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, 2004
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
---------------------------------------------------
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 checkmark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes X 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: 5,495,834 issued and
outstanding shares of common stock as of May 1, 2004.
INDEX
Part I.
Item 1. Financial Statements Page
Condensed Consolidated Balance Sheets -
March 31, 2004 (unaudited) and December 31, 2003 2
Condensed Consolidated Statements of Income -
For the three months ended March 31, 2004 and 2003 (unaudited) 3
Condensed Consolidated Statements of Changes in Stockholders' Equity -
For the three months ended March 31, 2004 and 2003 (unaudited) 4
Condensed Consolidated Statements of Cash Flows -
For the three months ended March 31, 2004 and 2003(unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8-13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 14
Item 4. Controls and Procedures 14
Part II.
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 15
PART I
Item 1. Financial Statements
SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
March 31, December 31,
ASSETS: 2004 2003
- ------- --------------- ----------------
(unaudited)
Cash and due from banks $19,606 $ 19,391
Interest bearing deposits with other banks 9,873 9,897
Federal funds sold 27,587 17,443
Investment securities:
Held-to-maturity, at amortized cost (fair value of $16,576,
$15,585, respectively) 16,193 15,313
Available for sale, at fair value 120,630 144,368
Loans, less allowance for credit losses ($3,940,
$4,060, respectively) 488,856 470,895
Insurance premiums receivable 646 845
Bank premise and equipment, net 11,229 11,302
Accrued interest receivable on loans and investment securities 2,972 3,042
Investment in unconsolidated subsidiary 1,203 1,203
Goodwill 5,990 5,990
Other intangible assets 1,527 1,581
Other assets 5,152 4,109
-------- --------
TOTAL ASSETS $711,464 $705,379
======== ========
LIABILITIES:
Deposits:
Noninterest bearing demand $ 73,270 $ 91,669
NOW and Super NOW 109,586 103,415
Certificates of deposit $100,000 or more 88,454 71,385
Other time and savings 317,872 325,940
-------- --------
Total Deposits 589,182 592,409
Short term borrowings 27,254 20,957
Long term debt 5,000 5,000
Other liabilities 4,443 3,486
-------- --------
TOTAL LIABILITIES 625,879 621,852
-------- --------
STOCKHOLDERS' EQUITY:
Common Stock, Par Value $.01; authorized 35,000,000 shares; issued and
outstanding:
March 31, 2004 5,409,967
December 31, 2003 5,400,793 54 54
Additional paid in capital 24,420 24,231
Retained earnings 60,474 58,932
Accumulated other comprehensive income 637 310
-------- -------
TOTAL STOCKHOLDERS' EQUITY 85,585 83,527
-------- -------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $711,464 $705,379
======== ========
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,
2004 2003
---------------- ----------------
INTEREST INCOME
Loans, including fees $7,149 $ 7,230
Interest and dividends on investment securities:
Taxable 1,193 1,133
Tax-exempt 154 147
Other interest income 54 118
------ -------
Total interest income 8,550 8,628
------ -------
INTEREST EXPENSE
Certificates of deposit, $100,000 or more 557 690
Other deposits 1,471 1,856
Other interest 100 110
------ -------
Total interest expense 2,128 2,656
------ -------
NET INTEREST INCOME 6,422 5,972
PROVISION FOR CREDIT LOSSES 105 90
------ -------
NET INTEREST INCOME AFTER PROVISION FOR
CREDIT LOSSES 6,317 5,882
------ -------
NONINTEREST INCOME
Service charges on deposit accounts 495 460
Gain on sale of securities 16 276
Insurance agency commissions 1,909 1,810
Other noninterest income 458 393
------ -------
Total noninterest income 2,878 2,939
------ -------
NONINTEREST EXPENSE
Salaries and employee benefits 3,118 3,050
Expenses of premises and equipment 589 493
Other noninterest expense 1,506 1,279
------ -------
Total noninterest expense 5,213 4,822
------ -------
INCOME BEFORE TAXES ON INCOME 3,982 3,999
Federal and State income taxes 1,466 1,478
------ -------
NET INCOME $2,516 $ 2,521
====== ========
Basic earnings per common share $ .47 $ .47
Diluted earnings per common share $ .46 $ .46
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, 2004 $ 54 $24,231 $58,932 $310 $83,527
Comprehensive income:
Net income - - 2,516 - 2,516
Other comprehensive income, net of tax:
Unrealized loss on available for sale
securities - - - 327 327
--------
Total comprehensive income 2,843
Shares issued - 189 - - 189
Cash dividends paid $0.18 per share - - (974) - (974)
------ -------- -------- ------ --------
Balances, March 31, 2004 $ 54 $24,420 $60,474 $ 637 $85,585
====== ======== ======== ====== ========
Balances, January 1, 2003 $ 54 $23,837 $52,985 $1,152 $78,028
Comprehensive income:
Net income - - 2,521 - 2,521
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
====== ======== ======== ====== ========
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,
2004 2003
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2,516 $ 2,521
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 334 403
Discount accretion on debt securities (30) (11)
Provision for credit losses, net (120) 29
Gain on sale of securities (16) (276)
Loss on other real estate owned - 8
Net changes in:
Insurance premiums receivable 199 168
Accrued interest receivable 70 (56)
Other assets (1,189) (1,042)
Accrued interest payable on deposits 12 (77)
Accrued expenses 947 714
--------- ---------
Net cash provided by operating activities 2,723 2,381
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal payments of securities
available for sale 21,906 27,247
Proceeds from sale of investment securities available for sale 7,867 4,325
Purchase of securities available for sale (5,521) (35,796)
Proceeds from maturities and principal payments of securities
held to maturity 453 553
Purchase of securities held to maturity (1,340) (819)
Net increase in loans (17,841) (15,832)
Purchase of bank premises and equipment (137) (309)
Proceeds from sale of other real estate owned - 37
Purchase of other real estate owned (60) -
--------- ---------
Net cash provided (used) in investing activities 5,327 (20,594)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in demand, NOW, money market and
savings deposits (18,432) 18,219
Net increase (decrease) in certificates of deposit 15,206 (12,709)
Net increase in securities sold under agreement to repurchase 6,296 2,056
Proceeds from issuance of common stock 189 11
Dividends paid (974) (806)
--------- ---------
Net cash provided by financing activities 2,285 6,771
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 10,335 (11,442)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 46,731 69,468
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 57,066 $ 58,026
========= =========
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, 2004, the results of operations for the
three-month periods ended March 31, 2004 and 2003, and cash flows for the
three-month periods ended March 31, 2004 and 2003, have been included. The
amounts as of December 31, 2003 are derived from audited financial
statements. 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 Company's Annual Report on Form 10-K for the year ended
December 31, 2003. The results of operations for the three months ended
March 31, 2004 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, 2003.
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 5,407,991 for the first quarter of
2004 and 5,372,429 for the year ended December 31, 2003. 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, 2004 and 2003 were 5,474,082 and 5,461,513, 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) 2004 2003
--------- ------------
Impaired loans with valuation allowance $ 677 $ 729
Impaired loans with no valuation allowance 761 273
-------- -------
Total impaired loans $ 1,438 $ 1,002
======= =======
Allowance for credit losses applicable to impaired loans $ 403 $ 349
Allowance for credit losses applicable to other than impaired loans 3,537 3,711
------- -------
Total allowance for credit losses $ 3,940 $ 4,060
======== =======
Interest income on impaired loans recorded on the cash basis $ 1 $ 26
======== =======
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 Company's bank subsidiaries 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, 2004, total commitments to extend credit were approximately
$136,846,000. Outstanding letters of credit were approximately $9,266,000
at March 31, 2004.
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
-6-
interpretations in accounting for its equity compensation plans. No
compensation expense related to these plans was recorded during the
three-month periods ended March 31, 2004 and 2003. 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:
Three-month period Ended March 31,
2004 2003
---- ----
Net income:
As reported $2,516 $2,521
Less pro forma stock-based compensation
expense determined under the fair value
method, net of related tax effects (32) (30)
------- -------
Pro forma net income $2,484 $2,491
======= =======
Basic net income per share:
As reported $0.47 $0.47
Pro forma 0.46 0.46
Diluted earnings per share
As reported $0.46 $0.46
Pro forma 0.45 0.46
The pro forma amounts are not representative of the effects on reported net
income for future periods.
6) Shore Bancshares operates two primary businesses: Community Banking and
Insurance Products and Services. The Community Banking business covered by
this report provides services to consumers and small businesses on the
Eastern Shore of Maryland through its twelve-branch network. Community
banking activities include small business services, retail brokerage, and
consumer banking products and services. Loan products available to
consumers include mortgage, home equity, automobile, marine, and
installment loans, credit cards and other secured and unsecured personal
lines of credit. Small business lending includes commercial mortgages, real
estate development loans, equipment and operating loans, as well as secured
and unsecured lines of credit, credit cards, accounts receivable financing
arrangements, and merchant card services.
A full range of insurance products and services are available to businesses and
consumers in the Company's market areas. Products include property and casualty,
life, marine, individual health and long-term care insurance. Pension and profit
sharing plans and retirement plans for executives and employees are available to
suit the needs of individual businesses.
-7-
Selected financial information by line of business for the three months ended
March 31, is included in the following table:
Community Insurance products Parent Intersegment Consolidated
(In thousands) banking and services Company(a) Transactions Total
- -----------------------------------------------------------------------------------------------------------------------------------
2004
Net Interest income $ 6,421 $ - $ 1 - $ 6,422
Provision for credit losses 105 - - - 105
-------------------------------------------------------------------------------------
Net interest income after provision 6,316 - 1 - 6,317
Noninterest income 856 1,998 514 (490) 2,878
Noninterest expense 3,817 1,335 551 490 5,213
-------------------------------------------------------------------------------------
Income before taxes 3,355 663 (36) - 3,982
Income tax expense 1,224 256 (14) - 1,466
------------------------------------------------------------------------------------
Net income $ 2,131 $ 407 $ (22) - $ 2,516
-------------------------------------------------------------------------------------
Intersegment revenue(expense) $ (440) $ (50) $ 490 - $ -
Average assets $692,476 $7,492 $3,392 - $703,360
2003
Net Interest income $ 5,983 $ (11) $ - - $ 5,972
Provision for credit losses 90 - - - 90
-------------------------------------------------------------------------------------
Net interest income after provision 5,893 (11) - - 5,882
Noninterest income 1,108 1,831 - - 2,939
Noninterest expense 3,556 1,266 - - 4,822
-------------------------------------------------------------------------------------
Income before taxes 3,445 554 - - 3,999
Income tax expense 1,264 214 - - 1,478
-------------------------------------------------------------------------------------
Net income $ 2,181 $340 - - $ 2,521
-------------------------------------------------------------------------------------
Intersegment revenue(expense) $ 11 $ (11) $ - - $ -
Average assets $643,785 $7,111 $ - - $651,452
(a) Amount included in Parent Company in 2004 relate to services provided to
subsidiaries by the holding company and rental income.
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"), and,
as of April 1, 2004, of The Felton Bank, a Delaware bank. 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 Small Cap Market 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 From 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
March 31, 2004 Consolidated Financial Statements and Notes thereto included
elsewhere in this report, and in conjunction with the December 31, 2003 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, 2003.
-8-
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 Item 1 of Part I of the Company's Annual Report on
Form 10-K for the year ended December 31, 2003, 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.
Recent Developments
On April 1, 2004 the Company completed its merger with Midstate Bancorp, Inc. As
a result of the merger, The Felton Bank became a wholly-owned subsidiary of
Shore Bancshares. Felton Bank has a branch in each of Felton, Delaware and
Milford, Delaware. In the aggregate, the Company paid cash in the amount of
$2,953,710 and issued 82,786 shares of common stock to the stockholders of
Midstate Bancorp, Inc.
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.
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 as of the balance sheet
date. The allowance is based on two basic principles of accounting: (i) SFAS No.
5, "Accounting for Contingencies", which requires that losses be accrued when
they are probable of occurring and estimable; and (ii) SFAS No. 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.
Three basic components comprise the Company's allowance for credit losses: (i) a
specific allowance; (ii) a formula allowance; and (iii) a nonspecific allowance.
Each component is determined based on estimates that can and do change when the
actual events occur. The specific allowance is used to individually allocate an
allowance to loans identified as impaired. An impaired loan may show
deficiencies in the borrower's overall financial condition, payment history,
support available from financial guarantors and/or the fair market value of
collateral. When a loan is identified as impaired, a specific reserve is
established based on the Company's assessment of the loss that may be associated
with the individual loan. The formula allowance is used to estimate the loss on
internally risk rated loans, exclusive of those identified as impaired. Loans
identified as special mention, substandard, doubtful and loss, as well as
impaired, are segregated from performing loans. Remaining loans are then grouped
by type (commercial, commercial real estate, construction, home equity or
consumer). Each loan type is assigned an allowance factor based on Management's
estimate of the risk, complexity and size of individual loans within a
particular category. Classified loans are assigned higher allowance factors than
non-rated loans due to Management's concerns regarding collectibility or
Management's knowledge of particular elements regarding the
-9-
borrower. Allowance factors grow with the worsening of the internal risk rating.
The nonspecific formula is used to estimate the loss of non-classified loans
stemming from more 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. The nonspecific allowance captures
losses whose impact on the portfolio have occurred but have yet to be recognized
in either the formula or specific allowance.
Overview
Net income for the first quarter of 2004 was $2,516,000, compared to $2,521,000
for the first quarter of 2003. On a per share basis, diluted earnings were $0.46
for the first quarters of 2004 and 2003. Return on average assets was 1.43% for
the first quarter of 2004, compared to 1.55% for the same period in 2003. Return
on average stockholders' equity was 11.87% and 12.77% for the three months ended
March 31, 2004 and 2003, respectively.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income totaled $6,422,000 for the first quarter of 2004,
representing a $450,000 increase over the same period last year. Total interest
income was $8,550,000 for the first quarter of 2004, representing a decrease of
$78,000 when compared to the same period last year. Total interest expense for
the quarter ended March 31, 2004 was $2,128,000, a decrease of $528,000 or 19.9%
over last year.
The Company's net interest margin remained stable during the three-month period
ended March 31, 2004 when compared to the year ended December 31, 2003 and the
same period last year. The yield on earning assets declined to 5.24%, compared
to 5.70% for the three months ended March 31,2003, however an offsetting
reduction in the rate paid for interest bearing liabilities resulted in a net
interest margin of 3.95%. The rate paid for interest bearing liabilities
declined 53 basis points to 1.59%, compared to 2.12% for the same period last
year.
On a tax equivalent basis, interest and fees on loans declined $91,000 for the
three-month period ended March 31, 2004 when compared to March 31, 2003. The
decline is the direct result of lower loan yields, despite continued growth in
the portfolio. Compared to the first quarter of 2003, the overall yield on loans
fell 58 basis points to 5.90% for the first quarter of 2004. The average balance
of loans increased $38,179,000, totaling $485,430,000 for the three months ended
March 31, 2004 when compared to the same period in 2003. The yield on investment
securities declined to 3.77% for the period ended March 31, 2004 from 4.35% for
the same period in 2003. Proceeds from called or matured bonds were reinvested
in bonds with lower overall returns. The average balance of investment
securities for the three-month periods ended March 31, 2004 and 2003 was
$151,381,000 and $125,175,000, respectively.
The overall rate earned on federal funds sold was 0.98% for the three months
ended March 31, 2004, compared to 1.21% for the same period last year. Interest
bearing deposits earned 0.88% for the first quarter of 2004, compared to 1.13%
for the first quarter of 2003. Interest expense continued to decline as deposits
shifted from higher yielding certificates of deposit into other lower yielding
deposit and savings vehicles. The average balance of interest bearing deposits
increased $31,623,000, with $32,270,000 of that increase occurring in Money
Management account balances. The average balance of Certificates of Deposit
$100,000 or more decreased $10,731,000, while other certificates of deposit
balances decreased by $3,094,000. The average balance of NOW and SuperNOW
deposits increased $5,616,000 and Regular savings balances increased $7,562,000.
See the Analysis of Interest Rates and Interest Differentials below for further
details.
Loans comprised 73.6% and 72.9% of total average earning assets at March 31,
2004 and 2003, respectively.
- 10-
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, 2004 March 31, 2003
-------------- --------------
Average Income/ Yield Average Income/ Yield
(Dollars in thousands) Balance Expense(1) Rate Balance Expense(1) Rate
- -----------------------------------------------------------------------------------------------------------------------------
Earning Assets
Investment securities $151,381 $1,427 3.77% $125,175 $1,362 4.35%
Loans (2) (3) 485,430 7,157 5.90% 447,251 7,248 6.48%
Interest bearing deposits 9,375 21 0.88% 18,761 53 1.13%
Federal funds sold 13,743 34 0.98% 21,700 65 1.21%
-------- ------- ----- ------- ------- -----
Total earning assets 659,929 8,639 5.24% 612,887 8,728 5.70%
------- -------
Noninterest earning assets 43,431 38,565
-------- -------
Total Assets 703,360 651,452
======== =======
Interest bearing liabilities
Interest bearing deposits 507,600 2,027 1.60% 475,977 2,546 2.14%
Short term borrowing 22,445 38 0.67% 21,180 48 0.89%
Long term debt 5,000 63 5.03% 5,000 62 4.97%
-------- ------- ----- ------- ------- -----
Total interest bearing liabilities 535,045 2,128 1.59% 502,157 2,656 2.12%
------- -------
Noninterest bearing liabilities 83,518 70,307
Stockholders' equity 84,797 78,988
-------- -------
Total liabilities and stockholders' equity $703,360 $651,452
======== ========
Net interest spread $6,511 3.65% $6,072 3.58%
======= =======
Net interest margin 3.95% 3.96%
(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 35% 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.
Non-interest Income
Total non-interest income for the three-month period ended March 31, 2004
decreased $61,000 when compared to the same period in 2003. The decline is
primarily attributable to gains on sales of securities that occurred in 2003.
Excluding these gains, noninterest income increased $199,000 for the first
quarter of 2004 when compared to the same period last year. The increase is
primarily the result of increased service charges on deposit accounts of
$35,000, increased Insurance Agency commissions of $99,000 and other income
associated with the Insurance Agency of $68,000.
Non-interest Expense
Total non-interest expense increased $391,000 for the three-month period ended
March 31, 2004 from the comparable period in 2003. The increase is attributable
to increases in salaries and benefits of $68,000, premises and equipment expense
of $96,000, increased data processing costs of $69,000 and other operating
expense increases of $158,000. During the first quarter of 2004, the Company
moved its operations department and consolidated its accounting departments,
which resulted in some duplicate costs for occupancy which are nonrecurring.
Other operating expense increases relate to increased advertising costs and
costs associated with new products and services, as well as a general increase
in overhead resulting from growth of the Company.
Income Taxes
The effective tax rates for the three-month periods ended March 31, 2004 and
2003 were 36.8% and 37.0%, respectively. Management is not aware of any
significant changes in applicable tax law or to the Company's tax structure that
are likely to materially impact the Company's effective tax rate.
Analysis of Financial Condition
Loans
Loans, net of unearned income, totaled $492,796,000 at March 31, 2004, an
increase of $17,841,000 or 3.8% since December 31, 2003. The increase is
primarily attributable to an increase in loans secured by real estate. On
average, loans net of unearned income, increased $38,179,000 or 8.5%, totaling
$485,430,000 for the three-month period ended March 31, 2004, compared to
$447,251,000 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. Please refer to the discussion under
the caption, "Critical Accounting Policies" above for an overview of the
underlying methodology Management employs on a
-11-
quarterly basis to maintain the allowance.
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. The provisions for credit losses for the three-month periods
ended March 31, 2004 and 2003 were $105,000 and $90,000, respectively. The
Company had net charge-offs of $225,000 for the first quarter of 2004, compared
to net charge-offs of $61,000 for the same period last year. An increase in
nonperforming loans and loan delinquencies was the primary reason for the
increase in the provision for loan losses for the quarter ended March 31, 2004
when compared to the same period last year. Nonaccrual loans increased $436,000
since December 31, 2003, totaling $1,438,000 as of March 31, 2004. The increase
relates to the addition of several real estate secured loans for which inherent
losses have been determined at March 31, 2004. 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, 2004 when compared
to March 31, 2003. The majority of this growth has been in real estate secured
loans, which present lower overall risk to the Company and, therefore, require a
smaller allowance. Expressed as a percentage of average loans, the allowances
totaled .81% and .93% as of March 31, 2004 and 2003, 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, 2004.
The following table presents a summary of the activity in the allowance for
credit losses:
Three Months Ended March 31,
(Dollars in thousands) 2004 2003
- -------------------------------------------------------------------------------
Allowance balance - beginning of period $4,060 $ 4,117
Charge-offs:
Commercial and other 271 2
Real estate 0 45
Consumer 14 46
------ --------
Totals 285 93
------ --------
Recoveries:
Commercial 9 1
Real estate 19 7
Consumer 32 24
------ --------
Totals 60 32
------ --------
Net charge-offs: 225 61
Provision for credit losses 105 90
------ --------
Allowance balance - end of period $3,940 $ 4,146
====== ========
Average loans outstanding during period $485,430 $447,251
======== ========
Net charge-offs (annualized) as a percentage of
average loans outstanding during period .19% .05%
====== ========
Allowance for credit losses at period end as a
percentage of average loans .81% 93%
====== ========
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: 2004 2003
------------ ------------
Nonaccrual loans 1,438 1,002
Other real estate owned 60 -
--------- --------
Total nonperforming assets 1,498 1,002
Past due loans 1,047 1,128
--------- --------
Total nonperforming and past due loans $2,545 $2,130
========= ========
-12-
Investment Securities
Investment securities declined $22,858,000 during the first quarter of 2004 when
compared to December 31, 2003. The overall yield on investment securities also
declined as a result of the reinvestment of the proceeds from maturing and
called bonds in securities with much lower yields. The average balance of
investment securities was $151,381,000 for the first quarter of 2004, compared
to $125,175,000 for the same period in 2003. The tax equivalent yields on
investment securities were 3.77% and 4.35% for the three months ended March 31,
2004 and 2003, respectively.
Deposits
Total deposits at March 31, 2004 were $589,182,000, compared to $592,409,000 at
December 31, 2003. Certificates of deposit of $100,000 or more increased
$17,069,000 during the three-month period ended March 31, 2004 when compared to
December 31, 2003. The change was primarily a result of increased balances of a
municipal depositor. Other time and savings accounts declined $8,068,000 during
the three-month period ended March 31, 2004 when compared to December 31, 2003.
Borrowed Funds
Short-term borrowings at March 31, 2004 and 2003 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, 2004
and 2003. 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. Management knows of no
trends or demands, commitments, events or uncertainties that are likely to
materially affect the Company's ability to maintain liquidity at satisfactory
levels.
Total stockholders' equity was $85,585,000 at March 31, 2004, a 2.5% increase
over December 31, 2003. Accumulated other comprehensive income, which consists
solely of net unrealized gains on investment securities available for sale,
increased $327,000 during the three-month period ended March 31, 2004, resulting
in an accumulated other comprehensive gain of $637,000 at March 31, 2004.
Bank regulatory agencies 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, 2004 for the Company with the minimum requirements
is presented below.
Minimum
Actual Requirements
------ ------------
Tier 1 risk-based capital 15.21% 4.00%
Total risk-based capital 16.01% 8.00%
Leverage ratio 11.08% 4.00%
-13-
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The Company's principal market risk exposure is to interest rates. The Company
utilizes a simulation model to quantify the effect that hypothetical plus or
minus 200 and 100 basis point changes 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, 2004, the model produced the
following sensitivity profile for net interest income and the fair value
capital:
Immediate Change in Rates
+200 +100 -100 -200 Policy
Basis Points Basis Points Basis Points Basis Points Limit
--------------------------------------------------------------------
% Change in Net Interest Income 15.19% 5.62% (7.86)% (15.54)% + 25%
-
% Change in Fair Value of Capital 5.29% 3.36% (6.33)% (10.35)% + 15%
-
Further information regarding market risk and the Company's objectives and
strategies in managing market risk is set forth in the Company's Annual Report
on Form 10-K for the year ended December 31, 2003, under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Market Risk Management".
Item 4. Controls and Procedures.
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's reports filed
under the Securities Exchange Act of 1934 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 the Company's management, including the Chief Executive Officer
("CEO") and the Principal Accounting Officer ("PAO"), 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, control 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 as of March 31,
2004 was carried out under the supervision and with the participation of the
Company's management, including the CEO and the PAO. Based on that evaluation,
the Company's management, including the CEO and the PAO, has concluded that the
Company's disclosure controls and procedures are effective.
During the first quarter of 2004, there was no change in the Company's internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits
3.1 Shore Bancshares, Inc. Amended and Restated Articles of Incorporation
(incorporated by reference to Exhibit 3.1 on Form 8-K filed by Shore
Bancshares, Inc. on December 14, 2000).
3.2 Shore Bancshares, Inc. Amended and Restated By-Laws (incorporated by
reference to Exhibit 3.2 on Form 8-K filed by Shore Bancshares, Inc.
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
Shore Bancshares, Inc. on July 31, 2000).
-14-
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 Shore
Bancshares, Inc. 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).
10.4 Form of Supplemental Retirement Plan Agreement and Life Insurance
Endorsement Method Split Dollar Plan Agreement between The Centreville
National Bank of Maryland and Daniel T. Cannon (incorporated by
reference to Exhibit 10.4 of the Company's Quarterly Report on Form
10-Q for the period ended June 30, 2003).
10.5 Form of Life Insurance Endorsement Method Split Dollar Plan Agreement
between The Centreville National Bank of Maryland and Daniel T. Cannon
(incorporated by reference to Exhibit 10.5 of the Company's Quarterly
Report on Form 10-Q for the period ended June 30, 2003)
31.1 Certifications of the CEO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith).
31.2 Certifications of the PAO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith).
32.1 Certifications of the CEO and the PAO pursuant to 18 U.S.C.ss.1350
(furnished herewith)
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 1998 Stock Option Plan (incorporated by reference from the Shore
Bancshares, Inc. 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 Shore Bancshares, Inc. Registration Statement on
Form S-8 filed on May 4, 2001 (Registration No. 333-60214)).
b) Reports on Form 8-K.
On January 15, 2004, the Company filed a Current Report on Form 8-K in
which it announced in Item 5 that it had amended its definitive merger
agreement with Midstate Bancorp, Inc.
On February 19, 2004, the Company filed a Current Report on Form 8-K
in which it furnished under Item 12 the results of operations for the
year ended December 31, 2003.
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 7, 2004 By: /s/ W. Moorhead Vermilye
--------------------------------------------
W. Moorhead Vermilye
President and Chief Executive Officer
Date: May 7, 2004 By: /s/ Susan E. Leaverton
-----------------------------------------
Susan E. Leaverton, CPA
Treasurer and Principal Accounting Officer
-15-
EXHIBIT INDEX
Exhibit No. Description
3.1 Shore Bancshares, Inc. Amended and Restated Articles of
Incorporation (incorporated by reference to Exhibit 3.1 on Form
8-K filed by Shore Bancshares, Inc. on December 14, 2000).
3.2 Shore Bancshares, Inc. Amended and Restated By-Laws (incorporated
by reference to Exhibit 3.2 on Form 8-K filed by Shore
Bancshares, Inc. 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 Shore Bancshares, Inc. 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
Shore Bancshares, Inc. 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 10K for the year ended
December 31, 2002).
10.4 Form of Executive Supplemental Retirement Plan Agreement between
The Centreville National Bank of Maryland and Daniel T. Cannon
(incorporated by reference to Exhibit 10.4 of the Company's
Quarterly Report on Form 10-Q for the period ended June 30,
2003).
10.5 Form of Life Insurance Endorsement Method Split Dollar Plan
Agreement between The Centreville National Bank of Maryland and
Daniel T. Cannon (incorporated by reference to Exhibit 10.5 of
the Company's Quarterly Report on Form 10-Q for the period ended
June 30, 2003).
31.1 Certifications of the CEO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith).
31.2 Certifications of the PAO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith).
32.1 Certifications of the CEO and the PAO pursuant to 18
U.S.C.ss.1350 (furnished herewith)
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 1998 Stock Option Plan (incorporated by reference from the Shore
Bancshares, Inc. 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 Shore Bancshares, Inc. Registration
Statement on Form S-8 filed on May 4, 2001 (Registration No.
333-60214)).