SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
------------------------------
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 1998
COMMISSION FILE NUMBER 0-22345
------------------------------
SHORE BANCSHARES, INC.
109 North Commerce Street
Post Office Box 400
Centreville, Maryland 21617-0400
Telephone: (410) 758-1600
IRS Employer Identification Number: 52-1974638
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act: Common Stock, Par Value
$0.01
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 the number of shares of outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
As of May 8, 1998, there were 2,014,848 shares of
Common Stock $0.01 Par Value outstanding.
This is the only class of outstanding shares.
<PAGE>
SHORE BANCSHARES, INC.
FORM 10-Q
INDEX
PART I FINANCIAL INFORMATION
- -----------------------------
Item 1. Financial Statements (Unaudited)
Balance Sheets --March 31, 1998 and December 31, 1997
Statements of Income -- Three months ended March 31, 1998 and 1997
Statements of Cash Flows -- Three months ended March 31, 1998 and 1997
and the twelve months ended December 31, 1997
Notes to Financial Statements - March 31, 1998
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
- ----------
<PAGE>
PART I
FINANCIAL INFORMATION
<PAGE>
ITEM 1. FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
SHORE BANCSHARES, INC.
March 31, December 31,
Dollars in thousands 1998 1997
(Unaudited)
----------- -----------
ASSETS
Cash and due from banks $ 5,538 $ 5,092
Federal funds sold 12,155 3,504
Securities (Note 2)
Held to Maturity 33,017 39,298
Available for Sale 9,351 9,444
Loans, less allowance for credit losses
(Note 3 and 4) 105,165 107,764
Premises and fixed assets 3,277 3,259
Investments in unconsolidated subsidiaries 1,188 1,187
Accrued interest receivable 776 1,476
Goodwill 2,051 2,088
Net deferred taxes and other assets 2,492 2,003
---------- ----------
TOTAL ASSETS $ 175,010 $ 175,115
========== ==========
LIABILITIES
Deposits
Non-interest bearing demand $ 15,854 $ 17,727
Interest bearing transaction 18,186 19,176
Savings and money market 38,341 37,575
Time, $100,000 or more 13,845 13,474
Other time 59,097 57,861
---------- ----------
Total deposits 145,323 145,813
---------- ----------
Long term debt (Note 5) 5,000 5,000
Accrued interest payable 197 189
Other liabilities 751 598
---------- ----------
5,948 5,787
---------- ----------
Total liabilities 151,271 151,600
---------- ----------
COMMITMENTS
EQUITY CAPITAL
Common stock, par value $.01; authorized
10,000,000 shares, issued and outstanding
2,014,848 shares 20 10
Surplus 10,064 10,064
Retained earnings 13,690 13,480
Accumulated other comprehensive income (35) (39)
---------- ----------
Total stockholders' equity 23,739 23,515
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 175,010 $ 175,115
========== ==========
See Notes to Financial Statements
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
SHORE BANCSHARES, INC.
(UNAUDITED) Quarter Quarter
Dollars in thousands except per share data Ended Ended
March 31, March 31,
1998 1997
---------------------------
INTEREST INCOME
Interest and fee income on loans $ 2,438 $ 1,961
Interest and dividends on securities
U.S. Treasury and U.S. Govt agencies 520 506
States and political subdivisions
Taxable securities 10 10
Tax-exempt securities 122 107
Other securities (debt and equity) 32 11
Interest on federal funds sold 94 91
---------------------------
Total interest income 3,216 2,686
---------------------------
INTEREST EXPENSE
Interest on certificates of deposit
of $100,000 or more 185 210
Interest on other deposits 1,182 937
Interest on long term debt 71 -
---------------------------
Total interest expense 1,438 1,147
---------------------------
NET INTEREST INCOME 1,778 1,539
Provision for credit losses - -
---------------------------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 1,778 1,539
---------------------------
NONINTEREST INCOME
Service charges on deposit accounts 159 161
Other noninterest income 49 28
Gains (losses) on securities - 4
---------------------------
Total noninterest income 208 193
---------------------------
NONINTEREST EXPENSE
Salaries and employee benefits 592 512
Expenses of premises and fixed assets 172 151
Other noninterest expense 509 386
---------------------------
Total noninterest expense 1,273 1,049
---------------------------
INCOME BEFORE TAXES 713 683
Applicable income taxes 251 241
---------------------------
NET INCOME $ 462 $ 442
===========================
Net Income Per Share $ 0.23 $ 0.22
Number of Shares Outstanding 2,014,848 2,014,848
See Notes to the Financial Statements
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
SHORE BANCSHARES, INC. Accumulated
(Unaudited) Other
Common Retained Comprehensive
Dollars in thousands Stock Surplus Earnings Income Total
--------- -------- -------- ------------- ----------
<S><C>
Balance at January 1, 1998 $10 $ 10,064 $13,480 ($39) $ 23,515
Comprehensive income:
Net income 462 462
Other comprehensive income, net of tax:
Unrealized gain on available-for-sale
securities, net of reclassification adjustment 4 4
--------
Other comprehensive income 4
--------
Comprehensive income 466
Two-for-one stock split effected in the
form of a 100% stock dividend 10 (10) 0
Cash dividends declared ($.12 per
common share)* (242) (242)
-------- --------- -------- -------------- -----------
Balance at March 31, 1998 20 10,064 13,690 (35) 23,739
======== ========= ======== ============== ===========
</TABLE>
*Restated for two-for-one stock split effected in the form of a 100% stock
dividend
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOW
SHORE BANCSHARES, INC.
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Year Three Months
Ended Ended Ended
March 31, December 31, March 31,
1998 1997 1997
------------------------------------------
<S><C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 462 $ 2,370 $ 442
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation and amortization 60 424 50
Equity in net earnings of unconsolidated subsidiaries - (73) -
Provision for credit losses, net (13) (115) (10)
Deferred income tax benefits 58 265 -
Net (gains) losses on disposal of assets - 40 (4)
Changes in assets and liabilities:
(Increase) decrease in accrued interest receivable 700 10 142
(Increase) decrease in other assets (576) (1,346) (624)
Increase (decrease) in interest payable 8 (118) (1)
Increase (decrease) in other liabilities 153 (89) 203
-----------------------------------------
Net cash provided by operating activities 852 1,368 198
-----------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of held-to-maturity securities 12,405 16,221 3,054
Proceeds from maturities of available-for-sale securities 42 1,081 1,500
Proceeds from sale of available-for-sale securities - 3,373 -
Purchases of held-to-maturity securities (5,981) (22,899) (2,000)
Purchases of available-for-securities - (1,693) (5,601)
Net (increase) decrease in loans 2,612 46 549
Purchase of premises and equipment (101) (1,276) (193)
Proceeds from sale of premises and equipment - - -
Aquisition, net of cash aquired - (2,799) -
-----------------------------------------
Net cash provided by (used in) investing activities 8,977 (7,946) (2,691)
-----------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in demand, interest-bearing
transaction, and savings deposits (2,097) 6,923 1,700
Increase (decrease) in time deposits 1,607 (6,034) (974)
Proceeds from long-term debt - 5,000
Cash dividends paid (242) (977) (232)
-----------------------------------------
Net cash provided by (used in) financing activities (732) 4,912 494
-----------------------------------------
Net increase (decrease) in cash and
cash equivalents 9,097 (1,667) (1,999)
Cash and cash equivalents, beginning 8,596 10,263 10,263
-----------------------------------------
Cash and cash equivalents, ending $ 17,693 $ 8,596 $ 8,264
=========================================
Supplementary cash flow information:
Interest paid $ 1,360 $ 5,417 $ 1,148
Income taxes paid $ 369 $ 1,120 $ 15
All dollar amounts in thousands
<PAGE>
Note 1 - Financial Information
The unaudited interim consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10Q. In the opinion of management,
all necessary adjustments have been made for a fair presentation of financial
position and results of operations for the periods presented. Operating results
for the three month period ended March 31, 1997 are not necessarily indicative
of the results that may be expected for the year ended December 31, 1998. For
further information, refer to the audited consolidated financial statements and
footnotes included in the 1997 Annual Report to Shareholders and Form 10.
New Accounting Standard
During the first quarter 1998, Shore Bancshares, Inc. adopted FASB Statement no.
130 REPORTING COMPREHENSIVE INCOME. Statement no. 130 requires the reporting of
comprehensive income in addition to net income from operations. Comprehensive
income discloses certain financial information that historically has not been
recognized in the calculation of net income.
The Company holds securities classified as available-for-sale, which have
unrealized gain of $6 thousand before tax during the first quarter of 1998. The
after tax gain of $4 thousand is reflected in the CONSOLIDATED STATEMENT OF
SHAREHOLDERS' EQUITY.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SECURITIES
(UNAUDITED)
</TABLE>
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
-------------------------------------------- --------------------------------------------
Held-to-Maturity Available-for-Sale Held-to-Maturity Available-for-Sale
Amortized Fair Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value Cost Value
------------------------------------------ ----------------------------------------------
<S><C>
U.S. Treasury securities $ 6,971 $ 7,019 $ 6,966 $ 7,014
U.S. Government agency and
corporation obligations issued by
U.S. Government sponsored $ 22,153 $ 22,148 $ 29,064 $ 29,086 100 100
agencies
Securities issued by states and
political subdivisions in the U.S.
a.General obligations 9,494 9,633 9,221 9,378
b.Revenue obligations 1,348 1,361 989 1,007
Mortgage-backed securities 22 25 323 333 24 27 365 374
Equity Securities
a. Investments in Mutual Funds 1,048 931 1,010 888
b. Other equity securites with
readily determinable fair values
c. All other equity securities 1,068 1,068 1,068 1,068
------------------------------------------ ----------------------------------------------
TOTAL SECURITIES $ 33,017 $ 33,167 $ 9,410 $ 9,351 $ 39,298 $ 39,498 $ 9,509 $ 9,444
========================================== ==============================================
PLEDGED SECURITIES $14,406 $17,338
========= ==========
</TABLE>
All dollar amounts in thousands
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE - 3 LOANS AND LEASE FINANCING RECEIVABLES
(UNAUDITED)
March 31, December 31
1998 1997
---------- -----------
Loans secured by real estate
a. Construction and land development $ 3,284 $ 2,866
b. Secured by farmland (including farm
residential and other improvements) 4,235 4,282
c. Secured by 1-4 family residential properties
1. Revolving, open end loans 2,028 1,703
2. All others
(a) Secured by first liens 65,456 68,772
(b) Secured by junior liens 3,482 3,855
d. Secured by multi-family (5 or more)
residential properties
e. Secured by nonfarm nonresidential
properties 13,650 12,871
Loans to finance agricultural production and
other loans to farmers 1,816 1,322
Commercial and industrial loans 6,108 7,027
Loans to individuals for household, family,
and other personal expenditures (includes
purchased paper)
a. Credit card and related plans 91 81
b. Other 6,498 6,500
Obligations (other than securities) of states and
political subdivisions in the U. S. - 13
Other loans
a. Loans for purchasing or carrying securities
(secured and unsecured)
b. All other loans 36 42
Less any unearned income on loans 128 166
--------- ---------
Total loans and leases, net of unearned income 106,556 109,168
Less allowance for loan and lease losses 1,391 1,404
--------- ---------
Total loans and leases, net of unearned income
and allowance for loan and lease losses $ 105,165 $ 107,764
========= =========
All dollar amounts in thousands
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE - 4 CHARGE OFFS AND RECOVERIES AND CHANGE IN
ALLOWANCE FOR LOAN AND LEASE LOSSES
(UNAUDITED)
I. CHARGE-OFFS AND RECOVERIES ON LOANS AND LEASES
March 31, 1998 December 31, 1997
Charge-offs Recoveries Charge-offs Recoveries
------------------------- ------------------------
1. Real estate loans $ - $ - $ 22 $ -
2. Installment loans 35 8 99 40
3. Credit cards and
related plans 4
4. Commercial (time and
demand) and all other
loans - 18 37 4
------------------------- -------------------------
6. Total $ 39 $ 26 $ 158 $ 44
========================= =========================
II. CHANGES IN ALLOWANCE FOR LOAN AND LEASE LOSSES
1. Balance at end of previous period $ 1,404 $ 1,503
2. Recoveries 26 44
3. Charge-offs (39) (158)
4. Provision for loan and lease losses - -
5. Allowance aquired - 15
---------- ---------
6. Balance at end of period $ 1,391 $ 1,404
========== =========
7. Net charge-offs $ 13 $ 114
8. Average daily loan balance 108,539 103,742
9. Ratio-net of charge offs to
average loans outstanding 0.01% 0.11%
All dollar amounts in thousands
<PAGE>
Note 5 - Other Borrowed Funds
As of September 30, 1997, the Bank had received a convertible advance
from the Federal Home Loan Bank in the amount of $5,000,000 at an interest rate
of 5.66% which is due September 24, 2002. The Bank has pledged mortgage loans as
collateral on this advance.
<PAGE>
AVERAGE BALANCES, YIELDS AND RATES
<TABLE>
<CAPTION>
YTD 3/31/98 YTD 3/31/97
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
<S><C>
ASSETS
Interest Earning assets:
Money market investments:
Federal funds sold 6,575,826 93,652 5.78% 6,881,660 91,422 5.39%
Investment Securities:
U.S. Treasury securities
and obligations of U.S.
government agencies 32,437,402 520,199 6.50% 32,139,550 505,681 6.38%
Obligations of States and
political subdivisions 10,008,958 184,224 7.46% 8,525,608 162,145 7.71%
Taxable Municipals 512,815 10,121 8.00% 512,815 10,121 8.00%
All other investment securities 1,710,819 31,940 7.58% 1,487,504 10,632 2.90%
Federal Reserve Bank stock 302,250 - 0.00% 302,250 - 0.00%
---------------------------------- -----------------------------------
Total investment securities 44,972,244 746,501 6.73% 42,967,727 688,579 6.50%
Loans - net of unearned income
Commercial loans 9,144,563 221,326 9.82% 8,910,484 214,045 9.74%
Installment loans 5,508,107 137,993 10.16% 5,247,975 130,403 10.08%
Mortgage loans 93,886,763 2,059,711 8.90% 74,413,812 1,597,419 8.71%
---------------------------------- -----------------------------------
Total loans 108,539,433 2,419,030 9.04% 88,572,271 1,941,867 8.89%
---------------------------------- -----------------------------------
TOTAL INTEREST EARNING ASSETS 160,087,503 3,259,166 8.26% 138,421,658 2,721,868 7.97%
Cash and due from banks 4,341,238 3,678,594
Other assets 9,815,479 6,029,266
Allowance for loan and lease losses (1,403,934) (1,496,608)
---------------------------------- -----------------------------------
TOTAL ASSETS 172,840,286 146,632,910
================================== ===================================
LIABILITIES
Interest-bearing liabilities
Other Borrowed Funds 5,007,500 70,860 5.74% - -
Super NOW accounts 17,003,245 118,271 2.82% 16,209,094 120,818 3.02%
Money market deposit accounts 19,805,752 164,436 3.37% 20,240,182 166,261 3.33%
Time, $100,000 or more 12,109,406 160,870 5.39% 14,828,444 193,549 5.29%
Other time deposits 44,839,794 594,067 5.37% 30,764,822 393,478 5.19%
IRA deposits 15,705,086 197,106 5.09% 14,273,369 177,979 5.06%
Savings deposits 17,449,893 133,211 3.10% 12,147,103 94,684 3.16%
---------------------------------- -----------------------------------
TOTAL INTEREST-BEARING LIABILITIES 131,920,676 1,438,821 4.42% 108,463,014 1,146,769 4.29%
Demand deposits 16,210,359 15,127,398
Other liabilities 1,164,231 740,277
---------------------------------- -----------------------------------
Total liabilities 149,295,265 124,330,689
Stockholders' equity 23,545,020 22,302,221
---------------------------------- -----------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY 172,840,286 146,632,910
================================== ===================================
Net interest income & interest rate spread 1,820,345 3.83% 1,575,099 3.69%
Net interest income as a % of earning assets 4.45% 4.45%
================================== ===================================
</TABLE>
1. All amounts are reported on a tax equivalent basis computed using the
statutory federal income tax rate of 34%, exclusive of the alternative
minimum tax rate and non deductible interest expense.
2. Loan fee income is included in interest income for each loan catagory and
yields are stated to include all.
3. Balances of nonaccrual loans and related income have been included for
computational purposes.
<PAGE>
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion is designed to provide a better understanding of the
financial position of Shore Bancshares, Inc., and should be read in conjunction
with the December 31, 1997 audited consolidated financial statements and notes.
ORGANIZATIONAL BACKGROUND
On July 1, 1996, Shore Bancshares, Inc. (the Company) commenced
operations as the parent company of its sole subsidiary, The Centreville
National Bank of Maryland (the Bank) which has conducted the business of banking
since 1876. Since the Bank is the primary possession of the Company, the assets
and liabilities of the Company are made up almost entirely of the assets and
liabilities of the Bank. The same is true for the income and expense of the
Company. All data for the periods on and after July 1996 is presented in this
analysis in consolidated form and is compared to like data for the Bank for
prior years, restated to reflect the exchange of shares of Bank common stock for
Company shares.
Effective April 1, 1997, The Centreville National Bank of Maryland
completed its merger with Kent Savings and Loan Association, F.A. (Kent Savings)
of Chestertown, Maryland. The transaction was accounted for purchase and,
therefore, results of operations for Kent Savings subsequent to March 31, 1997
are included in the consolidated statements of income and cash flows from date
of acquisition.
RESULTS OF OPERATIONS
OVERVIEW
The Company reported $462 thousand in net income for the three months
ended March 31, 1997 or $.23 per share compared to the three months ended March
31, 1997 with net income of $442 thousand or $.22 per share. Net income in 1998
increased $20 thousand or 4.5% over the same period in 1997. The improvement was
attributable to the $ 239 thousand or 15.5% growth in net interest income, the
Company's major income component. March 31, 1998 net income includes net
interest earnings on assets acquired in the Kent Savings merger. The March 31,
1997 net interest income does not reflect the April 1, 1997 merger. Year to date
net income absorbed on going non-interest expense associated with the merger of
Kent Savings including goodwill amortization as well as increased depreciation
expense for the renovation of the Centreville office. Despite an increase in net
interest spread, net interest income as a percent of earning assets of 4.45%
remained unchanged as of March 31, 1998 compared to the same period in 1997,
which reflects a growth in assets at the same rate as growth in earnings.
NET INTEREST INCOME and NET INTEREST MARGIN
Net interest income is the principal source of earnings for a banking
company. It represents the difference between interest and fees earned on the
loan and investment portfolios and the interest paid on deposits. The quarter
ended March 31, 1998 has been characterized by
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<PAGE>
relatively stable interest rates at the Bank level subsequent to decreases in
loan and deposit rates recognized early in the quarter. As a result of balance
sheet growth resulting from the Kent purchase, the Bank's net interest income,
on a fully tax-equivalent basis, increased in the first three months of 1998
compared to the same period in 1997. Net interest income (on a tax equivalent
basis) for March 31, 1998 increased by $245 thousand or 15.6% compared to the
three months ended March 31, 1997.
Interest rate spread is the difference between the average yield on
interest earning assets and the average rate paid on interest bearing
liabilities (deposits). Interest rate spread for the three months ended March
31, 1998 and 1997 was 3.83%, and 3.69%, respectively. Interest rate spread in
1998 improved in the first quarter compared to the same period in 1997 resulting
from an increased yield on average earning assets of .29% and an increase in
yield of average interest bearing liabilities at a slower rate by .13%. A change
in the mix of the balance sheet accounted for the increase in interest rate
spread when comparing the first quarters of 1998 and 1997. A review of average
earning assets shows 2.4% increase in earnings on federal funds because of yield
increase but essentially no difference in average balance. The average balance
in municipal bonds increased $1,483 thousand which provide a higher tax
equivalent yield than U.S. Treasuries and government agency bonds which grew
only $298 thousand. Despite loan rate decreases early in 1998 loan yield has
grown in comparison to March 31, 1997. Average balances in each loan category
have also increased adding to total interest income. Deposits have seen a change
in mix as well. Other Time and IRA deposits average balances have increased.
These are more "costly" deposits and account for the increased deposit interest
expense. Despite lowering deposit rates early in 1998 the change in deposit mix
provided higher yields on deposits as of March 31, 1998 than they were the
previous year.
Interest rate spread has essentially remained the same comparing March
31, 1998 to a spread of 3.82% at December 31, 1997. Yield on average earning
assets have increased .09% primarily as a result of improved yield on
investments and fed funds. Deposit yields have also increased primarily as a
result in increased cost of funds for time deposits. The increased yield on
interest bearing liabilities was assisted by additional cost of borrowed funds
at a higher rate than other interest bearing liabilities.
No change in net interest margin was reflected comparing March 31, 1998
to March 31, 1997. Net interest margin is calculated as tax equivalent net
interest income divided by average earning assets and represents the net yield
on its earning assets. As of March 31, 1998 and 1997 the net interest margin was
4.45% reflecting a growth in earning assets at the same rate as the growth in
earnings. See the table 1 titled "Average Balances, Yields and Rates" for
additional information.
Management and the Board of Directors monitor interest rates
on a regular basis to assess the Company's competitive position and to maintain
a reasonable and profitable interest rate spread. The Company also considers the
maturity distribution of loans, investments, and deposits and its effect on net
interest income as interest rates rise and fall over time.
PROVISION and ALLOWANCE FOR CREDIT LOSSES
For the quarter ended March 31, 1998 and 1997, the Company recorded net
charge offs of $13 thousand and $11 thousand, respectively compared to net
charge offs of $114 thousand for
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<PAGE>
the year ended December 31, 1997. Internal loan review, in particular, has been
effective in identifying problem credits and in achieving timely recognition of
potential and actual losses within the loan portfolio. Improved overall credit
quality and increased collection efforts have also contributed to the immaterial
amount of net charge offs in the first quarters of 1998 and for the year ended
December 31, 1997.
Gross charge offs as of March 31, 1998 amounted to $39 thousand, $23
thousand for the same period in 1997 and $158 thousand for the year ended 1997,
the majority of which were installment loans. Efforts to collect charged off
loans continue and are evidenced by recoveries totaling $26 thousand in the
first quarter of 1998, $12 thousand for the same three months in 1997 and $44
thousand for the year ended December 31, 1997.
The provision for credit losses has followed the same general trend as
the amount of charge offs. No provision for credit losses was charged to expense
in 1997 nor to date in 1998. The allowance for credit losses is maintained at a
level believed adequate by management to absorb estimated probable credit
losses. Management's quarterly evaluation of the adequacy of the allowance is
based on analysis of the loan portfolio and its known and inherent risks,
assessment of current economic conditions, diversification and size of the
portfolio, adequacy of the collateral, past and anticipated loss experience and
the amount of non-performing loans. The allowance for credit losses has remained
relatively unchanged despite the increase in outstanding loan balances. The
allowance for credit losses of $1.4 million as of March 31, 1998 and December
31, 1997 represents 1.30% and 1.29%, respectively of gross loans. As of March
31, 1997, the $1.5 million allowance for credit losses reflected 1.69% of gross
loans. The decrease in percentage of allowance to outstanding loans, despite the
increasing outstanding gross loans, is justified by lower levels of past due and
classified loans. Analysis by loan review supports adequacy of the allowance.
The reduction in percentage of allowance to outstanding loans reflects
improvements in credit quality achieved through better credit underwriting and
more aggressive collection efforts. In management's opinion, the allowance for
credit losses is adequate as of March 31, 1998.
See Notes 3 and 4 in the Notes to Financial Statements.
NON-INTEREST INCOME AND EXPENSE
As of March 31, 1998 non-interest income reflects $15 thousand increase compared
to March 31, 1997 primarily resulting from a $6 thousand increase in check order
commissions and $6 thousand in ATM surcharges implemented in February 1998.
Non-interest expense as of March 31, 1998 increased $224 thousand or 21.3%
compared to the same period last year. A portion of the increase reflects $80
thousand in salaries and benefits costs associated with the addition of 6 full
time equivalent staff when comparing March 31, 1998 to March 31, 1997. Premise
and fixed asset expenses increased $21 thousand as of March 31, 1998 compared to
the same period in 1997 primarily as a result of overhead of the Kent Branch
acquired in the purchase of Kent Savings and Loan Association as well as the
increased cost of depreciation and facility costs for the renovated Commerce
Street office. The $123 thousand increase in other non-interest expense in the
first quarter of 1998 compared to the same period in 1997 includes the
amortization of intangibles which increased as goodwill from the merger is
amortized over 15 years. In the first
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<PAGE>
three months of 1998 costs have been added as the Company has invested in
additional marketing programs and staff training programs. Data processing costs
have also increased to as a result of the additional customers acquired in the
Kent Savings merger.
INVESTMENT SECURITIES
Investment securities classified as available-for-sale are held for an
indefinite period of time and may be sold in response to changing market and
interest rate conditions as part of the asset/liability management strategy.
Available-for-sale securities are carried at market value, with unrealized gains
and losses excluded from earnings and reported as a separate component of
stockholders' equity net of income taxes. Investment securities classified as
held-to-maturity are those that management has both the positive intent and
ability to hold to maturity, and are reported at amortized cost. The Company
does not currently follow a strategy of making securities purchases with a view
to near-term sales, and, therefore, does not own trading securities, nor are
derivatives used as investments. The Company manages the investment portfolios
within policies which seek to achieve desired levels of liquidity, manage
interest rate sensitivity risk, meet earnings objectives, and provide required
collateral support for deposit activities.
Total investment securities amounted to $42.4 million and $48.7 million
as of March 31 1998 and December 31, 1997, respectively. The net decreased level
of investments in securities resulted primarily from securities called in the
first quarter as a result of the bond market offering lower interest rates. The
funds were primarily reinvested in federal funds and continue to be reinvested
in federal funds and loans. Excluding the U.S. Government and U.S. Government
sponsored agencies, the Company had no concentrations of investment securities
from any single issuers that exceeded 10% of stockholders' equity.
See Note 2 in the Notes to Financial Statements.
LOAN PORTFOLIO
The Bank is actively engaged in originating loans to customers in Queen
Anne's, Caroline, Kent and Talbot Counties. The Company has policies and
procedures designed to mitigate credit risk and to maintain the quality of the
loan portfolio. These policies include underwriting standards for new credits as
well as the continuous monitoring and reporting of asset quality and the
adequacy of the allowance for credit losses. These policies, coupled with
continuous training efforts, have provided effective checks and balances for the
risk associated with the lending process. Lending authority is based on the
level of risk, size of the loan and the experience of the lending officer. Total
loans as of March 31, 1998 have decreased $2.6 million dollars since December
31, 1997. The decrease is attributed to loans refinancing to the secondary
market at the lower rates offered by the market as well as pay downs of a number
of lines of credit. Note 3 "Summary of Loan Portfolio" presents the composition
of the Company's loan portfolio by significant concentration. The Company had no
loan concentrations exceeding 10% of total loans which are not otherwise
disclosed.
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<PAGE>
The Company's policy is to make the majority of its loan commitments in
the market area it serves. This tends to reduce risk because management is
familiar with the credit histories of loan applicants and has an in-depth
knowledge of the risk to which a given credit is subject. The Company had no
foreign loans in its portfolio as of March 31, 1998.
It is the policy of the Bank to place a loan in non-accrual status
whenever there is substantial doubt about the ability of a borrower to pay
principal or interest on any outstanding credit. Management considers such
factors as payment history, the nature of the collateral securing the loan and
the overall economic situation of the borrower when making a non-accrual
decision. Non-accrual loans are closely monitored by management . A non-accruing
loan is restored to current status when the prospects of future contractual
payments are no longer in doubt. At March 31, 1998 and December 31, 1997, $136
thousand and $199 thousand, respectively, of non-accrual loans were secured by
collateral with an estimated value of $986 thousand as of March 31, 1998 and
$1.1 million as of December 31, 1997. At March 31, 1998, the Bank had one
troubled debt restructuring of $292 and $4.09 million in loans on the watch list
for which payments were current, but the borrowers have the potential for
experiencing financial difficulties. These loans are subject to on going
management attention and their classifications are reviewed regularly.
DEPOSITS
Deposit liabilities reflected .03% decrease in the first three months
of 1998 compared to December 31, 1997. Savings, money market and time account
deposits were the main source of deposit growth and were offset by decreases in
non-interest bearing demand deposits and interest bearing transaction accounts.
The Company generally experiences deposit run off in the first quarter of the
year, therefore, the decreases noted are not unusual. The Company continues to
experience strong competition from other commercial banks, credit unions, the
stock market and mutual funds. The Company has no foreign banking offices.
OTHER BORROWED FUNDS
Other borrowed funds consist of an advance from the Federal Home Loan
Bank of $5,000,000 at the end of the third quarter of 1997. These funds were
utilized for securities purchases. See Note 5 in the Notes to Financial
Statements.
LIQUIDITY MANAGEMENT
Liquidity describes the ability of Shore Bancshares, Inc. and its
subsidiary, The Centreville National Bank of Maryland to meet financial
obligations that arise out of the ordinary course of business. Liquidity is
primarily needed to meet borrowing and deposit withdrawal requirements of the
customers of the Bank and to fund current and planned expenditures. The Company
maintains its asset liquidity position internally through short term
investments, the maturity distribution of the investment portfolio, loan
repayments and income from earning assets. A substantial portion of the
investment portfolio contains readily marketable securities that could be
converted to cash immediately. Refer to Note 2 in the Consolidated Financial
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<PAGE>
Statements for a table reflecting the Bank's security portfolio's estimated fair
value. On the liability side of the balance sheet, liquidity is affected by the
timing of maturing liabilities and the ability to generate new deposits or
borrowings as needed. Other sources, not currently in use, are available through
borrowings from the Federal Reserve Bank and from lines of credit approved at
correspondent banks. As discussed above, an additional source is the Federal
Home Loan Bank from which a $5,000,000 advance was outstanding at March 31,
1998. During the first quarter of 1998 calls of investment securities, decreases
in the loan portfolio and essentially no change in deposit liabilities have
provided for the Company's higher liquidity position. Management knows of no
trend or event which will have a material impact on the Bank's ability to
maintain liquidity at satisfactory levels.
MARKET RISK MANAGEMENT
Market risk is the risk of loss that arises from changes in interest
rates, foreign currency exchange prices, commodity prices, equity prices, and
other market changes that affect market sensitive financial instruments. The
Company's subsidiary's, The Centreville National Bank of Maryland, risk is
composed primarily of interest rate risk, which is the exposure of the Bank's
earnings and capital arising from future interest rate changes. This risk is a
normal part of the banking business because assets and liabilities do not
reprice at the same rate, nor do they move to the same degree as rates change.
In addition, the maturity distribution of the Bank's assets and liabilities do
not match for given periods of time. The Bank's Board of Directors has adopted
an Asset Liability Management Policy, which is administered by the Asset
Liability Committee of the Board of Directors. The Committee is responsible for
monitoring the Bank's interest rate sensitivity position and recommending
policies to the Board of Directors to limit exposure to interest rate risk while
maximizing net interest income.
The Bank uses earnings simulation modeling to measure the effect
specific rate changes would have on one year of net interest income. Key
assumptions include calls and maturities of investment securities, depositors'
rate sensitivity, maturity dates of fixed rate loans and investment securities
and repricing date of variable rate loans. As with any method of gauging risk,
there are inherent shortcomings and actual results may deviate significantly
from assumptions used in the model. Actual results will differ from simulated
results due to timing, magnitude and frequency of interest-rate changes as well
as changes in market conditions and management strategies. At December 31, 1997
the Bank's estimated earnings sensitivity profile reflected a modest sensitivity
to interest rate changes. Based on an assumed 100 basis point immediate change
in interest rates the Bank's net interest income would decrease by $142 thousand
if rates were to increase by that amount and would increase $199 thousand if
rates would decline a similar amount.
CAPITAL RESOURCES AND ADEQUACY
Total stockholders' equity increased $224 thousand or .9% in 1998 to
$23.7 million at the end of the March 31, 1998 from $23.5 million at December
31, 1997. Earnings of $462 thousand were the primary contributor to this
increase. The change in unrealized gain (loss) on
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<PAGE>
investments classified as available for sale accounted for a $4 thousand
increase and dividends paid reduced stockholders' equity $242 thousand.
One measure of capital adequacy is the leverage capital ratio which is
calculated by dividing average total assets for the most recent quarter into
Tier 1 capital. The regulatory minimum for this ratio is 4%. The leverage
capital ratio at the Company level at March 31, 1998 was 12.70% and at December
31, 1997 was 12.23%.
Another measure of capital adequacy is the risk based capital ratio or
the ratio of total capital to risk adjusted assets. Total capital is composed of
both core capital (Tier 1) and supplemental capital (Tier 2) including
adjustments for off balance sheet items such as letters of credit and taking
into account the different degrees of risk among various assets. Regulators
require a minimum total risk based capital ratio of 8%. The Company's ratio at
March 31, 1998 was 23.28% and at December 31, 1997 was 23.61%. According to FDIC
capital guidelines, the Company is considered to be "Well Capitalized."
Building and technological improvements begun in 1997 were completed in
1997. Renovations at the Commerce street location are significantly complete.
The remaining phase is the replacing the lighting and flooring will be completed
in 1998. Cost estimates have not yet been finalized.
On December 5, 1996 the Bank entered into an agreement to acquire Kent
Savings and Loan Association, F.A.(Kent Savings) of Chestertown, Maryland. The
merger transaction was accounted for as a purchase. Under the terms of the
agreement, the Bank paid approximately $5,100,000 for all of the outstanding
shares of Kent Savings resulting in $2.1 million in goodwill to be amortized
over 15 years. The Kent Savings shareholders met on March 17, 1997 and approved
the merger. The effective date of the merger was April 1, 1997.
On March 3, 1998 the Board of Directors also approved a 2 for 1 stock
split in the form of a 100% stock dividend to be distributed on March 31, 1998
to shareholders of record on March 10, 1998. Total capital did not change as a
result of the transaction, nor were the Company's capital ratios impacted in a
negative manner.
Management knows of no other trend or event which will have a material
impact on capital.
FUTURE TRENDS
The Year 2000 (Y2K) issue is a potential problem that is facing all
users of automated information systems and equipment. The concern is that many
computers and equipment are based on two digits for the year of the transaction
(for example "97") rather than a full four digits. These systems may not operate
effectively when the last two digits become "00", as occurs on January 1, 2000.
This could result in a systems failure or miscalculations, causing disruptions
in operations, the inability to process transactions or engage in similar normal
business activity. This is not just a banking problem, as corporations and
business around the world are similarly impacted.
To mitigate the effects of the Y2K issue, the Company's subsidiary, The
Centreville National Bank of Maryland, adopted a plan and formed an internal
task force to identify and assess impact of the Year 2000 issues, test the
systems, and determine and implement the needed changes. The Bank is
coordinating its efforts with other entities with which it interacts including
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<PAGE>
suppliers, customers, creditors, borrowers and financial service organizations.
The Bank's primary supplier of data processing services also has adopted a Year
2000 plan and timetable. Based on assessments made to date, the total cost of
the project is estimated to be approximately $170 thousand and may be as low as
$120 thousand, which is being funded through operating cash flows. The majority
of the cost is attributable to the purchase of equipment and software to replace
those systems which cannot be made Year 2000 compliant. The equipment and
software will be capitalized. Additional costs including staff time will be
expensed in the normal course of business and will not have a material impact on
the Company's results of operations, liquidity, capital resources or financial
condition.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the market risk of the Company's financial
instruments, see "Management Discussion and Analysis of Results of Operation and
Financial Condition - Market Risk Management." The Company's principal market
risk exposure is to interest rates.
Page 8
<PAGE>
PART II
OTHER INFORMATION
<PAGE>
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
EXHIBIT INDEX
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or
Succession
(2.1) Plan of Reorganization and Agreement to Merge dated March 15,
1996, is incorporated by reference from the Company's Form 10, filed with the
Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30,
1997 (Registration No. 0-22345).
(2.2) Merger Agreement dated December 5, 1996 among Kent Savings and
Loan Association, F.A., The Centreville National Bank of Maryland, and the
Company is incorporated by reference from the Company's Form 10, filed with the
Commission on April 3, 1997, and Form 10/A, filed with the Commission on May 30,
1997 (Registration No. 0-22345).
(3) Charter and Bylaws
(3.1) Articles of Incorporation of the Company are incorporated by
reference from the Company's Form 10, filed with the Commission on April 3,
1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration
No. 0-22345).
(3.2) Bylaws of the Company are incorporated by reference from the
Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A,
filed with the Commission on May 30, 1997 (Registration No. 0-22345)
(13) 1997 Annual Report filed herewith.
(16) Letter re: Change in Certifying Accountants is incorporated by
reference from the Company's Form 10, filed with the Commission on April 3,
1997, and Form 10/A, filed with the Commission on May 30, 1997 (Registration
No. 0-22345)
(21) List of Subsidiaries is incorporated by reference from the
Company's Form 10, filed with the Commission on April 3, 1997, and Form 10/A,
filed with the Commission on May 30, 1997 (Registration No. 0-22523)
(27) Financial Data Schedule is filed electronically herewith via
EDGAR.
(b) Reports on Form 8-K
None
(c) Exhibits to Item 601 to Regulation S-K
See the Exhibits described in Item 14(a)(3) above.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities and
Exchange Act of 1934, the Bank has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: March 12, 1998
SHORE BANCSHARES, INC.
/S/ DANIEL T. CANNON
________________________________
DANIEL T. CANNON
President
/S/ CAROL I. BROWNAWELL
________________________________
CAROL I. BROWNAWELL
Treasurer
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