SHORE BANCSHARES INC - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2021

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-22345

SHORE BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Maryland		52-1974638
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

18 E. Dover Street, Easton, Maryland		21601
(Address of Principal Executive Offices)		(Zip Code)

(410) 763-7800

Registrant’s Telephone Number, Including Area Code

N/A

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	SHBI	NASDAQ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒

The number of shares outstanding of the registrant’s common stock as of May 7, 2021 was 11,751,859.

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INDEX

		Page

Part I. Financial Information		3

Item 1. Financial Statements		3

Consolidated Balance Sheets – March 31, 2021 (unaudited) and December 31, 2020		3

Consolidated Statements of Income For the three months ended March 31, 2021 and 2020 (unaudited)		4

Consolidated Statements of Comprehensive Income For the three months ended March 31, 2021 and 2020 (unaudited)		5

Consolidated Statements of Changes in Stockholders’ Equity For the three months ended March 31, 2021 and 2020 (unaudited)		6

Consolidated Statements of Cash Flows For the three months ended March 31, 2021 and 2020 (unaudited)		7

Notes to Consolidated Financial Statements (unaudited)		8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		33

Item 3. Quantitative and Qualitative Disclosures about Market Risk		44

Item 4. Controls and Procedures		45

Part II. Other Information		45

Item 1. Legal Proceedings		45

Item 1A. Risk Factors		45

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		46

Item 3. Defaults Upon Senior Securities		46

Item 4. Mine Safety Disclosures		46

Item 5. Other Information		46

Item 6. Exhibits		47

Signatures		48

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

SHORE BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS


	March 31,		December 31,
(In thousands, except share and per share data)	2021		2020
ASSETS	(Unaudited)
Cash and due from banks	$	14,553	$	16,666
Interest-bearing deposits with other banks		212,533		170,251
Cash and cash equivalents		227,086		186,917
Investment securities:
Available-for-sale, at fair value		124,103		139,568
Held to maturity, at amortized cost - fair value of $125,076 (2021) and $65,828 (2020)		125,929		65,706
Equity securities, at fair value		1,382		1,395
Restricted securities		3,189		3,626

Loans		1,461,522		1,454,256
Less: allowance for credit losses		(14,313)		(13,888)
Loans, net		1,447,209		1,440,368

Premises and equipment, net		25,308		24,924
Goodwill		17,518		17,518
Other intangible assets, net		1,593		1,719
Other real estate owned, net		205		—
Right-of-use assets		7,229		4,795
Other assets		58,880		46,779
TOTAL ASSETS	$	2,039,631	$	1,933,315

LIABILITIES
Deposits:
Noninterest-bearing	$	533,823	$	509,091
Interest-bearing		1,266,813		1,191,614
Total deposits		1,800,636		1,700,705

Securities sold under retail repurchase agreements		3,501		1,050
Subordinated debt		24,460		24,429
Total borrowings		27,961		25,479

Lease liabilities		7,329		4,874
Other liabilities		7,601		7,238
TOTAL LIABILITIES		1,843,527		1,738,296

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share; shares authorized - 35,000,000; shares issued and outstanding - 11,751,859 (2021) and 11,783,380 (2020)		118		118
Additional paid in capital		51,445		52,167
Retained earnings		143,794		141,205
Accumulated other comprehensive income		747		1,529
TOTAL STOCKHOLDERS' EQUITY		196,104		195,019
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	2,039,631	$	1,933,315

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)


	For Three Months Ended
	March 31,
(In thousands, except per share data)	2021		2020
INTEREST INCOME
Interest and fees on loans	$	14,366	$	13,795
Interest and dividends on investment securities:
Taxable		931		719
Interest on deposits with other banks		47		172
Total interest income		15,344		14,686

INTEREST EXPENSE
Interest on deposits		1,184		2,059
Interest on short-term borrowings		1		2
Interest on long-term borrowings		359		107
Total interest expense		1,544		2,168

NET INTEREST INCOME		13,800		12,518
Provision for credit losses		425		350

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		13,375		12,168

NONINTEREST INCOME
Service charges on deposit accounts		674		866
Trust and investment fee income		407		375
Other noninterest income		1,476		1,111
Total noninterest income		2,557		2,352

NONINTEREST EXPENSE
Salaries and wages		4,142		4,296
Employee benefits		1,844		1,722
Occupancy expense		814		698
Furniture and equipment expense		307		317
Data processing		1,127		1,044
Directors' fees		149		141
Amortization of other intangible assets		126		144
FDIC insurance premium expense		185		91
Other real estate owned expenses, net		1		18
Legal and professional fees		516		634
Other noninterest expenses		1,288		1,244
Total noninterest expense		10,499		10,349

Income before income taxes		5,433		4,171
Income tax expense		1,435		1,053

NET INCOME	$	3,998	$	3,118
Earnings per common share - Basic and diluted
Basic and diluted net income per common share	$	0.34	$	0.25
Net income	$	0.34	$	0.25

Dividends paid per common share	$	0.12	$	0.12

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)


	For Three Months Ended
	March 31,
(In thousands)	2021		2020
Net income	$	3,998	$	3,118

Other comprehensive (loss) income:
Investment securities:
Unrealized holding (losses) gains on available-for-sale-securities		(1,075)		1,714
Tax effect		293		(468)

Amortization of unrealized loss on securities transferred from available-for-sale to held-to-maturity		—		8
Tax effect		—		(3)
Total other comprehensive (loss) income		(782)		1,251
Comprehensive income	$	3,216	$	4,369

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

For the Three months Ended March 31, 2021 and 2020


							Accumulated
			Additional				Other		Total
	Common		Paid in		Retained		Comprehensive		Stockholders’
(In thousands)	Stock		Capital		Earnings		Income		Equity
Balances, January 1, 2021	$	118	$	52,167	$	141,205	$	1,529	$	195,019

Net income		—		—		3,998		—		3,998

Other comprehensive (loss)		—		—		—		(782)		(782)

Retirement of common stock		—		(819)		—		—		(819)

Stock-based compensation		—		97		—		—		97

Cash dividends declared		—		—		(1,409)		—		(1,409)

Balances, March 31, 2021	$	118	$	51,445	$	143,794	$	747	$	196,104


							Accumulated
			Additional				Other		Total
	Common		Paid in		Retained		Comprehensive		Stockholders’
(In thousands)	Stock		Capital		Earnings		Income		Equity
Balances, January 1, 2020	$	125	$	61,045	$	131,425	$	207	$	192,802

Net Income		—		—		3,118		—		3,118

Other comprehensive income		—		—		—		1,251		1,251

Stock-based compensation		—		61		—		—		61

Vesting of restricted stock, net of shares surrendered		—		(39)		—		—		(39)

Cash dividends declared		—		—		(1,499)		—		(1,499)

Balances, March 31, 2020	$	125	$	61,067	$	133,044	$	1,458	$	195,694

See accompanying notes to Consolidated Financial Statements.

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SHORE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)


	For Three Months Ended
	March 31,
(In thousands)	2021		2020

CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	3,998	$	3,118
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of acquisition accounting estimates		(80)		(110)
Provision for credit losses		425		350
Depreciation and amortization		628		620
Net amortization of securities		307		111
Amortization of debt issuance costs		31		—
Stock-based compensation expense		97		61
Deferred income tax (benefit)		(485)		(108)
Losses on sales and valuation adjustments on other real estate owned		—		18
Fair value adjustment on equity securities		18		(1)
Bank owned life insurance income		(253)		(257)
Net changes in:
Accrued interest receivable		607		(215)
Other assets		(1,638)		397
Accrued interest payable		(385)		—
Other liabilities		626		479
Net cash provided by operating activities		3,896		4,463

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal payments of investment securities available for sale		14,173		20,021
Proceeds from maturities and principal payments of investment securities held to maturity		1,093		105
Purchases of securities held to maturity		(61,406)		—
Purchases of equity securities		(5)		(7)
Net change in loans		(7,416)		(28,739)
Purchases of premises and equipment		(711)		(1,397)
Proceeds from sales of other real estate owned		—		18
Net redemption (purchase) of restricted securities		437		(73)
Purchases of bank owned life insurance		(10,071)		—
Net cash (used in) investing activities		(63,906)		(10,072)


CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Noninterest-bearing deposits		24,732		(1,564)
Interest-bearing deposits		75,224		9,055
Short-term borrowings		2,451		936
Common stock dividends paid		(1,409)		(1,499)
Retirement of common stock		(819)		—
Repurchase of shares for tax withholding on exercised options and vested restricted stock		—		(39)
Net cash provided by financing activities		100,179		6,889
Net increase in cash and cash equivalents		40,169		1,280
Cash and cash equivalents at beginning of period		186,917		94,971
Cash and cash equivalents at end of period	$	227,086	$	96,251

Supplemental cash flows information:
Interest paid	$	1,924	$	2,199
Income taxes paid	$	7	$	77
Lease liabilities arising from right-of-use assets	$	2,577	$	419
Unrealized (loss) gain on securities available for sale	$	(1,075)	$	1,714
Transfers from loans to other real estate owned	$	205	$	—
Amortization of unrealized loss on securities transferred from available for sale to held to maturity	$	—	$	8

See accompanying notes to Consolidated Financial Statements.

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Shore Bancshares, Inc.

Notes to Consolidated Financial Statements

For the Three Months Ended March 31, 2021 and 2020

(Unaudited)

Note 1 – Basis of Presentation

The consolidated financial statements include the accounts of Shore Bancshares, Inc. and its subsidiary with all significant intercompany transactions eliminated. The consolidated financial statements conform to accounting principles generally accepted in the United States of America (“GAAP”) and to prevailing practices within the banking industry. The accompanying interim financial statements are unaudited; however, in the opinion of management all adjustments necessary to present fairly the consolidated financial position at March 31, 2021, the consolidated results of income and comprehensive income for the three months ended March 31, 2021 and 2020, changes in stockholders’ equity for the three months ended March 31, 2021 and 2020 and cash flows for the three months ended March 31, 2021 and 2020, have been included. All such adjustments are of a normal recurring nature. The amounts as of December 31, 2020 were derived from the 2020 audited financial statements. The results of operations for the three months ended March 31, 2021 are not necessarily indicative of the results to be expected for any other interim period or for the full year. This Quarterly Report on Form 10-Q should be read in conjunction with the Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2020. For purposes of comparability, certain immaterial reclassifications have been made to amounts previously reported to conform with the current period presentation.

When used in these notes, the term “the Company” refers to Shore Bancshares, Inc. and, unless the context requires otherwise, its consolidated subsidiary, Shore United Bank (the “Bank”).

Risks and Uncertainties

Since the novel coronavirus ("COVID-19") was declared a pandemic in March 2020, COVID-19 has significantly affected our communities, customers, and operations. COVID-19 continues to have a significant impact in 2021, however, the extent of its effects are dependent upon multiple factors, such as the extent of distribution and efficacy of vaccines, COVID-19 variants, pandemic-related restrictions, and government response, among others. As a result, the ultimate effects of COVID-19 over the longer term cannot be reasonably estimated at this time. Risks and uncertainties arising from the pandemic remain, primarily concerning the ability of customers to fulfill their financial obligations to the Company as well as potential operational disruptions and the ability of the Company to generate demand for its products and services. Accordingly, estimates used in the preparation of our financial statements may be subject to significant adjustments in future periods.

Recent Accounting Standards and Other Authoritative Guidance

ASU No. 2016-13 – In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. At the FASB’s October 16, 2019 meeting, the Board affirmed its decision to amend the effective date of this ASU for many companies. Public business entities that are SEC filers, excluding those meeting the smaller reporting company definition, will retain the initial required implementation date of fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. All other entities will be required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. At this time, the Company has established a project management team which meets periodically to discuss and assign roles and responsibilities, key tasks to complete, and a general timeline to be followed for implementation. The team has been working with an advisory consultant and has purchased a vendor model for implementation. Historical data has been collected and uploaded to the new model and the team is in the process of finalizing the methodologies that will be utilized.

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The team is currently running a parallel simulation to its current incurred loss impairment model. The Company is continuing to evaluate the extent of the potential impact of this standard and continues to keep current on evolving interpretations and industry practices via webcasts, publications, conferences, and peer bank meetings.

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

ASU No. 2020-04 – In March 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Inter-bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. At present, the Bank has limited exposure to LIBOR based pricing. LIBOR based loans only comprise 28 loans or 7.9% of the loan portfolio. The Bank is confident it can successfully negotiate a migration to the Secured Overnight Financing Rate (“SOFR”) between now and the implementation date. The Bank will notify customers within 120 days prior to migration to SOFR. The Bank acknowledges the replacement rate will be more volatile based on different countries migrating to different indexes and limited liquidity to support the rate. The Bank further acknowledges the volatility will be greatly influenced by the support provided by the Federal Reserve.

In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early adoption is not permitted. All entities should apply ASU No. 2020-08 on a prospective basis as of the beginning of the period of adoption for existing or newly purchased callable debt securities. The Company does not expect the adoption of ASU 2020-08 to have a material impact on its consolidated financial statements.

Recently Adopted Accounting Developments

ASU No. 2019-12 – In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. The amendments were effective in the first quarter of 2021 for the Company and there was no material impact on the Company’s Consolidated Financial Statements.

ASU No. 2020-01 – In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. The amendments were effective in the first quarter of 2021 for the Company and there was no material impact on the Company’s Consolidated Financial Statements.

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Note 2 – Earnings Per Share

Basic earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period, adjusted for the dilutive effect of potential common stock equivalents (stock-based awards). The following table provides information relating to the calculation of earnings per common share:


	For the Three Months Ended
	March 31,
(In thousands, except per share data)	2021		2020
Net Income	$	3,998	$	3,118
Weighted average shares outstanding - Basic		11,745		12,513
Dilutive effect of common stock equivalents-options		2		5
Weighted average shares outstanding - Diluted		11,747		12,518

Earnings per common share - Basic and Diluted	$	0.34	$	0.25

There were no weighted average common stock equivalents excluded from the calculation of diluted earnings per share for the three months ended March 31, 2021 and 2020.

Note 3 – Investment Securities

The following tables provide information on the amortized cost and estimated fair values of debt securities.


			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
(Dollars in thousands)	Cost		Gains		Losses		Value
Available-for-sale securities:
March 31, 2021
U.S. Government agencies	$	18,583	$	4	$	438	$	18,149
Mortgage-backed		104,492		2,031		569		105,954
Total	$	123,075	$	2,035	$	1,007	$	124,103

December 31, 2020
U.S. Government agencies	$	23,600	$	20	$	83	$	23,537
Mortgage-backed		113,865		2,234		68		116,031
Total	$	137,465	$	2,254	$	151	$	139,568

No available for sale securities were sold during the three months ended March 31, 2021 and 2020.

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			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
(Dollars in thousands)	Cost		Gains		Losses		Value
Held-to-maturity securities:
March 31, 2021
U.S. Government agencies	$	38,409	$	12	$	423	$	37,998
Mortgage-backed		68,067		74		700		67,441
States and political subdivisions		400		1		—		401
Other debt securities		19,053		226		43		19,236
Total	$	125,929	$	313	$	1,166	$	125,076

December 31, 2020
U.S. Government agencies	$	18,893	$	38	$	43	$	18,888
Mortgage-backed		27,347		7		18		27,336
States and political subdivisions		400		1		—		401
Other debt securities		19,066		139		2		19,203
Total	$	65,706	$	185	$	63	$	65,828

Equity securities with an aggregate fair value of $1.4 million at March 31, 2021 and $1.4 million at December 31, 2020 are presented separately on the balance sheet. The fair value adjustment recorded through earnings totaled $(18) thousand for the three months ended March 31, 2021 and $1 thousand for the three months ended March 31, 2020, respectively.

The following tables provide information about gross unrealized losses and fair value by length of time that the individual securities have been in a continuous unrealized loss position at March 31, 2021 and December 31, 2020.


	Less than				More than
	12 Months				12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(Dollars in thousands)	Value		Losses		Value		Losses		Value		Losses
March 31, 2021
Available-for-sale securities:
U.S. Government agencies	$	17,564	$	436	$	223	$	2	$	17,787	$	438
Mortgage-backed		49,427		569		—		—		49,427		569
Total	$	66,991	$	1,005	$	223	$	2	$	67,214	$	1,007

Held-to-maturity securities:
U.S. Government agencies	$	22,082	$	423	$	—	$	—	$	22,082	$	423
Mortgage-backed		49,863		700		—		—		49,863		700
Other debt securities		4,457		43		—		—		4,457		43
Total	$	76,402	$	1,166	$	—	$	—	$	76,402	$	1,166

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	Less than				More than
	12 Months				12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(Dollars in thousands)	Value		Losses		Value		Losses		Value		Losses
December 31, 2020
Available-for-sale securities:
U.S. Government agencies	$	14,919	$	82	$	236	$	1	$	15,155	$	83
Mortgage-backed		11,869		68		—		—		11,869		68
Total	$	26,788	$	150	$	236	$	1	$	27,024	$	151

Held-to-maturity securities:
U.S. Government agencies	$	6,646	$	43	$	—	$	—	$	6,646	$	43
Mortgage-backed		5,093		18		—		—		5,093		18
Other debt securities		498		2		—		—		498		2
Total	$	12,237	$	63	$	—	$	—	$	12,237	$	63

All of the securities with unrealized losses in the portfolio have modest duration risk, low credit risk, and minimal losses when compared to total amortized cost. The unrealized losses on debt securities that exist are the result of market changes in interest rates since original purchase. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost basis, which may be at maturity for debt securities, the Company considers the unrealized losses to be temporary.

There were eighteen available-for-sale securities and nineteen held-to-maturity securities in an unrealized loss position at March 31, 2021.

The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at March 31, 2021.


	Available for sale				Held to maturity
	Amortized				Amortized
(Dollars in thousands)	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	—	$	—	$	—	$	—
Due after one year through five years		1,174		1,214		7,919		7,968
Due after five years through ten years		57,863		59,015		37,492		37,403
Due after ten years		64,038		63,874		80,518		79,705
Total	$	123,075	$	124,103	$	125,929	$	125,076

The maturity dates for debt securities are determined using contractual maturity dates.

Note 4 – Loans and Allowance for Credit Losses

The Company makes residential mortgage, commercial and consumer loans to customers primarily in Talbot County, Queen Anne’s County, Kent County, Caroline County, Dorchester County, Worcester County, Baltimore County and

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Howard County in Maryland, Kent County, Delaware and Accomack County, Virginia. The following table provides information about the principal classes of the loan portfolio at March 31, 2021 and December 31, 2020.


(Dollars in thousands)	March 31, 2021		December 31, 2020
Construction	$	115,971	$	106,760
Residential real estate		449,651		443,542
Commercial real estate		641,155		661,232
Commercial		218,923		211,256
Consumer		35,822		31,466
Total loans		1,461,522		1,454,256
Allowance for credit losses		(14,313)		(13,888)
Total loans, net	$	1,447,209	$	1,440,368

Loans are stated at their principal amount outstanding net of any purchase premiums/discounts, deferred fees and costs. Loans included deferred fees, net of costs, of $751 thousand and discounts on acquired loans of $677 thousand at March 31, 2021. Loans included deferred costs, net of deferred fees, of $622 thousand and discounts on acquired loans of $754 thousand at December 31, 2020. At March 31, 2021 and December 31, 2020, included in total loans were $44.6 million and $52.3 million in loans, respectively, acquired as part of the NWBI branch acquisition in 2017. Interest income on loans is accrued at the contractual rate based on the principal amount outstanding. Fees charged and costs capitalized for originating loans are being amortized substantially on the interest method over the term of the loan. A loan is placed on nonaccrual (i.e., interest income is no longer accrued) when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more, unless the loan is well secured and in the process of collection. Any unpaid interest previously accrued on those loans is reversed from income.

Interest payments received on nonaccrual loans are applied as a reduction of the loan principal balance unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

A loan is considered impaired if it is probable that the Company will not collect all principal and interest payments according to the loan’s contractual terms when due. An impaired loan may show deficiencies in the borrower’s overall financial condition, payment history, support available from financial guarantors and/or the fair market value of collateral. The impairment of a loan is measured at the present value of expected future cash flows using the loan’s effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Generally, the Company measures impairment on such loans by reference to the fair value of the collateral. Once the amount of impairment has been determined, the uncollectible portion is charged off. Loan payments received on nonaccrual impaired loans are generally applied to the outstanding principal balance. In certain circumstances, income may be recognized on a cash basis. Generally, interest income is not recognized on impaired loans unless the likelihood of further loss is remote. The allowance for credit losses may include specific reserves related to impaired loans. Specific reserves remain until charge offs are made. Impaired loans do not include groups of smaller balance homogenous loans such as residential mortgage and consumer installment loans that are evaluated collectively for impairment. Reserves for probable credit losses related to these loans are based on historical loss ratios and are included in the formula portion of the allowance for credit losses.

A loan is considered a TDR if a borrower is experiencing financial difficulties and a creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Loans are identified to be restructured when signs of impairment arise such as borrower interest rate reduction request, slowness to pay, or when an inability to repay becomes evident. The terms being offered are evaluated to determine if they are more liberal than those that would be indicated by policy or industry standards for similar, untroubled credits. In those situations where the terms or the interest rates are considered to be more favorable than industry standards or the Bank’s current underwriting guidelines the loan is classified as a TDR. All loans designated as TDRs are considered impaired loans and may be on either accrual or nonaccrual status. In instances where the loan has been placed on nonaccrual status, six consecutive months of timely payments are required prior to returning the loan to accrual status.

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All loans classified as TDRs which are restructured and accrue interest under revised terms require a full and comprehensive review of the borrower’s financial condition, capacity for repayment, realistic assessment of collateral values, and the assessment of risk entered into any workout agreement. Current financial information on the borrower, guarantor, and underlying collateral is analyzed to determine if it supports the ultimate collection of principal and interest. For commercial loans, the cash flows are analyzed, both for the underlying project and globally. For consumer loans, updated salary, credit history and cash flow information is obtained. Current market conditions are also considered. Following a full analysis, the determination of the appropriate loan structure is made.

In 2020, the Company began its participation in the Paycheck Protection Program (PPP). The PPP commenced subsequent to the passage of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act in March 2020, and was later expanded by the Paycheck Protection Program and Health Care Enhancement Act of April 2020. The PPP was designed to provide U.S. small businesses with cash-flow assistance during the COVID-19 pandemic through loans that are fully guaranteed by the Small Business Administration (SBA) which may be forgiven upon satisfaction of certain criteria. As of March 31, 2021, the Company held PPP loans with a total outstanding balance of $129.1 million, which is included in the commercial loan segment in the table above. As compensation for originating the loans, the Company received lender processing fees from the SBA, which were deferred, along with the related loan origination costs. These net fees are being accreted to interest income over the remaining contractual lives of the loans. Upon forgiveness of a PPP loan and repayment by the SBA, which may be prior to the loan’s maturity, the remainder of any unrecognized net fees are recognized as interest income. The Company has continued to participate in the newest round of the PPP during the first quarter of 2021.

In the normal course of banking business, risks related to specific loan categories are as follows:

Construction loans – Construction loans are offered primarily to builders and individuals to finance the construction of single-family dwellings. In addition, the Bank periodically finances the construction of commercial projects. Credit risk factors include the borrower’s ability to successfully complete the construction on time and within budget, changing market conditions which could affect the value and marketability of projects, changes in the borrower’s ability or willingness to repay the loan and potentially rising interest rates which can impact both the borrower’s ability to repay and the collateral value.

Residential real estate – Residential real estate loans are typically made to consumers and are secured by residential real estate. Credit risk arises from the borrower’s continuing financial stability, which can be adversely impacted by job loss, divorce, illness, or personal bankruptcy, among other factors. Also impacting credit risk would be a shortfall in the value of the residential real estate in relation to the outstanding loan balance in the event of a default or subsequent liquidation of the real estate collateral.

Commercial real estate – Commercial real estate loans consist of both loans secured by owner occupied properties and non-owner occupied properties where an established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of occupancy and cash flow. These loans are subject to adverse changes in the local economy and commercial real estate markets. Credit risk associated with owner occupied properties arises from the borrower’s financial stability and the ability of the borrower and the business to repay the loan. Non-owner occupied properties carry the risk of a tenant’s deteriorating credit strength, lease expirations in soft markets and sustained vacancies which can adversely impact cash flow.

Commercial – Commercial loans are secured or unsecured loans for business purposes. Loans are typically secured by accounts receivable, inventory, equipment and/or other assets of the business. Credit risk arises from the successful operation of the business which may be affected by competition, rising interest rates, regulatory changes and adverse conditions in the local and regional economy.

Consumer – Consumer loans include home equity loans and lines, installment loans and personal lines of credit. Credit risk is similar to residential real estate loans above as it is subject to the borrower’s continuing financial stability and the value of the collateral securing the loan.

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The following tables include impairment information relating to loans and the allowance for credit losses as of March 31, 2021 and December 31, 2020.


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
March 31, 2021
Loans individually evaluated for impairment	$	329	$	5,281	$	6,638	$	248	$	28	$	12,524
Loans collectively evaluated for impairment		115,642		444,370		634,517		218,675		35,794		1,448,998
Total loans	$	115,971	$	449,651	$	641,155	$	218,923	$	35,822	$	1,461,522

Allowance for credit losses allocated to:
Loans individually evaluated for impairment	$	—	$	95	$	—	$	—	$	—	$	95
Loans collectively evaluated for impairment		2,796		3,604		5,097		2,000		721		14,218
Total allowance	$	2,796	$	3,699	$	5,097	$	2,000	$	721	$	14,313


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
December 31, 2020
Loans individually evaluated for impairment	$	331	$	5,722	$	6,917	$	258	$	28	$	13,256
Loans collectively evaluated for impairment		106,429		437,820		654,315		210,998		31,438		1,441,000
Total loans	$	106,760	$	443,542	$	661,232	$	211,256	$	31,466	$	1,454,256

Allowance for credit losses allocated to:
Loans individually evaluated for impairment	$	—	$	135	$	78	$	—	$	—	$	213
Loans collectively evaluated for impairment		2,022		3,564		5,348		2,089		652		13,675
Total allowance	$	2,022	$	3,699	$	5,426	$	2,089	$	652	$	13,888

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The following tables provide information on impaired loans and any related allowance by loan class as of March 31, 2021 and December 31, 2020. The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken and interest paid on nonaccrual loans that has been applied to principal.



			Recorded		Recorded
	Unpaid		investment		investment				Quarter-to-date		Interest
	principal		with no		with an		Related		average recorded		recorded
(Dollars in thousands)	balance		allowance		allowance		allowance		investment		investment
March 31, 2021
Impaired nonaccrual loans:
Construction	$	297	$	297	$	—	$	—	$	297	$	—
Residential real estate		1,309		1,222		—		—		1,411		—
Commercial real estate		4,085		3,085		—		—		3,012		—
Commercial		396		248		—		—		251		—
Consumer		28		28		—		—		28		—
Total	$	6,115	$	4,880	$	—	$	—	$	4,999	$	—

Impaired accruing TDRs:
Construction	$	32	$	32	$	—	$	—	$	33	$	—
Residential real estate		3,381		2,250		1,131		95		3,530		40
Commercial real estate		3,043		3,043		—		—		3,065		23
Commercial		—		—		—		—		—		—
Consumer		—		—		—		—		—		—
Total	$	6,456	$	5,325	$	1,131	$	95	$	6,628	$	63

Other impaired accruing loans:
Construction	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate		678		678		—		—		853		5
Commercial real estate		510		510		—		—		510		1
Commercial		—		—		—		—		50		—
Consumer		—		—		—		—		—		—
Total	$	1,188	$	1,188	$	—	$	—	$	1,413	$	6

Total impaired loans:
Construction	$	329	$	329	$	—	$	—	$	330	$	—
Residential real estate		5,368		4,150		1,131		95		5,794		45
Commercial real estate		7,638		6,638		—		—		6,587		24
Commercial		396		248		—		—		301		—
Consumer		28		28		—		—		28		—
Total	$	13,759	$	11,393	$	1,131	$	95	$	13,040	$	69

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			Recorded		Recorded				March 31, 2020
	Unpaid		investment		investment				Quarter-to-date		Interest
	principal		with no		with an		Related		average recorded		income
(Dollars in thousands)	balance		allowance		allowance		allowance		investment		recognized
December 31, 2020
Impaired nonaccrual loans:
Construction	$	297	$	297	$	—	$	—	$	99	$	—
Residential real estate		1,665		1,585		—		—		2,871		—
Commercial real estate		4,288		3,220		67		67		7,352		—
Commercial		401		258		—		—		382		—
Consumer		28		28		—		—		—		—
Total	$	6,679	$	5,388	$	67	$	67	$	10,704	$	—

Impaired accruing TDRs:
Construction	$	34	$	34	$	—	$	—	$	39	$	1
Residential real estate		3,845		2,617		1,228		135		4,023		38
Commercial real estate		3,118		2,479		639		11		3,406		24
Commercial		—		—		—		—		—		—
Consumer		—		—		—		—		—		—
Total	$	6,997	$	5,130	$	1,867	$	146	$	7,468	$	63

Other impaired accruing loans:
Construction	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate		292		292		—		—		—		—
Commercial real estate		512		512		—		—		—		—
Commercial		—		—		—		—		—		—
Consumer		—		—		—		—		—		—
Total	$	804	$	804	$	—	$	—	$	—	$	—

Total impaired loans:
Construction	$	331	$	331	$	—	$	—	$	138	$	1
Residential real estate		5,802		4,494		1,228		135		6,894		38
Commercial real estate		7,918		6,211		706		78		10,758		24
Commercial		401		258		—		—		382		—
Consumer		28		28		—		—		—		—
Total	$	14,480	$	11,322	$	1,934	$	213	$	18,172	$	63

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The following tables provide a roll-forward for TDRs as of March 31, 2021 and March 31, 2020.


	1/1/2021												3/31/2021
	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For three months ended
March 31, 2021
Accruing TDRs
Construction	$	34	$	—	$	(2)	$	—	$	—	$	—	$	32	$	—
Residential real estate		3,845		—		(29)		—		—		(435)		3,381		95
Commercial real estate		3,118		—		(75)		—		—		—		3,043		—
Commercial		—		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—		—
Total	$	6,997	$	—	$	(106)	$	—	$	—	$	(435)	$	6,456	$	95

Nonaccrual TDRs
Construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate		—		—		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—		—		—
Commercial		258		—		(10)		—		—		—		248		—
Consumer		—		—		—		—		—		—		—		—
Total	$	258	$	—	$	(10)	$	—	$	—	$	—	$	248	$	—

Total	$	7,255	$	—	$	(116)	$	—	$	—	$	(435)	$	6,704	$	95


	1/1/2020												3/31/2020
	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For three months ended
March 31, 2020
Accruing TDRs
Construction	$	41	$	—	$	(3)	$	—	$	—	$	—	$	38	$	—
Residential real estate		4,041		—		(28)		—		—		—		4,013		174
Commercial real estate		3,419		—		(26)		—		—		—		3,393		18
Commercial		—		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—		—
Total	$	7,501	$	—	$	(57)	$	—	$	—	$	—	$	7,444	$	192

Nonaccrual TDRs
Construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate		1,393		—		(26)		—		—		—		1,367		94
Commercial real estate		—		1,506		(344)		—		—		—		1,162		—
Commercial		299		—		(10)		—		—		—		289		—
Consumer		—		—		—		—		—		—		—		—
Total	$	1,692	$	1,506	$	(380)	$	—	$	—	$	—	$	2,818	$	94

Total	$	9,193	$	1,506	$	(437)	$	—	$	—	$	—	$	10,262	$	286

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There were no loans modified and considered to be TDRs during the three months ended March 31, 2021 and 1 loan modified and considered to be TDR during the three months ended March 31, 2020. The following tables provide information on loans that were modified and considered to be TDRs during the three months ended March 31, 2021 and March 31, 2020.


		Premodification		Postmodification
		outstanding		outstanding
	Number of	recorded		recorded		Related
(Dollars in thousands)	contracts	investment		investment		allowance
TDRs:
For three months ended
March 31, 2021
Construction	—	$	—	$	—	$	—
Residential real estate	—		—		—		—
Commercial real estate	—		—		—		—
Commercial	—		—		—		—
Consumer	—		—		—		—
Total	—	$	—	$	—	$	—

For three months ended
March 31, 2020
Construction	—	$	—	$	—	$	—
Residential real estate	—		—		—		—
Commercial real estate	1		1,535		1,506		—
Commercial	—		—		—		—
Consumer	—		—		—		—
Total	1	$	1,535	$	1,506	$	—

For the three months ended March 31, 2021, the Company had executed principal and/or interest deferrals on outstanding loan balances of $221.1 million, of which only $16.1 million, or 1.10% of the total portfolio remained on deferral as of March 31, 2021. These deferrals were no more than six months in duration and were for loans not more than 30 days past due as of March 31, 2021. As such, they were not considered TDRs based on the relief provisions of the CARES Act and recent interagency regulatory guidance.

There were no TDRs which subsequently defaulted within 12 months of modification for the three months ended March 31, 2021 and 2020. Generally, a loan is considered in default when principal or interest is past due 90 days or more, the loan is placed on nonaccrual, the loan is charged off, or there is a transfer to OREO or repossessed assets.

Management uses risk ratings as part of its monitoring of the credit quality in the Company’s loan portfolio. Loans that are identified as special mention, substandard or doubtful are adversely rated. These loans and the pass/watch loans are assigned higher qualitative factors than favorably rated loans in the calculation of the formula portion of the allowance for credit losses. At March 31, 2021, there were no nonaccrual loans classified as special mention or doubtful and $4.9 million of nonaccrual loans were classified as substandard. Similarly, at December 31, 2020, there were no nonaccrual loans classified as special mention or doubtful and $5.5 million of nonaccrual loans were classified as substandard.

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The following tables provide information on loan risk ratings as of March 31, 2021 and December 31, 2020.

Special

(Dollars in thousands)

Pass/Performing

Pass/Watch

Mention

Substandard

Doubtful

Total

March 31, 2021

Construction

91,439

22,279

1,956

297

—

115,971

Residential real estate

409,929

34,871

2,900

1,951

—

449,651

Commercial real estate

490,787

139,634

1,711

9,023

—

641,155

Commercial

193,713

22,251

2,698

261

—

218,923

Consumer

35,587

205

—

35,822

Total

1,221,455

219,240

9,265

11,562

—

1,461,522


					Special
(Dollars in thousands)	Pass/Performing		Pass/Watch		Mention		Substandard		Doubtful		Total
December 31, 2020
Construction	$	81,926	$	22,547	$	1,990	$	297	$	—	$	106,760
Residential real estate		401,494		36,759		2,946		2,343		—		443,542
Commercial real estate		514,524		133,892		3,504		9,312		—		661,232
Commercial		182,166		25,870		2,948		272		—		211,256
Consumer		31,221		215		—		30		—		31,466
Total	$	1,211,331	$	219,283	$	11,388	$	12,254	$	—	$	1,454,256

The following tables provide information on the aging of the loan portfolio as of March 31, 2021 and December 31, 2020.

Accruing

30‑59 days

60‑89 days

Greater than

Total

(Dollars in thousands)

Current

past due

90 days

past due

Nonaccrual

Total

March 31, 2021

Construction

115,642

—

297

115,971

Residential real estate

447,208

505

678

1,221

1,222

449,651

Commercial real estate

637,197

363

—

510

873

3,085

641,155

Commercial

218,532

143

—

143

248

218,923

Consumer

35,779

—

35,822

Total

1,454,358

1,058

1,188

2,284

4,880

1,461,522

Percent of total loans

99.5

0.1

—

0.1

0.2

0.3

100.0


	Accruing
				30‑59 days			60‑89 days			Greater than			Total
(Dollars in thousands)	Current			past due			past due			90 days			past due			Nonaccrual			Total
December 31, 2020
Construction	$	106,463		$	—		$	—		$	—		$	—		$	297		$	106,760
Residential real estate		440,210			517			938			292			1,747			1,585			443,542
Commercial real estate		657,066			367			—			512			879			3,287			661,232
Commercial		210,704			226			68			—			294			258			211,256
Consumer		31,318			119			1			—			120			28			31,466
Total	$	1,445,761		$	1,229		$	1,007		$	804		$	3,040		$	5,455		$	1,454,256
Percent of total loans		99.3	%		0.1	%		0.1	%		0.1	%		0.3	%		0.4	%		100.0	%

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The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three months ended March 31, 2021 and March 31, 2020. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer

Total

For three months ended

March 31, 2021

Allowance for credit losses:

Beginning Balance

2,022

3,699

5,426

2,089

652

13,888

Charge-offs

—

(61)

(4)

(65)

Recoveries

—

Net (charge-offs) recoveries

—

(9)

(2)

—

Provision

769

(6)

(329)

(80)

425

Ending Balance

2,796

3,699

5,097

2,000

721

14,313


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
For three months ended
March 31, 2020
Allowance for credit losses:
Beginning Balance	$	1,576	$	2,501	$	4,032	$	1,929	$	469	$	10,507

Charge-offs		—		(191)		(271)		(82)		(7)		(551)
Recoveries		3		3		1		63		2		72
Net (charge-offs) recoveries		3		(188)		(270)		(19)		(5)		(479)

Provision		(451)		169		203		353		76		350
Ending Balance	$	1,128	$	2,482	$	3,965	$	2,263	$	540	$	10,378

Foreclosure Proceedings

There were no consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure as of March 31, 2021 and December 31, 2020, respectively. There was 1 residential real estate property included in the balance of other real estate owned totaling $205 thousand at March 31, 2021 and $0 at December 31, 2020.

All accruing TDRs were in compliance with their modified terms. Both performing and non-performing TDRs had no further commitments associated with them as of March 31, 2021 and December 31, 2020.

Note 5 – Leases

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company’s long-term lease agreements are classified as operating leases. Certain leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably certain of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

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The following tables present information about the Company’s leases:


(Dollars in thousands)	March 31, 2021			December 31, 2020
Lease liabilities	$	7,329		$	4,874
Right-of-use assets	$	7,229		$	4,795
Weighted average remaining lease term		15.47	years		10.49	years
Weighted average discount rate		2.77	%		2.89	%


	For the Three Months Ended		For the Three Months Ended
Lease cost (in thousands)	March 31, 2021		March 31, 2020
Operating lease cost	$	188	$	180
Short-term lease cost		—		—
Total lease cost	$	188	$	180

Cash paid for amounts included in the measurement of lease liabilities	$	167	$	164

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows:


	As of
Lease payments due (in thousands)	March 31, 2021
Nine months ending December 31, 2021	$	524
Twelve months ending December 31, 2022		524
Twelve months ending December 31, 2023		760
Twelve months ending December 31, 2024		729
Twelve months ending December 31, 2025		697
Twelve months ending December 31, 2026		561
Thereafter		5,839
Total undiscounted cash flows	$	9,634
Discount		2,305
Lease liabilities	$	7,329

Note 6 – Goodwill and Other Intangibles

The Company concluded there was no impairment of goodwill during its annual fourth quarter assessment in 2020. Following the fourth quarter evaluation, management evaluated the events and circumstances that could indicate that goodwill may be impaired and concluded that an interim test was not necessary. The Company will continue to monitor the impact of COVID-19 on the Company as well as the financial markets in evaluating the necessity of interim testing during 2021.

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The following table provides information on the significant components of goodwill and other acquired intangible assets at March 31, 2021 and December 31, 2020.

March 31, 2021

Weighted

Gross

Accumulated

Net

Average

Carrying

Impairment

Accumulated

Carrying

Remaining Life

(Dollars in thousands)

Amount

Charges

Amortization

Amount

(in years)

Goodwill

19,728

(1,543)

(667)

17,518

—

Other intangible assets

Amortizable

Core deposit intangible

3,954

—

(2,361)

1,593

4.1

Total other intangible assets

3,954

—

(2,361)

1,593


December 31, 2020
									Weighted
	Gross			Accumulated			Net		Average
	Carrying		Impairment			Accumulated	Carrying		Remaining Life
(Dollars in thousands)	Amount		Charges			Amortization	Amount		(in years)

Goodwill	$	19,728	$	(1,543)	$	(667)	$	17,518		—

Other intangible assets
Amortizable
Core deposit intangible	$	3,954	$	—	$	(2,235)	$	1,719		4.7
Total other intangible assets	$	3,954	$	—	$	(2,235)	$	1,719

The aggregate amortization expense was $126 thousand for the three months ended March 31, 2021 and $144 thousand for the three months ended March 31, 2020.

At March 31, 2021, estimated future remaining amortization for amortizing intangibles within the years ending December 31, is as follows:


(Dollars in thousands)	Amortization Expense
2021	$	335
2022		389
2023		317
2024		246
2025		174
2026		102
Thereafter		30
Total amortizing intangible assets	$	1,593

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Note 7 – Other Assets

The Company had the following other assets at March 31, 2021 and December 31, 2020.


	March 31,		December 31,
(Dollars in thousands)	2021		2020
Accrued interest receivable	$	6,009	$	6,616
Deferred income taxes		5,221		4,442
Prepaid expenses		1,694		1,472
Cash surrender value on life insurance		41,343		31,018
Income taxes receivable		—		156
Other assets		4,613		3,075
Total	$	58,880	$	46,779

The following table provides information on significant components of the Company’s deferred tax assets and liabilities as of March 31, 2021 and December 31, 2020.


	March 31,		December 31,
(Dollars in thousands)	2021		2020
Deferred tax assets:
Allowance for credit losses	$	3,834	$	3,721
Write-downs of other real estate owned		12		12
Nonaccrual loan interest		258		367
Other		2,702		2,152
Total deferred tax assets		6,806		6,252
Less valuation allowance		(214)		(169)
Deferred tax assets, net of valuation allowance		6,592		6,083
Deferred tax liabilities:
Depreciation		169		177
Acquisition accounting adjustments		631		580
Deferred capital gain on branch sale		185		187
Unrealized gains on available-for-sale securities		273		567
Other		113		130
Total deferred tax liabilities		1,371		1,641
Net deferred tax assets	$	5,221	$	4,442

Note 8 - Subordinated Debt

On August 25, 2020, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which the Company issued and sold $25.0 million in aggregate principal amount with an initial interest rate of 5.375% Fixed-to-Floating Rate Subordinated Notes due September 1, 2030.

The Company plans to use the net proceeds of this offering for general corporate purposes, organic growth and to support the Bank’s regulatory capital ratios. The Notes were structured to qualify as Tier 2 capital for regulatory capital purposes and bear an initial interest rate of 5.375% until September 1, 2025, with interest during this period payable semi-annually in arrears. From and including September 1, 2025, to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month SOFR, plus 526.5 basis points, with interest during this period payable quarterly in arrears. The Notes are redeemable by the Company at its option, in whole or in part, on or after September 1, 2025. Initial debt issuance costs were $611 thousand. The debt balance of $24.5 million is presented net of unamortized issuance costs of $540 thousand at March 31, 2021.

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Note 9 – Other Liabilities

The Company had the following other liabilities at March 31, 2021 and December 31, 2020.


(Dollars in thousands)	March 31, 2021		December 31, 2020
Accrued interest payable	$	261	$	647
Deferred compensation liability		3,374		2,905
Income taxes payable		1,765		—
Other liabilities		2,201		3,686
Total	$	7,601	$	7,238

Note 10 - Stock-Based Compensation

At the 2016 annual meeting, stockholders approved the Shore Bancshares, Inc. 2016 Stock and Incentive Plan (“2016 Equity Plan”), replacing the Shore Bancshares, Inc. 2006 Stock and Incentive Plan (“2006 Equity Plan”), which expired on that date. The Company may issue shares of common stock or grant other equity-based awards pursuant to the 2016 Equity Plan. Stock-based awards granted to date generally are time-based, vest in equal installments on each anniversary of the grant date and range over a one- to five-year period of time, and, in the case of stock options, expire 10 years from the grant date. As part of the 2016 Equity Plan, a performance equity incentive award program, known as the “Long-term incentive plan” allows participating officers of the Company to earn incentive awards of performance share/restricted stock units if certain pre-determined targets are achieved at the end of a three-year performance cycle. Stock-based compensation expense based on the grant date fair value is recognized ratably over the requisite service period for all awards and reflects forfeitures as they occur. The 2016 Equity Plan originally reserved 750,000 shares of common stock for grant, and 583,831 shares remained available for grant at March 31, 2021.

The following tables provide information on stock-based compensation expense for the three months ended March 31, 2021 and 2020.


	For Three Months Ended
	March 31,
(Dollars in thousands)	2021		2020
Stock-based compensation expense	$	97	$	61
Excess tax benefits related to stock-based compensation		3		7


	March 31,
(Dollars in thousands)	2021			2020
Unrecognized stock-based compensation expense	$	329		$	257
Weighted average period unrecognized expense is expected to be recognized		0.8	years		1.8	years

The following table summarizes restricted stock award activity for the Company under the 2016 Equity Plan for the three months ended March 31, 2021.


	Three Months Ended March 31, 2021
		Weighted Average
	Number of	Grant Date
	Shares	Fair Value
Nonvested at beginning of period	24,505	$	13.78
Granted	24,583		13.34
Vested	(16,333)		14.09
Forfeited	—		—
Nonvested at end of period	32,755	$	13.22

The fair value of restricted stock awards that vested during the first three months of 2021 and 2020 was $230 thousand and $254 thousand, respectively.

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The following table summarizes stock option activity for the Company under the 2016 Equity Plan for the three months ended March 31, 2021.


	Three Months Ended March 31, 2021
		Weighted Average
	Number of	Grant Date
	Shares	Exercise Price
Outstanding at beginning of period	2,709	$	6.64
Granted	—		—
Exercised	—		—
Expired/Cancelled	—		—
Outstanding at end of period	2,709	$	6.64

Exercisable at end of period	2,709	$	6.64

There were no stock options granted during the three months ended March 31, 2021 and March 31, 2020.

At the end of the first quarter of 2021, the aggregate intrinsic value of the options outstanding under the 2016 Equity Plan was $28 thousand based on the $17.02 market value per share of the Company’s common stock at March 31, 2021. Similarly, the aggregate intrinsic value of the options exercisable was $28 thousand at March 31, 2021. At March 31, 2021, the weighted average remaining contract life of options outstanding and exercisable was 1 year.

Note 11 – Accumulated Other Comprehensive Income

The Company records unrealized holding gains (losses), net of tax, on investment securities available for sale as accumulated other comprehensive income (loss), a separate component of stockholders’ equity. The following table provides information on the changes in the components of accumulated other comprehensive income (loss) for the three months ended March 31, 2021 and 2020.


			Unrealized gains
			(losses) on securities
	Unrealized		transferred from		Accumulated
	gains (losses) on		Available-for-sale		other
	available for sale		to		comprehensive
(Dollars in thousands)	securities		Held-to-maturity		income (loss)
Balance, December 31, 2020	$	1,529	$	—	$	1,529
Other comprehensive loss		(782)		—		(782)
Balance, March 31, 2021	$	747	$	—	$	747

Balance, December 31, 2019	$	218	$	(11)	$	207
Other comprehensive income		1,246		5		1,251
Balances, March 31, 2020	$	1,464	$	(6)	$	1,458

Note 12 – Fair Value Measurements

Accounting guidance under GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This accounting guidance also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as

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impaired loans, loans held for sale and other real estate owned (foreclosed assets). These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Under fair value accounting guidance, assets and liabilities are grouped at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine their fair values. These hierarchy levels are:

Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Below is a discussion on the Company’s assets measured at fair value on a recurring basis.

Investment Securities Available for Sale

Fair value measurement for investment securities available for sale is based on quoted prices from an independent pricing service. The fair value measurements consider observable data that may include present value of future cash flows, prepayment assumptions, credit loss assumptions and other factors. The Company classifies its investments in U.S. Treasury securities, if any, as Level 1 in the fair value hierarchy, and it classifies its investments in U.S. Government agencies securities and mortgage-backed securities issued or guaranteed by U.S. Government sponsored entities as Level 2.

Equity Securities

Fair value measurement for equity securities is based on quoted market prices retrieved by the Company via on-line resources. Although these securities have readily available fair market values, the Company determined that they should be classified as level 2 investments in the fair value hierarchy due to not being considered traded in a highly active market.

The tables below present the recorded amount of assets measured at fair value on a recurring basis at March 31, 2021 and December 31, 2020. No assets were transferred from one hierarchy level to another during the first three months of 2021 or 2020.

Significant

Other

Significant

Quoted

Observable

Unobservable

Prices

Inputs

(Dollars in thousands)

Fair Value

(Level 1)

(Level 2)

(Level 3)

March 31, 2021

Securities available for sale:

U.S. Government agencies

18,149

—

18,149

—

Mortgage-backed

105,954

—

105,954

—

124,103

—

124,103

—

Equity

1,382

—

1,382

—

Total

125,485

—

125,485

—

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					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2020
Securities available for sale:
U.S. Government agencies	$	23,537	$	—	$	23,537	$	—
Mortgage-backed		116,031		—		116,031		—
		139,568		—		139,568		—

Equity		1,395		—		1,395		—
Total	$	140,963	$	—	$	140,963	$	—

Below is a discussion on the Company’s assets measured at fair value on a nonrecurring basis.

Impaired Loans

Loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts according to the contractual terms of the loan agreement when due. Loan impairment is measured using the present value of expected cash flows, the loan’s observable market price or the fair value of the collateral (less selling costs) if the loans are collateral dependent and these are considered Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of business equipment, inventory and accounts receivable, discounted on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business.

Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those techniques applied in prior periods.

Other Real Estate Owned (Foreclosed Assets)

Foreclosed assets are adjusted for fair value upon transfer of loans to foreclosed assets establishing a new cost basis. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. The estimated fair value for foreclosed assets included in Level 3 are determined by independent market based appraisals and other available market information, less costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of the collateral deteriorates subsequent to the initial recognition, the Company records the foreclosed asset as a non-recurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods.

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The following tables set forth the Company’s financial and nonfinancial assets subject to fair value adjustments (impairment) on a nonrecurring basis at March 31, 2021 and December 31, 2020, that are valued at the lower of cost or market. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


	Quantitative Information about Level 3 Fair Value Measurements
								Weighted
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range	Average (3)
March 31, 2021
Nonrecurring measurements:

Impaired loans	$	617	Appraisal of collateral	(1)	Liquidation expense	(2)	10%	(10%)

Impaired loans	$	419	Discounted cash flow analysis	(1)	Discount rate		4% - 7.25%	(6%)

Other real estate owned	$	205	Appraisal of collateral	(1)	Appraisal adjustments	(2)	0% - 19%	(0%)


	Quantitative Information about Level 3 Fair Value Measurements
								Weighted
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range	Average (3)
December 31, 2020
Nonrecurring measurements:

Impaired loans	$	610	Appraisal of collateral	(1)	Liquidation expense	(2)	10%	(10%)

Impaired loans	$	1,110	Discounted cash flow analysis	(1)	Discount rate		6% - 7.25%	(6%)

Other real estate owned	$	—	Appraisal of collateral	(1)	Appraisal adjustments	(2)	0% - 19%	(19%)

(1)Fair value is generally determined through independent appraisals of the underlying collateral (impaired loans and OREO) or discounted cash flow analyses (impaired loans), which generally include various level III inputs which are not identifiable.

(2)Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

(3)Unobservable inputs were weighted by the relative fair value of the instruments.

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The carrying amounts and estimated fair values of the Company’s financial instruments not carried at fair value on the Company’s Consolidated Balance Sheets are presented in the following table. Fair values for March 31, 2021 and December 31, 2020 were estimated using an exit price notion.


	March 31, 2021				December 31, 2020
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	227,086	$	227,086	$	186,917	$	186,917

Level 2 inputs
Investment securities held to maturity	$	125,929	$	125,076	$	65,706	$	65,828
Restricted securities		3,189		3,189		3,626		3,626
Cash surrender value on life insurance		41,343		41,343		31,018		31,018

Level 3 inputs
Loans, net	$	1,447,209	$	1,447,025	$	1,440,368	$	1,436,292

Financial liabilities
Level 2 inputs
Deposits:
Noninterest-bearing demand	$	533,823	$	533,823	$	509,091	$	509,091
Checking plus interest		405,601		405,601		446,243		446,243
Money market		381,461		381,461		292,974		292,974
Savings		202,198		202,198		177,524		177,524
Club		782		782		392		392
Certificates of deposit, $100,000 or more		133,378		135,376		129,623		131,271
Other time		143,393		144,917		144,858		146,137
Securities sold under retail repurchase agreement		3,501		3,501		1,050		1,050
Advances from FHLB - long-term		—		—		—		—
Subordinated debt		24,460		24,869		24,429		25,745

Note 13 – Financial Instruments with Off-Balance Sheet Risk

In the normal course of business, to meet the financial needs of its customers, the Bank is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Letters of credit and other commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the letters of credit and commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements.

The following table provides information on commitments outstanding at March 31, 2021 and December 31, 2020.


(Dollars in thousands)	March 31, 2021		December 31, 2020
Commitments to extend credit	$	244,543	$	248,607
Letters of credit		7,365		7,944
Total	$	251,908	$	256,551

Note 14 – Revenue Recognition

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees and merchant income. Noninterest revenue streams in-scope of Topic 606 are discussed below.

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Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided.

Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or at the end of the month through a direct charge to customers’ accounts.

Trust and Investment Fee Income

Trust and investment fee income are primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end through a direct charge to customers’ accounts. The Company does not earn performance-based incentives.

Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered.

Other Noninterest Income

Other noninterest income consists of: fees, exchange, other service charges, safety deposit box rental fees, and other miscellaneous revenue streams. Fees and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that rentals and renewals of safe deposit boxes will be recognized on a monthly basis consistent with the duration of the performance obligation.

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The following presents noninterest income from continuing operations, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three months ended March 31, 2021 and 2020.


	For Three Months Ended
	March 31,
(Dollars in thousands)	2021		2020
Noninterest Income
In-scope of Topic 606:
Service charges on deposit accounts	$	674	$	866
Trust and investment fee income		407		375
Interchange income		869		652
Other noninterest income		305		280
Noninterest Income (in-scope of Topic 606)		2,255		2,173
Noninterest Income (out-of-scope of Topic 606)		302		179
Total Noninterest Income	$	2,557	$	2,352

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of March 31, 2021, and December 31, 2020, the Company did not have any significant contract balances.

Note 15 – Proposed Merger

On March 3, 2021, the Company and Severn Bancorp, Inc. (“Severn”) entered into a definitive agreement for the Company to acquire the Maryland-based Severn.

This transaction will create the third largest community bank headquartered in Maryland. One of the primary reasons for the proposed acquisition of Severn was the ability to access and deploy excess capital and deposits into a high growth market, while also enhancing scale to drive efficiency and profitability. Additionally, this transaction will create a competitive position in the Columbia/Baltimore/Towson MSA, while filling in our current market footprint.

Under the terms of the agreement, Severn shareholders will receive 0.6207 shares of Shore common stock and $1.59 in cash for each share of Severn common stock. Upon closing, Shore shareholders will own approximately 59.6% of the combined Company and Severn will own approximately 40.4% of the combined Company. The transaction is still subject to satisfaction of customary closing conditions, including regulatory approvals and shareholder approval from Shore and Severn shareholders. The transaction is expected to close in the third quarter of 2021.

As of December 31, 2020, Severn had more than $950 million in assets and operated 7 full-service community banking offices throughout Anne Arundel County, Maryland.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Unless the context clearly suggests otherwise, references to “the Company”, “we”, “our”, and “us” in the remainder of this report are to Shore Bancshares, Inc. and its consolidated subsidiary.

Forward-Looking Information

This Quarterly Report on Form 10-Q contains forward-looking statements. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “project,” “projection,” “forecast,” “goal,” “target,” “would,” “aim” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry and management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. The inclusion of these forward-looking statements should not be regarded as a representation by us or any other person that such expectations, estimates and projections will be achieved. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence. In addition, we cannot assess the impact of each risk and uncertainty on our business or the extent to which any risk or uncertainty, or combination of risks and uncertainties, may cause actual results to differ materially from those contained in any forward-looking statements.

Further, given its ongoing and dynamic nature, it is difficult to predict the full impact of the novel coronavirus (“COVID-19”) outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and how the economy may be fully reopened. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations: the demand for our products and services may decline, making it difficult to grow assets and income; if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income; collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase; our allowance for loan losses may increase if borrowers experience financial difficulties, which will adversely affect our net income; the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; as the result of the decline in the Federal Reserve’s target federal funds rate to near 0%, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income; our cybersecurity risks are increased as the result of an increase in the number of employees working remotely; and FDIC premiums may increase if the agency experiences additional resolution costs.

If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Quarterly Report on Form 10-Q and other reports and registration statements filed by us with the Securities and Exchange Commission (“SEC”). For information on the factors that could cause actual results to differ from the expectations stated in the forward- looking statements, see “Risk Factors” under Part I, Item 1A of our 2020 Form 10-K and other reports as filed with the SEC.

Any forward-looking statement speaks only as of the date of this report, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether because of new information, future developments or otherwise, except as required by law.

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Introduction

The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes presented elsewhere in this report, as well as the audited consolidated financial statements and related notes included in the 2020 Annual Report.

Shore Bancshares, Inc. is the largest independent financial holding company headquartered on the Eastern Shore of Maryland. It is the parent company of Shore United Bank. The Bank operates 22 full-service branches in Baltimore County, Howard County, Kent County, Queen Anne’s County, Talbot County, Caroline County, Dorchester County and Worcester County in Maryland, Kent County, Delaware and Accomack County, Virginia. The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank.

The shares of common stock of Shore Bancshares, Inc. are listed on the NASDAQ Global Select Market under the symbol “SHBI”.

Shore Bancshares, Inc. maintains an Internet site at www.shorebancshares.com on which it makes available free of charge its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

COVID-19 Pandemic

The outbreak of COVID-19 has led to adverse impacts on economic conditions and created uncertainty in financial markets. Correspondingly, in early March 2020, the Company began preparing for potential disruptions and government limitations of activity in the markets in which we serve. Our team activated our Business Continuity Program and was able to quickly execute on multiple initiatives to adjust our operations to protect the health and safety of our employees and clients. Since the beginning of the crisis, we have been in close contact with our clients, assessing the level of impact on their businesses, and providing relief programs according to each client’s specific situation and qualifications. We have also enhanced awareness of digital banking offerings, expanded services at our drive through locations, and allowed customers to make appointments in the branch for critical services. The Company’s branches remain open and have taken steps to comply with various government directives regarding “social distancing,” as well as, enhanced cleaning and disinfecting of all surface areas to protect its clients and employees.

Small Business Administration’s Paycheck Protection Program

We established our process for participating in the Small Business Administration’s Paycheck Protection Program (“PPP”) that enabled our clients to utilize this valuable resource beginning in April 2020. Loans under the PPP are designed to provide assistance for small businesses during the COVID-19 pandemic to help meet the costs associated with payroll, mortgage interest, rent and utilities. These loans are guaranteed by the SBA and forgiveness of the loans, by the SBA, is granted to the borrower if the borrower uses at least 60% of the funds to cover payroll costs and benefits. Forgiveness is also based on the small business maintaining or quickly rehiring their employees and maintaining salary levels for their employees. Loans under the PPP do not require any collateral or personal guarantees, as such, these loans are included in the Company’s commercial loans segment. The first round of PPP lending resulted in 1,488 loans for $126.7 million, of which 387 loans have been forgiven for $52.2 million as of March 31, 2021. The second round of PPP lending which began in 2021, resulted in 660 loans for $54.8 million. As of March 31, 2021, the Company had 1,761 PPP loans totaling $129.1 million that were outstanding, inclusive of loans issued during both the first and second rounds of the PPP. This has allowed us to further strengthen and deepen our client relationships, while positively impacting thousands of individuals. We are also closely monitoring the credit quality of the loan portfolio and monitor lines of credit draws for deviation from normal activity to improve loan performance and reduce credit risk.

Short-term Modifications for Borrowers

In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), the Company is providing modifications

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where appropriate, including interest only payments or payment deferrals for clients that could be adversely affected by the COVID-19 pandemic. Section 4013 of the CARES Act addressed COVID-19 related modifications and specified that such modifications made on loans that were current as of December 31, 2019 are not TDRs. In accordance with interagency guidance issued in April 2020, short-term modifications made to borrowers affected by the COVID-19 pandemic and governmental shutdown orders, such as payment deferrals, fee waivers and extensions of repayment terms, do not need to be identified as TDRs if the loans were current at the time a modification plan was implemented. For the three months ended March 31, 2021, the Company had executed principal and/or interest deferrals on outstanding loan balances of $221.1 million, of which only $16.1 million, or 1.10% of the total portfolio remained on deferral as of March 31, 2021.


							Loans
					Loans Modified		Modified to
	Total Loan		Total Loans		to Interest		Payment		Percentage
	Balance as of		Modified as of		Only Payments		Deferral		of Loans
(Dollars in thousands)	March 31, 2021		March 31, 2021		(6 months or less)		(3 months)		Modified
Hospitality Industry	$	115,021	$	1,355	$	1,355	$	-	1.18	%
Non-owner occupied Retail Stores		135,787		13,250		13,250		-	9.76
Non-owner occupied Restaurants		11,858		-		-		-	—
Owner-occupied Retail Stores		13,463		-		-		-	—
Owner-occupied Restaurants		8,933		80		80		-	0.90
Oil & Gas Industry		-		-		-		-	—
Other Commercial Loans		782,534		1,060		429		631	0.14
Total Commercial Loans		1,067,596		15,745		15,114		631	1.47

Residential 1-4 family Personal		218,428		-		-		-	—
Residential 1-4 family Rentals		100,770		-		-		-	—
Home Equity Loans		43,695		-		-		-	—
Total Residential Real Estate Loans		362,893		-		-		-	—

Consumer Loans		34,718		306		-		306	0.88
Mortgage Warehouse Loans		-		-		-		-	—
Credit Card, Overdrafts and Other		(3,685)		-		-		-	—
TOTAL LOANS	$	1,461,522	$	16,051	$	15,114	$	937	1.10	%

Liquidity

We are vigilantly monitoring our liquidity position on an ongoing basis. The Company has several available sources of on and off-balance sheet liquidity. Currently, the Company has not needed to tap into these available liquidity sources due to payment deferrals by customers, funding of PPP loans, or organic loan growth. Additional discussion on our liquidity as of the report date is reflected in the “Liquidity and Capital Resources” section of management’s discussion and analysis.

Share Repurchases

At the present time all share repurchases have been suspended due to the current status of our merger with Severn. Once the merger is consummated, the Company intends to resume its current share buyback program in which $546 thousand remains available. The Board of directors and management will re-evaluate the need for an additional stock repurchase program once the current plan is exhausted or expires.

Dividends and Capital

We currently expect to maintain our quarterly cash dividend based on our strong capital position. At March 31, 2021, the Bank exceeded all the capital requirements to which it was subject, and based on the most recent notification from its primary federal regulator is considered to be well-capitalized. There are no conditions or events since that notification that management believes would change the Bank’s classification. We are closely monitoring our capital position and are taking appropriate steps to ensure our level of capital remains strong. Our capital, while significant, may deteriorate in future periods due to the impact of the pandemic and limit our ability to pay dividends.

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Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.

The most significant accounting policies that the Company follows are presented in Note 1 of the 2020 Annual Report. These policies, along with the disclosures presented in the notes to the financial statements and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for credit losses and goodwill and other intangible assets are critical accounting policies. These policies are considered critical because they relate to accounting areas that require the most subjective or complex judgments, and, as such, could be most subject to revision as new information becomes available.

The allowance for credit losses represents management’s estimate of credit losses inherent in the loan portfolio as of the balance sheet date. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of similar loans based on historical loss experience, and consideration of current economic trends and conditions and other factors, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheets. Note 1 to the 2020 Annual Report describes the methodology used to determine the allowance for credit losses. A discussion of the allowance determination and factors driving changes in the amount of the allowance for credit losses is included in the Provision for Credit Losses and Allowance for Credit Losses sections below.

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Determining fair value is subjective, requiring the use of estimates, assumptions and management judgment. Goodwill is tested at least annually for impairment, usually during the fourth quarter, or on an interim basis if circumstances dictate. Impairment testing requires a qualitative assessment or that the fair value of each of the Company’s reporting units be compared to the carrying amount of its net assets, including goodwill. If the fair value of a reporting unit is less than book value, an expense may be required to write down the related goodwill to record an impairment loss. As of March 31, 2021, the Company had only one banking reporting unit.

OVERVIEW

The Company reported net income of $4.0 million for the first quarter of 2021, or diluted income per common share of $0.34, compared to net income of $3.1 million, or diluted income per common share of $0.25, for the first quarter of 2020. For the fourth quarter of 2020, the Company reported net income of $3.9 million, or diluted income per common share of $0.32. When comparing net income for the first quarter of 2021 to the first quarter of 2020, the increase was due to increases in net interest income of $1.3 million and noninterest income of $205 thousand, partially offset by an increase in noninterest expense of $150 thousand. When comparing net income for the first quarter of 2021 to the fourth quarter of 2020, the increase was primarily due to a decrease in the provision for credit losses of $625 thousand, partially offset by a decrease in noninterest income of $490 thousand.

RESULTS OF OPERATIONS

Net Interest Income

Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments. As shown in the table below, tax-equivalent net interest income was $13.8 million for the first quarter of

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2021 and $12.6 million for the first quarter of 2020. Tax-equivalent net interest income was $13.8 million for the fourth quarter of 2020. The increase in net interest income when comparing the first quarter of 2021 to the first quarter of 2020, was the result of higher interest and fees on loans and income from investment securities, coupled with a decrease in interest expense. Net interest income remained flat for the first quarter of 2021 when compared to the fourth quarter of 2020 due to less interest income on loans, offset by lower rates paid on interest-bearing deposits. Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets. The net interest margin for the first quarter of 2021 was 3.00%, which was a decrease of 48bps when compared to 3.48% for the first quarter of 2020 and a decrease of 8bps when compared to 3.08% for the fourth quarter of 2020. The decline in net interest margin in the first quarter of 2021 when compared to the fourth quarter of 2020 and the first quarter of 2020, was significantly impacted by excess liquidity of approximately $100 million, which has yet to be fully invested. Without this excess liquidity the margin for the first quarter of 2021 would have been 3.17%.

Interest Income

On a tax-equivalent basis, interest income increased $658 thousand, or 4.5%, for the first quarter of 2021 when compared to the first quarter of 2020. The increase was the result of higher interest and fees on loans and income from investment securities. The primary driver for the increase in interest income on loans was the result of higher average volume of loans of $187 million, which included PPP lending. The average balance of investment securities increased $98.4 million, providing $212 thousand of additional income, despite a decrease in the average yield of 59bps.

On a tax-equivalent basis, interest income decreased $148 thousand, or 1.0%, for the first quarter of 2021 when compared to the fourth quarter of 2020. The decrease in interest and fees on loans was primarily due to loan interest recoveries from problem assets experienced in the fourth quarter of 2020, which was absent in the first quarter of 2021, and resulted in a 2bps decline in the average yield on loans.

Interest Expense

Interest expense decreased $624 thousand, or 28.8%, when comparing the first quarter of 2021 to the first quarter of 2020. The decrease in interest expense from the first quarter of 2020 was a result of the decrease in the average rate paid on interest-bearing deposits of 46bps, as well as, the elimination of long-term advances from FHLB which had an average balance of $15 million. These decreases in interest expense, were partially offset by the issuance of subordinated debt in the third quarter of 2020 which added $359 thousand of additional expense for the first quarter of 2021. The average balance of noninterest-bearing deposits increased $165.1 million, or 46.8%, between the comparable quarters.

Interest expense decreased $185 thousand, or 10.7%, when comparing the first quarter of 2021 to the fourth quarter of 2020. The decrease in interest expense on deposits was due to an 8bps decline in the average rate paid on interest-bearing deposits, specifically time deposits that matured and renewed during the first quarter of 2021.

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The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended March 31, 2021 and 2020.


	For Three Months Ended						For Three Months Ended
	March 31, 2021						March 31, 2020
	Average		Income(1)/		Yield/		Average		Income(1)/		Yield/
(Dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Earning assets
Loans (2), (3)	$	1,450,883	$	14,402	4.03	%	$	1,263,441	$	13,831	4.40	%
Investment securities:
Taxable		227,816		931	1.63			129,410		719	2.22
Interest-bearing deposits		189,231		47	0.10			57,657		172	1.20
Total earning assets		1,867,930		15,380	3.34	%		1,450,508		14,722	4.08	%
Cash and due from banks		19,245						17,874
Other assets		103,010						89,154
Allowance for credit losses		(14,234)						(10,545)
Total assets	$	1,975,951					$	1,546,991

Interest-bearing liabilities
Demand deposits	$	438,340		156	0.14	%	$	284,176		395	0.56	%
Money market and savings deposits		510,881		230	0.18			410,252		466	0.46
Certificates of deposit $100,000 or more		130,745		405	1.26			129,408		597	1.85
Other time deposits		144,919		393	1.10			150,645		601	1.60
Interest-bearing deposits		1,224,885		1,184	0.39			974,481		2,059	0.85
Securities sold under retail repurchase agreements and short-term FHLB advances		2,238		1	0.18			1,235		2	0.65
Advances from FHLB - long-term		—		—	—			15,000		107	2.87
Subordinated debt		24,443		359	5.96			—		—	—
Total interest-bearing liabilities		1,251,566		1,544	0.50	%		990,716		2,168	0.88	%
Noninterest-bearing deposits		517,781						352,681
Other liabilities		10,813						9,262
Stockholders’ equity		195,791						194,332
Total liabilities and stockholders’ equity	$	1,975,951					$	1,546,991

Net interest spread			$	13,836	2.84	%			$	12,554	3.20	%
Net interest margin					3.00	%					3.48	%

Tax-equivalent adjustment
Loans			$	36					$	36
Total			$	36					$	36

(1)	All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%, exclusive of nondeductible interest expense.

(2)	Average loan balances include nonaccrual loans.

(3)	Interest income on loans includes accreted loan fees, net of costs and accretion of discounts on acquired loans, which are included in the yield calculations.

Noninterest Income

Total noninterest income for the first quarter of 2021 increased $205 thousand, or 8.7%, when compared to the first quarter of 2020. The increase from the first quarter of 2020 was mainly due to additional income from BOLI contracts of $141 thousand and additional bank service fees of $219 thousand, partially offset by a decrease in service charges on deposit accounts of $192 thousand. Noninterest income decreased $490 thousand, or 16.1%, when compared to the fourth quarter of 2020 primarily due to the absence of swap fee income on loans originated during the fourth quarter of 2020 of $350 thousand and a decrease in service charges on deposits accounts of $108 thousand.

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Noninterest Expense

Total noninterest expense for the first quarter of 2021 increased $150 thousand, or 1.4%, when compared to the first quarter of 2020 and decreased $57 thousand, or less than 1%, when compared to the fourth quarter of 2020. The increase in noninterest expenses when compared to the first quarter of 2020 was primarily due to higher employee benefits, occupancy expense, data processing fees and FDIC insurance premium expense, partially offset by a decrease in salaries and wages and legal and professional expenses. The decrease in noninterest expense when compared to the fourth quarter of 2020 was primarily related to lower salaries and wages and legal and professional fees, partially offset by higher employee benefit costs. The decrease in salaries and wages were attributed to the deferral of costs associated with originating the second round of PPP loans. The increase in employee benefits was the result of higher medical insurance claims.

Provision for Credit Losses

The provision for credit losses was $425 thousand for the first quarter of 2021, $350 thousand for the first quarter of 2020 and $1.1 million for the fourth quarter of 2020. The ratio of the allowance for credit losses to period-end loans was 0.98% at March 31, 2021. Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% at March 31, 2021, higher than both the 1.04% at December 31, 2020 and the 0.81% at March 31, 2020. The primary drivers of the increased percentage of the allowance to total loans, excluding PPP loans, as compared to March 31, 2020, were elevated qualitative factors within the allowance model related to economic conditions and the COVID-19 pandemic. The allowance percentage, excluding PPP loans, increased only slightly in the first quarter of 2021 as compared to December 31, 2020, reflecting the Company’s ongoing evaluation of the risk of probable losses inherent in the portfolio and the consideration of factors, both positive and negative, which have impacted the portfolio since year end. The decrease in provision for credit losses when compared to the fourth quarter of 2020 was the result of a decline in historical losses and minimal loan growth. The Company reported no net charge offs or recoveries in the first quarter of 2021, compared to net recoveries of $61 thousand for the fourth quarter of 2020 and net charge-offs of $479 thousand for the first quarter of 2020.

Income Taxes

The Company reported income tax expense of $1.4 million for the first quarter of 2021, $1.1 million for the first quarter of 2020 and $1.3 million for the fourth quarter of 2020. Income tax expense increased when compared to the first quarter of 2020 and the fourth quarter of 2020 due to higher pre-tax earnings. The effective tax rate for the first quarter of 2021 was 26.4% and was 25.3% for the fourth quarter of 2020. The effective tax rate for the first quarter of 2020 was 25.2%.

ANALYSIS OF FINANCIAL CONDITION

Loans

Loans totaled $1.462 billion at March 31, 2021 and $1.454 billion at December 31, 2020, an increase of $7.3 million, or less than 1%. The increase was primarily due to the origination of 660 round two PPP loans totaling $54.8 million, almost entirely offset by forgiveness of round one PPP loans of $52.2 million. Excluding PPP loans, organic growth for the first three months of 2021 was $4.7 million, which was hampered by an uncharacteristic level of payoffs experienced during the quarter. The loan pipeline remains very strong and is still expected to produce double-digit annualized loan growth for 2021, despite the recent payoffs in the first quarter. Loans included deferred fees, net of deferred costs, of $751 thousand and discounts on acquired loans of $677 thousand at March 31, 2021, compared to deferred costs, net of deferred fees, of $622 thousand and discounts on acquired loans of $754 thousand at December 31, 2020. We do not engage in foreign or subprime lending activities. See Note 4, “Loans and Allowance for Credit Losses”, in the Notes to Consolidated Financial Statements and below under the caption “Allowance for Credit Losses” for additional information.

Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans. Construction loans were $116.0 million, or 7.9% of total loans, at March 31, 2021 and $106.8 million, or 7.3% of total loans, at December 31, 2020. Commercial real estate loans were $641.2 million, or 43.9% of total loans, at March 31, 2021, compared to $661.2 million, or 45.5% of total loans, at December 31, 2020.

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The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total non-owner occupied commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s non-owner occupied commercial real estate loan portfolio (including construction) has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years. At March 31, 2021, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 303.2% of total risk-based capital. At such time, construction, land and land development loans represented 58.0% of total risk-based capital.

The commercial real estate portfolio (including construction) has increased 46.4% during the prior 36 months. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, as well as strong underwriting criteria with respect to its commercial real estate portfolio. Monitoring practices include periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital or be required to sell/participate portions of loans, which may adversely affect shareholder returns.

Allowance for Credit Losses

We have established an allowance for credit losses, which is increased by provisions charged against earnings and recoveries of previously charged-off loans and is decreased by current period charge-offs of uncollectible loans. Management evaluates the adequacy of the allowance for credit losses at least quarterly and adjusts the provision for credit losses based on this analysis. The evaluation of the adequacy of the allowance for credit losses is based primarily on a risk rating system of individual loans, as well as on a collective evaluation of smaller balance homogenous loans, each grouped by loan type. Each loan type is assigned allowance factors based on criteria such as past credit loss experience, local economic and industry trends, and other measures which may impact collectability. Please refer to the discussion above under the caption “Critical Accounting Policies” for an overview of the underlying methodology management employs to maintain the allowance.

The allowance for credit losses was $14.3 million at March 31, 2021, $10.4 million at March 31, 2020 and $13.9 million at December 31, 2020. There were no net charge-offs or recoveries for the first quarter of 2021, compared to net charge-offs of $479 thousand for the first quarter of 2020 and net recoveries of $61 thousand for the fourth quarter of 2020. The ratio of annualized net recoveries to average loans was 0% for the first quarter of 2021, compared to annualized net charge-offs of 0.15% for the first quarter of 2020 and (0.02)% for the fourth quarter of 2020.

Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming loans to enable the Company to continue to improve its overall credit quality. The allowance for credit losses as a percentage of period-end loans was 0.98% at March 31, 2021, 0.81% at March 31, 2020 and 0.95% at December 31, 2020. Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 1.07% at March 31, 2021, higher than both the 0.81% and 1.04% at March 31, 2020 and December 31, 2020, respectively. The increase in the percentage of the allowance to total loans at March 31, 2021, compared to March 31, 2020 and December 31, 2020, was primarily due to elevated qualitative factors within the allowance model primarily related to economic conditions and the COVID-19 pandemic. Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at March 31, 2021.

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The following table presents a summary of the activity in the allowance for credit losses at or for the three months ended March 31, 2021 and 2020.


	For the Three Months Ended March 31,
	2021				2020
			Percentage of net				Percentage of net
			charge-offs				charge-offs
			(annualized) to				(annualized) to
			average loans				average loans
	Net (charge-offs)		outstanding		Net (charge-offs)		outstanding
(Dollars in thousands)	recoveries		during the year		recoveries		during the year
Construction	$	5	-	%	$	3	(0.01)	%
Residential real estate		6	-			(188)	0.17
Commercial real estate		—	-			(270)	0.18
Commercial		(9)	-			(19)	0.08
Consumer		(2)	0.01			(5)	0.09
Total	$	—	-	%	$	(479)	0.15	%

Average loans outstanding during the period	$	1,450,883			$	1,263,441
Allowance for credit losses at period end as a percentage of total period end loans ⁽¹⁾			0.98	%			0.81	%
Allowance for credit losses at period end as a percentage of average loans ⁽²⁾			0.99	%			0.82	%
Allowance for credit losses at period end as a percentage of period end nonaccrual loans			293.30	%			89.93	%

(1)

At March 31, 2021, the loan balances used to calculate the ratio include PPP loans of $129.1 million. Excluding PPP loans, the ratio is 1.07%.

(2)

At March 31, 2021, the loan balances used to calculate the ratio include PPP loans of $131.9 million. Excluding PPP loans, the ratio is 1.09%.

Nonperforming Assets and Accruing TDRs

As shown in the following table, nonperforming assets remained relatively unchanged at March 31, 2021 from the $6.3 million at December 31, 2020. Despite the balance of nonperforming assets being similar for both the first quarter of 2021 and the fourth quarter of 2020, the composition of these assets was in contrast. When comparing nonperforming assets at March 31, 2021 to December 31, 2020, total nonaccrual loans decreased $575 thousand, or 10.5%, and loans 90 days past due and still accruing increased $384 thousand, or 47.8%. Accruing troubled debt restructurings (“TDRs”) decreased $541 thousand, or 7.7%, over the same time period. Other real estate owned properties increased to $205 thousand at March 31, 2021 from $0 at December 31, 2020 and $38 thousand at March 31, 2020. The ratio of nonaccrual loans and accruing TDRs to total loans decreased to 0.78% at March 31, 2021 from 0.86% at December 31, 2020.

The Company continues to focus on the resolution of its nonperforming and problem assets. The efforts to accomplish this goal include frequently contacting borrowers until the delinquency is cured or until an acceptable payment plan has been agreed upon; obtaining updated appraisals; provisioning for credit losses; charging-off loans; transferring loans to other real estate owned; aggressively marketing other real estate owned. The reduction of nonperforming and problem assets is and will continue to be a high priority for the Company.

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The following table summarizes our nonperforming assets and accruing TDRs at March 31, 2021 and December 31, 2020.


(Dollars in thousands)	March 31, 2021			December 31, 2020
Nonperforming assets
Nonaccrual loans	$	4,880		$	5,455
Total loans 90 days or more past due and still accruing		1,188			804
Other real estate owned		205			—
Total nonperforming assets	$	6,273		$	6,259

Total accruing TDRs	$	6,456		$	6,997

As a percent of total loans:
Nonaccrual loans		0.33	%		0.38	%
Accruing TDRs		0.44	%		0.48	%
Nonaccrual loans and accruing TDRs		0.78	%		0.86	%

As a percent of total loans and other real estate owned:
Nonperforming assets		0.43	%		0.43	%
Nonperforming assets and accruing TDRs		0.87	%		0.91	%

As a percent of total assets:
Nonaccrual loans		0.24	%		0.28	%
Nonperforming assets		0.31	%		0.32	%
Accruing TDRs		0.32	%		0.36	%
Nonperforming assets and accruing TDRs		0.63	%		0.69	%

Investment Securities

The investment portfolio is comprised of debt and equity securities. Debt securities are classified as either available for sale or held to maturity. Investment securities available for sale are stated at estimated fair value based on quoted prices. They represent securities which may be sold as part of the asset/liability management strategy or in response to changing interest rates. Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income (loss), a separate component of stockholders’ equity.

Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts. We have the intent and current ability to hold such securities until maturity. At March 31, 2021, 49.8% of the portfolio of debt securities was classified as available for sale and 50.2% was classified as held to maturity, compared to 68.0% and 32.0% respectively, at December 31, 2020. See Note 3 – “Investment Securities”, in the Notes to Consolidated Financial Statements for additional details on the composition of our investment portfolio.

Investment securities including restricted stock totaled $254.6 million at March 31, 2021, a $44.3 million, or 21.1%, increase since December 31, 2020. The increase was primarily due to the purchases of held to maturity securities of $61.4 million, partially offset by proceeds from maturities and sales of available for sale securities of $14.2 million, during 2021. Due to the excess liquidity experienced in 2020 and 2021, the Company strategically purchased short duration available for sale securities and subordinated debt of other banks which earn significantly higher average yields than interest-bearing deposits with other banks. As loan demand begins to strengthen, the Company will redeploy proceeds and excess liquidity to fund loan growth. At March 31, 2021, 85.4% of the securities available for sale were mortgage-backed and 14.6% were U.S. Government agencies, compared to 83.1% and 16.9%, respectively, at year-end 2020. Our investments in mortgage-backed securities are issued or guaranteed by U.S. Government agencies or government-sponsored agencies.

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Deposits

Total deposits at March 31, 2021 amounted to $1.80 billion, an increase of $99.9 million, or 5.9%, when compared to the level at December 31, 2020. The increase in total deposits consisted of increases in interest-bearing deposits of $75.2 million and noninterest-bearing deposits of $24.7 million. The growth in interest-bearing deposits was represented by increases in savings and money market accounts of $113.2 million and other time deposits of $2.7 million, partially offset by a decrease in interest-bearing checking accounts of $40.6 million. The significant movement within deposit accounts continues to be impacted by direct government stimulus payments to our customers.

Short-Term Borrowings

Short-term borrowings consisted of securities sold under agreements to repurchase, which increased by $2.5 million, or 233.4%, to $3.5 million at March 31, 2021 when compared to December 31, 2020. Securities sold under agreements to repurchase are issued in conjunction with cash management services for commercial depositors. Other short-term borrowings may consist of overnight borrowing from correspondent banks or advances from the FHLB. Short-term advances are defined as those with original maturities of one year or less. At March 31, 2021 and December 31, 2020, the Company had no outstanding short-term or long-term advances with FHLB.

Long-Term Debt

The Company uses long-term borrowings to meet longer term liquidity needs, specifically to fund loan growth when liquidity from deposit growth is not sufficient. On August 25, 2020, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which the Company issued and sold $25.0 million in aggregate principal amount with an initial interest rate of 5.375% Fixed-to-Floating Rate Subordinated Notes due September 1, 2030.

Liquidity and Capital Resources

We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets. As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net increase in cash and cash equivalents was $40.2 million for the first three months of 2021 compared to an increase of $1.3 million for the first three months of 2020. The increase in cash and cash equivalents in 2021 was mainly due to the significant increase in deposits, the direct result of customer stimulus deposited to and remaining in these accounts as of March 31, 2021. The Company expects these funds to be utilized over the coming months, which may or may not result in a decline in deposit balances. Furthermore, the increase in cash and cash equivalents was the result of the issuance of subordinated notes in the third quarter of 2020, which, net of issuance costs, resulted in $24.5 million in additional liquidity.

To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets. The Bank has arrangements with other corresponding banks whereby it has $15 million available in federal funds lines of credit and a reverse repurchase agreement available to meet any short-term needs which may not otherwise be funded by the Bank’s portfolio of readily marketable investments that can be converted to cash. The Bank is also a member of the FHLB, which provides another source of liquidity. Through the FHLB, the Bank had collateral pledged of approximately $314.3 million and $316.7 million at March 31, 2021 and December 31, 2020, respectively. The Bank has pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB.

Total stockholders’ equity increased $1.1 million to $196.1 million at March 31, 2021 when compared to December 31, 2020 primarily due to the current year’s retained earnings, partially offset by dividends paid during the three months ended March 31, 2021 and the change in fair value of available-for-sale securities recorded in accumulated other comprehensive income.

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CBLR

On September 17, 2019, the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (“CBLR”) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

On April 6, 2020, in a joint statement, the FDIC, Federal Reserve and the Office of Comptroller of the Currency (“OCC”), issued two interim final rules regarding temporary changes to the CBLR framework to implement provisions of the CARES Act. Under the interim final rules, the community bank leverage ratio was reduced to 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 8%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The Company has not opted-in to the CBLR framework.

Basel III

Under final Federal Reserve and FDIC approved rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks minimum requirements increased for both the quantity and quality of capital held by the Bank. The Basel III capital standards substantially revised the risk based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the definitions and the components of Tier 1 capital and Total Capital, the method of evaluating risk-weighted assets, institutions of a capital conservation buffer, and other matters affecting regulatory capital ratios. Strict eligibility criteria for regulatory capital instruments were also implemented under the rules.

The phase-in period for the final rules became effective for the Bank on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, which was fully phased in on January 1, 2019. As of March 31, 2021, the Bank’s capital levels remained characterized as “well-capitalized” under the rules.

The following tables present the applicable capital ratios as of March 31, 2021 and December 31, 2020.

Tier 1

Common Equity

Tier 1

Total

leverage

Tier 1

risk-based

March 31, 2021

ratio

capital ratio

Shore United Bank

9.49

13.39

14.45

Tier 1

Common Equity

Tier 1

Total

leverage

Tier 1

risk-based

December 31, 2020

ratio

capital ratio

Shore United Bank

9.73

13.21

14.25

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Our primary market risk is interest rate fluctuation and management has procedures in place to evaluate and mitigate this risk. This risk and these procedures are discussed in Item 7 of Part II of the 2020 Annual Report under the caption “Market Risk Management and Interest Sensitivity”. Management believes that there have been no material changes in our market risks, the procedures used to evaluate and mitigate these risks, or our actual and simulated sensitivity positions since December 31, 2020.

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Item 4. Controls and Procedures.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that Shore Bancshares, Inc. files under the Securities Exchange Act of 1934, as amended (“Exchange Act”) with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in those rules and forms, and that such information is accumulated and communicated to management, including Shore Bancshares, Inc.’s principal executive officer (“PEO”) and its principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls and procedures as of March 31, 2021 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, the Company’s management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level at March 31, 2021.

There was no change in our internal control over financial reporting during the first quarter of 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

From time to time the Company may become involved in legal proceedings. At the present time, there are no proceedings which the Company believes will have a material adverse impact on the financial condition or earnings of the Company.

Item 1A. Risk Factors

The section titled Risk Factors in Part I, Item 1A of our 2020 Form 10-K includes a discussion of the many risks and uncertainties we face, any one or more of which could have a material adverse effect on our business, results of operations, financial condition (including capital and liquidity), or prospects or the value of or return on an investment in the Company. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed in our 2020 Annual Report.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On November 24, 2020, the Company announced a stock repurchase program which was approved by the Board and authorized management to repurchase up to $5.0 million of the Company’s common stock. During the first quarter of 2021, the Company repurchased 56,104 shares of its common stock under the repurchase plan. The stock repurchase program is currently suspended due to the recent announcement of our merger with Severn.

The following table provides information with respect to purchases made by or on behalf of us or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of our common stock during the first quarter of 2021.

Stock Repurchase Plan $5.0 million (2020-2021)

Total Number of

Maximum Dollar Value

Total Number

Average Price

Shares Purchased as Part

Of Shares that May Yet Be

Of Shares

Paid Per

of the Publicly Announced

Purchased Under the

Period

Purchased

Share

Plans or Programs

January 1, 2021 to January 31, 2021

56,104

14.69

56,104

541,973

February 1, 2021 to February 28, 2021

—

541,973

March 1, 2021 to March 31, 2021

—

541,973

Total

56,104

14.69

56,104

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

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Item 6. Exhibits.

Exhibit Number		Description

3.1(i)		Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on December 14, 2000).

3.1(ii)		Articles Supplementary relating to the Fixed Rate Cumulative Perpetual Preferred Stock Series A (incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K filed on January 13, 2009).

3.1(iii)		Articles Supplementary relating to the reclassification of the Fixed Rate Cumulative Perpetual Preferred Stock Series A, as common stock (incorporated by reference to Exhibit 3.1(i) of the Company’s Form 8-K filed on June 17, 2009).

3.2		Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 of the Company’s Form 10-K for the year ended December 31, 2020).

4.1		Description of Registrant’s Securities (incorporated by reference to Exhibit 4.1 to the Company’s Form 10-K filed March 13, 2020).

4.2		Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company’s Form S-3 filed on June 25, 2010).

31.1		Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).

31.2		Certifications of the Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).

32		Certification pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith).

101		Inline Interactive Data File

101.INS		Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document)

101.SCH		Inline XBRL Taxonomy Extension Schema (filed herewith)

101.CAL		Inline XBRL Taxonomy Extension Calculation Linkbase (filed herewith)

101.DEF		Inline XBRL Taxonomy Extension Definition Linkbase (filed herewith)

101.LAB		Inline XBRL Taxonomy Extension Label Linkbase (filed herewith)

101.PRE		Inline XBRL Taxonomy Extension Presentation Linkbase (filed herewith)

104		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	SHORE BANCSHARES, INC.

Date: May 14, 2021	By:	/s/ Lloyd L. Beatty, Jr.
		Lloyd L. Beatty, Jr.
		President & Chief Executive Officer
		(Principal Executive Officer)

Date: May 14, 2021	By:	/s/ Edward C. Allen
		Edward C. Allen
		Executive Vice President & Chief Financial Officer
		(Principal Accounting Officer)