UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2003
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 East Dover Street, Easton, Maryland 21601
- --------------------------------------- -------------------
(Address of Principal Executive Offices) (Zip Code)
(410) 822-1400
Registrant's Telephone Number, Including Area Code
N/A
Former name, former address and former fiscal year,
if changed since last report.
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 period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes X . No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). X Yes ___No.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
As of May 1, 2003, registrant had 5,374,704 issued and outstanding
shares of common stock.
INDEX
Part I.
Item 1. Financial Statements Page
Condensed Consolidated Balance Sheets -
March 31, 2003 (unaudited) and December 31, 2002 2
Condensed Consolidated Statements of Income -
For the three months ended March 31, 2003 and 2002 (unaudited) 3
Condensed Consolidated Statements of Changes in Stockholders' Equity -
For the three months ended March 31, 2003 and 2002 (unaudited) 4
Condensed Consolidated Statements of Cash Flows -
For the three months ended March 31, 2003 and 2002(unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6-7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 7-12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 12
Item 4. Controls and Procedures 12-13
Part II.
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 15
Certifications 16-17
Part I
Item 1. Financial Statements
SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
March 31, December 31,
ASSETS: 2003 2002
- ------- --------------- ----------------
(unaudited)
Cash and due from banks $20,262 $ 22,321
Interest bearing deposits with other banks 16,853 20,006
Federal funds sold 20,911 27,141
Investment securities:
Held-to-maturity, at amortized cost (fair value of $13,647,
$13,379, respectively) 13,384 13,124
Available for sale, at fair value 114,635 110,864
Loans, less allowance for credit losses ($4,146,
$4,117, respectively) 451,226 435,422
Insurance premiums receivable 1,451 1,619
Bank premise and equipment, net 8,678 8,534
Accrued interest receivable on loans and investment securities 3,014 2,959
Investment in unconsolidated subsidiary 1,166 1,166
Goodwill 5,990 5,990
Other intangible assets 1,743 1,797
Other assets 4,338 3,124
----------- -----------
TOTAL ASSETS $663,651 $654,067
======== ========
LIABILITIES:
Deposits:
Noninterest bearing demand $70,121 $ 70,110
NOW and Super NOW 107,685 99,434
Certificates of deposit $100,000 or more 85,919 99,644
Other time and savings 286,977 276,004
------- ---------
Total Deposits 550,702 545,192
Short term borrowings 24,064 22,008
Long term debt 5,000 5,000
Other liabilities 4,476 3,839
--------- ----------
TOTAL LIABILITIES 584,242 576,039
-------- --------
STOCKHOLDERS' EQUITY:
Common Stock, Par Value $.01; authorized 35,000,000 shares; issued and
outstanding:
March 31, 2003 5,372,612
December 31, 2002 5,372,064 54 54
Additional paid in capital 23,848 23,837
Retained earnings 54,700 52,985
Accumulated other comprehensive income 807 1,152
---------- ---------
TOTAL STOCKHOLDERS' EQUITY 79,409 78,028
-------- --------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $663,651 $654,067
======== ========
See accompanying notes to Condensed Consolidated Financial Statements.
2
SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share amounts)
For the three Months Ended March 31,
2003 2002
---------------- ----------------
INTEREST INCOME
Loans, including fees $7,230 $ 7,030
Interest and dividends on investment securities:
Taxable 1,133 1,516
Tax-exempt 147 106
Other interest income 118 153
------- ---------
Total interest income 8,628 8,805
------- --------
INTEREST EXPENSE
Certificates of deposit, $100,000 or more 690 761
Other deposits 1,856 2,429
Other interest 110 114
------- --------
Total interest expense 2,656 3,304
-------- ------
NET INTEREST INCOME 5,972 5,501
PROVISION FOR CREDIT LOSSES 90 132
--------- --------
NET INTEREST INCOME AFTER PROVISION FOR
CREDIT LOSSES 5,882 5,369
-------- ------
NONINTEREST INCOME
Service charges on deposit accounts 460 465
Gain on sale of securities 276 -
Insurance agency commissions 1,810 -
Other noninterest income 393 218
------- ------
Total noninterest income 2,939 683
-------- -------
NONINTEREST EXPENSE
Salaries and employee benefits 3,050 1,840
Expenses of premises and equipment 493 369
Other noninterest expense 1,279 1,078
------ -------
Total noninterest expense 4,822 3,287
------ ------
INCOME BEFORE TAXES ON INCOME 3,999 2,765
Federal and State income taxes 1,478 1,025
------- --------
NET INCOME $2,521 $ 1,740
======= ========
Basic earnings per common share $ .47 $ .33
Diluted earnings per common share $ .46 $ .32
See accompanying notes to Condensed Consolidated Financial Statements.
3
SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(Dollars in thousands)
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Stockholders'
Stock Capital Earnings Income(loss) Equity
----------- ----------- --------- ------------------ -----------
Balances, January 1, 2003 $54 $23,837 $52,985 $1,152 $78,028
Comprehensive income: - - 2,521 - 2,521
Net income - - -
Other comprehensive income, net of tax:
Unrealized loss on available for sale
securities - - - (345) (345)
-----
Total comprehensive income 2,176
Shares issued - 11 - - 11
Cash dividends paid $0.15 per share - - (806) - (806)
-------- ------------- -------- --------- ---------
Balances, March 31, 2003 $ 54 $23,848 $54,700 $ 807 $79,409
====== ======== ======= ====== ========
Balances, January 1, 2002 $ 53 $23,039 $47,412 $ 466 $70,970
Comprehensive income: - - 1,740 - 1,740
Net income - - -
Other comprehensive income, net of tax:
Unrealized loss on available for sale
securities - - - (485) (485)
-----
Total comprehensive income 1,255
Stock repurchased and retired - (21) - - (21)
Exercise of stock options - 2 - - 2
Cash dividends paid $0.15 per share - - (800) - (800)
-------- ------------- ------ --------- -----
Balances, March 31, 2002 $ 53 $23,020 $48,352 $ (19) $71,406
==== ======== ======== ====== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
4
SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
For the Three Months Ended March 31,
2003 2002
--------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2,521 $ 1,740
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 403 263
Discount accretion on debt securities (11) (21)
Provision for credit losses, net 29 109
Gain on sale of securities (276) -
Loss on other real estate owned 8 -
Net changes in:
Insurance premiums receivable 168 -
Accrued interest receivable (56) (331)
Other assets (1,042) (569)
Accrued interest payable on deposits (77) (117)
Accrued expenses 714 890
---------- ---------
Net cash provided by operating activities 2,381 1,964
---------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal payments of securities
available for sale 27,247 14,377
Proceeds from sale of investment securities available for sale 4,325 -
Purchase of securities available for sale (35,796) (17,438)
Proceeds from maturities and principal payments of securities
held to maturity 553 164
Purchase of securities held to maturity (819) (693)
Net increase in loans (15,832) (16,280)
Purchase of bank premises and equipment (309) (142)
Proceeds from sale of other real estate owned 37 -
----------- -------------
Net cash used in investing activities (20,594) (20,012)
----------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand, NOW, money market and
savings deposits 18,219 21,051
Net decrease in certificates of deposit (12,709) (4,084)
Net increase in securities sold under agreement to repurchase 2,056 3,431
Proceeds from issuance of common stock 11 2
Repurchase of common stock - (21)
Dividends paid (806) (800)
--------- ---------
Net cash provided by financing activities 6,771 19,579
--------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (11,442) 1,531
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 69,468 51,638
--------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 58,026 $ 53,169
========== ==========
See accompanying notes to Condensed Consolidated Financial Statements
5
Shore Bancshares, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1) The consolidated financial statements include the accounts of Shore
Bancshares, Inc. (the "Company") 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 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
financial position at March 31, 2003, the results of operations for the
three-month periods ended March 31, 2003 and 2002, and cash flows for the
three-month periods ended March 31, 2003 and 2002, have been included. All
such adjustments are of a normal and recurring nature. There have been no
significant changes to the Company's accounting policies as disclosed in
the 2002 Annual Report. The results of operations for the three months
ended March 31, 2003 are not necessarily indicative of the results to be
expected for the full year. This quarterly report on Form 10-Q should be
read in conjunction with the Company's annual report on Form 10-K for the
year ended December 31, 2002.
2) Year to date basic earnings per share is derived by dividing net income
available to common stockholders by the weighted average number of common
shares outstanding during the period of 5,372,429 shares for 2003 and
5,332,941 shares for 2002. The diluted earnings per share calculation is
arrived at by dividing net income by the weighted average number of shares
The diluted earnings per share calculation is derived by dividing net
income by the weighted average number of shares outstanding, adjusted for
the dilutive effect of outstanding options and warrants. Considering the
effect of these common stock equivalents, the adjusted average shares for
the three months ended March 31, 2003 and 2002 were 5,461,513 and
5,390,859, respectively.
3) Under the provisions of Statements of Financial Accounting Standards (SFAS)
Nos. 114 and 118, "Accounting by Creditors for Impairment of a Loan," a
loan is considered impaired if it is probable that the Company will not
collect all principal and interest payments according to the loan's
contracted terms. The impairment of a loan is measured at the present value
of expected future cash flows using the loan's effective interest rate, or
at the loan's observable market price or the fair value of the collateral
if the loan is collateral dependent. Interest income generally is not
recognized on specific impaired loans unless the likelihood of further loss
is remote. Interest payments received on such loans are applied as a
reduction of the loans principal balance. Interest income on other
nonaccrual loans is recognized only to the extent of interest payments
received.
Information with respect to impaired loans and the related valuation allowance
is shown below:
March 31, December 31,
(Dollars in thousands) 2003 2002
- ---------------------- ---- ----
Impaired loans with valuation allowance $203 $ 433
Impaired loans with no valuation allowance 559 379
------ -------
Total impaired loans $ 762 $ 812
======= =======
Allowance for credit losses applicable to impaired loans $ 120 $ 116
Allowance for credit losses applicable to other than impaired loans 4,026 4,001
------- -------
Total allowance for credit losses $4,146 $4,117
======= ======
Interest income on impaired loans recorded on the cash basis $ 5 $ 78
======== ========
Impaired loans do not include groups of smaller balance homogenous loans
such as residential mortgage and consumer installment loans that are
evaluated collectively for impairment. Reserves for probable credit losses
related to these loans are based upon historical loss ratios and are
included in the allowance for credit losses.
4) In the normal course of business, to meet the financial needs of its
customers, the Banks are parties to financial instruments with off-balance
sheet risk. These financial instruments include commitments to extend
credit and standby letters of credit. At March 31, 2003, total commitments
to extend credit were approximately $125,922,000. Outstanding letters of
credit were approximately $11,970,000 at March 31, 2003.
6
5) The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure", but applies APB
Opinion No. 25 and related interpretations in accounting for its plans. No
compensation expense related to the plans was recorded during the
three-month periods ended March 31, 2003 and 2002. If the Company had
elected to recognize compensation cost based on fair value at the vesting
dates for awards under the plans consistent with the method prescribed by
SFAS No. 123, net income and earnings per share would have been changed to
the pro forma amounts as follows for the three-month periods ended March
31:
2003 2002
---- ----
Net income:
As reported $2,521 $1,740
Less pro forma stock-based compensation
expense determined under the fair value
method, net of related tax effects (30) (30)
-------- --------
Pro forma net income $2,491 $1,710
======== =========
Basic net income per share:
As reported $0.47 $0.33
Pro forma 0.46 0.32
Diluted earnings per share
As reported $0.46 $0.32
Pro forma 0.46 0.32
The pro forma amounts are not representative of the effects on reported net
income for future periods.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The Company is the largest independent financial holding company located on the
Eastern Shore of Maryland. It is the parent company of The Talbot Bank of
Easton, Maryland located in Easton, Maryland and The Centreville National Bank
of Maryland located in Centreville, Maryland (collectively, the "Banks"). The
Banks operate 12 full service branches in Kent, Queen Anne's, Talbot, Caroline
and Dorchester Counties. The Company offers a full range of insurance products
and services to its customers through The Avon-Dixon Agency, LLC, Elliott Wilson
Insurance, LLC, and Mubell Finance, LLC (collectively, the "Insurance Agency")
and investment advisory services through Wye Financial Services, LLC, all of
which are wholly owned subsidiaries of the Company. The shares of the Company's
common stock are listed on the NASDAQ SmallCap Market, trading under the symbol
"SHBI."
The Company maintains an Internet site at www.shbi.net on which it makes
available, free of charge, its Annual Report on Form 10-K, Quarterly Report 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 Securities and Exchange Commission.
The following discussion is designed to provide a better understanding of the
financial position of the Company and should be read in conjunction with the
December 31, 2002 audited Consolidated Financial Statements and Notes thereto
and Management's Discussion and Analysis of Financial Condition and Results of
Operations set forth in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002.
Forward-Looking Information
Portions of this Quarterly Report on Form 10-Q contain forward-looking
statements within the meaning of The Private Securities Litigation Reform Act of
1995. Statements that are not historical in nature, including statements that
include the words "anticipate," "estimate," "should," expect," "believe,"
"intend," and similar expressions, are expressions about the Company's
confidence, policies, and strategies, the adequacy of capital levels, and
liquidity and are not guarantees of future performance. Such forward-looking
statements involve certain risks and uncertainties, including economic
conditions, competition in the geographic and business areas in which the
Company and its affiliates operate, inflation, fluctuations in interest rates,
legislation, and governmental regulation. These risks and uncertainties are
described in more detail in the Company's Form 10-K, under the heading "Risk
Factors." Actual results may differ materially from such forward-looking
statements, and the Company assumes no obligation to update forward-looking
statements at any time.
Critical Accounting Policies
The Company's financial statements are prepared in accordance with accounting
principals generally accepted in the United States of America (GAAP). The
financial information contained within the financial statements is, to a
significant extent, financial information contained that is based on measures of
the financial effects of transactions and events that have already occurred. A
variety of factors could affect the ultimate value that is obtained either when
earning income, recognizing an expense, recovering an asset or relieving a
liability.
7
The Company believes its most critical accounting policy relates to the
allowance for credit losses. The allowance for credit losses is an estimate of
the losses that may be sustained in the loan portfolio. The allowance is based
on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies,
which requires that losses be accrued when they are probable of occurring and
estimable, and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan,
which requires that losses be accrued based on the differences between the loan
balance and the value of collateral, present value of future cash flows or
values that are observable in the secondary market. Management uses many
factors, including economic conditions and trends, the value and adequacy of
collateral, the volume and mix of the loan portfolio, and internal loan
processes of the Company, in determining the inherent loss that may be present
in the Company's loan portfolio. Actual losses could differ significantly from
Management's estimates. In addition, GAAP itself may change from one previously
acceptable method to another. Although the economics of transactions would be
the same, the timing of events that would impact the transactions could change.
Management has significant discretion in making the adjustments inherent in the
determination of the provision and allowance for credit losses, including in
connection with the valuation of collateral, the borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance and
unallocated allowance components of the allowance. The establishment of
allowance factors is a continuing exercise, based on Management's continuing
assessment of the global factors such as delinquencies, loss history, trends in
volume and terms of loans, effects of changes in lending policy, the experience
and depth of Management, national and local economic trends, concentrations of
credit, quality of loan review system and the effect of external factors such as
competition and regulatory requirements, and their impact on the portfolio.
Allowance factors may change from period to period, resulting in an increase or
decrease in the amount of the provision or allowance, based upon the same volume
and classification of loans. Changes in allowance factors will have a direct
impact on the amount of the provision, and a corresponding effect on net income.
Errors in Management's perception and assessment of the global factors and their
impact on the portfolio could result in the allowance not being adequate to
cover losses in the portfolio, and may result in additional provisions or
charge-offs.
RESULTS OF OPERATIONS
Overview
Net income for the first quarter of 2003 was $2,521,000, an increase of 44.9%
when compared to the first quarter of 2002. On a per share basis, diluted
earnings were $0.46, compared to $0.32 for the same period last year. Return on
average assets was 1.55% for the first quarter of 2003, compared to 1.18% for
the same period in 2002. Return on average stockholders' equity was 12.77% and
9.72% for the three months ended March 31, 2003 and 2002, respectively.
Net Interest Income
Net interest income totaled $5,972,000 for the first quarter of 2003,
representing a $471,000 increase over the same period last year. Total interest
income was $8,628,000 for the first quarter of 2003, which represents a decrease
of $177,000 or 2.0% when compared to the same period last year. Total interest
expense for the quarter ended March 31, 2003 was $2,656,000, a decrease of
$648,000 or 19.6% over last year.
The Company's net interest margin declined 9 basis points for the three-month
period ended March 31, 2003 when compared to the same period last year. The
decline was caused by an overall reduction in the yield on average assets. The
yield on earning assets was 5.70% and 6.44% for the three months ended March 31,
2003 and 2002, respectively. The Federal Reserve cut the short-term federal
funds rate by 50 basis points in November of 2002, resulting in a corresponding
reduction in the New York Prime rate used to price variable rate loans. The full
effect of this rate cut was felt during the first quarter of 2003. The Company
continued to monitor the rate paid for interest bearing liabilities and was able
to reduce interest expense by 85 basis points resulting in an overall rate paid
for interest bearing liabilities of 2.12% for the quarter ended March 31, 2003
compared to 2.97% for the same quarter last year.
On a tax equivalent basis, interest and fees on loans increased $174,000 for the
three-month period ended March 31, 2003 when compared to March 31, 2002. The
increase was the result of increased volume of loans, despite a declining yield.
Compared to the first quarter of 2002, the overall yield on loans fell 69 basis
points to 6.48% for the three months ended March 31, 2003, as loans maturing or
paid off were replaced with loans at much lower rates. The average balance of
loans increased $47,187,000 totaling $447,251,000 for the three months ended
March 31, 2003 when compared to the same period in 2002. The yield on investment
securities declined to 4.35% for the period ended March 31, 2003 from 5.45% for
the same period in 2002, as reinvestment rates available were significantly
lower than those earned on the matured or called bonds. The average balance of
investment securities for the three-month periods ended March 31, 2003 and 2002
was $125,175,000 and $125,330,000, respectively. The overall rate earned on
federal funds sold was 1.21% for the three months ended March 31, 2003, compared
to 1.75% for the same period last year. Interest bearing deposits earned 1.13%
for the first quarter of 2003, compared to 1.65% for the first quarter of 2002.
Interest expense decreased primarily as a result of lower rates paid for
certificates of deposit. The overall rate paid for certificates of deposit
declined 123 basis points for the period ended March 31, 2003 compared to the
same period in 2002. The average balance of interest bearing deposits increased
$46,765,000, with $26,516,000 of that increase occurring in Certificates of
Deposit $100,000 or more.
8
An additional $19,377,000 growth occurred in money management and savings
accounts, and $6,487,000 of growth occurred in interest bearing transaction
accounts. The average balance of other certificates of deposit declined
$5,653,813 for the period ended March 31, 2003 compared to the same period in
2002. See the Analysis of Interest Rates and Interest Differentials below for
further details.
Loans comprised 72.9% and 71.3% of total average earning assets at March 31,
2003 and 2002, respectively.
Analysis of Interest Rates and Interest Differentials.
The following table presents the distribution of the average consolidated
balance sheets, interest income/expense, and annualized yields earned and rates
paid through the first three months of the year.
March 31, 2003 March 31, 2002
-------------- --------------
Average Income/ Yield Average Income/ Yield
(Dollars in thousands) Balance Expense(1) Rate Balance Expense(1) Rate
- -----------------------------------------------------------------------------------------------------------------------------
Earning Assets
Investment securities $125,175 $1,362 4.35% $125,330 $1,684 5.45%
Loans (2) (3) 447,251 7,248 6.48% 400,064 7,074 7.17%
Interest bearing deposits 18,761 53 1.13% 13,119 53 1.65%
Federal funds sold 21,700 65 1.21% 22,927 99 1.75%
---------- --------- ----- ------------ ------- ----
Total earning assets 612,887 8,728 5.70% 561,440 8,910 6.44%
Noninterest earning assets 38,565 27,055
---------- -------
Total Assets 651,452 588,495
======== =======
Interest bearing liabilities
Interest bearing deposits 475,977 2,546 2.14% 429,212 3,190 3.01%
Short term borrowing 21,180 48 0.89% 17,377 52 1.21%
Long term debt 5,000 62 4.97% 5,000 62 5.04%
---------- --------- ----- ------------ -------- ----
Total interest bearing liabilities 502,157 2,656 2.12% 451,589 3,304 2.97%
Noninterest bearing liabilities 70,307 65,301
Stockholders' equity 78,988 71,605
------ ------
Total liabilities and stockholders' equity $651,452 $588,495
======== ========
Net interest spread $6,072 3.58% $5,606 3.47%
======= ======
Net interest margin 3.96% 4.05%
<FN>
(1) All amounts are reported on a tax equivalent basis computed using the
statutory federal income tax rate exclusive of the alternative minimum tax rate
of 34% and nondeductible interest expense.
(2) Average loan balances include nonaccrual loans.
(3) Interest income on loans includes amortized loan fees, net of costs, for
each loan category and yield calculations are stated to include all.
</FN>
Non-interest Income
Total non-interest income for the three-month period ended March 31, 2003
increased $2,256,000 when compared to the same period in 2002. The increase is
primarily attributable to insurance commissions totaling $1,810,000 resulting
from the operation of the Company's Insurance Agency, which was acquired May 1,
2002. In addition, the Company had gains on sale of securities totaling $276,000
and fee income from the origination of residential mortgage loans on the
secondary market totaling $136,000 for the three months ended March 31, 2003.
Non-interest Expense
Total non-interest expense increased $1,535,000 for the three-month period ended
March 31, 2003 from the comparable period in 2002. Operation of the Company's
Insurance Agency accounted for $1,259,000 of the increase during the three-month
period ended March 31, 2003, when compared to the same period in 2002. Other
increases relate to the costs associated with a new bank branch, new products
and services, as well as a general increase in overhead resulting from growth of
the Company.
Income Taxes
The effective tax rate for each of the three-month periods ended March 31, 2003
and 2002 was 37.0%. There have been no significant changes in tax law or to the
Company's tax structure that would impact the effective tax rate.
9
Analysis of Financial Condition
Loans
Loans, net of unearned income, totaled $455,372,000 at March 31, 2003, an
increase of $15,833,000 or 3.6% since December 31, 2002. The increase is
primarily attributable to an increase in loans secured by real estate. On
average, loans net of unearned income, increased $47,187,000 or 11.8%, totaling
$447,251,000 for the three-month period ended March 31, 2003, compared to
$400,064,000 for the same period last year.
Allowance for Credit Losses
The Company has established an allowance for credit losses, which is increased
by provisions charged against earnings and recoveries of previously charged-off
debts. The allowance is decreased by current period charge-off of uncollectible
debts. Management evaluates the adequacy of the allowance for credit losses on a
quarterly basis and adjusts the balance of the allowance based upon this
analysis. The evaluation of the adequacy of the allowance for credit losses is
based on a risk rating system of individual loans, as well as on a collective
evaluation of smaller balance homogenous loans based on factors such as past
credit loss experience, local economic trends, nonperforming and problem loans,
and other factors which may impact collectibility. A loan is placed on
nonaccrual when it is specifically determined to be impaired and principal and
interest is delinquent for 90 days or more.
The provision for credit losses for the three-month periods ended March 31, 2003
and 2002 was $90,000 and $132,000, respectively. The Company had net charge-offs
of $61,000 for the first quarter of 2003, compared to net charge-offs of $23,000
for the same period last year. Management adjusts the allowance for credit
losses through the provision based on its evaluation and analysis of the
adequacy of the allowance, including consideration of general economic
conditions, growth of the loan portfolio, current trends in delinquencies and
nonperforming assets, as well as past credit loss experience. A reduction in
nonperforming loans and loan delinquencies was the primary reason for a
reduction in the provision for loan losses for the quarter ended March 31, 2003
when compared to the same period last year. Nonaccrual loans remained relatively
unchanged from December 31, 2002, totaling $762,000 as of March 31, 2003. The
allowance for credit losses as a percentage of average loans declined as a
result of continued loan growth and a decline in the balance of the allowance as
of March 31, 2003 compared to March 31, 2002. Expressed as a percentage of
average loans, the allowance totaled .93% and 1.07% as of March 31, 2003 and
2002, respectively. Based on Management's quarterly evaluation of the adequacy
of the allowance for credit losses, it believes that the allowance for credit
losses and the related provision are adequate at March 31, 2003.
The following table presents a summary of the activity in the allowance for
credit losses:
Three Months Ended March 31,
(Dollars in thousands) 2003 2002
- ---------------------- ---- ----
Allowance balance - beginning of period $4,117 $ 4,189
Charge-offs:
Commercial and other 2 -
Real estate 45 25
Consumer 46 23
----- ------
Totals 93 48
----- ------
Recoveries:
Commercial 1 3
Real estate 7 2
Consumer 24 20
----- -------
Totals 32 25
----- --------
Net charge-offs: 61 23
Provision for credit losses 90 132
-------- ---------
Allowance balance - end of period $4,146 $ 4,298
====== ========
Average loans outstanding during period $447,251 $400,064
======== =========
Net charge-offs (annualized) as a percentage of
average loans outstanding during period .05% .02%
===== ==========
Allowance for credit losses at period end as a
percentage of average loans .93% 1.07%
====== ========
10
Because the Company's loans are predominately real estate secured, weaknesses in
the local real estate market may have an adverse effect on collateral values.
The Company does not have any concentrations of loans in any particular
industry, nor does it engage in foreign lending activities
Nonperforming Assets
The following table summarizes past due and nonperforming assets of the Company
(in thousands):
March 31, December 31,
Nonperforming Assets: 2003 2002
------------ ------------
Nonaccrual loans 762 771
Other real estate owned 9 54
------ --------
771 825
Past due loans 264 374
------- -----
Total nonperforming and past due loans $1,035 $1,199
====== ======
Investment Securities
Investment securities increased $4,031,000 during the first quarter of 2003 when
compared to December 31, 2002. The overall yield on investment securities
declined, however, as bonds which matured or were called during the period had
much higher yields than those available on securities purchased. The average
balance of investment securities was $125,175,000 for the first quarter of 2003,
compared to $125,330,000 for the same period in 2002. The tax equivalent yield
on investment securities was 4.35% and 5.45% for the three months ended March
31, 2003 and 2002, respectively.
Deposits
Total deposits at March 31, 2003 were $550,702,000, compared to $545,192,000 at
December 31, 2002. Due to the lower rates offered for certificates of deposit,
much of the deposit growth was in savings account balances. Certificates of
deposit of $100,000 or more declined $13,725,000 during the three-month period
ended March 31, 2003 when compared to December 31, 2002. The change was
primarily a result of a $10,500,000 reduction in certificate of deposit balances
of a municipal depositor. Approximately $5,500,000 of those certificate of
deposit balances were shifted into NOW and SuperNOW accounts by the depositor.
Other time and savings accounts increased $10,973,000 during the three-month
period ended March 31, 2003 when compared to December 31, 2002.
Borrowed Funds
Short-term borrowings at March 31, 2003 and 2002 consisted of securities sold
under agreements to repurchase. The Company also had a convertible advance from
the Federal Home Loan Bank of Atlanta in the amount $5,000,000 at March 31, 2003
and 2002. The advance is due in March 2006 and has a one-time call provision in
2004.
Liquidity and Capital Resources
The Company derives liquidity through increased customer deposits, maturities in
the investment portfolio, loan repayments and income from earning assets. To the
extent that deposits are not adequate to fund customer loan demand, liquidity
needs can be met in the short-term funds markets through arrangements with its
correspondent banks. The Banks are also members of the Federal Home Loan Bank of
Atlanta, which provides another source of liquidity. There are no known trends
or demands, commitments, events or uncertainties that Management is aware of
which will materially affect the Company's ability to maintain liquidity at
satisfactory levels.
Total stockholders' equity was $79,409,000 at March 31, 2003, a 1.8% increase
over December 31, 2002. Accumulated other comprehensive income, which consists
solely of net unrealized gains on investment securities available for sale,
declined $345,000 during the three-month period ended March 31, 2003, resulting
in an accumulated other comprehensive gain of $807,000 at March 31, 2003.
Federal banking agencies that regulate the Company and the Banks have adopted
various capital standards for financial institutions, including risk-based
capital standards. The primary objectives of the risk-based capital framework
are to provide a more consistent system for comparing capital positions of
financial institutions and to take into account the different risks among
financial institutions' assets and off-balance sheet items.
Risk-based capital standards have been supplemented with requirements for a
minimum Tier 1 capital to assets ratio (leverage ratio). In addition, regulatory
agencies consider the published capital levels as minimum levels and may require
a financial institution to maintain capital at higher levels.
A comparison of the capital as of March 31, 2003 for the Company with the
minimum requirements is presented below:
11
Minimum
Actual Requirements
------ ------------
Tier 1 risk-based capital 15.21% 4.00%
Total risk-based capital 16.12% 8.00%
Leverage ratio 10.97% 4.00%
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to changes in interest rates, exchange rates or
equity pricing. The Company's principal market risk is interest rate risk that
arises from its lending, investing and deposit taking activities. The Company's
profitability is dependent on the Banks' net interest income. Interest rate risk
can significantly affect net interest income to the degree that interest bearing
liabilities mature or reprice at different intervals than interest earning
assets. The Asset/Liability Committee of the Board of Directors (the "ALCO") of
both Banks oversees the management of interest rate risk. The ALCO's primary
purpose is to manage the exposure of net interest margins to unexpected changes
due to interest rate fluctuations. These efforts affect the loan pricing and
deposit rate policies of the Company as well as the asset mix, volume
guidelines, and liquidity and capital planning.
The Company utilizes a simulation model to quantify the effect a hypothetical
plus or minus 200 basis point change in rates would have on net interest income
and the fair value of capital. The model takes into consideration the effect of
call features of investments as well as repayments of loans in periods of
declining rates. When actual changes in interest rates occur, the changes in
interest earning assets and interest bearing liabilities may differ from the
assumptions used in the model. As of March 31, 2003, the model produced the
following sensitivity profile for net interest income and the fair value
capital:
Immediate Change in Rates
+200 Basis Points -200 Basis Points Policy Limit
- ----------------------------------------------------------------------------------------------------
% Change in net interest income 4.51% ( 8.60%) + 25%
-
% Change in fair value of capital 2.91% ( 6.62%) + 15%
-
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Within the 90
days prior to the date of this report, the Company carried out an evaluation
("Evaluation"), under the supervision and with the participation of the
Company's management, including the Company's President/Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the design
and operation of the Company's disclosure controls and procedures ("Disclosure
Controls") and its internal controls and procedures for financial reporting
("Internal Controls").
Disclosure Controls are procedures that are designed with the
objective of ensuring that information required to be disclosed in the Company's
reports filed under the Securities Exchange Act of 1934 ("Exchange Act"), such
as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and
reported within the time periods specified in the rules and forms issued by the
Securities and Exchange Commission ("SEC"). Disclosure Controls are also
designed with the objective of ensuring that such information is
12
accumulated and communicated to management, including the CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure. Internal
Controls are procedures that are designed with the objective of providing
reasonable assurance that the Company's (i) transactions are properly
authorized; (ii) assets are safeguarded against unauthorized or improper use;
and (iii) transactions are properly recorded and reported, all to permit the
preparation of the Company's financial statements in conformity with generally
accepted accounting principles.
CEO and CFO Certifications
Appearing immediately following the Signatures section of this Quarterly Report
there are "Certifications" of the CEO and the CFO. The Certifications are
required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. The
section of the Form 10-Q that you are currently reading is the information
concerning the Evaluation, and this information should be read in conjunction
with the Certifications for a more complete understanding of the topics
presented.
Limitations on the Effectiveness of Controls
The Company's management, including the CEO and CFO, does not expect that the
Disclosure Controls or the Internal Controls will prevent all error and all
fraud. 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. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been
detected. 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, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Conclusions
Based upon the Evaluation, the Company's CEO and the CFO have concluded that the
Disclosure Controls are effective in timely alerting them to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in the Company's periodic SEC filings, and that the
Internal Controls are effective to provide reasonable assurance that the
Company's financial statements are fairly presented in conformity with generally
accepted accounting principles.
(b) Changes in Internal Controls. There were no significant changes in
the Company's Internal Controls or in other factors that could significantly
affect those Internal Controls, including any corrective actions with regard to
significant deficiencies and material weaknesses.
13
Part II
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Exhibit 3.1 on Form 8-K filed by the Company on
December 14, 2000).
3.2 Amended and Restated By-Laws (incorporated by reference to
Exhibit 3.2 on Form 8-K filed by the Company on December 14,
2000).
10.1 Form of Employment Agreement with W. Moorhead Vermilye
(incorporated by reference to Appendix XIII of Exhibit 2.1 on
Form 8-K filed by the Company on July 31, 2000).
10.2 Form of Employment Agreement with Daniel T. Cannon (incorporated
by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by
the Company on July 31, 2000).
10.3 Form of Employment Agreement between Avon Dixon Agency, LLC and
Kevin P. LaTulip (incorporated by reference to Exhibit 10.3 of
the Company's Annual Report on Form 10-K for the year ended
December 31, 2002).
99.1 Shore Bancshares, Inc. 1998 Employee Stock Purchase Plan, as
amended and restated (incorporated by reference to Appendix A of
the Company's Definitive Proxy Statement on Schedule 14A for the
2003 Annual Meeting of Stockholders, filed on March 31, 2003).
99.2 Shore Bancshares, Inc. 1998 Stock Option Plan (incorporated by
reference to the Company's Registration Statement on Form S-8
filed on September 25, 1998 (Registration No. 333-64319)).
99.3 Talbot Bancshares, Inc. Employee Stock Option Plan (incorporated
by reference from the Company's Registration Statement on Form
S-8 filed on May 4, 2001 (Registration No. 333-60214)).
99.4 Certifications of the CEO and the Principal Accounting Officer
pursuant to 18 U.S.C. Section 1350 (filed herewith).
b) Reports on Form 8-K.
None.
14
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Shore Bancshares, Inc.
Date: May 14, 2003 By: /s/ W. Moorhead Vermilye
------------------------------------------
W. Moorhead Vermilye
President/CEO
Date: May 14, 2003 By: /s/ Susan E. Leaverton
-----------------------------------------
Susan E. Leaverton, CPA
Treasurer/Principal Accounting Officer
15
CERTIFICATIONS
I, W. Moorhead Vermilye, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q (this "Report") of Shore
Bancshares, Inc. (the "Company");
2. Based on my knowledge, this Report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this Report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls and
procedures as of the date within 90 days prior to the filing date of this report
(the "Evaluation Date"); and
c) presented in this Report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of
Company's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls that could adversely affect the Company's ability to record, process,
summarize and report financial data and have identified for the Company's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal controls;
and
6. The Company's other certifying officers and I have indicated in this Report
whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions with regard to
significant deficiencies and material weakness.
Date: March 14, 2003 /s/ W. Moorhead Vermilye
---------------------------------
By: W. Moorhead Vermilye
Title: President/CEO
16
CERTIFICATIONS
I, Susan E. Leaverton, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q (this "Report") of Shore
Bancshares, Inc. (the "Company");
2. Based on my knowledge, this Report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this Report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls and
procedures as of the date within 90 days prior to the filing date of this report
(the "Evaluation Date"); and
c) presented in this Report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of
Company's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls that could adversely affect the Company's ability to record, process,
summarize and report financial data and have identified for the Company's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal controls;
and
6. The Company's other certifying officers and I have indicated in this Report
whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions with regard to
significant deficiencies and material weakness.
Date: March 14, 2003 /s/ Susan E. Leaverton
------------------------
By: Susan E. Leaverton
Title: Treasurer/Principal Accounting Officer
17
EXHIBIT INDEX
Exhibit No. Description
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Exhibit 3.1 on Form 8-K filed by the Company on
December 14, 2000)
3.2 Amended and Restated By-Laws (incorporated by reference to
Exhibit 3.2 on Form 8-K filed by the Company on December 14,
2000)
10.1 Form of Employment Agreement with W. Moorhead Vermilye
(incorporated by reference to Appendix XIII of Exhibit 2.1 on
Form 8-K filed by the Company on July 31, 2000).
10.2 Form of Employment Agreement with Daniel T. Cannon
(incorporated by reference to Appendix XIII of Exhibit 2.1 on
Form 8-K filed by the Company on July 31, 2000)
10.3 Form of Employment Agreement between Avon Dixon Agency, LLC and
Kevin P. LaTulip (incorporated by reference to Exhibit 10.3 of
the Company's Annual Report on Form 10-K for the year ended
December 31, 2002)
99.1 Shore Bancshares, Inc. 1998 Employee Stock Purchase Plan, as
amended and restated (incorporated by reference to Appendix A
of the Company's Definitive Proxy Statement on Schedule 14A for
the 2003 Annual Meeting of Stockholders filed on March 31,
2003)
99.2 Shore Bancshares, Inc. 1998 Stock Option Plan (incorporated by
reference to the Company's Registration Statement on Form S-8
filed on September 25, 1998 (Registration No. 333-64319))
99.3 Talbot Bancshares, Inc. Employee Stock Option Plan
(incorporated by reference from the Company's Registration
Statement on Form S-8 filed on May 4, 2001 (Registration No.
333-60214))
99.4 Certifications of the CEO and the Principal Accounting Officer
pursuant to 18 U.S.C. Section 1350 (filed herewith)