) ( 3,130 ) ( 1,088 ) ( 9,837 ) Comprehensive (loss) income $ ( 7,932 ) $ 6,528 $ 3,003 $ 12,932 See accompanying notes to Consolidated Financial Statements. 5 Table of Contents SHORE BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited) For the Three and Nine Months Ended September 30, 2023 and 2022 (In thousands) Common Stock Additional Paid in Capital Retained Earnings Accumulated Other Comprehensive (Loss) Income Total Stockholders’ Equity Balances, January 1, 2023 $ 199 $ 201,494 $ 171,613 $ ( 9,021 ) $ 364,285 Cumulative effect adjustment due to the adoption of ASC 326, net of tax — — ( 7,818 ) — ( 7,818 ) Net income — — 6,457 — 6,457 Other comprehensive income — — — 860 860 Common shares issued for employee stock purchase plan — 87 — — 87 Stock-based compensation — 155 — — 155 Cash dividends declared — — ( 2,388 ) — ( 2,388 ) Balances, March 31, 2023 $ 199 $ 201,736 $ 167,864 $ ( 8,161 ) $ 361,638 Net income $ — $ — $ 4,018 $ — $ 4,018 Other comprehensive loss — — — ( 400 ) ( 400 ) Common shares issued for employee stock purchase plan — 102 — — 102 Stock-based compensation — 170 — — 170 Cash dividends declared — — ( 2,388 ) — ( 2,388 ) Balances, June 30, 2023 $ 199 $ 202,008 $ 169,494 $ ( 8,561 ) $ 363,140 Net loss $ — $ — $ ( 6,384 ) $ — $ ( 6,384 ) Other comprehensive loss — — — ( 1,548 ) ( 1,548 ) TCFC acquisition 132 152,954 — — 153,086 Common shares issued for employee stock purchase plan — 84 — — 84 Stock-based compensation — 529 — — 529 Cash dividends declared — — ( 3,976 ) — ( 3,976 ) Balances, September 30, 2023 $ 331 $ 355,575 $ 159,134 $ ( 10,109 ) $ 504,931 6 Table of Contents SHORE BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited) - Continued (In thousands) Common Stock Additional Paid in Capital Retained Earnings Accumulated Other Comprehensive (Loss) Income Total Stockholders’ Equity Balances, January 1, 2022 $ 198 $ 200,473 $ 149,966 $ 56 $ 350,693 Net Income — — 5,613 — 5,613 Other comprehensive loss — — — ( 2,228 ) ( 2,228 ) Common shares issued for employee stock purchase plan — 37 — — 37 Stock-based compensation — 130 — — 130 Cash dividends declared — — ( 2,381 ) — ( 2,381 ) Balances, March 31, 2022 $ 198 $ 200,640 $ 153,198 $ ( 2,172 ) $ 351,864 Net Income $ — $ — $ 7,499 $ — $ 7,499 Other comprehensive loss — — — ( 4,479 ) ( 4,479 ) Common shares issued for employee stock purchase plan — 102 — — 102 Stock-based compensation — 172 — — 172 Cash dividends declared — — ( 2,381 ) — ( 2,381 ) Balances, June 30, 2022 $ 198 $ 200,914 $ 158,316 $ ( 6,651 ) $ 352,777 Net Income $ — $ — $ 9,658 $ — $ 9,658 Other comprehensive loss — — — ( 3,130 ) ( 3,130 ) Common shares issued for employee stock purchase plan 1 124 — — 125 Stock-based compensation — 175 — — 175 Cash dividends declared — — ( 2,384 ) — ( 2,384 ) Balances, September 30, 2022 $ 199 $ 201,213 $ 165,590 $ ( 9,781 ) $ 357,221 See accompanying notes to Consolidated Financial Statements. 7 Table of Contents SHORE BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For Nine Months Ended September 30, (In thousands) 2023 2022 CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 4,091 $ 22,769 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Net accretion of acquisition accounting estimates ( 6,672 ) ( 1,225 ) Provision for credit losses 30,056 1,475 Depreciation and amortization 6,847 4,253 Net amortization of securities 724 1,121 Amortization of debt issuance costs 92 92 Bargain purchase gain ( 12,169 ) — (Gain) on mortgage banking activities ( 2,602 ) ( 2,526 ) Proceeds from sale of mortgage loans held for sale 80,846 128,595 Originations of loans held for sale ( 89,485 ) ( 98,020 ) Stock-based compensation expense 853 477 Deferred income tax (benefit) ( 934 ) ( 723 ) Losses on sales and calls of securities 2,166 — Loss (Gain) on valuation adjustments on mortgage servicing rights 5 ( 459 ) Valuation adjustments on premises transferred to held for sale 271 — (Gain) Loss on sales and valuation adjustments on other real estate owned ( 3 ) 44 Fair value adjustments on loans held for investments, at fair value 492 — Fair value adjustment on equity securities 177 162 Bank owned life insurance income ( 1,305 ) ( 702 ) Net changes in: Accrued interest receivable 2,810 ( 721 ) Other assets ( 10,145 ) ( 304 ) Accrued interest payable 1,192 ( 217 ) Other liabilities ( 20,663 ) ( 4,030 ) Net cash (used in) provided by operating activities ( 13,356 ) 50,061 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities and principal payments of investment securities available for sale 12,304 16,719 Proceeds from the sale of acquired AFS securities 434,215 — Proceeds from maturities and principal payments of investment securities held to maturity 35,023 40,603 Proceeds from sale of loans held for investment 8,611 — Purchases of securities held to maturity — ( 207,466 ) Purchases of equity securities ( 41 ) ( 12 ) Purchase of restricted securities ( 26,076 ) ( 5,735 ) Net change in loans ( 297,999 ) ( 280,874 ) Purchases of premises and equipment ( 3,654 ) ( 2,274 ) Proceeds from sales of other real estate owned 21 394 Improvements to other real estate owned — ( 34 ) Redemption of restricted securities 28,224 — Purchases of bank owned life insurance ( 187 ) ( 10,131 ) Proceeds from disposal of premises held for sale 721 — Cash acquired in the acquisition of TCFC, net of cash paid 25,372 — Net cash provided by (used in) investing activities 216,534 ( 448,810 ) 8 Table of Contents SHORE BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) - Continued For Nine Months Ended September 30, (In thousands) 2023 2022 CASH FLOWS FROM FINANCING ACTIVITIES: Net changes in: Noninterest-bearing deposits ( 239,293 ) ( 33,689 ) Interest-bearing deposits 206,804 23,156 Short-term borrowings ( 109,000 ) ( 4,143 ) Common stock dividends paid ( 8,752 ) ( 7,146 ) Issuance of common stock 273 264 Net cash provided by (used in) financing activities ( 149,968 ) ( 21,558 ) Net increase (decrease) in cash and cash equivalents 53,210 ( 420,307 ) Cash and cash equivalents at beginning of period 55,499 583,613 Cash and cash equivalents at end of period $ 108,709 $ 163,306 Supplemental cash flows information: Interest paid $ 47,243 $ 7,705 Income taxes paid $ 7,894 $ 7,070 Recognition (remeasurement of) lease liabilities arising from right-of-use assets $ 45 $ ( 616 ) Transfers from loans to other real estate owned $ — $ 69 Unrealized losses on securities available for sale $ ( 1,498 ) $ ( 13,533 ) Transfer of premises to held for sale (included in other assets) $ 750 $ — See accompanying notes to Consolidated Financial Statements. 9 Table of Contents Shore Bancshares, Inc. Notes to Consolidated Financial Statements For the Three and Nine Months Ended September 30, 2023 and 2022 (Unaudited) Note 1 – Basis of Presentation The consolidated financial statements include the accounts of Shore Bancshares, Inc. and its subsidiaries with all significant intercompany transactions eliminated. The consolidated financial statements conform to accounting principles generally accepted in the United States of America (“GAAP”) and to prevailing practices within the banking industry. The accompanying interim financial statements are unaudited; however, in the opinion of management all adjustments necessary to present fairly the consolidated financial position at September 30, 2023, the consolidated results of income and comprehensive income for the three and nine months ended September 30, 2023 and 2022, changes in stockholders’ equity for the three and nine months ended September 30, 2023 and 2022 and cash flows for the nine months ended September 30, 2023 and 2022, have been included. All such adjustments were of a normal recurring nature. The amounts as of December 31, 2022 were derived from the 2022 audited financial statements. The results of operations for the three and nine months ended September 30, 2023 are not necessarily indicative of the results to be expected for any other interim period or for the full year. This Quarterly Report on Form 10-Q should be read in conjunction with the Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2022. For purposes of comparability, certain immaterial reclassifications have been made to amounts previously reported to conform with the current period presentation. When used in these notes, the term “the Company” refers to Shore Bancshares, Inc. and, unless the context requires otherwise, its consolidated subsidiaries, Shore United Bank, N.A. (the “Bank”) and Mid-Maryland Title Company, Inc. (the “Title Company”). Pending Recent Accounting Standards ASU No. 2022-03 - In June 2022, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2022-03, “Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions”. ASU 2022-03 clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. The ASU is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted. The Company does not expect the adoption of ASU 2022-03 to have a material impact on its consolidated financial statements. Note 2 – Adoption of Accounting Standards On January 1, 2023, the Company adopted ASU 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,” ASU 2019-05, “Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief,” ASU 2019-10, “Financial instruments – Credit losses (Topic 326), Derivatives and hedging (Topic 815), and Leases (Topic 842) – Effective dates,” ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2020-02, “Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842),” ASU 2020-03, “Codification Improvements to Financial Instruments” and ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326) – Troubled Debt Restructurings and Vintage Disclosures” (collectively, ASC 326). The significant impacts of adopting these standards and related updates to the Company’s accounting policies are discussed below. ASC 326 requires entities to estimate an allowance for credit losses (“ACL”) on certain types of financial instruments measured at amortized cost using a current expected credit losses (“CECL”) methodology, replacing the incurred loss methodology from prior GAAP. It also applies to unfunded commitments to extend credit, including loan commitments, standby letters of credit, and other similar instruments. The impairment model for available-for-sale (“AFS”) debt securities was modified and ASC 326 also provided for a simplified accounting model for purchased financial assets with credit deterioration since their origination. Additionally, the measurement principles for modifications of loans to borrowers experiencing financial difficulty were modified, including how the ACL is measured for such loans. The amendments of ASC 326, upon adoption, were applied on a modified retrospective basis, by recording an increase in the reported balance of loans and the allowance for credit losses on loans, an increase in the liability for credit losses on commitments to extend credit and reducing total equity of both the Company and the Bank. As a result of adopting ASC 326, the Company recorded a decrease to opening retained earnings, net of taxes, of approximately $ 7.8 million. ASC 326 also replaced the Company’s previous accounting policies for purchased credit-impaired (“PCI”) loans and troubled-debt restructurings (“TDRs”). With the adoption of ASC 326, loans previously designated as PCI loans were designated as purchased loans with credit deterioration (“PCD loans”). The Company adopted ASC 326 using the prospective transition approach for PCD loans that were previously identified as PCI and accounted for under ASC 310-30. On January 1, 2023, the Company’s PCD loans were adjusted to reflect the addition of expected credit losses to the amortized cost basis of the loans and a corresponding increase to the ACL. The remaining 10 Table of Contents noncredit discount, which represents the difference between the adjusted amortized cost basis and the outstanding principal balance on PCD loans, will be accreted into interest income over the estimated remaining lives of the loans using the effective interest rate method. The evaluation of the ACL will include PCD loans together with other loans that share similar risk characteristics, rather than using the separate pools that were used under PCI accounting, unless the loans are specifically identified for individual evaluation under our CECL methodology. The adoption of ASC 326 also replaced previous TDR accounting guidance, and the evaluation of the ACL will include loans previously designated as TDRs together with other loans that share similar risk characteristics, unless the loans are specifically identified for individual evaluation under our CECL methodology. The following table shows the impact of the Company's adoption of ASC 326 on loans, the ACL, and the Company’s reserve for unfunded commitments. January 1, 2023 (Dollars in thousands) As Reported Under ASC 326 Pre-ASC 326 Adoption Change Total Loans, gross $ 2,556,267 $ 2,556,107 $ 160 Allowance for credit losses ( 27,434 ) ( 16,643 ) ( 10,791 ) Total loans, net $ 2,528,833 $ 2,539,464 $ ( 10,631 ) Liabilities: Reserve for Unfunded Commitments $ 581 $ 316 $ 265 As discussed in Note 3, the Company completed the merger with The Community Financial Corporation (“TCFC”) on July 1, 2023. Due to inconsistencies with historical loan loss data between the Bank and TCFC, management updated the methodology used to estimate the probability of default and the independent economic variables used to forecast default rates. Due to the lack of uniformity of historical data used for probability default data between the legacy banks, management concluded that the exclusive use of either legacy model was inappropriate in a post-merger environment. As a result, management engaged the model vendor to perform a Loss Driver Analysis ("LDA"), which utilized the legacy Shore United and legacy CBTC’s Call Report data to derive gross loan balances and charge-off data on a quarterly basis dating back to 2004. Using this data, the vendor performed regression analyses of a number of independent economic variables to determine the "best fit" of the economic variable to be used as a predictor of expected losses or the periodic default rate ("PDR"). Loss Given Default (“LGD”) values were calculated utilizing Frye-Jacobs model using the same historical gross-charge-off data derived from the Call Reports. In conjunction with our change in methodology used to derive the PDR/LGD, management also reassessed our qualitative factor overlay design. The following table shows the impact of change in methodology. (Dollars in thousands) Balance as of June 30, 2023 Impact of methodology change Balance as of adoption of methodology change Construction $ 2,386 $ 33 $ 2,419 Residential real estate 9,151 4,016 13,167 Commercial real estate 10,267 1,065 11,332 Commercial 1,956 442 2,398 Consumer 5,254 1,791 7,045 Total allowance $ 29,014 $ 7,347 $ 36,361 The following accounting policies have been updated in connection with the adoption of ASC 326 and apply to periods beginning after December 31, 2022. Accounting policies applying to prior periods are described in the 2022 Annual Report, as discussed above. Investments in Debt Securities Investments in debt securities are classified as either held to maturity (“HTM”), AFS, or trading, based on management’s intent. Currently, the Company has classified its debt securities within the AFS and HTM classifications. Debt securities purchased with the positive intent and ability to hold to maturity are classified as HTM and are recorded at amortized cost, net of any ACL. Debt securities not classified as HTM are classified as AFS and are carried at estimated fair value with the corresponding unrealized gains and losses recognized in other comprehensive income (loss). Gains or losses are recognized in net income on the trade date using the amortized cost of the specific security sold. Purchase premiums are recognized in interest income using the effective interest rate method over the period from purchase to maturity or, for callable securities, the earliest call date, and purchase discounts are recognized in the same manner from purchase to maturity. 11 Table of Contents The Company has elected to exclude accrued interest receivable from the amortized cost basis and fair value of its HTM and AFS debt securities and has included such accrued interest of $ 2.0 million at September 30, 2023 within the accrued interest receivable line item of the Consolidated Balance Sheets. The Company estimates an ACL for held to maturity debt securities on a collective basis by major security type and standard credit rating. Certain securities in our HTM securities portfolio are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major rating agencies and have a long history of no credit losses. With respect to these securities, we consider the risk of credit loss to be zero and, therefore, we do not record an ACL. The estimate of an ACL on our HTM securities that are not guaranteed by the U.S. government considers historical credit loss information and severity of loss in the event of default and leverages external data. No ACL is recorded on accrued interest receivable and amounts written-off are reversed by an adjustment to interest income. An ACL on held to maturity debt securities that do not share common risk characteristics with our collective portfolio are individually measured based on net realizable value, or the difference between the discounted value of the expected future cash flows and the recorded amortized cost basis of the security. For debt securities AFS, impairment is recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that the Company will be required to sell the security before recovery, the Company evaluates unrealized losses to determine whether a decline in fair value below amortized cost basis is a result of a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security, or other factors such as changes in market interest rates. If a credit loss exists, an ACL is recorded that reflects the amount of the impairment related to credit losses, limited by the amount by which the specific security’s amortized cost basis exceeds its fair value. Changes in the ACL are recorded in net income in the period of change and are included in provision for credit losses. Changes in the fair value of debt securities AFS not resulting from credit losses are recorded in other comprehensive income (loss). The Company regularly reviews unrealized losses in its investments in securities and cash flows expected to be collected from impaired securities based on criteria including the extent to which market value is below amortized cost, the financial health of and specific prospects for the issuer, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery. Loans Held for Investment The Company’s recorded investment in loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally is reported at the unpaid principal balances adjusted for charges-offs, unearned discounts, any deferred fees or costs on originated loans, and the ACL. The Company has elected to exclude accrued interest receivable from the amortized cost basis of its loans held for investment and has included such accrued interest of $ 13.6 million at September 30, 2023 within the accrued interest receivable line item of the Consolidated Balance Sheets. Interest on loans is recorded to interest income based on the contractual rates and the amount of outstanding principal of the loans. Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield using the level-yield method. Loans acquired in a business combination are recorded at estimated fair value on the date of acquisition. In the case of loans that have experienced more than insignificant deterioration in credit quality since origination as of the acquisition date, the loan’s amortized cost basis is increased above estimated fair value by the amount of expected credit losses as of the acquisition date, and a corresponding ACL is also recorded. A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain. Any accrued interest receivable on loans placed on nonaccrual status is reversed by an adjustment to interest income. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. Interest payments received on nonaccrual loans are applied as a reduction of the loan principal balance unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. In the ordinary course of business, the Company has entered into commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the Consolidated Balance Sheets when they are funded. In the normal course of banking business, risks related to specific loan categories are as follows: Construction loans – Construction loans are offered primarily to builders and individuals to finance the construction of single-family dwellings. In addition, the Bank periodically finances the construction of commercial projects. Credit risk factors include the borrower’s ability to successfully complete the construction on time and within budget, changing market conditions which could affect the value and 12 Table of Contents marketability of projects, changes in the borrower’s ability or willingness to repay the loan and potentially rising interest rates which can impact both the borrower’s ability to repay and the collateral value. Residential real estate – Residential real estate loans are typically made to consumers and are secured by residential real estate. Credit risk arises from the borrower’s continuing financial stability, which can be adversely impacted by job loss, divorce, illness, or personal bankruptcy, among other factors. Also impacting credit risk would be a shortfall in the value of the residential real estate in relation to the outstanding loan balance in the event of a default or subsequent liquidation of the real estate collateral. Commercial real estate – Commercial real estate loans consist of both loans secured by owner occupied properties and non-owner occupied properties where an established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of occupancy and cash flow. These loans are subject to adverse changes in the local economy and commercial real estate markets. Credit risk associated with owner occupied properties arises from the borrower’s financial stability and the ability of the borrower and the business to repay the loan. Non-owner occupied properties carry the risk of a tenant’s deteriorating credit strength, lease expirations in soft markets and sustained vacancies which can adversely impact cash flow. Commercial – Commercial loans are secured or unsecured loans for business purposes. Loans are typically secured by accounts receivable, inventory, equipment and/or other assets of the business. Credit risk arises from the successful operation of the business which may be affected by competition, rising interest rates, regulatory changes and adverse conditions in the local and regional economy. Consumer – Consumer loans include installment loans and personal lines of credit. Credit risk is similar to residential real estate loans above as it is subject to the borrower’s continuing financial stability and the value of the collateral securing the loan. ACL on Loans Held for Investment An ACL is estimated on loans held for investment, excluding loans carried at fair value. The ACL on loans is established through charges to earnings in the form of a provision for credit losses. Loan losses are charged against the ACL for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance represents management’s current estimate of expected credit losses over the contractual term of loans held for investment, and is recorded at an amount that, in management’s judgment, reduces the recorded investment in loans to the net amount expected to be collected. No ACL is recorded on accrued interest receivable and amounts written-off are reversed by an adjustment to interest income. Management’s judgment in determining the level of the allowance is based on evaluations of historical loan losses, current conditions and reasonable and supportable forecasts relevant to the collectability of loans. The methodology for estimating the amount reported in the ACL is the sum of two main components, an allowance assessed on a collective basis for pools of loans that share similar risk characteristics and an allowance assessed on individual loans that do not share similar risk characteristics with other loans . Loans that share common risk characteristics are evaluated collectively using a cash flow approach. The discounted cash flow approach used by the Company utilizes loan-level cash flow projections and pool-level assumptions. For loans that do not share risk characteristics with other loans, the ACL is measured based on the net realizable value, that is, the difference between the discounted value of the expected future cash flows and the amortized cost basis of the loan. When a loan is collateral-dependent and the repayment is expected to be provided substantially through the operation or sale of the collateral, the ACL is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral. Cash flow projections and estimated expected losses on loans which share common risk characteristics are based in part on forecasts economic independent variables, namely the national unemployment rate, 10 year Treasury rate and changes in GDP that are reasonable and supportable over a twelve month period and incorporated into the estimate of expected credit losses using a statistical regression analysis. For periods beyond those for which reasonable and supportable forecasts are available, projections are based on a reversion of the corresponding economic independent variable from the last forecast to a historical average level over the following twelve months. Management’s estimate of the ACL on loans that are collectively evaluated also includes a qualitative assessment of available information relevant to assessing collectability that is not captured in the quantitative loss estimation process. Factors considered by management include changes in general market, economic and business conditions; the nature and volume of the loan portfolio; the volume and severity of delinquencies and adversely classified loan balances and the value of underlying collateral; and other factors as deemed necessary and appropriate. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Reserve for Unfunded Commitments The Company records a reserve, reported in other liabilities, for expected credit losses on commitments to extend credit that are not unconditionally cancellable by the Company. The reserve for unfunded commitments is measured based on the principles utilized in estimating the ACL on loans and an estimate of the amount of unfunded commitments expected to be advanced. Changes in the reserve for unfunded commitments are recorded through the provision for credit losses. During the three and nine months ended September 30, 2023, the Company recorded a $ 241,000 and $ 308,000 , respectively, provision for credit losses associated with its unfunded commitments. 13 Table of Contents Note 3 – Business Combinations On July 1, 2023 (the “Acquisition Date”), the Company completed the acquisition of TCFC, a Maryland charted commercial bank, in accordance with the definitive agreement that was entered into on December 14, 2022, by and among the Company and TCFC. The primary reasons for the merger included: expansion of the branch network and commanding market share positions in attractive Maryland markets and a growing presence in Virginia and Delaware; attractive low-cost funding base; strong cultural alignment and a deep commitment to shareholders, customers, employees, and communities served by Shore and TCFC, meaningful value creation to shareholders; and increased trading liquidity for both companies and increased dividends for TCFC shareholders. In connection with the completion of the merger, former TCFC shareholders received 2.3287 shares of the Company’s common stock. The value of the total transaction consideration was approximately $ 153.6 million. The consideration included the issuance of 13,201,693 shares of the Company’s common stock, which had a value of $ 11.56 per share, which was the closing price of the Company’s common stock on June 30, 2023, the last trading day prior to the consummation of the acquisition. Also included in the total consideration were cash in lieu of any fractional shares, converted share-based payment awards, and debt of TCFC that was effectively settled upon closing. The acquisition of TCFC was accounted for as a business combination using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid are recorded at estimated fair values on the Acquisition Date. The provisional amount of bargain purchase gain as of the Acquisition Date was approximately $ 12.2 million. The exchange ratio was determined at the time of announcement of the merger between the Company and TCFC in December of 2022 when the stock price of the Company was much higher than at the legal merger date. The decline in the Company’s stock price was the primary driver in recording a bargain purchase gain on this transaction. The decline in stock price for the Company was comparable to other financial institutions similar to the Company leading up to the merger due to bank failures in the first quarter of 2023 and increases to overnight borrowing rates by the Fed which resulted in continued pressure on net interest margins. The Company will continue to keep the measurement of bargain purchase gain open for any additional adjustments to the fair value of certain accounts, for example loans, that may arise during the Company’s final review procedures of any updated information. If considered necessary, any subsequent adjustments to the fair value of assets acquired and liabilities assumed, identifiable intangible assets, or other purchase accounting adjustments will result in adjustments to bargain purchase gain within the first 12 months following the Acquisition Date. The bargain purchase gain is not expected to be included as taxable income for tax purposes. As a a result of the integration of operations of TCFC, it is not practicable to determine revenue or net income included in the Company’s consolidated operating results relating to TCFC since the Acquisition Date, as TCFC’s results cannot be separately identified. Comparative pro-forma financial statements for the prior year period were not presented, as adjustments to those statements would not be indicative of what would have occurred had the acquisition taken place on January 1, 2022. In particular, adjustments that would have been necessary to be made to record the loans at fair value, the provision of credit losses or the core deposit intangible would not be practical to estimate. 14 Table of Contents (Dollars in thousands) Purchase Price Consideration: Shore Bancshares, Inc. common stock paid at closing price of $ 11.56 as of June 30, 2023 $ 152,612 Effective settlement of pre-existing debt (1) 500 Cash consideration (cash in lieu for fractional shares) 5 Fair value of converted restricted stock units (2) 475 Total purchase price $ 153,592 Identifiable assets: Cash and cash equivalents $ 25,377 Total securities 454,468 Loans, net 1,765,255 Premises and equipment, net 29,277 Core deposit intangible, net 48,648 Other assets 93,161 Total identifiable assets $ 2,416,186 Identifiable Liabilities Deposits $ 2,131,141 Total debt 97,545 Other liabilities 21,739 Total identifiable liabilities $ 2,250,425 Provisional fair value of net assets acquired $ 165,761 Provisional bargain purchase gain $ ( 12,169 ) ____________________________________ (1) SHBI held $ 500,000 in subordinated debt of TCFC. The debt was effectively settled. (2) Represents the number of TCFC restricted stock units outstanding and the equity exchange ratio, further multiplied by the price per share of SHBI common stock of $ 11.56 and the estimated ratio of the completed service period relative to the total service period of the underlying awards. The Company recorded all loans acquired at the estimated fair value on the acquisition date with no carryover of the related allowance for loan losses. The Company determined the net discounted value of cash flows on gross loans totaling $ 1.9 billion, including 3,858 of Non-PCD loans and 323 PCD loans. The valuation took into consideration the loans’ underlying characteristics, including account types, remaining terms, annual interest rates, interest types, past delinquencies, timing of principal and interest payments, current market rates, loan-to-loan value ratios, loss exposures, and remaining balances. These Non-PCD loans were segregated into pools based on loan and payment type. The effect of the valuation process was a total net discount $ 120.9 million at the Acquisition Date. 15 Table of Contents Note 4 – Investment Securities On January 1, 2023, the Company adopted ASC 326, which made changes to accounting for AFS debt securities whereby credit losses should be presented as an allowance, rather than as a write-down when management does not intend to sell and does not believe that it is more likely than not they will be required to sell prior to maturity. In addition, ASC 326 requires an ACL to be recorded on HTM debt securities measured at amortized cost. All securities information presented as of September 30, 2023 is in accordance with ASC 326. All securities information presented as of December 31, 2022 or a prior date is presented in accordance with previously applicable GAAP. For further discussion on the Corporation’s accounting policies and policy elections related to the accounting standard update refer to Note 2. The following table summarizes the activity in the ACL on HTM securities. (Dollars in thousands) Three Months Ended September 30, 2023 Nine Months Ended September 30, 2023 Balance, beginning of period $ 163 $ — Other debt securities, provision for credit losses ( 37 ) 126 Balance, end of period $ 126 $ 126 The ACL for HTM securities was initially determined to be immaterial as of the date of adoption of ASC 326. Upon re-estimation in the third quarter of 2023, an ACL recovery of $ 37,000 was recorded based on the results of our evaluation at September 30, 2023. The provision for credit losses of $ 126,000 was recorded for the nine months ended September 30, 2023. The following tables provide information on the amortized cost and estimated fair values of debt securities. (Dollars in thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value Available-for-sale securities: September 30, 2023 U.S. Government agencies $ 23,622 $ 4 $ 3,995 $ 19,631 Mortgage-backed-residential 63,371 — 9,798 53,573 Other debt securities 6,059 26 146 5,939 Total $ 93,052 $ 30 $ 13,939 $ 79,143 December 31, 2022 U.S. Government agencies $ 21,798 $ 5 $ 3,625 $ 18,178 Mortgage-backed-residential 72,183 2 8,666 63,519 Other debt securities 2,018 — 128 1,890 Total $ 95,999 $ 7 $ 12,419 $ 83,587 No AFS securities were sold from the Company’s legacy securities’ portfolios during the three and nine months ended September 30, 2023 and 2022. The Company sold virtually all of the AFS securities portfolio acquired from TCFC immediately after the legal merger with the proceeds of $ 430.0 million, and recognized gross losses of $ 2.2 million from the sale of securities. 16 Table of Contents (Dollars in thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value Allowance for Credit Losses Held-to-maturity securities: September 30, 2023 U.S. Government agencies $ 143,494 $ — $ 14,873 $ 128,621 $ — Mortgage-backed-residential 367,712 — 61,177 306,535 — States and political subdivisions 1,471 2 68 1,405 — Other debt securities 10,500 — 1,409 9,091 126 Total $ 523,177 $ 2 $ 77,527 $ 445,652 $ 126 December 31, 2022 U.S. Government agencies $ 148,097 $ — $ 13,601 $ 134,496 $ — Mortgage-backed-residential 398,884 — 50,464 348,420 — States and political subdivisions 1,474 35 28 1,481 — Other debt securities 11,000 — 770 10,230 — Total $ 559,455 $ 35 $ 64,863 $ 494,627 $ — Equity securities with an aggregate fair value of $ 5.4 million at September 30, 2023 and $ 1.2 million at December 31, 2022 are presented separately on the balance sheet. The fair value adjustment recorded through earnings totaled $ 0.3 million for the nine months ended September 30, 2023 and $ 0.1 million for the nine months ended September 30, 2022, respectively. Credit Quality Information The Company monitors the credit quality of HTM securities through credit ratings provided by Standard & Poor’s Rating Services and Moody’s Investor Services. Credit ratings express opinions about the credit quality of a security, and are updated at each quarter end. Investment grade securities are rated BBB- or higher by S&P and Baa3 or higher by Moody’s and are generally considered by the rating agencies and market participants to be of low credit risk. Conversely, securities rated below investment grade, which are labeled as speculative grade by the rating agencies, are considered to have distinctively higher credit risk than investment grade securities. There were no speculative grade HTM securities at September 30, 2023 or December 31, 2022. HTM securities that are not rated are agency mortgage-backed securities sponsored by U.S. government agencies, as well as direct obligations of the agencies, with the remainder being sub-debt of other banks. The following table shows the amortized cost of HTM securities based on their lowest publicly available credit rating as of September 30, 2023. September 30, 2023 Investment Grade (Dollars in thousands) Aaa Aa1 A3 Baa1 Baa2 NR Total U.S. Government agencies $ 143,494 $ — $ — $ — $ — $ — $ 143,494 Mortgage-backed-residential 367,712 — — — — — 367,712 States and political subdivisions — 1,471 — — — — 1,471 Other debt securities — — 4,000 4,000 500 2,000 10,500 Total Held-to Maturity Securities $ 511,206 $ 1,471 $ 4,000 $ 4,000 $ 500 $ 2,000 $ 523,177 The following tables provide information about gross unrealized losses and fair value by length of time that the individual securities have been in a continuous unrealized loss position at September 30, 2023 and December 31, 2022. Less than 12 Months More than 12 Months Total (Dollars in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses September 30, 2023 Available-for-sale securities: U.S. Government agencies $ 596 $ 1 $ 16,352 $ 3,994 $ 16,948 $ 3,995 Mortgage-backed-residential 433 4 53,140 9,794 53,573 9,798 Other debt securities — — 1,866 146 1,866 146 Total $ 1,029 $ 5 $ 71,358 $ 13,934 $ 72,387 $ 13,939 17 Table of Contents Less than 12 Months More than 12 Months Total (Dollars in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses December 31, 2022 Available-for-sale securities: U.S. Government agencies $ 1,165 $ 4 $ 16,585 $ 3,621 $ 17,750 $ 3,625 Mortgage-backed-residential 29,125 2,409 34,167 6,257 63,292 8,666 Other debt securities 1,890 128 — — 1,890 128 Total $ 32,180 $ 2,541 $ 50,752 $ 9,878 $ 82,932 $ 12,419 Held-to-maturity securities: U.S. Government agencies $ 67,332 $ 2,786 $ 67,163 $ 10,815 $ 134,495 $ 13,601 Mortgage-backed-residential 148,771 9,402 199,649 41,062 348,420 50,464 States and political subdivisions 780 28 — — 780 28 Other debt securities 8,091 409 2,139 361 10,230 770 Total $ 224,974 $ 12,625 $ 268,951 $ 52,238 $ 493,925 $ 64,863 There were 116 AFS debt securities with a fair value below the amortized cost basis, totaling $ 13.9 million of aggregate fair value as of September 30, 2023. The Company concluded that a credit loss does not exist in its AFS securities portfolio as of September 30, 2023, and no impairment loss has been recognized based on the fact that (1) changes in fair value were caused primarily by fluctuations in interest rates, (2) securities with unrealized losses had generally high credit quality, (3) the Company intends to hold these investments in debt securities to maturity and it is more-likely-than-not the Company will not be required to sell these investments before a recovery of its investment, and (4) issuers have continued to make timely payments of principal and interest. Additionally, the Company’s mortgage-back securities are issued by either U.S. government agencies or U.S. government sponsored enterprises. Collectively, these entities provide a guarantee, which is either explicitly or implicitly supported by the full faith and credit of the U.S. government, that investors in such mortgage-backed securities will receive timely principal and interest payments. All HTM and AFS securities were current with no securities past due or on nonaccrual as of September 30, 2023. The Company has securities which have been pledged as collateral for obligations to federal, state, and local government agencies, and other purpose as required or permitted by law, or sold under agreements to repurchase. At September 30, 2023, the carrying value of pledged AFS securities was $ 53.3 million and $ 180.7 million of pledged HTM securities. The comparable amounts for December 31, 2022 were $ 72.1 million and $ 19.2 million, respectively. The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at September 30, 2023. Available for sale Held to maturity (Dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Due in one year or less $ 2,478 $ 2,479 $ 7,000 $ 6,873 Due after one year through five years 16,520 15,113 119,922 110,186 Due after five years through ten years 31,108 27,144 52,517 45,947 Due after ten years 42,946 34,407 343,738 282,646 Total $ 93,052 $ 79,143 $ 523,177 $ 445,652 The maturity dates for debt securities are determined using contractual maturity dates. 18 Table of Contents Note 5 – Loans and Allowance for Credit Losses On January 1, 2023, the Company adopted ASC 326. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables. For further discussion on the most significant accounting policies that the Company follows see Note 2 – Adoption of Accounting Standards and Note 1 of the Company’s 2022 Annual Report on Form 10-K. All loan information presented as of September 30, 2023 is in accordance with ASC 326. All loan information presented as of December 31, 2022, or a prior date is presented in accordance with previously applicable GAAP. The Company makes residential mortgage, commercial, and consumer loans to customers primarily in Anne Arundel County, Baltimore County, Charles County, Calvert County, St Mary’s County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County and Worcester County in Maryland, Kent and Sussex County, Delaware and in Accomack County and Spotsylvania County in Virginia. The following table provides information about the principal classes of the loan portfolio at September 30, 2023 and December 31, 2022. (Dollars in thousands) September 30, 2023 % of Total Loans December 31, 2022 % of Total Loans Construction $ 328,750 7.12 % $ 246,319 9.64 % Residential real estate 1,439,464 31.17 % 810,497 31.71 % Commercial real estate 2,283,521 49.45 % 1,065,409 41.68 % Commercial 229,474 4.97 % 147,856 5.78 % Consumer 330,411 7.16 % 286,026 11.19 % Credit Cards 6,099 0.13 % — — % Total loans 4,617,719 100.00 % 2,556,107 100.00 % Allowance for credit losses on loans ( 57,051 ) ( 16,643 ) Total loans, net $ 4,560,668 $ 2,539,464 Loans are stated at their principal amount outstanding net of any purchase premiums/discounts, deferred fees and costs. Included in loans were deferred costs, net of fees, of $ 2.0 million and $ 1.4 million at September 30, 2023 and December 31, 2022. At September 30, 2023 and December 31, 2022, included in total loans were $ 307.8 million and $ 372.2 million in loans, acquired as part of the acquisition of Severn Bancorp, Inc. (“Severn”), effective October 31, 2021. These balances were presented net of the related discount which totaled $ 4.9 million and $ 6.7 million at September 30, 2023 and December 31, 2022, respectively. At September 30, 2023 included in total loans were $ 1.7 billion acquired as part of the acquisition of TCFC, effective July 1, 2023. These balances were presented net of the related discount which totaled $ 109.8 million at September 30, 2023. The following purchased credit deteriorated loans were acquired in connection with the merger on the Acquisition Date. (Dollars in Thousands) Par Value Purchase Discount Allowance Purchase Price Construction $ 177 $ ( 11 ) $ ( 3 ) $ 163 Residential real estate 8,379 ( 1,157 ) ( 215 ) 7,007 Commercial real estate 55,779 ( 6,864 ) ( 985 ) 47,930 Commercial 2,137 ( 59 ) ( 278 ) 1,800 Consumer 519 ( 35 ) ( 14 ) 470 Credit Card 999 ( 144 ) ( 18 ) 837 Total $ 67,990 $ ( 8,270 ) $ ( 1,513 ) $ 58,207 At September 30, 2023, the Bank was servicing $ 361.8 million in loans for the Federal National Mortgage Association and $ 100.8 million in loans for Freddie Mac. 19 Table of Contents The following table provides information on nonaccrual loans by loan class as of September 30, 2023. (Dollars in thousands) Non-accrual with no allowance for credit loss Non-accrual with an allowance for credit loss Total Non-accruals September 30, 2023 Nonaccrual loans: Construction $ 147 $ — $ 147 Residential real estate 3,603 299 3,902 Commercial real estate 3,866 — 3,866 Commercial 174 671 845 Consumer 203 19 222 Total $ 7,993 $ 989 $ 8,982 Interest income $ — $ — $ — (Dollars in thousands) Non-accrual Delinquent Loans Non-accrual Current Loans Total Non-accruals September 30, 2023 Nonaccrual loans: Construction $ 147 $ — $ 147 Residential real estate 2,258 1,644 3,902 Commercial real estate 749 3,117 3,866 Commercial 1 844 845 Consumer 221 1 222 Total $ 3,376 $ 5,606 $ 8,982 The overall quality of the Bank’s loan portfolio is primarily assessed using the Bank’s risk-grading scale. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. Credit quality indicators are adjusted based on management’s judgment during the quarterly review process. Loans are graded on a scale of one to ten. Ratings 1 thru 6 – Pass - Ratings 1 thru 6 have asset risks ranging from excellent-low to adequate. The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks. Rating 7 – Special Mention - These credits have potential weaknesses due to economic conditions, less than adequate earnings performance or other factors which require the lending officer to direct more than normal attention to the credit. Financing alternatives may be limited and/or command higher risk interest rates. Special mention loan relationships are reviewed at least quarterly. Rating 8 – Substandard - Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged. Substandard loans are the first adversely classified loans on the Bank's watchlist. These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. The loans may have a delinquent history or combination of weak collateral, weak guarantor or operating losses. When a loan is assigned to this category the Bank may estimate a specific reserve in the loan loss allowance analysis and/or place the loan on nonaccrual. These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies. These relationships will be reviewed at least quarterly. Rating 9 – Doubtful - Doubtful assets have many of the same characteristics of substandard with the exception that the Bank has determined that loss is not only possible but is probable. The amount of loss is not discernible due to factors such as merger, acquisition, or liquidation; a capital injection; a pledge of additional collateral; the sale of assets; or alternative refinancing plans. Credits receiving a doubtful classification are required to be on nonaccrual. These relationships will be reviewed at least quarterly. Rating 10 – Loss – Loss assets are uncollectible or of little value. 20 Table of Contents The following table provides information on loan risk ratings as of September 30, 2023 and gross write-offs during the nine months ended September 30, 2023. Term Loans by Origination Year Revolving Loans Revolving Converted to Term Loans Total (Dollars in thousands) Prior 2019 2020 2021 2022 2023 September 30, 2023 Construction Pass $ 27,243 $ 14,732 $ 29,531 $ 40,493 $ 135,418 $ 72,852 $ 8,331 $ — $ 328,600 Substandard 138 — — 12 — — — — 150 Total $ 27,381 $ 14,732 $ 29,531 $ 40,505 $ 135,418 $ 72,852 $ 8,331 $ — $ 328,750 Gross Charge-offs $ — $ — $ — $ — $ — $ — $ — $ — $ — Residential real estate Pass $ 330,183 $ 55,088 $ 107,259 $ 248,445 $ 355,912 $ 218,563 $ 116,868 $ 876 $ 1,433,194 Special Mention 41 259 — — — — 192 — 492 Substandard 5,320 — — — — — 458 — 5,778 Total $ 335,544 $ 55,347 $ 107,259 $ 248,445 $ 355,912 $ 218,563 $ 117,518 $ 876 $ 1,439,464 Gross Charge-offs $ — $ — $ — $ — $ — $ — $ — $ — $ — Commercial real estate Pass $ 683,984 $ 192,789 $ 302,597 $ 430,908 $ 430,214 $ 195,260 $ 16,420 $ 2,202 $ 2,254,374 Special Mention 13,931 141 — 6,184 4,475 — — 426 25,157 Substandard 1,498 1,937 — 555 — — — — 3,990 Total $ 699,413 $ 194,867 $ 302,597 $ 437,647 $ 434,689 $ 195,260 $ 16,420 $ 2,628 $ 2,283,521 Gross Charge-offs $ ( 513 ) $ — $ ( 814 ) $ — $ — $ — $ — $ — $ ( 1,327 ) Commercial Pass $ 25,796 $ 14,254 $ 15,332 $ 43,209 $ 40,337 $ 24,582 $ 62,679 $ 1,641 $ 227,830 Special Mention 137 — — 440 — — 75 243 895 Substandard 1 186 — — 23 — 493 46 749 Total $ 25,934 $ 14,440 $ 15,332 $ 43,649 $ 40,360 $ 24,582 $ 63,247 $ 1,930 $ 229,474 Gross Charge-offs $ — $ — $ — $ — $ — $ — $ — $ — $ — Consumer Pass $ 682 $ 1,258 $ 15,574 $ 83,768 $ 150,126 $ 78,067 $ 713 $ — $ 330,188 Special Mention — — — — — — 1 — 1 Substandard — 26 — 117 78 — 1 — 222 Total $ 682 $ 1,284 $ 15,574 $ 83,885 $ 150,204 $ 78,067 $ 715 $ — $ 330,411 Gross Charge-offs $ ( 45 ) $ — $ ( 16 ) $ ( 3 ) $ ( 1 ) $ ( 328 ) $ ( 1 ) $ ( 5 ) $ ( 399 ) Total Pass $ 1,067,888 $ 278,121 $ 470,293 $ 846,823 $ 1,112,007 $ 589,324 $ 205,011 $ 4,719 $ 4,574,186 Special Mention 14,109 400 — 6,624 4,475 — 268 669 26,545 Substandard 6,957 2,149 — 684 101 — 952 46 10,889 Total loans by risk category $ 1,088,954 $ 280,670 $ 470,293 $ 854,131 $ 1,116,583 $ 589,324 $ 206,231 $ 5,434 $ 4,611,620 Total gross charge-offs $ ( 558 ) $ — $ ( 830 ) $ ( 3 ) $ ( 1 ) $ ( 328 ) $ ( 1 ) $ ( 5 ) $ ( 1,726 ) 21 Table of Contents Term Loans by Origination Year Revolving Loans Revolving Converted to Term Loans Total (Dollars in thousands) Prior 2019 2020 2021 2022 2023 September 30, 2023 Credit Cards Performing $ — $ — $ — $ — $ — $ — $ 6,099 $ — $ 6,099 Non-Performing — — — — — — — — — Total $ — $ — $ — $ — $ — $ — $ 6,099 $ — $ 6,099 Gross Charge-offs $ — $ — $ — $ — $ — $ — $ ( 60 ) $ — $ ( 60 ) Total loans evaluated by performing status $ — $ — $ — $ — $ — $ — $ 6,099 $ — $ 6,099 Total gross charge-offs $ — $ — $ — $ — $ — $ — $ ( 60 ) $ — $ ( 60 ) Total Recorded Investment $ 1,088,954 $ 280,670 $ 470,293 $ 854,131 $ 1,116,583 $ 589,324 $ 212,330 $ 5,434 $ 4,617,719 The following tables provide information on the aging of the loan portfolio as of September 30, 2023 and December 31, 2022. (Dollars in thousands) 30‑59 days past due 60‑89 days past due 90 days past due and still accruing 90 days past due and not accruing Total past due Current Non-accrual Current Accrual Loans (1) Total September 30, 2023 Construction $ 1,035 $ — $ 65 $ 147 $ 1,247 $ — $ 327,503 $ 328,750 Residential real estate 3,036 250 871 1,669 5,826 1,644 1,431,994 1,439,464 Commercial real estate 785 445 — 749 1,979 3,117 2,278,425 2,283,521 Commercial 103 — — — 103 844 228,527 229,474 Consumer 593 2,744 1,160 214 4,711 1 325,699 330,411 Credit Cards 61 41 53 — 155 — 5,944 6,099 Total $ 5,613 $ 3,480 $ 2,149 $ 2,779 $ 14,021 $ 5,606 $ 4,598,092 $ 4,617,719 Percent of total loans 0.1 % 0.1 % — % — % 0.3 % 0.1 % 99.6 % 100.0 % (1) Includes loans measured at fair value of $ 9.3 million at September 30, 2023. Accruing (Dollars in thousands) Current (1) 30‑59 days past due 60‑89 days past due 90 days or more past due Total past due Non-accrual PCI Total December 31, 2022 Construction $ 239,990 $ 4,343 $ 1,015 $ 24 $ 5,382 $ 297 $ 650 $ 246,319 Residential real estate 787,070 6,214 891 1,107 8,212 1,259 13,956 810,497 Commercial real estate 1,052,314 369 — 710 1,079 150 11,866 1,065,409 Commercial 147,511 15 — — 15 174 156 147,856 Consumer 285,750 223 11 — 234 28 14 286,026 Total $ 2,512,635 $ 11,164 $ 1,917 $ 1,841 $ 14,922 $ 1,908 $ 26,642 $ 2,556,107 Percent of total loans 98.3 % 0.4 % 0.1 % 0.1 % 0.6 % 0.1 % 1.0 % 100.0 % (1) Includes loans measured at fair value of $ 8.4 million at December 31, 2022. 22 Table of Contents The following tables provide a summary of the activity in the ACL allocated by loan class for the three and nine months ended September 30, 2023 and September 30, 2022. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes. (Dollars in thousands) Beginning Balance Merger Adjustments (2) Charge-offs Recoveries Net (charge-offs) recoveries Provisions Ending Balance For three months ended September 30, 2023 Construction $ 2,386 $ 3 $ — $ 3 $ 3 $ 1,439 $ 3,831 Residential real estate 9,151 215 — 3 3 9,806 19,175 Commercial real estate 10,267 985 ( 1,327 ) — ( 1,327 ) 12,875 22,800 Commercial 1,956 278 — 2 2 2,101 4,337 Consumer (1) 5,254 14 ( 115 ) 45 ( 70 ) 1,658 6,856 Credit Card — 18 ( 60 ) — ( 60 ) 94 52 Total $ 29,014 $ 1,513 $ ( 1,502 ) $ 53 $ ( 1,449 ) $ 27,973 $ 57,051 (1) Gross charge-offs of consumer loans for the three months ended September 30, 2023 included $ 95,000 of demand deposit overdrafts. (2) Merger adjustments consist of gross-up for acquired PCD loans in the TCFC merger. (Dollars in thousands) Beginning Balance Charge-offs Recoveries Net (charge-offs) recoveries Provisions Ending Balance For three months ended September 30, 2022 Construction $ 3,345 $ — $ 2 $ 2 $ ( 315 ) $ 3,032 Residential real estate 2,778 — 12 12 218 3,008 Commercial real estate 4,441 — 243 243 325 5,009 Commercial 1,681 ( 202 ) 60 ( 142 ) 368 1,907 Consumer 3,238 — 4 4 79 3,321 Total $ 15,483 $ ( 202 ) $ 321 $ 119 $ 675 $ 16,277 (Dollars in thousands) Beginning Balance Impact of ASC326 Adoption Merger Adjustments (2) Charge-offs Recoveries Net (charge-offs) recoveries Provisions Ending Balance For nine months ended September 30, 2023 Construction $ 2,973 $ 1,222 $ 3 $ — $ 10 $ 10 $ ( 377 ) $ 3,831 Residential real estate 2,622 4,974 215 — 37 37 11,327 19,175 Commercial real estate 4,899 3,742 985 ( 1,327 ) — ( 1,327 ) 14,501 22,800 Commercial 1,652 401 278 — 10 10 1,996 4,337 Consumer (1) 4,497 452 14 ( 399 ) 210 ( 189 ) 2,082 6,856 Credit Card — — 18 ( 60 ) — ( 60 ) 94 52 Total $ 16,643 $ 10,791 $ 1,513 $ ( 1,786 ) $ 267 $ ( 1,519 ) $ 29,623 $ 57,051 (1) Gross charge-offs of consumer loans for the nine months ended September 30, 2023 included $ 0.4 million of demand deposit overdrafts. (2) Merger adjustments consist of gross-up for acquired PCD loans in the TCFC merger. (Dollars in thousands) Beginning Balance Charge-offs Recoveries Net (charge-offs) recoveries Provisions Ending Balance For nine months ended September 30, 2022 Construction $ 2,454 $ — $ 9 $ 9 $ 569 $ 3,032 Residential real estate 2,858 ( 4 ) 131 127 23 3,008 Commercial real estate 4,598 ( 6 ) 948 942 ( 531 ) 5,009 Commercial 2,070 ( 416 ) 200 ( 216 ) 53 1,907 Consumer 1,964 ( 31 ) 27 ( 4 ) 1,361 3,321 Total $ 13,944 $ ( 457 ) $ 1,315 $ 858 $ 1,475 $ 16,277 23 Table of Contents There were no modifications to loans for borrowers experiencing financial difficulty (“BEFD”) during the three and nine months ended September 30, 2023. The following table presents the amortized cost basis of collateral-dependent loans by loan portfolio segment. September 30, 2023 (Dollars in thousands) Real Estate Collateral Other Collateral Total Construction $ 250 $ — $ 250 Residential real estate 7,620 — 7,620 Commercial real estate 5,411 — 5,411 Commercial — 1,100 1,100 Consumer — 1,381 1,381 Total $ 13,281 $ 2,481 $ 15,762 The Company did not identify any significant changes in the extent to which collateral secures its collateral dependent loans, whether in the form of general deterioration or from other factors during the period ended September 30, 2023 Foreclosure Proceedings There were $ 0.7 million of consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure as of September 30, 2023 and $ 0.3 million as of December 31, 2022, respectively. There were no residential real estate properties included in the balance of other real estate owned (“OREO”) at September 30, 2023 and one residential real estate property totaling $ 18,000 at December 31, 2022. 24 Table of Contents Prior to the adoption of ASC 326 The following table provides information about all loans acquired from Severn as of December 31, 2022. December 31, 2022 (Dollars in thousands) Acquired Loans - Purchased Credit Impaired Acquired Loans - Purchased Performing Acquired Loans - Total Outstanding principal balance $ 29,620 $ 349,262 $ 378,882 Carrying amount Construction $ 650 $ 18,761 $ 19,411 Residential real estate 13,956 116,118 130,074 Commercial real estate 11,866 174,278 186,144 Commercial 156 35,687 35,843 Consumer 14 697 711 Total loans $ 26,642 $ 345,541 $ 372,183 The following table presents a summary of the change in the accretable yield on PCI loans acquired from Severn. (Dollars in thousands) Nine Months Ended September 30, 2022 Accretable yield, beginning of period $ 5,367 Accretion ( 1,195 ) Reclassification of nonaccretable difference due to improvement in expected cash flows 399 Other changes, net 287 Accretable yield, end of period $ 4,858 The following tables include impairment information relating to loans and the ACL on loans as of December 31, 2022. (Dollars in thousands) Ending balance: Individually evaluated for impairment Ending balance: Collectively evaluated for impairment Acquired Loans- PCI Total (1) December 31, 2022 Loan Receivables: Construction $ 331 $ 236,901 $ 650 $ 237,882 Residential real estate 5,081 791,460 13,956 810,497 Commercial real estate 2,540 1,051,003 11,866 1,065,409 Commercial 174 147,526 156 147,856 Consumer 28 285,984 14 286,026 Total $ 8,154 $ 2,512,874 $ 26,642 $ 2,547,670 Allowance for credit losses on loans: Allocated to loans individually evaluated for impairment Allocated to loans collectively evaluated for impairment Total Construction $ — $ 2,973 $ 2,973 Residential real estate 127 2,495 2,622 Commercial real estate — 4,899 4,899 Commercial — 1,652 1,652 Consumer — 4,497 4,497 Total $ 127 $ 16,516 $ 16,643 (1) Excludes loans measured at fair value of $ 8.4 million at December 31, 2022. 25 Table of Contents The following tables provide information on impaired loans and any related allowance by loan class as of December 31, 2022. The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken and interest paid on nonaccrual loans that has been applied to principal. Unpaid principal balance Recorded investment with no allowance Recorded investment with an allowance Related allowance September 30, 2022 (Dollars in thousands) Quarter-to-date average recorded investment Year-to-date average recorded investment Interest income recognized December 31, 2022 Impaired nonaccrual loans: Construction $ 297 $ 297 $ — $ — $ 297 $ 314 $ — Residential real estate 1,363 1,259 — — 1,639 1,534 — Commercial real estate 159 150 — — 466 704 — Commercial 359 174 — — 197 242 — Consumer 29 28 — — 40 48 — Total $ 2,207 $ 1,908 $ — $ — $ 2,639 $ 2,842 $ — Impaired accruing TDRs: Construction $ 10 $ 10 $ — $ — $ 14 $ 18 $ 1 Residential real estate 2,849 1,176 1,539 127 2,750 3,064 83 Commercial real estate 1,680 1,680 — — 1,830 2,231 48 Commercial — — — — — — — Consumer — — — — — 6 — Total $ 4,539 $ 2,866 $ 1,539 $ 127 $ 4,594 $ 5,319 $ 132 Other impaired accruing loans: Construction $ 24 $ 24 $ — $ — $ 304 $ 190 $ 6 Residential real estate 1,107 1,107 — — 745 259 3 Commercial real estate 710 710 — — 537 493 7 Commercial — — — — 13 7 1 Consumer — — — — — 13 — Total $ 1,841 $ 1,841 $ — $ — $ 1,599 $ 962 $ 17 Total impaired loans: Construction $ 331 $ 331 $ — $ — $ 615 $ 522 $ 7 Residential real estate 5,319 3,542 1,539 127 5,134 4,857 86 Commercial real estate 2,549 2,540 — — 2,833 3,428 55 Commercial 359 174 — — 210 249 1 Consumer 29 28 — — 40 67 — Total $ 8,587 $ 6,615 $ 1,539 $ 127 $ 8,832 $ 9,123 $ 149 There were no loans modified and considered to be TDRs during the three and nine months ended September 30, 2022. All accruing TDRs were in compliance with their modified terms. Both performing and non-performing TDRs had no further commitments associated with them as of December 31, 2022. There were no TDRs which subsequently defaulted within 12 months of modification for the three and nine months ended September 30, 2022. Generally, a loan is considered in default when principal or interest is past due 90 days or more, the loan is placed on nonaccrual, the loan is charged off, or there is a transfer to other real estate owned (OREO) or repossessed assets. 26 Table of Contents The following tables provide information on loan risk ratings as of December 31, 2022. (Dollars in thousands) Pass/Performing (1) Pass Special Mention Substandard Doubtful PCI Total December 31, 2022 Construction $ 231,160 $ 14,212 $ — $ 297 $ — $ 650 $ 246,319 Residential real estate 761,405 32,467 1,239 1,430 — 13,956 810,497 Commercial real estate 929,501 121,711 1,814 517 — 11,866 1,065,409 Commercial 131,084 15,958 484 174 — 156 147,856 Consumer 285,786 196 2 28 — 14 286,026 Total $ 2,338,936 $ 184,544 $ 3,539 $ 2,446 $ — $ 26,642 $ 2,556,107 (1) Includes loans measured at fair value of $ 8.4 million at December 31, 2022. Note 6 – Goodwill and Other Intangibles The following table provides information on the significant components of goodwill and other acquired intangible assets at September 30, 2023 and December 31, 2022. September 30, 2023 (Dollars in thousands) Gross Carrying Amount Additions Accumulated Impairment Charges Accumulated Amortization Net Carrying Amount Weighted Average Remaining Life (in years) Goodwill $ 65,476 $ — $ ( 1,543 ) $ ( 667 ) $ 63,266 n/a Core deposit intangible $ 10,503 $ 48,648 $ — $ ( 8,466 ) $ 50,685 4.9 Total core deposit intangible $ 10,503 $ 48,648 $ — $ ( 8,466 ) $ 50,685 December 31, 2022 (Dollars in thousands) Gross Carrying Amount Measurement Period Adjustments Accumulated Impairment Charges Accumulated Amortization Net Carrying Amount Weighted Average Remaining Life (in years) Goodwill $ 65,631 $ ( 155 ) $ ( 1,543 ) $ ( 667 ) $ 63,266 n/a Core deposit intangible $ 10,504 $ — $ — $ ( 4,957 ) $ 5,547 2.6 Total core deposit intangible $ 10,504 $ — $ — $ ( 4,957 ) $ 5,547 The aggregate amortization expense was $ 3.5 million for the nine months ended September 30, 2023 and $ 1.5 million for the nine months ended September 30, 2022. At September 30, 2023, estimated future remaining amortization for amortizing core deposit intangible within the years ending December 31, is as follows: (Dollars in thousands) Amortization Expense 2023 $ 2,595 2024 9,779 2025 8,589 2026 7,399 2027 6,208 Thereafter 16,115 Total amortizing core deposit intangible $ 50,685 27 Table of Contents Note 7 – Leases Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor. The Company’s long-term lease agreements are classified as operating leases. Certain leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably certain of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations. During the third quarter of 2023, the Company acquired long-term branch leases and equipment leases due to the acquisition of TCFC. These leases were reassessed by management as of the Acquisition Date, which included updating the incremental borrowing rates and remaining lease terms. The following tables present information about the Company’s leases. (Dollars in thousands) September 30, 2023 December 31, 2022 Lease liabilities $ 13,082 $ 9,908 Right-of-use assets $ 12,741 $ 9,629 Weighted average remaining lease term 11.07 years 12.55 years Weighted average discount rate 3.18 % 2.50 % Remaining lease term - min 0.64 years 0.16 years Remaining lease term - max 17.93 years 18.68 years Three Months Ended September 30, Nine Months Ended September 30, Lease cost (in thousands) 2023 2022 2023 2022 Operating lease cost $ 485 $ 340 $ 1,153 $ 1,007 Total lease cost $ 485 $ 340 $ 1,153 $ 1,007 Cash paid for amounts included in the measurement of lease liabilities $ 459 $ 318 $ 1,090 $ 939 A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows: Lease payments due (in thousands) As of September 30, 2023 Three months ending December 31, 2023 $ 460 2024 1,768 2025 1,544 2026 1,554 2027 1,454 Thereafter 8,669 Total undiscounted cash flows $ 15,449 Discount 2,367 Lease liabilities $ 13,082 Total gross rental income was $ 0.3 million and $ 0.2 million for the three months ended September 30, 2023 and 2022, respectively. Total gross rental income was $ 0.9 million and $ 0.7 million for the nine months ended September 30, 2023, and 2022, respectively. 28 Table of Contents The following table presents our minimum future annual rental income on such leases as of September 30, 2023. (In thousands) As of September 30, 2023 Three months ending December 31, 2023 $ 206 2024 701 2025 719 2026 737 2027 418 Thereafter 1,554 Total $ 4,335 Note 8 - Deposits Deposits consist of the following categories as of the dates indicated: (dollars in thousands) September 30, 2023 December 31, 2022 Balance % Balance % Noninterest-bearing demand $ 1,211,401 23.70 % $ 862,015 28.60 % Interest-bearing: Demand 1,210,051 23.70 % 694,101 23.10 % Money market deposits 1,179,049 23.10 % 709,132 23.60 % Savings 371,755 7.30 % 320,188 10.60 % Certificates of deposit 1,136,488 22.20 % 424,348 14.10 % Total interest-bearing 3,897,343 76.30 % 2,147,769 71.40 % Total Deposits $ 5,108,744 100.00 % $ 3,009,784 100.00 % At September 30, 2023, the scheduled contractual maturities of certificates of deposit are as follows: (dollars in thousands) September 30, 2023 Within one year $ 894,384 Year 2 162,135 Year 3 48,171 Year 4 15,530 Year 5 15,816 Thereafter 452 $ 1,136,488 The aggregate amount of certificates of deposit that met or exceeded the FDIC insurance limit of $250,000 at September 30, 2023 and December 31, 2022 was $ 311.3 million and $ 77.7 million, respectively. 29 Table of Contents Note 9 - Borrowings Long-term debt consisted of the following: September 30, (dollars in thousands) 2023 2022 Issue Date Stated Maturity Date Earliest Call Date Interest Rate September 2030 Subordinated Debentures $ 25,000 $ 25,000 2020 2030 2025 5.375 % through September 2025, 3-month SOFR + 5.265 % thereafter October 2030 Subordinated Debentures 19,500 — 2020 2030 2025 4.75 % through October 2025, 3-month SOFR + 4.58 % thereafter Total subordinated debentures 44,500 25,000 Severn Capital Trust I 20,619 20,619 2004 2035 3-month SOFR + 2.00 % Tri-County Capital Trust I 7,000 — 2004 2034 90-day SOFR + 2.60 % Tri-County Capital Trust II 5,000 — 2005 2035 90-day SOFR + 1.70 % Total trust preferred securities 32,619 20,619 Less net discount and unamortized issuance costs ( 5,084 ) ( 2,547 ) Total long-term debt $ 72,035 $ 43,072 At September 30, 2023, subordinated notes consisted of $ 25.0 million of long-term debt issued by the Company in August 2020, and $ 19.5 million of long-term debt assumed as a result of the merger with TCFC. The recorded balance of subordinated debt issued in 2020 and the assumed subordinated debt from TCFC, net of unamortized issuance costs and fair value discounts, respectively, were $ 24.8 million and $ 18.2 million, respectively. The Company also assumed trust preferred securities in the aggregate of $ 32.6 million as a result of the merger with TCFC in 2023 and the acquisition of Severn in 2021. Trust preferred securities consisted of $ 20.6 million issued to Severn Capital Trust I, $ 7.0 million issued by Tri-County Capital Trust I and $ 5.0 million issued by Tri-County Capital Trust II. The recorded balance of the debt acquired from Severn at September 30, 2023 was $ 18.5 million, net of the unamortized fair value adjustment of $ 2.1 million. At September 30, 2023, the junior subordinated debt securities of Tri-County Capital Trust I and Tri-County Capital Trust II had a recorded balance of $ 6.4 million and $ 4.2 million, which are presented as net of the unamortized fair value adjustment of $ 0.6 million and $ 0.8 million, respectively. The Company may periodically borrow from a correspondent federal funds line of credit arrangement, under a secured reverse repurchase agreement, or from the FHLB to meet short-term liquidity needs. Short-term borrowings from the Federal Home Loan Bank (“FHLB”) at September 30, 2023 and December 31, 2022 were zero and $ 40.0 million, respectively. Further information on these obligations is provided in the Company’s 2022 Annual Report on Form 10-K. Note 10 - Stock-Based Compensation At the 2016 annual meeting, stockholders approved the Shore Bancshares, Inc. 2016 Stock and Incentive Plan (“2016 Equity Plan”), replacing the Shore Bancshares, Inc. 2006 Stock and Incentive Plan (“2006 Equity Plan”), which expired on that date. The Company may issue shares of common stock or grant other equity-based awards pursuant to the 2016 Equity Plan. Stock-based awards granted to date generally are time-based, vest in equal installments on each anniversary of the grant date and range over a one - to five-year period of time, and, in the case of stock options, expire 10 years from the grant date. Stock-based compensation expense based on the grant date fair value is recognized ratably over the requisite service period for all awards and reflects forfeitures as they occur. The 2016 Equity Plan originally reserved 750,000 shares of common stock for grant, and 472,320 shares remained available for grant at September 30, 2023. The Company assumed 3,977 shares of restricted stock and 90,783 of restricted stock units at a fair market value of $ 11.56 per share as a result of the merger with TCFC. The recipients of the restricted stock unites do not have any stockholder rights, including voting, dividend, or liquidation rights, with respect to the shares underlying awarded restricted stock units until the recipient becomes the record holder of those shares. The following table summarizes restricted stock award and restricted stock unit activity for the Company under the 2016 Equity Plan for the nine months ended September 30, 2023. 30 Table of Contents Restricted Stock Restricted Stock Units Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested at beginning of period 36,860 $ 20.15 — $ — Replacement awards issued in acquisition of TCFC 3,977 11.56 90,783 11.56 Granted 53,655 14.73 91,047 11.56 Vested ( 40,525 ) 17.65 ( 11,459 ) 11.56 Forfeited ( 1,671 ) 17.49 ( 1,202 ) 11.56 Nonvested at end of period 52,296 $ 15.95 169,169 $ 11.56 The fair value of restricted stock awards that vested during the first nine months of 2023 and 2022 was $ 0.6 million and $ 0.5 million, respectively. The fair value of restricted stock units vested during the first nine months of 2023 was $ 0.1 million. Note 11 – Derivatives The Company maintains and accounts for derivatives, in the form of interest rate lock commitments (“IRLCs”) and mandatory forward contracts, in accordance with the FASB guidance on accounting for derivative instruments and hedging activities. We recognize gains and losses through mortgage-banking revenue in the Consolidated Statements of Income. IRLCs on mortgage loans that we intend to sell in the secondary market are considered derivatives. We are exposed to price risk from the time a mortgage loan is locked in until the time the loan is sold. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 14 days to 120 days, however, this period may be longer for construction to permanent loans that are originated with the intent of selling in the secondary market upon permanent financing. For these IRLCs and our closed inventory in loans held for sale (“LHFS”), we attempt to protect the Bank from changes in interest rates through the use of to be announced (“TBA”) securities, which are forward contracts, as well as, to a significantly lesser degree, loan level commitments in the form of best efforts and mandatory forward contracts. These assets and liabilities are included in the Consolidated Balance Sheets in other assets and accrued expenses and other liabilities, respectively. The following table provides information pertaining to the carrying amounts of our derivative financial instruments at September 30, 2023 and December 31, 2022. September 30, 2023 December 31, 2022 (Dollars in thousands) Notional Amount Estimated Fair Value Notional Amount Estimated Fair Value Asset - IRLCs $ 10,969 $ 89 $ 4,166 $ 35 Asset - TBA securities 22,900 359 8,750 41 Liability - IRLCs 8,354 50 1,150 7 Liability - TBA securities 500 — 1,000 6 Note 12 – Accumulated Other Comprehensive Income (Loss) The Company records unrealized holding gains (losses), net of tax, on investment securities AFS as accumulated other comprehensive income (loss), a separate component of stockholders’ equity. The following table provides information on the changes in the component of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2023 and 2022. Three Months Ended September 30, 2023 Three Months Ended September 30, 2022 Nine Months Ended September 30, 2023 Nine Months Ended September 30, 2022 (Dollars in thousands) Net Unrealized Gains And (Losses) Net Unrealized Gains And (Losses) Net Unrealized Gains And (Losses) Net Unrealized Gains And (Losses) Beginning of period $ ( 8,561 ) $ ( 6,651 ) $ ( 9,021 ) $ 56 Other comprehensive losses, net of tax before reclassifications ( 1,548 ) ( 3,130 ) ( 1,088 ) ( 9,837 ) End of period $ ( 10,109 ) $ ( 9,781 ) $ ( 10,109 ) $ ( 9,781 ) 31 Table of Contents Note 13 – Regulatory Capital Banks and bank holding companies 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 direct material effect on the 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 the Banks’ assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Banks’ capital amounts and classification 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 Company and Bank to maintain amounts and ratios (set forth in the table below) of Common Equity Tier 1, Tier 1 and total capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (leverage ratio). As of September 30, 2023 and December 31, 2022, management believes that the Company and the Bank met all capital adequacy requirements to which they were subject. As of December 31, 2022, the most recent notification from our primary regulator categorized the Bank, as well capitalized under the regulatory framework for prompt corrective action. At September 30, 2023, there were no conditions or events since that notification that management believes would change the Bank’s classification. To be categorized as well capitalized, the Bank must maintain minimum common equity Tier 1, Tier 1 risk-based and total risk-based capital ratios, and Tier 1 leverage ratios, which are described below. The minimum ratios for capital adequacy purposes are 7.00 %, 8.50 %, 10.50 % and 4.00 % for the common equity Tier 1, Tier 1 risk-based capital, total risk-based capital and leverage ratios, respectively which include a capital conservation buffer of 2.50% respectively. To be categorized as well capitalized, a bank must maintain minimum ratios of 6.50 %, 8.00 %, 10.00 % and 5.00 % for its common equity Tier 1, Tier 1 risk-based capital, total risk-based capital and leverage ratios, respectively. Regulatory Capital and Ratios Regulatory Minimum Ratio + CCB ( 1) The Company The Bank (dollars in thousands) September 30, 2023 December 31, 2022 September 30, 2023 December 31, 2022 Common equity $ 504,931 $ 364,285 $ 566,129 $ 395,594 Goodwill ( 63,266 ) ( 63,266 ) ( 63,266 ) ( 63,266 ) Core deposit intangible (3) ( 37,507 ) ( 5,547 ) ( 37,507 ) ( 5,547 ) DTAs that arise from net operating loss and tax credit carry forwards ( 9,158 ) — ( 6,765 ) — AOCI (gains) losses 10,109 9,021 10,109 9,021 Common Equity Tier 1 Capital 405,109 304,493 468,700 335,802 TRUPs 29,079 18,398 — — Tier 1 Capital 434,188 322,891 468,700 335,802 Allowable reserve for credit losses and other Tier 2 adjustments 58,190 16,855 58,190 16,855 Subordinated notes 42,956 24,674 — — Tier 2 Capital $ 535,334 $ 364,420 $ 526,890 $ 352,657 Risk-Weighted Assets ("RWA") $ 4,707,597 $ 2,619,400 $ 4,703,362 $ 2,618,939 Average Assets ("AA") $ 5,674,370 $ 3,390,516 $ 5,661,864 $ 3,386,771 Common Tier 1 Capital to RWA 7.00 % 8.61 % 11.62 % 9.97 % 12.82 % Tier 1 Capital to RWA 8.50 % 9.22 % 12.33 % 9.97 % 12.82 % Tier 2 Capital to RWA 10.50 % 11.37 % 13.91 % 11.20 % 13.47 % Tier 1 Capital to AA (Leverage) (2) n/a 7.65 % 9.52 % 8.28 % 9.92 % ____________________________________ (1) The regulatory minimum capital ratio ("Min. Ratio") + the capital conservation buffer ("CCB"). (2) Tier 1 Capital to AA (Leverage) has no capital conservation buffer defined. The PCA well capitalized is defined as 5.00 %. (3) Core deposit intangible at September 30, 2023 is net of deferred tax liability. Bank and holding company regulations impose certain restrictions on dividend payments by the Bank, as well as restricting extensions of credit and transfers of assets between the Bank and the Company. At September 30, 2023, the Bank could pay dividends to the Company to the extent of its earnings so long as it maintained required capital ratios. 32 Table of Contents Note 14 – Fair Value Measurements Accounting guidance under GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This accounting guidance also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities on a recurring basis and to determine fair value disclosures. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Under fair value accounting guidance, assets and liabilities are grouped at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine their fair values. These hierarchy levels are: Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date. Level 2 inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Below is a discussion on the Company’s assets measured at fair value on a recurring basis. Investment Securities Available for Sale Fair value measurement for investment securities AFS is based on quoted prices from an independent pricing service. The fair value measurements consider observable data that may include present value of future cash flows, prepayment assumptions, credit loss assumptions and other factors. The Company classifies its investments in U.S. Treasury securities, if any, as Level 1 in the fair value hierarchy, and it classifies its investments in U.S. Government agencies securities and mortgage-backed securities issued or guaranteed by U.S. Government sponsored entities as Level 2. Equity Securities Fair value measurement for equity securities is based on quoted market prices retrieved by the Company via on-line resources. Although these securities have readily available fair market values, the Company determined that they should be classified as level 2 investments in the fair value hierarchy due to not being considered traded in a highly active market. LHFS LHFS are carried at fair value, which is determined based on Mark to Trade for allocated/committed loans or Mark to Market analysis for unallocated/uncommitted loans based on third-party pricing models (Level 2). Mortgage Servicing Rights The fair value of mortgage servicing rights (“MSRs”) is determined using a valuation model administered by a third party that calculates the present value of estimated future net servicing income (Level 3). The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service (including delinquency and foreclosure costs), escrow account earnings, contractual servicing fee income, and other ancillary income such as late fees. Management reviews all significant assumptions on a quarterly basis. Mortgage loan prepayment speed, a key assumption in the model, is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate used to determine the present value of estimated future net servicing income, another key assumption in the model, is an estimate of the required rate of return investors in the market would require for an asset with similar risk. Both assumptions can, and generally will, change as market conditions and interest rates change. The significant unobservable inputs used in the fair value measurement of the reporting entity’s residential MSRs are prepayment speeds, probability of default, rate of return, and cost of servicing. Significant increases/decreases in any of those inputs in isolation would have resulted in a significantly lower/higher fair value measurement. Generally, a change in the assumption used for prepayment speeds would have been accompanied by a directionally similar change in the markets, i.e. the 10-Year Treasury, and in the probability of default. 33 Table of Contents IRLCs We utilize a third-party specialist model to estimate the fair value of our IRLCs, which are valued based upon mortgage securities (TBA) prices less estimated costs to process and settle the loan. Fair value is adjusted for the estimated probability of the loan closing with the borrower (Level 3). (Dollars in thousands) Fair Value Valuation Technique Unobservable Input Range September 30, 2023 MSRs (1) $ 5,890 Market Approach Weighted average prepayment speed (PSA) (2) 108 IRLCs - net asset $ 39 Market Approach Range of pull through rate 84 % - 100 % Average pull through rate 98 % (Dollars in thousands) Fair Value Valuation Technique Unobservable Input Range December 31, 2022 MSRs (1) $ 5,275 Market Approach Weighted average prepayment speed (PSA) (2) 121 IRLCs - net asset $ 28 Market Approach Range of pull through rate 78 % - 100 % Average pull through rate 92 % ____________________________________ (1) The weighted average was calculated with reference to the principal balance of the underlying mortgages. (2) PSA = Public Securities Association Standard Prepayment Model The following table presents activity in MSRs for the three and nine months ended September 30, 2023. (Dollars in thousands) Three Months Ended September 30, 2023 Nine Months Ended September 30, 2023 Beginning balance $ 5,466 $ 5,275 Servicing rights resulting from sales of loans 390 620 Valuation adjustment 34 ( 5 ) Ending balance $ 5,890 $ 5,890 The following table presents activity in the IRLCs for the three and nine months ended September 30, 2023. (Dollars in thousands) Three Months Ended September 30, 2023 Nine Months Ended September 30, 2023 Beginning balance $ 32 $ 28 Valuation adjustment 7 11 Ending balance $ 39 $ 39 Forward Contracts To avoid interest rate risk, we hedge the open locked/closed position with TBA forward trades. On a regular basis, we allocate disbursed loans to mandatory commitments with government-sponsored enterprises (“GSE”) and private investors delivering the loans within 120 days of origination to maximize interest earnings. For a small percentage of our business, we enter into best efforts forward sales commitments with investors at the time we make an IRLC to a borrower. Once a loan has been closed and funded, the best efforts commitments convert to mandatory forward sales commitments. The mandatory commitments are derivatives, and we measure and report them at fair value. Fair value is based on the gain or loss that would occur if we were to pair-off the transaction with the investor at the measurement date. This is a level 2 input. We have elected to measure and report best efforts commitments at fair value, when outstanding, using a valuation methodology similar to that used for mandatory commitments. Market assumptions utilized in the fair value measurement of the reporting entity’s residential mortgage derivatives, inclusive of IRLCs, Closed Loan Inventory, TBA derivative trades, and Mandatory Forwards may be subject to investor overlays that may result in a significantly lower fair value measurement. Generally such overlays are announced with advanced notice in order to include the risk adjuster, however there are times when announcements are mandated resulting in a lower fair value measurement. Additionally market assumptions such as spec pool payups may result in a significantly higher fair value measurement at time of loan allocation to specific trades. 34 Table of Contents The following tables present the recorded amount of assets measured at fair value on a recurring basis at September 30, 2023 and December 31, 2022. No assets were transferred from one hierarchy level to another during the first nine months of 2023 or 2022. (Dollars in thousands) Fair Value Quoted Prices (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) September 30, 2023 Assets: Securities available for sale: U.S. Government agencies $ 19,631 $ — $ 19,631 $ — Mortgage-backed 53,573 — 53,573 — Other debt securities 5,939 — 5,939 — 79,143 — 79,143 — Equity securities 5,434 — 5,434 — TBA forward trades 359 — 359 — Loans Held for Sale 14,725 — 14,725 — Loans Held for Investment, at fair value 9,302 — 9,302 — MSRs 5,890 — — 5,890 IRLCs 89 — — 89 Total assets at fair value $ 114,942 $ — $ 108,963 $ 5,979 Liabilities: IRLCs $ 50 $ — $ — $ 50 TBA securities — — — — Total liabilities at fair value $ 50 $ — $ — $ 50 (Dollars in thousands) Fair Value Quoted Prices (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) December 31, 2022 Assets: Securities available for sale: U.S. Government agencies $ 18,178 $ — $ 18,178 $ — Mortgage-backed 63,519 — 63,519 — Other debt securities 1,890 — 1,890 — 83,587 — 83,587 — Equity securities 1,233 — 1,233 — TBA forward trades 41 — 41 — Loans Held for Sale 4,248 — 4,248 — Loans Held for Investment, at fair value 8,437 — 8,437 — MSRs 5,275 — — 5,275 IRLCs 35 — — 35 Total assets at fair value $ 102,856 $ — $ 97,546 $ 5,310 Liabilities: IRLCs $ 7 $ — $ — $ 7 TBA securities 6 — 6 — Total liabilities at fair value $ 13 $ — $ 6 $ 7 35 Table of Contents Below is a discussion on the Company’s assets measured at fair value on a nonrecurring basis. Individually Evaluated Collateral-Dependent Loans Loans for which repayment is substantially expected to be provided through the operation or sale of collateral are considered collateral dependent, and are valued based on the estimated fair value of the collateral, less estimated costs to sell at the reporting date, where applicable. Accordingly, collateral dependent loans are classified within Level 3 of the fair value hierarchy. Other Real Estate Owned (Foreclosed Assets) Foreclosed assets are adjusted for fair value upon transfer of loans to foreclosed assets establishing a new cost basis. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. The estimated fair value for foreclosed assets included in Level 3 are determined by independent market based appraisals and other available market information, less costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of the collateral deteriorates subsequent to the initial recognition, the Company records the foreclosed asset as a non-recurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods. The following tables set forth the Company’s financial and nonfinancial assets subject to fair value adjustments (impairment) on a nonrecurring basis at September 30, 2023 and December 31, 2022. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Quantitative Information about Level 3 Fair Value Measurements (Dollars in thousands) Fair Value Valuation Technique Unobservable Input Range Weighted Average (1) September 30, 2023 Nonrecurring measurements: Individually evaluated collateral dependent loans $ 619 Appraisal of collateral Liquidation expense 10 % 10 % Other real estate owned $ 179 Appraisal of collateral Appraisal adjustments ( 0 %) - ( 20 %) ( 0 %) Quantitative Information about Level 3 Fair Value Measurements (Dollars in thousands) Fair Value Valuation Technique Unobservable Input Range Weighted Average (1) December 31, 2022 Nonrecurring measurements: Other real estate owned $ 197 Appraisal of collateral Appraisal adjustments ( 0 %) - 20 % ( 2 %) _________________________________ (1) Unobservable inputs were weighted by the relative fair value of the instruments. 36 Table of Contents Note 15 – Fair Value of Financial Instruments Financial instruments require disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value. A financial instrument is defined as cash, evidence of an ownership interest in an entity or a contractual obligation which requires the exchange of cash. Certain items are specifically excluded from the financial instrument fair value disclosure requirements, including the Company’s common stock, OREO, premises and equipment and other assets and liabilities. The carrying amounts and estimated fair values of the Company’s financial instruments are presented in the following table. Fair values for September 30, 2023 and December 31, 2022 were estimated using an exit price notion. September 30, 2023 Carrying Amount Fair Value Fair Value Measurements Description of Asset (dollars in thousands) Level 1 Level 2 Level 3 Assets Cash and cash equivalents $ 108,709 $ 108,709 $ 108,709 $ — $ — Investment securities - AFS 79,143 79,143 — 79,143 — Investment securities - HTM, net 523,051 445,652 — 445,652 — Equity securities 5,434 5,434 — 5,434 — Restricted securities 13,361 13,361 — 13,361 — Loans held for sale 14,725 14,725 — 14,725 — TBA derivatives trades 359 359 — 359 — Cash surrender value on life insurance 100,950 100,950 — 100,950 — Loans, at fair value 9,302 9,302 — 9,302 — Loans, net 4,551,366 4,425,585 — — 4,425,585 MSRs 5,890 5,890 — — 5,890 IRLCs 89 89 — — 89 Liabilities Deposits: Noninterest-bearing demand $ 1,211,401 $ 1,211,401 $ — $ 1,211,401 $ — Checking plus interest 1,210,052 1,210,052 — 1,210,052 — Money Market 1,179,049 1,179,049 — 1,179,049 — Savings 370,049 370,049 — 370,049 — Club 1,706 1,706 — 1,706 — Certificates of Deposit 1,136,488 1,124,904 — 1,124,904 — Subordinated debt 42,956 41,503 — 41,503 — TRUPS 29,079 27,364 — 27,364 — IRLCs 50 50 — — 50 37 Table of Contents See the Company’s methodologies disclosed in Note 21 of the Company’s 2022 Annual Report for the fair value methodologies used as of December 31, 2022: December 31, 2022 Carrying Amount Fair Value Fair Value Measurements Description of Asset (dollars in thousands) Level 1 Level 2 Level 3 Assets Cash and cash equivalents $ 55,499 $ 55,499 $ 55,499 $ — $ — Investment securities - AFS 83,587 83,587 — 83,587 — Investment securities - HTM 559,455 494,626 — 494,626 — Equity securities 1,233 1,233 — 1,233 — Restricted securities 11,169 11,169 — 11,169 — Loans held for sale 4,248 4,248 — 4,248 — TBA securities 41 41 — 41 — Cash surrender value on life insurance 59,218 59,218 — 59,218 — Loans, at fair value 8,437 8,437 — 8,437 — Loans, net 2,531,027 2,431,808 — — 2,431,808 MSRs 5,275 5,275 — — 5,275 IRLCs 35 35 — — 35 Liabilities Deposits: Noninterest-bearing demand $ 862,015 $ 862,015 $ — $ 862,015 $ — Checking plus interest 694,101 694,101 — 694,101 — Money Market 709,132 709,132 — 709,132 — Savings 319,814 319,814 — 319,814 — Club 374 374 — 374 — Certificates of Deposit 424,348 410,455 — 410,455 — Advances from FHLB - short term 40,000 40,002 — 40,002 — Subordinated debt 43,072 41,193 — 41,193 — TBA Securities 6 6 — 6 — IRLCs 7 7 — — 7 Note 16 – Commitments and Contingencies In the normal course of business, to meet the financial needs of its customers, the Bank is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Letters of credit and other commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the letters of credit and commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The following table provides information on commitments outstanding at September 30, 2023 and December 31, 2022. (Dollars in thousands) September 30, 2023 December 31, 2022 Commitments to extend credit $ 618,628 $ 406,353 Letters of credit 28,896 8,009 Total $ 647,524 $ 414,362 The Company provides banking services to customers who do business in the cannabis industry. Prior to the second quarter of 2022, the Company restricted these businesses to include only those in the medical-use cannabis industry in the state of Maryland. During the second quarter of 2022, the Company expanded its cannabis banking program to include both medical and adult-use licensees in other states, with an initial offering to the Company’s existing Maryland customers with multi-state operations. While the Company is providing banking services to customers that are engaged in the growing, processing, and sales of cannabis in a manner that complies with applicable state 38 Table of Contents law, such customers engaged in those activities currently violate Federal laws. The Company may be deemed to be aiding and abetting illegal activities through the services that it provides to these customers. While we are not aware of any instance of a federally-insured financial institution being subject to such aiding and abetting liability, the strict enforcement of Federal laws regarding cannabis would likely result in the Company’s inability to continue to provide banking services to these customers and the Company could have legal action taken against it by the Federal government, including imprisonment and fines. There is an uncertainty of the potential impact to the Company’s Consolidated Financial Statements if the Federal government takes actions against the Company. As of September 30, 2023, the Company had not accrued an amount for the potential impact of any such actions. Following is a summary of the level of business activities with our cannabis industry customers: • Deposit and loan balances at September 30, 2023 were approximately $ 175.5 million, or 3.4 % of total deposits, and $ 76.2 million, or 1.7 % of total gross loans, respectively. • Interest and noninterest income for the nine months ended September 30, 2023, were approximately $ 7.2 million and $ 0.8 million, respectively. In the normal course of business, the Company may become involved in litigation arising from banking, financial, and other activities. Management, after consultation with legal counsel, does not anticipate that the future liability, if any, arising out of current proceedings will have a material effect on the Company’s financial condition, operating results, or liquidity. Note 17 – Earnings Per Share Basic earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period, adjusted for the dilutive effect of potential common stock equivalents (stock-based awards). The following table provides information relating to the calculation of earnings per common share. Three Months Ended September 30, Nine Months Ended September 30, (In thousands, except per share data) 2023 2022 2023 2022 Net (Loss)/Income $ ( 6,384 ) $ 9,658 $ 4,091 $ 22,769 Average number of common shares outstanding 33,129 19,852 24,354 19,842 Dilutive effect of common stock equivalents — — — — Average number of shares used to calculate diluted EPS 33,129 19,852 24,354 19,842 Anti-dilutive shares 219 — 219 — Earnings per common share Basic $ ( 0.19 ) $ 0.49 $ 0.17 $ 1.15 Diluted $ ( 0.19 ) $ 0.49 $ 0.17 $ 1.15 There were no potentially dilutive shares outstanding during the three and nine months ended September 30, 2022. Note 18 – Revenue Recognition Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees and merchant income. Noninterest revenue streams in-scope of Topic 606 are discussed below. Service Charges on Deposit Accounts Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. 39 Table of Contents Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or at the end of the month through a direct charge to customers’ accounts. Trust and Investment Fee Income Trust and investment fee income primarily comprise fees earned from the management and administration of trusts and other customer assets. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end through a direct charge to customers’ accounts. The Company does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered. Title Company Revenue Title Company revenue consists of revenue earned on performing title work for real estate transactions. The revenue is earned when the title work is performed. Payment for such performance obligations generally occurs at the time of the settlement of a real estate transaction. As such settlement is generally within 90 days of the performance of the title work, we recognize the revenue at the time of the settlement. All contract issuance costs are expensed as incurred. We had no contract assets or liabilities at September 30, 2023. Other Noninterest Income Other noninterest income consists of: fees, exchange, other service charges, safety deposit box rental fees, and other miscellaneous revenue streams. Fees and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Mastercard and VISA. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that rentals and renewals of safe deposit boxes will be recognized on a monthly basis consistent with the duration of the performance obligation. The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and nine months ended September 30, 2023 and 2022. Three Months Ended September 30, Nine Months Ended September 30, (Dollars in thousands) 2023 2022 2023 2022 Noninterest Income In-scope of Topic 606: Service charges on deposit accounts $ 1,505 $ 1,509 $ 3,981 $ 4,306 Trust and investment fee income 1,933 421 2,764 1,383 Interchange income 1,557 1,241 4,081 3,532 Title Company revenue 89 397 412 1,146 Other noninterest income 1,266 494 2,212 1,495 Noninterest Income (in-scope of Topic 606) 6,350 4,062 13,450 11,862 Noninterest Income (out-of-scope of Topic 606) 11,987 1,282 15,516 5,362 Total Noninterest Income $ 18,337 $ 5,344 $ 28,966 $ 17,224 40 Table of Contents