UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2023

OR

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-22345

SHORE BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Maryland		52-1974638
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

18 E. Dover Street, Easton, Maryland		21601
(Address of Principal Executive Offices)		(Zip Code)

(410) 763-7800

Registrant’s Telephone Number, Including Area Code

N/A

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	SHBI	NASDAQ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒

The number of shares outstanding of the registrant’s common stock as of August 9, 2023 was 33,123,020.

Table of Contents

INDEX

		Page

Part I. Financial Information		3

Item 1. Financial Statements		3

Consolidated Balance Sheets – June 30, 2023 (unaudited) and December 31, 2022		3

Consolidated Statements of Income For the three and six months ended June 30, 2023 and 2022 (unaudited)		4

Consolidated Statements of Comprehensive Income For the three and six months ended June 30, 2023 and 2022 (unaudited)		5

Consolidated Statements of Changes in Stockholders’ Equity For the three and six months ended June 30, 2023 and 2022 (unaudited)		6

Consolidated Statements of Cash Flows For the six months ended June 30, 2023 and 2022 (unaudited)		8

Notes to Consolidated Financial Statements (unaudited)		10

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		41

Item 3. Quantitative and Qualitative Disclosures about Market Risk		54

Item 4. Controls and Procedures		54

Part II. Other Information		55

Item 1. Legal Proceedings		55

Item 1A. Risk Factors		55

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		55

Item 3. Defaults Upon Senior Securities		55

Item 4. Mine Safety Disclosures		55

Item 5. Other Information		55

Item 6. Exhibits		56

Signatures		58

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

SHORE BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS


	June 30,		December 31,
(In thousands, except share and per share data)	2023		2022
ASSETS	(Unaudited)
Cash and due from banks	$	35,423	$	37,661
Interest-bearing deposits with other banks		10,404		17,838
Cash and cash equivalents		45,827		55,499
Investment securities:
Available-for-sale, at fair value (amortized cost of 89,846 (2023) and $95,999 (2022))		78,069		83,587
Held to maturity, (net of allowance for credit losses of $163 (2023)) (fair value of $473,296 (2023) and $494,627 (2022))		536,970		559,455
Equity securities, at fair value		1,245		1,233
Restricted securities, at cost		21,208		11,169

Loans held for sale, at fair value		6,845		4,248

Loans held for investment ($9,745 (2023) and $8,437 (2022), at fair value)		2,753,223		2,556,107
Less: allowance for credit losses		(29,014)		(16,643)
Loans, net		2,724,209		2,539,464

Premises and equipment, net		51,036		51,488
Goodwill		63,266		63,266
Other intangible assets, net		4,671		5,547
Other real estate owned, net		179		197
Mortgage servicing rights, at fair value		5,466		5,275
Right-of-use assets		9,077		9,629
Cash surrender value on life insurance		60,150		59,218
Other assets		33,413		28,001
TOTAL ASSETS	$	3,641,631	$	3,477,276

LIABILITIES
Deposits:
Noninterest-bearing	$	778,963	$	862,015
Interest-bearing		2,158,563		2,147,769
Total deposits		2,937,526		3,009,784

Advances from FHLB - short-term		276,000		40,000
Subordinated debt		43,227		43,072
Total borrowings		319,227		83,072

Lease liabilities		9,392		9,908
Other liabilities		12,346		10,227
TOTAL LIABILITIES		3,278,491		3,112,991

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share; shares authorized - 35,000,000; shares issued and outstanding - 19,907,290 (2023) and 19,864,956 (2022)		199		199
Additional paid in capital		202,008		201,494
Retained earnings		169,494		171,613
Accumulated other comprehensive loss		(8,561)		(9,021)
TOTAL STOCKHOLDERS' EQUITY		363,140		364,285
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	3,641,631	$	3,477,276

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)


	For Three Months Ended				For Six Months Ended
	June 30,				June 30,
(In thousands, except per share data)	2023		2022		2023		2022
INTEREST INCOME
Interest and fees on loans	$	32,729	$	23,452	$	63,557	$	45,537
Interest and dividends on taxable investment securities		3,729		2,392		7,793		4,377
Interest and dividends on tax-exempt investment securities		5		—		12		—
Interest on deposits with other banks		170		826		333		1,080
Total interest income		36,633		26,670		71,695		50,994

INTEREST EXPENSE
Interest on deposits		9,914		1,511		17,195		2,869
Interest on short-term borrowings		3,449		—		4,810		2
Interest on long-term borrowings		776		541		1,532		1,075
Total interest expense		14,139		2,052		23,537		3,946

NET INTEREST INCOME		22,494		24,618		48,158		47,048
Provision for credit losses		667		200		1,880		800

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		21,827		24,418		46,278		46,248

NONINTEREST INCOME
Service charges on deposit accounts		1,264		1,438		2,477		2,797
Trust and investment fee income		399		447		831		961
Interchange credits		1,311		1,253		2,523		2,291
Mortgage-banking revenue		1,054		1,096		2,031		2,963
Title Company revenue		186		426		323		749
Other noninterest income		1,080		1,173		2,443		2,118
Total noninterest income		5,294		5,833		10,628		11,879

NONINTEREST EXPENSE
Salaries and wages		8,955		8,898		17,639		18,460
Employee benefits		2,440		2,269		5,361		4,931
Occupancy expense		1,599		1,485		3,218		3,052
Furniture and equipment expense		477		411		1,011		840
Data processing		1,739		1,668		3,537		3,275
Directors' fees		185		210		435		400
Amortization of other intangible assets		435		511		876		1,028
FDIC insurance premium expense		758		429		1,129		772
Other real estate owned expenses, net		—		57		(1)		51
Legal and professional fees		959		811		1,709		1,448
Merger-related expenses		1,197		241		1,888		971
Other noninterest expenses		2,864		3,104		5,699		5,198
Total noninterest expense		21,608		20,094		42,501		40,426

Income before income taxes		5,513		10,157		14,405		17,701
Income tax expense		1,495		2,658		3,930		4,589

NET INCOME	$	4,018	$	7,499	$	10,475	$	13,112

Basic and diluted net income per common share	$	0.20	$	0.38	$	0.53	$	0.66

Dividends paid per common share	$	0.12	$	0.12	$	0.24	$	0.24

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)


	For Three Months Ended				For Six Months Ended
	June 30,				June 30,
(In thousands)	2023		2022		2023		2022
Net income	$	4,018	$	7,499	$	10,475	$	13,112

Other comprehensive income (loss):
Investment securities:
Unrealized holding (losses)/gains on available-for-sale-securities		(549)		(6,161)		634		(9,226)
Tax effect		149		1,682		(174)		2,519
Total other comprehensive (loss) income		(400)		(4,479)		460		(6,707)
Comprehensive income	$	3,618	$	3,020	$	10,935	$	6,405

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

For the Three and Six Months Ended June 30, 2023 and 2022


							Accumulated
			Additional				Other		Total
	Common		Paid in		Retained		Comprehensive		Stockholders’
(In thousands)	Stock		Capital		Earnings		(Loss) Income		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

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SHORE BANCSHARES, INC.

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


							Accumulated
			Additional				Other		Total
	Common		Paid in		Retained		Comprehensive		Stockholders’
(In thousands)	Stock		Capital		Earnings		Income (Loss)		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

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)


	For Six Months Ended
	June 30,
(In thousands)	2023		2022

CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	10,475	$	13,112
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of acquisition accounting estimates		(847)		(816)
Provision for credit losses		1,880		800
Depreciation and amortization		2,744		2,901
Net amortization of securities		660		781
Amortization of debt issuance costs		61		61
(Gain) on mortgage banking activities		(1,518)		(1,878)
Proceeds from sale of mortgage loans held for sale		47,815		104,005
Originations of loans held for sale		(49,191)		(72,301)
Stock-based compensation expense		325		302
Deferred income tax (benefit) expense		(743)		81
Loss (Gain) on valuation adjustments on mortgage servicing rights		40		(478)
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 investment, at fair value		(48)		—
Fair value adjustment on equity securities		3		108
Bank owned life insurance income		(758)		(410)
Net changes in:
Accrued interest receivable		731		(368)
Other assets		(2,510)		304
Accrued interest payable		1,721		5
Other liabilities		(458)		(3,202)
Net cash provided by operating activities		10,650		43,051

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal payments of investment securities available for sale		6,019		12,778
Proceeds from maturities and principal payments of investment securities held to maturity		21,795		23,613
Purchases of securities held to maturity		—		(78,468)
Purchases of equity securities		(15)		(7)
Purchase of restricted securities		(23,979)		(5,735)
Net change in loans		(196,213)		(143,947)
Purchases of premises and equipment		(1,768)		(1,720)
Proceeds from sales of other real estate owned		21		394
Improvements to other real estate owned		—		(34)
Redemption of restricted securities		13,940		—
Purchases of bank owned life insurance		(174)		(10,092)
Proceeds from disposal of premises held for sale		721		—
Net cash (used in) investing activities		(179,653)		(203,218)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Noninterest-bearing deposits		(83,052)		(38,375)
Interest-bearing deposits		10,970		26,704
Short-term borrowings		236,000		(4,143)
Common stock dividends paid		(4,776)		(4,762)
Issuance of common stock		189		139
Net cash provided by (used in) financing activities		159,331		(20,437)
Net (decrease) in cash and cash equivalents		(9,672)		(180,604)
Cash and cash equivalents at beginning of period		55,499		583,613
Cash and cash equivalents at end of period	$	45,827	$	403,009

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (CONTINUED)


Supplemental cash flows information:
Interest paid	$	21,836	$	4,101
Income taxes paid	$	6,372	$	2,261
Remeasurement of lease liabilities arising from right-of-use assets	$	(5)	$	(678)
Transfers from loans to other real estate owned	$	—	$	69
Unrealized gain (loss) on securities available for sale	$	634	$	(9,226)
Transfers of premises to held for sale (included in other assets)	$	750	$	—

See accompanying notes to Consolidated Financial Statements.

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Shore Bancshares, Inc.

Notes to Consolidated Financial Statements

For the Three and Six Months Ended June 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 June 30, 2023, the consolidated results of income and comprehensive income for the three and six months ended June 30, 2023 and 2022, changes in stockholders’ equity for the three and six months ended June 30, 2023 and 2022 and cash flows for the six months ended June 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 six months ended June 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 (the “2022 Annual Report”). 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 (FASB) issued (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 Accounting Standards Updates (ASU) 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,” ASU 2019-05, “Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief,” ASU 2019-10, “Financial instruments – Credit losses (Topic 326), Derivatives and hedging (Topic 815), and Leases (Topic 842) – Effective dates,” ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2020-02, “Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842),” ASU 2020-03, “Codification Improvements to Financial Instruments” and ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326) – Troubled Debt Restructurings and Vintage Disclosures” (collectively, ASC 326). The significant impacts of adopting these standards and related updates to the Company’s accounting policies are discussed below.

ASC 326 requires entities to estimate an allowance for credit losses (ACL) on certain types of financial instruments measured at amortized cost using a current expected credit losses (CECL) methodology, replacing the incurred loss methodology from prior GAAP. It also applies to unfunded commitments to extend credit, including loan commitments, standby letters of credit, and other similar instruments. The impairment model for available-for-sale debt securities was modified and ASC 326 also provided for a simplified accounting model for purchased financial assets with credit

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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 noncredit discount, which represented the difference between the adjusted amortized cost basis and the outstanding principal balance on PCD loans, will be accreted into interest income over the estimated remaining lives of the loans using the effective interest rate method. The evaluation of the ACL will include PCD loans together with other loans that share similar risk characteristics, rather than using the separate pools that were used under PCI accounting, unless the loans are specifically identified for individual evaluation under our CECL methodology. The adoption of ASC 326 also replaced previous TDR accounting guidance, and the evaluation of the ACL will include loans previously designated as TDRs together with other loans that share similar risk characteristics, unless the loans are specifically identified for individual evaluation under our CECL methodology.

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


	January 1, 2023
	As Reported Under		Pre-ASC 326
(Dollars in thousands)	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

The following accounting policies have been updated in connection with the adoption of ASC 326 and apply to periods beginning after December 31, 2022. Accounting policies applying to prior periods are described in the 2022 Annual Report, as discussed above.

Investments in Debt Securities

Investments in debt securities are classified as either held to maturity, available for sale, or trading, based on management’s intent. Currently, the Company has classified its debt securities within the available for sale and held to maturity classifications. Debt securities purchased with the positive intent and ability to hold to maturity are classified as held to maturity and are recorded at amortized cost, net of any ACL. Debt securities not classified as held to maturity are classified as available for sale and are carried at estimated fair value with the corresponding unrealized gains and losses recognized in other comprehensive income (loss).

Gains or losses are recognized in net income on the trade date using the amortized cost of the specific security sold. Purchase premiums are recognized in interest income using the effective interest rate method over the period from purchase to maturity or, for callable securities, the earliest call date, and purchase discounts are recognized in the same manner from purchase to maturity.

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The Company has elected to exclude accrued interest receivable from the amortized cost basis and fair value of its held to maturity and available for sale debt securities and has included such accrued interest of $2.1 million at June 30, 2023 within the other assets line item of the Consolidated Balance Sheets.

The Company estimates an ACL for held to maturity debt securities on a collective basis by major security type and standard credit rating. Certain securities in our held to maturity securities portfolio are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major rating agencies and have a long history of no credit losses. With respect to these securities, we consider the risk of credit loss to be zero and, therefore, we do not record an ACL.

The estimate of an ACL on our held to maturity securities that are not guaranteed by the U.S. government considers historical credit loss information and severity of loss in the event of default and leverages external data. No ACL is recorded on accrued interest receivable and amounts written-off are reversed by an adjustment to interest income.

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

For debt securities available for sale, impairment is recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that the Company will be required to sell the security before recovery, the Company evaluates unrealized losses to determine whether a decline in fair value below amortized cost basis is a result of a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security, or other factors such as changes in market interest rates. If a credit loss exists, an allowance for credit losses is recorded that reflects the amount of the impairment related to credit losses, limited by the amount by which the specific security’s amortized cost basis exceeds its fair value. Changes in the allowance for credit losses are recorded in net income in the period of change and are included in provision for credit losses. Changes in the fair value of debt securities available for sale not resulting from credit losses are recorded in other comprehensive income (loss). The Company regularly reviews unrealized losses in its investments in securities and cash flows expected to be collected from impaired securities based on criteria including the extent to which market value is below amortized cost, the financial health of and specific prospects for the issuer, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.

Loans Held for Investment

The Company’s recorded investment in loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally is reported at the unpaid principal balances adjusted for charges-offs, unearned discounts, any deferred fees or costs on originated loans, and the allowance for credit losses. The Company has elected to exclude accrued interest receivable from the amortized cost basis of its loans held for investment and has included such accrued interest of $6.6 million at June 30, 2023 within the other assets line item of the Consolidated Balance Sheets. Interest on loans is recorded to interest income based on the contractual rates and the amount of outstanding principal of the loans. Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield using the level-yield method.

Loans acquired in a business combination are recorded at estimated fair value on the date of acquisition. In the case of loans that have experienced more than insignificant deterioration in credit quality since origination as of the acquisition date, the loan’s amortized cost basis is increased above estimated fair value by the amount of expected credit losses as of the acquisition date, and a corresponding allowance for credit losses is also recorded. Any remaining non-credit discount or premium for such purchased loans with credit deterioration (PCD loans) and any fair value discount or premium for non-PCD loans is accreted or amortized as an adjustment to yield over the estimated lives of the loans using the level-yield method.

A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain. Any accrued interest receivable on loans placed on nonaccrual status is reversed by an adjustment to interest

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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 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

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on evaluations of historical loan losses, current conditions and reasonable and supportable forecasts relevant to the collectability of loans. The methodology for estimating the amount reported in the ACL is the sum of two main components, an allowance assessed on a collective basis for pools of loans that share similar risk characteristics and an allowance assessed on individual loans that do not share similar risk characteristics with other loans. Loans that share common risk characteristics are evaluated collectively using a cash flow approach. The discounted cash flow approach used by the Company utilizes loan-level cash flow projections and pool-level assumptions. For loans that do not share risk characteristics with other loans, the ACL is measured based on the net realizable value, that is, the difference between the discounted value of the expected future cash flows and the amortized cost basis of the loan. When a loan is collateral-dependent and the repayment is expected to be provided substantially through the operation or sale of the collateral, the ACL is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral.

Cash flow projections and estimated expected losses on loans which share common risk characteristics are based in part on forecasts of the national unemployment rate that are reasonable and supportable over a twelve month period and incorporated into the estimate of expected credit losses using a statistical regression analysis. For periods beyond those for which reasonable and supportable forecasts are available, projections are based on a reversion of the national unemployment rate from the last forecast to a historical average level over the following twelve months.

Management’s estimate of the allowance for credit losses on loans that are collectively evaluated also includes a qualitative assessment of available information relevant to assessing collectability that is not captured in the quantitative loss estimation process. Factors considered by management include changes in general market, economic and business conditions; the nature and volume of the loan portfolio; the volume and severity of delinquencies and adversely classified loan balances and the value of underlying collateral; and other factors as deemed necessary and appropriate. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

Reserve for Unfunded Commitments

The Company records a reserve, reported in other liabilities, for expected credit losses on commitments to extend credit that are not unconditionally cancelable by the Company. The reserve for unfunded commitments is measured based on the principles utilized in estimating the allowance for credit losses on loans and an estimate of the amount of unfunded commitments expected to be advanced. Changes in the reserve for unfunded commitments are recorded through the provision for credit losses.

Note 3 – 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:


	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
(In thousands, except per share data)	2023		2022		2023		2022
Net Income	$	4,018	$	7,499	$	10,475	$	13,112
Weighted average shares outstanding - Basic and Diluted		19,903		19,847		19,895		19,838

Earnings per common share - Basic and Diluted	$	0.20	$	0.38	$	0.53	$	0.66

There were no potentially dilutive shares outstanding during the three and six months ended June 30, 2023 and 2022.

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Note 4 – Investment Securities

On January 1, 2023, the Company adopted ASC 326, which made changes to accounting for available for sale debt securities whereby credit losses should be presented as an allowance, rather than as a write-down when management does not intend to sell and does not believe that it is more likely than not they will be required to sell a security prior to maturity. In addition, ASC 326 requires an allowance for credit losses to be recorded on held to maturity debt securities measured at amortized cost. All securities information presented as of June 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 held-to-maturity securities:


	Three Months Ended		Six Months Ended
(Dollars in thousands)	June 30, 2023		June 30, 2023
Provision for credit losses - HTM Debt Securities	$	—	$	163

The ACL for held-to-maturity securities was initially determined to be immaterial as of the date of adoption of ASC 326. Upon re-estimation in the first quarter of 2023, an ACL of $163 thousand was recorded based on the results of our evaluation at March 31, 2023. Based on the Company’s current period re-evaluation, no provision for credit losses was recorded for the three months ended June 30, 2023.

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


			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
(Dollars in thousands)	Cost		Gains		Losses		Value
Available-for-sale securities:
June 30, 2023
U.S. Government agencies	$	21,465	$	5	$	3,408	$	18,062
Mortgage-backed		66,367		—		8,188		58,179
Other debt securities		2,014		—		186		1,828
Total	$	89,846	$	5	$	11,782	$	78,069

December 31, 2022
U.S. Government agencies	$	21,798	$	5	$	3,625	$	18,178
Mortgage-backed		72,183		2		8,666		63,519
Other debt securities		2,018		—		128		1,890
Total	$	95,999	$	7	$	12,419	$	83,587

No available for sale securities were sold during the three and six months ended June 30, 2023 and 2022.

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			Gross		Gross		Estimated		Allowance
	Amortized		Unrealized		Unrealized		Fair		for credit
(Dollars in thousands)	Cost		Gains		Losses		Value		losses
Held-to-maturity securities:
June 30, 2023
U.S. Government agencies	$	144,882	$	—	$	13,035	$	131,847	$	—
Mortgage-backed		379,779		—		49,407		330,372		—
States and political subdivisions		1,472		39		30		1,481		—
Other debt securities		11,000		—		1,404		9,596		163
Total	$	537,133	$	39	$	63,876	$	473,296	$	163

December 31, 2022
U.S. Government agencies	$	148,097	$	—	$	13,601	$	134,496	$	—
Mortgage-backed		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 $1.2 million at June 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 $(3) thousand for the six months ended June 30, 2023 and $(108) thousand for the six months ended June 30, 2022, respectively.

Credit Quality Information

The Company monitors the credit quality of held-to-maturity securities through credit ratings provided by Standard & Poor’s Rating Services and Moody’s Investor Services. Credit ratings express opinions about the credit quality of a security, and are updated at each quarter end. Investment grade securities are rated BBB- or higher by S&P and Baa3 or higher by Moody’s and are generally considered by the rating agencies and market participants to be of low credit risk. Conversely, securities rated below investment grade, which are labeled as speculative grade by the rating agencies, are considered to have distinctively higher credit risk than investment grade securities. There were no speculative grade held-to-maturity securities at June 30, 2023 or December 31, 2022. Held-to-maturity securities that are not rated are agency mortgage-backed securities sponsored by US government agencies, as well as direct obligations of the agencies, with the remainder being subordinated debt of other financial institutions.

The following table shows the amortized cost of held-to-maturity securities based on their lowest publicly available credit rating as of June 30, 2023.


		June 30, 2023
		Investment Grade
(Dollars in thousands)		Aaa		Aa1		A3		Baa1		Baa2		Baa3		NR		Total
U.S. Government agencies	$	137,359	$	—	$	—	$	—	$	—	$	—	$	7,523	$	144,882
Mortgage-backed		—		—		—		—		—		—		379,779		379,779
States and political subdivisions		—		1,472		—		—		—		—		—		1,472
Other debt securities		—		—		4,000		4,000		500		500		2,000		11,000
Total Held-to Maturity Securities	$	137,359	$	1,472	$	4,000	$	4,000	$	500	$	500	$	389,302	$	537,133

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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 June 30, 2023 and December 31, 2022.

Less than

More than

12 Months

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

(Dollars in thousands)

Value

Losses

Value

Losses

Value

Losses

June 30, 2023

Available-for-sale securities:

U.S. Government agencies

$

952

$

5

$

16,705

$

3,403

$

17,657

$

3,408

Mortgage-backed

1,128

29

57,051

8,159

58,179

8,188

Other debt securities

—

1,828

186

1,828

186

Total

$

2,080

$

34

$

75,584

$

11,748

$

77,664

$

11,782


	Less than				More than
	12 Months				12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(Dollars in thousands)	Value		Losses		Value		Losses		Value		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		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		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 one hundred sixteen available-for-sale debt securities with a fair value below the amortized cost basis, with unrealized losses totaling $11.8 million as of June 30, 2023. The Company concluded that a credit loss does not exist in its available-for-sale securities portfolio as of June 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 US government agencies or US government sponsored enterprises. Collectively, these entities provide a guarantee, which is either explicitly or implicitly supported by the full faith and credit of the US government, that investors in such mortgage-backed securities will receive timely principal and interest payments.

All held-to-maturity and available for sale securities were current with no securities past due or on nonaccrual as of June 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 June 30, 2023 the amortized cost of pledged available-for-sale securities was $65.5 million and $166.2 million of pledged held to maturity securities. The comparable amounts for December 31, 2022 were $83.3 million and $19.2 million, respectively.

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The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at June 30, 2023.


	Available for sale				Held to maturity
	Amortized				Amortized
(Dollars in thousands)	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	30	$	30	$	1,019	$	1,009
Due after one year through five years		8,771		8,345		123,636		114,964
Due after five years through ten years		36,753		32,325		58,643		52,809
Due after ten years		44,292		37,369		353,835		304,514
Total	$	89,846	$	78,069	$	537,133	$	473,296

The maturity dates for debt securities are determined using contractual maturity dates.

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 2022 Annual Report. All loan information presented as of June 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, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County and Worcester County in Maryland, Kent and Sussex County, Delaware and in Accomack County, Virginia. The following table provides information about the principal classes of the loan portfolio at June 30, 2023 and December 31, 2022.


(Dollars in thousands)	June 30, 2023		December 31, 2022
Construction	$	220,228	$	246,319
Residential real estate		938,151		810,497
Commercial real estate		1,130,346		1,065,409
Commercial		138,459		147,856
Consumer		326,039		286,026
Total loans		2,753,223		2,556,107
Allowance for credit losses		(29,014)		(16,643)
Total loans, net	$	2,724,209	$	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 June 30, 2023 and December 31, 2022. At June 30, 2023 and December 31, 2022, included in total loans were $332.4 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 $5.7 million and $6.7 million at June 30, 2023 and December 31, 2022, respectively.

At June 30, 2023, the Bank was servicing $352.3 million in loans for the Federal National Mortgage Association and $78.0 million in loans for Freddie Mac.

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The following table provides information on nonaccrual loans by loan class as of June 30, 2023.


	Nonaccrual		Nonaccrual		Loans past due
	with no		with an		90 days or more
	allowance for		allowance for		and still
(Dollars in thousands)	credit loss		credit loss		accruing
June 30, 2023
Nonaccrual loans:
Construction	$	173	$	—	$	79
Residential real estate		2,602		131		250
Commercial real estate		368		—		721
Commercial		156		—		—
Consumer		27		24		—
Total	$	3,326	$	155	$	1,050

Interest income	$	—	$	—	$	2

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 credit 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.

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The following table provides information on loan risk ratings as of June 30, 2023 and gross write-offs during the six months ended June 30, 2023.


															Revolving
	Term Loans by Origination Year												Revolving		converted to
(Dollars in thousands)	Prior		2019		2020		2021		2022		2023		loans		term loans		Total
June 30, 2023
Construction
Pass	$	15,492	$	7,228	$	16,242	$	42,062	$	103,722	$	34,080	$	1,205	$	—	$	220,031
Substandard		185		—		—		12		—		—		—		—		197
Total	$	15,677	$	7,228	$	16,242	$	42,074	$	103,722	$	34,080	$	1,205	$	—	$	220,228
Gross Charge-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Residential real estate
Pass	$	217,796	$	35,596	$	68,945	$	177,830	$	232,814	$	127,464	$	73,990	$	321	$	934,756
Special Mention		41		—				—		—		—		193		—		234
Substandard		2,973		—		—		—		—		—		188		—		3,161
Total	$	220,810	$	35,596	$	68,945	$	177,830	$	232,814	$	127,464	$	74,371	$	321	$	938,151
Gross Charge-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Commercial real estate
Pass	$	374,795	$	105,944	$	153,693	$	195,339	$	208,386	$	71,276	$	9,083	$	1,223	$	1,119,739
Special Mention		8,421		142		—		1,395		—		—		—		—		9,958
Substandard		649		—		—		—		—		—		—		—		649
Total	$	383,865	$	106,086	$	153,693	$	196,734	$	208,386	$	71,276	$	9,083	$	1,223	$	1,130,346
Gross Charge-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Commercial
Pass	$	16,181	$	3,927	$	10,511	$	33,807	$	16,906	$	5,100	$	49,134	$	1,541	$	137,107
Special Mention		—		—		—		457		—		—		440		251		1,148
Substandard		156		—		—		—		—		—		—		48		204
Total	$	16,337	$	3,927	$	10,511	$	34,264	$	16,906	$	5,100	$	49,574	$	1,840	$	138,459
Gross Charge-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Consumer
Pass	$	894	$	1,517	$	17,458	$	88,451	$	157,030	$	59,935	$	702	$	—	$	325,987
Special Mention		—		—		—		—		—		—		2		—		2
Substandard		—		26		—		—		23		—		1		—		50
Total	$	894	$	1,543	$	17,458	$	88,451	$	157,053	$	59,935	$	705	$	—	$	326,039
Gross Charge-offs	$	—	$	—	$	—	$	(4)	$	—	$	(279)	$	—	$	(1)	$	(284)

Total
Pass		625,158		154,212		266,849		537,489		718,858		297,855		134,114		3,085		2,737,620
Special Mention		8,462		142		—		1,852		—		—		635		251		11,342
Substandard		3,963		26		—		12		23		—		189		48		4,261
Total loans by risk category	$	637,583	$	154,380	$	266,849	$	539,353	$	718,881	$	297,855	$	134,938	$	3,384	$	2,753,223

Total gross charge-offs	$	—	$	—	$	—	$	(4)	$	—	$	(279)	$	—	$	(1)	$	(284)

20

Table of Contents

The following tables provide information on the aging of the loan portfolio as of June 30, 2023 and December 31, 2022.

Accruing

30‑59 days

60‑89 days

90 days or more

Total

(Dollars in thousands)

Current (1)

past due

Nonaccrual

Total

June 30, 2023

Construction

$

218,784

$

683

$

509

$

79

$

1,271

$

173

$

220,228

Residential real estate

932,852

574

1,742

250

2,566

2,733

938,151

Commercial real estate

1,128,529

685

43

721

1,449

368

1,130,346

Commercial

138,303

—

156

138,459

Consumer

324,312

1,509

167

—

1,676

51

326,039

Total

$

2,742,780

$

3,451

$

2,461

$

1,050

$

6,962

$

3,481

$

2,753,223

Percent of total loans

99.7

%

0.1

%

0.1

%

—

%

0.2

%

0.1

%

100.0

%

(1)

Includes loans measured at fair value of $9.7 million at June 30, 2023.


	Accruing
				30‑59 days			60‑89 days			90 days or more			Total
(Dollars in thousands)	Current (1)			past due			past due			past due			past due			Nonaccrual			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.

The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three and six months ended June 30, 2023 and June 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.

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer (1)

Total

For three months ended

June 30, 2023

Allowance for credit losses:

Beginning Balance

$

2,689

$

8,747

$

9,858

$

1,921

$

5,249

$

28,464

Charge-offs

—

(177)

Recoveries

4

3

—

1

119

127

Net (charge-offs) recoveries

4

3

—

1

(58)

(50)

Provision

(307)

401

409

34

63

600

Ending Balance

$

2,386

$

9,151

$

10,267

$

1,956

$

5,254

$

29,014

(1)

Gross charge-offs of consumer loans for the three months ended June 30, 2023 included $172 of demand deposit overdrafts.

21

Table of Contents


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
For three months ended
June 30, 2022
Allowance for credit losses:
Beginning Balance	$	2,857	$	2,575	$	4,500	$	1,835	$	2,932	$	14,699

Charge-offs		—		(4)		(6)		(26)		(111)		(147)
Recoveries		4		73		555		20		79		731
Net (charge-offs) recoveries		4		69		549		(6)		(32)		584

Provision		484		134		(608)		(148)		338		200
Ending Balance	$	3,345	$	2,778	$	4,441	$	1,681	$	3,238	$	15,483

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer (1)

Total

For the six months ended

June 30, 2023

Allowance for credit losses:

Beginning Balance

$

2,973

$

2,622

$

4,899

$

1,652

$

4,497

$

16,643

Impact of ASC326 Adoption

1,222

4,974

3,742

401

452

10,791

Charge-offs

—

(284)

Recoveries

7

34

—

8

165

214

Net (charge-offs) recoveries

7

34

—

8

(119)

(70)

Provision

(1,816)

1,521

1,626

(105)

424

1,650

Ending Balance

$

2,386

$

9,151

$

10,267

$

1,956

$

5,254

$

29,014

(1)

Gross charge-offs of consumer loans for the six months ended June 30, 2023 included $279 of demand deposit overdrafts.


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
For the six months ended
June 30, 2022
Allowance for credit losses:
Beginning Balance	$	2,454	$	2,858	$	4,598	$	2,070	$	1,964	$	13,944

Charge-offs		—		(4)		(6)		(25)		(220)		(255)
Recoveries		7		119		705		25		138		994
Net (charge-offs) recoveries		7		115		699		—		(82)		739

Provision		884		(195)		(856)		(389)		1,356		800
Ending Balance	$	3,345	$	2,778	$	4,441	$	1,681	$	3,238	$	15,483

There were no modifications to loans for borrowers experiencing financial difficulty (“BEFD”) during the three and six months ending June 30, 2023.

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Table of Contents

The following table presents the amortized cost basis of collateral-dependent loans by loan portfolio segment.


	June 30, 2023
(Dollars in thousands)	Real Estate Collateral		Other Collateral		Total
Construction	$	252	$	—	$	252
Residential real estate		3,219		—		3,219
Commercial real estate		1,239		—		1,239
Commercial		—		156		156
Consumer		—		51		51
Total	$	4,710	$	207	$	4,917

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 June 30, 2023.

Foreclosure Proceedings

There were $39 thousand of consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure as of June 30, 2023 and $263 thousand as of December 31, 2022, respectively. There were no residential real estate properties included in the balance of other real estate owned at June 30, 2023 and 1 residential real estate property totaling $18 thousand at December 31, 2022.

Prior to the adoption of ASC 326

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


	December 31, 2022
	Acquired Loans -		Acquired Loans -
	Purchased		Purchased		Acquired Loans -
(Dollars in thousands)	Credit Impaired		Performing		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.


	For the Six Months Ended
(Dollars in thousands)	June 30, 2022
Accretable yield, beginning of period	$	5,367
Accretion		(788)
Reclassification of nonaccretable difference due to improvement in expected cash flows		325
Other changes, net		237
Accretable yield, end of period	$	5,141

23

Table of Contents

The following tables include impairment information relating to loans and the allowance for credit losses as of December 31, 2022.


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
December 31, 2022
Loans individually evaluated for impairment	$	331	$	5,081	$	2,540	$	174	$	28	$	8,154
Loans collectively evaluated for impairment		236,901		791,460		1,051,003		147,526		285,984		2,512,874
Acquired loans - PCI		650		13,956		11,866		156		14		26,642
Total loans (1)	$	237,882	$	810,497	$	1,065,409	$	147,856	$	286,026	$	2,547,670

Allowance for credit losses allocated to:
Loans individually evaluated for impairment	$	—	$	127	$	—	$	—	$	—	$	127
Loans collectively evaluated for impairment		2,973		2,495		4,899		1,652		4,497		16,516
Total allowance	$	2,973	$	2,622	$	4,899	$	1,652	$	4,497	$	16,643

(1)

Excludes loans measured at fair value of $8.4 million at December 31, 2022.

24

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.


			Recorded		Recorded				June 30, 2022
	Unpaid		investment		investment				Quarter-to-date		Year-to-date		Interest
	principal		with no		with an		Related		average recorded		average recorded		income
(Dollars in thousands)	balance		allowance		allowance		allowance		investment		investment		recognized
December 31, 2022
Impaired nonaccrual loans:
Construction	$	297	$	297	$	—	$	—	$	314	$	322	$	—
Residential real estate		1,363		1,259		—		—		1,487		1,482		—
Commercial real estate		159		150		—		—		740		823		—
Commercial		359		174		—		—		208		265		—
Consumer		29		28		—		—		31		52		—
Total	$	2,207	$	1,908	$	—	$	—	$	2,780	$	2,944	$	—

Impaired accruing TDRs:
Construction	$	10	$	10	$	—	$	—	$	18	$	20	$	—
Residential real estate		2,849		1,176		1,539		127		2,773		3,221		56
Commercial real estate		1,680		1,680		—		—		2,147		2,431		38
Commercial		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		9		—
Total	$	4,539	$	2,866	$	1,539	$	127	$	4,938	$	5,681	$	94

Other impaired accruing loans:
Construction	$	24	$	24	$	—	$	—	$	265	$	133	$	3
Residential real estate		1,107		1,107		—		—		5		17		4
Commercial real estate		710		710		—		—		524		471		4
Commercial		—		—		—		—		—		4		1
Consumer		—		—		—		—		—		19		—
Total	$	1,841	$	1,841	$	—	$	—	$	794	$	644	$	12

Total impaired loans:
Construction	$	331	$	331	$	—	$	—	$	597	$	475	$	3
Residential real estate		5,319		3,542		1,539		127		4,265		4,720		60
Commercial real estate		2,549		2,540		—		—		3,411		3,725		42
Commercial		359		174		—		—		208		269		1
Consumer		29		28		—		—		31		80		—
Total	$	8,587	$	6,615	$	1,539	$	127	$	8,512	$	9,269	$	106

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Table of Contents

There were no loans modified and considered to be TDRs during the three and six months ended June 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 six months ended June 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.

The following tables provide information on loan risk ratings as of December 31, 2022.


					Special
(Dollars in thousands)	Pass/Performing (1)		Pass		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 – 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.

The following tables present information about the Company’s leases:


(Dollars in thousands)	June 30, 2023			December 31, 2022
Lease liabilities	$	9,392		$	9,908
Right-of-use assets	$	9,077		$	9,629
Weighted average remaining lease term		12.36	years		12.55	years
Weighted average discount rate		2.55	%		2.50	%


	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
Lease cost (in thousands)	2023		2022		2023		2022
Operating lease cost	$	327	$	332	$	667	$	666
Short-term lease cost		—		—		—		—
Total lease cost	$	327	$	332	$	667	$	666

Cash paid for amounts included in the measurement of lease liabilities	$	310	$	311	$	631	$	621

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Table of Contents

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows:


	As of
Lease payments due (in thousands)	June 30, 2023
Six months ending December 31, 2023	$	600
2024		1,141
2025		917
2026		916
2027		849
Thereafter		6,584
Total undiscounted cash flows	$	11,007
Discount		1,615
Lease liabilities	$	9,392

Total gross rental income was $291 thousand and $254 thousand for the three months ended June 30, 2023 and 2022, respectively. Total gross rental income was $684 thousand and $526 thousand for the six months ended June 30, 2023 and 2022, respectively.

The following table presents our minimum future annual rental income on such leases as of June 30, 2023.


	As of
(In thousands)	June 30, 2023
Six months ending December 31, 2023	$	412
2024		701
2025		719
2026		737
2027		418
Thereafter		1,554
Total	$	4,541

27

Table of Contents

Note 7 – Goodwill and Other Intangibles

The following table provides information on the significant components of goodwill and other acquired intangible assets at June 30, 2023 and December 31, 2022.

June 30, 2023

Weighted

Gross

Accumulated

Net

Average

Carrying

Impairment

Accumulated

Carrying

Remaining Life

(Dollars in thousands)

Amount

Charges

Amortization

Amount

(in years)

Goodwill

$

65,476

$

(1,543)

$

(667)

$

63,266

—

Other intangible assets

Amortizable

Core deposit intangible

$

10,504

$

—

$

(5,833)

$

4,671

2.4

Total other intangible assets

$

10,504

$

—

$

(5,833)

$

4,671


December 31, 2022
											Weighted
	Gross		Measurement		Accumulated					Net	Average
	Carrying		Period		Impairment			Accumulated		Carrying	Remaining Life
(Dollars in thousands)	Amount		Adjustments		Charges			Amortization		Amount	(in years)

Goodwill	$	65,631	$	(155)	$	(1,543)	$	(667)	$	63,266	—

Other intangible assets
Amortizable
Core deposit intangible	$	10,504	$	—	$	—	$	(4,957)	$	5,547	2.6
Total other intangible assets	$	10,504	$	—	$	—	$	(4,957)	$	5,547

The aggregate amortization expense was $876 thousand for the six months ended June 30, 2023 and $1.0 million for the six months ended June 30, 2022.

At June 30, 2023, estimated future remaining amortization for amortizing intangibles within the years ending December 31, is as follows:


(Dollars in thousands)	Amortization Expense
2023	$	806
2024		1,376
2025		1,070
2026		765
2027		459
Thereafter		195
Total amortizing intangible assets	$	4,671

28

Table of Contents

Note 8 – Other Assets

The Company had the following other assets at June 30, 2023 and December 31, 2022.


	June 30,		December 31,
(Dollars in thousands)	2023		2022
Accrued interest receivable	$	8,778	$	9,384
Deferred income taxes		10,879		7,357
Prepaid expenses		2,921		2,680
Income taxes receivable		1,301		74
Other assets		9,534		8,506
Total	$	33,413	$	28,001

Note 9 - Borrowings

At June 30, 2023, subordinated debt consisted of $25.0 million of long-term debt issued by the Company in August 2020 and $20.6 million of long-term debt acquired in the acquisition of Severn in 2021. The recorded balance of subordinated debt issued in 2020, net of unamortized issuance costs was $24.7 million at June 30, 2023 and December 31, 2022. The recorded balance of the debt acquired from Severn was $18.5 million at June 30, 2023 and $18.4 million at December 31, 2022, which is presented net of the unamortized fair value adjustment of $2.1 million at June 30, 2023 and $2.2 at December 31, 2022. These obligations mature in 2030 and 2035, respectively. Further information on these obligations is provided in the 2022 Annual Report.

At June 30, 2023 and December 31, 2022, the Company had short-term borrowings from the FHLB of $276.0 million and $40.0 million, respectively. The outstanding obligations at June 30, 2023 carried interest rates ranging from 5.07% to 5.32%.

Note 10 – Other Liabilities

The Company had the following other liabilities at June 30, 2023 and December 31, 2022.


(Dollars in thousands)	June 30, 2023		December 31, 2022
Accrued interest payable	$	2,710	$	989
Accrued salaries and wages		1,391		1,360
Accounts payable		249		353
Deferred compensation liability		6,448		5,679
Other liabilities		1,548		1,846
Total	$	12,346	$	10,227

Note 11 - Stock-Based Compensation

At the 2016 annual meeting of the Company’s stockholders, 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 June 30, 2023.

29

Table of Contents

The following tables provide information on stock-based compensation expense for the three and six months ended June 30, 2023 and 2022.


	For Three Months Ended				For the Six Months Ended
	June 30,				June 30,
(Dollars in thousands)	2023		2022		2023		2022
Stock-based compensation expense	$	170	$	172	$	325	$	302
Excess tax benefits (deficiencies) related to stock-based compensation		(1)		2		21		45


	June 30,
(Dollars in thousands)	2023			2022
Unrecognized stock-based compensation expense	$	279		$	461
Weighted average period unrecognized expense is expected to be recognized		0.8	years		0.7	years

The following table summarizes restricted stock award activity for the Company under the 2016 Equity Plan for the six months ended June 30, 2023.


	2023
		Weighted Average
	Number of	Grant Date
	Shares	Fair Value
Nonvested at beginning of period	36,860	$	20.15
Granted	27,550		17.49
Vested	(30,199)		20.01
Forfeited	(900)		17.49
Nonvested at end of period	33,311	$	17.63

The fair value of restricted stock awards that vested during the first six months of 2023 and 2022 was $523 thousand and $505 thousand, respectively.

Note 12 – 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, 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.

30

Table of Contents

The following table provides information pertaining to the carrying amounts of our derivative financial instruments at June 30, 2023 and December 31, 2022.

June 30, 2023

December 31, 2022

Notional

Estimated

Notional

Estimated

(Dollars in thousands)

Amount

Fair Value

Amount

Fair Value

Asset - IRLCs

$

15,045

$

32

$

4,166

$

35

Asset - TBA securities

17,100

117

8,750

41

Liability - IRLCs

—

1,150

7

Liability - TBA securities

6,250

19

1,000

6

Note 13 – Accumulated Other Comprehensive Income (Loss)

The Company records unrealized holding gains (losses), net of tax, on investment securities available for sale as accumulated other comprehensive income (loss), a separate component of stockholders’ equity. The following tables provide information on the changes in the component of accumulated other comprehensive income (loss) for the three and six months ended June 30, 2023 and 2022.


	Unrealized
	gains (losses) on
	available for sale
(Dollars in thousands)	securities
Balance, March 31, 2023	$	(8,161)
Other comprehensive income		(400)
Balance, June 30, 2023	$	(8,561)

Balance, March 31, 2022	$	(2,172)
Other comprehensive (loss)		(4,479)
Balance, June 30, 2022	$	(6,651)


	Unrealized
	gains (losses) on
	available for sale
(Dollars in thousands)	securities
Balance, December 31, 2022	$	(9,021)
Other comprehensive income		460
Balance, June 30, 2023	$	(8,561)

Balance, December 31, 2021	$	56
Other comprehensive (loss)		(6,707)
Balance, June 30, 2022	$	(6,651)

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.

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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 available for sale 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

Loans held for sale (LHFS) are carried at fair value, which is determined based on Mark to Trade (MTT) for allocated/committed loans or Mark to Market (MTM) analysis for unallocated/uncommitted loans based on third-party pricing models (Level 2).

LHFI, at fair value

Certain loans that have been transferred from LHFS to LHFI have and continue to be accounted for under the fair value option as described in Note 1. These loans are valued based on third-party pricing models using quoted prices for similar loans and adjusted for observable inputs related to the loans.

MSRs

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.

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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.

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
June 30, 2023
MSRs (1)	$	5,466	Market Approach	Weighted average prepayment speed (PSA) (2)	111

IRLCs - asset	$	32	Market Approach	Range of pull through rate	86% - 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 six months ended June 30, 2023.


	For the Three Months Ended		For the Six Months Ended
(Dollars in thousands)	June 30, 2023		June 30, 2023
Beginning balance	$	5,310	$	5,275
Servicing rights resulting from sales of loans		114		231
Valuation adjustment		42		(40)
Ending balance	$	5,466	$	5,466

The following table presents activity in the IRLCs for the three and six months ended June 30, 2023.


	For the Three Months Ended		For the Six Months Ended
(Dollars in thousands)	June 30, 2023		June 30, 2023
Beginning balance	$	101	$	28
Valuation adjustment		(69)		4
Ending balance	$	32	$	32

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

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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.

The following tables present the recorded amount of assets measured at fair value on a recurring basis at June 30, 2023 and December 31, 2022. No assets were transferred from one hierarchy level to another during the first six months of 2023 or 2022.


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2023
Assets:
Securities available for sale:
U.S. Government agencies	$	18,062	$	—	$	18,062	$	—
Mortgage-backed		58,179		—		58,179		—
Other debt securities		1,828		—		1,828		—
		78,069		—		78,069		—

Equity securities		1,245		—		1,245		—

TBA securities		117		—		117		—
LHFS		6,845		—		6,845		—
LHFI, at fair value		9,745		—		9,745		—
MSRs		5,466		—		—		5,466
IRLCs		32		—		—		32
Total assets at fair value	$	101,519	$	—	$	96,021	$	5,498

Liabilities:
TBA securities	$	19	$	—	$	19	$	—
Total liabilities at fair value	$	19	$	—	$	19	$	—

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					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(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 securities		41		—		41		—
LHFS		4,248		—		4,248		—
LHFI, 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

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. Individually evaluated collateral-dependent loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. 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.

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The following tables set forth the Company’s financial and nonfinancial assets subject to fair value adjustments (impairment) on a nonrecurring basis at June 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
						Weighted
(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Range	Average (1)
June 30, 2023
Nonrecurring measurements:

Individually evaluated collateral dependent loans	$	890	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
						Weighted
(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Range	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.

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The carrying amounts and estimated fair values of the Company’s financial instruments are presented in the following table. Fair values for June 30, 2023 and December 31, 2022 were estimated using an exit price notion.


	June 30, 2023				December 31, 2022
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	45,827	$	45,827	$	55,499	$	55,499

Level 2 inputs
Investment securities available for sale	$	78,069	$	78,069	$	83,587	$	83,587
Investment securities held to maturity		536,970		473,296		559,455		494,626
Equity securities		1,245		1,245		1,233		1,233
Restricted securities		21,208		21,208		11,169		11,169
LHFS		6,845		6,845		4,248		4,248
TBA securities		117		117		41		41
Cash surrender value on life insurance		60,150		60,150		59,218		59,218
Loans, at fair value		9,745		9,745		8,437		8,437

Level 3 inputs
Loans, net	$	2,714,464	$	2,550,457	$	2,531,027	$	2,431,808
MSRs		5,466		5,466		5,275		5,275
IRLCs		32		32		35		35

Financial liabilities
Level 2 inputs
Deposits:
Noninterest-bearing demand	$	778,963	$	778,963	$	862,015	$	862,015
Checking plus interest		694,221		694,221		694,101		694,101
Money market		600,724		600,724		709,132		709,132
Savings		270,884		270,884		319,814		319,814
Club		1,098		1,098		374		374
Certificates of deposit		591,636		583,747		424,348		410,455
Advances from FHLB - short-term		276,000		276,012		40,000		40,002
Subordinated debt		43,227		40,377		43,072		41,193
TBA Securities		19		19		6		6

Level 3 inputs
IRLCs		—		—		7		7

Note 15 – 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.

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The following table provides information on commitments outstanding at June 30, 2023 and December 31, 2022.


(Dollars in thousands)	June 30, 2023		December 31, 2022
Commitments to extend credit	$	378,045	$	406,353
Letters of credit		9,130		8,009
Total	$	387,175	$	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 of 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 law, such customers engaged in those activities currently violate Federal law. 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 June 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 June 30, 2023 were approximately $121.8 million, or 4.2% of total deposits, and $59.8 million, or 2.2% of total gross loans, respectively.

● Interest and noninterest income for the six months ended June 30, 2023, were approximately $4.8 million and $549 thousand, 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 16 – 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.

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.

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Trust and Investment Fee Income

Trust and investment fee income are primarily comprised of 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 June 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 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 six months ended June 30, 2023 and 2022.


	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
(Dollars in thousands)	2023		2022		2023		2022
Noninterest Income
In-scope of Topic 606:
Service charges on deposit accounts	$	1,264	$	1,438	$	2,477	$	2,797
Trust and investment fee income		399		447		831		961
Interchange income		1,311		1,253		2,523		2,291
Title Company revenue		186		426		323		749
Other noninterest income		500		582		945		1,042
Noninterest Income (in-scope of Topic 606)		3,660		4,146		7,099		7,840
Noninterest Income (out-of-scope of Topic 606)		1,634		1,687		3,529		4,039
Total Noninterest Income	$	5,294	$	5,833	$	10,628	$	11,879

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Note 17 – Subsequent Events

On July 3, 2023, the Company announced that it had completed the acquisition, effective July 1, 2023, of The Community Financial Corporation (“TCFC”).

Pursuant to the terms of the merger agreement, each outstanding share of TCFC ‘s common stock was converted into the right to receive 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.

As of the closing, TCFC had more than $2.4 billion in assets and operated ten full-service offices in Maryland and two full-service offices in Virginia.


(Dollars in thousands)
Purchase Price:
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		500
Cash consideration (cash in lieu for fractional shares)		4
Fair value of converted share-based payment awards		499
Total purchase price	$	153,615

Sales of Acquired Securities

As of July 24, 2023, the Company sold most of the available-for-sale securities portfolio acquired from TCFC on July 1, 2023, for net proceeds of $430 million and used $380 million of the proceeds to reduce FHLB advances and brokered deposits. Management anticipates these actions will positively impact the return on average assets, net interest margin and the tangible common equity ratios in the third quarter.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Unless the context clearly suggests otherwise, references to “the Company”, “we”, “our”, and “us” in the remainder of this report are to Shore Bancshares, Inc. and its consolidated subsidiaries.

Forward-Looking Information

This Quarterly Report on Form 10-Q (“Quarterly Report”) contains forward-looking statements. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “project,” “projection,” “forecast,” “goal,” “target,” “would,” “aim” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry and management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. The inclusion of these forward-looking statements should not be regarded as a representation by us or any other person that such expectations, estimates and projections will be achieved. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence. In addition, we cannot assess the impact of each risk and uncertainty on our business or the extent to which any risk or uncertainty, or combination of risks and uncertainties, may cause actual results to differ materially from those contained in any forward-looking statements.

If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Quarterly Report and other reports and registration statements filed by us with the Securities and Exchange Commission (“SEC”). For information on the factors that could cause actual results to differ from the expectations stated in the forward- looking statements, see “Risk Factors” under Part I, Item 1A of our 2022 Form 10-K and other reports filed by us with the SEC.

Any forward-looking statement speaks only as of the date of this Quarterly Report, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether because of new information, future developments or otherwise, except as required by law.

Introduction

The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes presented elsewhere in this Quarterly Report, as well as the audited consolidated financial statements and related notes included in the 2022 Annual Report.

Shore Bancshares, Inc. is the largest independent financial holding company headquartered on the Eastern Shore of Maryland. It is the parent company of Shore United Bank, N.A. The Bank operates 30 full-service branches in Baltimore County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County, Anne Arundel County and Worcester County in Maryland, Kent County and Sussex County in Delaware and in Accomack County, Virginia. The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank, N.A. The Company also engages in title work for real estate transactions through Mid-Maryland Title Company, Inc. (“Title Company”). As a result of the acquisition of TCFC, which was effective July 1, 2023, the Bank now operates 43 full-service branches in the above locations as well as Calvert County, St Mary’s County, and Charles County in Maryland and Fredericksburg City and Spotsylvania County in Virginia.

The shares of common stock of Shore Bancshares, Inc. are listed on the NASDAQ Global Select Market under the symbol “SHBI”.

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Shore Bancshares, Inc. maintains an Internet site at www.shorebancshares.com on which it makes available free of charge its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.

The most significant accounting policies that the Company follows are presented in Note 1 of the 2022 Annual Report along with Note 2 of the current period interim financial information. These policies, along with the disclosures presented in the notes to the financial statements and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies relating to the allowance for credit losses on loans and goodwill are critical accounting policies. These policies are considered critical because they relate to accounting areas that require the most subjective or complex judgments, and, as such, could be most subject to revision as new information becomes available.

Allowance for Credit Losses on Loans

The Company adopted ASU No. 2026-13, “Financial Instruments – Credit Losses (Topic 326)”, as amended, on January 1, 2023 and in accordance with ASC 326, has recorded an allowance for credit losses (“ACL”) on loans carried at amortized cost. The ACL represents management’s estimate of expected lifetime credit losses within the Company's loan portfolio as of the balance sheet date. The ACL is established through a provision for credit losses and is increased by recoveries of loans previously charged off. Loan losses are charged against the allowance when management's assessments confirm that the Company will not collect the full amortized cost basis of a loan. The calculation of expected credit losses is determined using cash flow methodology, and includes considerations of historical experience, current conditions, and reasonable and supportable economic forecasts that may affect collection of the recorded balances. The Company assesses an ACL to groups of loans which share similar risk characteristics or on an individual basis, as deemed appropriate. Changes in the ACL on loans, and as a result, the related provision for credit losses, can materially affect financial results. Although the overall balance is determined based on specific portfolio segments and individually assessed assets, the entire balance is available to absorb credit losses for loans in the portfolio.

The determination of the appropriate level of ACL on loans inherently involves a high degree of subjectivity and requires the Company to make significant judgments concerning credit risks and trends using quantitative and qualitative information, as well as reasonable and supportable forecasts of future economic conditions, all of which may undergo frequent and significant changes. Changes in conditions, including unforeseen events, changes in asset-specific risk characteristics, and other economic factors, both within and outside the Company's control, may indicate the need for an increase or decrease in the ACL on loans. While management makes every effort to utilize the best information available in making its assessment of the ACL estimate, the estimation process is inherently challenging as potential changes in any one factor or input may occur at different rates and/or impact pools of loans in different ways. Further, changes in factors and inputs may also be directionally inconsistent, such that improvement in one factor may offset deterioration in others.

The Company’s management reviews the adequacy of the ACL on loans on at least a quarterly basis. Refer to Note 2, “Adoption of Accounting Standards”, of the interim consolidated financial information for additional detail concerning the determination of the ACL on loans.

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Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Determining fair value is subjective, requiring the use of estimates, assumptions and management judgment. Goodwill is tested at least annually for impairment, usually during the fourth quarter, or on an interim basis if circumstances dictate. Impairment testing requires a qualitative assessment or that the fair value of each of the Company’s reporting units be compared to the carrying amount of its net assets, including goodwill. If the fair value of a reporting unit is less than book value, an expense may be required to write down the related goodwill to record an impairment loss.

OVERVIEW

The Company reported net income of $4.0 million for the second quarter of 2023, or diluted income per common share of $0.20, compared to net income of $7.5 million, or diluted income per common share of $0.38, for the second quarter of 2022. For the first quarter of 2023, the Company reported net income of $6.5 million, or diluted income per common share of $0.32. Net income, excluding merger related expenses, for the second quarter of 2023 was $4.9 million or $0.25 per diluted common share, compared to net income, excluding merger related expenses, of $7.0 million or $0.35 per diluted common share for the first quarter of 2023 and net income, excluding merger related expenses, of $7.7 million or $0.39 per diluted common share for the second quarter of 2022. When comparing net income, excluding merger related expenses, for the second quarter of 2023 to the second quarter of 2022, net income decreased $2.8 million, primarily due to decreases in net interest income of $2.1 million and noninterest income of $539 thousand, coupled with increases in both noninterest expense of $558 thousand and provision for credit losses of $467 thousand. When comparing the second quarter of 2023 to the first quarter of 2023, excluding merger related expenses, net income decreased $1.9 million, due to decreases in net interest income of $3.2 million and noninterest income of $40 thousand, coupled with an increase in noninterest expense of $209 thousand, partially offset by a decrease in provision for credit losses of $546 thousand. Merger related expenses recorded for the second quarter of 2023 and the first quarter of 2023 were $1.2 million and $691 thousand, respectively.

For the first six months of 2023, the Company reported net income of $10.5 million, or diluted income per common share of $0.53, compared to net income of $13.1 million, or diluted income per common share of $0.66, for the first six months of 2022. When comparing net income for the first six months of 2023 to the first six months of 2022, the decrease in net income was primarily due to a decrease in noninterest income of $1.3 million and an increase in noninterest expense of $2.1 million, partially offset by an increase in net interest income of $1.1 million.

RESULTS OF OPERATIONS

Net Interest Income

Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments. As shown in the table below, tax-equivalent net interest income was $22.5 million for the second quarter of 2023 and $24.7 million for the second quarter of 2022. Tax-equivalent net interest income was $25.7 million for the first quarter of 2023. The decrease in net interest income when comparing the second quarter of 2023 to the second quarter of 2022 was due to increases in interest expense on interest-bearing deposits and FHLB short-term borrowings. The Company’s net interest margin decreased to 2.68% for the second quarter of 2023 from 3.18% for the first quarter of 2023 and decreased compared to 3.10% for the second quarter of 2022. The decrease in the net interest margin when compared to the first quarter of 2023 and the second quarter of 2022 was primarily due to increased funding costs as rates on deposits and borrowings increased at a faster pace than yields on loans as well as a change in the overall mix of interest-bearing liabilities. The average balance of FHLB short -term borrowings increased from $114.0 million in the first quarter of 2023 to $261.8 million in the second quarter of 2023. In addition, the migration of deposits from lower rate to higher rate accounts, specifically reciprocal deposits, contributed to the decrease in margins. The modest increase in average loan yields during the second quarter of 2023 to 4.85% from 4.79% in the first quarter of 2023 was due to a change in the overall mix of loans with more loans onboarded from lower yielding consumer mortgages than higher yielding commercial portfolios. Average consumer mortgage loans have increased from 33.0% of average loans in the fourth quarter of 2022 to 34.9% of average loans in the second quarter of 2023. Management intends to significantly decrease consumermortgage

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portfolio production in the second half of 2023 and emphasize the mortgage loan production of saleable loans. In addition, management intends to reduce the annualized growth rate on all loans to between 4%-6% in the second half of 2023.

Interest Income

On a tax-equivalent basis, interest income increased $10.0 million, or 37.4%, for the second quarter of 2023 when compared to the second quarter of 2022. The improvement to interest income was the result of increases in interest and fees on loans and income from investment securities. The primary driver for the increase in interest income on loans was the higher average volume of loans of $492.8 million coupled with an increase in the average yield of 60bps. The average balance of taxable investment securities increased $98.9 million and the average yield increased, providing $1.3 million of additional income.

On a tax-equivalent basis, interest income increased $1.6 million, or 4.5%, for the second quarter of 2023 when compared to the first quarter of 2023. The primary driver for the increase in interest income was growth in the average balance of loans of $98.3 million, or 3.8%, coupled with a higher average yield of 6bps.

Interest Expense

Interest expense increased $12.1 million, or 589.0%, when comparing the second quarter of 2023 to the second quarter of 2022. The increase in interest expense from the second quarter of 2022 was due to increases in expenses on interest-bearing deposits of $8.4 million and FHLB short-term borrowings of $3.4 million, primarily a result of an increase in the rates paid on interest-bearing deposits and an increase in the average balance of FHLB short-term borrowings of $261.2 million.

Interest expense increased $4.7 million, or 50.5%, when comparing the second quarter of 2023 to the first quarter of 2023 primarily due to increases in rates paid on interest-bearing liabilities. These interest-bearing liabilities included increases in the rate on interest-bearing deposits of 50bps and FHLB short-term borrowings of 44bps.

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The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended June 30, 2023 and 2022.


	For Three Months Ended						For Three Months Ended
	June 30, 2023						June 30, 2022
	Average		Income(1)/		Yield/		Average		Income(1)/		Yield/
(Dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Earning assets
Loans (2), (3)	$	2,709,944	$	32,780	4.85	%	$	2,217,139	$	23,490	4.25	%
Investment securities:
Taxable		645,178		3,729	2.32			546,252		2,392	1.75
Tax-exempt		664		6	3.62			—		—	—
Interest-bearing deposits		13,397		170	5.09			426,535		826	0.78
Total earning assets		3,369,183		36,685	4.37	%		3,189,926		26,708	3.36	%
Cash and due from banks		29,923						26,162
Other assets		225,935						218,353
Allowance for credit losses		(28,730)						(15,273)
Total assets	$	3,596,311					$	3,419,168

Interest-bearing liabilities
Demand deposits	$	685,674		3,913	2.29	%	$	644,881		354	0.22	%
Money market and savings deposits		907,068		2,526	1.12			1,019,295		522	0.21
Certificates of deposit $100,000 or more		312,367		2,337	3.00			234,325		337	0.58
Other time deposits		225,495		1,138	2.03			221,714		298	0.54
Interest-bearing deposits		2,130,604		9,914	1.87			2,120,215		1,511	0.29
Advances from FHLB - short-term		261,797		3,449	5.28			—		—	—
Advances from FHLB - long-term		—		—	—			10,075		15	0.60
Subordinated debt		43,185		776	7.21			42,876		527	4.93
Total interest-bearing liabilities		2,435,586		14,139	2.33	%		2,173,166		2,053	0.38	%
Noninterest-bearing deposits		778,058						872,883
Other liabilities		19,442						19,927
Stockholders’ equity		363,225						353,192
Total liabilities and stockholders’ equity	$	3,596,311					$	3,419,168

Net interest spread			$	22,546	2.04	%			$	24,655	2.98	%
Net interest margin					2.68	%					3.10	%

Tax-equivalent adjustment
Loans			$	51					$	38
Investment securities				1						—
Total			$	52					$	38

(1)	All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%, exclusive of nondeductible interest expense.

(2)	Average loan balances include nonaccrual loans.

(3)	Interest income on loans includes accreted loan fees, net of costs and accretion of discounts on acquired loans, which are included in the yield calculations.

Net Interest Income

Tax-equivalent net interest income increased $1.1 million, or 2.4%, during the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The increase in net interest income was primarily due to an increase in total interest income of $20.7 million, or 40.6%, with interest and fees on loans driving an increase of $18.0 million, or 39.6%. The improvement of interest and fees on loans was primarily due to the increase in the average balance of loans of $472.8 million, or 21.6%. Interest on investment securities increased $3.4 million, or 78.0%, primarily due to an increase in the average balance of $110.7 million, or 20.5%. Total interest expense increased $19.6 million, or 496.5%, primarily due to a 135bps increase in rates paid on interest-bearing deposits. In addition, an increase in the average balance of FHLB short-term borrowings of $188.3 million, or 100%, increased interest expense by $4.8 million.

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Interest Income

On a tax-equivalent basis, interest income increased $20.7 million, or 40.6%, for the six months ended June 30, 2023 when compared to the six months ended June 30, 2022. The increase was primarily due to higher interest and fees on loans of $18.0 million, or 39.5%, and increased interest income on taxable investment securities of $3.4 million, or 78.0%. The increase in interest and fees on loans was due to a higher average balance of loans of $472.8 million, or 21.6%, and the increase in interest on taxable investment securities was due to a higher average balance in these securities of $110.7 million, or 20.5%.

Interest Expense

Total interest expense increased $19.6 million, or 496.5%, primarily due to a 135bps increase in rates paid on interest-bearing deposits. In addition, an increase in the average balance of FHLB short term borrowings of $188.3 million, or 100%, increased interest expense by $4.8 million.


	For Six Months Ended						For Six Months Ended
	June 30, 2023						June 30, 2022
	Average		Income(1)/		Yield/		Average		Income(1)/		Yield/
(Dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Earning assets
Loans (2), (3)	$	2,661,066	$	63,646	4.82	%	$	2,188,236	$	45,614	4.20	%
Investment securities:
Taxable		649,329		7,793	2.42			538,676		4,377	1.64
Tax-exempt		665		15	4.55			—		—	—
Interest-bearing deposits		13,622		333	4.93			506,224		1,080	0.43
Total earning assets		3,324,682		71,787	4.35	%		3,233,136		51,071	3.19	%
Cash and due from banks		29,266						5,569
Other assets		226,989						224,219
Allowance for credit losses		(29,364)						(14,759)
Total assets	$	3,551,573					$	3,448,165

Interest-bearing liabilities
Demand deposits	$	690,258		7,149	2.09	%	$	617,461		582	0.19	%
Money market and savings deposits		955,541		4,899	1.03			1,048,634		1,120	0.22
Certificates of deposit $100,000 or more		277,096		3,413	2.48			260,312		623	0.48
Other time deposits		216,500		1,734	1.62			198,828		544	0.55
Interest-bearing deposits		2,139,395		17,195	1.62			2,125,235		2,869	0.27
Securities sold under retail repurchase agreements and federal funds purchased		—		—	—			1,377		2	0.29
Advances from FHLB - short-term		188,293		4,810	5.15			—		—	—
Advances from FHLB - long-term		—		—	—			10,096		29	0.58
Subordinated debt		43,147		1,532	7.16			42,840		1,046	4.92
Total interest-bearing liabilities		2,370,835		23,537	2.00	%		2,179,548		3,946	0.37	%
Noninterest-bearing deposits		798,994						893,282
Other liabilities		19,539						22,233
Stockholders’ equity		362,205						353,102
Total liabilities and stockholders’ equity	$	3,551,573					$	3,448,165

Net interest spread			$	48,250	2.35	%			$	47,125	2.82	%
Net interest margin					2.93	%					2.94	%

Tax-equivalent adjustment
Loans			$	89					$	77
Investment securities				3						—
Total			$	92					$	77

(1)	All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%, exclusive of nondeductible interest expense.

(2)	Average loan balances include nonaccrual loans.

(3)	Interest income on loans includes accreted loan fees, net of costs and accretion of discounts on acquired loans, which are included in the yield calculations.

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Noninterest Income

Total noninterest income for the second quarter of 2023 decreased $40 thousand from $5.33 million to $5.29 million compared to the first quarter of 2023 and decreased $539 thousand, or 9.2%, when compared to $5.83 million in the second quarter of 2022. The decrease compared to the first quarter of 2023 was primarily due to decreases in other loan and fee income, rental income and trust and investment fee income, partially offset by increases in interchange credits, mortgage banking revenue, service charges on deposit accounts, and revenue from the Title Company. The decrease in noninterest income when compared to the second quarter of 2022 was primarily due to decreases in revenue from the Title Company, service charges on deposit accounts and revenue associated with mortgage banking, partially offset by increases in interchange credits and other fees on bank services.

Total noninterest income for the six months ended June 30, 2023 decreased $1.3 million, or 10.5%, when compared to the same period in 2022. The decrease in noninterest income consisted of revenue associated with the mortgage division, title company revenue and service charges on deposit accounts, partially offset by an increase interchange credits and other noninterest income.

Noninterest Expense

Total noninterest expense, excluding merger related expenses, for the second quarter of 2023 increased $209 thousand to $20.4 million, or 1.0%, when compared to the first quarter of 2023 expense of $20.2 million and increased $558 thousand, or 2.8%, when compared to the second quarter of 2022 expense of $19.9 million. The increase in noninterest expense when compared to the first quarter of 2023 was primarily due to increases in FDIC insurance premiums, salaries and wages and legal and professional fees partially offset by decreases in employee related benefits. The increase from the second quarter of 2022 was primarily due to increases in FDIC insurance premiums, legal and professional fees and employee related benefits partially offset by decreases in other loan expense.

Total noninterest expense, excluding merger related expenses, for the six months ended June 30, 2023 increased $1.2 million, or 2.9%, when compared to the same period in 2022. The increase was primarily the result of an increase in employee benefits, occupancy expense, other intangibles, data processing costs, other noninterest expenses, and FDIC insurance premiums due to recent volatility in the banking industry and additional legal and professional fees related to a larger overall organization.

Provision for Credit Losses

The provision for credit losses was $667 thousand for the three months ended June 30, 2023. The comparable amounts were $1.2 million and $200 thousand for the three months ended March 31, 2023, and June 30, 2022, respectively. The provision for the second quarter of 2023 reflected the strong growth in total loans compared to the first quarter of 2023 and declined slightly based on the composition of growth and the Company’s evaluation of factors used in developing its estimate. The increase in the provision when compared to the second quarter of 2022 was primarily a result of higher reserves required by the Company’s CECL allowance model as compared to the incurred loss model utilized in 2022. Net charge-offs for the second quarter of 2023 were $50 thousand, compared to net charge-offs of $20 thousand for the first quarter of 2023 and net recoveries of $573 thousand for the second quarter of 2022.

The provision for credit losses for the six months ended June 30, 2023 and 2022 was $1.9 million and $800 thousand, respectively. The increase in the provision for credit losses was the result of loan growth during the first six months of 2023 outpacing loan growth during the first six months of 2022 by $51.7 million as well as higher levels of reserves required by the Company’s CECL allowance model as compared to the incurred loss methodology utilized in 2022.

Income Taxes

The Company reported income tax expense of $1.5 million for the second quarter of 2023, $2.7 million for the second quarter of 2022 and $2.4 million for the first quarter of 2023. Income tax expense decreased when compared to the second quarter of 2022 and the first quarter of 2023 due to lower pre-tax earnings. The effective tax rate for the second quarter of 2023 was 27.1%, 27.4% for the first quarter of 2023, and 26.2% for the second quarter of 2022. Income tax expense was $3.9 million for the six months ended June 30, 2023, and $4.6 million for the six months ended June 30, 2022. The effective

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tax rate was 27.3% for the six months ended June 30, 2023, and 25.9% for the six months ended June 30, 2022. The higher rate for the six months period in 2023 was due to an increase in merger-related nondeductible expenses and apportionment of earnings in states with higher tax rates.

ANALYSIS OF FINANCIAL CONDITION

Loans Held for Sale

The Bank originates residential mortgage loans for sale on the secondary market, which are recorded at fair value. At June 30, 2023 and December 31, 2022, the fair value of loans held for sale amounted to $6.8 million and $4.2 million, respectively.

The Bank makes certain representations to purchasers in the sale of the mortgage loans related to loan ownership, loan compliance and legality, and accurate documentation. If a loan is found to be out of compliance with any of the representations subsequent to the date of purchase, the Bank may be required to repurchase the loan or indemnify the purchaser.

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Loans Held for Investment

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


	June 30, 2023
			Loans acquired from
(Dollars in thousands)	Legacy Loans		Severn acquisition		Total Loans
Construction	$	208,230	$	11,998	$	220,228
Residential real estate		824,497		113,654		938,151
Commercial real estate		957,911		172,435		1,130,346
Commercial		104,597		33,714		138,311
Consumer		325,425		614		326,039
Total loans excluding PPP loans		2,420,660		332,415		2,753,075
PPP loans		148		—		148
Total loans	$	2,420,808	$	332,415	$	2,753,223
Allowance for credit losses						(29,014)
Total loans, net					$	2,724,209


	December 31, 2022
			Loans acquired from
(Dollars in thousands)	Legacy Loans		Severn acquisition		Total Loans
Construction	$	226,908	$	19,411	$	246,319
Residential real estate		680,423		130,074		810,497
Commercial real estate		879,265		186,144		1,065,409
Commercial		111,826		35,843		147,669
Consumer		285,315		711		286,026
Total loans excluding PPP loans		2,183,737		372,183		2,555,920
PPP loans		187		—		187
Total loans	$	2,183,924	$	372,183	$	2,556,107
Allowance for credit losses						(16,643)
Total loans, net					$	2,539,464

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $332.4 million in total loans remained outstanding as of June 30, 2023. Excluding these loans and PPP loans, total legacy loans increased $236.9 million, or 10.8%, when compared to December 31, 2022. Most of our loans, excluding PPP loans, are secured by real estate and are classified as construction, residential or commercial real estate loans. The increase in legacy loans, excluding PPP loans, was comprised of increases in residential real estate loans of $144.1 million, or 21.2%, consumer loans of $40.1 million, or 14.1% and commercial real estate loans of $78.6 million or 8.9%, partially offset by decreases in construction loans of $18.7 million, or 8.2%, and commercial loans of $7.2 million, or 6.5%, at June 30, 2023 compared to December 31, 2022. At June 30, 2023, the legacy loan portfolio, excluding PPP loans, was comprised of 39.6% commercial real estate, 34.1% residential real estate, 13.4% consumer, 8.6% construction and 4.3% commercial. That compares to 40.3%, 31.2%, 13.1%, 10.4% and 5.1%, respectively, at December 31, 2022. We do not engage in foreign or subprime lending activities. See Note 5, “Loans and Allowance for Credit Losses”, in the Notes to Consolidated Financial Statements and below under the caption “Allowance for Credit Losses” for additional information.

Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans. Construction loans were $220.2 million, or 8.0% of total loans, at June 30, 2023 and $246.3 million, or 9.6% of total loans, at December 31, 2022. Commercial real estate loans were $1.13 billion, or 41.1% of total loans, at June 30, 2023, compared to $1.07 billion, or 41.7% of total loans, at December 31, 2022.

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total non-owner occupied commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s non-owner occupied commercial real estate loan portfolio (including construction) has

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increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years. At June 30, 2023, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 287.5% of total risk-based capital. At such time, construction, land and land development loans represented 60.9% of total risk-based capital.

The commercial real estate portfolio (including construction) has increased 94.4% during the prior 36 months. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, as well as strong underwriting criteria with respect to its commercial real estate portfolio. Monitoring practices include periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital or be required to sell/participate portions of loans, which may adversely affect shareholder returns.

Allowance for Credit Losses on Loans

The allowance for credit losses was $29.0 million at June 30, 2023, $16.6 million at December 31, 2022 and $15.5 million at June 30, 2022. There were net charge-offs of $50 thousand for the second quarter of 2023, compared to net charge-offs of $20 thousand for the first quarter of 2023 and net recoveries of $573 thousand for the second quarter of 2022. The ratio of annualized net charge-offs to average loans was 0.01% for the second quarter of 2023, compared to annualized net charge-offs of 0.00% for the first quarter of 2023 and annualized net recoveries of 0.10% for the second quarter of 2022. Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming loans to enable the Company to maintain overall credit quality. The allowance for credit losses on loans as a percentage of period-end loans was 1.05% at June 30, 2023 and 0.65% at December 31, 2022.

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


	For the Three Months Ended
	June 30, 2023						June 30, 2022
					Percentage of net						Percentage of net
					charge-offs (recoveries)						charge-offs (recoveries)
					(annualized) to						(annualized) to
					average loans						average loans
			Net (charge-offs)		outstanding				Net (charge-offs)		outstanding
(Dollars in thousands)	Average balances		recoveries		during the year		Average balances		recoveries		during the year
Construction	$	228,689	$	4	(0.01)	%	$	253,742	$	4	(0.01)	%
Residential real estate		902,353		3	-			670,999		69	(0.04)
Commercial real estate		1,109,044		—	-			932,782		549	(0.24)
Commercial		138,067		1	-			164,944		(50)	0.12
Consumer		324,454		119	0.07			177,531		1	-
Total	$	2,702,607	$	127	0.01	%	$	2,199,998	$	573	(0.10)	%


Allowance for credit losses at period end as a percentage of total period end loans ⁽¹⁾	1.05	%	0.68	%
Allowance for credit losses at period end as a percentage of total period end loans ⁽²⁾	1.05	%	0.89	%
Allowance for credit losses at period end as a percentage of average loans ⁽³⁾	1.07	%	0.70	%
Allowance for credit losses at period end as a percentage of period end nonaccrual loans	833.50	%	574.94	%

(1)

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

(2)

For 2023, this ratio excludes only PPP loans given the Company’s adoption of the CECL standard. For periods in 2022, this ratio excludes PPP loans and loans acquired in the Severn and Northwest branch acquisitions.

(3)

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


	For the Six Months Ended
	June 30, 2023						June 30, 2022
					Percentage of net						Percentage of net
					charge-offs (recoveries)						charge-offs (recoveries)
					(annualized) to						(annualized) to
					average loans						average loans
			Net (charge-offs)		outstanding				Net (charge-offs)		outstanding
(Dollars in thousands)	Average balances		recoveries		during the year		Average balances		recoveries		during the year
Construction	$	238,540	$	7	(0.01)	%	$	253,156	$	7	(0.01)	%
Residential real estate		869,069		34	(0.01)			658,108		115	(0.04)
Commercial real estate		1,094,387		—	-			917,956		699	(0.15)
Commercial		139,975		8	(0.01)			169,525		(74)	0.09
Consumer		312,877		(119)	0.08			169,298		(8)	0.01
Total	$	2,654,848	$	(70)	0.01	%	$	2,168,043	$	739	(0.07)	%


Allowance for credit losses at period end as a percentage of total period end loans ⁽¹⁾	1.05	%	0.68	%
Allowance for credit losses at period end as a percentage of total period end loans ⁽²⁾	1.05	%	0.89	%
Allowance for credit losses at period end as a percentage of average loans ⁽³⁾	1.09	%	0.71	%
Allowance for credit losses at period end as a percentage of period end nonaccrual loans	833.50	%	574.94	%

(1)

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

(2)

For 2023, this ratio excludes only PPP loans given the Company’s adoption of the CECL standard. For periods in 2022, this ratio excludes PPP loans and loans acquired in the Severn and Northwest branch acquisitions.

(3)

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

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Nonperforming Assets

As shown in the following table, nonperforming assets were $4.7 million at June 30, 2023 and $3.9 million at December 31, 2022. The balance of nonperforming assets increased primarily due to an increase in total nonaccrual loans of $1.6 million, or 82.4%.

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


(Dollars in thousands)	June 30, 2023			December 31, 2022
Nonperforming assets
Nonaccrual loans	$	3,481		$	1,908
Total loans 90 days or more past due and still accruing		1,050			1,841
Other real estate owned		179			197
Total nonperforming assets	$	4,710		$	3,946

As a percent of total loans:
Nonaccrual loans		0.13	%		0.07	%

As a percent of total loans and other real estate owned:
Nonperforming assets		0.17	%		0.15	%

As a percent of total assets:
Nonaccrual loans		0.10	%		0.05	%
Nonperforming assets		0.13	%		0.11	%

Investment Securities

The investment portfolio includes debt and equity securities. Securities are classified as either available for sale or held to maturity. Investment securities available for sale are stated at estimated fair value based on quoted prices. They represent securities which may be sold as part of the asset/liability management strategy or in response to changing interest rates. Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income (loss), a separate component of stockholders’ equity.

Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts and the allowance for credit losses. We have the intent and ability to hold such securities until maturity. At June 30, 2023, 12.7% of the portfolio of debt securities was classified as available for sale and 87.3% was classified as held to maturity, compared to 14.5% and 85.5% respectively, at December 31, 2022. See Note 3 – “Investment Securities”, in the Notes to Consolidated Financial Statements for additional details on the composition of our investment portfolio.

Investment securities, including restricted stock, totaled $637.5 million at June 30, 2023, a $18.0 million, or 2.7%, decrease since December 31, 2022. At June 30, 2023, 74.5% of the securities available for sale were mortgage-backed, 23.1% were U.S. Government agencies and 2.3% were corporate bonds, compared to 76.0%, 21.7% and 2.3%, respectively, at year-end 2022. At June 30, 2023, 69.8% of the securities held to maturity were mortgage-backed, 27.9% were U.S. Government agencies, 2.0% were subordinated debt instruments and less than 1% were community reinvestment bonds, compared to 70.4%, 27.2%, 2.1% and less than 1%, respectively, at year-end 2022. Our investments in mortgage-backed securities are issued or guaranteed by U.S. Government agencies or government-sponsored agencies.

Deposits

Total deposits at June 30, 2023 amounted to $2.94 billion, a decrease of $72.3 million, or 2.4%, when compared to the level at December 31, 2022. The decrease in total deposits consisted of a decrease in money market and savings accounts of $157.3 million and $83.1 million in noninterest bearing deposits partially offset by an increase in total time deposits of $168.0 million. The decrease in money market and savings accounts was mainly due to competitive market pressures for these products. The decrease in noninterest bearing deposits were mainly due to a shift to higher yielding accounts.

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

Short-Term Borrowings

The Company had $276.0 million of short-term borrowings consisting of short-term advances with the FHLB as of June 30, 2023, compared to short-term borrowings consisting of advances with the FHLB of $40.0 million at December 31, 2022. This increase was due to funding needs as a result of the decrease in deposits and the increase in loans. Other short-term borrowings may consist of overnight borrowing from correspondent banks or securities sold under agreements to repurchase, primarily with commercial depositors. Short-term advances are defined as those with original maturities of one year or less. At June 30, 2023 and December 31, 2022, the Company had no securities sold under agreements to repurchase or overnight borrowings from correspondent banks.

Long-Term Debt

The Company occasionally borrows from the FHLB to meet longer term liquidity needs, specifically to fund loan growth when liquidity from deposit growth is not sufficient. There were no long-term borrowings from the FHLB outstanding at June 30, 2023 and December 31, 2022.

On August 25, 2020, the Company entered into Subordinated Note Purchase Agreements with certain purchasers pursuant to which the Company issued and sold $25.0 million in aggregate principal amount with an initial interest rate of 5.375% of Fixed-to-Floating Rate Subordinated Notes due September 1, 2030.

As a result of the Severn merger, the Company acquired Junior Subordinated Debt Securities due in 2035 which had an outstanding principal balance of $20.6 million. The debt balance of $18.5 million at June 30, 2023 and $18.4 million at December 31, 2022 was presented net of a fair value adjustment of $2.1 million and $2.2 million, respectively.

Liquidity and Capital Resources

We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets. As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $9.7 million for the first six months of 2023 compared to a decrease of $180.6 million for the first six months of 2022. The decrease in cash and cash equivalents in 2023 was mainly due to funding net loan growth of $196.2 million.

To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets. The Bank has arrangements with other correspondent banks whereby it has $15 million available in federal funds lines of credit and a reverse repurchase agreement available to meet any short-term needs which may not otherwise be funded by the Bank’s portfolio of readily marketable investments that can be converted to cash. The Bank is also a member of the FHLB, which provides another source of liquidity. Through the FHLB, the Bank had available lendable collateral of approximately $264.4 million and $298.9 million at June 30, 2023 and December 31, 2022, respectively. The Bank has pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB.

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

The Bank and the Company are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as

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calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank and the Company to maintain minimum ratios of common equity Tier 1, Tier 1, and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1,250%. The Bank and Company are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. The Bank and the Company were deemed “well capitalized” under applicable regulatory capital requirements at June 30, 2023.

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


	Tier 1			Common Equity			Tier 1			Total
	leverage			Tier 1			risk-based			risk-based
June 30, 2023	ratio			ratio			capital ratio			capital ratio
Shore Bancshares, Inc.		9.09	%		11.04	%		11.72	%	13.69	%
Shore United Bank		9.38	%		12.07	%		12.07	%	13.15	%

	Tier 1			Common Equity			Tier 1			Total
	leverage			Tier 1			risk-based			risk-based
December 31, 2022	ratio			ratio			capital ratio			capital ratio
Shore Bancshares, Inc.		9.52	%		11.62	%		12.33	%	13.91	%
Shore United Bank		9.92	%		12.82	%		12.82	%	13.47	%

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Our primary market risk is interest rate fluctuation and management has procedures in place to evaluate and mitigate this risk. This risk and these procedures are discussed in Item 7 of Part II of the 2022 Annual Report under the caption “Market Risk Management and Interest Sensitivity”. Management recognizes that recent increases in interest rates has had an impact on the Company’s market risk. The procedures used to evaluate and mitigate these risks remain unchanged and we continue to monitor our actual and simulated sensitivity positions since December 31, 2022.

Item 4. Controls and Procedures.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files under the Securities Exchange Act of 1934, as amended (“Exchange Act”) with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in those rules and forms, and that such information is accumulated and communicated to management, including Shore Bancshares, Inc.’s principal executive officer (“PEO”) and its principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls and procedures as of June 30, 2023 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, the Company’s management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level at June 30, 2023.

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There have been no changes in the Company’s internal control over financial reporting during the fiscal quarter ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

From time to time the Company may become involved in legal proceedings. At the present time, there are no proceedings which the Company believes will have a material adverse impact on the financial condition or earnings of the Company.

Item 1A. Risk Factors

There have been no material changes to the risk factors as previously disclosed under Item 1A in our Annual Report for the year ended December 31, 2022. Item 1A in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023 and those referenced in other reports on file with the SEC.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no unregistered sales of the Company’s common stock, par value $0.01 per share (“Common Stock”), during the quarter-to-date period ended June 30, 2023.

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

Rule 10b5-1 Trading Plans

During the quarter ended June 30, 2023, no officer or director of the Company adopted or terminated any contract, instruction, or written plan for the purchase or sale of securities of the Company’s common stock that is intended to satisfy the affirmative defense conditions of Securities Exchange Act Rule 10b5-1(c) or any non-Rule 10b5-1 trading arrangement as defined in 17 CFR § 229.408(c).

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Item 6. Exhibits.

Exhibit Number		Description

2.1		Agreement and Plan of Merger, dated as of December 14, 2022, between Shore Bancshares, Inc. and The Community Financial Corporation (incorporated by reference to Exhibit 2.1 of the Company’s Form 8-K filed on December 14, 2022)

3.1(i)		Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on December 14, 2000).

3.1(ii)		Articles of the Amendment of the Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on July 3, 2023).

3.1(iii)		Articles Supplementary relating to the Fixed Rate Cumulative Perpetual Preferred Stock Series A (incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K filed on January 13, 2009).

3.1(iv)		Articles Supplementary relating to the reclassification of the Fixed Rate Cumulative Perpetual Preferred Stock Series A, as common stock (incorporated by reference to Exhibit 3.1(i) of the Company’s Form 8-K filed on June 17, 2009).

3.2		Second Amended and Restated By-Laws, dated July 1, 2023 (incorporated by reference to Exhibit 3.2 of the Company’s Form 8-K filed on July 3, 2023).

4.1		Description of Registrant’s Securities (incorporated by reference to Exhibit 4.1 to the Company’s Form 10-K filed March 13, 2020).

4.2		Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company’s Form S-3 filed on June 25, 2010).

10.1		Assumption and Amendment of Employment Agreement, effective as of July 1, 2023, by and between Shore Bancshares, Inc. and James M. Burke (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on July 3, 2023).

10.2		Assumption and Amendment of Employment Agreement, effective as of July 1, 2023, by and between Shore Bancshares, Inc. and Todd L. Capitani (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed on July 3, 2023).

10.3		Retention Agreement, effective as of July 1, 2023, by and between Shore Bancshares, Inc. and James M. Burke (incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed on July 3, 2023)

10.4		Retention Agreement, effective as of July 1, 2023, by and between Shore Bancshares, Inc. and Todd L. Capitani (incorporated by reference to Exhibit 10.4 of the Company’s Form 8-K filed on July 3, 2023).

10.5		Retention Agreement, effective as of July 1, 2023, by and between Shore Bancshares, Inc. and Donna Stevens (incorporated by reference to Exhibit 10.5 of the Company’s Form 8-K filed on July 3, 2023).

31.1		Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).

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31.2		Certifications of the Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).

32		Certification pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith).

101		Inline Interactive Data File

101.INS		Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document)

101.SCH		Inline XBRL Taxonomy Extension Schema (filed herewith)

101.CAL		Inline XBRL Taxonomy Extension Calculation Linkbase (filed herewith)

101.DEF		Inline XBRL Taxonomy Extension Definition Linkbase (filed herewith)

101.LAB		Inline XBRL Taxonomy Extension Label Linkbase (filed herewith)

101.PRE		Inline XBRL Taxonomy Extension Presentation Linkbase (filed herewith)

104		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	SHORE BANCSHARES, INC.

Date: August 14, 2023	By:	/s/ James M. Burke
		James M. Burke
		President & Chief Executive Officer
		(Principal Executive Officer)

Date: August 14, 2023	By:	/s/ Todd L. Capitani
		Todd L. Capitani
		Executive Vice President & Chief Financial Officer
		(Principal Financial Officer)

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