Shore Bancshares, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Unaudited consolidated results. Dollar amounts below are in millions unless stated otherwise.
Business context
Shore Bancshares is a Maryland-based bank holding company operating Shore United Bank and related mortgage, wealth-management, and title businesses. The Severn Bancorp acquisition closed in October 2021; its inclusion materially affects year-over-year comparisons. The company reported community banking and mortgage banking segments.
Financial and operating metrics
- Q3 earnings: Net income was $9.7 million, or $0.49 per diluted share, versus $4.6 million and $0.39 per share in Q3 2021. Q3 2022 net income was $7.5 million, or $0.38 per share, in Q2 2022.
- Revenue and net interest income: Q3 net interest income was $27.3 million, compared with $15.6 million a year earlier. Noninterest income was $5.3 million, versus $2.9 million; together these totaled $32.7 million, versus $18.5 million. Nine-month net income was $22.8 million versus $12.6 million; net interest income was $74.4 million versus $43.5 million, and noninterest income was $17.2 million versus $8.4 million.
- Margin: Tax-equivalent net interest margin was 3.38% in Q3, up from 2.99% in Q3 2021 and 3.10% in Q2 2022. For the first nine months, it was 3.09%, compared with 2.97%.
- Expenses and credit costs: Q3 noninterest expense was $18.9 million, up from $11.9 million; the filing attributes much of the increase to Severn-related scale and operations. Provision for credit losses was $0.7 million, versus $0.3 million in Q3 2021. The effective tax rate was 26.2% in Q3.
- Balance sheet at September 30: Total assets were $3.45 billion; gross loans were $2.40 billion and net loans $2.39 billion; deposits were $3.02 billion; and stockholders’ equity was $357.2 million. Total assets and deposits were slightly below December 31, 2021, while gross loans grew about 13%.
- Credit quality: Allowance for credit losses was $16.3 million, or 0.68% of loans (0.84% excluding PPP and acquired loans). Nonperforming assets were $2.8 million; nonaccrual loans were $1.9 million. Accruing troubled debt restructurings were $4.5 million.
- Cash flow and liquidity: Cash and cash equivalents were $163.3 million, down from $583.6 million at year-end 2021. For the first nine months, operating cash flow was $50.1 million, investing cash outflow was $448.8 million, and financing cash outflow was $21.6 million. Loan growth and purchases of held-to-maturity securities were principal investing cash uses. The Bank reported $15 million of correspondent-bank federal funds lines and FHLB borrowing capacity against pledged collateral.
- Debt and capital: Total borrowings were $53.0 million, including $10.0 million of long-term FHLB advances and $43.0 million of subordinated debt. The FHLB advances were repaid in October 2022. At September 30, the company’s and Bank’s total risk-based capital ratios were 14.34% and 13.71%, respectively; management described both as well capitalized.
Material changes versus comparable periods
- Q3 net income increased by about $5.0 million year over year. Management cited higher net interest income and noninterest income, partially offset by higher expenses, largely reflecting the Severn acquisition.
- Loan growth, acquired Severn balances, and higher yields increased interest income. Deposit and borrowing costs also rose; the rate paid on interest-bearing deposits increased to 0.48% in Q3 from 0.29% in Q2.
- Loan growth excluding PPP and acquired balances was also strong: legacy loans excluding PPP increased $445.9 million, or 28.8%, from year-end 2021. PPP balances fell to $0.3 million from $27.6 million.
- Unrealized losses on available-for-sale securities reduced accumulated other comprehensive income by $9.8 million after tax from year-end. Held-to-maturity securities had $69.6 million of unrealized losses at September 30; management attributed securities losses to interest-rate changes, not credit concerns.
Outlook, risks, and unusual items
- The filing provides no specific earnings or financial guidance. Management said it would continue monitoring credit quality and allowance adequacy as economic conditions and portfolio changes develop.
- Commercial real estate is a significant concentration: non-owner-occupied CRE, including construction, was 288.8% of total risk-based capital, and the CRE portfolio including construction had grown 110.8% over three years. Management described heightened risk-management and stress-testing procedures; it cautioned that concentration could require higher capital or loan sales/participations.
- Rising interest rates are a key market risk, affecting deposit costs and securities values. The company reported $69.6 million of unrealized losses on held-to-maturity securities and stated it did not intend, nor expect to be required, to sell securities before recovery of amortized cost.
- The company expanded its cannabis banking program in Q2 to include licensed adult-use businesses in other states. It disclosed potential federal-law, enforcement, and legal risks; it had not accrued a liability for possible government action. Cannabis customers represented approximately $24.2 million of deposits and $43.6 million of loans at quarter-end.
- The company had $422.9 million of commitments to extend credit and letters of credit outstanding. These are off-balance-sheet exposures; amounts drawn may differ from total commitments.
- The company authorized a new $5 million stock repurchase program through March 31, 2023; no shares were repurchased in Q3. Management said there were no material changes to previously disclosed risk factors, and current litigation was not expected to materially affect financial condition, results, or liquidity.
- The company was preparing to adopt the current expected credit loss standard (CECL), with implementation work and parallel model testing underway. It was still assessing the potential financial-statement impact.
Important facts for investors to verify
- Whether loan growth, deposit levels, and rising deposit costs sustain the reported margin improvement.
- Credit performance and underwriting within the concentrated CRE portfolio, especially as rates and economic conditions change.
- Liquidity and funding capacity after the substantial reduction in cash, the October FHLB repayment, and continued loan growth.
- The effect of securities valuation losses and any future need to sell securities or use contingent funding.
- The eventual CECL adoption impact and any material exposure associated with cannabis banking or off-balance-sheet commitments.
- How much of the earnings and expense changes reflect ongoing operations versus Severn acquisition effects and integration costs.