SHORE BANCSHARES, INC. Unless the context clearly suggests otherwise, references to "the Company",
"we", "our", and "us" in the remainder of this report are to
Forward-Looking Information
This Quarterly Report on Form 10-Q contains forward-looking statements. These
forward-looking statements reflect our current views with respect to, among
other things, future events and our financial performance. These statements are
often, but not always, made through the use of words or phrases such as "may,"
"should," "could," "predict," "potential," "believe," "will likely result,"
"expect," "continue," "will," "anticipate," "seek," "estimate," "intend,"
"plan," "project," "projection," "forecast," "goal," "target," "would," "aim"
and "outlook," or the negative version of those words or other comparable words
or phrases of a future or forward-looking nature. These forward-looking
statements are not historical facts, and are based on current expectations,
estimates and projections about our industry and management's beliefs and
certain assumptions made by management, many of which, by their nature, are
inherently uncertain and beyond our control. The inclusion of these
forward-looking statements should not be regarded as a representation by us or
any other person that such expectations, estimates and projections will be
achieved. Accordingly, we caution you that any such forward-looking statements
are not guarantees of future performance and are subject to risks, assumptions
and uncertainties that are difficult to predict. New risks and uncertainties may
emerge from time to time, and it is not possible for us to predict their
occurrence. In addition, we cannot assess the impact of each risk and
uncertainty on our business or the extent to which any risk or uncertainty, or
combination of risks and uncertainties, may cause actual results to differ
materially from those contained in any forward-looking statements.
Further, given its ongoing and dynamic nature, it is difficult to predict the
full impact of the novel coronavirus ("COVID-19") outbreak on our business. The
extent of such impact will depend on future developments, which are highly
uncertain, including when the coronavirus can be controlled and abated and when
and how the economy may be fully reopened. As the result of the COVID-19
pandemic and the related adverse local and national economic consequences, we
could be subject to any of the following risks, any of which could have a
material, adverse effect on our business, financial condition, liquidity, and
results of operations: the demand for our products and services may decline,
making it difficult to grow assets and income; if the economy is unable to
substantially reopen, and high levels of unemployment continue for an extended
period of time, loan delinquencies, problem assets, and foreclosures may
increase, resulting in increased charges and reduced income; collateral for
loans, especially real estate, may decline in value, which could cause loan
losses to increase; our allowance for loan losses may increase if borrowers
experience financial difficulties, which will adversely affect our net income;
the net worth and liquidity of loan guarantors may decline, impairing their
ability to honor commitments to us; as the result of the decline in the Federal
Reserve's target federal funds rate to near 0%, the yield on our assets may
decline to a greater extent than the decline in our cost of interest-bearing
liabilities, reducing our net interest margin and spread and reducing net
income; our cybersecurity risks are increased as the result of an increase in
the number of employees working remotely; and FDIC premiums may increase if the
agency experiences additional resolution costs.
If one or more of the factors affecting our forward-looking information and
statements proves incorrect, then our actual results, performance or
achievements could differ materially from those expressed in, or implied by,
forward-looking information and statements contained in this Quarterly Report on
Form 10-Q and other reports and registration statements filed by us with the
Securities and Exchange Commission ("SEC"). For information on the factors that
could cause actual results to differ from the expectations stated in the
forward- looking statements, see "Risk Factors" under Part I, Item 1A of our
2020 Form 10-K and other reports as filed with the SEC .
Any forward-looking statement speaks only as of the date of this report, and we
do not undertake any obligation to publicly update or review any forward-looking
statement, whether because of new information, future developments or otherwise,
except as required by law.
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Introduction
The following discussion and analysis is intended as a review of significant
factors affecting the Company's financial condition and results of operations
for the periods indicated. This discussion and analysis should be read in
conjunction with the unaudited consolidated financial statements and related
notes presented elsewhere in this report, as well as the audited consolidated
financial statements and related notes included in the 2020 Annual Report.
Shore Bancshares, Inc. is the largest independent financial holding company
headquartered on the Eastern Shore of Maryland . It is the parent company of
Shore United Bank . The Bank operates 22 full-service branches in Baltimore
County , Howard County , Kent County , Queen Anne's County , Talbot County , Caroline
County , Dorchester County and Worcester County in Maryland , Kent County,
Delaware and Accomack County, Virginia . The Company engages in trust and wealth
management services through Wye Financial Partners , a division of Shore United
Bank .
As discussed in Note 15 to the consolidated financial statements, the Company
recently completed its acquisition of Annapolis -based Severn Bancorp, Inc.
("Severn"). The acquisition of Severn will expand the Company's footprint in
the Annapolis and Anne Arundel County market areas, among others, and provide
additional banking resources to our customers, including but not limited to, a
robust secondary market mortgage banking line of business.
The shares of common stock of
Shore Bancshares, Inc. maintains an Internet site at www.shorebancshares.com on which it makes available free of charge its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, theSEC .
COVID-19 Pandemic
The outbreak of COVID-19 has led to adverse impacts on economic conditions and created uncertainty in financial markets. Correspondingly, in earlyMarch 2020 , the Company began preparing for potential disruptions and government limitations of activity in the markets in which we serve. Our team activated our Business Continuity Program and was able to quickly execute on multiple initiatives to adjust our operations to protect the health and safety of our employees and clients. Since the beginning of the crisis, we have been in close contact with our clients, assessing the level of impact on their businesses, and providing relief programs according to each client's specific situation and qualifications. We have also enhanced awareness of digital banking offerings, expanded services at our drive through locations, and allowed customers to make appointments in the branch for critical services. The Company's branches remain open and have taken steps to comply with various government directives regarding "social distancing," as well as, enhanced cleaning and disinfecting of all surface areas to protect its clients and employees.
We established our process for participating in theSmall Business Administration's Paycheck Protection Program ("PPP") that enabled our clients to utilize this valuable resource beginning inApril 2020 . Loans under the PPP are designed to provide assistance for small businesses during the COVID-19 pandemic to help meet the costs associated with payroll, mortgage interest, rent and utilities. These loans are guaranteed by the SBA and forgiveness of the loans, by the SBA, is granted to the borrower if the borrower uses at least 60% of the funds to cover payroll costs and benefits. Forgiveness is also based on the small business maintaining or quickly rehiring their employees and maintaining salary levels for their employees. Loans under the PPP do not require any collateral or personal guarantees, as such, these loans are included in the Company's commercial loans segment. The first round of PPP lending resulted in 1,495 loans for$129.0 million , of which 1,447 loans have been forgiven or paid down in the amount of$125.9 million as ofSeptember 30, 2021 . The second round of PPP lending which began in 2021, resulted in 959 loans for$67.3 million , of which 597 loans have been forgiven or paid down in the amount of$28.9 million . As ofSeptember 30, 2021 , the Company had 410 PPP loans totaling$41.5 million that were outstanding, inclusive of loans issued during both the first and second rounds of the PPP. This has allowed us to further strengthen and deepen our client relationships, while positively impacting thousands of individuals. 37 Table of Contents
We are also closely monitoring the credit quality of the loan portfolio and monitor lines of credit draws for deviation from normal activity to improve loan performance and reduce credit risk.
Short-term Modifications for Borrowers
In keeping with regulatory guidance to work with borrowers during this
unprecedented situation and as outlined in Section 4013 of the Coronavirus Aid,
Relief, and Economic Security Act ("CARES Act") and the Consolidated
Appropriations Act of 2021 ("CAA"), the Company is providing modifications where
appropriate, including interest only payments or payment deferrals for clients
that could be adversely affected by the COVID-19 pandemic. Section 4013 of the
CARES Act and CAA addressed COVID-19 related modifications and specified that
such modifications made on loans that were current as of December 31, 2019 are
not TDRs. In accordance with interagency guidance issued in April 2020 and
December 2020 , short-term modifications made to borrowers affected by the
COVID-19 pandemic and governmental shutdown orders, such as payment deferrals,
fee waivers and extensions of repayment terms, do not need to be identified as
TDRs if the loans were current at the time a modification plan was implemented.
Since the beginning of the pandemic and through September 30, 2021 , the Company
had executed principal and/or interest deferrals on outstanding loan balances of
$221.1 million . As of September 30, 2021 , the Company had no COVID relatedloan deferrals remaining. Liquidity We are vigilantly monitoring our liquidity position on an ongoing basis. The Company has several available sources of on and off-balance sheet liquidity. Currently, the Company has not needed to tap into these available liquidity sources due to payment deferrals by customers, funding of PPP loans, or organic loan growth. Additional discussion on our liquidity as of the report date is reflected in the "Liquidity and Capital Resources" section of management's
discussion and analysis. Share Repurchases The Company currently has a share repurchase program, in which$542 thousand remains available until expirations onDecember 31, 2021 . The Board of directors and management will re-evaluate the need for an additional stock repurchase program based on the market price of the Company's stock, capital position, and necessary regulatory approvals.
Dividends and Capital
We currently expect to maintain our quarterly cash dividend based on our strong capital position. AtSeptember 30, 2021 , the Bank exceeded all the capital requirements to which it was subject, and based on the most recent notification from its primary federal regulator is considered to be well-capitalized. There are no conditions or events since that notification that management believes would change the Bank's classification. We are closely monitoring our capital position and are taking appropriate steps to ensure our level of capital remains strong. Our capital, while significant, may deteriorate in future periods due to the impact of the pandemic and limit our ability to pay dividends.
Critical Accounting Policies
The Company's consolidated financial statements are prepared in accordance with
GAAP and follow general practices within the industries in which it operates.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions, and judgments. Certain policies inherently
have a greater reliance on the use of estimates, assumptions, and judgments and
as such have a greater possibility of producing results that could be materially
different than originally reported.
The most significant accounting policies that the Company follows are presented
in Note 1 of the 2020 Annual Report. These policies, along with the disclosures
presented in the notes to the financial statements and in this discussion,
provide information on how significant assets and liabilities are valued in the
financial statements and how those values are determined. Based on the valuation
techniques used and the sensitivity of financial statement amounts to the
methods,
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assumptions, and estimates underlying those amounts, management has determined
that the accounting policies with respect to the allowance for credit losses and
goodwill are critical accounting policies. These policies are considered
critical because they relate to accounting areas that require the most
subjective or complex judgments, and, as such, could be most subject to revision
as new information becomes available.
The allowance for credit losses represents management's estimate of credit
losses inherent in the loan portfolio as of the balance sheet date. Determining
the amount of the allowance for credit losses is considered a critical
accounting estimate because it requires significant judgment and the use of
estimates related to the amount and timing of expected future cash flows on
impaired loans, estimated losses on pools of similar loans based on historical
loss experience, and consideration of current economic trends and conditions and
other factors, all of which may be susceptible to significant change. The loan
portfolio also represents the largest asset type on the consolidated balance
sheets. Note 1 to the 2020 Annual Report describes the methodology used to
determine the allowance for credit losses. A discussion of the allowance
determination and factors driving changes in the amount of the allowance for
credit losses is included in the Provision for Credit Losses and Allowance for
Credit Losses sections below.
Goodwill represents the excess of the cost of an acquisition over the fair value
of the net assets acquired. Determining fair value is subjective, requiring the
use of estimates, assumptions and management judgment. Goodwill is tested at
least annually for impairment, usually during the fourth quarter, or on an
interim basis if circumstances dictate. Impairment testing requires a
qualitative assessment or that the fair value of each of the Company's reporting
units be compared to the carrying amount of its net assets, including goodwill.
If the fair value of a reporting unit is less than book value, an expense may be
required to write down the related goodwill to record an impairment loss. As of
September 30, 2021 , the Company had only one banking reporting unit.
As previously noted, the Company acquired Severn Bancorp, Inc. during the 4th
quarter of 2021. The Company's 2021 Annual Report on Form 10-K will also include
the critical accounting policies related to its acquisition of Severn.
OVERVIEW
The Company reported net income of$4.6 million for the third quarter of 2021, or diluted income per common share of$0.39 , compared to net income of$3.4 million , or diluted income per common share of$0.27 , for the third quarter of 2020. For the second quarter of 2021, the Company reported net income of$4.0 million , or diluted income per common share of$0.34 . When comparing net income for the third quarter of 2021 to the third quarter of 2020, net income increased$1.2 million , primarily due to increases in net interest income of$2.3 million and noninterest income of$328 thousand , combined with a lower provision for credit losses of$1.2 million . These improvements to net income were partially offset by an increase in almost all expense line items, adding$2.1 million to noninterest expense. When comparing the third quarter of 2021 to the second quarter of 2021, the net income increased$586 thousand , due to an increase in net interest income of$1.5 million and lower provision for credit losses of$360 thousand , which was partially offset by an increase in noninterest expense of$1.1 million . In addition, merger-related expenses were recorded for the second and third quarters of 2021 of$377 thousand and$538 thousand , respectively. For the first nine months of 2021, the Company reported net income of$12.6 million , or diluted income per common share of$1.08 , compared to net income of$11.8 million , or diluted income per common share of$0.95 , for the first nine months of 2020. When comparing net income for the first nine months of 2021 to the first nine months of 2020, net income increased$801 thousand , primarily due to increases in net interest income of$4.7 million and noninterest income of$667 thousand , combined with a lower provision for credit losses of$1.5 million . These improvements to net income were partially offset by an increase in almost all expense line items, adding$5.5 million to noninterest expense. In addition, total merger-related expenses for the first nine months were$915
thousand. RESULTS OF OPERATIONS Net Interest Income
Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments. As shown in the table below, tax-equivalent net interest income was$15.6 million for the third quarter 39 Table of Contents
of 2021 and$13.3 million for the third quarter of 2020. Tax-equivalent net interest income was$14.1 million for the second quarter of 2021. The increase in net interest income when comparing the third quarter of 2021 to the third quarter of 2020 and the second quarter of 2021, was the result of higher interest and fees on loans and income from taxable investment securities, coupled with a decrease in interest expense. Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets. The net interest margin for the third quarter of 2021 was 2.99%, which was a decrease of 18bps when compared to 3.17% for the third quarter of 2020 and an increase of 8bps when compared to 2.91% for the second quarter of 2021. The decline in net interest margin in the third quarter of 2021 when compared to the third quarter of 2020, was significantly impacted by excess liquidity and the decrease in yields of taxable investment securities. The increase in net interest margin when compared to the second quarter of 2021, was primarily due to improvement in the yields on earning assets, specifically loans of 14bps, and the continued decrease in rates paid on interest-bearing deposits. Without excess liquidity of$200 million , the margin for the third quarter of 2021
would have been 3.31%. Interest Income On a tax-equivalent basis, interest income increased$2.0 million , or 13.4%, for the third quarter of 2021 when compared to the third quarter of 2020. The increase was the result of higher interest and fees on loans and income from investment securities. The primary driver for the increase in interest income on loans was the higher average volume of loans of$80.6 million and a higher average yield of 13bps, partially impacted by PPP forgiveness in the third quarter of 2021. The average balance of investment securities increased$198.2 million , providing$588 thousand of additional income, despite a decrease in the average yield of 56bps. On a tax-equivalent basis, interest income increased$1.4 million , or 8.8%, for the third quarter of 2021 when compared to the second quarter of 2021. The increase was primarily a result of growth in the average balance in loans of$42.6 million and a higher average yield of 14bps, partially impacted by PPP forgiveness in the third quarter of 2021. In addition, taxable investment securities were purchased during the third quarter of 2021, resulting in a higher average balance in these securities of$48.1 million and improvement in the average yield of 5bps, which provided$224 thousand of additional income.
Interest Expense
Interest expense decreased$309 thousand , or 19.0%, when comparing the third quarter of 2021 to the third quarter of 2020. The decrease in interest expense from the third quarter of 2020 was a result of the decrease in the average rate paid on interest-bearing deposits of 27bps. This decrease in interest expense was partially offset by the issuance of subordinated debt late in the third quarter of 2020 which added$211 thousand of additional expense for the third quarter of 2021 when compared to the third quarter of 2020.
Interest expense decreased
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The following tables present the distribution of the average consolidated
balance sheets, interest income/expense, and annualized yields earned and rates
paid for the three months ended
For Three Months Ended For Three Months Ended
September 30, 2021 September 30, 2020
Average Income(1)/ Yield/ Average Income(1)/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate
Earning assets
Loans (2), (3) $ 1,487,281 $ 15,518 4.14 % $ 1,406,683 $ 14,173 4.01 %
Investment securities:
Taxable 334,205 1,318 1.58 136,017 730 2.14
Interest-bearing deposits 250,019 97 0.15 127,494 33 0.10
Total earning assets 2,071,505 16,933 3.24 % 1,670,194 14,936 3.56 %
Cash and due from banks 19,453 18,860
Other assets 108,989 94,755
Allowance for credit losses (15,499) (11,865)
Total assets $ 2,184,448 $ 1,771,944
Interest-bearing liabilities
Demand deposits $ 462,950 165 0.14 % $ 370,922 174 0.19 %
Money market and savings 644,330 295 0.18 442,322 229 0.21
deposits
Certificates of deposit 136,059 243 0.71 127,983 539 1.68
$100,000 or more
Other time deposits 142,777 246 0.68 148,223 528 1.42
Interest-bearing deposits 1,386,116 949 0.27 1,089,450 1,470 0.54
Securities sold under retail
repurchase agreements and
short-term FHLB advances 2,718 2 0.29 1,575 1 0.25Advances from FHLB - short-term - - - - - - Advances from FHLB - long-term - - - - - - Subordinated debt 24,504 359 5.81 9,859 148 5.97 Total interest-bearing 1,413,338 1,310 0.37 % 1,100,884 1,619 0.59 %
liabilities
Noninterest-bearing deposits 557,109
458,622
Other liabilities 13,120 11,359
Stockholders' equity 200,881 201,079
Total liabilities and
stockholders' equity $ 2,184,448 $ 1,771,944
Net interest spread $ 15,623 2.87 % $ 13,317 2.97 %
Net interest margin 2.99 % 3.17 %
Tax-equivalent adjustment
Loans $ 34 $ 34
Total $ 34 $ 34
All amounts are reported on a tax-equivalent basis computed using the (1) statutory federal income tax rate of 21.0%, exclusive of nondeductible
interest expense.
(2) Average loan balances include nonaccrual loans.
Interest income on loans includes accreted loan fees, net of costs and (3) accretion of discounts on acquired loans, which are included in the yield
calculations.
Net Interest Income
Tax-equivalent net interest income increased $4.7 million , or 12.0%, during the
nine months ended September 30, 2021 compared to the nine months ended September
30, 2020 . The higher net interest income was due to an increase in interest
income of $3.6 million , or 8.1% and a decrease in interest expense on
interest-bearing deposits of $1.9 million , or 20.0%. Despite the improved
results, compression in the margin was due to lower yields on total earning
assets. This resulted in a net interest margin of 2.97% for the nine months
ended September 30, 2021 compared to 3.35% for the nine months ended September
30, 2020 .
Interest Income
On a tax-equivalent basis, interest income increased$3.6 million , or 8.1%, for the nine months endedSeptember 30, 2021 when compared to the nine months endedSeptember 30, 2020 . The increase was primarily due to higher interest and fees 41 Table of Contents
on loans of$2.4 million , or 5.6% and taxable investment securities of$1.3 million , or 60.2%. The increase in interest and fees on loans was due to a higher average balance of loans of$112.7 million , or 8.4%, which included forgiveness on PPP loans in 2021. The increase in interest on taxable investment securities was due to a higher average balance in these securities of$158.6 million , or 127.4%, despite the decline in the average yield of such securities of 66bps. Interest Expense
Interest expense decreased$1.1 million , or 20.0%, when comparing the nine months endedSeptember 30, 2021 to the nine months endedSeptember 30, 2020 . The decrease in interest expense was due to a decline in the rates paid on interest-bearing deposits of 33bps and the elimination of long-term advances from FHLB. These improvements were partially offset by the addition of subordinated debt, issued in the third quarter of 2020, which added$940 thousand in interest expense when compared to the first nine months of 2020. 42 Table of Contents
The following tables present the distribution of the average consolidated
balance sheets, interest income/expense, and annualized yields earned and rates
paid for the nine months ended
For Nine Months Ended For Nine Months Ended
September 30, 2021 September 30, 2020
Average Income(1)/ Yield/ Average Income(1)/ Yield/(Dollars in thousands) Balance Expense Rate Balance Expense Rate Earning assets Loans (2), (3)$ 1,461,083 $ 44,339 4.06 %$ 1,348,362 $ 41,987 4.16 % Investment securities: Taxable 283,104 3,343 1.58 124,487 2,087 2.24 Interest-bearing deposits 219,540 199 0.12 81,125 216 0.36 Total earning assets 1,963,727 47,881 3.26 % 1,553,974 44,290 3.81 % Cash and due from banks 18,536
18,302
Other assets 107,174
91,642
Allowance for credit losses (14,802)
(11,042)
Total assets$ 2,074,635
Interest-bearing liabilities Demand deposits$ 435,678 453 0.14 %$ 318,083 714 0.30 % Money market and savings 591,959 777 0.18 426,570 941 0.29
deposits
Certificates of deposit 134,080 998 1.00 129,319 1,723 1.78$100,000 or more Other time deposits 143,832 961 0.89 149,841 1,708 1.52 Interest-bearing deposits 1,305,549 3,189 0.33 1,023,813 5,086 0.66 Securities sold under retail repurchase agreements and federal funds purchased 2,695 5 0.25 1,613 4 0.33 Advances from FHLB - long-term - - - 5,255 113 2.87 Subordinated debt 24,474 1,088 5.94 3,310 148 5.97 Total interest-bearing 1,332,718 4,282 0.43 % 1,033,991 5,351 0.69 %
liabilities
Noninterest-bearing deposits 531,199
410,702
Other liabilities 12,631 10,088
Stockholders' equity 198,087 198,095
Total liabilities and
stockholders' equity $ 2,074,635 $ 1,652,876
Net interest spread $ 43,599 2.83 % $ 38,939 3.12 %
Net interest margin 2.97 % 3.35 %
Tax-equivalent adjustment
Loans $ 108 $ 107
Total $ 108 $ 107 All amounts are reported on a tax-equivalent basis computed using the (1) statutory federal income tax rate of 21.0%, exclusive of nondeductible
interest expense.
(2) Average loan balances include nonaccrual loans.
Interest income on loans includes accreted loan fees, net of costs and (3) accretion of discounts on acquired loans, which are included in the yield
calculations.
Noninterest Income
Total noninterest income for the third quarter of 2021 increased $328 thousand ,
or 12.7%, when compared to the third quarter of 2020. The increase from the
third quarter of 2020 included all lines of business, but predominately service
charges on deposit accounts, trust and investment fee income and other debit
card interchange fees. Noninterest income increased $6 thousand , or less than
1%, when compared to the second quarter of 2021 primarily due to higher service
charges on deposit accounts, almost entirely offset by the absence of a debit
card incentive received in the second quarter of 2021.
Total noninterest income for the nine months ended September 30, 2021 , increased
$667 thousand , or 8.7%, when compared to the same period in 2020. The increase
in noninterest income primarily consisted of higher trust and investment fee
income, deposit related fees and service charges on other bank services,
partially off-set by lower gains on securities year over year. The increase in
deposit related fees and other bank service charges has been impacted by the
growth in
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new accounts and balances of deposits, as well as a return to a more normalized local economy and consumer demand for products and services in 2021.
Noninterest Expense
Total noninterest expense for the third quarter of 2021 increased$2.1 million , or 21.4%, when compared to the third quarter of 2020 and increased$1.1 million , or 9.7%, when compared to the second quarter of 2021. The increase in noninterest expense when compared to both the third quarter of 2020 and second quarter of 2021 was primarily driven by salary and wages being deferred in the third quarter of 2020 and the second quarter of 2021, the result of originating first and second round PPP loans, combined with additional accruals related to incentive payouts and bonuses for employees. In addition, increases in employee benefits, furniture and fixtures, andFDIC insurance contributed to the higher expense base in the third quarter of 2021. Employee benefits increased due to higher supplemental executive retirement plan costs in the third quarter of 2021, while furniture and fixtures increased due to renovations of an existing bank branch.FDIC insurance premiums have increased due to the growth in deposit accounts in 2021. Merger-related expenses due to the acquisition of Severn remained a significant variance when comparing the comparative third quarters of 2021 and 2020. Total noninterest expense for the nine months endedSeptember 30, 2021 , increased$5.5 million , or 19.6%, when compared to the same period in 2020. The increase was mainly the result of the absence of the deferral in salaries and wages due to PPP loan originations in 2020, accruals related to incentive payouts and bonuses, higher data processing costs,FDIC insurance premiums and occupancy costs. The higher occupancy costs are associated with a new branch lease inOcean City, Maryland which will open in 2022. In addition, the Company recorded merger-related expenses of$915 thousand for the first nine months of 2021 due to the acquisition of Severn.
Provision for Credit Losses
The provision for credit losses was$290 thousand for the third quarter of 2021,$1.5 million for the third quarter of 2020 and$650 thousand for the second quarter of 2021. The ratio of the allowance for credit losses to period-end loans was 1.04% atSeptember 30, 2021 , 0.95% atDecember 31, 2020 and 1.02% atJune 30, 2021 . Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% atSeptember 30, 2021 , higher than the 1.04% atDecember 31, 2020 and slightly lower than the 1.09% atJune 30, 2021 . The primary driver of the increased percentage of the allowance to total loans, excluding PPP loans, as compared toDecember 31, 2020 , was significant loan originations within segments of the portfolio which carry higher reserves. The decrease in the percentage of the allowance to total loans, excluding PPP loans, as compared toJune 30, 2021 , was due slightly reduced pandemic qualitative factors within the allowance model. The Company reported net recoveries in the third quarter of 2021 of$147 thousand , compared to net recoveries of$187 thousand for the third quarter of 2020 and net recoveries of$125 thousand
for the second quarter of 2021. The provision for credit losses for the nine months endedSeptember 30, 2021 , and 2020 was$1.4 million and$2.9 million , respectively, while net recoveries were$272 thousand and net charge-offs were$580 thousand , respectively. The decrease in the provision for credit losses was the result of lower charge-offs in 2021, overall improved credit quality and a slight reduction in pandemic related qualitative factors. The ratio of allowance to total loans increased from 0.95% atDecember 31, 2020 , to 1.04% atSeptember 30, 2021 . Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% atSeptember 30, 2021 , higher than the 1.04% atDecember 31, 2020 . The primary drivers for the increase in the percentage of allowance for credit losses to total loans were significant originations within the construction and consumer loan portfolios, which require a higher level of allowance than certain other segments of the portfolio. The ratio of annualized net recoveries to average loans was 0.07% for the first nine months of 2021, compared to annualized net charge-offs of 0.06% for the first nine months of 2020. Management will continue to evaluate the adequacy of the allowance for credit losses as more economic data becomes available and as changes within the Company's portfolio are known.
Income Taxes
The Company reported income tax expense of$1.7 million for the third quarter of 2021,$1.1 million for the third quarter of 2020 and$1.4 million for the second quarter of 2021. Income tax expense increased when compared to both the third 44 Table of Contents
quarter of 2020 and second quarter of 2021 due to higher pre-tax earnings. The effective tax rate for the second and third quarters of 2021 was 26.4% and was 25.2% for the third quarter of 2020. Income tax expense for the nine months endedSeptember 30, 2021 , compared to the nine months endedSeptember 30, 2020 , increased$544 thousand due to higher pre-tax earnings. The effective tax rate atSeptember 30, 2021 andSeptember 30, 2020 were 26.4% and 25.2%, respectively.
ANALYSIS OF FINANCIAL CONDITION
Loans Loans totaled$1.495 billion atSeptember 30, 2021 and$1.454 billion atDecember 31, 2020 , an increase of$40.6 million , or 2.8%. Excluding PPP loans, the increase in total loans was$121.9 million , or 9.2%, due to significant loan growth late in the second and third quarters of 2021. The increase in loans, excluding PPP loans, was comprised of increases in consumer loans of$62.8 million , or 199.7%, construction loans of$23.8 million , or 22.3%, residential real estate loans of$17.3 million , or 3.9%, commercial loans of$15.2 million , or 7.2%, and commercial real estate loans of$2.7 million , or less than 1%. Construction loans included deferred fees, net of deferred costs, of$376 thousand and discounts on acquired loans of$577 thousand atSeptember 30, 2021 , compared to deferred costs, net of deferred fees, of$622 thousand and discounts on acquired loans of$754 thousand atDecember 31, 2020 . Outstanding PPP loans totaled$41.5 million atSeptember 30, 2021 and$122.8 million atDecember 31, 2020 , a decrease of$81.3 million or 66.2%. The decrease was primarily due to forgiveness on first and second round PPP loans originated in 2020 and 2021. We do not engage in foreign or subprime lending activities. See Note 4, "Loans and Allowance for Credit Losses", in the Notes to Consolidated Financial Statements and below under the caption "Allowance for Credit Losses" for additional information. Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans. Construction loans were$130.6 million , or 8.7% of total loans, atSeptember 30, 2021 and$106.8 million , or 7.3% of total loans, atDecember 31, 2020 . Commercial real estate loans were$663.9 million , or 44.4% of total loans, atSeptember 30, 2021 , compared to$661.2 million , or 45.5% of total loans,
atDecember 31, 2020 .
The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution's total risk-based capital; or (2) total non-owner occupied commercial real estate loans representing 300% or more of the institution's total risk-based capital and the institution's non-owner occupied commercial real estate loan portfolio (including construction) has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years. AtSeptember 30, 2021 , non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 301.6% of total risk-based capital. At such time, construction, land and land development loans represented 61.8% of total risk-based capital. The commercial real estate portfolio (including construction) has increased 45.2% during the prior 36 months. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, as well as strong underwriting criteria with respect to its commercial real estate portfolio. Monitoring practices include periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital or be required to sell/participate portions of loans, which may adversely affect
shareholder returns.
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Allowance for Credit Losses
We have established an allowance for credit losses, which is increased by
provisions charged against earnings and recoveries of previously charged-off
loans and is decreased by current period charge-offs of uncollectible loans.
Management evaluates the adequacy of the allowance for credit losses at least
quarterly and adjusts the provision for credit losses based on this analysis.
The evaluation of the adequacy of the allowance for credit losses is based
primarily on a risk rating system of individual loans, as well as on a
collective evaluation of smaller balance homogenous loans, each grouped by loan
type. Each loan type is assigned allowance factors based on criteria such as
past credit loss experience, local economic and industry trends, and other
measures which may impact collectability. Please refer to the discussion above
under the caption "Critical Accounting Policies" for an overview of the
underlying methodology management employs to maintain the allowance.
The allowance for credit losses was $15.5 million at September 30, 2021 , $13.9
million at December 31, 2020 and $15.1 million at June 30, 2021 . There were net
recoveries of $147 thousand for the third quarter of 2021, compared to net
recoveries of $61 thousand for the fourth quarter of 2020 and net recoveries of
$125 thousand for the second quarter of 2021. The ratio of annualized net
recoveries to average loans was 0.04% for the third quarter of 2021, compared to
annualized net recoveries of 0.02% for the fourth quarter of 2020 and 0.03% for
the second quarter of 2021.
Management remains focused on its efforts to dispose of problem loans and to
prudently charge-off nonperforming loans to enable the Company to continue to
improve its overall credit quality. The allowance for credit losses as
a percentage of period-end loans was 1.04% at September 30, 2021 and 0.95% at
December 31, 2020 . Excluding PPP loans, the ratio of the allowance for credit
losses to period-end loans as 1.07% at September 30, 2021 , higher than the 1.04%
at December 31, 2020 . The increase in the percentage of the allowance to total
loans at September 30, 2021 , compared to December 31, 2020 , was primarily due to
significant loan growth in the second and third quarters of 2021 as previously
discussed. Management currently believes that the provision for credit losses
and the resulting allowance were adequate to provide for probable losses
inherent in our loan portfolio at September 30, 2021 .
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The following tables present a summary of the activity in the allowance for
credit losses at or for the three and nine months ended
For the Three Months Ended September 30,
2021 2020
Percentage of net Percentage of net
charge-offs (recoveries) charge-offs (recoveries)
(annualized) to (annualized) to
average loans average loans
Net (charge-offs) outstanding Net (charge-offs) outstanding
(Dollars in thousands) recoveries during the year recoveries during the year
Construction $ 161 (0.49) % $ 5 (0.02) %
Residential real estate 9 (0.01) 189 (0.17)
Commercial real estate - - - -
Commercial (29) 0.08 (8) 0.01
Consumer 6 (0.03) 1 (0.01)
Total $ 147 (0.04) % $ 187 (0.05) %
Average loans outstanding during the period $ 1,487,281 $ 1,406,683 Allowance for credit losses at period end as a percentage of total period end loans (1) 1.04 % 0.91 % Allowance for credit losses at period end as a percentage of average loans (2) 1.04 % 0.90 % Allowance for credit losses at period end as a percentage of period end nonaccrual loans 449.09 % 183.42 %
At
(1) PPP loans of
PPP loans of $126.7 million . Excluding PPP loans, the ratio is 0.98%.
At September 30, 2021 , the quarter-to-date average loan balances used to
calculate the ratio include PPP loans of
(2) the ratio is 1.09%. At
balances used to calculate the ratio included PPP loans of
Excluding PPP loans, the ratio is 1.00%.
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For the Nine Months Ended September 30,
2021 2020
Percentage of net Percentage of net
charge-offs (recoveries) charge-offs (recoveries)
(annualized) to (annualized) to
average loans average loans
Net (charge-offs) outstanding Net (charge-offs) outstanding
(Dollars in thousands) recoveries during the year recoveries during the year
Construction $ 171 (0.19) % $ 13 (0.02) %
Residential real estate 72 (0.02) 5 -
Commercial real estate 64 (0.01) (601) 0.13
Commercial (40) 0.03 (3) -
Consumer 5 (0.01) 6 (0.02)
Total $ 272 (0.02) % $ (580) 0.05 %
Average loans outstanding during the period $ 1,461,083 $ 1,348,362 Allowance for credit losses at period end as a percentage of total period end loans (1) 1.04 % 0.90 % Allowance for credit losses at period end as a percentage of average loans (2) 1.06 % 0.95 % Allowance for credit losses at period end as a percentage of period end nonaccrual loans 449.09 % 183.42 %
At
(1) PPP loans of
PPP loans of $126.7 million . Excluding PPP loans, the ratio is 0.98%.
At September 30, 2021 , the year-to-date average loan balances used to
calculate the ratio include PPP loans of
(2) the ratio is 1.14%. At
balances used to calculate the ratio included PPP loans of
Excluding PPP loans, the ratio is 1.00%.
Nonperforming Assets and Accruing TDRs
As shown in the following table, nonperforming assets were$4.4 million and$6.3 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. The balance of nonperforming assets decreased primarily due to a decline in nonaccrual loans of$2.0 million , or 36.6%. Accruing troubled debt restructurings ("TDRs") decreased$1.2 million , or 17.8%, over the same time period. Other real estate owned properties increased to$203 thousand from$0 atDecember 31, 2020 . The ratio of nonaccrual loans and accruing TDRs to total loans decreased to 0.62% atSeptember 30, 2021 from 0.86% atDecember 31, 2020 . The Company continues to focus on the resolution of its nonperforming and problem assets. The efforts to accomplish this goal include frequently contacting borrowers until the delinquency is cured or until an acceptable payment plan has been agreed upon; obtaining updated appraisals; provisioning for credit losses; charging-off loans; transferring loans to other real estate owned; aggressively marketing other real estate owned. The reduction of nonperforming and problem assets is and will continue to be a high priority
for
the Company.
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The following table summarizes our nonperforming assets and accruing TDRs at
(Dollars in thousands) September 30, 2021 December 31, 2020 Nonperforming assets Nonaccrual loans $ 3,457 $ 5,455 Total loans 90 days or more past due and still accruing 748 804 Other real estate owned 203 - Total nonperforming assets $ 4,408 $
6,259
Total accruing TDRs $ 5,750 $ 6,997
As a percent of total loans:
Nonaccrual loans 0.23 % 0.38 %
Accruing TDRs 0.38 % 0.48 %
Nonaccrual loans and accruing TDRs 0.62 % 0.86 %
As a percent of total loans and other real
estate owned:
Nonperforming assets 0.29 % 0.43 %
Nonperforming assets and accruing TDRs 0.68 %
0.91 %
As a percent of total assets:
Nonaccrual loans 0.15 % 0.28 %
Nonperforming assets 0.19 % 0.32 %
Accruing TDRs 0.25 % 0.36 %Nonperforming assets and accruing TDRs 0.45 %
0.69 %
Investment Securities
The investment portfolio is comprised of debt and equity securities. Debt
securities are classified as either available for sale or held to maturity.
Investment securities available for sale are stated at estimated fair value
based on quoted prices. They represent securities which may be sold as part of
the asset/liability management strategy or in response to changing interest
rates. Net unrealized holding gains and losses on these securities are reported
net of related income taxes as accumulated other comprehensive income, a
separate component of stockholders' equity.
Investment securities in the held to maturity category are stated at cost
adjusted for amortization of premiums and accretion of discounts. We have the
intent and current ability to hold such securities until maturity. At September
30, 2021 , 29.8% of the portfolio of debt securities was classified as available
for sale and 70.2% was classified as held to maturity, compared to 68.0% and
32.0% respectively, at December 31, 2020 . See Note 3 - "Investment Securities ",
in the Notes to Consolidated Financial Statements for additional details on the
composition of our investment portfolio.
Investment securities including restricted stock totaled $360.2 million at
September 30, 2021 , a $149.9 million , or 71.3%, increase since December 31,
2020 . The increase was primarily due to the purchases of held to maturity
securities of $214.2 million , partially offset by proceeds from maturities and
sales of available for sale securities and held to maturity securities of $32.0
million and $29.0 million , respectively, during 2021. Due to the excess
liquidity experienced in 2020 and 2021, the Company strategically purchased
short duration held to maturity securities and subordinated debt of other banks
which earn significantly higher average yields than interest-bearing deposits
with other banks. As loan demand begins to strengthen, the Company will redeploy
proceeds from maturities and paydowns, as well as excess liquidity to fund loan
growth. At September 30, 2021 , 82.9% of the securities available for sale were
mortgage-backed and 17.1% were U.S. Government agencies, compared to 83.1% and
16.9%, respectively, at year-end 2020. At September 30, 2021 , 67.6% of the
securities held to maturity were mortgage-backed, 27.1% were U.S. Government
agencies and 5.3% were other debt securities, compared to 41.5%, 28.7% and
29.2%, respectively, at year-end 2020. Our investments in mortgage-backed
securities are issued or guaranteed by U.S. Government agencies or
government-sponsored agencies.
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Deposits
Total deposits atSeptember 30, 2021 amounted to$2.02 billion , an increase of$317.4 million , or 18.7%, when compared to the level atDecember 31, 2020 . The increase in total deposits consisted of increases in the following categories: Savings and money market accounts of$193.1 million , checking accounts of$69.6 million , noninterest-bearing deposits of$45.8 million and other time deposits of$8.9 million . The significant movement within deposit accounts continues to be impacted by direct government stimulus payments to our customers and new account openings.
Short-Term Borrowings
Short-term borrowings consisted of securities sold under agreements to repurchase, which increased by$2.5 million , or 233.4%, to$3.5 million atSeptember 30, 2021 when compared toDecember 31, 2020 . Securities sold under agreements to repurchase are issued in conjunction with cash management services for commercial depositors. Other short-term borrowings may consist of overnight borrowing from correspondent banks or advances from the FHLB. Short-term advances are defined as those with original maturities of one year or less. AtSeptember 30, 2021 andDecember 31, 2020 , the Company had no outstanding short-term or long-term advances with FHLB.
Long-Term Debt
The Company uses long-term borrowings to meet longer term liquidity needs, specifically to fund loan growth when liquidity from deposit growth is not sufficient. OnAugust 25, 2020 , the Company entered into Subordinated Note Purchase Agreements with certain purchasers pursuant to which the Company issued and sold$25.0 million in aggregate principal amount with an initial interest rate of 5.375% Fixed-to-Floating Rate Subordinated Notes dueSeptember 1, 2030 .
Liquidity and Capital Resources
We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets. As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net increase in cash and cash equivalents was$123.9 million for the first nine months of 2021 compared to an increase of$61.5 million for the first nine months of 2020. The increase in cash and cash equivalents in 2021 was mainly due to the significant increase in deposits, the direct result of new account openings, government stimulus and significant increases in municipal accounts. The Company expects these funds to be utilized over the coming months, which may result in deposit balance fluctuations. To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets. The Bank has arrangements with other correspondent banks whereby it has$15 million available in federal funds lines of credit and a reverse repurchase agreement available to meet any short-term needs which may not otherwise be funded by the Bank's portfolio of readily marketable investments that can be converted to cash. The Bank is also a member of the FHLB, which provides another source of liquidity. Through the FHLB, the Bank had collateral pledged of approximately$299.2 million and$316.7 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. The Bank has pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB. Total stockholders' equity increased$6.6 million to$201.6 million , or 3.4%, atSeptember 30, 2021 when compared toDecember 31, 2020 primarily due to the current year's retained earnings, partially offset by dividends paid during the first nine months of 2021 and the change in fair value of available-for-sale securities recorded in accumulated other comprehensive income.
CBLR
OnSeptember 17, 2019 , theFDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio ("CBLR") framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed 50
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to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.
OnApril 6, 2020 , in a joint statement, theFDIC ,Federal Reserve and theOffice of Comptroller of the Currency ("OCC"), issued two interim final rules regarding temporary changes to the CBLR framework to implement provisions of the CARES Act. Under the interim final rules, the community bank leverage ratio was reduced to 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 8%, less than$10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The Company has not opted-in to the CBLR framework.
Basel III
Under finalFederal Reserve andFDIC approved rules implementing theBasel Committee on Banking Supervision's capital guidelines forU.S. banks minimum requirements increased for both the quantity and quality of capital held by the Bank. The Basel III capital standards substantially revised the risk based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the definitions and the components of Tier 1 capital and Total Capital, the method of evaluating risk-weighted assets, institutions of a capital conservation buffer, and other matters affecting regulatory capital ratios. Strict eligibility criteria for regulatory capital instruments were also implemented under the rules. The phase-in period for the final rules became effective for the Bank onJanuary 1, 2015 , with full compliance with all of the final rules' requirements phased in over a multi-year schedule, which was fully phased in onJanuary 1, 2019 . As ofSeptember 30, 2021 , the Bank's capital levels remained characterized as "well-capitalized" under the rules.
The following tables present the applicable capital ratios as of
Tier 1 Common Equity Tier 1 Total
leverage Tier 1 risk-based risk-based
September 30, 2021 ratio ratio capital ratio capital ratio
Shore United Bank 9.04 % 12.90 % 12.90 % 13.94 %
Tier 1 Common Equity Tier 1 Total
leverage Tier 1 risk-based risk-based
December 31, 2020 ratio ratio capital ratio capital ratio
Shore United Bank 9.73 % 13.21 % 13.21 % 14.25 %© Edgar Online, source
