SHBI 10-Q Quarterly Report March 31, 2017

SHORE BANCSHARES INC

10-Ks and 10-Qs

10-Q	Quarter ended Sept. 30, 2025
10-Q	Quarter ended June 30, 2025
10-Q	Quarter ended March 31, 2025
10-K	Fiscal year ended Dec. 31, 2024
10-Q	Quarter ended Sept. 30, 2024
10-Q	Quarter ended June 30, 2024
10-Q	Quarter ended March 31, 2024
10-K	Fiscal year ended Dec. 31, 2023
10-Q	Quarter ended Sept. 30, 2023
10-Q	Quarter ended June 30, 2023
10-Q	Quarter ended March 31, 2023
10-K	Fiscal year ended Dec. 31, 2022
10-Q	Quarter ended Sept. 30, 2022
10-Q	Quarter ended June 30, 2022
10-Q	Quarter ended March 31, 2022
10-K	Fiscal year ended Dec. 31, 2021
10-Q	Quarter ended Sept. 30, 2021
10-Q	Quarter ended June 30, 2021
10-Q	Quarter ended March 31, 2021
10-K	Fiscal year ended Dec. 31, 2020
10-Q	Quarter ended Sept. 30, 2020
10-Q	Quarter ended June 30, 2020
10-Q	Quarter ended March 31, 2020
10-K	Fiscal year ended Dec. 31, 2019
10-Q	Quarter ended Sept. 30, 2019
10-Q	Quarter ended June 30, 2019
10-Q	Quarter ended March 31, 2019
10-K	Fiscal year ended Dec. 31, 2018
10-Q	Quarter ended Sept. 30, 2018
10-Q	Quarter ended June 30, 2018
10-Q	Quarter ended March 31, 2018
10-K	Fiscal year ended Dec. 31, 2017
10-Q	Quarter ended Sept. 30, 2017
10-Q	Quarter ended June 30, 2017
10-Q	Quarter ended March 31, 2017
10-K	Fiscal year ended Dec. 31, 2016
10-Q	Quarter ended Sept. 30, 2016
10-Q	Quarter ended June 30, 2016
10-Q	Quarter ended March 31, 2016
10-K	Fiscal year ended Dec. 31, 2015
10-Q	Quarter ended Sept. 30, 2015
10-Q	Quarter ended June 30, 2015
10-Q	Quarter ended March 31, 2015
10-K	Fiscal year ended Dec. 31, 2014
10-Q	Quarter ended Sept. 30, 2014
10-Q	Quarter ended June 30, 2014
10-Q	Quarter ended March 31, 2014
10-K	Fiscal year ended Dec. 31, 2013
10-Q	Quarter ended Sept. 30, 2013
10-Q	Quarter ended June 30, 2013
10-Q	Quarter ended March 31, 2013
10-K	Fiscal year ended Dec. 31, 2012
10-Q	Quarter ended Sept. 30, 2012
10-Q	Quarter ended June 30, 2012
10-Q	Quarter ended March 31, 2012
10-K	Fiscal year ended Dec. 31, 2011
10-Q	Quarter ended Sept. 30, 2011
10-Q	Quarter ended June 30, 2011
10-Q	Quarter ended March 31, 2011
10-K	Fiscal year ended Dec. 31, 2010
10-Q	Quarter ended Sept. 30, 2010
10-Q	Quarter ended June 30, 2010
10-Q	Quarter ended March 31, 2010
10-K	Fiscal year ended Dec. 31, 2009

PROXIES

DEF 14A	Filed on May 29, 2025
DEF 14A	Filed on April 15, 2025
DEF 14A	Filed on May 30, 2024
DEF 14A	Filed on April 16, 2024
DEF 14A	Filed on May 23, 2023
DEF 14A	Filed on April 12, 2023
DEF 14A	Filed on May 24, 2022
DEF 14A	Filed on April 11, 2022
DEF 14A	Filed on March 26, 2021
DEF 14A	Filed on March 13, 2020
DEF 14A	Filed on March 15, 2019
DEF 14A	Filed on March 16, 2018
DEF 14A	Filed on March 16, 2017
DEF 14A	Filed on March 15, 2016
DEF 14A	Filed on March 13, 2015
DEF 14A	Filed on March 20, 2014
DEF 14A	Filed on March 20, 2013
DEF 14A	Filed on March 22, 2012
DEF 14A	Filed on March 24, 2011
DEF 14A	Filed on March 25, 2010

10-Q 1 shbi-20170331x10q.htm FORM 10-Q 20170331 10Q Q1

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the Quarterly Period Ended March 31, 2017


	☐	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.)

28969 Information Lane, Easton, Maryland		21601
(Address of Principal Executive Offices)		(Zip Code)

(410) 763-7800

Registrant’s Telephone Number, Including Area Code

N/A

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐

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


Large accelerated filer	☐	Accelerated filer	☑
Non-accelerated filer	☐	Smaller reporting company	☐
(Do not check if a smaller reporting company)		Emerging growth company	☐

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

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

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 : 12,680,440 shares of common stock outstanding as of April 30, 2017.

INDEX


	Page

Part I. Financial Information	2

Item 1. Financial Statements	2

Consolidated Balance Sheets –March 31, 2017 (unaudited) and December 31, 2016	2

Consolidated Statements of Operations -For the three months ended March 31, 2017 and 2016 (unaudited)	3

Consolidated Statements of Comprehensive Income -For the three months ended March 31, 2017 and 2016 (unaudited)	4

Consolidated Statements of Changes in Stockholders’ Equity -For the three months ended March 31, 2017 and 2016 (unaudited)	4

Consolidated Statements of Cash Flows -For the three months ended March 31, 2017 and 2016 (unaudited)	6

Notes to Consolidated Financial Statements (unaudited)	7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	31

Item 3. Quantitative and Qualitative Disclosures about Market Risk	40

Item 4. Controls and Procedures	40

Part II. Other Information	41

Item 1. Legal Proceedings	41

Item 1A. Risk Factors	41

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	41

Item 3. Defaults Upon Senior Securities	41

Item 4. Mine Safety Disclosures	41

Item 5. Other Information	41

Item 6. Exhibits	41

Signatures	41

Exhibit Index	42

PART I – FINANCIAL INFORMATION

Item 1. Financial S tatements.


SHORE BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)



	March 31,		December 31,
	2017		2016
ASSETS		(Unaudited)
Cash and due from banks	$	14,884	$	14,596
Interest-bearing deposits with other banks		33,967		61,342
Cash and cash equivalents		48,851		75,938
Investment securities:
Available-for-sale, at fair value		178,072		163,902
Held to maturity, at amortized cost - fair value of $6,855 (2017)
and $6,806 (2016)		6,615		6,704

Loans		891,864		871,525
Less: allowance for credit losses		(8,927)		(8,726)
Loans, net		882,937		862,799

Premises and equipment, net		16,831		16,558
Goodwill		11,931		11,931
Other intangible assets, net		1,047		1,079
Other real estate owned, net		2,354		2,477
Other assets		18,258		18,883
TOTAL ASSETS	$	1,166,896	$	1,160,271

LIABILITIES
Deposits:
Noninterest-bearing	$	266,611	$	261,575
Interest-bearing		734,931		735,914
Total deposits		1,001,542		997,489

Short-term borrowings		2,919		3,203
Other liabilities		4,809		5,280
TOTAL LIABILITIES		1,009,270		1,005,972

STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share; shares authorized -
35,000,000 ; shares issued and outstanding - 12,672,675 (2017) and
12,664,797 (2016)		127		127
Additional paid in capital		64,619		64,201
Retained earnings		93,131		90,964
Accumulated other comprehensive (loss)		(251)		(993)
TOTAL STOCKHOLDERS' EQUITY		157,626		154,299
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,166,896	$	1,160,271

See accompanying notes to Consolidated Financial Statements.

SHORE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except per share amounts)

	For Three Months Ended
	March 31,
	2017		2016

INTEREST INCOME
Interest and fees on loans	$	9,550	$	8,961
Interest and dividends on investment securities:
Taxable		827		870
Tax-exempt		2		2
Interest on federal funds sold		-		3
Interest on deposits with other banks		68		72
Total interest income		10,447		9,908

INTEREST EXPENSE
Interest on deposits		511		661
Interest on short-term borrowings		3		4
Total interest expense		514		665

NET INTEREST INCOME		9,933		9,243
Provision for credit losses		427		450

NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES		9,506		8,793

NONINTEREST INCOME
Service charges on deposit accounts		834		813
Trust and investment fee income		361		351
Insurance agency commissions		2,819		2,759
Other noninterest income		793		618
Total noninterest income		4,807		4,541

NONINTEREST EXPENSE
Salaries and wages		4,502		4,477
Employee benefits		1,240		1,114
Occupancy expense		625		613
Furniture and equipment expense		233		235
Data processing		872		809
Directors' fees		80		104
Amortization of other intangible assets		33		33
FDIC insurance premium expense		164		282
Other real estate owned expense, net		55		7
Legal and professional		660		385
Other noninterest expenses		1,187		1,280
Total noninterest expense		9,651		9,339

INCOME BEFORE INCOME TAXES		4,662		3,995
Income tax expense		1,862		1,535

NET INCOME	$	2,800	$	2,460

Basic net income per common share	$	0.22	$	0.19
Diluted net income per common share		0.22		0.19
Dividends paid per common share		0.05		0.03

See accompanying notes to Consolidated Financial Statements.


SHORE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
	For Three Months Ended
	March 31,
	2017		2016

Net Income	$	2,800	$	2,460

Other comprehensive income
Securities available for sale:
Unrealized holding gains on available-for-sale-securities		1,224		1,589
Tax effect		(482)		(642)
Net of tax amount		742		947

Total other comprehensive income		742		947
Comprehensive income	$	3,542	$	3,407

See accompanying notes to Consolidated Financial Statements.


SHORE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
For the Three Months Ended March 31, 2017 and 2016
(Dollars in thousands, except per share amounts)

							Accumulated
			Additional				Other		Total
	Common		Paid in		Retained		Comprehensive		Stockholders'
	Stock		Capital		Earnings		Income (Loss)		Equity

Balances, January 1, 2017	$	127	$	64,201	$	90,964	$	(993)	$	154,299

Net Income		-		-		2,800		-		2,800

Unrealized gains on available-for-sale
securities, net of taxes		-		-		-		742		742


Stock-based compensation		-		418		-		-		418

Cash dividends declared		-		-		(633)		-		(633)

Balances, March 31, 2017	$	127	$	64,619	$	93,131	$	(251)	$	157,626

Balances, January 1, 2016	$	126	$	63,815	$	83,097	$	(71)	$	146,967

Net Income		-		-		2,460		-		2,460

Unrealized gains on available-for-sale
securities, net of taxes		-		-		-		947		947

Common shares issued for employee stock-
based awards		-		3		-		-		3

Stock-based compensation		-		111		-		-		111

Cash dividends declared		-		-		(379)		-		(379)

Balances, March 31, 2016	$	126	$	63,929	$	85,178	$	876	$	150,109

See accompanying notes to Consolidated Financial Statements.


SHORE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)

	For Three Months Ended
	March 31,
	2017		2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	2,800	$	2,460
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for credit losses		427		450
Depreciation and amortization		546		611
Discount accretion on debt securities		(7)		(7)
Stock-based compensation expense		418		111
Deferred income tax expense		1,583		1,258
Losses on disposals of premises and equipment		-		2
(Gains) losses on sales of other real estate owned		(2)		11
Write-downs of other real estate owned		57		7
Net changes in:
Accrued interest receivable		(78)		(144)
Other assets		(1,422)		(286)
Accrued interest payables		(7)		(9)
Other liabilities		(472)		(570)
Net cash provided by operating activities		3,843		3,894

CASH FLOWS FROM INVESTING ACTIVITES:
Proceeds from maturities and principal payments of investment securities
available for sale		9,528		9,752
Purchases of investment securities available for sale		(22,661)		(3,006)
Proceeds from maturities and principal payments of investment securities
held to maturity		94		192
Net change in loans		(20,565)		(4,265)
Purchases of premises and equipment		(531)		(183)
Proceeds from sales of other real estate owned		69		338
Net cash (used in) provided by investing activities		(34,066)		2,828

CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Noninterest-bearing deposits		5,036		(40)
Interest-bearing deposits		(983)		(5,691)
Short-term borrowings		(284)		(800)
Proceeds from the issuance of common stock		-		3
Common stock dividends paid		(633)		(379)
Net cash provided by (used in) financing activities		3,136		(6,907)
Net decrease in cash and cash equivalents		(27,087)		(185)
Cash and cash equivalents at beginning of period		75,938		73,811
Cash and cash equivalents at end of period	$	48,851	$	73,626

Supplemental cash flows information:
Interest paid	$	521	$	672
Income taxes paid	$	-	$	235
Change in unrealized (gains) losses on securities available for sale	$	(1,217)	$	1,469

See accompanying notes to Consolidated Financial Statements.

Shore Bancshares, Inc.

Notes to Consolidated Financial Statements

For the Three Months Ended March 31, 2017 and 2016

(Unaudited)

Note 1 - Basis of Presentation

The consolidated financial statements include the accounts of Shore Bancshares, Inc. 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 (“GAAP”) and to prevailing practices within the banking industry. The accompanying interim financial statements are unaudited; however, in the opinion of management all adjustments necessary to present fairly the consolidated financial position at March 31, 2017 , the consolidated results of operations and comprehensive income for the three months ended March 31, 2017 and 2016 , and changes in stockholders’ equity and cash flows for the three months ended March 31, 2017 and 2016 , have been included. All such adjustments are of a normal recurring nature. The amounts as of December 31, 2016 were derived from the 2016 audited financial statements. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results to be expected for any other interim period or for the full year. This Quarterly Report on Form 10-Q should be read in conjunction with the Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2016 . For purposes of comparability, certain reclassifications have been made to amounts previously reported to conform with the current period presentation.

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

Effective July 1, 2016, the Company’s two bank subsidiaries, The Talbot Bank of Easton Maryland and CNB were consolidated into one bank known as Shore United Bank. In these notes to the consolidated financial statements and the management discussion and analysis section, the term “the Bank” refers to Shore United Bank, unless the context requires stipulating results of the individual banks before the consolidation occurred.

Recent Accounting Standards

ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” amendment requires entities to recognize revenue to depict the transfer of promised goods or services to customers in amounts that reflect the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for periods beginning after December 16, 2016. ASU 2015-14, “ Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date ” – ASU 2015-14 amendments defer the effective date of Update 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. ASU 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations ” – ASU 2016-08 amendments are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. ASU 2016-10, “ Revenue from Contracts with Customers (Topic 606) : Identifying Performance Obligations and Licensing” – ASU 2016-10 amendments clarify that contractual provisions that, explicitly or implicitly, require an entity to transfer control of additional goods or services to a customer should be distinguished from contractual provisions that, explicitly or implicitly, define the attributes of a single promised license. Attributes of a promised license define the scope of a customer’s right to use or right to access an entity’s intellectual property and, therefore, do not define whether the entity satisfies its performance obligation at a point in time or over time and do not create an obligation for the entity to transfer any additional rights to use or access its intellectual property. Revenues form services provided by financial institutions that could be impacted by the new guidance includes credit card arrangements, trust and custody services and administration services for customer deposits accounts (e.g., ATM and wire transfer transactions). This update will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently performing an overall assessment of revenue streams potentially affected by the guidance and evaluating the impact this guidance, including the method of implementation, will have on its consolidated financial statements. In addition, the Company continues to monitor certain implementation issues relevant to the banking industry which are still pending resolution.

ASU No. 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities ” . This ASU, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by

measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. ASU 2016-01 will be effective for us on January 1, 2018 and is not expected to have a significant impact on our financial statements.

ASU No. 2016-02, “Leases (Topic 842).” This ASU stipulates that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statement , and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. When measuring assets and liabilities arising from a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. Similarly, optional payments to purchase the underlying asset should be included in the measurement of lease assets and lease liabilities only if the lessee is reasonably certain to exercise that purchase option. In addition, also consistent with the previous leases guidance, a lessee (and a lessor) should exclude most variable lease payments in measuring lease assets and lease liabilities, other than those that depend on an index or a rate or are in substance fixed payments. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company expects to elect the package of practical expedients that allows it to not reassess whether any expire or existing contracts represent leases, the lease classification of any expired or existing lease and initial direct costs for any existing or expired leases. The Company expects this standard will have a material impact on its financial statements through gross-up of the balance sheet for lease assets and liabilities. However, no material change to lease expense recognition is expected .

ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” This ASU simplifies the treatment and accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public business entities, the amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. Upon adoption of ASU No. 2016-09 on January 1, 2017, the Company made an accounting policy election to recognize forfeitures of stock-based awards as they occur . The adoption of ASU No. 2016-09 did not have a material impact on our consolidated financial statements.

ASU No. 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU will replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The amendments broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit losses, which will be more decision useful to users of the financial statements. It is not expected that an entity will need to create an economic forecast over the entire contractual life of long-dated financial assets. Therefore, the amendments will allow an entity to revert to historical loss information that is reflective of the contractual term (considering the effect of prepayments) for periods that are beyond the time frame for which the entity is able to develop reasonable and supportable forecasts. The amendments retain many of the disclosure amendments in Accounting Standards Update No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology. Credit losses on available-for-sale debt securities should be measured in a manner similar to current GAAP. However, the amendments require that credit losses be presented as an allowance rather than a write-down. For public entities that are U.S. Securities and Exchange Commission (SEC) filers, the amendments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company believes this ASU will have a significant impact on our consolidated financial statements and the method in which we calculate our credit losses, primarily on loans and available-for sale securities. At this time, the Company will continue to evaluate the impact and implementation of this standard to meet the effective date for consolidated financ ial statements beginning in 2020 .

ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments." Current GAAP is unclear or does not include specific guidance on how to classify certain transactions in the statement of cash flows. This ASU is intended to reduce diversity in practice in how eight particular transactions are classified in the statement of cash flows. ASU No. 2016-15 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, provided that all of the amendments are adopted in the same period. Entities will be required to apply the guidance retrospectively. If it is impracticable to apply the guidance retrospectively for an issue, the amendments related to that issue would be applied prospectively. We adopted the amendments in this ASU effective January 1, 2017. The adoption of ASU No. 2016-15 did not have a material impact on our consolidated financial statements.

ASU No. 2017-01 – In January 2017, FASB issued ASU No. 2017-01, Business Combinations (Topic 805)” Clarifying the Definition of a Business. The ASU clarifies the definition of a business to assist with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The guidance is not expected to have a significant impact on the Company’s financial positions, results of operations or disclosures.

ASU No. 2017-03 – In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-03, “ Accounting Changes and Error Corrections (Topic 250) and Investments – Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings.” The ASU adds an SEC paragraph to ASUs 2014-09, 2016-02, and 2016-13 which specifies the SEC staff view that a registrant should evaluate ASUs that have not yet been adopted to determine the appropriate disclosure about the potential material effects of those ASUs on the financial statements when adopted. The guidance also specifies the SEC staff view on financial statement disclosures when the company does not know or cannot reasonably estimate the impact that adoption of the ASUs will have on the financial statements. The ASU also conforms SEC guidance on accounting for tax benefits resulting from investments in affordable housing projects to the guidance in ASU 2014-01, Investments – Equity Method and Joint Ventures (Topic 323). The amendments in this update are effective upon issuance. The guidance did not have a significant impact on our consolidated financial statements.

ASU No. 2017-04 – In January 2017, FASB issued ASU No. 2017-04, “ Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ” The ASU simplifies measurement of goodwill and eliminates Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this update are effective for fiscal years beginning after

December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The guidance is not expected to have a significant impact on the Company’s financial positions, results of operations or disclosures

ASU No. 2017-08 – In March 2017, the FASB issued ASU No. 2017-08, “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.” Under current GAAP, entities normally amortize the premium as an adjustment of yield over the contractual life of the instrument. This guidance shortens the amortization period of certain callable debt securities held at a premium to the earliest call date. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The adoption of ASU No. 2017-08 is not expected to have a material impact on the Company’s consolidated financial statements.

Note 2 – Earnings Per Share

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


	For the Three Months Ended
	March 31,
(In thousands, except per share data)	2017		2016

Net Income	$	2,800	$	2,460
Weighted average shares outstanding - Basic		12,670		12,635
Dilutive effect of common stock equivalents-options		21		14
Dilutive effect of common stock equivalents-restricted stock units		16		-
Weighted average shares outstanding - Diluted		12,707		12,649
Earnings per common share - Basic	$	0.22	$	0.19
Earnings per common share - Diluted	$	0.22	$	0.19

There were no weighted average common stock equivalents excluded from the calculation of diluted earnings per share for the three months ended March 31, 2017 and 2016 .

Note 3 – Investment Securities

The following table provides information on the amortized cost and estimated fair values of investment securities.


			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
(Dollars in thousands)	Cost		Gains		Losses		Value
Available-for-sale securities:
March 31, 2017
U.S. Government agencies	$	43,311	$	38	$	74	$	43,275
Mortgage-backed		134,449		481		781		134,149
Equity		655		-		7		648
Total	$	178,415	$	519	$	862	$	178,072

December 31, 2016
U.S. Government agencies	$	34,320	$	56	$	58	$	34,318
Mortgage-backed		130,490		263		1,809		128,944
Equity		652		-		12		640
Total	$	165,462	$	319	$	1,879	$	163,902

Held-to-maturity securities:
March 31, 2017
U.S. Government agencies	$	2,001	$	29	$	-	$	2,030
States and political subdivisions		1,614		72		-		1,686
Other equity securities (1)		3,000		139		-		3,139
Total	$	6,615	$	240	$	-	$	6,855

December 31, 2016
U.S. Government agencies	$	2,089	$	26	$	-	$	2,115
States and political subdivisions		1,615		76		-		1,691
Other equity securities (1)		3,000		-		-		3,000
Total	$	6,704	$	102	$	-	$	6,806

(1)

On December 15, 2016, the Company bought $3.0 million in subordinated notes from a local regional bank which it intends to hold to maturity of December 30, 2026 .

The following tables provide information about gross unrealized losses and fair value by length of time that the individual securities have been in a continuous unrealized loss position at March 31, 2017 and December 31, 2016 .


	Less than				More than
	12 Months				12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(Dollars in thousands)	Value		Losses		Value		Losses		Value		Losses
March 31, 2017
Available-for-sale securities:
U.S. Government agencies	$	26,948	$	74	$	-	$	-	$	26,948	$	74
Mortgage-backed		49,097		534		8,883		247		57,980		781
Equity securities		648		7		-		-		648		7
Total	$	76,693	$	615	$	8,883	$	247	$	85,576	$	862


	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, 2016
Available-for-sale securities:
U.S. Government agencies	$	11,926	$	58	$	-	$	-	$	11,926	$	58
Mortgage-backed		100,237		1,546		9,208		263		109,445		1,809
Equity securities		640		12		-		-		640		12
Total	$	112,803	$	1,616	$	9,208	$	263	$	122,011	$	1,879

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

The following table provides information on the amortized cost and estimated fair values of investment securities by maturity date at March 31, 2017 .


	Available for sale				Held to maturity
	Amortized		Estimated		Amortized		Estimated
(Dollars in thousands)	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	15,012	$	15,007	$	210	$	210
Due after one year through five years		26,022		25,974		500		529
Due after five years through ten years		17,745		17,670		904		947
Due after ten years		118,981		118,773		2,001		2,030
		177,760		177,424		3,615		3,716
Equity securities		655		648		3,000		3,139
Total	$	178,415	$	178,072	$	6,615	$	6,855

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

Note 4 – Loans and Allowance for Credit Losses

The Company makes residential mortgage, commercial and consumer loans to customers primarily in Talbot County, Queen Anne’s County, Kent County, Caroline County and Dorchester County in Maryland and in Kent County, Delaware. The following table provides information about the principal classes of the loan portfolio at March 31, 2017 and December 31, 2016.


(Dollars in thousands)	March 31, 2017		December 31, 2016
Construction	$	91,498	$	84,002
Residential real estate		331,191		325,768
Commercial real estate		388,391		382,681
Commercial		74,189		72,435
Consumer		6,595		6,639
Total loans		891,864		871,525
Allowance for credit losses		(8,927)		(8,726)
Total loans, net	$	882,937	$	862,799

Loans are stated at their principal amount outstanding net of any purchase premiums, deferred fees and costs. 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. An impaired loan may show deficiencies in the borrower’s overall financial condition, payment history, support available from financial guarantors and/or the fair market value of collateral. The impairment of a loan is measured at the present value of expected future cash flows using the loan’s effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Generally, the Company measures impairment on such loans by reference to the fair value of the collateral. Once the amount of impairment has been determined, the uncollectible portion is charged off. Income on impaired loans is recognized on a cash basis, and payments are first applied against the principal balance outstanding (i.e., placing impaired loans on nonaccrual status). 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”) 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 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.

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

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

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

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

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

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

The following tables include impairment information relating to loans and the allowance for credit losses as of March 31, 2017 and December 31, 2016.


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Unallocated		Total
March 31, 2017
Loans individually
evaluated for impairment	$	7,883	$	7,974	$	5,555	$	-	$	99	$	-	$	21,511
Loans collectively
evaluated for impairment		83,615		323,217		382,836		74,189		6,496		-		870,353
Total loans	$	91,498	$	331,191	$	388,391	$	74,189	$	6,595	$	-	$	891,864

Allowance for credit
losses allocated to:
Loans individually
evaluated for impairment	$	683	$	282	$	183	$	-	$	-	$	-	$	1,148
Loans collectively
evaluated for impairment		1,607		1,849		2,729		1,338		256		-		7,779
Total loans	$	2,290	$	2,131	$	2,912	$	1,338	$	256	$	-	$	8,927


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Unallocated		Total
December 31, 2016
Loans individually
evaluated for impairment	$	8,007	$	7,778	$	6,088	$	-	$	99	$	-	$	21,972
Loans collectively
evaluated for impairment		75,995		317,990		376,593		72,435		6,540		-		849,553
Total loans	$	84,002	$	325,768	$	382,681	$	72,435	$	6,639	$	-	$	871,525

Allowance for credit
losses allocated to:
Loans individually
evaluated for impairment	$	1,639	$	317	$	185	$	-	$	-	$	-	$	2,141
Loans collectively
evaluated for impairment		1,148		1,636		2,425		1,145		231		-		6,585
Total loans	$	2,787	$	1,953	$	2,610	$	1,145	$	231	$	-	$	8,726

The following tables provide information on impaired loans and any related allowance by loan class as of March 31, 2017 and December 31, 2016. The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken.


				Recorded		Recorded
	Unpaid			investment		investment			Average		Interest
	principal			with no		with an	Related		recorded		income
(Dollars in thousands)	balance			allowance		allowance	allowance		investment		recognized
March 31, 2017
Impaired nonaccrual loans:
Construction	$	7,527	$	76	$	3,628	$	666	$	3,717	$	-
Residential real estate		4,491		2,689		1,581		134		4,010		-
Commercial real estate		1,213		481		175		99		721		-
Commercial		-		-		-		-		-		-
Consumer		99		99		-		-		99		-
Total	$	13,330	$	3,345	$	5,384	$	899	$	8,547	$	-

Impaired accruing TDRs:
Construction	$	4,179	$	3,474	$	705	$	17	$	4,182	$	30
Residential real estate		3,704		2,665		1,039		148		3,762		43
Commercial real estate		4,899		1,877		3,022		84		4,908		57
Commercial		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
Total	$	12,782	$	8,016	$	4,766	$	249	$	12,852	$	130

Total impaired loans:
Construction	$	11,706	$	3,550	$	4,333	$	683	$	7,899	$	30
Residential real estate		8,195		5,354		2,620		282		7,772		43
Commercial real estate		6,112		2,358		3,197		183		5,629		57
Commercial		-		-		-		-		-		-
Consumer		99		99		-		-		99		-
Total	$	26,112	$	11,361	$	10,150	$	1,148	$	21,399	$	130



				Recorded		Recorded			March 31, 2016
	Unpaid			investment		investment			Average		Interest
	principal			with no		with an	Related		recorded		income
(Dollars in thousands)	balance			allowance		allowance	allowance		investment		recognized
December 31, 2016
Impaired nonaccrual loans:
Construction	$	7,247	$	-	$	3,818	$	1,621	$	7,216	$	-
Residential real estate		4,013		1,957		1,946		166		2,292		-
Commercial real estate		1,801		959		193		117		2,559		-
Commercial		-		-		-		-		158		-
Consumer		99		99		-		-		121		-
Total	$	13,160	$	3,015	$	5,957	$	1,904	$	12,346	$	-

Impaired accruing TDRs:
Construction	$	4,189	$	3,479	$	710	$	18	$	4,041	$	25
Residential real estate		3,875		2,829		1,046		151		5,669		55
Commercial real estate		4,936		1,573		3,363		68		5,363		46
Commercial		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
Total	$	13,000	$	7,881	$	5,119	$	237	$	15,073	$	126

Total impaired loans:
Construction	$	11,436	$	3,479	$	4,528	$	1,639	$	11,257	$	25
Residential real estate		7,888		4,786		2,992		317		7,961		55
Commercial real estate		6,737		2,532		3,556		185		7,922		46
Commercial		-		-		-		-		158		-
Consumer		99		99		-		-		121		-
Total	$	26,160	$	10,896	$	11,076	$	2,141	$	27,419	$	126

The following tables provide a roll-forward for troubled debt restructurings as of March 31, 2017 and March 31, 2016.


	1/1/2017												3/31/2017
	TDR		New		Disbursements		Charge		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For three months ended
March 31, 2017
Accruing TDRs
Construction	$	4,189	$	-	$	(10)	$	-	$	-	$	-	$	4,179	$	17
Residential real estate		3,875		-		(82)		(89)		-		-		3,704		148
Commercial real estate		4,936		-		(37)		-		-		-		4,899		84
Commercial		-		-		-		-		-		-		-		-
Consumer		-		-		-		-		-		-		-		-
Total	$	13,000	$	-	$	(129)	$	(89)	$	-	$	-	$	12,782	$	249

Nonaccrual TDRs
Construction	$	3,818	$	-	$	(190)	$	-	$	-	$	-	$	3,628	$	666
Residential real estate		1,603		-		(22)		-		-		-		1,581		134
Commercial real estate		83		-		-		-		-		-		83		-
Commercial		-		-		-		-		-		-		-		-
Consumer		-		-		-		-		-		-		-		-
Total	$	5,504	$	-	$	(212)	$	-	$	-	$	-	$	5,292	$	800

Total	$	18,504	$	-	$	(341)	$	(89)	$	-	$	-	$	18,074	$	1,049


	1/1/2016												3/31/2016
	TDR		New		Disbursements		Charge		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For three months ended
March 31, 2016
Accruing TDRs
Construction	$	4,069	$	-	$	(77)	$	-	$	-	$	-	$	3,992	$	28
Residential real estate		5,686		-		(31)		-		-		-		5,655		112
Commercial real estate		5,740		-		(517)		(117)		-		-		5,106		552
Commercial		-		-		-		-		-		-		-		-
Consumer		-		-		-		-		-		-		-		-
Total	$	15,495	$	-	$	(625)	$	(117)	$	-	$	-	$	14,753	$	692

Nonaccrual TDRs
Construction	$	4,960	$	2,570	$	(691)	$	(241)	$	-	$	-	$	6,598	$	755
Residential real estate		445		-		(288)		-		-		-		157		11
Commercial real estate		-		-		-		-		-		-		-		-
Commercial		-		-		-		-		-		-		-		-
Consumer		23		-		-		-		-		-		23		-
Total	$	5,428	$	2,570	$	(979)	$	(241)	$	-	$	-	$	6,778	$	766

Total	$	20,923	$	2,570	$	(1,604)	$	(358)	$	-	$	-	$	21,531	$	1,458

The following tables provide information on loans that were modified and considered TDRs during the three months ended March 31, 2017 and March 31, 2016.


		Premodification		Postmodification
		outstanding		outstanding
	Number of	recorded		recorded		Related
(Dollars in thousands)	contracts	investment		investment		allowance
TDRs:
For three months ended
March 31, 2017
Construction	-	$	-	$	-	$	-
Residential real estate	-		-		-		-
Commercial real estate	1		760		755		-
Commercial	-		-		-		-
Consumer	-		-		-		-
Total	1	$	760	$	755	$	-

For three months ended
March 31, 2016
Construction	1	$	2,570	$	2,570	$	-
Residential real estate	-		-		-		-
Commercial real estate	-		-		-		-
Commercial	-		-		-		-
Consumer	-		-		-		-
Total	1	$	2,570	$	2,570	$	-

During the three months ended March 31, 2017, there was one TDR which was modified. The modification to this TDR consisted of a change in maturity date.

The following tables provide information on TDRs that defaulted during the three months ended March 31, 2017 and March 31, 2016. Generally, a loan is considered in default when principal or interest is past due 90 days or more.


	Number of	Recorded		Related
(Dollars in thousands)	contracts	investment		allowance
TDRs that subsequently defaulted:
For three months ended
March 31, 2017
Construction	-	$	-	$	-
Residential real estate	1		89		-
Commercial real estate	-		-		-
Commercial	-		-		-
Consumer	-		-		-
Total	1	$	89	$	-

For three months ended
March 31, 2016
Construction	1	$	241	$	-
Residential real estate	-		-		-
Commercial real estate	1		117		-
Commercial	-		-		-
Consumer	-		-		-
Total	2	$	358	$	-

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. They are assigned higher risk ratings than favorably rated loans in the calculation of the formula portion of the allowance for credit losses. At March 31, 2017, there were no nonaccrual loans classified as special mention or doubtfu l and $8.7 million of nonaccrual loans were identified as substandard. The comparable amounts at December 31, 2016 were special mention $0 , substandard $9.0 million and doubtful $0 , respectively.

The following tables provide information on loan risk ratings as of March 31, 2017 and December 31, 2016.


			Special
(Dollars in thousands)	Pass/Performing		Mention		Substandard		Doubtful		Total
March 31, 2017
Construction	$	80,284	$	4,164	$	7,050	$	-	$	91,498
Residential real estate		317,461		6,496		7,234		-		331,191
Commercial real estate		364,732		15,925		7,734		-		388,391
Commercial		73,304		814		71		-		74,189
Consumer		6,496		-		99		-		6,595
Total	$	842,277	$	27,399	$	22,188	$	-	$	891,864


			Special
(Dollars in thousands)	Pass/Performing		Mention		Substandard		Doubtful		Total
December 31, 2016
Construction	$	72,641	$	4,195	$	7,166	$	-	$	84,002
Residential real estate		312,242		6,646		6,880		-		325,768
Commercial real estate		363,461		10,939		8,281		-		382,681
Commercial		71,313		857		265		-		72,435
Consumer		6,540		-		99		-		6,639
Total	$	826,197	$	22,637	$	22,691	$	-	$	871,525

The following tables provide information on the aging of the loan portfolio as of March 31, 2017 and December 31, 2016.


		Accruing
				30-59 days			60-89 days			Greater than			Total
(Dollars in thousands)	Current			past due			past due			90 days			past due			Nonaccrual			Total
March 31, 2017
Construction	$	87,683		$	111		$	-		$	-		$	111		$	3,704		$	91,498
Residential real estate		324,573			1,062			1,286			-			2,348			4,270			331,191
Commercial real estate		385,788			1,449			390			108			1,947			656			388,391
Commercial		74,088			89			12			-			101			-			74,189
Consumer		6,465			13			8			10			31			99			6,595
Total	$	878,597		$	2,724		$	1,696		$	118		$	4,538		$	8,729		$	891,864
Percent of total loans		98.5	%		0.3	%		0.2	%		-	%		0.5	%		1.0	%		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, 2016
Construction	$	80,079		$	-		$	105		$	-		$	105		$	3,818		$	84,002
Residential real estate		317,992			1,778			2,095			-			3,873			3,903			325,768
Commercial real estate		375,552			3,219			2,758			-			5,977			1,152			382,681
Commercial		72,272			19			134			10			163			-			72,435
Consumer		6,515			13			2			10			25			99			6,639
Total	$	852,410		$	5,029		$	5,094		$	20		$	10,143		$	8,972		$	871,525
Percent of total loans		97.8	%		0.6	%		0.6	%		-	%		1.2	%		1.0	%		100.0	%

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 following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three months ended March 31, 2017 and 2016. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.

Management re-evaluated the allowance methodology during the third quarter of 2016, in connection with the consolidation of the two former bank subsidiaries. Prior to consolidation, each bank subsidiary applied a separate allowance methodology based on their respective loan portfolios. The revised methodology incorporates both previous methodologies to align with a consolidated loan portfolio. In addition, beginning in January of 2017 , the allowance methodology was expanded to require the allocation of general reserves to pass/watch loans. This change resulted in an increase in allowance for the first quarter of 2017 when compared to the fourth quarter of 2016 of $1.1 million, which was partially offset by a reduction in specific reserves for a net effect of $250 thousand.


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Unallocated		Total
For three months ended
March 31, 2017
Allowance for credit losses:
Beginning Balance	$	2,787	$	1,953	$	2,610	$	1,145	$	231	$	-	$	8,726

Charge-offs		(29)		(223)		-		(65)		-		-		(317)
Recoveries		7		11		11		58		4		-		91
Net charge-offs		(22)		(212)		11		(7)		4		-		(226)

Provision		(475)		390		291		200		21		-		427
Ending Balance	$	2,290	$	2,131	$	2,912	$	1,338	$	256	$	-	$	8,927


			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Unallocated		Total
For three months ended
March 31, 2016
Allowance for credit losses:
Beginning Balance	$	1,646	$	2,181	$	2,999	$	558	$	156	$	776	$	8,316

Charge-offs		(241)		(16)		(238)		(67)		(8)		-		(570)
Recoveries		6		34		-		65		8		-		113
Net charge-offs		(235)		18		(238)		(2)		-		-		(457)

Provision		342		(185)		496		29		21		(253)		450
Ending Balance	$	1,753	$	2,014	$	3,257	$	585	$	177	$	523	$	8,309

Foreclosure Proceedings

Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $410 thousand and $687 thousand as of March 31, 2017 and December 31, 2016, respectively. At March 31, 2017 and December 31, 2016, there were 3 residential properties held in other real estate owned totaling $92 thousand.

Performing TDRs were in compliance with their modified terms and there are no further commitments associated with these loans.

Note 5 – Other Assets

The Company had the following other assets at March 31, 2017 and December 31, 2016.


(Dollars in thousands)	March 31, 2017		December 31, 2016
Nonmarketable investment securities	$	3,070	$	1,650
Accrued interest receivable		2,753		2,675
Deferred income taxes		4,973		7,039
Prepaid expenses		1,215		1,149
Cash surrender value on life insurance		2,591		2,589
Other assets		3,656		3,781
Total	$	18,258	$	18,883

The following table provides information on significant components of the Company’s deferred tax assets and liabilities as of March 31, 2017 and December 31, 2016.


	March 31,		December 31,
(Dollars in thousands)	2017		2016
Deferred tax assets:
Allowance for credit losses	$	3,566	$	3,486
Reserve for off-balance sheet commitments		122		122
Net operating loss carry forward		1,260		2,232
Write-downs of other real estate owned		267		387
Deferred income		985		1,011
Unrealized losses on available-for-sale securities		189		672
Accrued expenses		-		-
AMT Credits		606		869
Other		1,013		1,192
Total deferred tax assets		8,008		9,971
Deferred tax liabilities:
Depreciation		220		239
Amortization on loans FMV adjustment		145		156
Purchase accounting adjustments		2,153		2,019
Deferred capital gain on branch sale		353		401
Other		164		116
Total deferred tax liabilities		3,035		2,931
Net deferred tax assets	$	4,973	$	7,040

The Company’s deferred tax assets consist of gross net operating loss carryovers for state tax purposes of $23.5 million that will be used to offset taxable income in future periods. The Company’s state net operating loss carryovers will begin to expire in the year ended December 31, 2026 with limited amounts available through December 31, 2034 . Additionally, the Company has $606 thousand of alternative minimum tax credit carryforwards as of March 31, 2017 which may be carried forward indefinitely.

No valuation allowance on these deferred tax assets was recorded at March 31, 2017 and December 31, 2016 as management believes it is more likely than not that all deferred tax assets will be realized based on the following positive material factors: 1) The Company was profitable for all four quarters of 2014, 2015 and 2016 on a GAAP basis. The net operating loss was originally created in the third quarter of 2013 and was solely attributable to the former Talbot Bank’s sale of loans and other real estate owned (the “Asset Sale”), which is considered non-recurring. 2) The Company had pre-tax income of $15.9 million and $11.5 million for the years ended December 31, 2016 and 2015, providing further evidence that the Asset Sale was producing positive results and confirming the expectation of utilizing the deferred tax assets. Alternatively, the Company has reviewed negative factors which would influence the conclusion of realizing the deferred tax assets. These factors include the following: 1) The Company could be subject to Section 382 of the Internal Revenue Code (“IRC”), which could further limit the realization of the net operating loss-related deferred tax asset (“NOL-DTA”). 2) Although the local economy of the market in which the Company operates has been showing continued signs of improvement over the past four years, if this trend flattens or reverses, there is a potential that this potential negative evidence could outweigh the prevailing positive factors.

Based on the aforementioned considerations, the Company has concluded that the predominance of observable positive evidence outweighs the future potential of negative evidence and therefore it is more likely than not that the Company will be able to realize in the future all of the net deferred tax assets.

Note 6 – Other Liabilities

The Company had the following other liabilities at March 31, 2017 and December 31, 2016.


(Dollars in thousands)	March 31, 2017		December 31, 2016
Accrued interest payable	$	67	$	74
Other accounts payable		1,878		2,461
Deferred compensation liability		1,415		1,444
Other liabilities		1,449		1,301
Total	$	4,809	$	5,280

Note 7 - Stock-Based Compensation

At the 2016 annual meeting, stockholders approved the Shore Bancshares, Inc. 2016 Stock and Incentive Plan (“2016 Equity Plan”), replacing the Shore Bancshares, Inc. 2006 Stock and Incentive Plan (“2006 Equity Plan”), which expired on that date. The Company may issue shares of common stock or grant other equity-based awards pursuant to the 2016 Equity Plan. Stock-based awards granted to date generally are time-based, vest in equal installments on each anniversary of the grant date and range over a one- to five-year period of time, and, in the case of stock options, expire 10 years from the grant date. As part of the 2016 Equity Plan, a performance equity incentive award program, known as the “Long-term incentive plan” allows participating officers of the Company to earn incentive awards of performance share/restricted stock units if certain pre-determined targets are achieved at the end of a three-year performance cycle. Stock-based compensation expense based on the grant date fair value is recognized ratably over the requisite service period for all awards and reflects forfeitures as they occur. The 2016 Equity Plan originally reserved 750,000 shares of common stock for grant, and 723,965 shares remained available for grant at March 31, 2017.

The following tables provide information on stock-based compensation expense for the three months ended March 31, 2017 and 2016.


	For the Three Months Ended
	March 31,
(Dollars in thousands)	2017		2016
Stock-based compensation expense	$	418	$	111
Excess tax benefits related to stock-based
compensation		2		3


	March 31,
(Dollars in thousands)	2017			2016
Unrecognized stock-based compensation
expense	$	345		$	70
Weighted average period unrecognized
expense is expected to be recognized		0.1	years		0.6	years

The following table summarizes restricted stock award activity for the Company under the 2016 Equity Plan for the three months ended March 31, 2017 and 2016.


	Three Months Ended March 31, 2017			Three Months Ended March 31, 2016
		Weighted Average			Weighted Average
	Number of	Grant Date		Number of	Grant Date
	Shares	Fair Value		Shares	Fair Value
Nonvested at beginning of period	17,066	$	11.46	12,488	$	8.74
Granted	7,378		16.44	8,524		11.16
Vested	(8,138)		13.92	(13,467)		9.49
Cancelled	-		-	-		-
Nonvested at end of period	16,306	$	12.49	7,545	$	10.16

The fair value of restricted stock awards that vested during the first three months of 2017 and 2016 was $113 thousand and $122 thousand, respectively.

Restricted stock units (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 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.

During 2016, the Company entered into a long-term incentive program 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. 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 are between 12,214 shares and 48,871 shares, assuming a certain performance metric is met. In addition, two members of the long-term incentive plan from 2015 forfeited their RSUs due to leaving the Company before the end of the vesting period. The following table presents management’s evaluation of the probable number of common stock awards to be issued at the end of the performance cycle.

During 2015, the Company entered into a long-term incentive program agreement with officers of the Company and its subsidiaries to award RSUs based on performance metrics to be achieved as of December 31, 2017. 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 are 10,953 shares and 43,821 shares, assuming certain performance metrics are met. The following table presents management’s evaluation of the probable number of common stock awards to be issued at the end of the performance cycle.

The following table summarizes restricted stock units activity for the Company under the 2016 and 2006 Equity Plans for the three months ended March 31, 2017 and 2016.


	Three Months Ended March 31, 2017			Three Months Ended March 31, 2016
		Weighted Average			Weighted Average
	Number of	Grant Date		Number of	Grant Date
	Shares	Fair Value		Shares	Fair Value
Outstanding at beginning of period	46,342	$	10.64	-	$	-
Granted	-		-	26,943		9.49
Vested	-		-	-		-
Forfeited	-		-	-		-
Outstanding at end of period	46,342	$	10.64	26,943	$	9.49

The following table summarizes stock option activity for the Company under the 2016 Equity Plan for the three months ended March 31, 2017 and 2016.


	Three Months Ended March 31, 2017			Three Months Ended March 31, 2016
		Weighted Average			Weighted Average
	Number of	Grant Date		Number of	Grant Date
	Shares	Fair Value		Shares	Fair Value
Outstanding at beginning of period	62,086	$	8.29	61,327	$	8.05
Granted	1,202		10.99	12,443		11.12
Exercised	(859)		6.64	(450)		6.64
Expired/Cancelled	-		-	-		-
Outstanding at end of period	62,429	$	8.36	73,320	$	8.58

Exercisable at end of period	61,828	$	8.34	67,099	$	8.35

The weighted average fair value of stock options granted during 2017 was $10.99 . The Company estimates the fair value of options using the Black-Scholes valuation model with weighted average assumptions for 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. The following weighted average assumptions were used as inputs to the Black-Scholes valuation model for options granted in 2017 and 2016.


	2017		2016
Dividend yield	0.84	%	0.73	%
Expected volatility	64.80	%	38.60	%
Expected forfeiture rate	-	%	-	%
Risk-free interest rate	2.42	%	1.75	%
Expected contract life (in years)	10 years		10 years

At the end of the first quarter of 2017, the aggregate intrinsic value of the options outstanding under the 2016 Equity Plan was $521 thousand based on the $16.71 market value per share of the Company’s common stock at March 31, 2017. Similarly, the aggregate intrinsic value of the options exercisable was $232 thousand at March 31, 2017. The intrinsic value on options exercised in 2017 was $8 thousand based on the $15.89 market value per share of the Company’s common stock at January 30, 2017. The intrinsic value on options exercised in the first three months of 2016 was $2 thousand based on the $11.35 market value per share of the Company’s common stock at February 8, 2016. At March 31, 2017, the weighted average remaining contract life of options outstanding was 6.7 years.

Note 8 – Accumulated Other Comprehensive Income

The Company records unrealized holding gains (losses), net of tax, on investment securities available for sale as accumulated other comprehensive income (loss), a separate component of stockholders’ equity. The following table provides information on the changes in the components of accumulated other comprehensive income (loss) for the three months ended March 31, 2017 and 2016 .


	Accumulated net
	unrealized holding		Total accumulated
	gains (losses) on		other
	available for sale		comprehensive
(Dollars in thousands)	securities		income(loss)
Balance, December 31, 2016	$	(993)	$	(993)
Other comprehensive income		742		742
Balance, March 31, 2017	$	(251)	$	(251)

Balance, December 31, 2015	$	(71)	$	(71)
Other comprehensive income		947		947
Balances, March 31, 2016	$	876	$	876

Note 9 – 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.

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

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

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

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

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

Investment Securities Available for Sale

Fair value measurement for investment securities available for sale is based on quoted prices from an independent pricing service. The fair value measurements consider observable data that may include present value of future cash flows, prepayment assumptions, credit loss assumptions and other factors. The Company classifies its investments in U.S. Treasury securities 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.

The tables below present the recorded amount of assets measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016. No assets were transferred from one hierarchy level to another during the first three months of 2017 or 2016.


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
March 31, 2017
Securities available for sale:
U.S. Government agencies	$	43,275	$	-	$	43,275	$	-
Mortgage-backed		134,149		-		134,149		-
Equity		648		-		648		-
Total	$	178,072	$	-	$	178,072	$	-

					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2016
Securities available for sale:
U.S. Government agencies	$	34,318	$	-	$	34,318	$	-
Mortgage-backed		128,944		-		128,944		-
Equity		640		-		640		-
Total	$	163,902	$	-	$	163,902	$	-

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 due according to the contractual terms of the loan agreement. Loan impairment is measured using the present value of expected cash flows, the loan’s observable market price or the fair value of the collateral (less selling costs) if the loans are collateral dependent and these are considered Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of business equipment, inventory and accounts receivable, discounted on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those techniques applied in prior periods.

Other Real Estate Owned (Foreclosed Assets)

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

The tables below present the recorded amount of assets measured at fair value on a nonrecurring basis at March 31, 2017 and December 31, 2016. The assets in the following table were transferred during 2016 from Level 2 to Level 3, based on management’s reassessment an evaluation of the inputs in relation to impaired loans and foreclosed assets. This reassessment resulted in management conclusion that the inputs for these assets were more reflective of Level 3 as unobservable inputs and applied retrospectively to prior periods reported.


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
March 31, 2017
Impaired loans
Construction	$	7,200	$	-	$	-	$	7,200
Residential real estate		7,692		-		-		7,692
Commercial real estate		5,372		-		-		5,372
Commercial		-		-		-		-
Consumer		99		-		-		99
Total impaired loans		20,363		-		-		20,363
Other real estate owned		2,354		-		-		2,354
Total assets measured at fair value on a
nonrecurring basis	$	22,717	$	-	$	-	$	22,717


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2016
Impaired loans
Construction	$	6,368	$	-	$	-	$	6,368
Residential real estate		7,461		-		-		7,461
Commercial real estate		5,903		-		-		5,903
Commercial		-		-		-		-
Consumer		99		-		-		99
Total impaired loans		19,831		-		-		19,831
Other real estate owned		2,477		-		-		2,477
Total assets measured at fair value on a
nonrecurring basis	$	22,308	$	-	$	-	$	22,308

The following information relates to the estimated fair values of financial assets and liabilities that are reported in the Company’s consolidated balance sheets at their carrying amounts. The discussion below describes the methods and assumptions used to estimate the fair value of each class of financial asset and liability for which it is practicable to estimate that value.

Cash and Cash Equivalents

Cash equivalents include interest-bearing deposits with other banks and federal funds sold. For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment Securities Held to Maturity

For all investments in debt securities, fair values are based on quoted prices. If a quoted price is not available, fair value is estimated using quoted prices for similar securities.

Loans

The fair values of categories of fixed rate loans, such as commercial loans, residential real estate, and other consumer loans, are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Other loans, including variable rate loans, are adjusted for differences in loan characteristics.

Deposits and Short-Term Borrowings

The fair values of demand deposits, savings accounts, and certain money market deposits are the amounts payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. These estimates do not take into consideration the value of core deposit intangibles. Generally, the carrying amount of short-term borrowings is a reasonable estimate of fair value. The fair values of securities sold under agreements to repurchase (included in short-term borrowings) and long-term debt are estimated using the rates offered for similar borrowings.

Commitments to Extend Credit and Standby Letters of Credit

The majority of the Company’s commitments to grant loans and standby letters of credit are written to carry current market interest rates if converted to loans. In general, commitments to extend credit and letters of credit are not assignable by the Company or the borrower, so they generally have value only to the Company and the borrower. Therefore, it is impractical to assign any value to these commitments.

The following table provides information on the estimated fair values of the Company’s financial assets and liabilities that are reported in the balance sheets at their carrying amounts. The financial assets and liabilities have been segregated by their classification level in the fair value hierarchy.


	March 31, 2017				December 31, 2016
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	48,851	$	48,851	$	75,938	$	75,938

Level 2 inputs
Investment securities held to maturity	$	6,615	$	6,855	$	6,704	$	6,806
Loans, net		882,937		885,952		862,799		867,594

Financial liabilities
Level 2 inputs
Deposits	$	1,001,542	$	934,021	$	997,489	$	929,573
Short-term borrowings		2,919		2,919		3,203		3,203

Note 10 – Financial Instruments with Off-Balance Sheet Risk

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

The following table provides information on commitments outstanding at March 31, 2017 and December 31, 2016 .


(Dollars in thousands)	March 31, 2017		December 31, 2016
Commitments to extend credit	$	190,254	$	178,233
Letters of credit		7,774		8,024
Total	$	198,028	$	186,257

Note 11 – Segment Reporting

The Company operates two primary business segments: 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 its 17-branch network and a loan production office in Delaware. Community banking activities include small business services, retail brokerage, trust services 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 business, 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.

The following table includes selected financial information by business segments for the first three months of 2017 and 2016.


	Community		Insurance Products		Parent		Consolidated
(Dollars in thousands)	Banking		and Services		Company		Total
2017
Interest Income	$	10,387	$	-	$	60	$	10,447
Interest Expense		(514)		-		-		(514)
Provision for credit losses		(427)		-		-		(427)
Noninterest income		1,883		2,924		-		4,807
Noninterest expense		(5,861)		(1,809)		(1,981)		(9,651)
Net intersegment (expense) income		(1,677)		(198)		1,875		-
Income (loss) before taxes		3,791		917		(46)		4,662
Income tax (expense) benefit		(1,513)		(367)		18		(1,862)
Net Income (loss)	$	2,278	$	550	$	(28)	$	2,800

Total assets	$	1,150,411	$	9,345	$	7,141	$	1,166,896

2016
Interest Income	$	9,846	$	-	$	62	$	9,908
Interest Expense		(665)		-		-		(665)
Provision for credit losses		(450)		-		-		(450)
Noninterest income		1,830		2,711		-		4,541
Noninterest expense		(5,297)		(1,709)		(2,333)		(9,339)
Net intersegment (expense) income		(1,936)		(172)		2,108		-
Income (loss) before taxes		3,328		830		(163)		3,995
Income tax (expense) benefit		(1,279)		(319)		63		(1,535)
Net Income (loss)	$	2,049	$	511	$	(100)	$	2,460

Total assets	$	1,103,842	$	9,133	$	18,200	$	1,131,175

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.

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 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 section 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 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, 2016 (the “2016 Annual Report”)). Actual results may differ materially from such forward-looking statements, and we assume no obligation to update forward-looking statements at any time except as required by law.

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 201 6 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 18 full service branches in Kent County, Queen Anne’s County, Talbot County, Caroline County and Dorchester County in Maryland and Kent County, Delaware. The Company engages in the insurance business through an insurance producer firm, The Avon-Dixon Agency, LLC, (“Avon-Dixon”) with two specialty lines, Elliott Wilson Insurance (Trucking) and Jack Martin Associates (Marine); and an insurance premium finance company, Mubell Finance, LLC (“Mubell”) (Avon-Dixon and Mubell are collectively referred to as the “Insurance Subsidiaries”). Avon-Dixon and Mubell are wholly-owned subsidiaries of Shore Bancshares, Inc. The Company engages in the trust services business through the trust department at Shore United Bank under the trade name Wye Financial & Trust.

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

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

Critical Accounting Policies

Our financial statements are prepared in accordance with GAAP. The financial information contained within the financial statements is, to a significant extent, financial information 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 income, recognizing an expense, recovering an asset or relieving a liability. 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, 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.

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) Topic 450, “ Contingencies ”, of the Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”), which requires that losses be accrued when they are probable of occurring and estimable; and (ii) ASC Topic 310, “ Receivables ”, 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 to estimate the inherent loss that may be present in our loan portfolio, including economic conditions and trends, the value and adequacy of collateral, the volume and mix of the loan portfolio, and our internal loan processes. 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.

Three basic components comprise our allowance for credit losses: (i) the specific allowance; (ii) the formula allowance; and (iii) the unallocated allowance. Each component is determined based on estimates that can and do change when the actual events occur. The specific allowance is established against impaired loans (i.e., nonaccrual loans and troubled debt restructurings (“TDRs”)) based on our assessment of the losses that may be associated with the individual loans. The specific allowance remains until charge-offs are made. An impaired loan may show deficiencies in the borrower’s overall financial condition, payment history, support available from financial guarantors and/or the fair market value of collateral. The formula allowance is used to estimate the loss on internally risk-rated loans, exclusive of those identified as impaired. Loans are grouped by type (construction, residential real estate, commercial real estate, commercial or consumer). Each loan type is assigned allowance factors based on management’s estimate of the risk, complexity and size of individual loans within a particular category. Loans identified as special mention, substandard, and doubtful are adversely rated. These loans are assigned higher allowance factors than favorably rated loans due to management’s concerns regarding collectability or management’s knowledge of particular elements regarding the borrower. The unallocated allowance captures losses that have impacted the portfolio but have yet to be recognized in either the specific or formula allowance.

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 estimation of a borrower’s prospects of repayment, and the establishment of the allowance factors in the formula allowance and unallocated allowance components of the allowance. The establishment of allowance factors is a continuing exercise, based on management’s ongoing assessment of the totality of all factors, including, but not limited to, 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, the quality of the loan review system and the effect of external factors such as competition and regulatory requirements, and their impact on the portfolio. Allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based on 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 these 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.

Goodwill and Other Intangible Assets

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 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. Determining fair value is subjective, requiring the use of estimates, assumptions and management judgment. Goodwill and other intangible assets with indefinite lives are tested at least annually for impairment, usually during the third 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 that the fair value of each of the Company’s reporting units be compared to the carrying amount of its net assets, including goodwill. The Company’s reporting units were identified based on an analysis of each of its individual operating segments (i.e., the Bank and Insurance Subsidiaries). If the fair value of 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

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 of certain assets and liabilities. Deferred taxes result from such temporary differences. A valuation allowance, if needed, reduces deferred tax assets to the amount most likely to be realized, which is based on estimates of future taxable income, recoverable taxes paid in prior years and expected results of 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.

Fair Value

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, the Company is required to maximize the use of observable inputs and minimize the use of unobservable inputs, reducing subjectivity.

OVERVIEW

The Company reported net income of $2.8 million for the first quarter of 2017, or diluted income per common share of $0.22, compared to net income of $2.5 million, or diluted income per common share of $0.19, for the first quarter of 2016. For the fourth quarter of 2016, the Company reported net income of $2.5 million, or diluted income per common share of $0.20. When comparing the first quarter of 2017 to the first quarter of 2016, the primary reasons for improved net income were increases in net interest income of $690 thousand and noninterest income of $268 thousand, partially offset by an increase in noninterest expenses of $314 thousand. When comparing the first quarter of 2017 to the fourth quarter of 2016, the higher net income was primarily attributable to an increase in noninterest income of $753 thousand, offset by an increase in noninterest expense of $427 thousand.

RESULTS OF OPERATIONS

Net Interest Income

Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments. As shown in the table below, tax-equivalent net interest income was $10.0 million for the first quarter of 2017 and $9.3 million for the first quarter of 2016. Tax-equivalent net interest income was $10.0 million for the fourth quarter of 2016 . The increase in net interest income for the first quarter of 2017 when compared to the first quarter of 2016 was primarily due to an increase in average earning assets, almost entirely the result of an increase in average loans. Total average interest-bearing deposits exhibited an increase primarily in demand, money market and savings deposits, partially offset by a decline in time deposits resulting in a lower cost of funding.

The decrease of $35 thousand in net interest income for the first quarter of 2017 when compared to the fourth quarter of 2016 was primarily due to two fewer days of earning interest and a decline in total a verage loan yields of 4 basis points. This was partially offset by a higher yield on taxable investment securities and interest-bearing deposits, coupled with a decline in volume of and rates paid on interest-bearing deposits. Further, the Company was able to change its asset composition by transitioning from lower yielding securities to higher yielding loans which positively impacted net interest income despite a decrease in the overall yield on loans. Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets. Our net interest margin was 3.71% for the first quarter of 2017, compared to 3.50% for the first quarter of 2016 and 3. 6 3% for the fourth quarter of 2016. The higher net interest margin for the first quarter of 2017 when compared to the first quarter of 2016 was due to an increase in average loans of $90.0 million resulting in $62 0 thousand in additional interest and fees on loans, compounded by lower volumes of and rates paid on time deposits. The higher net interest margin for the first quarter of 2017 when compared to the fourth quarter of 2016 was primarily due to funding loan growth with lower yielding assets, followed by increases in yields on investment securities and the federal funds rate.

On a tax-equivalent basis, net interest income increased $ 690 thousand, or 7. 5 %, for the first quarter of 2017 when compared to the first quarter of 2016. The increase in interest income was due to a 5.7 % increase in interest income on average earning assets (i.e., loans, interest-bearing deposits with other banks, and federal funds sold) resulting in a 15 basis point increase in yields earned on such assets . Loans had the largest impact on the increase in interest income, due to an increase in the average balance of $ 90.0 million, or 11.4 %, resulting in an increase in interest income of $ 620 thousand, or 6. 9 %. The balance on taxable investment securities decreased $ 36.9 million, or 17.2 %, and corresponding interest income decreased $ 43 thousand, or 4.9 %, compared to the first quarter of 2016, resulting in a favorable shift to higher yielding loans. The decline in the yield on average loans was due to downward re-pricing on renewal loans as well as yields on newly originated loans.

Interest expense decreased $151 thousand, or 22.7%, when comparing the first quarter of 2017 to the first quarter of 2016. The decrease in interest expense was due to a 8 basis point decline in rates paid on interest-bearing liabilities (i.e., deposits and borrowings). Changes in the rates and balances related to time deposits (i.e., certificates of deposit $100,000 or more and other time deposits) had the largest impact on interest expense. For the three months ended March 31, 2017, the rates paid on time deposits decreased 21 basis points and the average balances of these deposits decreased $29.4 million, or 10.3%, when compared to the same period last year, which reduced interest expense $161 thousand. A portion of this decline was offset primarily by increases in the average balance of demand, money market and savings deposits. The average balance of noninterest-bearing deposits increased $24.0 million when compared to the same period last year contributing to a lower cost of funding.

The following table presents the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended March 31, 2017 and 2016.


	For the Three Months Ended						For the Three Months Ended
	March 31, 2017						March 31, 2016
	Average		Income(1)/		Yield/		Average		Income(1)/		Yield/
(Dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Earning assets
Loans (2), (3)	$	880,791	$	9,610	4.43	%	$	790,777	$	8,990	4.57	%
Investment securities:
Taxable		177,864		827	1.86			214,778		870	1.62
Tax-exempt		210		3	5.38			210		3	5.30
Federal funds sold		-		-	-			3,640		3	0.33
Interest-bearing deposits		34,069		68	0.80			56,109		72	0.51
Total earning assets		1,092,934		10,508	3.90	%		1,065,514		9,938	3.75	%
Cash and due from banks		13,907						16,205
Other assets		50,763						57,037
Allowance for credit losses		(8,847)						(8,518)
Total assets	$	1,148,757					$	1,130,238

Interest-bearing liabilities
Demand deposits	$	195,005		69	0.14	%	$	193,087		60	0.12	%
Money market and savings deposits		276,175		88	0.13			258,715		86	0.13
Certificates of deposit $100,000 or more		118,970		157	0.54			132,412		234	0.71
Other time deposits		137,832		197	0.58			153,774		281	0.74
Interest-bearing deposits		727,982		511	0.28			737,988		661	0.36
Short-term borrowings		4,150		3	0.27			6,242		4	0.24
Total interest-bearing liabilities		732,132		514	0.28	%		744,230		665	0.36	%
Noninterest-bearing deposits		254,974						231,003
Other liabilities		5,377						5,973
Stockholders' equity		156,274						149,032
Total liabilities and stockholders' equity	$	1,148,757					$	1,130,238

Net interest spread			$	9,994	3.62	%			$	9,273	3.39	%
Net interest margin					3.71	%					3.50	%

Tax-equivalent adjustment
Loans			$	60					$	29
Investment securities				1						1
Total			$	61					$	30


						(1)	All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 35.0%, exclusive of the alternative minimum tax rate and nondeductible interest expense.
						(2)	Average loan balances include nonaccrual loans.
						(3)	Interest income on loans includes amortized loan fees, net of costs, and all are included in the yield calculations.

Noninterest Income

Total noninterest income for the first quarter of 2017 increased $266 thousand, or 5.9%, when compared to the first quarter of 2016 . The increase was mostly the result of a gain on an insurance agency investment in the first quarter of 2017, opposed to a loss in the first quarter of 2016. In addition, insurance agency commissions increased $60 thousand in 2017 over the prior period. Noninterest income increased $751 thousand, or 18.5%, when compared to the fourth quarter of 2016 mainly due to higher insurance agency commissions from contingency payments which are typically received in the first quarter of each year based on the prior year’s performance, partially offset by the absence of the gain on sale of the Bank ’ s credit card portfolio in the fourth quarter of 2016.

Noninterest Expense

Total noninterest expense for the first quarter of 2017 increased $312 thousand, or 3.3%, when compared to the first quarter of 2016 and increased $425 thousand, or 4.6%, when compared to the fourth quarter of 2016. The increase from the first quarter of 2016 was primarily due to higher employee benefits, primarily insurance premiums for group health insurance and merger and acquisition costs. The merger and acquisition costs are related to the branch purchase which is presently scheduled to be completed in the second quarter of 2017, resulting in higher data processing and legal and professional fees for a combined $226 thousand for the first quarter of 2017 . Partially offsetting these additional expenses is a reduction in the FDIC insurance premiums of $118 thousand, the direct result of the consolidation of the two former bank subsidiaries. The increase in noninterest expense compared to the fourth quarter of 2016 was primarily due to higher costs associated with employee benefits of $334 thousand, which included higher insurance premiums for group insurance and federal unemployment insurance which is usually paid in the f irst two quarters of the year. Salaries and wages increased by $121 thousand in the first quarter due to pay increases implemented during the period. The remaining increases were related to merger and acquisition costs for the branch purchase of $22 6 thousand, partially offset by a decrease in write-downs of other real estate owned of $111 thousand .

Income Taxes

For the first quarter of 2017 and 2016, the Company reported income tax expense of $1.9 million and $1.5 million, respectively, while the effective tax rate was 39.9% and 38.4%, respectively. The increase in effective tax rates for the first quarter of 2017 when compared to the same period in 2016 w as due to higher levels of expected taxable income on a consolidated basis.

The Company has NOLs for federal and state income tax purposes that can be utilized to offset future taxable income. The Company’s use of the NOLs would be limited, however, under Section 382 of the Internal Revenue Code ("IRC"), if the Company were to undergo a change in ownership of more than 50% of its capital stock over a three-year period as measured under Section 382 of the IRC. These complex changes of ownership rules generally focus on ownership changes involving shareholders owning directly or indirectly 5% or more of the Company’s stock, including certain public "groups" of shareholders as set forth under Section 382 of the IRC, including those arising from new stock issuances and other equity transactions. Due to the Company’s public offer and sale of its common stock (the “stock sale”) in June, 2014 and other ownership changes by shareholders owning 5% or more of the Company’s stock, the Company estimates that it has experienced an ownership change of approximately 44% for the three-year period ended March 31, 2017. The Company intends to take all action within its control to prevent a change in ownership in excess of 50% over any three-year testing period. For a further discussion of Section 382 and the potential impact on the Company, see “Part II – Item 1A. Risk Factors” herein.

ANALYSIS OF FINANCIAL CONDITION

Loans

Loans totaled $891.9 million at March 31, 2017 and $871.5 million at December 31, 2016, an increase of $20.3 m illion, or 2.3%. Construction, c ommercial and residential real estate categories experienced the most significant change with increases of $7.5 million , $5.7 million and $5.4 million, respectively. Further, the commercial category increased $1.8 million, offset by a decline in the consumer category of $44 thousand. Loans included deferred costs, net of deferred fees, of $524 thousand at March 31, 2017 and $509 thousand at December 31, 2016. We do not engage in foreign or subprime lending activities. See Note 4, “Loans and Allowance for Credit Losses”, in the Notes to Consolidated Financial Statements and below under the caption “Allowance for Credit Losses” for additional information.

Our loan portfolio has a commercial real estate loan concentration, which is defined as a combination of construction and commercial real estate loans. Construction loans were $91.5 million, or 10.3% of total loans, at March 31, 2017, higher than the $84.0 million, or 9.6% of total loans at December 31, 2016. Commercial real estate loans were $388.4 million, or 43.5% of total loans, at March 31, 2017, compared to $382.7 million, or 43.9% of total loans at December 31, 2016.

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 commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years. At March 31, 2017, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represent ed 206.6% of total risk based capital. At such time, c onstruction, land and land development loans represent ed 62.6% of total risk based cap ital. The commercial real estate portfolio has increased 7.4% during the prior 36 months. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, and strong underwriting criteria with respect to its commercial real estate portfolio. Monitoring practices include periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and 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 debts and is decreased by current period charge-offs of uncollectible debts. 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 provision for credit losses was $427 thousand for the first quarter of 2017, $450 thousand for the first quarter of 2016 and $418 thousand for the fourth quarter of 2016. The lower level of provision for credit losses when comparing the first quarter of 2017 to the first quarter of 2016 was primarily due to decreases in loan charge-offs and nonaccrual loans. The higher level of provision for credit losses when compared to the fourth quarter of 2016 was due to growth in the loan portfolio of $20.3 million.

Net charge-offs were $226 thousand for the first quarter of 2017 and $457 thousand for the first quarter of 2016. Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming assets 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 1.00% as of March 31, 2017, 1.04% as of March 31, 2016 and 1.00% as of December 31, 2016. In January of 2017 , the allowance methodology was exp a nded to require the allocation of general reserves to pass/watch loans. This change resulted in an increase in allowance for the first quarter of 2017 when compared to the fourth quarter of 2016 of $1.1million, which was partially offset by a reduction in specific reserves for a net effect of $250 thousand. Management believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at March 31, 2017.

The following table presents a summary of the activity in the allowance for credit losses at or for the three months ended March 31, 2017 and 2016.


	At or for Three Months
	Ended March 31,
(Dollars in thousands)		2017	2016
Allowance balance - beginning of period	$	8,726	$	8,316
Charge-offs:
Construction		(29)		(241)
Residential real estate		(223)		(16)
Commercial real estate		-		(238)
Commercial		(65)		(67)
Consumer		-		(8)
Total		(317)		(570)

Recoveries:
Construction		7		6
Residential real estate		11		34
Commercial real estate		11		-
Commercial		58		65
Consumer		4		8
Totals		91		113
Net charge-offs		(226)		(457)
Provision for credit losses		427		450
Allowance balance - end of period	$	8,927	$	8,309

Average loans outstanding during the period	$	880,791	$	790,777
Net charge-offs (annualized) as a percentage of
average loans outstanding during the period		0.10%		0.23%
Allowance for credit losses at period end as a
percentage of total period end loans		1.00%		1.04%

Nonperforming Assets and Accruing TDRs

As shown in the following table, nonperforming assets decreased $268 thousand to $11.2 million at March 31, 2017 from $11.5 million at December 31, 2016, primarily due to decreases in nonaccrual loans of $243 thousand and other real estate owned of $123 thousand. Accruing TDRs decreased $218 thousand to $12.8 million at March 31, 2017 from $13.0 million at December 31, 2016. The ratio of nonaccrual loans to total loans decreased to 0.98% at March 31, 2017 from 1.03% at December 31, 2016 .

The Company continues to focus on the resolution of its nonperforming and problem loans. 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; and selling loans. The reduction of nonperforming and problem loans is and will continue to be a high priority for the Company.

The following table summarizes our nonperforming assets and accruing TDRs at March 31, 2017 and December 31, 2016 .


(Dollars in thousands)	March 31, 2017			December 31, 2016
Nonperforming assets
Nonaccrual loans
Construction	$	3,704		$	3,818
Residential real estate		4,270			3,903
Commercial real estate		656			1,152
Commercial		-			-
Consumer		99			99
Total nonaccrual loans		8,729			8,972
Loans 90 days or more past due and still accruing
Construction		-			-
Residential real estate		-			-
Commercial real estate		108			-
Commercial		-			10
Consumer		10			10
Total loans 90 days or more past due and still accruing		118			20
Other real estate owned		2,354			2,477
Total nonperforming assets	$	11,201		$	11,469

Accruing TDRs
Construction	$	4,179		$	4,189
Residential real estate		3,704			3,875
Commercial real estate		4,899			4,936
Commercial		-			-
Consumer		-			-
Total accruing TDRs	$	12,782		$	13,000

Total nonperforming assets and accruing TDRs	$	23,983		$	24,469

As a percent of total loans:
Nonaccrual loans		0.98	%		1.03	%
Accruing TDRs		1.43	%		1.49	%
Nonaccrual loans and accruing TDRs		2.41	%		2.52	%

As a percent of total loans and other real estate owned:
Nonperforming assets		1.25	%		1.31	%
Nonperforming assets and accruing TDRs		2.68	%		2.80	%

As a percent of total assets:
Nonaccrual loans		0.75	%		0.77	%
Nonperforming assets		0.96	%		0.99	%
Accruing TDRs		1.10	%		1.12	%
Nonperforming assets and accruing TDRs		2.06	%		2.11	%

Investment Securities

The investment portfolio is comprised of securities that are 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, a separate component of stockholders’ equity. Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts. We have the intent and current ability to hold such securities until maturity. At March 31, 2017 and December 31, 2016, 96 % of the portfolio was classified as available for sale and 4% as held to maturity. With the exception of municipal securities, our general practice is to classify all newly-purchased securities as available for sale. See Note 3 - Investment Securities, in the Notes to Consolidated Financial Statements for additional details on the composition of our investment portfolio.

Investment securities totaled $184.7 million at March 31, 2017, a $14.1 million, or 8.3%, increase since December 31, 2016. The increase was due to the transition of interest-bearing deposits to higher yielding investment securities. At the end of March 2017, 75.3% of the securities available for sale were mortgage-backed, 24.3% were U.S. Government agencies, compared to 78.7%, and 20.9%, respectively, at year-end 2016. Our investments in mortgage-backed securities are issued or guaranteed by U.S. Government agencies or government-sponsored agencies.

Deposits

Total deposits at March 31, 2017 were $1.0 billion, a $4.1 million, or less than 1%, increase when compared to the level at December 31, 2016. The increase in total deposits was mainly due to higher balances in money market and savings deposits o f $6.7 million and noninterest-bearing deposits of $5.0 million, partially offset by a decline in time deposits of $6.9 million.

Short-Term Borrowings

Short-term borrowings at March 31, 2017 and December 31, 2016 were $2.9 million and $3.2 million, respectively. 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 March 31, 2017 and December 31, 2016, short-term borrowings included only repurchase agreements.

Liquidity and Capital Resources

We derive liquidity through increased customer deposits, maturities in the investment portfolio, loan repayments and income from earning assets. As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $ 27.1 million for the first three months of 2017 compared to a de crease in cash of $ 185 thousand for the first three months of 2016. The decrease in cash and cash equivalents in 2017 was mainly due to funding loan growth and purchasing investment securities.

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. The Bank had $15 million in federal funds lines of credit and a reverse repurchase agreement available on a short-term basis from correspondent banks at March 31, 2017 and December 31, 2016. The Bank is also a member of the FHLB, which provides another source of liquidity. Through the FHLB, the Bank had credit availability of approximately $207.1 million and $205.1 million at March 31, 2017 and December 31, 2016, respectively. These lines of credit are paid for monthly on a fee basis of 0.10%. The Bank has 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 $3.3 million to $157.6 million at March 31, 2017 when compared to December 31, 2016 primarily due to current year’s earnings.

Basel III

The FRB and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision's (“BCBS”) capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer became effective as of January 1, 2016 at 0.625% of risk-weighted assets and will increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revise the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets.

The phase-in period for the final rules became effective for the Company on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of March 31, 2017 , the Company's capital levels remained characterized as "well-capitalized" under the new rules.

The following tables present the capital ratios for Shore Bancshares, Inc. and Shore United Bank as of March 31, 2017 and December 31, 2016.

During the first quarter of 2017, Shore Bancshares , Inc. contributed $10.5 million in capital to its bank subsidiary, Sho re United Bank, in preparation for the branch acquisition in the second quarter of 2017. Of the $10.5 million contributed, $10.2 million consisted of mortgage-backed securities and $300 thousand cash.


	Tier 1		Common Equity		Tier 1		Total
	leverage		Tier 1		risk-based		risk-based
March 31, 2017	ratio		ratio		capital ratio		capital ratio
Company	12.74	%	15.84	%	15.84	%	16.85	%
Shore United Bank	12.22	%	15.05	%	15.05	%	16.07	%

	Tier 1		Common Equity		Tier 1		Total
	leverage		Tier 1		risk-based		risk-based
December 31, 2016	ratio		ratio		capital ratio		capital ratio
Company	12.31	%	15.78	%	15.78	%	16.79	%
Shore United Bank	10.88	%	13.84	%	13.84	%	14.86	%

Item 3. Quantitative and Qualitative Disclosur es 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 201 6 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, 2016 .

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 (“CEO”) and its 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, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls and procedures as of March 31, 2017 was carried out under the supervision and with the participation of management, including the CEO and the PAO. Based on that evaluation, the Company’s management, including the CEO and the PAO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level at March 31, 2017 .

There was no change in our internal control over financial reporting during the first quarter of 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER I NFORMATION

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 risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the 2016 Annual Report. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed in our 2016 Annual Report.

Item 2. Unregistered Sales of E quity Securities and Use of Proceeds

None .

Item 3. Defaults Upon S enior Securities

None

Item 4. Mine Safet y Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. E xhi bits.

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.

SIGNATURES

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


	SHORE BANCSHARES, INC.

Date: May 9 , 201 7	By:	/s/ Lloyd L. Beatty, Jr.
		Lloyd L. Beatty, Jr.
		President & Chief Executive Officer
		(Principal Executive Officer)

Date: May 9 , 2017	By:	/s/ Edward C. Allen
		Edward C. Allen
		Senior Vice President & Chief Financial Officer
		(Principal Financial Officer)

EXHIBIT I ND EX


Exhibit
Number		Description

10.1		Form of Performance Share/Restricted Stock Unit Award Agreement under the 2006 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on July 8, 2015).

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		Interactive Data File

101.INS		XBRL Instance Document (filed herewith)

101.SCH		XBRL Taxonomy Extension Schema (filed herewith)

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

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

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

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

SHBI 10-Q Quarter ended March 31, 2017