Shore Bancshares, Inc. — Q1 2017 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. The unaudited consolidated statements cover Shore Bancshares and its subsidiaries. Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance and condition
| Metric | Q1 2017 | Comparable / change |
|---|---|---|
| Net interest income | $9.93 | $9.24 in Q1 2016; +7.5% |
| Net interest margin | 3.71% | 3.50% in Q1 2016; 3.63% in Q4 2016 |
| Noninterest income | $4.81 | $4.54 in Q1 2016; +5.9% |
| Noninterest expense | $9.65 | $9.34 in Q1 2016; +3.3% |
| Net income / diluted EPS | $2.80 / $0.22 | $2.46 / $0.19 in Q1 2016 |
| Operating cash flow | $3.84 | $3.89 in Q1 2016 |
Net interest income plus noninterest income, a simple revenue proxy, was $14.74 million versus $13.78 million in Q1 2016. Management attributed improved earnings primarily to higher net interest income and noninterest income, partly offset by higher expenses. Q1 2017 net income was also above Q4 2016’s $2.5 million.
At March 31, total assets were $1,166.9 million, loans $891.9 million, deposits $1,001.5 million, and stockholders’ equity $157.6 million. Compared with year-end, loans rose 2.3%, deposits rose less than 1%, and equity increased $3.3 million. Short-term borrowings were $2.9 million; the filing reports no long-term debt balance.
Cash and cash equivalents fell $27.1 million to $48.9 million during the quarter, mainly reflecting loan growth and purchases of investment securities. Investing cash outflow was $34.1 million, while financing cash inflow was $3.1 million. Available liquidity included $15 million in correspondent-bank federal funds lines and approximately $207.1 million of FHLB credit availability. The company and Shore United Bank were described as well-capitalized; company ratios were 12.74% Tier 1 leverage, 15.84% common equity Tier 1 and Tier 1 risk-based, and 16.85% total risk-based capital.
Material changes and credit quality
- Average loans increased $90.0 million year over year, supporting interest income; lower time-deposit balances and rates reduced funding costs. Management also noted a shift from lower-yielding securities toward higher-yielding loans.
- Noninterest income benefited from a gain on an insurance-agency investment, higher insurance commissions, and first-quarter contingency payments. The prior-year period included a loss on the investment; Q4 2016 included a gain on sale of the bank’s credit-card portfolio.
- Higher employee benefits and branch-acquisition-related legal and data-processing costs contributed to expense growth. The branch purchase was scheduled to close in Q2 2017. The parent contributed $10.5 million of capital to Shore United Bank in preparation, largely in mortgage-backed securities.
- Loans grew $20.3 million from year-end, with increases in construction, residential real estate, and commercial real estate lending. Commercial real estate, including construction, represented a significant portfolio concentration.
- Nonperforming assets declined to $11.2 million from $11.5 million at year-end. Nonaccrual loans were $8.7 million, or 0.98% of loans; the allowance for credit losses was $8.9 million, or 1.00% of loans. Net charge-offs were $226,000, or 0.10% of average loans on an annualized basis. Accruing troubled debt restructurings were $12.8 million.
Outlook, risks and unusual items
The filing provides no quantified earnings or revenue guidance. Management expects no material liquidity constraint based on available funding sources, but notes that actual results may differ from forward-looking statements. Key risks include interest-rate movements, economic conditions, competition, regulation, and the judgments and estimates used in credit-loss provisioning and asset valuations.
Commercial real estate concentration is a notable risk: non-owner-occupied commercial real estate, including construction and land-development loans, equaled 206.6% of risk-based capital; construction, land and land-development loans equaled 62.6%. Management described heightened monitoring and underwriting practices. The company also estimated that ownership changes had reached approximately 44% over the applicable three-year period; a change exceeding 50% could limit use of tax net operating losses under Section 382.
Management stated that unrealized securities losses were temporary and attributed them to interest-rate changes; it did not intend, nor expect to be required, to sell the affected securities before recovery. The company reported no legal proceedings expected to have a material adverse effect, no material change in risk factors, and effective disclosure controls as of March 31, 2017.
Important facts for investors to verify
- Progress, closing conditions, purchase price and expected contribution to earnings for the branch acquisition scheduled for Q2 2017.
- Loan growth and performance, particularly commercial real estate and construction exposures, nonaccrual loans, TDRs, charge-offs, and allowance adequacy.
- Whether deposit mix and funding costs sustain the reported net interest margin as interest rates and loan yields change.
- Capital and liquidity after the $10.5 million bank contribution and any acquisition-related funding needs.
- Section 382 ownership-change calculations and the future realizability of deferred tax assets and net operating losses.
- Implementation impacts of the expected-credit-loss accounting standard, which the company said could significantly affect credit-loss measurement and is effective for it in 2020.