Shore Bancshares, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited consolidated results; amounts below are in U.S. dollars unless stated otherwise. Shore Bancshares is a Maryland-based financial holding company operating community banking and insurance businesses in Maryland, Delaware, and Virginia.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $12.63 million | $10.90 million | $24.96 million | $20.83 million |
| Noninterest income | $4.54 million | $4.18 million | $9.47 million | $8.99 million |
| Provision for credit losses | $418,000 | $974,000 | $907,000 | $1.40 million |
| Noninterest expense | $10.83 million | $10.20 million | $22.29 million | $19.85 million |
| Net income | $4.39 million | $2.35 million | $8.45 million | $5.15 million |
| Diluted earnings per share | $0.34 | $0.19 | $0.66 | $0.41 |
| Tax-equivalent net interest margin | 3.79% | 3.73% | 3.80% | 3.71% |
- Q2 total operating revenue, calculated as net interest income plus noninterest income, was approximately $17.17 million, up from $15.08 million. Six-month operating revenue was approximately $34.43 million versus $29.82 million.
- Q2 net income increased about 87% year over year; six-month net income increased about 64%. Management attributed the six-month improvement principally to higher net interest income, higher noninterest income, and lower credit-loss provision.
- Q2 interest income rose with loan growth and improved yields. Funding costs also increased: quarterly interest expense was $1.04 million versus $549,000, reflecting increased short-term borrowings and brokered deposits.
- At June 30, assets were $1.452 billion, loans $1.157 billion, deposits $1.175 billion, and stockholders’ equity $168.1 million. Loans grew 5.8% from year-end 2017, while deposits declined 2.3%.
- Six-month operating cash flow was $7.33 million. Cash and cash equivalents ended at $43.48 million, up $11.66 million from year-end; the increase was mainly funded by short-term borrowings. Investing activities used $47.20 million, primarily reflecting $63.74 million of net loan growth; financing activities provided $51.53 million.
- Short-term borrowings rose to $102.7 million from $21.7 million at year-end. The Bank also reported $27.4 million of brokered deposits at quarter-end. Available FHLB credit was approximately $116.0 million, down from $205.6 million at year-end; $15 million of correspondent-bank lines were available.
- The allowance for credit losses was $10.12 million, or 0.87% of loans. Six-month net charge-offs were $567,000, compared with $995,000 in 2017.
- Company capital ratios included a 9.98% Tier 1 leverage ratio, 11.89% common equity Tier 1 ratio, and 12.78% total risk-based capital ratio. Management stated the Company remained “well-capitalized.”
Material changes versus comparable periods
- Q2 net interest income increased 15.9% year over year, while noninterest income grew 8.6%. Six-month net interest income increased about 19.8% and noninterest income about 5.4%.
- Six-month noninterest expense increased 12.3%, reflecting the operating costs of four additional branches and a new loan production office, as well as higher compensation and benefits. Data-processing costs declined following a core-processor contract renegotiation.
- Loan growth and deposit outflows increased funding needs. Average Q2 short-term borrowings were $91.98 million, compared with $5.59 million a year earlier; management said loan demand outpaced deposit growth.
- Nonperforming assets increased to $8.33 million from $7.40 million at year-end, mainly due to a $2.0 million commercial real estate borrower becoming nonaccrual. Accruing troubled debt restructurings (TDRs) declined to $9.62 million from $13.33 million, primarily after collateral on a significant TDR was sold.
- Available-for-sale securities declined to $175.6 million from $197.0 million at year-end as securities were used to fund loan growth. Accumulated other comprehensive loss widened to $3.77 million, primarily from unrealized market-value losses on securities; management attributed those losses to interest-rate movements and considered them temporary.
- The federal corporate tax-rate reduction contributed to a lower effective tax rate: 25.9% in Q2 2018 versus 39.8% in Q2 2017. The Company adopted the new revenue-recognition standard in 2018 without material impact.
Outlook, commentary, risks, and unusual items
- The filing provides no specific earnings, revenue, or margin guidance. Management emphasized the need to grow core deposits to keep pace with loan demand and described problem-loan resolution as a high priority.
- Commercial real estate concentration is a key risk: non-owner-occupied commercial real estate loans, including construction, were 305.2% of total risk-based capital; construction, land, and land-development loans were 95.6%. The commercial real estate portfolio, including construction, grew 97.9% over three years. Management cited heightened monitoring and stress testing; the filing notes potential requirements for higher capital and possible adverse effects on shareholder returns.
- Other stated risks include credit deterioration, local economic and real estate market conditions, interest-rate fluctuations, competition, regulation, and reliance on higher-cost funding as loan growth exceeds deposit growth.
- The expected-credit-loss standard, ASU 2016-13, was expected to significantly affect the Company’s credit-loss methodology; implementation work was ongoing. Lease-accounting implementation was also under assessment.
- Q2 provision and charge-offs were materially lower than a year earlier, when a large individual commercial-loan charge-off affected results. In the first half of 2018, two TDRs totaling $533,000 defaulted within 12 months of restructuring; no new TDRs were recorded during the period.
- The Company reported no legal proceedings believed likely to materially adversely affect financial condition or earnings, and no material changes to previously disclosed risk factors. Management reported disclosure controls effective at June 30, 2018 and no material second-quarter change in internal control over financial reporting.
Most important facts for investors to verify
- Whether core deposit growth can reduce reliance on short-term borrowings and brokered deposits without materially pressuring funding costs or net interest margin.
- Credit quality trends, particularly the new commercial real estate nonaccrual exposure, nonperforming assets, TDR performance, and allowance adequacy as the loan portfolio expands.
- Commercial real estate concentration levels, related regulatory expectations, and any resulting capital requirements or limits on growth.
- Whether loan growth and improving earnings can offset higher operating expenses, funding costs, and implementation costs for new accounting standards.
- Capital and liquidity disclosures in subsequent filings, including changes in FHLB availability and the securities portfolio’s unrealized losses.