Shore Bancshares, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited consolidated results; balance-sheet comparisons are against December 31, 2017. The company operates community banking and insurance businesses, primarily in Maryland, Delaware, and Virginia.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $12.9m | $12.3m | $37.9m | $33.2m |
| Provision for credit losses | $0.3m | $0.3m | $1.2m | $1.7m |
| Noninterest income | $4.7m | $4.4m | $14.2m | $13.4m |
| Noninterest expense | $11.3m | $10.7m | $33.6m | $30.6m |
| Net income | $4.5m | $3.4m | $12.9m | $8.6m |
| Diluted EPS | $0.35 | $0.27 | $1.01 | $0.67 |
| Net interest margin, tax-equivalent | 3.76% | 3.79% | 3.79% | 3.75% |
Financial condition and liquidity
- Total assets were $1.474bn, up $79.7m from year-end 2017. Loans were $1.181bn, up $87.0m (8.0%), driven mainly by commercial real estate, residential real estate, and commercial lending. Net loans were $1.170bn.
- Deposits totaled $1.182bn, down $20.9m (1.7%). Short-term borrowings rose to $114.0m from $21.7m, reflecting loan growth and deposit outflows. Cash and cash equivalents were $48.8m, up $17.0m.
- For the first nine months, operating cash flow was $12.0m; investing cash outflow was $63.7m, primarily reflecting $87.5m of net loan growth; financing cash inflow was $68.6m, principally from $92.3m of increased short-term borrowings.
- Stockholders’ equity was $171.4m, up $7.7m from year-end. The bank was classified as well-capitalized: Tier 1 leverage 9.62%, common equity Tier 1 and Tier 1 risk-based 11.79%, and total risk-based capital 12.71% at September 30.
- Available FHLB borrowing capacity was approximately $119.8m, down from $205.6m at year-end; the bank also had $15m in short-term correspondent-bank lines. Management reported no known commitments or uncertainties likely to materially impair liquidity.
Material changes and management commentary
- Q3 net income rose 30.5% year over year; nine-month net income increased 50.7%. Management attributed the improvement to higher net interest and noninterest income, lower credit-loss provision year to date, and the reduced federal corporate tax rate. Higher operating expenses partly offset gains; nine-month expenses rose 9.8%, including costs of operating four additional branches.
- Q3 net interest income increased $0.6m year over year. Loan growth and improved earning-asset yields were partly offset by sharply higher funding costs: Q3 interest expense was $1.3m versus $0.6m, including increased short-term borrowing costs. Management said loan demand outpaced deposit growth in the near term.
- Net charge-offs were $0.1m in Q3 and $0.7m for nine months, down from $0.2m and $1.2m in the comparable 2017 periods. The allowance was $10.3m, or 0.87% of period-end loans.
- Nonperforming assets rose to $8.9m from $7.4m at year-end, mainly because nonaccrual loans increased by $2.4m. The company cited a $2.0m commercial real estate borrower exposure, with collateral value above the loan balance. Accruing troubled debt restructurings declined to $8.9m from $13.3m; nonaccrual loans plus accruing TDRs fell to 1.38% of loans from 1.67%.
- Commercial real estate, including construction, is a significant concentration: non-owner-occupied CRE including construction was 297.5% of total risk-based capital, and the CRE portfolio including construction grew 88.1% over three years. Management described enhanced monitoring, underwriting, and stress testing; it warned concentration could result in higher capital requirements and affect shareholder returns.
- Available-for-sale securities declined $29.3m from year-end as securities rolled off to fund loan growth. Net unrealized losses on available-for-sale securities were $4.0m before tax; accumulated other comprehensive loss was $4.1m. Management attributed the unrealized losses to interest-rate movements and considered them temporary, stating it did not intend, nor expect to be required, to sell before recovery.
Outlook, risks, and unusual items
- The filing provides no numerical earnings or revenue guidance. Management’s results discussion is not a forecast; it cautions interim results are not necessarily indicative of full-year results.
- Key stated risks include economic conditions, competition, interest-rate changes, regulation, credit quality, and the commercial real estate concentration. Rising funding costs and reliance on short-term borrowings are relevant to monitor.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate from 35% to 21% effective January 1, 2018, materially lowering the company’s tax burden. Q3 effective tax rate was 26.6%, versus 40.0% a year earlier.
- The company said adoption of the expected-credit-loss standard (CECL) is expected to significantly affect its financial statements and credit-loss methodology. It was developing its model and planned parallel simulations in Q1 2019; the filing did not quantify the expected impact.
- The company reported no legal proceedings believed to have a material adverse effect, no material changes to previously disclosed risk factors, and effective disclosure controls. It also reported that revised small bank holding company rules exempted the parent from consolidated capital requirements at September 30, 2018.
Important facts for investors to verify
- Whether deposit trends and funding mix improve, and whether elevated short-term borrowings and funding costs persist.
- Loan growth, CRE concentration, nonaccrual exposures, collateral valuations, and adequacy of the allowance as CECL implementation proceeds.
- The sustainability of earnings growth after the benefit of the lower tax rate and the costs associated with expanded branch operations.
- Changes in securities values and accumulated other comprehensive loss as interest rates move.
- Future FHLB availability, bank capital ratios, and any capital implications from CRE concentration or regulatory changes.