Shore Bancshares, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Interim financial statements are unaudited; amounts below are in U.S. dollars, with financial figures generally rounded to millions.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $12.3 million | $9.7 million | $33.2 million | $28.3 million |
| Provision for credit losses | $0.3 million | $0.6 million | $1.7 million | $1.4 million |
| Noninterest income | $4.4 million | $4.0 million | $13.4 million | $12.6 million |
| Noninterest expense | $10.7 million | $9.2 million | $30.6 million | $27.9 million |
| Net income | $3.4 million | $2.4 million | $8.6 million | $7.1 million |
| Diluted earnings per share | $0.27 | $0.19 | $0.67 | $0.56 |
- Q3 net interest margin was 3.79%, versus 3.54% a year earlier and 3.73% in Q2 2017. Nine-month margin was 3.75%, versus 3.54% in 2016. The filing reports net interest margin, not a net profit margin.
- At September 30, total assets were $1.376 billion; loans, net of allowance, were $1.038 billion; deposits were $1.206 billion; and stockholders’ equity was $162.6 million. Total assets grew from $1.160 billion at December 31, 2016.
- Cash and cash equivalents were $43.9 million, down from $75.9 million at year-end 2016. Nine-month operating cash flow was $13.7 million; investing activities used $38.4 million and financing activities used $7.3 million, producing a $32.0 million net cash decrease.
- Short-term borrowings were $1.5 million, down from $3.2 million at year-end. Available liquidity included $15 million in correspondent-bank lines and approximately $222 million of FHLB borrowing capacity. Management said it knew of no circumstances likely to materially impair its ability to maintain satisfactory liquidity.
- Regulatory capital ratios at September 30 included a 9.72% Tier 1 leverage ratio and 13.02% total risk-based capital ratio at the company level. Management reported the company and bank remained “well-capitalized.”
Material changes and business context
- On May 19, 2017, Shore United Bank acquired three Maryland branches from Northwest Bank. The transaction included $122.9 million of loans and $212.5 million of deposits at acquisition, and generated $15.3 million of goodwill and a $4.0 million core deposit intangible. The company said the acquisition expanded its footprint into the greater Baltimore area.
- Total loans increased $175.5 million, or 20.2%, from year-end; excluding acquired loans, management reported organic growth of $58.8 million, or 6.7%. Deposits increased $208.7 million, or 20.9%, largely due to the branch purchase.
- Compared with Q3 2016, net income rose about 42%. Management attributed the improvement primarily to higher net interest income and noninterest income and a lower credit-loss provision, partly offset by higher expenses. The acquired branches contributed to these changes.
- For the first nine months, net income rose about 20%. Higher net interest income and noninterest income were partly offset by higher credit provisions and expenses, including $977,000 of branch-acquisition costs.
Credit, risks, outlook and unusual items
- Commercial real estate is a significant concentration: commercial real estate loans were 43.4% of total loans and construction loans 10.2% at September 30. Non-owner-occupied CRE, including construction and land-development loans, equaled 269.9% of risk-based capital; the CRE portfolio had grown 95.3% over three years. The company described heightened monitoring and underwriting controls and warned concentration could require higher capital and affect shareholder returns.
- Nonperforming assets declined to $8.1 million from $11.5 million at year-end, while nonaccrual loans fell to $6.3 million. Accruing troubled debt restructurings increased to $13.5 million. The allowance was $9.3 million, or 0.89% of loans; excluding acquired loans, management stated the ratio was 1.00% and considered the allowance adequate.
- Nine-month net charge-offs were $1.2 million, compared with $1.1 million in 2016. Management said a large second-quarter charge-off on a negotiated restructured commercial loan drove much of the higher provision for the period; Q3 provision was lower than both Q3 2016 and Q2 2017.
- Management cited interest-rate fluctuations, economic conditions, competition, legislation and regulation as risks to forward-looking statements. It reported no material change in risk factors since the 2016 annual report and no material change in market risk or related procedures since year-end.
- No earnings or financial guidance was provided. Management said the 2017 results were not necessarily indicative of full-year results. The company reported no legal proceedings it believed would materially adversely affect financial condition or earnings.
- The company expects the upcoming expected-credit-loss standard (CECL) to have a significant impact on its financial statements and credit-loss methodology; it was assessing implementation. Other listed accounting standards were generally not expected to have significant effects, except lease accounting was expected to increase recognized assets and liabilities.
Important facts for investors to verify
- Whether the acquired branches deliver sustainable loan and deposit growth and revenue sufficient to offset integration, staffing, FDIC and other operating costs.
- Credit performance in the CRE and construction portfolios, including nonperforming assets, restructured loans, charge-offs and allowance adequacy—especially excluding acquired performing loans.
- Deposit retention and funding costs, liquidity use, and the company’s capacity to preserve capital ratios as assets and lending grow.
- Underlying expense trends and the durability of noninterest income, including the reported positive insurance-investment contribution.
- The expected CECL impact and the timing and effect of lease-standard adoption; the filing does not quantify the CECL effect.