Shore Bancshares, Inc. — Q2 2023 Form 10-Q
Business context and period. Unaudited results cover the three and six months ended June 30, 2023. Shore Bancshares is a Maryland-based bank holding company whose principal subsidiary is Shore United Bank. The quarter-end financial statements do not include the July 1 acquisition of The Community Financial Corporation (TCFC).
Financial performance and position
- Q2 earnings: Net income was $4.0 million, or $0.20 per diluted share, versus $7.5 million, or $0.38, in Q2 2022. Management reported Q2 net income excluding merger costs of $4.9 million, or $0.25 per diluted share; this is a non-GAAP comparison.
- First-half earnings: Net income was $10.5 million, or $0.53 per diluted share, versus $13.1 million, or $0.66, in the first half of 2022.
- Interest income and margin: Q2 net interest income was $22.5 million, down from $24.6 million a year earlier; first-half net interest income was $48.2 million, up from $47.0 million. Q2 net interest margin fell to 2.68% from 3.10% a year earlier and 3.18% in Q1 2023. Management attributed pressure to higher deposit and borrowing costs and a shift toward higher-cost funding.
- Other income and expenses: Q2 noninterest income was $5.3 million, down 9.2% year over year. Noninterest expense was $21.6 million, including $1.2 million of merger-related expense. The six-month provision for credit losses was $1.9 million versus $0.8 million in 2022.
- Loans and credit: Gross loans reached $2.75 billion, up from $2.56 billion at year-end 2022. The allowance for credit losses was $29.0 million, or 1.05% of period-end loans, compared with $16.6 million, or 0.65%, at year-end. Nonperforming assets were $4.7 million, or 0.17% of loans and other real estate owned; nonaccrual loans rose to $3.5 million from $1.9 million at year-end. First-half net charge-offs were $70,000.
- Deposits, liquidity, and borrowings: Deposits declined 2.4% from year-end to $2.94 billion; estimated uninsured deposits were $503.5 million, or 17.1%. Cash and cash equivalents were $45.8 million. Short-term FHLB advances rose to $276.0 million from $40.0 million, at rates of 5.07%–5.32%. First-half operating cash flow was $10.7 million versus $43.1 million a year earlier; net cash used in investing was $179.7 million, largely reflecting loan growth.
- Capital and securities: Stockholders’ equity was $363.1 million. The Company and Bank were reported as well capitalized; their June 30 total risk-based capital ratios were 13.69% and 13.15%, respectively. Available-for-sale securities had $11.8 million of gross unrealized losses; management attributed these mainly to interest-rate changes and reported no credit impairment.
Material changes and notable items
- Q2 net income fell year over year as higher interest expense outweighed loan and securities income growth. Deposit interest expense and short-term borrowing costs increased substantially.
- Legacy loans, excluding Severn-acquired and PPP loans, grew $236.9 million, or 10.8%, in the first half. Commercial real estate, including construction, represented a significant concentration: non-owner-occupied CRE, including construction, was 287.5% of risk-based capital, and the portfolio had grown 94.4% over three years.
- On January 1, 2023, the Company adopted CECL. Adoption reduced opening retained earnings by approximately $7.8 million after tax and increased the loan allowance by $10.8 million.
- TCFC’s acquisition closed July 1 for reported consideration of approximately $153.6 million, primarily Company shares. The acquired company had more than $2.4 billion in assets. By July 24, Shore had sold most of TCFC’s available-for-sale securities for $430 million and used $380 million to reduce FHLB advances and brokered deposits. Management expected the actions to benefit Q3 return on average assets, net interest margin, and tangible common equity ratios.
Outlook, risks, and contingencies
- Management intended to reduce annualized loan growth to 4%–6% in the second half of 2023, significantly reduce consumer mortgage portfolio production, and emphasize production of mortgage loans for sale.
- Key risks include deposit competition and migration to higher-rate accounts, continued funding-cost pressure, interest-rate exposure, and credit risk from the CRE concentration. Management described heightened CRE monitoring and stress testing.
- The Company provides banking services to cannabis businesses whose activities remain illegal under federal law. At quarter-end, these customers had approximately $121.8 million in deposits and $59.8 million in loans. The Company had not accrued for potential federal action; the possible financial impact was described as uncertain.
- Commitments to extend credit and letters of credit totaled $387.2 million. Management said current legal proceedings were not expected to materially affect financial condition, results, or liquidity. No material risk-factor changes were reported.
Important facts for investors to verify
- How Q3 results reflect the TCFC acquisition, the securities sale, and the use of proceeds to reduce funding costs.
- Whether deposit balances and mix stabilize, and whether deposit and FHLB funding costs continue to compress net interest margin.
- Whether CRE credit quality, nonaccrual loans, and the CECL allowance develop consistently with management’s assumptions and stated loan-growth plans.
- The Company’s CRE concentration relative to regulatory thresholds, capital needs, and any effects on lending or shareholder returns.
- The scale and financial or regulatory exposure associated with cannabis banking, and the potential effects of interest-rate movements on securities values and liquidity.