KBRA Affirms Ratings for Shore Bancshares, Inc.

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Easton, Maryland-based Shore Bancshares, Inc. (NASDAQ: SHBI) (“Shore” or “the company”). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for its subsidiary, Shore United Bank, N.A. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The ratings recognize Shore’s solidified presence and market share in its footprint, specifically among locally headquartered banks in Maryland (fourth overall in terms of deposit market share), which has been facilitated by a well-executed M&A strategy in recent years. Following the recent merger-of-equals with The Community Financial Corporation (“TCFC”) in 3Q23, the company is nearing $6 billion in assets, and in our view, reflects a favorable funding profile among local banks. Following the balance sheet repositioning at merger close, which included the sale of TCFC’s securities portfolio to reduce higher-cost borrowings, SHBI’s core deposits represent 90% of total funding. Additionally, it is worth noting that both legacy banks reflected a strong level of core deposits historically. Moreover, the company’s total cost of deposits (1.84% for 3Q23) track well below local peers and helps support a relatively healthy NIM (3.40% for 3Q23), which combined with a respectable level of noninterest income (~15% of total revenues excluding the bargain purchase gain), and well contained operating expense, results in solid earnings power (core ROA of just below 1.20% for the third quarter). In the near-term, Shore is also in an enviable position given the expected purchase accounting accretion income that will continue to be a NIM tailwind prospectively. Furthermore, over the medium term, if the Fed cuts its target rate in 2024, the company maintains a liability sensitive balance sheet that will also benefit the margin. Management is finalizing cost-savings from the merger and pursuing revenue synergies between both institutions, both of which could also reinforce stronger profitability. As such, we expect earnings performance to remain at the higher end of the rating group. SHBI has a conservative and credit focused management team with prudent underwriting standards, evidenced by sound credit performance in recent periods, including minimal NPAs and NCOs, as well as a lower levels of classified/criticized loans. The company maintains ample LLR coverage at 1.24% of loans, covering NPAs by nearly 10x, and a gross credit mark of ~$23 million. The merger was dilutive to capital given the substantial amount of interest rate marks on TCFC’s loan and securities portfolio, most notably a significant decline in the CET1 ratio of 250 bps with CET1 falling to 8.5% at 3Q23. However, management intends to rebuild capital closer to pre-merger levels, forecasting for the CET1 to reach the mid-9% to 10% range by YE24. We view this rebuild as achievable given the improved earnings capacity, measured balance sheet growth expected, and digestible dividend payout. Although the operating footprint is relatively smaller, located mainly throughout the Eastern Shore and Southern MD, which represents geographic concentration risks, KBRA recognizes that the company’s focus on its local communities has resulted in management’s deep knowledge and expertise in these particular markets and has been a catalyst of SHBI’s solid deposit market share. Moreover, we take comfort in the recent diversification in the footprint that has been achieved through the aforementioned M&A, including a closer presence to major MSAs in footprint, including Baltimore and DC. Lastly, despite more concentrated operations, KBRA also acknowledges the strong underlying demographics in the home state of Maryland, including a very low level of unemployment, and the presence of governmental entities and contractors that together also helps support the local economies.

Rating Sensitivities

A rating upgrade is not expected, though continued growth and geographic expansion of the franchise, greater earnings diversification that supports returns more consistent with the higher rating category, and rebuilding capital metrics above peer averages may have positive rating implications over time. Negative rating implications may apply if SHBI fails to rebuild capital ratios to be consistent with the rated peer group (9.5%-10% CET1 by YE24), or if increased risk appetite results in deterioration of credit quality and weaker earnings profile.

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