changes in filer status are to be applied beginning with the filer’s first annual report filed with the SEC subsequent to the effective date. Prior to these changes, the Company was required to comply with section 404(b) of the Sarbanes Oxley Act concerning auditor attestation over internal control over financial reporting as an “accelerated filer” as it had more than $75 million in public float but less than $700 million at the end of the Company’s most recent second quarter. The rule change expands the category of “smaller reporting companies” to include entities with public float of less than $700 million and less than $100 million in annual revenues. The Company expects to meet this expanded category of small reporting company and will no longer be considered an accelerated filer after the 2020 Annual Report. If the Company’s annual revenues exceed $100 million, its category will change back to “accelerated filer”. The classifications of “accelerated filer” and “large accelerated filer” require a public company to obtain an auditor attestation concerning the effectiveness of internal control over financial reporting (“ICFR”) and include the opinion on ICFR in its annual report on Form 10-K. Smaller reporting companies also have additional time to file quarterly and annual financial statements. All public companies are required to obtain and file annual financial statement audits, as well as provide management’s assertion on effectiveness of internal control over financial reporting, but the external auditor attestation of internal control over financial reporting is not required for smaller reporting companies. As the Bank has total assets exceeding $1.0 billion, it remains subject to FDICIA, which requires an auditor attestation concerning internal controls over financial reporting. As such, other than the additional time provided to file quarterly and annual financial statements, this change does not significantly change the Company’s annual reporting and audit requirements.

In March 2020, (Revised in April 2020) various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” (“ASC 310-40”), a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. As of June 30, 2020, the Company has offered payment deferrals for commercial and consumer customers for up to six months. The loan modifications offered to specific loan types are as follows:

●

Full payment-balloon or full amortization loans – Once the deferral period has ended, the Company will go back to billing principal and interest. As payments are made, all funds will go towards interest until all accrued interest has been caught up. Once the accrued interest is satisfied, future payments will be broken out for both principal and interest. The amount of principal that had been deferred will be re-amortized when the balloon maturity/payoff date occurs.

●

Full payment ARM loans – Once the deferral period has ended, the Company will go back to billing principal and interest. As payments are made, all funds will go towards interest until all accrued interest has been caught up. Once the accrued interest is satisfied, future payments will be broken out for both principal and interest. The amount of principal that had been deferred will be re-amortized when the ARM repricing occurs.

●

Full Payment Rate Reset Loans - Once the deferral period has ended, the Company will go back to billing principal and interest. As payments are made, all funds will go towards interest until all accrued interest has been caught up. Once the accrued interest is satisfied, future payments will be broken out for both principal and interest. The amount of principal that had been deferred will be re-amortized when the rate reset occurs.

●

Principal deferral only loans (any type) - Once the deferral period has ended, the Company will go back to billing principal and interest. The principal amount that has been deferred will be re-amortized when either the maturity, ARM repricing or rate reset occurs.

●

Consumer loans – Borrowers are required to sign an amendment to the initial loan agreement at the time of deferral, which re-amortizes the loan and extends the maturity date based on the number of months deferred.

This interagency guidance is expected to have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time.

11

Table of Contents

Note 2 – ~~Sale of Subsidiary~~

~~Avon-Dixon Agency Sale~~Discontinued Operations

On December 31, 2018, the Company completed the sale of the specific assets and activities related to its insurance agency, Avon-Dixon Agency, LLC (“Avon-Dixon”) to Avon-Dixon, an Alera Group Agency, LLC (“Alera”). Also, on this date the Company discontinued the operations of its premium finance company, Mubell Finance, LLC (“Mubell”). Together, Avon-Dixon and Mubell ~~companies~~ are referred to as the “Insurance Subsidiaries”. The Insurance Subsidiaries represented the Company’s insurance products and services segment, the activities of which related to originating, servicing and underwriting retail insurance policies. ~~Assets sold to Alera included various intangible assets and a 40% interest in segregated portfolio of Eastern Re. LTD., a specialty reinsurance company. Mubell, along with certain~~Certain other assets and liabilities ~~that will~~to be sold or settled separately within one year, iswere classified as discontinued operations in the ~~accompanying Consolidated Balance Sheets and Consolidated Statements~~Company’s consolidated financial statements. All of ~~Income.~~

~~The specific~~the remaining assets acquired by Alera include, among other things, the insurance origination offices, insurance expirations, workforce and system procedures, trade names and goodwill. Alera has assumed certain obligations and liabilities of ~~the Company under the acquired leases, and with respect~~discontinued operations were settled prior to ~~the employment~~December 31, 2019.

There were 0 assets or liabilities of ~~transferred employees. The Company received a $25.2 million cash payment, upon the closing of the transaction.~~

discontinued operations at June 30, 2020 or December 31, 2019. The following table ~~summarizes the calculation of the net gain on disposal of discontinued operations.~~

($ in thousands)

Year Ended December 31, 2018
Proceeds from the transaction

$
29,276
Compensation expense related to the transaction

2,588
Broker fees

935
Other transaction costs

594
Net cash proceeds

25,159
Net assets sold

(12,423)
Net gain on disposal

$
12,736

~~The following tables present~~presents the financial information of discontinued operations ~~as of the dates and~~ for the periods indicated:

June 30,

December 31,
($ in thousands)

2019

2018
ASSETS

Goodwill

$
—

$
8
Other assets

—

625
Assets of discontinued operations

$
—

$
633

LIABILITIES

Accrued expenses and other liabilities

$
—

$
3,323
Liabilities of discontinued operations

$
—

$
3,323


	For Six Months Ended
	June 30,
($ in thousands)	2020		2019
Noninterest income
All other income	$	—	$	14
Total noninterest income		—		14
Noninterest expense
Salaries and wages		—		31
Employee benefits		—		7
Occupancy expense		—		18
Furniture and equipment		—		1
Legal and professional fees		—		64
Other noninterest expenses		—		(8)
Total noninterest expense		—		113
Loss from discontinued operations before income taxes		—		(99)
Income tax benefit		—		(25)
Loss from discontinued operations	$	—	$	(74)

1012

Table of Contents

For the Three Months Ended

For the Six Months Ended

June 30,

June 30,
($ in thousands)

2019

2018

2019

2018
Noninterest income

Insurance agency commissions

$
—

$
2,151

$
—

$
4,845
All other income

1

93

15

188
Total noninterest income

1

2,244

15

5,033
Noninterest expense

Salaries and wages

(3)

1,282

28

2,529
Employee benefits

—

324

7

665
Occupancy expense

(4)

105

14

209
Furniture and equipment

—

28

1

60
Amortization of intangible assets

—

11

—

23
Legal and professional fees

7

18

71

34
Other noninterest expenses

5

207

(3)

465
Total noninterest expense

5

1,975

118

3,985
(Loss) income from discontinued operations before income taxes

(4)

269

(103)

1,048
Income tax (benefit) expense

—

70

(25)

253
(Loss) income from discontinued operations

$
(4)

$
199

$
(78)

$
795

Note 3 – 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

For the Six Months Ended

June 30,

June 30,
(In thousands, except per share data)

2019

2018

2019

2018
Net income from continuing operations

$
4,228

$
4,192

$
8,056

$
7,654
Net (loss) income from discontinued operations

(4)

199

(78)

795
Net Income

$
4,224

$
4,391

$
7,978

$
8,449
Weighted average shares outstanding - Basic

12,779

12,744

12,774

12,730
Dilutive effect of common stock equivalents-options

5

13

5

13
Weighted average shares outstanding - Diluted

12,784

12,757

12,779

12,743

Basic earnings per common share

Income from continuing operations

$
0.33

$
0.33

$
0.63

$
0.60
(Loss) income from discontinued operations

—

0.01

(0.01)

0.06
Net income

$
0.33

$
0.34

$
0.62

$
0.66

Diluted earnings per common share








Income from continuing operations

$
0.33

$
0.33

$
0.63

$
0.60
(Loss) income from discontinued operations

—

0.01

(0.01)

0.06
Net income

$
0.33

$
0.34

$
0.62

$
0.66


	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
(In thousands, except per share data)	2020		2019		2020		2019
Net income from continuing operations	$	5,335	$	4,228	$	8,453	$	8,056
Net loss from discontinued operations		-		(4)		-		(78)
Net Income	$	5,335	$	4,224	$	8,453	$	7,978
Weighted average shares outstanding - Basic		12,524		12,779		12,519		12,774
Dilutive effect of common stock equivalents-options		1		5		2		5
Weighted average shares outstanding - Diluted		12,525		12,784		12,521		12,779
							��
Basic earnings per common share
Income from continuing operations	$	0.43	$	0.33	$	0.68	$	0.63
Loss from discontinued operations		—		—		—		(0.01)
Net income	$	0.43	$	0.33	$	0.68	$	0.62

Diluted earnings per common share
Income from continuing operations	$	0.43	$	0.33	$	0.68	$	0.63
Loss from discontinued operations		—		—		—		(0.01)
Net income	$	0.43	$	0.33	$	0.68	$	0.62

There were no0 weighted average common stock equivalents excluded from the calculation of diluted earnings per share for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019.

11

~~Table of Contents~~

Note 4 – 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:

June 30, 2019

U.S. Government agencies

$
34,125

$
4

$
110

$
34,019
Mortgage-backed

111,520

361

490

111,391
Total

$
145,645

$
365

$
600

$
145,410

December 31, 2018

U.S. Government agencies

$
34,285

$
2

$
651

$
33,636
Mortgage-backed

124,162

115

3,481

120,796
Total

$
158,447

$
117

$
4,132

$
154,432


			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
(Dollars in thousands)	Cost		Gains		Losses		Value
Available-for-sale securities:
June 30, 2020
U.S. Government agencies	$	9,710	$	82	$	3	$	9,789
Mortgage-backed		73,551		2,681		1		76,231
Total	$	83,261	$	2,763	$	4	$	86,020

December 31, 2019
U.S. Government agencies	$	23,854	$	3	$	31	$	23,826
Mortgage-backed		98,638		574		247		98,965
Total	$	122,492	$	577	$	278	$	122,791

During the three and six months ended, the Company sold available for sale securities for proceeds of $13.0 million and recognized gross gains of $347 thousand. NaN available for sale securities were sold during the three and six months ended June 30, 2019.

Held-to-maturity securities:








June 30, 2019

U.S. Government agencies

$
1,504

$
10

$
—

$
1,514
States and political subdivisions

1,401

5

—

1,406
Other Debt securities

3,000

—

33

2,967
Total

$
5,905

$
15

$
33

$
5,887

December 31, 2018

U.S. Government agencies

$
1,642

$
—

$
25

$
1,617
States and political subdivisions

1,401

14

—

1,415
Other Debt securities

3,000

—

32

2,968
Total

$
6,043

$
14

$
57

$
6,000

13

Table of Contents


			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
(Dollars in thousands)	Cost		Gains		Losses		Value
Held-to-maturity securities:
June 30, 2020
U.S. Government agencies	$	1,292	$	35	$	—	$	1,327
States and political subdivisions		400		1		—		401
Other debt securities		10,018		12		43		9,987
Total	$	11,710	$	48	$	43	$	11,715

December 31, 2019
U.S. Government agencies	$	1,386	$	—	$	5	$	1,381
States and political subdivisions		400		1		—		401
Other debt securities		7,000		—		128		6,872
Total	$	8,786	$	1	$	133	$	8,654

~~The Company adopted ASU 2016-01 effective January 1, 2018 and equity~~Equity securities with an aggregate fair value of ~~$1.3~~$1.4 million at June 30, ~~2019~~2020 and $1.3 million at December 31, ~~2018~~2019 are presented separately on the balance sheet. The fair value adjustment recorded through earnings totaled $32 thousand for the six months ended June 30, 2020 and $41 thousand for the six months ended June 30, 2019, ~~and $(13) thousand for six months ended June 30, 2018,~~ 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 June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

Less than

More than

12 Months

12 Months

Total


Fair

Unrealized

Fair

Unrealized

Fair

Unrealized
(Dollars in thousands)

Value

Losses

Value

Losses

Value

Losses
June 30, 2019

Available-for-sale securities:

U.S. Government agencies

$
—

$
—

$
30,018

$
110

$
30,018

$
110
Mortgage-backed

—

—

59,065

490

59,065

490
Total

$
—

$
—

$
89,083

$
600

$
89,083

$
600

Held-to-maturity securities:

Other debt securities

2,967

33

—

—

2,967

33
Total

$
2,967

$
33

$
—

$
—

$
2,967

$
33


	Less than				More than
	12 Months				12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(Dollars in thousands)	Value		Losses		Value		Losses		Value		Losses
June 30, 2020
Available-for-sale securities:
U.S. Government agencies	$	—	$	—	$	402	$	3	$	402	$	3
Mortgage-backed		—		—		1,936		1		1,936		1
Total	$	—	$	—	$	2,338	$	4	$	2,338	$	4

Held-to-maturity securities:
Other debt securities	$	3,990	$	10	$	2,967	$	33	$	6,957	$	43
Total	$	3,990	$	10	$	2,967	$	33	$	6,957	$	43


	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, 2019
Available-for-sale securities:
U.S. Government agencies	$	4,995	$	5	$	18,516	$	26	$	23,511	$	31
Mortgage-backed		12,180		27		22,282		220		34,462		247
Total	$	17,175	$	32	$	40,798	$	246	$	57,973	$	278

Held-to-maturity securities:
U.S. Government agencies	$	1,381	$	5	$	—	$	—	$	1,381	$	5
Other debt securities		3,905		95		2,967		33		6,872		128
Total	$	5,286	$	100	$	2,967	$	33	$	8,253	$	133

12

~~Table of Contents~~

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, 2018

Available-for-sale securities:

U.S. Government agencies

$
1,079

$
10

$
32,362

$
641

$
33,441

$
651
Mortgage-backed

13,981

261

99,904

3,220

113,885

3,481
Total

$
15,060

$
271

$
132,266

$
3,861

$
147,326

$
4,132

Held-to-maturity securities:

U.S. Government agencies

—

—

1,617

25

1,617

25
Other debt securities

2,968

32

—

—

2,968

32
Total

$
2,968

$
32

$
1,617

$
25

$
4,585

$
57

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

14

Table of Contents

likely than not that the Company will be required to sell these securities before recovery of their amortized cost bases, which may be at maturity for debt securities, the Company considers the unrealized losses to be temporary. There were ~~forty-six~~3 available-for-sale securities and ~~two~~2 held-to-maturity ~~securities~~security in an unrealized loss position at June 30, ~~2019.~~2020.

The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at June 30, ~~2019.~~2020.

Available for sale

Held to maturity


Amortized



Amortized


(Dollars in thousands)

Cost

Fair Value

Cost

Fair Value
Due in one year or less

$
5,996

$
5,978

$
500

$
503
Due after one year through five years

28,874

28,780

400

401
Due after five years through ten years

59,748

59,787

3,501

3,469
Due after ten years

51,027

50,865

1,504

1,514
Total

$
145,645

$
145,410

$
5,905

$
5,887


	Available for sale				Held to maturity
	Amortized				Amortized
(Dollars in thousands)	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	9,002	$	9,080	$	—	$	—
Due after one year through five years		1,916		1,977		400		401
Due after five years through ten years		42,964		44,744		10,018		9,987
Due after ten years		29,379		30,219		1,292		1,327
Total	$	83,261	$	86,020	$	11,710	$	11,715

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

Note 5 – 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, Wicomico County, Baltimore County and 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 June 30, ~~2019~~2020 and December 31, ~~2018.~~

(Dollars in thousands)

June 30, 2019

December 31, 2018
Construction

$
134,145

$
127,572
Residential real estate

430,020

429,560
Commercial real estate

559,568

523,427
Commercial

108,615

107,522
Consumer

7,947

7,274
Total loans

1,240,295

1,195,355
Allowance for credit losses

(10,305)

(10,343)
Total loans, net

$
1,229,990

$
1,185,012

2019.


(Dollars in thousands)	June 30, 2020		December 31, 2019
Construction	$	110,657	$	99,829
Residential real estate		430,436		442,506
Commercial real estate		626,339		586,562
Commercial		214,616		102,020
Consumer		25,201		17,737
Total loans		1,407,249		1,248,654
Allowance for credit losses		(11,090)		(10,507)
Total loans, net	$	1,396,159	$	1,238,147

13

~~Table of Contents~~

Loans are stated at their principal amount outstanding net of any purchase premiums/discounts, deferred fees and costs. Loans included deferred costs, net of deferred fees, of ~~$1.2 million~~$470 thousand and discounts on acquired loans of ~~$1.3 million~~$912 thousand at June 30, ~~2019.~~2020. Loans included deferred costs, net of deferred fees, of ~~$789 thousand~~$1.8 million and discounts on acquired loans of ~~$1.4~~$1.1 million at December 31, ~~2018.~~2019. At June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, included in total loans were ~~$86.9~~$72.9 million and ~~$92.8~~$79.2 million in loans, respectively, acquired as part of the NWBI branch ~~acquisition.~~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.

15

Table of Contents

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. See additional discussion under the caption “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

A loan is considered a ~~troubled debt restructuring (“TDR”)~~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 ~~of the Company’s banking subsidiary, Shore United Bank (the “Bank”),~~ 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.

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.

14

~~Table of Contents~~

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 ~~nonowner~~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. ~~Nonowner~~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.

16

Table of Contents

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.

The following tables include impairment information relating to loans and the allowance for credit losses as of June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

Residential

Commercial






(Dollars in thousands)

Construction

real estate

real estate

Commercial

Consumer

Total
June 30, 2019

Loans individually evaluated for impairment

$
1,494

$
6,761

$
13,794

$
311

$
—

$
22,360
Loans collectively evaluated for impairment

132,651

423,259

545,774

108,304

7,947

1,217,935
Total loans

$
134,145

$
430,020

$
559,568

$
108,615

$
7,947

$
1,240,295

Allowance for credit losses allocated to:

Loans individually evaluated for impairment

$
152

$
230

$
272

$
7

$
—

$
661
Loans collectively evaluated for impairment

2,291

1,925

3,095

2,050

283

9,644
Total allowance

$
2,443

$
2,155

$
3,367

$
2,057

$
283

$
10,305

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer

Total

June 30, 2020

Loans individually evaluated for impairment

$

335

$

7,775

$

10,884

$

571

$

—

$

19,565

Loans collectively evaluated for impairment

110,322

422,661

615,455

214,045

25,201

1,387,684

Total loans

$

110,657

$

430,436

$

626,339

$

214,616

$

25,201

$

1,407,249

Allowance for credit losses allocated to:

Loans individually evaluated for impairment

$

—

$

265

$

81

$

—

$

—

$

346

Loans collectively evaluated for impairment

1,497

2,374

4,016

2,355

502

10,744

Total allowance

$

1,497

$

2,639

$

4,097

$

2,355

$

502

$

11,090


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
December 31, 2019
Loans individually evaluated for impairment	$	41	$	7,072	$	12,006	$	298	$	—	$	19,417
Loans collectively evaluated for impairment		99,788		435,434		574,556		101,722		17,737		1,229,237
Total loans	$	99,829	$	442,506	$	586,562	$	102,020	$	17,737	$	1,248,654

Allowance for credit losses allocated to:
Loans individually evaluated for impairment	$	—	$	395	$	580	$	—	$	—	$	975
Loans collectively evaluated for impairment		1,576		2,106		3,452		1,929		469		9,532
Total allowance	$	1,576	$	2,501	$	4,032	$	1,929	$	469	$	10,507

In the first quarter of 2020, the Company transitioned from its in-house allowance model to an external vendor's allowance model software for the calculation of the allowance for loan losses. Prior to the adoption of the new model, the Company ran both models parallel for multiple periods to confirm the reasonableness of the new model's output as compared to the old. The primary motivation for the change was to increase efficiencies in the calculation of the allowance estimate under the current incurred loss standard and also allow for a more seamless transition for the Company's eventual adoption of the Current Expected Credit Loss standard in 2023. The Company's processes for loan segmentation, assessing qualitative factors, and determining specific reserves for impaired loans remained substantially unchanged when comparing the models. As part of the new model, more precise averages are utilized in the calculation

1517

Table of Contents

Residential

Commercial






(Dollars in thousands)

Construction

real estate

real estate

Commercial

Consumer

Total
December 31, 2018

Loans individually evaluated for impairment

$
2,893

$
8,553

$
13,532

$
340

$
—

$
25,318
Loans collectively evaluated for impairment

124,679

421,007

509,895

107,182

7,274

1,170,037
Total loans

$
127,572

$
429,560

$
523,427

$
107,522

$
7,274

$
1,195,355

Allowance for credit losses allocated to:

Loans individually evaluated for impairment

$
320

$
301

$
104

$
36

$
—

$
761
Loans collectively evaluated for impairment

2,342

2,052

2,973

1,913

302

9,582
Total allowance

$
2,662

$
2,353

$
3,077

$
1,949

$
302

$
10,343

of the net charge-off ratios used in the historical loss analysis and the historical loss rates are applied to all pools of loans accounted for under ASC 450. Additionally, the historical look-back periods for retail loan pools were adjusted to four years in the new model as compared to two years under the prior in-house model. While there were some variances between loan pools when comparing the two models, the Company's ending recorded allowance and provision for loan losses during the first and second quarter of 2020 were not materially impacted as a result of the transition.

The following tables provide information on impaired loans and any related allowance by loan class as of June 30, ~~2019~~2020 and December 31, ~~2018.~~2019. 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



June 30, 2019

Unpaid

investment

investment

Quarter-to-date

Average

Interest

principal

with no

with an

Related

average recorded

recorded

recorded
(Dollars in thousands)

balance

allowance

allowance

allowance

investment

investment

investment
June 30, 2019

Impaired nonaccrual loans:

Construction

$
1,581

—

1,449

152

1,515

2,153

—
Residential real estate

3,035

2,549

—

—

2,730

3,034

—
Commercial real estate

10,949

8,956

1,327

247

9,613

9,466

—
Commercial

425

—

311

7

314

319

—
Consumer

—

—

—

—

—

—

—
Total

$
15,990

$
11,505

$
3,087

$
406

$
14,172

$
14,972

$
—

Impaired accruing TDRs:

Construction

$
45

$
45

$
—

$
—

$
47

$
48

$
8
Residential real estate

4,212

1,228

2,984

230

4,219

4,263

81
Commercial real estate

3,511

2,822

689

25

3,516

3,533

66
Commercial

—

—

—

—

—

—

—
Consumer

—

—

—

—

—

—

—
Total

$
7,768

$
4,095

$
3,673

$
255

$
7,782

$
7,844

$
155

Total impaired loans:

Construction

$
1,626

$
45

$
1,449

$
152

$
1,562

$
2,201

$
8
Residential real estate

7,247

3,777

2,984

230

6,949

7,297

81
Commercial real estate

14,460

11,778

2,016

272

13,129

12,999

66
Commercial

425

—

311

7

314

319

—
Consumer

—

—

—

—

—

—

—
Total

$
23,758

$
15,600

$
6,760

$
661

$
21,954

$
22,816

$
155



			Recorded		Recorded				June 30, 2020
	Unpaid		investment		investment				Quarter-to-date		Year-to-date		Interest
	principal		with no		with an		Related		average recorded		average recorded		recorded
(Dollars in thousands)	balance		allowance		allowance		allowance		investment		investment		investment
June 30, 2020
Impaired nonaccrual loans:
Construction	$	297	$	297	$	—	$	—	$	297	$	198	$	—
Residential real estate		4,250		2,474		1,342		75		3,555		3,213		—
Commercial real estate		8,016		6,921		67		67		6,853		7,103		—
Commercial		679		548		—		—		551		466		—
Consumer		—		—		—		—		—		—		—
Total	$	13,242	$	10,240	$	1,409	$	142	$	11,256	$	10,980	$	—

Impaired accruing TDRs:
Construction	$	38	$	38	$	—	$	—	$	38	$	38	$	1
Residential real estate		3,905		1,199		2,706		190		3,912		3,967		79
Commercial real estate		3,369		2,712		657		14		3,373		3,390		47
Commercial		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—
Total	$	7,312	$	3,949	$	3,363	$	204	$	7,323	$	7,395	$	127

Other impaired accruing loans:
Construction	$	—	$	—	$	—	$	—	$	—	$	49	$	—
Residential real estate		54		54		—		—		179		394		1
Commercial real estate		527		527		—		—		1,053		867		3
Commercial		23		23		—		—		6		5		—
Consumer		—		—		—		—		16		9		—
Total	$	604	$	604	$	—	$	—	$	1,254	$	1,324	$	4

Total impaired loans:
Construction	$	335	$	335	$	—	$	—	$	335	$	285	$	1
Residential real estate		8,209		3,727		4,048		265		7,646		7,574		80
Commercial real estate		11,912		10,160		724		81		11,279		11,360		50
Commercial		702		571		—		—		557		471		—
Consumer		—		—		—		—		16		9		—
Total	$	21,158	$	14,793	$	4,772	$	346	$	19,833	$	19,699	$	131

1618

Table of Contents



			Recorded		Recorded				June 30, 2019
	Unpaid		investment		investment				Quarter-to-date		Year-to-date		Interest
	principal		with no		with an		Related		average recorded		average recorded		income
(Dollars in thousands)	balance		allowance		allowance		allowance		investment		investment		recognized
December 31, 2019
Impaired nonaccrual loans:
Construction	$	—	$	—	$	—	$	—	$	1,515	$	2,153	$	—
Residential real estate		2,660		678		1,797		215		2,730		3,034		—
Commercial real estate		8,242		5,680		2,137		561		9,613		9,466		—
Commercial		421		298		—		—		314		319		—
Consumer		—		—		—		—		—		—		—
Total	$	11,323	$	6,656	$	3,934	$	776	$	14,172	$	14,972	$	—

Impaired accruing TDRs:
Construction	$	41	$	41	$	—	$	—	$	47	$	48	$	8
Residential real estate		4,041		2,583		1,458		180		4,219		4,263		81
Commercial real estate		3,419		2,748		671		19		3,516		3,533		66
Commercial		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—
Total	$	7,501	$	5,372	$	2,129	$	199	$	7,782	$	7,844	$	155

Other impaired accruing loans:
Construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate		556		556		—		—		88		95		—
Commercial real estate		770		770		—		—		531		266		2
Commercial		—		—		—		—		11		10		—
Consumer		—		—		—		—		7		5		—
Total	$	1,326	$	1,326	$	—	$	—	$	637	$	376	$	2

Total impaired loans:
Construction	$	41	$	41	$	—	$	—	$	1,562	$	2,201	$	8
Residential real estate		7,257		3,817		3,255		395		7,037		7,392		81
Commercial real estate		12,431		9,198		2,808		580		13,660		13,265		68
Commercial		421		298		—		—		325		329		—
Consumer		—		—		—		—		7		5		—
Total	$	20,150	$	13,354	$	6,063	$	975	$	22,591	$	23,192	$	157

19

Recorded

Recorded



June 30, 2018

Unpaid

investment

investment

Quarter-to-date

Average

Interest

principal

with no

with an

Related

average recorded

recorded

income
(Dollars in thousands)

balance

allowance

allowance

allowance

investment

investment

recognized
December 31, 2018

Impaired nonaccrual loans:

Construction

$
3,219

$
127

$
2,715

$
320

$
2,982

$
2,987

$
—
Residential real estate

4,281

2,605

1,494

118

1,590

1,504

—
Commercial real estate

10,029

9,307

67

67

1,853

1,286

—
Commercial

445

—

340

36

332

344

—
Consumer

—

—

—

—

—

—

—
Total

$
17,974

$
12,039

$
4,616

$
541

$
6,757

$
6,121

$
—

Impaired accruing TDRs:

Construction

$
51

$
51

$
—

$
—

$
291

$
1,634

$
13
Residential real estate

4,454

1,440

3,014

183

4,839

4,565

46
Commercial real estate

4,158

1,286

2,872

37

4,541

4,596

41
Commercial

—

—

—

—

—

—

—
Consumer

—

—

—

—

—

—

—
Total

$
8,663

$
2,777

$
5,886

$
220

$
9,671

$
10,795

$
100

Total impaired loans:

Construction

$
3,270

$
178

$
2,715

$
320

$
3,273

$
4,621

$
13
Residential real estate

8,735

4,045

4,508

301

6,429

6,069

46
Commercial real estate

14,187

10,593

2,939

104

6,394

5,882

41
Commercial

445

—

340

36

332

344

—
Consumer

—

—

—

—

—

—

—
Total

$
26,637

$
14,816

$
10,502

$
761

$
16,428

$
16,916

$
100

17

Table of Contents

The following tables provide a roll-forward for TDRs as of June 30, ~~2019~~2020 and June 30, ~~2018.~~2019.


	1/1/2019												6/30/2019
	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related

																	1/1/2020												6/30/2020
																	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance		Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For six months ended
June 30, 2019
June 30, 2020
Accruing TDRs
Construction	$	51	$	—	$	(6)	$	—	$	—	$	—	$	45	$	—	$	41	$	—	$	(3)	$	—	$	—	$	—	$	38	$	—
Residential real estate		4,454		—		(45)		—		—		(197)		4,212		230		4,041		—		(53)		—		—		(83)		3,905		190
Commercial real estate		4,158		—		(647)		—		—		—		3,511		25		3,419		—		(50)		—		—		—		3,369		14
Commercial		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—
Total	$	8,663	$	—	$	(698)	$	—	$	—	$	(197)	$	7,768	$	255	$	7,501	$	—	$	(106)	$	—	$	—	$	(83)	$	7,312	$	204


Nonaccrual TDRs
Construction	$	2,798	$	—	$	(1,346)	$	(3)	$	—	$	—	$	1,449	$	152	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate		—		—		—		—		—		—		—		—		1,393		—		(51)		—		—		—		1,342		75
Commercial real estate		—		—		—		—		—		—		—		—		—		1,506		(373)		—		—		—		1,133		—
Commercial		320		—		(9)		—		—		—		311		7		299		—		(19)		—		—		—		280		—
Consumer		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—
Total	$	3,118	$	—	$	(1,355)	$	(3)	$	—	$	—	$	1,760	$	159	$	1,692	$	1,506	$	(443)	$	—	$	—	$	—	$	2,755	$	75


Total	$	11,781	$	—	$	(2,053)	$	(3)	$	—	$	(197)	$	9,528	$	414	$	9,193	$	1,506	$	(549)	$	—	$	—	$	(83)	$	10,067	$	279


	1/1/2018												6/30/2018
	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related

																	1/1/2019												6/30/2019
																	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance		Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For six months ended
June 30, 2018
June 30, 2019
Accruing TDRs
Construction	$	3,972	$	—	$	(6)	$	(379)	$	—	$	(2,600)	$	987	$	—	$	51	$	—	$	(6)	$	—	$	—	$	—	$	45	$	—
Residential real estate		4,536		—		(42)		—		(154)		(237)		4,103		—		4,454		—		(45)		—		—		(197)		4,212		230
Commercial real estate		4,818		—		(69)		—		—		(219)		4,530		—		4,158		—		(647)		—		—		—		3,511		25
Commercial		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—
Total	$	13,326	$	—	$	(117)	$	(379)	$	(154)	$	(3,056)	$	9,620	$	—	$	8,663	$	—	$	(698)	$	—	$	—	$	(197)	$	7,768	$	255


Nonaccrual TDRs
Construction	$	2,878	$	—	$	(40)	$	—	$	—	$	—	$	2,838	$	392	$	2,798	$	—	$	(1,346)	$	(3)	$	—	$	—	$	1,449	$	152
Residential real estate		—		—		—		—		154		—		154		—		—		—		—		—		—		—		—		—
Commercial real estate		83		—		—		—		—		—		83		—		—		—		—		—		—		—		—		—
Commercial		337		—		(4)		—		—		—		333		29		320		—		(9)		—		—		—		311		7
Consumer		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—		—
Total	$	3,298	$	—	$	(44)	$	—	$	154	$	—	$	3,408	$	421	$	3,118	$	—	$	(1,355)	$	(3)	$	—	$	—	$	1,760	$	159


Total	$	16,624	$	—	$	(161)	$	(379)	$	—	$	(3,056)	$	13,028	$	421	$	11,781	$	—	$	(2,053)	$	(3)	$	—	$	(197)	$	9,528	$	414

1820

Table of Contents

There were no loans modified and considered TDRs during the three months ended June 30, 2020 and 2019. The following tables provide information on ~~TDRs~~loans that ~~defaulted within twelve months of restructuring~~were modified and considered TDRs during the six months ended June 30, ~~2019~~2020 and June 30, ~~2018.~~ 2019.


		Premodification		Postmodification
		outstanding		outstanding
	Number of	recorded		recorded		Related
(Dollars in thousands)	contracts	investment		investment		allowance
TDRs:
For six months ended
June 30, 2020
Construction	—	$	—	$	—	$	—
Residential real estate	—		—		—		—
Commercial real estate	1		1,535		1,162		—
Commercial	—		—		—		—
Consumer	—		—		—		—
Total	1	$	1,535	$	1,162	$	—

For six months ended
June 30, 2019
Construction	—	$	—	$	—	$	—
Residential real estate	—		—		—		—
Commercial real estate	—		—		—		—
Commercial	—		—		—		—
Consumer	—		—		—		—
Total	—	$	—	$	—	$	—

As of June 30, 2020, the Company had executed principal and/or interest deferrals on outstanding loan balances of $221.1 million. These deferrals were no more than six months in duration and were for loans not more than 30 days past due as of December 31, 2019. As such, they were not considered TDRs based on the relief provisions of the CARES Act and recent interagency regulatory guidance.

There were ~~no defaults during~~0 TDRs which subsequently defaulted within 12 months of modification for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019. 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.

Number of

Recorded

Related
(Dollars in thousands)

contracts

investment

allowance
TDRs that subsequently defaulted:

For six months ended

June 30, 2019

Construction

—

$
—

$
—
Residential real estate

—

—

—
Commercial real estate

—

—

—
Commercial

—

—

—
Consumer

—

—

—
Total

—

$
—

$
—

For six months ended

June 30, 2018

Construction

1

$
379

$
—
Residential real estate

1

154

—
Commercial real estate

—

—

—
Commercial

—

—

—
Consumer

—

—

—
Total

2

$
533

$
—

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 June 30, ~~2019,~~2020, there were no0 nonaccrual loans classified as special mention or doubtful and ~~$14.6~~$11.6 million of nonaccrual loans were classified as substandard. Similarly, at December 31, ~~2018,~~2019, there were no0 nonaccrual loans classified as special mention or doubtful and ~~$16.7~~$10.6 million of nonaccrual loans were classified as substandard.

1921

Table of Contents

The following tables provide information on loan risk ratings as of June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

Special






(Dollars in thousands)

Pass/Performing

Pass/Watch

Mention

Substandard

Doubtful

Total
June 30, 2019

Construction

$
104,892

$
25,633

$
2,153

$
1,467

$
—

$
134,145
Residential real estate

390,307

32,098

3,878

3,737

—

430,020
Commercial real estate

426,909

111,664

5,749

15,246

—

559,568
Commercial

88,611

19,335

324

345

—

108,615
Consumer

7,528

416

—

3

—

7,947
Total

$
1,018,247

$
189,146

$
12,104

$
20,798

$
—

$
1,240,295


					Special

																	Special
(Dollars in thousands)	Pass/Performing		Pass/Watch		Mention		Substandard		Doubtful		Total		Pass/Performing		Pass/Watch		Mention		Substandard		Doubtful		Total
December 31, 2018
June 30, 2020
Construction	$	93,977	$	30,735	$	—	$	2,860	$	—	$	127,572	$	91,746	$	16,551	$	2,063	$	297	$	—	$	110,657
Residential real estate		386,553		33,739		3,769		5,499		—		429,560		392,692		29,518		3,845		4,381		—		430,436
Commercial real estate		389,219		113,873		4,515		15,820		—		523,427		488,095		120,113		6,303		11,828		—		626,339
Commercial		90,777		15,727		642		376		—		107,522		184,908		26,023		3,105		580		—		214,616
Consumer		6,805		466		—		3		—		7,274		24,864		332		—		5		—		25,201
Total	$	967,331	$	194,540	$	8,926	$	24,558	$	—	$	1,195,355	$	1,182,305	$	192,537	$	15,316	$	17,091	$	—	$	1,407,249


					Special
(Dollars in thousands)	Pass/Performing		Pass/Watch		Mention		Substandard		Doubtful		Total
December 31, 2019
Construction	$	84,357	$	13,068	$	2,404	$	—	$	—	$	99,829
Residential real estate		404,500		29,223		5,549		3,234		—		442,506
Commercial real estate		455,388		115,190		4,822		11,162		—		586,562
Commercial		80,816		20,130		746		328		—		102,020
Consumer		17,347		383		2		5		—		17,737
Total	$	1,042,408	$	177,994	$	13,523	$	14,729	$	—	$	1,248,654

The following tables provide information on the aging of the loan portfolio as of June 30, ~~2019~~2020 and December 31, ~~2018.~~

Accruing




30‑59 days

60‑89 days

Greater than

Total





(Dollars in thousands)

Current

past due

past due

90 days

past due

Nonaccrual

Total

June 30, 2019

Construction

$
132,478

$
—

$
218

$
—

$
218

$
1,449

$
134,145

Residential real estate

423,119

3,088

1,112

152

4,352

2,549

430,020

Commercial real estate

545,125

1,657

2,225

278

4,160

10,283

559,568

Commercial

107,534

471

290

9

770

311

108,615

Consumer

7,925

1

21

—

22

—

7,947

Total

$
1,216,181

$
5,217

$
3,866

$
439

$
9,522

$
14,592

$
1,240,295

Percent of total loans

98.1
%

0.4
%

0.3
%

—
%

0.7
%

1.2
%

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, 2018

Construction

$
124,535

$
195

$
—

$
—

$
195

$
2,842

$
127,572

Residential real estate

423,732

1,384

206

139

1,729

4,099

429,560

Commercial real estate

512,252

253

1,548

—

1,801

9,374

523,427

Commercial

107,089

83

10

—

93

340

107,522

Consumer

7,238

30

6

—

36

—

7,274

Total

$
1,174,846

$
1,945

$
1,770

$
139

$
3,854

$
16,655

$
1,195,355

Percent of total loans

98.3
%

0.2
%

0.1
%

—
%

0.3
%

1.4
%

100.0
%

2019.

Accruing

30‑59 days

60‑89 days

Greater than

Total

(Dollars in thousands)

Current

past due

90 days

past due

Nonaccrual

Total

June 30, 2020

Construction

$

110,259

$

101

$

—

$

—

$

101

$

297

$

110,657

Residential real estate

425,440

663

463

54

1,180

3,816

430,436

Commercial real estate

618,524

—

300

527

827

6,988

626,339

Commercial

213,919

121

28

—

149

548

214,616

Consumer

25,134

15

29

23

67

—

25,201

Total

$

1,393,276

$

900

$

820

$

604

$

2,324

$

11,649

$

1,407,249

Percent of total loans

99.0

%

0.1

%

0.1

%

—

%

0.2

%

0.8

%

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, 2019
Construction	$	99,234		$	595		$	—		$	—		$	595		$	—		$	99,829
Residential real estate		435,671			3,021			783			556			4,360			2,475			442,506
Commercial real estate		577,015			743			217			770			1,730			7,817			586,562
Commercial		101,476			246			—			—			246			298			102,020
Consumer		17,680			57			—			—			57			—			17,737
Total	$	1,231,076		$	4,662		$	1,000		$	1,326		$	6,988		$	10,590		$	1,248,654
Percent of total loans		98.6	%		0.4	%		0.1	%		0.1	%		0.6	%		0.8	%		100.0	%

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Table of Contents

The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three and six months ended June 30, ~~2019~~2020 and June 30, ~~2018.~~2019. 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

real estate

Commercial

Consumer

Total
For three months ended

June 30, 2019

Allowance for credit losses:

Beginning Balance

$
2,657

$
2,433

$
3,057

$
2,009

$
262

$
10,418

Charge-offs

(3)

(300)

—

(81)

(23)

(407)
Recoveries

4

3

8

77

2

94
Net charge-offs

1

(297)

8

(4)

(21)

(313)

Provision

(215)

19

302

52

42

200
Ending Balance

$
2,443

$
2,155

$
3,367

$
2,057

$
283

$
10,305


			Residential		Commercial

															Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total		Construction		real estate		real estate		Commercial		Consumer		Total
For three months ended
June 30, 2018
June 30, 2020
Allowance for credit losses:
Beginning Balance	$	2,541	$	2,359	$	2,643	$	2,027	$	217	$	9,787	$	1,128	$	2,482	$	3,965	$	2,263	$	540	$	10,378


Charge-offs		—		(41)		—		(126)		(14)		(181)		—		—		(331)		(37)		—		(368)
Recoveries		6		73		8		10		—		97		5		4		—		61		10		80
Net charge-offs		6		32		8		(116)		(14)		(84)		5		4		(331)		24		10		(288)


Provision		46		(241)		194		299		120		418		364		153		463		68		(48)		1,000
Ending Balance	$	2,593	$	2,150	$	2,845	$	2,210	$	323	$	10,121	$	1,497	$	2,639	$	4,097	$	2,355	$	502	$	11,090


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
For three months ended
June 30, 2019
Allowance for credit losses:
Beginning Balance	$	2,657	$	2,433	$	3,057	$	2,009	$	262	$	10,418

Charge-offs		(3)		(300)		—		(81)		(23)		(407)
Recoveries		4		3		8		77		2		94
Net charge-offs		1		(297)		8		(4)		(21)		(313)

Provision		(215)		19		302		52		42		200
Ending Balance	$	2,443	$	2,155	$	3,367	$	2,057	$	283	$	10,305

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Table of Contents

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer

Total

For six months ended

June 30, 2020

Allowance for credit losses:

Beginning Balance

$

1,576

$

2,501

$

4,032

$

1,929

$

469

$

10,507

Charge-offs

—

(191)

(601)

(119)

(7)

(918)

Recoveries

8

7

—

124

12

151

Net charge-offs

8

(184)

(601)

5

(767)

Provision

(87)

322

666

421

28

1,350

Ending Balance

$

1,497

$

2,639

$

4,097

$

2,355

$

502

$

11,090


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Total
For six months ended
June 30, 2019
Allowance for credit losses:
Beginning Balance	$	2,662	$	2,353	$	3,077	$	1,949	$	302	$	10,343

Charge-offs		(3)		(423)		—		(162)		(29)		(617)
Recoveries		7		11		107		152		2		279
Net charge-offs		4		(412)		107		(10)		(27)		(338)

Provision		(223)		214		183		118		8		300
Ending Balance	$	2,443	$	2,155	$	3,367	$	2,057	$	283	$	10,305

Residential

Commercial






(Dollars in thousands)

Construction

real estate

real estate

Commercial

Consumer

Total
For six months ended

June 30, 2019

Allowance for credit losses:

Beginning Balance

$
2,662

$
2,353

$
3,077

$
1,949

$
302

$
10,343

Charge-offs

(3)

(423)

—

(162)

(29)

(617)
Recoveries

7

11

107

152

2

279
Net charge-offs

4

(412)

107

(10)

(27)

(338)

Provision

(223)

214

183

118

8

300
Ending Balance

$
2,443

$
2,155

$
3,367

$
2,057

$
283

$
10,305

Residential

Commercial






(Dollars in thousands)

Construction

real estate

real estate

Commercial

Consumer

Total
For six months ended

June 30, 2018

Allowance for credit losses:












Beginning Balance

$
2,460

$
2,284

$
2,594

$
2,241

$
202

$
9,781

Charge-offs

(379)

(179)

—

(126)

(24)

(708)
Recoveries

15

86

18

22

—

141
Net charge-offs

(364)

(93)

18

(104)

(24)

(567)

Provision

497

(41)

233

73

145

907
Ending Balance

$
2,593

$
2,150

$
2,845

$
2,210

$
323

$
10,121

Foreclosure Proceedings

Consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure totaled ~~$961~~$23 thousand as of June 30, ~~2019~~2020 and ~~$949 as of~~ December 31, ~~2018,~~2019, respectively. There were no0 residential real estate properties included in the balance of other real estate owned at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

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 June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

Note 6 – Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and consistent with such elections did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. As stated in the Company’s ~~2018~~2019 Form 10-K, the implementation of the new standard resulted in recognition of right-of-use assets and lease liabilities totaling $3.8 million at the date of adoption, which are primarily related to the Company’s lease of premises used in operations. During the course of 2019, the Company recognized additional right-of-use assets and lease liabilities of $1.4 million, primarily related to the lease of additional premises used in operations. During the first quarter of 2020, the Company renewed its copier lease for all locations which added approximately $419 thousand to right-of-use assets and lease liabilities.

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

2224

Table of Contents

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 of these 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.

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



(Dollars in thousands)	June 30, 2019			June 30, 2020			December 31, 2019
Lease liabilities	$	3,663		$	4,941		$	4,792
Right-of-use assets	$	3,663		$	4,879		$	4,771
Weighted average remaining lease term		11.55	years		10.94	years		11.76	years
Weighted average discount rate		3.49	%		2.93	%		3.13	%


	For the three months ended		For the six months ended
Lease cost (in thousands)	June 30, 2020		June 30, 2020
Operating lease cost	$	177	$	358
Short-term lease cost		—		—
Total lease cost	$	177	$	358

Cash paid for amounts included in the measurement of lease liabilities	$	167	$	330

For the three months ended

For the six months ended
Lease cost (in thousands)

June 30, 2019

June 30, 2019
Operating lease cost

$
155

$
294
Short-term lease cost

—

—
Total lease cost

$
155

$
294

Cash paid for amounts included in the measurement of lease liabilities

$
144

$
287

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

			As of
Lease payments due (in thousands)	June 30, 2019		June 30, 2020
Six months ending December 31, 2019	$	289
Twelve months ending December 31, 2020		480
Nine months ending December 31, 2020				332
Twelve months ending December 31, 2021		417	$	647
Twelve months ending December 31, 2022		404		634
Twelve months ending December 31, 2023		381		618
Twelve months ending December 31, 2024		371		562
Twelve months ending December 31, 2025				465
Thereafter		2,156		2,956
Total undiscounted cash flows	$	4,498	$	6,214
Discount		835		1,273
Lease liabilities	$	3,663	$	4,941

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Table of Contents

Note 7 – Goodwill and Other Intangibles

Due to the COVID-19 pandemic and its impact on market conditions, the Company performed a qualitative assessment of goodwill as of June 30, 2020. As a result of management’s qualitative evaluation of relevant events and circumstances at June 30, 2020, the Company concluded that it was not more likely than not that fair value was less than carrying value. Changes in the economic environment, operations, or other adverse events could result in future impairment charges which could have a material adverse impact on the Company's operating results. The following table provides information on the significant components of goodwill and other acquired intangible assets at June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

June 30, 2019

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

$
—

$
(1,414)

$
2,540

6.5
Total other intangible assets

$
3,954

$
—

$
(1,414)

$
2,540


December 31, 2018
									Weighted
	Gross			Accumulated			Net		Average
	Carrying		Impairment			Accumulated	Carrying		Remaining Life

June 30, 2020											June 30, 2020
																				Weighted
												Gross		Accumulated				Net		Average
												Carrying		Impairment		Accumulated		Carrying		Remaining Life
(Dollars in thousands)	Amount		Charges			Amortization	Amount		(in years)			Amount		Charges		Amortization		Amount		(in years)


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


Other intangible assets
Amortizable
Core deposit intangible	$	3,954	$	—	$	(1,097)	$	2,857		7.2		$	3,954	$	—	$	(1,984)	$	1,970		5.0
Total other intangible assets	$	3,954	$	—	$	(1,097)	$	2,857				$	3,954	$	—	$	(1,984)	$	1,970


December 31, 2019
									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	$	—	$	(1,702)	$	2,252		5.7
Total other intangible assets	$	3,954	$	—	$	(1,702)	$	2,252

The aggregate amortization expense included in continuing operations was $282 thousand for the six months ended June 30, 2020 and $317 thousand for the six months ended June 30, ~~2019 and $350 thousand for June 30, 2018.~~2019.

At June 30, ~~2019,~~2020, estimated future remaining amortization for amortizing intangibles within the years ending December 31, is as follows:

(Dollars in thousands)

Amortization
Expense
2019

$
288
2020

533
2021

461
2022

389
2023

317
2024

246
Thereafter

306
Total amortizing intangible assets

$
2,540


(Dollars in thousands)	Amortization Expense
2020	$	252
2021		461
2022		389
2023		317
2024		246
2025		174
Thereafter		131
Total amortizing intangible assets	$	1,970

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Table of Contents

Note 8 – Other Assets

The Company had the following other assets at June 30, ~~2019~~2020 and December 31, ~~2018 excluding discontinued operations.~~2019.

(Dollars in thousands)

June 30, 2019

December 31, 2018

Accrued interest receivable

3,671

3,345

Deferred income taxes

2,912

4,182

Prepaid expenses

1,186

1,067

Cash surrender value on life insurance

3,752

3,726

Income taxes receivable

781

—

Other assets

2,300

5,358

Total

$
14,602

$
17,678


(Dollars in thousands)	2020		2019
Accrued interest receivable	$	6,167	$	3,455
Deferred income taxes		3,677		2,754
Prepaid expenses		1,366		1,157
Cash surrender value on life insurance		30,430		29,770
Income taxes receivable		—		175
Other assets		3,624		3,261
Total	$	45,264	$	40,572

The following table provides information on significant components of the Company’s deferred tax assets and liabilities as of June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

June 30,

December 31,
(Dollars in thousands)

2019

2018
Deferred tax assets:




Allowance for credit losses

$
2,815

$
2,797
Reserve for off-balance sheet commitments

81

81
Net operating loss carry forward

33

—
Write-downs of other real estate owned

45

273
Nonaccrual loan interest

345

260
Unrealized losses on available-for-sale securities

72

1,105
Unrealized losses on available-for-sale securities transferred to held to maturity

8

12
Other

464

524
Total deferred tax assets

3,863

5,052
Deferred tax liabilities:




Depreciation

200

238
Amortization on loans FMV adjustment

52

60
Acquisition accounting adjustments

381

247
Deferred capital gain on branch sale

197

200
Other

121

125
Total deferred tax liabilities

951

870
Net deferred tax assets

$
2,912

$
4,182


	June 30,		December 31,
(Dollars in thousands)	2020		2019
Deferred tax assets:
Allowance for credit losses	$	3,005	$	2,850
Write-downs of other real estate owned		2		9
Nonaccrual loan interest		443		353
Unrealized losses on available-for-sale securities transferred to held to maturity		1		4
Other		2,192		735
Total deferred tax assets		5,643		3,951
Less valuation allowance		(95)		(63)
Deferred tax assets net of valuation allowance		5,548		3,888
Deferred tax liabilities:
Depreciation		172		198
Acquisition accounting adjustments		615		508
Deferred capital gain on branch sale		190		194
Unrealized gains on available-for-sale securities		746		74
Other		148		160
Total deferred tax liabilities		1,871		1,134
Net deferred tax assets	$	3,677	$	2,754

Note 9 – Other Liabilities

The Company had the following other liabilities at June 30, ~~2019~~2020 and December 31, ~~2018 excluding discontinued operations.~~

(Dollars in thousands)

June 30, 2019

December 31, 2018

Accrued interest payable

$
221

$
604

Other accounts payable

1,616

3,213

Deferred compensation liability

962

1,040

Income taxes payable

—

3,454

Other liabilities

1,285

104

Total

$
4,084

$
8,415

2019.


(Dollars in thousands)	June 30, 2020		December 31, 2019
Accrued interest payable	$	207	$	330
Deferred compensation liability		2,120		1,401
Income taxes payable		4,279		—
Other liabilities		2,051		2,350
Total	$	8,657	$	4,081

25

~~Table of Contents~~

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

27

Table of Contents

of the grant date and range over a ~~one-~~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 ~~636,465~~614,298 shares remained available for grant at June 30, ~~2019.~~2020.

The following tables provide information on stock-based compensation expense for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019.

For Three Months Ended

For Six Months Ended

June 30,

June 30,

(Dollars in thousands)

2019

2018

2019

2018

Stock-based compensation expense

$
(32)

$
163

$
31

$
306

Excess tax benefits related to stock-based compensation

3

11

3

146

As of

June 30,

(Dollars in thousands)

2019

2018

Unrecognized stock-based compensation expense

$
150

$
677

Weighted average period unrecognized expense is expected to be recognized

0.1
years

1.0
years


	For Three Months Ended				For Six Months Ended
	June 30,				June 30,
(Dollars in thousands)	2020		2019		2020		2019
Stock-based compensation expense	$	62	$	(32)	$	123	$	31
Excess tax benefits related to stock-based compensation		7		3		14		3


	June 30,
(Dollars in thousands)	2020			2019
Unrecognized stock-based compensation expense	$	198		$	150
Weighted average period unrecognized expense is expected to be recognized		0.7	years		0.1	years

The following table summarizes restricted stock award activity for the Company under the 2016 Equity Plan for the six months ended June 30, ~~2019 and 2018.~~2020.

Six Months Ended June 30, 2019

Weighted Average

Number of

Grant Date

Shares

Fair Value
Nonvested at beginning of period

—

$
—
Granted

15,702

15.36
Vested

—

—
Cancelled

—

—
Nonvested at end of period

15,702

$
15.36


	Six Months Ended June 30, 2020
		Weighted Average
	Number of	Grant Date
	Shares	Fair Value
Nonvested at beginning of period	15,702	$	15.36
Granted	22,166		14.11
Vested	(15,702)		15.36
Forfeited	(902)		16.25
Nonvested at end of period	21,264	$	14.11

The fair value of restricted stock awards that vested during the first six months of 2020 and 2019 was $254 and ~~2018 was~~ $0 ~~and $133~~ thousand, respectively.

Restricted stock units ~~(RSUs)~~(“RSUs”) are similar to restricted stock, except the recipient does not receive the stock immediately, but instead receives it upon the terms and conditions of the Company’s long-term incentive plans which are subject to performance milestones achieved at the end of a three-year period. Each RSU cliff vests at the end of the three-year period and entitles the recipient to receive ~~one~~1 share of common stock on a specified issuance date. The recipient does not have any stockholder rights, including voting rights, with respect to the shares underlying awarded RSUs until the recipient becomes the holder of those shares.

26

~~Table of Contents~~

In the second quarter of 2019, the Long-Term Incentive Plan culminating December 31, 2020 was terminated by the Board’s Compensation Committee and all outstanding RSUs were forfeited as presented in the table below. To replace this compensation incentive plan, the Compensation Committee elected to institute individual Supplemental Executive Retirement Plans (“SERPs”) which will be executed in the beginning of 2020, with the exception of three SERPs which began on July 19, 2019 for Lloyd L. Beatty, Jr., President and Chief Executive Officer, Edward C. Allen, Executive Vice President and Chief Financial Officer and Donna J. Stevens, Executive Vice President and Chief Operating Officer. These individuals also forfeited their RSUs in the LTI culminating December 31, 2019. More information about these SERP agreements can be found in Footnote 15 – Subsequent Events.

During 2017, the Company entered into a long-term incentive plan agreement with officers of the Company and its subsidiaries to award RSUs based on a performance metric to be achieved as of December 31, 2019. Assuming the performance metric is achieved, these awards will cliff vest on this date, in which the final number of common shares to be issued will be determined. The range of RSUs which could potentially be awarded at the end of the performance cycle is between 6,178 shares and 24,726 shares, assuming a certain performance metric is met. The table below presents management’s evaluation of the probable number of common stock awards to be issued at the end of the performance cycle.

During 2016, the Company entered into a long-term incentive plan agreement with officers of the Company and its subsidiaries to award RSUs based on a performance metric to be achieved as of December 31, 2018. Based on the results for the year ended December 31, ~~2018, 15,577~~2019, 6,451 shares were vested.

28

Table of Contents

The following table summarizes restricted stock units activity ~~based on management’s evaluation of the probable number of common stock awards to be issued~~ at the end of the performance cycle for the Company under the 2016 Equity Plan for the six months ended June 30, ~~2019.~~2020.

Six Months Ended June 30, 2019

Weighted Average

Number of

Grant Date

Shares

Fair Value
Outstanding at beginning of period

38,562

$
14.69
Granted

—

—
Vested

(15,577)

11.68
Forfeited

(16,807)

16.78
Outstanding at end of period

6,178

$
16.57


	Six Months Ended June 30, 2020
		Weighted Average
	Number of	Grant Date
	Shares	Fair Value
Outstanding at beginning of period	6,451	$	16.57
Granted	—		—
Vested	(6,451)		16.57
Forfeited	—		—
Outstanding at end of period	—	$	—

The fair value of restricted stock units that vested during the first six months of 2020 and 2019 was $107 thousand and ~~2018 was~~ $237 thousand, ~~and $695 thousand.~~respectively.

The following table summarizes stock option activity for the Company under the 2016 Equity Plan for the six months ended June 30, ~~2019 and 2018.~~2020.

Six Months Ended June 30, 2019

Weighted Average

Number of

Grant Date

Shares

Exercise Price
Outstanding at beginning of period

27,249

$
9.68
Granted

—

—
Exercised

(15,578)

10.01
Expired/Cancelled

—

—
Outstanding at end of period

11,671

$
9.25

Exercisable at end of period

11,671

$
9.25


	Six Months Ended June 30, 2020
		Weighted Average
	Number of	Grant Date
	Shares	Exercise Price
Outstanding at beginning of period	11,671	$	9.25
Granted	—		—
Exercised	—		—
Expired/Cancelled	—		—
Outstanding at end of period	11,671	$	9.25

Exercisable at end of period	11,671	$	9.25

There were no0 stock options granted during the three and six months ended June 30, ~~2019~~2020 and June 30, ~~2018. The Company estimates the fair value of options using the Black-Scholes valuation model with weighted average assumptions for~~

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~~Table of Contents~~

dividend yield, expected volatility, risk-free interest rate and expected lives (in years). The expected dividend yield is calculated by dividing the total expected annual dividend payout by the average stock price. The expected volatility is based on historical volatility of the underlying securities. The risk-free interest rate is based on the Federal Reserve Bank’s constant maturities daily interest rate in effect at grant date. The expected contract life of the options represents the period of time that the Company expects the awards to be outstanding based on historical experience with similar awards.2019.

At the end of the second quarter of ~~2019,~~2020, the aggregate intrinsic value of the options outstanding under the 2016 Equity Plan was ~~$83~~$22 thousand based on the ~~$16.34~~$11.09 market value per share of the Company’s common stock at June 30, ~~2019.~~2020. Similarly, the aggregate intrinsic value of the options exercisable was ~~$83~~$22 thousand at June 30, 2019. The intrinsic value on options exercised during the six months ended June 30, 2019 was $72 thousand based on the $14.66 market value per share of the Company’s common stock at January 15, 2019. The intrinsic value on options exercised in 2018 was $365 thousand based on the $17.92 market value per share of the Company’s common stock at January 31, 2018.2020. At June 30, ~~2019,~~2020, the weighted average remaining contract life of options outstanding and exercisable was ~~5.3~~4.3 years.

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Table of Contents

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 six months ended June 30, ~~2019~~2020 and ~~2018.~~2019.

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

(loss)
Balance, December 31, 2018

$
(2,918)

$
(32)

$
(2,950)
Other comprehensive income

2,747

10

2,757
Balance, June 30, 2019

$
(171)

$
(22)

$
(193)

Balance, December 31, 2017

$
(1,255)

$
(54)

$
(1,309)
Cumulative effect adjustment (ASU 2016-01)

6

—

6
Other comprehensive income

(2,474)

10

(2,464)
Balances, June 30, 2018

$
(3,723)

$
(44)

$
(3,767)


			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, 2019	$	218	$	(11)	$	207
Other comprehensive income before reclassifications		2,047		9		2,056
Reclassification of gains recognized		(259)		—		(259)
Balance, June 30, 2020	$	2,006	$	(2)	$	2,004

Balance, December 31, 2018	$	(2,918)	$	(32)	$	(2,950)
Other comprehensive income		2,747		10		2,757
Balances, June 30, 2019	$	(171)	$	(22)	$	(193)

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 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.

28

~~Table of Contents~~

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.

30

Table of Contents

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.

29

~~Table of Contents~~

The tables below present the recorded amount of assets measured at fair value on a recurring basis at June 30, ~~2019~~2020 and December 31, ~~2018. No~~2019. NaN assets were transferred from one hierarchy level to another during the first six months of ~~2019~~2020 or ~~2018.~~2019.

Significant

Other

Significant

Quoted

Observable

Unobservable

Prices

Inputs

Inputs
(Dollars in thousands)

Fair Value

(Level 1)

(Level 2)

(Level 3)
June 30, 2019








Securities available for sale:








U.S. Government agencies

$
34,019

$
—

$
34,019

$
—
Mortgage-backed

111,391

—

111,391

—

145,410

—

145,410

—

Equity

1,325

—

1,325

—
Total

$
146,735

$
—

$
146,735

$
—


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs

													Significant
													Other		Significant
											Quoted		Observable		Unobservable
											Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)		Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2018
June 30, 2020
Securities available for sale:
U.S. Government agencies	$	33,636	$	—	$	33,636	$	—	$	9,789	$	—	$	9,789	$	—
Mortgage-backed		120,796		—		120,796		—		76,231		—		76,231		—
		154,432		—		154,432		—

										86,020		—		86,020		—

Equity		1,269		—		1,269		—		1,388		—		1,388		—
Total	$	155,701	$	—	$	155,701	$	—	$	87,408	$	—	$	87,408	$	—


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2019
Securities available for sale:
U.S. Government agencies	$	23,826	$	—	$	23,826	$	—
Mortgage-backed		98,965		—		98,965		—
		122,791		—		122,791		—

Equity		1,342		—		1,342		—
Total	$	124,133	$	—	$	124,133	$	—

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

31

Table of Contents

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 ~~and~~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

30

~~Table of Contents~~

asset as a non-recurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods.

The following tables ~~below present~~set forth the ~~recorded amount of~~Company’s financial assets ~~measured at~~subject to fair value adjustments (impairment) on a nonrecurring basis at June 30, ~~2019~~2020 and December 31, ~~2018.~~

Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)

Fair Value

Valuation Technique

Unobservable Input

Range
June 30, 2019








Nonrecurring measurements:









Impaired loans

$
1,994

Appraisal of collateral
(1)
Appraisal adjustments
(2)
0% - 17%

Liquidation expense
(2)
0% - 10%

Impaired loans

$
4,105

Discounted cash flow analysis
(1)
Discount rate

4% - 7.25%

Other real estate owned

$
524

Appraisal of collateral
(1)
Appraisal adjustments
(2)
15% - 40%





Liquidation expense
(2)
5% - 10%

2019, 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

(Dollars in thousands)

Fair Value

Valuation Technique

Unobservable Input

Range
December 31, 2018







Nonrecurring measurements:







Impaired loans

$
3,839

Appraisal of collateral
(1)
Appraisal adjustments
(2)
0% - 17%

Liquidation expense
(2)
0% - 10%

Impaired loans

$
5,902

Discounted cash flow analysis
(1)
Discount rate

4% - 7.25%

Other real estate owned

$
1,222

Appraisal of collateral
(1)
Appraisal adjustments
(2)
15% - 40%





Liquidation expense
(2)
5% - 10%


	Quantitative Information about Level 3 Fair Value Measurements
								Weighted
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range	Average (3)
June 30, 2020
Nonrecurring measurements:

Impaired loans	$	1,877	Appraisal of collateral	(1)	Liquidation expense	(2)	10%	(10%)


Impaired loans	$	2,549	Discounted cash flow analysis	(1)	Discount rate		4% - 7.25%	(6%)

Other real estate owned	$	38	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.

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Table of Contents


	Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range
December 31, 2019
Nonrecurring measurements:

Impaired loans	$	2,489	Appraisal of collateral	(1)	Liquidation expense	(2)	10%


Impaired loans	$	2,599	Discounted cash flow analysis	(1)	Discount rate		4% - 7.25%

Other real estate owned	$	74	Appraisal of collateral	(1)	Appraisal adjustments	(2)	0% - 31%
					Liquidation expense	(2)	10%

(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.

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 June 30, ~~2019~~2020 and December 31, ~~2018~~2019 were estimated using an exit price notion.


	June 30, 2020				December 31, 2019
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	126,284	$	126,284	$	94,971	$	94,971

Level 2 inputs
Investment securities held to maturity	$	11,710	$	11,715	$	8,786	$	8,654
Restricted securities		3,626		3,626		4,190		4,190
Cash surrender value on life insurance		30,430		30,430		29,782		29,782

Level 3 inputs
Loans, net	$	1,396,159	$	1,394,326	$	1,238,147	$	1,242,867

Financial liabilities
Level 2 inputs
Deposits:
Noninterest-bearing demand	$	442,996	$	442,996	$	356,618	$	356,618
Checking plus interest		344,940		344,940		302,227		302,227
Money market		274,783		274,783		262,050		262,050
Savings		163,320		163,320		143,322		143,322
Club		1,155		1,155		387		387
Certificates of deposit, $100,000 or more		129,467		132,577		127,600		128,167
Other time		148,067		152,358		149,130		149,209
Short-term borrowings		1,064		1,064		1,226		1,226
Long-term borrowings		—		—		15,000		15,040

June 30, 2019

December 31, 2018

Estimated

Estimated

Carrying

Fair

Carrying

Fair
(Dollars in thousands)

Amount

Value

Amount

Value
Financial assets








Level 1 inputs








Cash and cash equivalents

$
39,280

$
39,280

$
67,225

$
67,225

Level 2 inputs








Investment securities held to maturity

$
5,905

$
5,887

$
6,043

$
6,000
Restricted securities

5,095

5,095

6,476

6,476
Cash surrender value on life insurance

3,752

3,752

3,726

3,726

Level 3 inputs








Loans, net

$
1,229,990

$
1,222,190

$
1,185,012

$
1,150,418

Financial liabilities








Level 2 inputs








Deposits:








Noninterest-bearing demand

$
346,916

$
346,916

$
330,466

$
330,466
Checking plus interest

232,123

232,123

239,809

239,809
Money market

239,942

239,942

232,613

232,613
Savings

142,497

142,497

148,723

148,723
Club

1,142

1,142

387

387
Brokered Deposits

19,998

19,997

22,084

22,075
Certificates of deposit, $100,000 or more

117,855

117,968

97,905

96,435
Other time

148,527

148,125

140,354

136,292
Short-term borrowings

25,508

25,508

60,812

60,812
Long-term borrowings

15,000

15,021

15,000

15,012

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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 June 30, ~~2019~~2020 and December 31, ~~2018.~~

(Dollars in thousands)

June 30, 2019

December 31, 2018
Commitments to extend credit

$
223,777

$
210,463
Letters of credit

5,967

6,917
Total

$
229,744

$
217,380

2019.


(Dollars in thousands)	June 30, 2020		December 31, 2019
Commitments to extend credit	$	252,572	$	211,652
Letters of credit		7,019		7,691
Total	$	259,591	$	219,343

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Note 14 – Revenue Recognition

~~On January 1, 2018, the Company adopted ASU No. 2014-09~~ ~~“Revenue from Contracts with Customers” (Topic 606)~~ and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

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. ~~However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers.~~ Noninterest revenue streams in-scope of Topic 606 are discussed below.

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

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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

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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.

The following presents noninterest income from continuing operations, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019.

For Three Months Ended

For Six Months Ended

June 30,

June 30,

(Dollars in thousands)

2019

2018

2019

2018

Noninterest Income









In-scope of Topic 606:









Service charges on deposit accounts

$
1,028

$
947

$
1,962

$
1,852

Trust and investment fee income

385

414

757

814

Other noninterest income

1,146

915

1,986

1,725

Noninterest Income (in-scope of Topic 606)

2,559

2,276

4,705

4,391

Noninterest Income (out-of-scope of Topic 606)

50

20

92

45

Total Noninterest Income

$
2,609

$
2,296

$
4,797

$
4,436


	For Three Months Ended				For Six Months Ended
	June 30,				June 30,
(Dollars in thousands)	2020		2019		2020		2019
Noninterest Income
In-scope of Topic 606:
Service charges on deposit accounts	$	544	$	1,028	$	1,410	$	1,962
Trust and investment fee income		363		385		738		757
Interchange income		708		689		1,361		1,276
Other noninterest income		407		457		686		710
Noninterest Income (in-scope of Topic 606)		2,022		2,559		4,195		4,705
Noninterest Income (out-of-scope of Topic 606)		747		50		926		92
Total Noninterest Income	$	2,769	$	2,609	$	5,121	$	4,797

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 June 30, ~~2019~~2020, and December 31, ~~2018,~~2019, the Company did not have any significant contract balances.

~~Note 15 – Subsequent Events~~

On July 19, 2019, the Company entered into individual SERPs for the following Named Executive Officers: Lloyd L. Beatty, Jr. President and Chief Executive Officer, Edward C. Allen, Executive Vice President and Chief Financial Officer and Donna J. Stevens, Executive Vice President and Chief Operating Officer. Also, on this day the Bank purchased $14 million in BOLI which will be used to fund contributions to these SERPs in future years. These SERPs were created to replace the 2019 and 2020 Long-term Incentive Plans in which these officers forfeited their rights to receive shares of the Company’s common stock. More information and copies of these agreements were filed on July 25, 2019 in the form of a Current Report on 8-K and have been included as exhibits herein for reference.

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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 ~~subsidiaries.~~subsidiary.

Forward-Looking Information

~~Portions~~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 2019 Form 10-K in addition to Part II, Item 1A - Risk Factors of this Quarterly Report on Form ~~10‑Q contain~~10-Q and other reports as filed with the SEC.

Any forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature, including statements that include the words “anticipate”, “estimate”, “should”, “expect”, “believe”, “intend”, and similar expressions, are expressions about our confidence, policies, and strategies, the adequacy of capital levels, and liquidity and are not guarantees of future performance. Such forward-looking statements involve certain risks and uncertainties, including economic conditions, competition in the geographic and business areas in which we operate, inflation, fluctuations in interest rates, legislation, and governmental regulation. These risks and uncertainties are described in detail in the sectionstatement speaks only as of the ~~periodic reports that Shore Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) entitled “Risk Factors” (see Item 1A of Part II~~date of this report, and Item 1A of Part I of the Annual Report of Shore Bancshares, Inc. on Form 10‑K for the year ended December 31, 2018 (the “2018 Annual Report”)). Actual results may differ materially from such forward-looking statements, and we ~~assume no~~do not undertake any obligation to publicly update or review any forward-looking ~~statements at any time~~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 ~~2018~~2019 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 ~~21 full service~~22 full-service branches in Baltimore County, Howard County, Kent County, Queen Anne’s County, Talbot County, Caroline County, Dorchester County and ~~Dorchester~~Wicomico County in Maryland, Kent County, Delaware and Accomack County, Virginia. The Company engages in ~~the~~ trust and wealth management services ~~business~~ through ~~the trust department at~~Wye Financial Partners, a division of Shore United ~~Bank under the trade name Wye Financial & Trust.~~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,~~10-K, Quarterly Reports on Form ~~10‑Q,~~10-Q, Current Reports on Form ~~8‑K,~~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 recent outbreak of COVID-19, which was declared a pandemic by the World Health Organization on March 11, 2020, 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 thru 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 loan, 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. Through June 30, 2020, our team has been able to process 1,427 PPP loans for approximately $123.0 million in the first and second rounds of the program, which 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 where appropriate, including interest only payments or payment deferrals for clients that could be adversely affected by

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the COVID-19 pandemic. Section 4013 of the CARES Act also 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, these short-term modifications made to a borrower 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. As of June 30, 2020, we had deferred payments of principal and/or interest on a short-term basis for commercial and residential loans with an aggregate balance of $221.1 million, or 15.7% of the total loan portfolio.


							Loan Balances Modified Due to COVID-19 Through July 31, 2020
									Loans Modified		Loans
									to Interest		Modified to
	Total Loan		Total Loans		Total Loan		Total		Only Payments		Payment		Percentage
	Balance as of		Modified as of		Balance as of		Loans		(6 months		Deferral		of Loans
(Dollars in thousands)	June 30, 2020		June 30, 2020		July 31, 2020		Modified		or less)		(3 months)		Modified
Hospitality Industry	$	112,531	$	80,431	$	112,514	$	84,200	$	14,998	$	69,202	74.83	%
Non-owner occupied Retail Stores		92,755		55,995		103,464		25,031		3,251		21,780	24.19
Non-owner occupied Restaurants		8,442		3,215		8,499		3,192		-		3,192	37.56
Owner-occupied Retail Stores		17,758		2,628		15,248		1,363		160		1,203	8.94
Owner-occupied Restaurants		7,102		2,079		6,862		2,162		221		1,941	31.50
Oil & Gas Industry		-		-		-		-		-		-	—
Other Commercial Loans		762,970		66,767		752,201		45,560		16,431		29,129	6.06
Total Commercial Loans		1,001,558		211,115		998,788		161,508		35,061		126,447	16.17

Residential 1-4 family Personal		234,096		-		230,800		-		-		-	—
Residential 1-4 family Rentals		95,223		9,989		95,461		7,771		1,195		6,576	8.14
Home Equity Loans		50,555		-		51,947		-		-		-	—
Total Residential Real Estate Loans		379,874		9,989		378,208		7,771		1,195		6,576	2.05

Consumer Loans		26,877		-		27,792		373		-		373	1.34
Mortgage Warehouse Loans		-		-		-		-		-		-	—
Credit Card, Overdrafts and Other		(1,060)		-		(789)		-		-		-	—
TOTAL LOANS	$	1,407,249	$	221,104	$	1,403,999	$	169,652	$	36,256	$	133,396	12.08	%

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Liquidity

We are vigilantly monitoring our liquidity position on an ongoing basis as the circumstances surrounding the pandemic continue to evolve. 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. The potential for increased reliance on available liquidity sources may be required based on the effects of the pandemic and their impact on the level of deposits and other factors. 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

We have suspended all share buybacks of the Company’s common stock until further notice.

Dividends and Capital

We currently expect to maintain our quarterly cash dividend based on our strong capital position. At June 30, 2020, 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.

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. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility.

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The fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices, collateral value or are provided by other third-party sources, when available.

The most significant accounting policies that the Company follows are presented in Note 1 of the ~~2018~~2019 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 ~~deferred tax assets, and fair value~~ 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 ~~homogeneous~~similar loans based on historical loss experience, and consideration of current economic trends and conditions, 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 ofto the ~~2018~~2019 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 ~~Asset Quality -~~ Provision for Credit Losses and ~~Risk Management section~~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. Other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of

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contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability. Goodwill and other intangible assets are required to be recorded at fair value at inception. Determining fair value is subjective, requiring the use of estimates, assumptions and management judgment. Goodwill ~~and other intangible assets with indefinite lives are~~is tested at least annually for impairment, usually during the ~~first~~fourth quarter, or on an interim basis if circumstances dictate. Intangible assets that have finite lives are amortized over their estimated useful lives and also are subject to impairment testing. 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. ~~At the present time the Company only has one reporting unit, the Bank.~~ If the fair value of ~~the Bank~~a reporting unit is less than book value, an expense may be required to write down the related goodwill ~~or purchased intangibles~~ to record an impairment loss.

Deferred tax assets and liabilities are determined by applying the applicable federal and state income tax rates to cumulative temporary differences. These temporary differences represent differences between financial statement carrying amounts and the corresponding tax bases As of certain assets and liabilities. Deferred taxes result from such temporary differences. A valuation allowance, if needed, reduces deferred tax assets to the expected amount most likely to be realized. Realization of deferred tax assets is dependent on the generation of a sufficient level of future taxable income, recoverable taxes paid in prior years and tax planning strategies. The Company evaluates all positive and negative evidence before determining if a valuation allowance is deemed necessary regarding the realization of deferred tax assets.

The Company measures certain financial assets and liabilities at fair value, with the measurements made on a recurring or nonrecurring basis. Significant financial instruments measured at fair value on a recurring basis are investment securities. Impaired loans and other real estate owned are significant financial instruments measured at fair value on a nonrecurring basis. Fair value is defined 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. In determining fair value,June 30, 2020, the Company ~~is required to maximize the use of observable inputs and minimize the use of unobservable inputs, reducing subjectivity.~~

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had only one banking reporting unit.

OVERVIEW

The Company reported net income of ~~$4.2~~$5.3 million for the second quarter of ~~2019,~~2020, or diluted income per common share of $0.43, compared to net income of $4.2 million, or diluted income per common share of $0.33, ~~compared to~~for the second quarter of 2019. For the first quarter of 2020, the Company reported net income of ~~$4.4~~$3.1 million, or diluted income per common share of ~~$0.34,~~$0.25. When comparing net income for the second quarter of ~~2018. For the first quarter of 2019, the Company reported net income of $3.8 million, or diluted income per common share of $0.29. Net income from continuing operations for~~2020 to the second quarter of 2019, the increase was ~~$4.2~~due to a decrease in noninterest expense of $1.3 million, ~~or $0.33 per diluted common share, compared to~~coupled with increases in net interest income ~~from continuing operations~~ of ~~$4.2 million or $0.33 per diluted common share~~$738 thousand and noninterest income of $160 thousand, partially offset by an increase in the provision for ~~the second quarter~~credit losses of ~~2018, and net income from continuing operations of $3.9 million or $0.30 per diluted common share for the first quarter of 2019.~~$800 thousand. When comparing net income from continuing operations for the second quarter of 2019 to the second quarter of 2018, the primary reasons for slightly improved results were an increase in noninterest income and a reduction in provision for credit losses, almost entirely offset by increases in interest expense and noninterest expense. When comparing net income from continuing operations for the second quarter of 20192020 to the first quarter of ~~2019,~~2020, the ~~improved results were~~increase was primarily ~~attributable~~due to ~~increases~~a decrease in noninterest expenses of $2.7 million. In addition, net interest income and noninterest income ~~as well as a reduction in noninterest expense,~~increased $513 thousand and $417 thousand, respectively, partially offset by ~~higher interest expense and higher~~an increase in the provision for credit ~~losses.~~losses of $650 thousand.

For the first six months of ~~2019,~~2020, the Company reported net income of $8.5 million, or diluted income per common share of $0.68, compared to net income of $8.0 million, or diluted income per common share of $0.62, ~~compared to net income of $8.4 million, or diluted income per common share of $0.66,~~ for the first six months of 2018. Net income from continuing operations for the first six months of 2019 was $8.1 million, or 0.63 per diluted common share, compared to net income from continuing operations of $7.7 million or $0.60 per diluted common share for the first six months of 2018.2019. When comparing net income from continuing operations for the first six months of ~~2019~~2020 to the first six months of ~~2018,~~2019, the improved results were due to ~~higher~~increases in net interest income of $862 thousand and noninterest income of $324 thousand, coupled with a ~~reduction to the provision for credit losses,~~decrease in noninterest expense of $316 thousand, partially offset by an increase in ~~interest expense and noninterest expense.~~the provision for credit losses of $1.1 million.

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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 $13.1 million for the second quarter of 2020 and $12.3 million for the second quarter of ~~2019 and $12.6 million for the second quarter of 2018.~~2019. Tax-equivalent net interest income was ~~$12.4~~$12.6 million for the first quarter of ~~2019.~~2020. The ~~decrease~~increase in net interest income for the second quarter of ~~2019~~2020 when compared to the second quarter of ~~2018 and first quarter of~~ 2019 was ~~primarily~~ due to ~~an increase~~lower interest expenses on interest bearing deposits of $648 thousand, or 29.4% and short and long-term borrowings of $245 thousand, or 92.2%. In addition, interest on loans increased $192 thousand, or 1.4%. These improvements to net interest income were partially offset by decreases in interest ~~expense, primarily interest~~income on ~~deposits~~taxable investment securities of ~~$1.6 million,~~$249 thousand, or ~~280.0%~~28.1%, and ~~$257~~interest-bearing deposits with other banks of $102 thousand, or ~~13.2%, respectively. These increases in~~90.3%. Net interest ~~expense~~income increased for the second quarter of ~~2019~~2020 when compared to the first quarter of 2020 due to lower interest expenses on interest bearing deposits of $503 thousand, or 24.4%, and short and long-term borrowings of $102 thousand, or 93.6%. In addition, interest on loans increased $151 thousand, or 1.1%. These improvements to net interest income were partially offset by ~~higher~~decreases in interest income ~~and fees~~ on ~~loans when compared to the second quarter~~taxable investment securities of ~~2018 and the first quarter of 2019 of $1.1 million,~~$81 thousand, or ~~8.9%~~11.3%, and ~~$257~~interest-bearing deposits with other banks of $161 thousand, or ~~1.9%, respectively.~~93.6%. Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets. The net interest margin for the second quarter of ~~2019~~2020 was ~~3.54%~~3.41%, which iswas a decrease of 2513 basis points (bps) when compared to ~~3.79%~~3.54% for the second quarter of ~~2018~~2019 and a decrease of 7bps when compared to 3.48% for the first quarter of ~~2019 of 3.61%.~~2020.

Interest Income

On a tax-equivalent basis, interest income ~~increased $1.1 million,~~decreased $159 thousand, or ~~7.9%~~1.1%, for the second quarter of ~~2019~~2020 when compared to the second quarter of ~~2018.~~2019. The ~~increase~~decrease was due to a $1.1 million, or 8.9%, increase in interest income and fees on loans, primarily the result of the increase in the average balance of loans of $79.9 million, or 7.0%. The average yield on loans increased 8bps from the comparable quarter in 2018. Interest on interest-bearing deposits with other banks increased $52 thousand, or 85.2% due to increased average yield on these deposits of 65bps. Interest on investment securities decreased $95 thousand, or 9.7%, due to a decrease in the average balance of taxable investment securities of ~~$26.6~~$52.0 million, or ~~14.3% which was used~~32.5% due to the proceeds being utilized to fund loan growth between the periods, coupled with a decrease in the average yield on interest-bearing deposits with other banks of 240bps. The average balance of loans increased $153.1 million, or 12.5%, between the comparable ~~quarters.~~periods and the average yield on loans decreased 44bps, which were the direct result of adding 1,427 PPP loans with an average yield of 2.36%.

On a tax-equivalent basis, interest income ~~increased $96~~decreased $90 thousand, or ~~0.7%~~less than 1%, for the second quarter of ~~2019~~2020 when compared to the first quarter of ~~2019.~~2020. The ~~increase~~decrease was primarily due to ~~an increase~~decreases in ~~interest income and fees~~the average rate paid on ~~loans~~interest-bearing deposits with other banks of ~~$257 thousand, primarily~~113bps, as well as, a decrease in the ~~result~~average balance of taxable investment securities of $21.5 million, or 16.6%, partially offset by an increase in the average balance onof loans of ~~$19.3 million. Partially offsetting~~$110.9 million, or 8.8% due to the ~~increase in interest income and fees on~~influx of PPP loans ~~was reduced income on taxable investment securities and interest-bearing deposits with other banks~~processed during the second quarter of ~~$111 thousand and $50 thousand, respectively. Both interest-bearing deposits with other~~

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~~Table of Contents~~

banks and taxable investment securities were impacted by lower average balances of $9.5 million and $5.1 million, with the addition of a decrease in the yield for taxable investment securities of 23bps.2020.

Interest Expense

Interest expense ~~increased $1.4 million,~~decreased $893 thousand, or ~~135.9%~~36.4%, when comparing the second quarter of ~~2019~~2020 to the second quarter of ~~2018.~~2019. The ~~increase in~~decrease was a direct result of lower interest ~~expense was due to an increase in the rates~~expenses paid on interest-bearing deposits of ~~72bps, which equated to $1.6 million in additional interest expense. The addition of~~$648 thousand, and short and long-term borrowings ~~resulted in additional interest expense~~ of ~~$107 thousand, partially offset by a decrease in the average balance of short-term borrowings of $70.4 million, or 76.6%.~~$245 thousand. The average balance of short and long-term borrowings decreased $33.7 million, or 92.2%, while the average rate paid on interest-bearing deposits increased $54.7 million, or 6.5% which was a positive transition from higher rates paid on short-term borrowings and a more sustainable approach for funding long-term loan growth. The average balance of noninterest-bearing deposits increased $17.4 million, or 5.4% between the comparable quarters.

~~Interest expense increased $190 thousand, or 8.4%, when comparing the second quarter of 2019 to the first quarter of 2019. The increase in interest expense was due to~~decreased 37bps, partially offset by an increase in the average balance of interest-bearing deposits of ~~$9.7~~$112.4 million, or 1.1%, coupled with higher rates paid on these deposits of 10bps. This increase provided the opportunity for the Company to pay-down short-term borrowings resulting in a decrease in the average balance of $11.4 million, or 34.6%12.6%. The average balance of noninterest-bearing deposits increased ~~$8.6~~$80.7 million, or ~~2.6%~~23.8% between the comparable quarters.

Interest expense decreased $605 thousand, or 27.9%, when comparing the second quarter of 2020 to the first quarter of 2020. The decrease in interest expense was mainly due to a decrease in the average rate paid on interest-bearing deposits of 23bps. The decrease in rates paid on interest-bearing deposits was partially offset by an increase in the average balance of $32.3 million, or 3.3%. The average balance of noninterest-bearing deposits increased $67.6 million, or 19.2%, when compared to the first quarter of ~~2019.~~

2020.

3841

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The following tables ~~presents~~present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended June 30, ~~2019~~2020 and ~~2018.~~2019.


	For Three Months Ended						For Three Months Ended
	June 30, 2020						June 30, 2019
	Average		Income(1)/		Yield/		Average		Income(1)/		Yield/
(Dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Earning assets
Loans (2), (3)	$	1,374,324	$	13,982	4.09	%	$	1,221,215	$	13,790	4.53	%
Investment securities:
Taxable		107,908		638	2.37			159,878		887	2.22
Interest-bearing deposits		57,713		11	0.07			18,325		113	2.47
Total earning assets		1,539,945		14,631	3.82	%		1,399,418		14,790	4.24	%
Cash and due from banks		18,167						17,225
Other assets		90,981						61,906
Allowance for credit losses		(10,706)						(10,456)
Total assets	$	1,638,387					$	1,468,093

Interest-bearing liabilities
Demand deposits	$	298,568		145	0.20	%	$	234,775		382	0.65	%
Money market and savings deposits		426,963		246	0.23			385,272		803	0.84
Brokered Deposits		—		—	—			20,866		131	2.52
Certificates of deposit $100,000 or more		130,582		586	1.81			107,549		413	1.54
Other time deposits		150,675		579	1.54			145,900		475	1.31
Interest-bearing deposits		1,006,788		1,556	0.62			894,362		2,204	0.99
Short-term borrowings		2,030		1	0.20			21,557		145	2.70
Long-term debt		824		6	2.93			15,000		107	2.86
Total interest-bearing liabilities		1,009,642		1,563	0.62	%		930,919		2,456	1.06	%
Noninterest-bearing deposits		420,275						339,589
Other liabilities		9,628						8,484
Stockholders’ equity		198,842						189,101
Total liabilities and stockholders’ equity	$	1,638,387					$	1,468,093

Net interest spread			$	13,068	3.20	%			$	12,334	3.18	%
Net interest margin					3.41	%					3.54	%

Tax-equivalent adjustment
Loans			$	37					$	41
Total			$	37					$	41

For Three Months Ended

For Three Months Ended

June 30, 2019

June 30, 2018


Average

Income(1)/

Yield/

Average

Income(1)/

Yield/

(Dollars in thousands)

Balance

Expense

Rate

Balance

Expense

Rate

Earning assets













Loans (2), (3)

$
1,221,215

$
13,790

4.53
%
$
1,141,296

$
12,659

4.45
%

Investment securities:











Taxable

159,878

887

2.22

186,453

982

2.11

Interest-bearing deposits

18,325

113

2.47

13,301

61

1.82

Total earning assets

1,399,418

14,790

4.24
%

1,341,050

13,702

4.10
%

Cash and due from banks

17,225





16,905





Other assets

61,906





78,185





Allowance for credit losses

(10,456)





(10,193)





Total assets

$
1,468,093





$
1,425,947





Interest-bearing liabilities













Demand deposits

$
234,775

382

0.65
%
$
204,068

108

0.21
%

Money market and savings deposits

385,272

803

0.84

381,047

127

0.13

Brokered Deposits

20,866

131

2.52

10,684

52

1.96

Certificates of deposit $100,000 or more

107,549

413

1.54

96,873

129

0.54

Other time deposits

145,900

475

1.31

146,946

164

0.45

Interest-bearing deposits

894,362

2,204

0.99

839,618

580

0.27

Short-term borrowings

21,557

145

2.70

91,980

461

2.01

Long-term debt

15,000

107

2.86

—

—

—

Total interest-bearing liabilities

930,919

2,456

1.06
%

931,598

1,041

0.44
%

Noninterest-bearing deposits

339,589





322,172





Other liabilities

8,484





5,697





Stockholders’ equity

189,101





166,480





Total liabilities and stockholders’ equity

$
1,468,093





$
1,425,947





Net interest spread



$
12,334

3.18
%



$
12,661

3.66
%

Net interest margin





3.54
%





3.79
%

Tax-equivalent adjustment

Loans

$
41

$
28

Total

$
41

$
28

(1)

~~(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)

~~(2)~~

Average loan balances include nonaccrual loans.

(3)

~~(3)~~

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

Net Interest Income

Tax-equivalent net interest income ~~decreased $256~~increased $860 thousand, or ~~1.0%~~3.5%, during the six months ended June 30, ~~2019~~2020 compared to the six months ended June 30, ~~2018.~~2019. The ~~decrease~~increase in net interest income was ~~primarily~~ due to ~~an increase~~a decrease in interest ~~expense~~expenses on interest-bearing deposits of ~~$3.0 million,~~$535 thousand, or ~~268.0%, partially offset by an increase in interest income from~~12.9% and short and long-term borrowings of $455 thousand, or 79.7%. In addition, the average yield on earning assets ~~of $2.7 million, or 9.9%.~~decreased 31bps. This resulted in a net interest margin of 3.45% for the six months ended June 30, 2020 compared to 3.57% for the six months ended June 30, ~~2019 compared to 3.80% for the six months ended June 30, 2018.~~2019.

Interest Income

On a tax-equivalent basis, interest income ~~increased $2.7 million,~~decreased $130 thousand, or ~~9.9%~~less than 1%, for the six months ended June 30, ~~2019~~2020 when compared to the six months ended June 30, ~~2018.~~2019. The ~~increase~~decrease was primarily due to a ~~$2.6~~decline in the average balance of taxable investment securities of $43.8 million, or ~~10.5%~~26.9%, ~~increase in interest income~~ and ~~fees on loans. The average balance on loans increased $87.8 million, or 7.8%, while~~ the lower yield on ~~these loans expanded 11bps. In addition, interest income from~~ interest-bearing deposits with other banks of 178bps. The average balance of loans increased ~~$177~~$107.3 million, or 8.9%, while the average yield declined

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31bps, in part due to the funding of 1,348 PPP loans during the second quarter of 2020 which had an average yield of 2.36%.

Interest Expense

Interest expense decreased $990 thousand, or 178.8%, primarily due to a 70bps increase in yield on these deposits. This was partially offset by a decrease in interest income on investment securities of $118 thousand, or 5.9%, primarily due to a decrease in the average balance in these investments of $29.4 million, or 15.3%, which was used to fund loan growth between the comparable periods.

~~Interest Expense~~

~~Interest expense increased $2.9 million, or 160.2%~~21.0%, when comparing the six months ended June 30, ~~2019~~2020 to the six months ended June 30, ~~2018.~~2019. The ~~increase~~decrease in interest expense was due to a decline in the rates paid on interest-bearing deposits of 21bps and the decline in the average balance on short and long-term borrowings of $32.7 million, or 77.4%. These decreases were partially offset by an increase in the average balance of ~~interest-bearing~~noninterest-bearing deposits of ~~$43.8~~$51.1 million, or 5.2%, and the average rate paid on these deposits of 67bps. This added $3.0 million in additional interest expense when comparing the first six months of 2019 to the first six months of 2018. The addition of long-term borrowings of $15.0 million was offset by a decrease in the average balance of short-term borrowings of $47.1 million which decreased the dependence on outside funding sources which carry a higher rate than core deposits.15.3%.

The following tables ~~presents~~present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the six months ended June 30, ~~2019~~2020 and ~~2018.~~2019.

For Six Months Ended

For Six Months Ended

June 30, 2019

June 30, 2018


Average

Income(1)/

Yield/

Average

Income(1)/

Yield/

(Dollars in thousands)

Balance

Expense

Rate

Balance

Expense

Rate

Earning assets













Loans (2), (3)

$
1,211,618

$
27,323

4.55
%
$
1,123,852

$
24,731

4.44
%
Investment securities:













Taxable

162,429

1,885

2.34

191,839

2,003

2.09

Interest-bearing deposits

23,039

276

2.42

11,536

99

1.72

Total earning assets

1,397,086

29,484

4.26
%

1,327,227

26,833

4.08
%
Cash and due from banks

17,211





16,646





Other assets

60,340





77,266





Allowance for credit losses

(10,423)





(10,081)





Total assets

$
1,464,214





$
1,411,058





Interest-bearing liabilities













Demand deposits

$
237,271

741

0.63
%
$
210,403

233

0.22
%
Money market and savings deposits

384,508

1,610

0.84

380,969

244

0.13

Brokered Deposits

21,470

260

2.44

5,372

52

1.96

Certificates of deposit $100,000 or more

103,067

714

1.40

99,387

255

0.52

Other time deposits

143,226

826

1.16

149,619

344

0.46

Interest-bearing deposits

889,542

4,151

0.94

845,750

1,128

0.27

Short-term borrowings

27,239

358

2.65

74,381

687

1.86

Long-term debt

15,000

213

2.86

—

—

—

Total interest-bearing liabilities

931,781

4,722

1.02
%

920,131

1,815

0.40
%
Noninterest-bearing deposits

335,334





319,434





Other liabilities

10,051





5,715





Stockholders’ equity

187,048





165,778





Total liabilities and stockholders’ equity

$
1,464,214





$
1,411,058





Net interest spread



$
24,762

3.24
%



$
25,018

3.68
%
Net interest margin





3.57
%





3.80
%

Tax-equivalent adjustment

Loans

$
75

$
56

Total

$
75

$
56

~~(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 amortized loan fees, net of costs, and accretion of discounts on acquired loans, which are included in the yield calculations.~~


	For Six Months Ended						For Six Months Ended
	June 30, 2020						June 30, 2019
	Average		Income(1)/		Yield/		Average		Income(1)/		Yield/
(Dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Earning assets
Loans (2), (3)	$	1,318,883	$	27,813	4.24	%	$	1,211,618	$	27,323	4.55	%
Investment securities:
Taxable		118,659		1,357	2.30			162,429		1,885	2.34
Interest-bearing deposits		57,685		183	0.64			23,039		276	2.42
Total earning assets		1,495,227		29,353	3.95	%		1,397,086		29,484	4.26	%
Cash and due from banks		18,020						17,211
Other assets		90,068						60,340
Allowance for credit losses		(10,626)						(10,423)
Total assets	$	1,592,689					$	1,464,214

Interest-bearing liabilities
Demand deposits	$	291,372		540	0.37	%	$	237,271		741	0.63	%
Money market and savings deposits		418,608		712	0.34			384,508		1,610	0.84
Brokered Deposits		—		—	—			21,470		260	2.44
Certificates of deposit $100,000 or more		129,995		1,183	1.83			103,067		714	1.40
Other time deposits		150,659		1,180	1.58			143,226		826	1.16
Interest-bearing deposits		990,634		3,615	0.73			889,542		4,151	0.94
Short-term borrowings		1,632		3	0.37			27,239		358	2.65
Long-term debt		7,912		113	2.87			15,000		213	2.86
Total interest-bearing liabilities		1,000,178		3,731	0.75	%		931,781		4,722	1.02	%
Noninterest-bearing deposits		386,478						335,334
Other liabilities		9,446						10,051
Stockholders’ equity		196,587						187,048
Total liabilities and stockholders’ equity	$	1,592,689					$	1,464,214

Net interest spread			$	25,622	3.20	%			$	24,762	3.24	%
Net interest margin					3.45	%					3.57	%

Tax-equivalent adjustment
Loans			$	73					$	75
Total			$	73					$	75

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Table of Contents

Noninterest Income

Total noninterest income ~~from continuing operations~~ for the second quarter of ~~2019~~2020 increased ~~$313~~$160 thousand, or ~~13.6%~~6.1%, when compared to the second quarter of ~~2018.~~2019. The increase from the second quarter of ~~2018~~2019 was mainly due to ~~increases~~additional income from BOLI purchased late in 2019 and other bank and loan fees, ~~on bank services of $259 thousand,~~partially offset by lower service charges on deposit accounts of $81 thousand, other loan fee income of $26 thousand and a change in the fair value of equity securities of $51 thousand, partially offset by a decrease in trust and investment fee income of $29 thousand.accounts. Noninterest income ~~from continuing operations~~ increased ~~$421~~$417 thousand, or ~~19.2%~~17.7%, when compared to the first quarter of ~~2019 mainly~~2020 primarily due to sales of available for sale investment securities at a gain of $347 thousand, other bank service and loan fees of $211 thousand and ~~bank services~~a gain on directors life insurance of ~~$288~~$86 thousand, partially offset by a decrease in service charges on deposit accounts of ~~$94~~$322 thousand other loan fee income of $29 thousand and trust and investment fee income of $13 thousand. The increase in fee income in the second quarter of 2019 when compared to the second quarter of 2018 and the first quarter of 2019which was ~~primarily due to certain one-time fees received in the second quarter of 2019 as a one-time occurrence.~~significantly impacted by decreased consumer spending.

Total noninterest income from continuing operations for the six months ended June 30, ~~2019~~ 2020 increased ~~$361~~$324 thousand, or ~~8.1%~~6.8%, when compared to the same period in ~~2018.~~2019. The increase in noninterest income primarily ~~consists~~consisted of increases in BOLI income, gains on sales of available for sale securities and other ~~fees on~~ bank services, ~~of $311 thousand, service charges on deposit accounts of $110 thousand, other loan fee income of $40 thousand, and a~~ ~~change in the fair value of equity securities~~ ~~of $54 thousand,~~ partially offset by a decrease in ~~trust and investment income of $57 thousand.~~service charges on deposit accounts.

Noninterest Expense

Total noninterest expense from continuing operations for the second quarter of ~~2019 increased $132 thousand,~~2020 decreased $1.3 million, or ~~1.5%~~14.7%, when compared to the second quarter of ~~2018. The increase in noninterest expense for the second quarter of~~ 2019 ~~compared to the second quarter of 2018 was primarily due to higher expense related to data processing of $230 thousand, other real estate owned expense, net of $55 thousand, furniture~~ and equipment expense of $48 thousand and legal and professional fees of $72 thousand, partially offset by a decrease in salaries and wages of $309 thousand. The higher data processing fees were the result of a new contract with our core service provider which occurred in the third quarter of 2018. The decrease in salaries and wages was due to the termination of the 2020 Long-term Incentive Plan and the absence of the former president of the Bank’s salary for an entire quarter. The decrease in total noninterest expenses from continuing operationsdecreased $2.7 million, or 26.0%, when compared to the first quarter of 2020. The decrease in noninterest expense when compared to the second quarter of 2019 and the first quarter of 2020 was primarily in salaries and wages, due to ~~lower employee benefit~~the origination of PPP loans which resulted in heightened loan origination costs being deferred for the period. These loan origination costs were deferred at origination along with the related origination fees. The net fees of ~~$186 thousand~~$2.6 million have and ~~lower other real estate owned~~will continue to be accreted to interest income as a yield adjustment over the lives of the related PPP loans, which for most was 24 months at the time of origination. The recognition of these deferred fees and costs as a component of interest income will be accelerated upon forgiveness or repayment of the PPP loans. As previously stated, the Company processed 1,427 PPP loans during the second quarter of 2020 and does not anticipate additional originations at this volume resulting in additional reductions of salaries and wages expense ~~net of $173 thousand.~~in future quarters.

Total noninterest expense from continuing operations for the six months ended June 30, ~~2019 increased $23~~2020 decreased $316 thousand, or ~~0.01%~~1.7%, when compared to the same period in ~~2018. Despite the minimal increase in total noninterest expenses from continuing operations, several expense line items experienced significant variances.~~2019. The ~~significant increases in noninterest expenses were the following: Other~~decrease was a result of lower salaries and wages due to FASB 91 deferrals, lower FDIC insurance premiums and other real estate owned expenses, ~~net of $334 thousand, data processing fees of $272 thousand, legal and professional fees of $225 thousand, and~~partially offset by higher employee ~~benefits of $101 thousand.~~benefit costs. The ~~significant decreases in noninterest expense were the following: Salaries~~deferred costs for salaries and wages are being recognized over the lives of ~~$769 thousand, other noninterest expenses of $121 thousand and $64 thousand in directors’ fees.~~ the related loans as previously mentioned.

Provision for Credit Losses

The provision for credit losses was $1.0 million for the second quarter of 2020, $200 thousand for the second quarter of 2019 ~~$418~~and $350 thousand for the first quarter of 2020. The ratio of the allowance for credit losses to period-end loans was 0.79% at June 30, 2020. Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 0.86% at June 30, 2020, higher than both the 0.83% at June 30, 2019 and the 0.81% at March 31, 2020. The primary drivers of the increased percentage of the allowance to total loans, excluding the guaranteed PPP loans, and the increase in provision for loan losses as compared to both the prior periods were increases in qualitative factors and, in particular, elevated unemployment statistics and the impact of the COVID-19 pandemic. Net charge-offs were $288 thousand for the second quarter of ~~2018 and $100 thousand for the first quarter of 2019. The lower level of provision for credit losses when comparing the second quarter of 2019~~2020, compared to ~~the second quarter of 2018~~ was due to lower loan growth in the second quarter of 2019. The higher level of provision for credit losses when comparing the second quarter of 2019 to the first quarter of 2019 was due to the absence of recoveries experienced in the first quarter of 2019 of $185 thousand. Net charge-offs were $313 thousand for the second quarter of 2019 ~~$84 thousand for the second quarter of 2018~~ and ~~$25~~$479 thousand for the first quarter of ~~2019.~~2020. The ~~increase in net~~ charge-offs in the second quarter ~~of 2019 when compared~~related to the second quarter of 2018 and the first quarter of 2019, was primarily due to the sale of real estate securing specific loans at a foreclosure auction, which resulted in additional charge-offs during the second quarter of 2019. Totalcontinued workout efforts on nonperforming assets at June 30, 2019 increased $5.4 million when compared to June 30, 2018, which was due to a nonaccrual loan added late in the fourth quarter of 2018, in which the Company does not anticipate any further losses. Total nonperforming assets when compared to the first quarter of 2019 decreased $891 thousand, the result of decreases in nonaccrual loans of $768 thousand and other real estate owned

41

~~Table of Contents~~

of $455 thousand, partially offset by an increase in loans 90 days past due and still accruing of $392 thousand. The ratio of annualized net charge-offs to average loans was 0.10% for the second quarter of 2019, 0.03% for the second quarter of 2018 and 0.01% for the first quarter of 2019.assets.

The provision for credit losses for the six months ended June 30, 2020 and 2019 was $1.4 million and ~~2018 was~~ $300 ~~thousand and $907~~ thousand, respectively, while net charge-offs were ~~$338~~$767 thousand and ~~$567~~$338 thousand, respectively. The ~~decrease~~increase in provision for credit losses was the result of ~~improved overall credit quality exclusive~~higher charge-offs in 2020, qualitative factors related to economic conditions and the COVID-19 pandemic. The ratio of ~~one large nonaccrual loan with an outstanding loan balance of $7.5 million added late in the fourth quarter of 2018.Additionally, the decrease in provision for credit losses for~~allowance to total loans decreased over the first six months of the year from 0.84% at December 31, 2019 ~~when compared~~to 0.79% at June 30, 2020. As previously discussed, this ratio decreased as a result of the PPP loans’ inclusion in the balance of total loans. Additionally, a reduction in specific reserves for certain credits through charge-offs during the six months ended June 30, 2020 reduced the allowance to total loans ratio. The general reserve component of

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the allowance to legacy, non-impaired and non-PPP loans increased from 0.75% at December 31, 2019 to 0.89% at June 30, 2020, primarily resulting from increased qualitative allocations related to the ~~first six months of 2018 was impacted by lower loan growth and lower net charge-offs in 2019.~~COVID-19 pandemic. The ratio of annualized net charge-offs to average loans was 0.12% for the first half of 2020 and 0.06% for the first ~~six months~~half of ~~June 30, 2019~~2019. Management will continue to evaluate the adequacy of the allowance for credit losses as more economic data becomes available and ~~0.10% for~~as changes within the ~~same period in 2018.~~Company’s portfolio are known.

Income Taxes

The Company reported income tax expense from continuing operations of $1.8 million for the second quarter of 2020, $1.5 million for the second quarter of 2019 and ~~2018 and $1.3~~$1.1 million for the first quarter of ~~2019.~~2020. Income tax expense ~~remained flat~~increased when compared to the second quarter of ~~2018 due to a minimal change in pre-tax earnings. Income tax expense increased $178 thousand when compared to~~2019 and the first quarter of ~~2019~~2020 due to ~~improved~~higher pre-tax ~~earnings for the Company.~~earnings. The effective tax rate on continuing operations for the second and first quarter of 2020 was ~~26.0%~~25.2%. The effective tax rate for the second quarter of 2019 ~~25.9% for the second quarter of 2018 and 25.5% for the first quarter of 2019.~~was 26.0%. Income taxes from continuing operations for the six months ended June 30, 2020 as compared to the six months ended June 30, 2019 increased ~~$268~~$55 thousand or ~~10.6%~~2.0%, due to an increase in net income.

ANALYSIS OF FINANCIAL CONDITION

Loans

Loans totaled ~~$1.240~~$1.407 billion at June 30, ~~2019~~2020 and ~~$1.195~~$1.249 billion at December 31, ~~2018,~~2019, an increase of ~~$44.9~~$158.6 million, or ~~3.8%~~12.7%. The increase was primarily due to ~~organic~~the origination of 1,427 PPP loans totaling $123.0 million. Organic growth for the first six months of ~~$36.1~~2020 was $35.6 million, which consisted of increases in commercial real estate loans ~~$6.6~~of $39.8 million, in construction loans of $10.8 million and ~~$1.1~~consumer loans of $7.5 million, partially offset by decreases in residential real estate loans of $12.1 million and commercial ~~loans.~~loans, excluding PPP loans, of $10.4 million. Loans included deferred costs, net of deferred fees, of ~~$1.2 million~~$470 thousand and discounts on acquired loans of ~~$1.3 million~~$912 thousand at June 30, ~~2019,~~2020, compared to ~~$789 thousand~~$1.8 million and ~~$1.4~~$1.1 million, respectively, at December 31, ~~2018.~~2019. We do not engage in foreign or subprime lending activities. See Note 5, “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 ~~$134.1~~$110.7 million, or ~~10.8%~~7.9% of total loans, at June 30, ~~2019~~2020 and ~~$127.6~~$99.8 million, or ~~10.7%~~8.0% of total loans at December 31, ~~2018.~~2019. Commercial real estate loans were ~~$559.6~~$626.3 million, or ~~45.1%~~44.5% of total loans, at June 30, ~~2019,~~2020, compared to ~~$523.4~~$586.6 million, or ~~43.8%~~47.0% of total loans, at December 31, ~~2018.~~2019.

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 June 30, ~~2019,~~2020, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented ~~299.9%~~291.0% of total risk-based capital. At such time, construction, land and land development loans represented ~~84.2%~~60.2% of total risk-based capital.

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The commercial real estate portfolio (including construction) has increased ~~99.4%~~48.3% 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

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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 $11.1 million at June 30, 2020, $10.3 million at June 30, 2020 and $10.4 million at March 31, 2020. Net ~~charge-offs~~charge offs for the second quarter of 2020 were $288 thousand, compared to $313 thousand for the second quarter of 2019 ~~$84 thousand for the second quarter of 2018~~ and ~~$25~~$479 thousand for the first quarter of 2020. The ratio of net charge-offs to average loans was 0.08% for the second quarter of 2020, compared to 0.10% for the second quarter of 2019 and 0.15% for the first quarter of 2020. Net charge-offs were $767 thousand for the six months ended June 30, 2020, compared to $338 thousand for the six months ended June 30, 2019. The ratio of net charge-offs to average loans was 0.12% and 0.06% for the six months ended June 30, 2020 and June 30, 2019, respectively.

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 0.79% at June 30, 2020, 0.83% at June 30, 2019 and ~~0.87%~~0.84% at December 31, 2019. Excluding PPP loans, the ratio of the allowance for credit losses to period-end loans was 0.86% at June 30, ~~2018~~2020, higher than both the 0.83% and 0.84% at June 30, 2019 and December 31, ~~2018.~~2019. The increase in the percentage of the allowance to total loans at June 30, 2020, compared to June 30, 2019 and December 31, 2019, was primarily due to increases in qualitative factors, and in particular, elevated unemployment statistics, the impact of COVID-19 pandemic. Management currently believes that the provision for credit losses and the resulting allowance ~~was~~were adequate to provide for probable losses inherent in our loan portfolio at June 30, ~~2019.~~2020. However, management will continue to evaluate the adequacy of the allowance for credit losses as more economic data becomes available and as the impact of the COVID 19 pandemic on the Company’s portfolio becomes known. Increases in unemployment, declines in consumer confidence, and a reluctance on the part of businesses to invest in and expand their operations, among other things, may result in additional weakness in economic conditions, place financial strain on our borrowers and ultimately impact the credit quality of our loan portfolio. As a result, we may experience increases in the level of past due, nonaccrual and classified loans, as well as higher net charge-offs. Deterioration in credit quality in conjunction with weakness in current and expected economic conditions, may require us to record additional provisions for credit losses in excess of historical levels.

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The following table presents a summary of the activity in the allowance for credit losses at or for the three and six months ended June 30, ~~2019~~2020 and ~~2018.~~2019.


	At or for Three Months Ended						At or for Six Months Ended
	June 30,						June 30,

													At or for Three Months Ended						At or for Six Months Ended
													June 30,						June 30,
(Dollars in thousands)	2019			2018			2019			2018			2020			2019			2020			2019
Allowance balance - beginning of period	$	10,418		$	9,787		$	10,343		$	9,781		$	10,378		$	10,418		$	10,507		$	10,343


Charge-offs:
Construction		(3)			—			(3)			(379)			—			(3)			—			(3)
Residential real estate		(300)			(41)			(423)			(179)			—			(300)			(191)			(423)
Commercial real estate		—			—			—			—			(331)			—			(601)			—
Commercial		(81)			(126)			(162)			(126)			(37)			(81)			(119)			(162)
Consumer		(23)			(14)			(29)			(24)			—			(23)			(7)			(29)
Total		(407)			(181)			(617)			(708)			(368)			(407)			(918)			(617)
Recoveries:
Construction		4			6			7			15			5			4			8			7
Residential real estate		3			73			11			86			4			3			7			11
Commercial real estate		8			8			107			18			—			8			—			107
Commercial		77			10			152			22			61			77			124			152
Consumer		2			—			2			—			10			2			12			2
Totals		94			97			279			141			80			94			151			279
Net charge-offs		(313)			(84)			(338)			(567)			(288)			(313)			(767)			(338)
Provision for credit losses		200			418			300			907			1,000			200			1,350			300
Allowance balance - end of period	$	10,305		$	10,121		$	10,305		$	10,121		$	11,090		$	10,305		$	11,090		$	10,305


Average loans outstanding during the period	$	1,221,215		$	1,141,296		$	1,211,618		$	1,123,852		$	1,374,324		$	1,221,215		$	1,318,883		$	1,211,618
Net charge-offs (annualized) as a percentage of average loans outstanding during the period		0.10	%		0.03	%		0.06	%		0.10	%		0.08	%		0.10	%		0.12	%		0.06	%
Allowance for credit losses at period end as a percentage of total period end loans(1)		0.83	%		0.87	%		0.83	%		0.87	%		0.79	%		0.83	%		0.79	%		0.83	%
Allowance for credit losses at period end as a percentage of average loans														0.81	%		0.84	%		0.84	%		0.85	%

(1)

At June 30, 2020, the ratio includes PPP loans of $123.0 million. Without PPP loans, the ratio is 0.86%.

Nonperforming Assets and Accruing TDRs

As shown in the following table, nonperforming assets ~~decreased $2.5 million~~increased $301 thousand to ~~$15.6~~$12.3 million at June 30, ~~2019~~2020 from ~~$18.0~~$12.0 million at December 31, ~~2018,~~2019, primarily due to ~~a decrease~~an increase in nonaccrual loans of ~~$2.1~~$1.1 million, or ~~12.4%~~10.0%, partially offset by a decrease in loans 90 days past due and still accruing of $722 thousand, or 54.4%. Accruing TDRs decreased ~~$895~~$189 thousand to ~~$7.8~~$7.3 million at June 30, ~~2019~~2020 from ~~$8.7~~$7.5 million at December 31, ~~2018.~~2019. Additionally, other real estate owned decreased ~~$698~~$36 thousand, or ~~57.1%~~48.6%, when compared to December 31, ~~2018.~~2019. The ~~decrease~~increase in nonaccrual loans was due to ~~two~~one loan relationship with a residential ~~relationships in~~real estate customer with nonaccrual loans amounting to $1.1 million, which the ~~collateral was sold by the borrower and the loans were subsequently paid off. One of these relationships required a charge-off of $123 thousand.~~Bank has been monitoring for several quarters. The decrease in accruing TDRs was due to normal ~~payments and one payoff of $197 thousand.~~payments. The ratio of nonaccrual loans and accruing TDRs to total loans decreased 10 bps to ~~1.80%~~1.35% at June 30, ~~2019~~2020 from ~~2.12%~~1.45% at December 31, ~~2018.~~2019.

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 June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.



(Dollars in thousands)	June 30, 2019			December 31, 2018			June 30, 2020			December 31, 2019
Nonperforming assets
Nonaccrual loans
Construction	$	1,449		$	2,842		$	297		$	—
Residential real estate		2,549			4,099			3,816			2,475
Commercial real estate		10,283			9,374			6,988			7,817
Commercial		311			340			548			298
Consumer		—			—			—			—
Total nonaccrual loans		14,592			16,655			11,649			10,590
Loans 90 days or more past due and still accruing
Construction		—			—			—			—
Residential real estate		152			139			54			556
Commercial real estate		278			—			527			770
Commercial		9			—			—			—
Consumer		—			—			23			—
Total loans 90 days or more past due and still accruing		439			139			604			1,326
Other real estate owned		524			1,222			38			74
Total nonperforming assets	$	15,555		$	18,016		$	12,291		$	11,990


Accruing TDRs
Construction	$	45		$	51		$	38		$	41
Residential real estate		4,212			4,454			3,905			4,041
Commercial real estate		3,511			4,158			3,369			3,419
Commercial		—			—			—			—
Consumer		—			—			—			—
Total accruing TDRs	$	7,768		$	8,663		$	7,312		$	7,501

Total nonperforming assets and accruing TDRs	$	23,323		$	26,679


As a percent of total loans:
Nonaccrual loans		1.18	%		1.39	%		0.83	%		0.85	%
Accruing TDRs		0.63	%		0.72	%		0.52	%		0.60	%
Nonaccrual loans and accruing TDRs		1.80	%		2.12	%		1.35	%		1.45	%


As a percent of total loans and other real estate owned:
Nonperforming assets		1.25	%		1.51	%		0.87	%		0.96	%
Nonperforming assets and accruing TDRs		1.88	%		2.23	%		1.39	%		1.56	%


As a percent of total assets:
Nonaccrual loans		0.98	%		1.12	%		0.68	%		0.68	%
Nonperforming assets		1.04	%		1.21	%		0.71	%		0.77	%
Accruing TDRs		0.52	%		0.58	%		0.43	%		0.48	%
Nonperforming assets and accruing TDRs		1.56	%		1.80	%		1.13	%		1.25	%

Investment Securities

The investment portfolio is comprised of debt and equity securities. Debt securities ~~that~~ 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.

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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 June 30, ~~2019, 96.1%~~2020, 88.0% of the portfolio of debt securities was classified as available for sale and ~~3.9%~~12.0% was classified as held to maturity, compared to ~~96.3%~~93.5% and ~~3.7%~~6.5% respectively, at December 31, ~~2018. With the exception of municipal securities, our general practice is to classify all newly-purchased debt securities as available for sale.~~2019. See Note 4 ~~- Investment Securities,~~– “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 ~~$157.7~~$102.7 million at June 30, ~~2019,~~2020, a ~~$10.5~~$34.4 million, or ~~6.2%~~25.1%, decrease since December 31, ~~2018.~~2019. The decrease was due to agency bonds being called during the ~~roll-off~~first quarter of ~~investment~~2020 and the sale of available for sale securities in the second quarter of 2020. The proceeds ~~of which~~ were primarily redeployed to fund loan growth during the ~~first~~ six months ~~of 2019.~~ended June 30, 2020. At June 30, ~~2019, 76.6%~~2020, 88.6% of the securities available for sale were mortgage-backed and ~~23.4%~~11.4% were U.S. Government agencies, compared to ~~78.2%~~80.6% and ~~21.8%~~19.4%, respectively, at year-end ~~2018.~~2019. Our investments in mortgage-backed securities are issued or guaranteed by U.S. Government agencies or government-sponsored agencies.

Deposits

Total deposits at June 30, ~~2019 totaled $1.2~~2020 amounted to $1.50 billion, an increase of ~~$36.7~~$163.4 million, or ~~3.0%~~12.2% when compared to the level at December 31, ~~2018.~~ 2019. The increase in total deposits ~~primarily~~ consisted of increases in noninterest-bearing deposits of $86.4 million and interest-bearing deposits of $77.0 million. The growth in interest-bearing deposits was represented by increases in interest-bearing checking accounts of $42.7 million, savings and money market accounts of $32.7 million, and time deposits greater than $100 thousand of ~~$20.0~~$1.9 million, ~~noninterest-bearing deposits of $16.5 million,~~partially offset by a decrease in other time deposits of $8.9 million and savings and money market accounts of $1.1 million, partially offset by decreases in interest bearing checking deposits of $7.7 million and brokered deposits of $2.1 million. The Company has continued its efforts in 2019 to focus on growing core deposits as an alternative to short-term borrowings for funding loan growth.$295 thousand.

Short-Term Borrowings

Short-term borrowings decreased by ~~$35.3 million,~~$162 thousand, or ~~58.1%~~13.2%, to ~~$25.5~~$1.1 million at June 30, ~~2019~~2020 when compared to December 31, 2018. The decrease in short-term borrowings was the result of utilizing cash received from the sale of the Company’s former insurance subsidiary on December 31, 2018 as well as growth in core deposits.2019. Short-term borrowings generally consist of securities sold under agreements to repurchase, which are issued in conjunction with cash management services for commercial depositors, overnight borrowings from correspondent banks and short-term advances from the Federal Home Loan Bank (the “FHLB”). Short-term advances are defined as those with original maturities of one year or less. At June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, short-term borrowings consisted of ~~borrowings from the FHLB and~~ repurchase agreements.

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. The Company had ~~$15.0 million outstanding~~no long-term borrowings at June 30, ~~2019 and December 31, 2018. The~~2020, due to a payoff of $15.0 million in ~~fixed rate~~April of 2020. The amount of outstanding long-term borrowings ~~from the FHLB carries~~at December 31, 2019 was $15.0 million, which carried an interest rate of 2.82% ~~and will mature in April 2020.~~.

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 ~~decrease~~increase in cash and cash equivalents was $31.3 million for the first six months of 2020 compared to a decrease of $27.9 million for the first six months of ~~2019 compared to an increase of $11.7 million for the first six months of 2018.~~2019. The increase in cash and cash equivalents in ~~2018~~2020 was mainly due to ~~short-term borrowings.~~the significant increase in deposits, the direct result of PPP loan proceeds deposited to and remaining in these accounts as of June 30, 2020. The Company expects these funds to be utilized over the coming weeks and months, which may or may not result in a decline in deposit balances. Additionally, the increase in cash and cash equivalents was the result of bonds being called in the first quarter of 2020 and the sale of available for sale securities in the second quarter of 2020. The Company anticipates using these proceeds to purchase additional investment securities and fund loan growth.

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

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member of the FHLB, which provides another source of liquidity. Through the FHLB, the Bank had ~~credit availability~~collateral pledged of approximately ~~$212.9~~$293.4 million and ~~$154.7~~$270.1 million at June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively. The Bank has

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pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB. ~~Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our future ability to maintain liquidity at satisfactory levels.~~

Total stockholders’ equity increased ~~$8.1~~$7.3 million to ~~$191.3~~$200.1 million at June 30, ~~2019~~2020 when compared to December 31, ~~2018~~2019 primarily due to the current year’s ~~earnings.~~retained earnings and a positive change in accumulated other comprehensive income of $1.8 million, or 868.1%.

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 will be 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 CBLR framework was available for banks to use in their March 31, 2020 Call Report. The Bank did not opt into the CBLR framework in the first or second quarter of 2020.

Basel III

Under final ~~FRB~~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 ~~Company.~~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 ~~Company~~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 June 30, ~~2019,~~2020, the Bank’s capital levels remained characterized as “well-capitalized” under the new ~~rules~~rules.

The following tables present the applicable capital ratios as of June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

Tier 1

Common Equity

Tier 1

Total

leverage

Tier 1

risk-based

June 30, 2020

ratio

capital ratio

Shore United Bank

10.66

%

13.26

%

13.26

%

14.14

%

Tier 1

Common Equity

Tier 1

Total

leverage

Tier 1

risk-based

December 31, 2019

ratio

capital ratio

Shore United Bank

10.64

%

13.00

%

13.00

%

13.87

%

Tier 1

Common Equity

Tier 1

Total

leverage

Tier 1

risk-based

risk-based

June 30, 2019

ratio

ratio

capital ratio

capital ratio

Shore United Bank

10.29
%

12.11
%

12.11
%
12.98
%

Tier 1

Common Equity

Tier 1

Total

leverage

Tier 1

risk-based

risk-based

December 31, 2018

ratio

ratio

capital ratio

capital ratio

Shore United Bank

9.79
%

11.84
%

11.84
%
12.73
%

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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 ~~2018~~2019 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, ~~2018.~~2019.

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 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 ~~accounting~~financial officer (“~~PAO”~~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

47

~~Table of Contents~~

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 June 30, ~~2019~~2020 was carried out under the supervision and with the participation of management, including the PEO and the ~~PAO.~~PFO. Based on that evaluation, the Company’s management, including the PEO and the ~~PAO,~~PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level at June 30, ~~2019.~~2020.

There was no change in our internal control over financial reporting during the second quarter of ~~2019~~2020 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 2019 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. The information presented below provides an update to, and should be read in conjunction with, the risk factors and other information contained in our 2019 Form 10-K.

51

Table of Contents

The ongoing COVID-19 pandemic has led to periods of significant volatility in financial, commodities and other markets and could harm our business and results of operations.

In December 2019, COVID-19 was first reported in Wuhan, Hubei Province, China. Since then, COVID-19 infections have spread to additional countries including the United States. In March 2020, the World Health Organization declared COVID-19 to be a pandemic. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the impact of the coronavirus pandemic on our business, and there is no guarantee that our efforts to address or mitigate the adverse impacts of the coronavirus will be effective. The impact to date has included periods of significant volatility in financial, commodities and other markets. This volatility has had and, if it continues, could continue to have an adverse impact on our customers and on our business, financial condition and results of operations as well as our growth strategy.

Our business is dependent upon the willingness and ability of our customers to conduct banking and other financial transactions. The spread of COVID-19 has caused and could continue to cause severe disruptions in the U.S. economy at large, and has resulted and may continue to result in disruptions to our customers’ businesses, and a decrease in consumer confidence and business generally. In addition, recent actions by US federal, state and local governments to address the pandemic, including travel bans, stay-at-home orders and school, business and entertainment venue closures, have had and may continue to have a significant adverse effect on our customers and the markets in which we conduct our business. The extent of impacts resulting from the coronavirus pandemic and other events beyond our control will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus pandemic and actions taken to contain the coronavirus or its impact, among others.

Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans. The escalation of the pandemic may also negatively impact regional economic conditions for a period of time, resulting in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability. If the global response to contain COVID-19 escalates or is unsuccessful, we could experience a material adverse effect on our business, financial condition, results of operations and cash flows.

The spread of the COVID-19 outbreak and the governmental responses may disrupt banking and other financial activity in the areas in which we operate and could potentially create widespread business continuity issues for us.

The outbreak of COVID-19 and the U.S. federal, state and local governmental responses may result in a disruption in the services we provide. We rely on our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services or experience interruptions in their ability to provide us with these services, it could negatively impact our ability to serve our customers. Furthermore, the coronavirus pandemic could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in the geographic areas in which we operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to infection, quarantine or other effects and restrictions of a COVID-19 outbreak in our market areas. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective. If we are unable to promptly recover from such business disruptions, our business and financial conditions and results of operations would be adversely affected. We also may incur additional costs to remedy damages caused by such disruptions, which could adversely affect our financial condition and ~~operations~~results of operations.

Our participation in the SBA PPP loan program exposes us to risks related to noncompliance with the PPP, as well as litigation risk related to our administration of the PPP loan program, which could have a material adverse impact on our business, financial condition and results of operations.

The Company is a participating lender in the PPP, a loan program administered through the SBA, that was created to help eligible businesses, organizations and self-employed persons fund their operational costs during the COVID-19 pandemic. Under this program, the SBA guarantees 100% of the amounts loaned under the PPP. The PPP opened on April 3, 2020; however, because of the short window between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP. For instance, other financial institutions have experienced litigation related to their process

52

Table of Contents

and procedures used in processing applications for the PPP. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations. In addition, the Company may be exposed to credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced. If a deficiency is identified, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

Interest rate volatility stemming from COVID-19 could negatively affect our net interest income, lending activities, deposits and profitability.

Our net interest income, lending activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0 to 0.25 percent, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.

We are subject ~~are discussed in detail in Item 1A of Part I~~to increasing credit risk as a result of the ~~2018 Annual Report. Management does~~COVID-19 pandemic, which could adversely impact our profitability.

Our business depends on our ability to successfully measure and manage credit risk. As a commercial lender, we are exposed to the risk that the principal of, or interest on, a loan will not ~~believe~~be paid timely or at all or that the value of any ~~material~~collateral supporting a loan will be insufficient to cover our outstanding exposure. In addition, we are exposed to risks with respect to the risks resulting from changes in ~~our risk factors have occurred since they were last disclosed~~economic and industry conditions and risks inherent in dealing with individual loans and borrowers. As the overall economic climate in the U.S., generally, and in our ~~2018 Annual Report.~~market areas specifically, experiences material disruption due to the COVID-19 pandemic, our borrowers may experience difficulties in repaying their loans and governmental actions may provide payment relief to borrowers affected by COVID-19 and preclude our ability to initiate foreclosure proceedings in certain circumstances and, as a result, the collateral we hold may decrease in value or become illiquid, and the level of our nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for credit losses. Additional factors related to the credit quality of certain commercial real estate and multifamily residential loans include the duration of state and local moratoriums on evictions for non-payment of rent or other fees. The payment on these loans that are secured by income producing properties are typically dependent on the successful operation of the related real estate property and may subject us to risks from adverse conditions in the real estate market or the general economy.

We are actively working to support our borrowers to mitigate the impact of the COVID-19 pandemic on them and on our loan portfolio, including through loan modifications that defer payments for those who experienced a hardship as a result of the COVID-19 pandemic. Although recent regulatory guidance provides that such loan modifications are exempt from the calculation and reporting of TDRs and loan delinquencies, we cannot predict whether such loan modifications may ultimately have an adverse impact on our profitability in future periods. Our inability to successfully manage the increased credit risk caused by the COVID-19 pandemic could have a material adverse effect on our business, financial condition and results of operations.

We may incur impairments to goodwill or other intangibles as a result of the economic volatility resulting from the COVID-19 pandemic, which could adversely affect our financial condition, results of operations and stock price.

As of June 30, 2020, we had approximately $17.5 million recorded as goodwill. We evaluate our goodwill for impairment at least annually. Although we conducted an impairment assessment of goodwill and intangibles in the first and second quarter of 2020 and the impairment evaluation did not identify any impairment in either quarter of 2020, there can be no assurances that prolonged significant negative economic trends resulting from the COVID-19 pandemic, including the lack of recovery in the market price of our common stock, or reduced estimates of future cash flows or disruptions to our

53

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business, will not result in impairments to goodwill or other intangibles, such as our core deposit intangibles. If our analysis results in impairment to goodwill or other intangibles, we would be required to record an impairment charge to earnings in our financial statements during the period in which such impairment is determined to exist. Any such change could have a material adverse effect on our financial condition, results of operations and stock price.

Unpredictable future developments related to or resulting from the COVID-19 pandemic could materially and adversely affect our business and results of operations.

Because there have been no comparable recent global pandemics that resulted in a similar global impact, we do not yet know the full extent of the COVID-19 pandemic’s effects on our business, operations, or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work from home arrangements, third party providers’ ability to support our operation, and any actions taken by governmental authorities and other third parties in response to the pandemic. We are continuing to monitor the COVID-19 pandemic and related risks, although the rapid development and fluidity of the situation precludes any specific prediction as to its ultimate impact on us. However, if the pandemic continues to spread or otherwise results in a continuation or worsening of the current economic and commercial environments, our business, financial condition, results of operations and cash flows as well as our regulatory capital and liquidity ratios could be materially adversely affected and many of the risks described in our 2019 Form 10-K will be heightened.

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

On April 24, 2019 the Corporation’s Board of Directors approved a stock repurchase program. Under the stock repurchase program, the Corporation is authorized to repurchase up to $10 million, or approximately 5%, of its common stock for 2019 and 2020. The program may be limited or terminated at any time without prior notice. During the three months ended June 30, 2020, the Corporation had no repurchases. The Company has suspended all share buybacks of the Company’s common stock until further notice.

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 second quarter of 2020.

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

April 1, 2020 to April 30, 2020

—

$

—

$

5,551,624

May 1, 2020 to May 31, 2020

—

5,551,624

June 1, 2020 to June 30, 2020

—

5,551,624

Total

—

$

—

~~None.~~

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. Exhibits.

~~The exhibits filed or furnished with this quarterly report are shown on the Exhibit List that follows the signatures to this report, which list is incorporated herein by reference.~~

4854

Table of Contents

~~EXHIBIT INDEX~~

Exhibit Number		Description

~~10.1~~3.1(i)		~~Supplemental Executive Retirement Plan for Lloyd L. Beatty, Jr. (Incorporated~~Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit ~~10.1 to~~3.1 of the Company’s Form 8-K filed on ~~July 25, 2019)~~December 14, 2000).

~~10.2~~3.1(ii)		~~Supplemental Executive Retirement Plan for Edward C. Allen (Incorporated~~Articles Supplementary relating to the Fixed Rate Cumulative Perpetual Preferred Stock Series A (incorporated by reference to Exhibit ~~10.2 to~~4.1 of the Company’s Form 8-K filed on ~~July 25, 2019)~~January 13, 2009).

~~10.3~~3.1(iii)		~~Supplemental Executive Retirement Plan for Donna J. Stevens (Incorporated~~Articles Supplementary relating to the reclassification of the Fixed Rate Cumulative Perpetual Preferred Stock Series A, as common stock (incorporated by reference to Exhibit ~~10.3 to~~3.1(i) of the Company’s Form 8-K filed on ~~July 25, 2019)~~June 17, 2009).

3.2(i)		Amended and Restate By-Laws (incorporated by reference to Exhibit 3.2(i) of the Company’s Form 10-K for the year ended December 31, 2010).

3.2(ii)		First Amendment to Amended and Restate By-Laws (incorporated by reference to Exhibit 3.2(ii) of the Company’s Form 10-K for the year ended December 31, 2010).

3.2(iii)		Second Amendment to Amended and Restate By-Laws (incorporated by reference to Exhibit 3.2(iii) of the Company’s Form 10-K for the year ended December 31, 2010).

3.2(iv)		Third Amendment to Amended and Restate By-Laws (incorporated by reference to Exhibit 3.2(iv) of the Company’s Form 10-K for the year ended December 3, 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 ~~(filed herewith)~~(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).

4955

Table of Contents

~~SIGNATURES~~

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: August ~~9, 2019~~7, 2020	By:	/s/ Lloyd L. Beatty, Jr.
		Lloyd L. Beatty, Jr.
		President & Chief Executive Officer
		(Principal Executive Officer)

Date: August ~~9, 2019~~7, 2020	By:	/s/ Edward C. Allen
		Edward C. Allen
		Executive Vice President & Chief Financial Officer
		(Principal Accounting Officer)

5056

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

~~28969 Information Lane,~~18 E. Dover Street, Easton, Maryland		21601
(Address of Principal Executive Offices)		(Zip Code)


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



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


	For Six Months Ended
	June 30,
	2020		2019
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:	$	8,453	$	7,978
Net Income
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of acquisition accounting estimates		(172)		(262)
Provision for credit losses		1,350		300
Depreciation and amortization		1,225		1,198
Net amortization of securities		203		262
Stock-based compensation expense		123		31
Deferred income tax (benefit) expense		(1,598)		233
(Gains) on sales and calls of securities		(347)		—
Losses on sales and disposals of premises and equipment		40		—
Losses on sales and valuation adjustments on other real estate owned		18		287
Fair value adjustment on equity securities		(32)		(41)
Bank owned life insurance income		(647)		—
Net changes in:
Accrued interest receivable		(2,712)		(326)
Other assets		(455)		2,644
Accrued interest payable		(123)		(383)
Other liabilities		4,429		(7,485)
Net cash provided by operating activities		9,755		4,436

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal payments of investment securities available for sale		26,360		12,542
Proceeds from sales and calls of investment securities available for sale		13,019		—
Proceeds from maturities and principal payments of investment securities held to maturity		105		150
Purchases of securities held to maturity		(3,021)		—
Purchases of equity securities		(14)		(15)
Net change in loans		(159,251)		(45,130)
Purchases of premises and equipment		(1,476)		(545)
Proceeds from sales of premises and equipment		2		—
Proceeds from sales of other real estate owned		18		411
Net redemption of restricted securities		564		1,381
Net cash (used in) investing activities		(123,694)		(31,206)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Noninterest-bearing deposits		86,378		16,450
Interest-bearing deposits		77,077		20,323
Short-term borrowings		(162)		(35,304)
Long-term borrowings		(15,000)		—
Common stock dividends paid		(3,002)		(2,556)
Repurchase of shares for tax withholding on exercised options and vested restricted stock		(39)		(88)
Net cash provided by (used in) financing activities		145,252		(1,175)
Net increase in cash and cash equivalents		31,313		(27,945)
Cash and cash equivalents at beginning of period		94,971		67,225
Cash and cash equivalents at end of period	$	126,284	$	39,280

Supplemental cash flows information:
Interest paid	$	3,914	$	5,219
Income taxes paid	$	174	$	9,669
Lease liabilities arising from right-of-use assets	$	419	$	3,877
Unrealized gain on securities available for sale	$	2,460	$	3,780
Amortization of unrealized loss on securities transferred from available for sale to held to maturity	$	12	$	14


	For Six Months Ended
	June 30,
	2019		2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	7,978	$	8,449
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of acquisition accounting estimates		(262)		(310)
Provision for credit losses		300		907
Depreciation and amortization		1,198		1,030
Net amortization of securities		262		339
Stock-based compensation expense		31		306
Deferred income tax expense		233		558
Losses (gains) on sales and valuation adjustments on other real estate owned		287		(55)
Fair value adjustment on equity securities		(41)		13
Net changes in:
Accrued interest receivable		(326)		473
Other assets		2,644		(4,532)
Accrued interest payable		(383)		202
Other liabilities		(7,485)		(52)
Net cash provided by operating activities		4,436		7,328

CASH FLOWS FROM INVESTING ACTIVITES:
Proceeds from maturities and principal payments of investment securities available for sale		12,542		16,979
Proceeds from maturities and principal payments of investment securities held to maturity		150		91
Purchases of equity securities		(15)		(7)
Net change in loans		(45,130)		(63,740)
Purchases of premises and equipment		(545)		(798)
Proceeds from sales of other real estate owned		411		280
Net redemption of restricted securities		1,381		—
Net cash (used in) investing activities		(31,206)		(47,195)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Noninterest-bearing deposits		16,450		(1,688)
Interest-bearing deposits		20,323		(25,881)
Short-term borrowings		(35,304)		81,007
Common stock dividends paid		(2,556)		(1,912)
Repurchase of shares for tax withholding on exercised options and vested restricted stock		(88)		—
Net cash (used in) provided by financing activities		(1,175)		51,526
Net (decrease) increase in cash and cash equivalents		(27,945)		11,659
Cash and cash equivalents at beginning of period		67,225		31,820
Cash and cash equivalents at end of period	$	39,280	$	43,479

Supplemental cash flows information:
Interest paid	$	5,219	$	1,726
Income taxes paid	$	9,669	$	2,825
Lease liabilities arising from right-of-use assets	$	3,877	$	—
Unrealized gain (loss) on securities available for sale	$	3,780	$	(3,416)
Amortization of unrealized loss on securities transferred from available for sale to held to maturity	$	14	$	15

		Page

Part I. Financial Information		3

Item 1. Financial Statements		3

Consolidated Balance Sheets ~~–June~~– June 30, ~~2019~~2020 (unaudited) and December 31, ~~201~~82019		3

Consolidated Statements of Income For the three and six months ended June 30, 2020 and 2019 ~~and 2018~~ (unaudited)		4

Consolidated Statements of Comprehensive Income For the three and six months ended June 30, 2020 and 2019 ~~and 2018~~ (unaudited)		56

Consolidated Statements of Changes in Stockholders’ Equity For the three and six months ended June 30, 2020 and 2019 ~~and 2018~~ (unaudited)		67

Consolidated Statements of Cash Flows For the three and six months ended June 30, 2020 and 2019 ~~and 2018~~ (unaudited)		78

Notes to Consolidated Financial Statements (unaudited)		89

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		3536

Item 3. Quantitative and Qualitative Disclosures about Market Risk		4751

Item 4. Controls and Procedures		4751

Part II. Other Information		4851

Item 1. Legal Proceedings		4851

Item 1A. Risk Factors		4851

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		4854

Item 3. Defaults Upon Senior Securities		4854

Item 4. Mine Safety Disclosures		4854

Item 5. Other Information		4854

Item 6. Exhibits		4854

~~Exhibit Index~~Signatures		49

~~Signatures~~		5056


	June 30,		December 31,
(In thousands, except share and per share data)	2020		2019
ASSETS		(Unaudited)
Cash and due from banks	$	24,585	$	18,465
Interest-bearing deposits with other banks		101,699		76,506
Cash and cash equivalents		126,284		94,971
Investment securities:
Available-for-sale, at fair value		86,020		122,791
Held to maturity, at amortized cost - fair value of $11,715 (2020) and $8,654 (2019)		11,710		8,786
Equity securities, at fair value		1,388		1,342
Restricted securities		3,626		4,190

Loans		1,407,249		1,248,654
Less: allowance for credit losses		(11,090)		(10,507)
Loans, net		1,396,159		1,238,147

Premises and equipment, net		24,668		23,821
Goodwill		17,518		17,518
Other intangible assets, net		1,970		2,252
Other real estate owned, net		38		74
Right-of-use assets		4,879		4,771
Other assets		45,264		40,572
TOTAL ASSETS	$	1,719,524	$	1,559,235

LIABILITIES
Deposits:
Noninterest-bearing	$	442,996	$	356,618
Interest-bearing		1,061,732		984,716
Total deposits		1,504,728		1,341,334

Short-term borrowings		1,064		1,226
Long-term borrowings		—		15,000
Lease liabilities		4,941		4,792
Other liabilities		8,657		4,081
TOTAL LIABILITIES		1,519,390		1,366,433

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share; shares authorized - 35,000,000; shares issued and outstanding - 12,525,667 (2020) and 12,500,372 (2019)		125		125
Additional paid in capital		61,129		61,045
Retained earnings		136,876		131,425
Accumulated other comprehensive income		2,004		207
TOTAL STOCKHOLDERS' EQUITY		200,134		192,802
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,719,524	$	1,559,235


Earnings per common share - Basic
Income from continuing operations	$	0.43	$	0.33	$	0.68	$	0.63
Loss from discontinued operations		—		—		—		(0.01)
Net income	$	0.43	$	0.33	$	0.68	$	0.62
Earnings per common share - Diluted
Income from continuing operations	$	0.43	$	0.33	$	0.68	$	0.63
Loss from discontinued operations		—		—		—		(0.01)
Net income	$	0.43	$	0.33	$	0.68	$	0.62

Dividends paid per common share		0.12		0.10	$	0.24	$	0.20


							Accumulated
			Additional				Other		Total
	Common		Paid in		Retained		Comprehensive		Stockholders’
	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

Net Income		—		—		5,335		—		5,335

Other comprehensive income		—		—		—		546		546

Stock-based compensation		—		62		—		—		62

Cash dividends declared		—		—		(1,503)		—		(1,503)

Balances, June 30, 2020	$	125	$	61,129	$	136,876	$	2,004	$	200,134


($ in thousands)	Year Ended December 31, 2018
Proceeds from the transaction	$	29,276
Compensation expense related to the transaction		2,588
Broker fees		935
Other transaction costs		594
Net cash proceeds		25,159
Net assets sold		(12,423)
Net gain on disposal	$	12,736


	Available for sale				Held to maturity
	Amortized				Amortized
(Dollars in thousands)	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	5,996	$	5,978	$	500	$	503
Due after one year through five years		28,874		28,780		400		401
Due after five years through ten years		59,748		59,787		3,501		3,469
Due after ten years		51,027		50,865		1,504		1,514
Total	$	145,645	$	145,410	$	5,905	$	5,887


	Six Months Ended June 30, 2019
		Weighted Average
	Number of	Grant Date
	Shares	Fair Value
Nonvested at beginning of period	—	$	—
Granted	15,702		15.36
Vested	—		—
Cancelled	—		—
Nonvested at end of period	15,702	$	15.36