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, 1999
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 7, 1999, there were 1,913,786 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, 1999 and December 31, 1998
Statements of Income -- Three months ended March 31,
1999 and 1998.
Statements of Cash Flows -- Three months ended March
31, 1999 and 1998 and the twelve months ended December
31, 1998.
Notes to Financial Statements - March 31, 1999
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
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
SHORE BANCSHARES, INC.
<TABLE>
<CAPTION>
March 31, December 31,
Dollars in thousands 1999 1998
(Unaudited)
----------- ------------
<S><C>
ASSETS
Cash and due from banks $ 4,475 $ 4,536
Federal funds sold 7,689 9,752
Securities
Held to Maturity, at amortized cost
(fair value of $20,639 and $24,253 respectively) 20,419 23,916
Available for Sale 31,242 23,203
Loans, less allowance for credit losses
($1,261 and $1,349 respectively) 111,951 109,848
Premises and fixed assets 3,314 3,369
Investments in unconsolidated subsidiaries 1,173 1,167
Accrued interest receivable 1,514 1,355
Goodwill 1,880 1,917
Other assets 2,086 1,991
--------- ---------
TOTAL ASSETS $ 185,743 $ 181,054
========= =========
LIABILITIES
Deposits
Non-interest bearing demand $ 19,552 $ 19,774
Interest bearing transaction 20,701 20,467
Savings and money market 37,771 35,322
Time, $100,000 or more 15,379 15,357
Other time 64,448 62,388
--------- ---------
Total deposits 157,851 153,308
--------- ---------
Long term debt 5,000 5,000
Accrued interest payable 208 208
Other liabilities 745 634
--------- ---------
5,953 5,842
--------- ---------
Total liabilities 163,804 159,150
--------- ---------
COMMITMENTS
EQUITY CAPITAL
Common stock, par value $.01; authorized
10,000,000 shares, issued and outstanding
1,913,516 shares 19 19
Surplus 10,064 10,064
Retained earnings 12,032 11,866
Accumulated other comprehensive income (176) (45)
--------- ---------
Total stockholders' equity 21,939 21,904
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 185,743 $ 181,054
========= =========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
SHORE BANCSHARES, INC.
<TABLE>
<CAPTION>
(UNAUDITED) Quarter Quarter
Dollars in thousands except per share data Ended Ended
March 31, March 31,
1999 1998
----------------------------------
<S><C>
INTEREST INCOME
Interest and fees on loans $ 2,323 $ 2,438
Interest and dividends on investment securities
Taxable securities 553 530
Tax-exempt securities 111 122
Other securities (debt and equity) 34 32
Interest on federal funds sold 114 94
----------------------------------
Total interest income 3,135 3,216
----------------------------------
INTEREST EXPENSE
Interest on certificates of deposit
of $100,000 or more 211 185
Interest on other deposits 1,219 1,182
Interest on long term debt 71 71
----------------------------------
Total interest expense 1,501 1,438
----------------------------------
NET INTEREST INCOME 1,634 1,778
Provision for credit losses - -
----------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 1,634 1,778
----------------------------------
NONINTEREST INCOME
Service charges on deposit accounts 190 159
Other noninterest income 66 49
Gains (losses) on securities 42 -
----------------------------------
Total noninterest income 298 208
----------------------------------
NONINTEREST EXPENSE
Salaries and employee benefits 656 592
Expenses of premises and fixed assets 139 172
Other noninterest expense 498 509
----------------------------------
Total noninterest expense 1,293 1,273
----------------------------------
INCOME BEFORE TAXES 639 713
Applicable income taxes 224 251
----------------------------------
NET INCOME $ 415 $ 462
==================================
Basic Earnings Per Common Share $ 0.22 $ 0.23
Diluted Earnings Per Common Share 0.22 0.23
Dividends Declared Per Common Share 0.13 0.12
</TABLE>
See Notes to the Financial Statements
<PAGE>
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
SHORE BANCSHARES, INC.
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Other
Common Retained Comprehensive
Dollars in thousands Stock Surplus Earnings Income Total
--------- --------- ----------- ------------- -----------
<S><C>
Balance at December 31, 1998 $ 19 $ 10,064 $11,866 ($45) 21,904
Comprehensive income:
Net income 415 415
Other comprehensive income, net of tax:
Unrealized loss on available-for-sale
securities, net of reclassification adjustment (131) (131)
-------------
Total comprehensive income 284
-------------
Cash dividends declared ($.13 per
common share) (249) (249)
--------- --------- ----------- ----------- -------------
Balance at March 31, 1999 19 10,064 12,032 (176) 21,939
========= ========= =========== =========== =============
</TABLE>
<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,
1999 1998 1998
------------------------------------------------------
<S><C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 415 $ 2,219 $ 462
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation and amortization 104 457 60
Equity in net earnings of unconsolidated subsidiaries - 20 -
Provision for credit losses, net (88) (55) (13)
Deferred income taxes (1) (31) 58
Net (gains) losses on sale of assets (42) (5) -
Changes in assets and liabilities:
(Increase) decrease in accrued interest receivable (159) 121 700
(Increase) decrease in other assets 25 47 (576)
Increase (decrease) in accrued interest payable - 19 8
Increase (decrease) in other liabilities 111 36 153
---------------------------------------------------
Net cash provided by operating activities 365 2,828 852
---------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of investment securities held to maturity 5,066 34,268 12,405
Proceeds from maturities of investment securities available for sale 3,023 2,651 42
Proceeds from sale of investment securities available-for-sale 2,032 - -
Purchases of held-to-maturity securities (1,563) (18,767) (5,981)
Purchases of available-for-securities (13,246) (16,499) -
Net (increase) decrease in loans (2,015) (2,029) 2,612
Purchase of premises and equipment (80) (429) (101)
---------------------------------------------------
Net cash provided by (used in) investing activities (6,783) (805) 8,977
---------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in demand, interest-bearing
transaction, and savings deposits 2,461 1,084 (2,097)
Increase (decrease) in time deposits 2,082 6,410 1,607
Common stock repurchased and retired - (1,012) -
Cash dividends paid (249) (2,812) (242)
---------------------------------------------------
Net cash provided by (used in) financing activities 4,294 3,670 (732)
---------------------------------------------------
Net increase (decrease) in cash and
cash equivalents (2,124) 5,693 9,097
Cash and cash equivalents, beginning 14,288 8,596 8,596
---------------------------------------------------
Cash and cash equivalents, ending $ 12,164 $ 14,289 $ 17,693
===================================================
Supplementary cash flow information:
Interest paid $ 1,431 $ 5,617 $ 1,360
Income taxes paid $ 185 $ 1,240 $ 369
</TABLE>
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, 1999 are not necessarily indicative of the results that
may be expected for the year ended December 31, 1999. For further
information, refer to the audited consolidated financial statements and
footnotes included in the 1998 Annual Report to Shareholders and Form 10
K.
<PAGE>
NOTE -2 Analysis of the Allowance for Credit Losses
(In Thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------------------------------------
<S><C>
BALANCE AT BEGINNING OF PERIOD $1,349 $1,404
CHARGE-OFFS:
Real Estate:
Construction and land development 0 0
Commercial 0 0
Residential 0 14
Commercial 61 0
Consumer installment 31 90
--------------------------------------
92 104
--------------------------------------
RECOVERIES:
Real Estate:
Construction and land development 0 0
Commercial 0 0
Residential 0 0
Commercial 0 26
Consumer installment 4 23
--------------------------------------
4 49
--------------------------------------
NET CHARGE-OFFS (RECOVERIES) 88 55
PROVISION FOR CREDIT LOSSES 0 0
ALLOWANCE ACQUIRED 0 0
--------------------------------------
BALANCE AT END OF PERIOD $1,261 $1,349
======================================
Average daily balance of loans $111,816 $108,180
Ratio of net charge-offs to average loans outstanding 0.08% 0.05%
</TABLE>
<PAGE>
Note 3 - 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.
Note 4 - Computation of Earnings Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS
No. 128, Earnings Per Share, which became effective for the Company for
reporting periods ending after December 31, 1998. Under the provisions
of SFAS No. 128, primary and fully-diluted earnings per share were
replaced with basic and diluted earnings per share in an effort to
simplify the computation of these measures and align them more closely
with the methodology used internationally. Basic earnings per share is
arrived at by dividing net income available to common stockholders by
the weighted-average number of common shares outstanding and does not
include the impact of any potentially dilutive common stock equivalents.
The diluted earnings per share calculation method is arrived at by
dividing net income by the weighted-average number of shares
outstanding, adjusted for the dilutive effect of outstanding stock
options and warrants. For purposes of comparability, the prior-period
earnings per share data has been restated
<TABLE>
<CAPTION>
3/31/99 3/31/98
------- -------
<S><C>
Basic:
Net income (applicable to common stock) 415,000 462,000
Average common shares outstanding 1,913,516 2,014,848
Basic net income per share .22 .23
Diluted:
Net income (applicable to common stock) 415,000 462,000
Average common shares outstanding 1,913,516 2,014,848
Dilutive effect of stock options 228 0
------------- -------------
Average common shares outstanding diluted 1,913,744 2,014,848
Diluted net income per share .22 .23
</TABLE>
<PAGE>
AVERAGE BALANCES, YIELDS AND RATES
<TABLE>
<CAPTION>
YTD 3/31/99 YTD 3/31/98
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
<S><C>
ASSETS
Interest Earning assets:
Money market investments:
Federal funds sold 9,612,944 114,089 4.81% 6,575,826 93,654 5.78%
Investment Securities:
U.S. Treasury securities
and obligations of U.S.
government agencies 36,785,798 552,806 6.09% 32,437,402 520,199 6.50%
Obligations of States and
political subdivisions 9,719,450 167,804 7.00% 10,008,958 184,224 7.46%
Taxable Municipals - - - 512,815 10,121 8.00%
All other investment securities 1,682,452 29,311 7.07% 1,710,819 31,957 7.58%
Federal Reserve Bank stock 302,250 4,534 6.08% 302,250 - 0.00%
-------------------------------------- ---------------------------------
Total investment securities 48,489,950 754,455 6.31% 44,972,244 746,501 6.73%
Loans - net of unearned income
Commercial loans 9,844,620 225,210 9.28% 9,144,563 221,326 9.82%
Installment loans 6,135,617 144,298 9.54% 5,508,107 137,993 10.16%
Mortgage loans 95,835,591 1,933,737 8.18% 93,886,763 2,059,711 8.90%
-------------------------------------- ---------------------------------
Total loans 111,815,828 2,303,245 8.35% 108,539,433 2,419,030 9.04%
-------------------------------------- ---------------------------------
TOTAL INTEREST EARNING ASSETS 169,918,722 3,171,789 7.57% 160,087,503 3,259,185 8.26%
Cash and due from banks 3,762,271 4,341,238
Other assets 9,684,405 9,815,479
Allowance for loan and lease losses (1,302,045) (1,403,934)
-------------------------------------- ---------------------------------
TOTAL ASSETS 182,063,353 172,840,286
====================================== =================================
LIABILITIES
Interest-bearing liabilities
Other Borrowed Funds 5,000,000 70,750 5.74% 5,007,500 70,860 5.74%
Super NOW accounts 19,044,017 126,285 2.69% 17,003,245 118,271 2.82%
Money market deposit accounts 19,360,385 153,095 3.21% 19,805,752 164,436 3.37%
Time, $100,000 or more 13,726,397 186,118 5.50% 12,109,406 160,870 5.39%
Other time deposits 49,839,353 653,460 5.32% 44,839,795 594,067 5.37%
IRA deposits 15,283,747 180,660 4.79% 15,705,086 197,106 5.09%
Savings deposits 17,703,085 130,967 3.00% 17,449,893 133,211 3.10%
-------------------------------------- ---------------------------------
TOTAL INTEREST BEARING LIABILITIES 139,956,984 1,501,335 4.35% 131,920,677 1,438,821 4.42%
Demand deposits 19,283,700 16,210,359
Other liabilities 963,728 1,164,230
-------------------------------------- ---------------------------------
Total liabilities 160,204,412 149,295,266
Stockholders' equity 21,858,941 23,545,020
-------------------------------------- ---------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY 182,063,353 172,840,286
====================================== =================================
Net interest income & interest rate spread 1,670,454 3.22% 1,820,345 3.83%
Net interest income as a % of earning assets 3.85% 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, 1998 audited consolidated financial statements and notes.
Portions of this Quarterly Report on Form 10Q contain
forward-looking statements (as defined in the Private Securities Litigation
Reform Act of 1995) with respect to the adequacy of the allowance for loan
losses, interest rate risk, realization of deferred taxes, liquidity levels, and
the Year 2000 issue, which, by their nature, are subject to significant
uncertainties which are described in further detail in Item 1 of the Company's
1998 Form 10-K, under the heading "Risk Factors." The Company believes that the
expectations reflected in such forward-looking statements are reasonable.
However, because these uncertainties and the assumptions on which statements in
this report are based, the actual future results may differ materially from
those indicated in this report.
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.
RESULTS OF OPERATIONS
OVERVIEW
The Company reported $415 thousand in net income for the three
months ended March 31, 1999 or $.22 diluted earnings per share compared to the
three months ended March 31, 1998 with net income of $462 thousand or $.23
diluted earnings per share. Net income for the first quarter 1999 reflects a
slight decline after absorbing the impact of declining interest rates. The
decline in rates in 1998 resulted in the refinancing of many loans as well as
the call of investment securities. The effects of those repriced loans and
investments continue to negatively impact net income. Net interest spread
declined from 3.83% as of March 31, 1998 to 3.22% as of March 31, 1999. The
Company experienced growth in total assets of 2.59% and in total deposits of
2.96% in the first quarter of 1999. Despite the average earning assets growth at
a rate of 6.14% net interest income declined $150 thousand or 8.23%. Earnings
reflect a shrinking net interest margin to 3.85% as of March 31, 1999 compared
to 4.45% for the same period in 1998.
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
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<PAGE>
and the interest paid on deposits and borrowings. Despite balance sheet growth
resulting primarily from loan and deposit growth, the Bank's net interest
income, on a fully tax-equivalent basis, decreased in the first three months of
1999 compared to the same period in 1998. Net interest income (on a tax
equivalent basis) for March 31, 1999 decreased $150 thousand or 8.23% compared
to the three months ended March 31, 1998. The table titled "Average Balances,
Yields and Rates" sets forth the major components of net interest income, on a
tax equivalent basis, for March 31, 1999 and 1998.
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, 1999 and
1998 was 3.22%, and 3.83%, respectively. Interest rate spread in 1999 decreased
at the end of the first quarter compared to the same period in 1998 resulting
from a decreased yield on average earning assets of 69 basis points and a
decrease in yield of average interest bearing liabilities by only 7 basis
points. This is also a decrease from the December 31, 1998 interest rate spread
of 3.65% . The balance sheet mix has not changed significantly since year end,
however, the yields on earning assets decreased at a faster rate than the
decrease in yields on deposits. As a result of a lower interest rate
environment, the Company experienced a large number of calls of investment
securities in 1998. These securities were replaced with lower yielding
investments and the full effects of this are evident in the 39 basis point
reduction in investment yield comparing March 31, 1999 to the same period in
1998. Despite some loan rate increases during 1998 and the first quarter of
1999, overall loan yield decreased 69 basis points in the first quarter compared
to March 31, 1998. Fourth quarter 1998 loan rate decreases and more
significantly, loans refinanced with the Company or other lenders are reflected
in decreased loan yield in the first quarter of 1999. However, the average
balances in each loan category have increased although the volume has not
improved enough to increase interest income when comparing the first quarters of
1999 and 1998. Deposits have grown in Time and Super NOW deposit average
balances. These are more costly deposits which account for increased deposit
interest expense. The effects of lowering deposit rates during 1998 and in the
first quarter of 1999 reflect a slightly lower yield on deposits of 4.35% as of
March 31, 1999 compared to the same period in the prior year.
Net interest margin decreased comparing March 31, 1999 to
March 31, 1998 from 4.45% to 3.85%. 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. The first quarter 1999 net interest margin
decrease is the result of repricing as previously discussed.
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, 1999 and 1998, the Company
recorded net charge offs of $88 thousand and $13 thousand, respectively compared
to net charge offs of $55 thousand for the year ended December 31, 1998.
Internal loan review, in particular, is effective in identifying
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<PAGE>
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 1999 and for the year ended December 31,1998.
Gross charge offs as of March 31, 1999 amounted to $92
thousand, $39 thousand for the same period in 1998 and $104 thousand for the
year ended 1998, the majority of which were commercial loans. Efforts to collect
charged off loans continue and are evidenced by recoveries totaling $4 thousand
in the first quarter of 1999, $26 thousand for the same three months in 1998 and
$49 thousand for the year ended December 31, 1998.
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 1998 nor to date in 1999. 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, the Year 2000 issue,
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 $1.3
million as of March 31, 1999 and December 31, 1998 represents 1.11% and 1.22%,
respectively, of gross loans. The decrease in percentage of allowance to
outstanding loans, despite the increase in gross loans, is justified by lower
levels of classified loans. Past due loan levels have decreased from year end
and they consist primarily of loans secured by real estate. Analysis by loan
review supports adequacy of the allowance. In management's opinion, the
allowance for credit losses is adequate as of March 31, 1999.
See Note 2 in the Notes to Financial Statements.
NONINTEREST INCOME AND EXPENSE
As of March 31, 1999, noninterest income reflects a $90
thousand increase compared to March 31, 1998 primarily resulting from a $42
thousand gain on the sale of available for sale investment securities.
Noninterest expense as of March 31, 1999 increased $20 thousand or 1.6% compared
to the same period last year. Salaries and benefits increased as a result of an
additional pay in the first quarter of 1999. A new biweekly pay schedule was
implemented in April 1998 superceding a semimonthly pay system. Increased pay
rates and insurance premiums are reflected when comparing March 31, 1999 to
March 31, 1998. Premise and fixed asset expenses decreased $33 thousand as of
March 31, 1999 compared to the same period in 1998 resulting from a change in
accounting estimates and 1998 reflects increased expensed equipment costs for
the renovated Commerce Street office. The overall minimal decrease in
noninterest expense is the result of efforts to control these costs.
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
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<PAGE>
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 $51.7 million and
$47.1 million as of March 31, 1999 and December 31, 1998, respectively. The net
increased level of investments in securities resulted primarily from the
investment of funds from deposit growth and the use of federal funds. 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.
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
gross loans as of March 31, 1999 have grown approximately $2 million since
December 31, 1998. Loan growth is attributed to new product development and the
reduction in loan rates. In addition, an active officer calling program
supported by increased marketing efforts were implemented and are showing signs
of success. The Company had no loan concentrations exceeding 10% of total loans
which are not otherwise disclosed.
The Company policy is to make the majority of its loan
commitments in the market area it serves. The Company attempts to reduce risk
through its management's familiarity with the credit histories of loan
applicants and in-depth knowledge of the risk to which a given credit is
subject. Lending in a limited market area does subject the Company to economic
conditions of that market area. The Company had no foreign loans in its
portfolio as of March 31, 1999.
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, 1999 and December 31, 1998, $54
thousand and $55 thousand, respectively, of non-accrual loans were secured by
collateral with an estimated value of $343 thousand as of March 31, 1999 and
December 31, 1998. At March 31, 1999, the Bank had troubled debt restructurings
of $869 and $2.8 million in loans on the watch list for which
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<PAGE>
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 3.0% increase in the first three
months of 1999 compared to December 31, 1998. Interest bearing transactions and
time account deposits were the main sources of deposit growth. Competitive time
deposit rates, NOW account product features, and marketing efforts have
contributed to the growth in these products. In addition, the Company's new
Silver CD product, with limited withdrawal penalties, for consumers over age 62
continues to be a popular product. 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.
LONG TERM DEBT
Long term debt consists 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 3 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. As indicated by the Consolidated
Statement of Cash Flows, the primary sources of cash flow in the first quarter
of 1999 were the maturity of investment securities and deposit growth. A
substantial portion of the investment portfolio contains readily marketable
securities that could be converted to cash immediately. On the liability side of
the balance sheet, liquidity is affected by the timing of maturing deposits 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. 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 market risk for the Company 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 in which rates
Page 5
<PAGE>
change. In addition, the maturity distribution of the Bank's assets and
liabilities do not match for given periods of time. The Bank's interest
rate sensitivity position is managed to maintain an appropriate balance
between the maturity and repricing characteristics of assets and
liabilities that is consistent with the Bank's liquidity, growth,
earnings and capital adequacy goals. The Board of Directors has adopted
an Asset / Liability Management Policy, which is administered by the
Asset / Liability Committee. 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 March 31, 1999 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 $236 thousand if
rates were to increase by that amount and would increase $92 thousand if rates
would decline a similar amount.
CAPITAL RESOURCES AND ADEQUACY
Total stockholders' equity increased $35 thousand to $21.9
million as of March 31,1999. Earnings of $415 thousand added to shareholders'
equity. Dividends paid reduced stockholders' equity $249 thousand as did the
increase in unrealized loss in available for sale securities of $131 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, 1999 was 11.19% and at December
31, 1998 was 11.08%.
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, 1999 was 20.58% and at December 31, 1998 was 21.05%.
According to FDIC capital guidelines, the Company is considered to be "Well
Capitalized."
In the first quarter of 1999 the Office of the Comptroller of
the Currency approved two new branches for The Centreville National Bank of
Maryland. A branch site at the corner of Sharp Road and Route 404 in Denton,
Maryland, Caroline County has been approved and completion is anticipated late
in the fourth quarter of 1999. The property on the corner of Route 18/Piney
Creek Road and Castle Marina Road in Chester, Maryland is an additional Queen
Anne County site. This branch location is anticipated to be completed in the
second or third quarter
Page 6
<PAGE>
of 2000. The total anticipated cost of the land and buildings for both
projects is approximately $2 million dollars. Subsequent to completion
of the branches the opportunity cost of the funds invested in the
branches, operating costs and depreciation expense could have an impact
on earnings in the short term until the long term growth of the branch
improves profitability.
Management knows of no other trend or event, which
will have a material impact on capital.
FUTURE TRENDS
This is a Year 2000 Readiness Disclosure under the Year 2000
Information and Readiness Disclosure Act of 1998.
The "Year 2000 Issue", which is common to most corporations,
including banks, is a general term used to describe the problems that may result
from the improper processing of dates and date-sensitive calculations as the
Year 2000 approaches. This issue is caused by the fact that many of the world's
existing computer programs use only two digits to identify the year in the date
field of a program. These programs could experience serious malfunctions when
the last two digits of the year change to "00" as a result of identifying a year
designated "00" as the year 1900 rather than the Year 2000.
The Company formed a Year 2000 Committee, which is comprised
of a cross-section of the Company's employees, in the fourth quarter of 1997.
This Committee is leading the Company's Year 2000 efforts to ensure that the
Company is properly prepared for the Year 2000. The Company's Board of Directors
has approved a plan submitted by the Year 2000 Committee that was developed in
accordance with guidelines set forth by the Federal Financial Institutions
Examination Council. This plan has five primary phases related to internal Year
2000 compliance:
1. Awareness - this phase is ongoing and is designed to inform
the Company's Board of Directors (the "Board") and Executive management
("Management"), employees, customers and vendors of the impact of the Year 2000
Issue. Since January 1998, the Board has been apprised of the Company's efforts
at their regular meetings. In addition, customers and the community continue to
be updated with respect to the Company's Year 2000 efforts through mailings,
published articles, lobby brochures and a Year 2000 Readiness Disclosure posted
in the branch lobbies. A public seminar was presented in April 1998. The
Company's ongoing outreach efforts include Year 2000 presentations to business
organizations and community groups.
2. Assessment - during this phase an inventory was conducted
of all known Company processes that could reasonably be expected to be impacted
by the Year 2000 Issue and their related vendors, if applicable. The
identification process included information technology and communication systems
such as personal computers, local area networks and servers, ATM modems,
printers, copy machines, facsimile machines, telephones and the operating
systems and software for these systems. It also included non-information
technology systems, such as heating, air conditioning and vault controls, alarm
systems, surveillance systems, and postage meters. The Company inventoried all
the systems listed above in the second and third quarters of 1998 and performed
an initial assessment of potential risks from either under or nonperformance
arising from incorrect processing
Page 7
<PAGE>
and usage of dates after December 31, 1999. All outside servicers and
major vendors were contacted to ascertain their individual levels of
Year 2000 compliance. From vendor responses and/or certifications of
Year 2000 compliance the Company determined that all vendors and service
providers who provide mission critical and significant systems to the
Company are addressing Year 2000 compliance for the products and
services they provide to the Company and the Company expects all of the
mission critical and significant vendors to be Year 2000 compliant by
December 31, 1999. The assessment phase is complete, although it is
updated periodically as necessary.
3. Renovation and/or replacement - this phase includes programming code
enhancements, hardware and software upgrades, system replacements, vendor
certification and any other changes necessary to make any hardware, software and
other equipment Year 2000 compliant.
The Company does not perform in-house programming, and thus is dependent on
external vendors to ensure and modify, if needed, the hardware, software or
other services they provide to the Company for Year 2000 compliance. The
Company's primary service provider has a comprehensive Year 2000 Plan in place
and has successfully completed Year 2000 testing of their mission critical
systems.
4. Testing - The next phase for the Company under the plan is to complete a
comprehensive testing of all known processes. As noted in the renovation and/or
replacement phase above, the Company's primary service provider has already
successfully tested their system for Year 2000 compliance. The next step, which
is scheduled for completion in the second quarters of fiscal 1999, is to
complete testing of the Company's network mission critical software applications
and hardware. The Company has performed Year 2000 testing of all employee
computer work stations, and is in the process of updating or replacing work
stations which are not Year 2000 compliant. The testing of the remainder of the
Company's processes is expected to be substantially complete by June 1999.
5. Implementation - this phase will occur when Year 2000 processing
commences. On some applications the Company is already entering dates
greater than December 31, 1999 into their systems. In these situations
no adverse events have been noted. The significant part of the
implementation phase will occur after December 31,1999.
The Company is in the process of developing contingency plans for
processes that do not process information reliably and accurately after
December 31, 1999. The contingency plans for all systems should be
substantially complete by the end of the second calendar quarter of
fiscal 1999.
Senior management completed a contingency plan to provide operating
alternatives for continuation of services to the Company's customers in
the event of systems or communication failures at the beginning of the
Year 2000. Contingency plans will be updated as necessary. Based on
preliminary planning during development of the contingency plan,
management expects that the Company will be able to continue to operate
in the Year 2000 even if some systems fail. At the end of December 1999,
the Company will generate paper and systems backup of all customer and
general ledger accounts. Due to the size of the Company, the Company
expects that it will be able to operate with all transactions processed
manually until normal operations can be restored. This procedure could
require changing of schedules and hiring of temporary staff, which would
increase cost of operations. If this procedure were to
Page 8
<PAGE>
continue for any extended period of time, or if the Company ultimately
had to change data service providers, the cost could be material.
The Company is in the process of assessing the Year 2000 readiness of
significant borrowers and depositors. The Company has completed its initial
review of these significant relationships and assessed the risks these
relationships may pose to the Company. The Company will continue to monitor the
risk and expects any potential losses to the Company caused by Year 2000
problems of significant borrowers and depositors not to be material. This step
is not expected to require a significant amount of time or resources.
As of December 31, 1998 the following chart shows the current and projected
status of the Company's Year 2000 compliance efforts:
Phase 9/30/98 12/31/98 3/31/99 6/30/99
- ----- ------- -------- ------- -------
Awareness 100% 100% 100% 100%
Assessment 98 98 100 100
Renovation 89 96 100 100
Validation 58 78 85 100
Implementation 54 67 80 100
The Company expensed approximately $14 thousand on Year 2000 costs in
the first quarter in 1999. Based on an analysis of projected expenses
performed during the first quarter of 1998 and subsequent updates, the
total cost of the Year 2000 project is currently estimated at $110
thousand. These costs do not include the opportunity costs of the
additional cash that will be held in our vaults to meet anticipated
customer demand at year end. Funding of the Year 2000 project costs has
come and is expected to come from normal operating cash flow. 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.
However, the expenses associated with the Year 2000 issue will directly
reduce otherwise reported net income for the Company. Should the Company
have to resort to alternative operating procedures due to major systems
or communications failures at the beginning of the Year 2000, the extra
cost could be material.
Management of the Company believes that the potential effects on the Company's
internal operations of the Year 2000 Issue can and will be addressed prior to
the Year 2000. However, if required modifications or conversions are not made or
are not completed on a timely basis prior to the Year 2000, the Year 2000 Issue
could disrupt normal business operations. The most reasonably likely worst case
Year 2000 scenarios foreseeable at this time would include the Company
temporarily not being able to process, in some combination, various types of
customer transactions. This could affect the ability of the Company to, among
other things, originate new loans, post loan payments, accept deposits or allow
immediate withdrawals, and, depending on the amount of time such a scenario
lasted, could have a material adverse effect on the Company.
Because of the serious implications of these scenarios, the primary emphasis of
the Company's Year 2000 efforts is to correct, with complete replacement if
necessary, any systems or processes whose Year 2000 test results are not
satisfactory prior to the Year 2000. Nevertheless, should one of the most
reasonably likely worst case scenarios occur in the Year 2000, the Company, as
Page 9
<PAGE>
noted above, is in the process of formalizing a contingency plan that would
allow for limited transactions until the Year 2000 problems are fixed.
The costs of the Year 2000 project and the date on which the Company plans to
complete Year 2000 compliance are based on management's best estimates, which
were derived using numerous assumptions of future events such as the
availability of certain resources (including internal and external resources),
third party vendor plans and other factors. However, there can be no guarantee
that these estimates will be achieved at the cost disclosed or within the
timeframe indicated, and actual results could differ materially from these
plans. Factors that might affect the timely and efficient completion of the
Company's Year 2000 project include, but are not limited to, vendor's ability to
adequately correct or convert software and the effect on the Company's ability
to test its systems, the availability and cost of personnel trained in the Year
2000 area, the ability to identify and correct all relevant computer programs
and similar uncertainties.
Bank regulatory agencies have recently issued additional guidance under which
they are assessing Year 2000 readiness. The failure of a financial institution
to take appropriate action to address deficiencies in the Year 2000 project
management process may result in enforcement actions which could have a material
adverse effect on such institution, result in the imposition of civil money
penalties or result in the delay (or receipt of an unfavorable or critical
evaluation of management of a financial institution in connection with
regulatory review) of applications seeking to acquire other entities or
otherwise expand the institution's activities.
Ultimately, the success of the Company's efforts to address the Year 2000 issue
depends to a large extent not only on the corrective measures that the Company
undertakes, but also on the efforts undertaken by businesses and other
independent entities who provide data to, or receive data from, the Company such
as borrowers, vendors or customers. In particular, the Company's credit risk
associated with its borrowers may increase as a result of problems such
borrowers may have resolving their own Year 2000 issues. Although it is not
possible to evaluate the magnitude of any potential increased credit risk at
this time, the impact of the Year 2000 issue on borrowers could result in
increases in problem loans and credit losses in future years. From now until
2000, the Company will endeavor to monitor the Year 2000 efforts of its
borrowers and will implement a course of action and procedures designed to
reduce any increased potential risk as a result of Year 2000 issues.
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 10
<PAGE>
PART II
OTHER INFORMATION
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
A. Exhibits Required by Item 601 of Regulation S-K are set forth below:
(3) Charter and Bylaws
(3.1) Articles of Amendment and Restatement of the Company
are incorporated by reference from the Company's June
30, 1998 Form 10-Q, filed with the Commission on August
13, 1998.
(3.2) Bylaws of the Company as amended and restated are
incorporated by reference from the Company's June 30,
1998 Form 10-Q, filed with the Commission on August 13,
1998.
(10.1) 1998 Employee Stock Purchase Plan is incorporated by
reference from the Company's Registration Statement on
Form S-8 filed with the Commission on September 25,
1998 (Registration No. 333-64317).
(10.2) 1998 Stock Option Plan is incorporated by reference
from the Company's Registration Statement on Form S-8
filed with the Commission on September 25, 1998
(Registration No. 333-64319).
(13) 1998 Annual Report filed with the Commission on March
31, 1999 (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 for March 31, 1999 is filed
electronically herewith via EDGAR.
B Reports on Form 8-K
None
<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: May 11, 1999
SHORE BANCSHARES, INC.
/s/ DANIEL T. CANNON
________________________
DANIEL T. CANNON
President
/s/ CAROL I. BROWNAWELL
________________________
CAROL I. BROWNAWELL
Treasurer
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