10-Q 1 cor2655.txt SHORE BANCSHARES, INC. FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------------- FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission file number 0-22345 SHORE BANCSHARES, INC. (Exact name of registrant as specified in its charter) Maryland 52-1974638 -------------------------------------- ------------------ (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 18 East Dover Street, Easton, Maryland 21601 --------------------------------------- --------------------- (Address of Principal Executive Offices) (Zip Code) (410) 822-1400 Registrant's Telephone Number, Including Area Code N/A --- Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes X No -- -- Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No -- -- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of July 30, 2004, registrant had 5,512,828 issued and outstanding shares of common stock. INDEX Part I -- Financial Information Item 1. Financial Statements Page Condensed Consolidated Balance Sheets - June 30, 2004 (unaudited) and December 31, 2003 3 Condensed Consolidated Statements of Income - For the three and six months ended June 30, 2004 and 2003 (unaudited) 4 Condensed Consolidated Statements of Changes in Stockholders' Equity - For the six months ended June 30, 2004 and 2003 (unaudited) 5 Condensed Consolidated Statements of Cash Flows - For the six months ended June 30, 2004 and 2003 (unaudited) 6 Notes to Condensed Consolidated Financial Statements (unaudited) 7-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-17 Item 3. Quantitative and Qualitative Disclosures about Market Risk 18 Item 4. Controls and Procedures 18-19 Part II -- Other Information Item 4. Submission of Matters to a Vote of Security Holders 19 Item 5. Other Information 20 Item 6. Exhibits and Reports on Form 8-K 20 Signatures 21 -2- Part I Item 1. Financial Statements SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)
June 30, December 31, ASSETS: 2004 2003 ------- --------------- ----------------- (unaudited) Cash and due from banks $ 22,779 $ 19,391 Interest bearing deposits with other banks 5,977 9,897 Federal funds sold 32,429 17,443 Investment securities: Held-to-maturity, at amortized cost (fair value of $15,229, $15,585, respectively) 15,351 15,313 Available for sale, at fair value 122,389 144,368 Loans, less allowance for credit losses ($4,331, $4,060, respectively) 547,165 470,895 Insurance premiums receivable 642 845 Premise and equipment, net 12,430 11,302 Accrued interest receivable on loans and investment securities 3,042 3,042 Investment in unconsolidated subsidiary 843 1,203 Goodwill 8,214 5,990 Other intangible assets 2,411 1,581 Other assets 6,304 4,109 -------- -------- TOTAL ASSETS $779,976 $705,379 ======== ======== LIABILITIES: Deposits: Noninterest bearing demand $ 94,937 $ 91,669 NOW and Super NOW 113,565 103,415 Certificates of deposit $100,000 or more 90,295 71,385 Other time and savings 354,497 325,940 -------- -------- Total Deposits 653,294 592,409 Short term borrowings 28,726 20,957 Long term debt 5,000 5,000 Other liabilities 4,098 3,486 -------- -------- TOTAL LIABILITIES 691,118 621,852 -------- -------- STOCKHOLDERS' EQUITY: Common stock, par value $.01; authorized 35,000,000 shares; issued and outstanding: June 30, 2004 5,512,309 December 31, 2003 5,400,793 55 54 Additional paid in capital 27,950 24,231 Retained earnings 62,084 58,932 Accumulated other comprehensive income (loss) (1,231) 310 -------- -------- TOTAL STOCKHOLDERS' EQUITY 88,858 83,527 -------- -------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $779,976 $705,379 ======== ======== See accompanying notes to Condensed Consolidated Financial Statements.
-3- SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands, except per share amounts)
Three months ended June 30, Six months ended June 30, 2004 2003 2004 2003 ---- ---- ---- ---- INTEREST INCOME Loans, including fees $8,013 $7,362 $15,162 $14,591 Interest and dividends on investment securities: Taxable 1,099 1,015 2,292 2,147 Tax-exempt 150 142 304 289 Other interest income 83 123 137 242 ------ ------ ------ ------ Total interest income 9,345 8,642 17,895 17,269 ------ ------ ------ ------ INTEREST EXPENSE Certificates of deposit, $100,000 or more 584 627 1,141 1,318 Other deposits 1,569 1,787 3,040 3,643 Other interest 105 114 205 223 ------ ------ ------ ------ Total interest expense 2,258 2,528 4,386 5,184 ------ ------ ------ ------ NET INTEREST INCOME 7,087 6,114 13,509 12,085 PROVISION FOR CREDIT LOSSES 100 70 205 160 ------ ------ ------ ------ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 6,987 6,044 13,304 11,925 ------ ------ ------ ------ NONINTEREST INCOME Service charges on deposit accounts 658 495 1,153 955 Gain (loss) on sale of securities (2) 81 14 358 Insurance agency commissions 1,499 1,520 3,408 3,329 Other noninterest income 497 388 955 781 ------ ------ ------ ------ Total noninterest income 2,652 2,484 5,530 5,423 ------ ------ ------ ------ NONINTEREST EXPENSE Salaries and employee benefits 3,530 3,025 6,648 6,074 Expenses of premises and equipment 574 482 1,163 975 Other noninterest expense 1,482 1,227 2,988 2,506 ------ ------ ------ ------ Total noninterest expense 5,586 4,734 10,799 9,555 ------ ------ ------ ------ INCOME BEFORE TAXES ON INCOME 4,053 3,794 8,035 7,793 Federal and State income taxes 1,453 1,338 2,919 2,816 ------ ------ ------ ------ NET INCOME $2,600 $2,456 $5,116 $4,977 ====== ====== ====== ====== Basic earnings per common share $.47 $.46 $.94 $.93 Diluted earnings per common share $.47 $.45 $.93 $.91 Dividends declared per common share $.18 $.17 $.36 $.32 See accompanying notes to Condensed Consolidated Financial Statements.
-4-
SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (Dollars in thousands) Accumulated Additional other Total Common Paid in Retained Comprehensive Stockholders' Stock Capital Earnings Income(loss) Equity ----- ------- -------- ------------ ------ Balances, January 1, 2004 $ 54 $ 24,231 $ 58,932 $310 $83,527 Comprehensive income: Net income - - 5,116 - 5,116 Other comprehensive income, net of tax: Unrealized loss on available for sale securities - - - (1,541) (1,541) -------- Total comprehensive income 3,575 -------- Shares issued 1 3,719 - - 3,720 Cash dividends paid $0.36 per share - - (1,964) - (1,964) ---------- -------- -------- ---------- -------- Balances, June 30, 2004 $ 55 $ 27,950 $ 62,084 $ (1,231) $ 88,858 ========== ======== ======== ========== ======== Balances, January 1, 2003 $ 54 $ 23,837 $ 52,985 $1,152 $78,028 Comprehensive income: Net income - - 4,977 - 4,977 Other comprehensive income, net of tax: Unrealized loss on available for sale securities - - - (614) (614) -------- Total comprehensive income 4,363 -------- Shares issued - 71 - - 71 Cash dividends paid $0.32 per share - - (1,720) - (1,720) ---------- -------- -------- ------- -------- Balances, June 30, 2003 $ 54 $ 23,908 $ 56,242 $ 538 $ 80,742 ========== ======== ======== ======= ========
See accompanying Notes to Condensed Consolidated Financial Statements -5- SHORE BANCSHARES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands)
For the Six Months Ended June 30, 2004 2003 --------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 5,116 $ 4,977 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 717 772 Discount accretion on debt securities (51) (21) Provision for credit losses, net (119) 62 Gain on sale of securities (14) (358) Loss on other real estate owned - 8 Equity in earnings of unconsolidated subsidiary (20) - Net changes in: Insurance premiums receivable 202 (418) Accrued interest receivable 232 149 Other assets (689) (1,026) Accrued interest payable on deposits 25 (163) Accrued expenses 274 (99) --------- --------- Net cash provided by operating activities 5,673 3,883 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities and principal payments of securities available for sale 39,360 58,192 Proceeds from sale of investment securities available for sale 7,867 4,685 Purchase of securities available for sale (17,682) (57,318) Proceeds from maturities and principal payments of securities held to maturity 1,287 1,145 Purchase of securities held to maturity (1,340) (2,875) Net increase in loans (38,303) (17,226) Proceeds from sale of loans - 621 Purchase of premises and equipment (697) (455) Purchase of other real estate owned (60) - Proceeds from sale of other real estate owned - 37 Proceeds from sale of investment in unconsolidated subsidiary 380 - Acquisition, net of stock issued (235) - ---------- --------- Net cash used in investing activities (9,423) (13,194) ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand, NOW, money market and savings deposits 872 23,574 Net increase (decrease) in certificates of deposit 11,017 (9,783) Net increase in securities sold under agreement to repurchase 7,768 2,800 Proceeds from issuance of common stock 511 71 Dividends paid (1,964) (1,720) ---------- --------- Net cash provided by financing activities 18,204 14,942 ---------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 14,454 5,631 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 46,731 69,468 ---------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 61,185 $ 75,099 ========== ========= See accompanying notes to Condensed Consolidated Financial Statements
-6- Shore Bancshares, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) 1) The consolidated financial statements include the accounts of Shore Bancshares, Inc. (the "Company") and its subsidiaries with all significant intercompany transactions eliminated. The consolidated financial statements conform to accounting principles generally accepted in the United States of America and to prevailing practices within the banking industry. The accompanying interim financial statements are unaudited; however, in the opinion of management all adjustments necessary to present fairly the financial position at June 30, 2004, the results of operations for the three- and six-month periods ended June 30, 2004 and 2003, and cash flows for the six-month period ended June 30, 2004 and 2003, have been included. The amounts as of December 31, 2003 were derived from audited financial statements. All such adjustments are of a normal recurring nature. The results of operations for the three- and six-month periods ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year. The consolidated financial statements and related notes contained herein should be read in conjunction with the audited consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K, as amended by Amendment No. 1 on Form 10-K/A, for the year ended December 31, 2003. 2) Year to date basic earnings per share is derived by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period of 5,451,928 shares for 2004 and 5,373,484 shares for 2003. The diluted earnings per share calculation is derived by dividing net income by the weighted average number of shares outstanding, adjusted for the dilutive effect of outstanding options and warrants. Considering the effect of these common stock equivalents, the adjusted average shares for the six months ended June 30, 2004, and 2003 were 5,497,949 and 5,463,656, respectively. As of June 30, 2004, there were 4,000 shares excluded from the diluted net income per share computation because the exercise price of related options exceeded the average market price of those shares and, therefore, their effect would be anti-dilutive. No shares were excluded from the diluted net income per share computation as of June 30, 2003. 3) Under the provisions of Statements of Financial Accounting Standards (SFAS) Nos. 114 and 118, "Accounting by Creditors for Impairment of a Loan", 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 contracted terms. 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. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loans principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. -7- Information with respect to impaired loans and the related valuation allowance is shown below: June 30, December 31, 2004 2003 --------------------------------- Impaired loans with valuation allowance $ 529 $ 729 Impaired loans with no valuation allowance 740 273 ------ ------ Total impaired loans $1,269 $1,002 ====== ====== Allowance for credit losses applicable to impaired loans $ 318 $ 349 Allowance for credit losses applicable to other than impaired loans 4,013 3,711 ------ ------ Total allowance for credit losses $4,331 $4,060 ====== ====== Interest income on impaired loans recorded on the cash basis $ 7 $ 26 ====== ======
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 upon historical loss ratios and are included in the allowance for credit losses. 4) In the normal course of business, to meet the financial needs of its customers, the Company's bank subsidiaries are parties to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. At June 30, 2004, total commitments to extend credit were approximately $110,036,000. Outstanding letters of credit were approximately $5,779,000 at June 30, 2004. 5) The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-based Compensation" and SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure", but applies APB Opinion No. 25 and related interpretations in accounting for its plans. No compensation expense related to the plans was recorded during the three-month periods ended June 30, 2004 and 2003. If the Company had elected to recognize compensation cost based on fair value at the vesting dates for awards under the plans consistent with the method prescribed by SFAS No. 123, net income and earnings per share would have been changed to the pro forma amounts as follows: -8- Six-month period ended June 30, 2004 2003 ---- ---- Net income: As reported $ 5,116 $ 4,977 Less pro forma stock-based compensation expense determined under the fair value method, net of related tax effects (11) (63) --------- -------- Pro forma net income $ 5,105 $ 4,914 ========= ======== Basic net income per share: As reported $0.94 $ 0.93 Pro forma 0.94 0.91 Diluted earnings per share As reported 0.93 $ 0.91 Pro forma 0.93 0.90 Three-month period ended June 30, 2004 2003 ---- ---- Net income: As reported 2,600 $ 2,456 Less pro forma stock-based compensation expense determined under the fair value method, net of related tax effects (5) (33) --------- -------- Pro forma net income $2,595 $ 2,423 ========= ======== Basic net income per share: As reported $0.47 $ 0.46 Pro forma 0.47 0.45 Diluted earnings per share As reported 0.47 $ 0.45 Pro forma 0.47 0.44 The pro forma amounts are not representative of the effects on reported net income for future periods. 6) The Company operates two primary businesses: Community Banking and Insurance Products and Services. Through the Community Banking business, the Company provides services to consumers and small businesses on the Eastern Shore of Maryland and Delaware through the Company's 14-branch network. Community banking activities include small business services, retail brokerage, and consumer banking products and services. Loan products available to consumers include mortgage, home equity, automobile, marine, and installment loans, credit cards and other secured and unsecured personal lines of credit. Small business lending includes commercial mortgages, real estate development loans, equipment and operating loans, as well as secured and unsecured lines of credit, credit cards, accounts receivable financing arrangements, and merchant card services. Through the Insurance Products and Services buisness, the Company provides a full range of insurance products and services to businesses and consumers in the Company's market areas. Products include property and casualty, life, marine, individual health and long-term care insurance. Pension and profit sharing plans and retirement plans for executives and employees are available to suit the needs of individual businesses. -9- Selected financial information by line of business for the six months ended June 30, is included in the following table:
Community Insurance products Parent Intersegment Consolidated (In thousands) banking and services Company(a) Transactions Total ----------------------------------------------------------------------------------------------------------------------------------- 2004 Net Interest income $ 13,508 $ - $ 1 $ - $ 13,509 Provision for credit losses 205 - - - 205 ------------------------------------------------------------------------------------- Net interest income after provision 13,303 - 1 - 13,304 Noninterest income 1,956 3,537 1,132 (1,095) 5,530 Noninterest expense 8,011 2,766 1,117 (1,095) 10,799 ------------------------------------------------------------------------------------- Income before taxes 7,248 771 16 - 8,035 Income tax expense 2,608 305 6 - 2,919 ------------------------------------------------------------------------------------- Net income $ 4,640 $ 466 $ 10 $ - $5,116 ------------------------------------------------------------------------------------- Intersegment revenue(expense) $ (978) $ (102) $ 1,080 $ - $ - Average assets $755,625 $ 6,830 $ 3,289 $ - $ 765,744 2003 Net Interest income $ 12,087 $ (14) $ 12 $ - $ 12,085 Provision for credit losses 160 - - - 160 ------------------------------------------------------------------------------------- Net interest income after provision 11,927 (14) 12 - 11,925 Noninterest income 1,966 3,377 736 (656) 5,423 Noninterest expense 7,021 2,540 650 (656) 9,555 ------------------------------------------------------------------------------------- Income before taxes 6,872 823 98 - 7,793 Income tax expense 2,452 325 39 - 2,816 ------------------------------------------------------------------------------------- Net income $ 4,420 $ 498 59 $ - $ 4,977 ------------------------------------------------------------------------------------- Intersegment revenue(expense) $ (642) $ (14) $ 656 $ - $ - Average assets $647,825 $ 6,387 $ 539 $ - $ 654,751
(a) Amount included in Parent Company in 2004 relate to services provided to subsidiaries by the holding company and rental income. 7) On April 1, 2004, the Company completed its merger with Midstate Bancorp, Inc., a Delaware bank holding company ("Midstate Bancorp"). Pursuant to the merger agreement, each share of common stock of Midstate Bancorp was converted into the right to receive (i) $31.00 in cash, plus (ii) 0.8732 shares of the common stock of the Corporation, with cash being paid in lieu of fractional shares at the rate of $33.83 per share. The Company paid $2,953,710 in cash and issued 82,786 shares of common stock to stockholders of Midstate Bancorp in connection with the merger. The Company recorded approximately $2,224,000 of goodwill and $968,000 of other intangible assets as a result of the acquisition. -10- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Introduction The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of Shore Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and realted notes presented in this report, as well as the audited consolidated financial statements and related notes included in the Annual Report of Shore Bancshares, Inc. on Form 10-K, as amended by Amendment No. 1 on Form 10-K/A, for the year ended December 31, 2003. Unless the context clearly suggests otherwise, references to the Company in this report are to Shore Bancshares, Inc. and its consolidated subsidiaries. Shore Bancshares, Inc. is the largest independent financial holding company located on the Eastern Shore of Maryland. It is the parent company of The Talbot Bank of Easton, Maryland located in Easton, Maryland, The Centreville National Bank of Maryland located in Centreville, Maryland and The Felton Bank, located in Felton, Delaware, (collectively, the "Banks"). The Banks operate 14 full service branches in Kent, Queen Anne's, Talbot, Caroline and Dorchester Counties in Maryland and Kent and Sussex Counties in Delaware. The Company offers a full range of insurance products and services to its customers through The Avon-Dixon Agency, LLC, Elliott Wilson Insurance, LLC, and Mubell Finance, LLC (collectively, the "Insurance Agency") and investment advisory services through Wye Financial Services, LLC, all of which are wholly owned subsidiaries of the Company. The shares of the Company's common stock are listed on the Nasdaq SmallCap Market under the symbol "SHBI". The Company maintains an Internet site at www.shbi.net on which it makes available free of charge its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the Securities and Exchange Commission. Forward-Looking Information Portions of this Quarterly Report on Form 10-Q contain 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 the Company's 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 the Company and its affiliates operate, inflation, fluctuations in interest rates, legislation, and governmental regulation. These risks and uncertainties are described in more detail in Item 1 of Part I of the Company's Annual Report on Form 10-K, as amended by Amendment No. 1 on Form 10-K/A, for the year ended December 31, 2003, under the heading "Risk Factors". Actual results may differ materially from such forward-looking statements, and the Company assumes no obligation to update forward-looking statements at any time. Critical Accounting Policies The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within the financial statements is, to a significant extent, financial information contained that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning of income, recognizing an expense, recovering an asset or relieving a liability. -11- The Company believes its most critical accounting policy relates to the allowance for credit losses. The allowance for credit losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable, and (ii) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the loan balance and the value of collateral, present value of future cash flows or values that are observable in the secondary market. Management uses many factors, including economic conditions and trends, the value and adequacy of collateral, the volume and mix of the loan portfolio, and internal loan processes of the Company in determining the inherent loss that may be present in the Company's loan portfolio. Actual losses could differ significantly from Management's estimates. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of transactions would be the same, the timing of events that would impact the transactions could change. Management has significant discretion in making the adjustments inherent in the determination of the provision and allowance for credit losses, including in connection with the valuation of collateral, the borrower's prospects of repayment, and in establishing allowance factors on the formula allowance and unallocated allowance components of the allowance. The establishment of allowance factors is a continuing exercise, based on Management's continuing assessment of the global factors such as delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of Management, national and local economic trends, concentrations of credit, quality of loan review system and the effect of external factors such as competition and regulatory requirements, and their impact on the portfolio, and allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based upon the same volume and classification of loans. Changes in allowance factors will have a direct impact on the amount of the provision, and a corresponding effect on net income. Errors in Management's perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs. Three basic components comprise the Company's allowance for credit losses: (i) a specific allowance; (ii) a formula allowance; and (iii) a nonspecific allowance. Each component is determined based on estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance to loans identified as impaired. 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. When a loan is identified as impaired, a specific allowance is established based on the Company's assessment of the loss that may be associated with the individual loan. The formula allowance is used to estimate the loss on internally risk rated loans, exclusive of those identified as impaired. Loans identified as special mention, substandard, doubtful and loss, as well as impaired, are segregated from performing loans. Remaining loans are then grouped by type (commercial, commercial real estate, construction, home equity or consumer). Each loan type is assigned an allowance factor based on Management's estimate of the risk, complexity and size of individual loans within a particular category. Classified loans are assigned higher allowance factors than non-rated loans due to management's concerns regarding collectibility or management's knowledge of particular elements regarding the borrower. Allowance factors grow with the worsening of the internal risk rating. The nonspecific formula is used to estimate the loss of non-classified loans stemming from more global factors such as delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of Management, national and local economic trends, concentrations of credit, quality of loan review system and the effect of external factors such as competition and regulatory requirements. The nonspecific allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. -12- OVERVIEW Net income for the quarter ended June 30, 2004 was $2,600,000 or diluted earnings per share of $.47, compared to $2,456,000 or diluted earnings per share of $.45 for the second quarter of 2003. Net income for the six months ended June 30, 2004 was $5,116,000, compared to $4,977,000 for the same period in 2003. On a per share basis, diluted earnings for the six months ended June 30, 2004 were $ .93, compared to $ .91 for the same period last year. Return on average assets was 1.34% for the first six months of 2004, compared to 1.52% for the same period in 2003. Return on average stockholders' equity was 11.29% and 12.46% for the six months ended June 30, 2004 and 2003, respectively. RESULTS OF OPERATIONS Net Interest Income Net interest income for the quarter ended June 30, 2004 increased 15.9% totaling $7,087,000, compared to $6,114,000 for the same period last year. Of the $973,000 increase, $609,000 is attributable to the net interest income of The Felton Bank, which was acquired on April 1, 2004. The balance of the increase relates to an overall decline in the cost of deposits. Net interest income for the six months ended June 30, 2004 increased 11.8% totaling $13,509,000, or $1,424,000 over the same period last year. The acquisition of The Felton Bank coupled with a reduction in overall interest expense were the reasons for the increases. The Company's net interest margin was 3.83% for the six months ended June 30, 2004, which is 16 basis points lower than one year ago. The Company continued to increase its volume of earning assets, which averaged $715,285,000 for the six months ended June 30, 2004, as compared to $615,425,000 at June 30, 2003. Approximately 52% of the growth is attributable to the acquisition of The Felton Bank, while the balance was as a result of loan growth during the period. Average loans increased $82,467,000 totaling $533,997,000 for the six-month period ended June 30, 2004. The yield on earning assets declined 63 basis points to 5.05% for the six-month period ended June 30, 2004, when compared to the same period in 2003. The overall yield on loans for the six months ended June 30, 2004 was 5.68%, compared to 6.48% for the corresponding period in 2003. The yield on investment securities declined to 3.63% for the first six months of 2004 from 4.22% for the same period of 2003, and the average balance of investment securities increased $28,567,000 to $151,556,000 for the six months ended June 30, 2004 when compared to June 30, 2003. Total interest expense for the three and six months ended June 30, 2004 was $2,258,000 and $4,386,000, respectively. Interest expense attributable to the acquisition of The Felton Bank totaled $175,000 for the three- and six-month periods ended June 30, 2004. Compared to the same periods in 2003, the Company recognized a decrease in total interest expense of $270,000 and $798,000 or 10.7% and 15.4%, respectively. Lower rates paid for certificates of deposit were the primary cause for the overall decline in interest expense for the three- and six-month periods ended June 30, 2004. The average balance of all categories of deposits increased during the six-month period ended June 30, 2004, approximately half of which was attributable to the acquisition of The Felton Bank. The average balance of interest bearing demand deposits increased $9,237,000, while the average rate paid for those deposits declined 28 basis points for the six months ended June 30, 2004 compared to the same period in 2003. The average balance of certificates of deposits increased $12,912,000, while the average rate paid for certificates of deposit decreased 66 basis points to 2.64% for the six months ended June 30, 2004 when compared to the same period last year. See the Analysis of Interest Rates and Interest Differentials below for further details. Loans comprised 74.7% and 73.4% of total average earning assets at June 30, 2004 and 2003, respectively. -13- Analysis of Interest Rates and Interest Differentials. The following table presents the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid through the first six months of the year.
June 30, 2004 June 30, 2003 ------------- ------------- Average Income Yield Average Income Yield (Dollars in thousands) Balance Expense Rate Balance Expense Rate ------------------------------------------------------------------------------------------------------------------------------- Earning Assets Investment securities $151,556 $ 2,752 3.63% $122,989 $ 2,596 4.22% Loans 533,997 15,178 5.68% 451,530 14,629 6.48% Interest bearing deposits 7,589 34 .90% 18,574 106 1.15% Federal funds sold 22,143 103 .93% 22,332 134 1.20% --------- -------- ------ --------- ------- ------ Total earning assets 715,285 18,067 5.05% 615,425 17,465 5.68% Noninterest earning assets 50,459 39,326 --------- --------- Total Assets 765,744 654,751 ========= ========= Interest bearing liabilities Interest bearing deposits 550,606 4,181 1.52% 475,468 4,961 2.09% Short term borrowing 24,187 80 .66% 22,222 98 .89% Long term debt 5,000 125 5.03% 5,000 125 5.00% --------- -------- ------ --------- ------- ------ Total interest bearing liabilities 579,793 4,386 1.51% 502,690 5,184 2.06% Noninterest bearing liabilities 95,288 72,199 Stockholders' equity 90,663 79,862 --------- --------- Total liabilities and stockholders' equity $765,744 $654,751 ========= ========= Net interest spread $13,681 3.54% $12,281 3.62% ======== ======= Net interest margin 3.83% 3.99%
(1) All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate exclusive of the alternative minimum tax rate of 34% and nondeductible interest expense. (2) Average loan balances include nonaccrual loans. (3) Interest income on loans includes amortized loan fees, net of costs, for each loan category and yield calculations are stated to include all. Noninterest Income Excluding gains and losses on sales of securities for the three- and six-month periods ended June 30, 2004, noninterest income increased $251,000 and $451,000, respectively, when compared to the same periods last year. Approximately $71,000 of the increases for these periods relates to noninterest income of The Felton Bank, of which approximately $47,000 relates to service charges on deposit accounts. Excluding amounts attributable to the acquisition of The Felton Bank, $116,000 and $151,000 of the increases for the three- and six-month periods ended June 30, 2004, respectively, are attributable to service charges related to new deposit products and certain fee increases implemented during the first quarter of 2004. Other fees and services offered by the Company increased $109,000 and $174,000 for the three and six month periods, respectively, when compared to the same periods in 2003. -14- Noninterest Expense Total noninterest expense increased $852,000 and $1,244,000 for the three- and six-month periods ended June 30, 2004, respectively, from the comparable periods in 2003. Expenses realted to the operation of The Felton Bank represented $462,000 of the increase. For the quarter ended June 30, 2004, an additional $256,000 in salaries and benefits expense, $36,000 in occupancy expense related to certain new facilities owned by the Company, and $98,000 in other noninterest expense were recognized over the amounts for the same period in 2003. For the six months ended June 30, 2004, salaries and benefits expense increased $325,000, occupancy expense increased $132,000, and other noninterest expense increased $325,000 when compared to the same period in 2003. These increases are due to overall growth of the Company. Income Taxes The effective tax rate for the three- and six-month periods ended June 30, 2004 were 35.8% and 36.3%, respectively, compared to 35.3% and 36.1% for the same periods last year. To the Company's knowledge, no changes have occurred in applicable tax laws or to the Company's tax structure that are likely to have a significant impact on the effective tax rate. FINANCIAL CONDITION Loans Loans, net of unearned income, totaled $551,496,000 at June 30, 2004, an increase of $76,541,000 or 16.1% since December 31, 2003. Approximately $42,516,000 of this increase is attributable to the acquisition of The Felton Bank, with the remaining growth concentrated in real estate lending. Average loans, net of unearned income, increased $82,467,000 or 18.3% for the six months ended June 30, 2004 totaling $533,997,000, compared to an increase of $39,500,000 or 9.6% for the same period last year, with a total of $451,530,000 at June 30, 2003. Allowance for Credit Losses The Company has established an allowance for credit losses, which is increased by provisions charged against earnings and recoveries of previously charged-off debts. The allowance is decreased by current period charge-off of uncollectible debts. Management evaluates the adequacy of the allowance for credit losses on a quarterly basis and adjusts the provision for credit losses based upon this analysis. The evaluation of the adequacy of the allowance for credit losses is based on, among other things, a risk rating system of individual loans, a collective evaluation of smaller balance homogenous loans based on factors such as past credit loss experience, and consideration of general economic conditions, growth of the loan portfolio, problem loans, current trends in delinquencies and nonperforming assets, past credit loss experience, and other factors which may impact collectibility. A loan is placed on nonaccrual when it is specifically determined to be impaired and principal and interest is delinquent for 90 days or more. Please refer to the discussion under the caption, "Critical Accounting Policies" for an overview of the underlying methodology Management employs on a quarterly basis to maintain the allowance. The provision for credit losses for the three- and six-month periods ended June 30, 2004 was $100,000 and $205,000, respectively, compared to $70,000 and $160,000 for the same periods in 2003. Despite an increase in nonaccrual loans the specific allowance associated with those loans has declined, based on management's evaluation of the borrower's ability to repay and the value of the underlying loan collateral. The increased provision is the result of increases in both the formula allowance and nonspecific allowance components. Growth of the loan portfolio and Management's assessment of factors used in calculating the nonspecific allowance contributed to the increased provision. The Company continues to maintain strong underwriting guidelines, believes that the local economy remains stable, and believes that the strong local real estate economy to date has increased collateral values. Management believes that each of these factors has had a positive effect on the quality of the Company's loan portfolio. The Company's historical charge-off ratios are much lower than those of similarly-sized institutions according to the most recent (March 31, 2004) FDIC quarterly banking profile. During 2004, however, charge-offs have increased. Net charge-offs were $360,000 for the six-month period ended June 30, 2004, compared to $98,000 for the same period last year. Nonaccrual loans increased $267,000 totaling $1,269,000 at June 30, 2004 when compared to December 31, 2003. Loans past due 90 days and still accruing decreased $331,000 since December 31, 2003 totaling $797,000 at June 30, 2004. The Company's ratio of nonperforming assets, including other real estate owned remains low. The allowance for credit losses as a percentage of average loans declined from .93% as of June 30, 2003 to .81% as of June 30, 2004. The decline is primarily the result of growth in loans secured by real estate, which Management believes present less risk of loss to the Company than other types of loans. Based on Management's quarterly evaluation of the adequacy of the allowance for credit losses, it believes that the allowance for credit losses and the related provision are adequate at June 30, 2004. -15- The following table presents a summary of the activity in the allowance for credit losses: Six months ended June 30, (Dollars in thousands) 2004 2003 ----------------------------------------------------------------------------- Allowance balance - beginning of year $ 4,060 $ 4,117 Charge-offs: Commercial and other 404 84 Real estate - 2 Consumer 52 70 -------- -------- Totals 456 156 -------- -------- Recoveries: Commercial 37 16 Real estate 19 3 Consumer 40 39 -------- -------- Totals 96 58 -------- -------- Net charge-offs: 360 98 Allowance of acquired institution 426 - Provision for credit losses 205 160 -------- -------- Allowance balance-ending $4,331 $ 4,179 ======== ======== Average loans outstanding during period $533,997 $451,530 ======== ========= Net charge-offs (annualized) as a percentage of average loans outstanding during period .13% .04% ===== ===== Allowance for credit losses at period end as a percentage of average loans .81% .93% ===== ===== Because the Company's loans are predominately secured by real estate, weaknesses in the local real estate market may have an adverse effect on collateral values. The Company does not have any concentrations of loans in any particular industry, nor does it engage in foreign lending activities. -16- Nonperforming Assets The following table summarizes past due and nonperforming assets of the Company (in thousands): June 30, December 31, Nonperforming Assets: 2004 2003 ----------- ------------- Nonaccrual loans 1,269 1,002 Other real estate owned 60 - -------- ------- 1,329 1,002 Past due loans still accruing 797 1,128 -------- ------- Total nonperforming and past due loans $ 2,126 $2,130 ======== ======= Investment Securities Investment securities declined $21,941,000 during the six-month period ended June 30, 2004 when compared to December 31, 2003. The yields on bonds purchased during 2004 are much lower than the yields on similar bonds which matured or were called during the first six months of the year. The average balance of investment securities was $151,556,000 for the six months ended June 30, 2004, compared to $122,989,000 for the same period in 2003. The tax equivalent yields on investment securities were 3.63% and 4.22% for the six-month periods ended June 30, 2004 and 2003, respectively. Deposits Total deposits at June 30, 2004 were $653,294,000, compared to $592,409,000 at December 31, 2003. Since December 31, 2003, certificates of deposit of $100,000 or more increased $18,910,000 and other certificates of deposit increased $13,587,000, with $5,137,000 and $18,672,000 of those respective increases being attributable to the acquisition of The Felton Bank. Borrowed Funds Short term borrowings at June 30, 2004 and 2003 consisted of securities sold under agreements to repurchase. The Company also had a convertible advance from the Federal Home Loan Bank of Atlanta in the amount of $5,000,000 at June 30, 2004 and 2003. The advance is due in March 2006 and has a one-time call provision in 2004. Liquidity and Capital Resources The Company derives liquidity through increased customer deposits, maturities in the investment portfolio, loan repayments and income from earning assets. To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short term funds markets through arrangements with correspondent banks. Talbot Bank and Centreville National Bank are also members of the Federal Home Loan Bank of Atlanta, which provides another source of liquidity. Management knows of no trends or demands, commitments, events or uncertainties that are likely to materially affect the Company's ability to maintain liquidity at satisfactory levels. Total stockholders' equity was $88.9 million at June 30, 2004, a 6.4% increase since December 31, 2003. Accumulated other comprehensive income, which consists solely of net unrealized losses on investment securities available for sale, decreased $1,541,000 during this period, resulting in accumulated other comprehensive loss of $1,231,000 at June 30, 2004 when compared to December 31, 2003. Bank regulatory agencies have adopted various capital standards for financial institutions, including risk-based capital standards. The primary objectives of the risk-based capital framework are to provide a more consistent system for comparing capital positions of financial institutions and to take into account the different risks among financial institutions' assets and off-balance sheet items. Risk-based capital standards have been supplemented with requirements for a minimum Tier 1 capital to assets ratio (leverage ratio). In addition, regulatory agencies consider the published capital levels as minimum levels and may require a financial institution to maintain capital at higher levels. A comparison of the capital as of June 30, 2004 for the Company with the minimum requirements is presented below: Minimum Actual Requirements ------ ------------ Tier 1 risk-based capital 13.99% 4.00% Total risk-based capital 14.78% 8.00% Leverage ratio 10.46% 3.00% -17- Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company's principal market risk exposure is to fluctuating interest rates. The Company utilizes a simulation model to quantify the effect that hypothetical plus or minus 200 and 100 basis point changes in rates would have on net interest income and the fair value of capital. The model takes into consideration the effect of call features of investments as well as repayments of loans in periods of declining rates. When actual changes in interest rates occur, the changes in interest earning assets and interest bearing liabilities may differ from the assumptions used in the model. As of June 30, 2004, the model produced the following sensitivity profile for net interest income and the fair value capital:
Immediate Change in Rates +200 +100 -100 -200 Policy Basis Points Basis Points Basis Points Basis Points Limit -------------------------------------------------------------------- % Change in Net Interest Income 8.44% 5.61% (7.35)% (16.02)% + 25% - % Change in Fair Value of Capital 2.46% 1.88% (4.01)% (8.74)% + 15% -
Further information regarding market risk and the Company's objectives and strategies in managing market risk is set forth in the Company's Annual Report on Form 10-K, as amended by Amendment No. 1 on Form 10-K/A, for the year ended December 31, 2003 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations--Market Risk Management". Item 4. Controls and Procedures The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's reports filed 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 the Company's management, including the Chief Executive Officer ("CEO") and the Principal Accounting Officer ("PAO"), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. -18- An evaluation of the effectiveness of these disclosure controls as of June 30, 2004 was carried out under the supervision and with the participation of the Company's management, including the CEO and the PAO. Based on that evaluation, the Company's management, including the CEO and the PAO, has concluded that the Company's disclosure controls and procedures are effective. During the second quarter of 2004, there was no change in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Part II Item 4. Submission of Matters to Vote of Security Holders At the Company's Annual Meeting of Stockholders held on April 28, 2004, the stockholders elected four individuals to serve as Directors until the 2007 Annual Meeting of Stockholders, and until their successors are duly elected and qualify. The Company submitted the matter to a vote through solicitation of proxies. The results of the vote is as follows:
Class III Nominees (Term expires 2007) For Withheld Abstain Broker Non-Votes --- -------- ------- ---------------- Daniel T. Cannon 3,835,198 6,510 0 0 Richard C. Granville 3,681,381 160,327 0 0 Kevin P. LaTulip 3,831,386 10,322 0 0 Christopher F. Spurry 3,835,322 6,386 0 0
-19- Item 5. Other Information On April 1, 2004, The Avon-Dixon Agency, LLC entered into an employment agreement with Steven Fulwood to serve as the President of the Insurance Subsidiary. Mr. Fulwood replaces Kevin P. LaTulip, who retired as President effective April 1, 2004. A copy of Mr. Fulwood's employment agreement is filed herewith as Exhibit 10.6. Item 6. Exhibits and Reports on Form 8-K. a) Exhibits: 3.1 Shore Bancshares, Inc. Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 3.2 Shore Bancshares, Inc. Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 10.1 Form of Employment Agreement with W. Moorhead Vermilye (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 10.2 Form of Employment Agreement with Daniel T. Cannon (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 10.3 Form of Employment Agreement between The Avon-Dixon Agency, LLC and Kevin P. LaTulip (incorporated by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the year ended December 31, 2002). 10.4 Form of Supplemental Retirement Plan Agreement and Life Insurance Endorsement Method Split Dollar Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.4 of the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2003). 10.5 Form of Life Insurance Endorsement Method Split Dollar Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.5 of the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2003). 10.6 Employment Agreement between The Avon-Dixon Agency, LLC and Steven Fulwood (filed herewith). 31.1 Certifications of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith). 31.2 Certifications of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith). 32.1 Certifications of the CEO and the PAO pursuant to 18 U.S.C.ss. 1350(furnished herewith) 99.1 Shore Bancshares, Inc. 1998 Employee Stock Purchase Plan, as amended and restated (incorporated by reference to Appendix A of the Company's Definitive Proxy Statement on Schedule 14A for the 2003 Annual Meeting of Stockholders, filed on March 31, 2003). 99.2 1998 Stock Option Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed on September 25, 1998 (Registration No. 333-64319)). 99.3 Talbot Bancshares, Inc. Employee Stock Option Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed on May 4, 2001 (Registration No. 333-60214)). b) Reports on Form 8-K. On April 2, 2004, the Company filed a Current Report on Form 8-K in which it announced in Item 5 the completion of its merger with Midstate Bancorp, Inc. On May 7, 2004, the Company filed a Current Report on Form 8-K in which it furnished in Item 12 the unaudited results of operations for the quarter ended March 31, 2004. -20- Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Shore Bancshares, Inc. Date: August 9, 2004 By:/s/ W. Moorhead Vermilye ----------------------------------------- W. Moorhead Vermilye President and Chief Executive Officer Date: August 9, 2004 By:/s/ Susan E. Leaverton ----------------------------------------- Susan E. Leaverton, CPA Treasurer and Principal Accounting Officer -21- EXHIBIT INDEX ------------- Exhibit Description ------- ----------- 3.1 Shore Bancshares, Inc. Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 3.2 Shore Bancshares, Inc. Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 on Form 8-K filed by Shore Bancshares, Inc. on December 14, 2000). 10.1 Form of Employment Agreement with W. Moorhead Vermilye (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 10.2 Form of Employment Agreement with Daniel T. Cannon (incorporated by reference to Appendix XIII of Exhibit 2.1 on Form 8-K filed by Shore Bancshares, Inc. on July 31, 2000). 10.3 Form of Employment Agreement between The Avon-Dixon Agency, LLC and Kevin P. LaTulip (incorporated by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the year ended December 31, 2002). 10.4 Form of Supplemental Retirement Plan Agreement and Life Insurance Endorsement Method Split Dollar Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.4 of the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2003). 10.5 Form of Life Insurance Endorsement Method Split Dollar Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.5 of the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2003). 10.6 Employment Agreement between The Avon-Dixon Agency, LLC and Steven Fulwood (filed herewith). 31.1 Certifications of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith). 31.2 Certifications of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith). 32.1 Certifications of the CEO and the PAO pursuant to 18 U.S.C.ss.1350 (furnished herewith) 99.1 Shore Bancshares, Inc. 1998 Employee Stock Purchase Plan, as amended and restated (incorporated by reference to Appendix A of the Company's Definitive Proxy Statement on Schedule 14A for the 2003 Annual Meeting of Stockholders, filed on March 31, 2003). 99.2 1998 Stock Option Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed on September 25, 1998 (Registration No. 333-64319)). 99.3 Talbot Bancshares, Inc. Employee Stock Option Plan (incorporated by reference from the Shore Bancshares, Inc. Registration Statement on Form S-8 filed on May 4, 2001 (Registration No. 333-60214)).