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 June 30, 2017

or

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

For the transition period from _____to _____

Commission file number   0-23090

BAY BANCORP, INC.

(Exact name of registrant as specified in its charter)

MARYLAND	52-1660951
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

7151 Columbia Gateway Drive, Suite A, Columbia, Maryland 21046

(Address of principal executive offices)                (Zip Code)

Registrant’s telephone number, including area code (410) 494-2580

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

Title of Each Class	Name of Each Exchange on Which Registered:
Common Stock, par value $1.00 per share	NASDAQ Capital Market

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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes ☑ 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 (§232.405of 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, a smaller reporting companyor an emerging growth company. (See definition of “large accelerated filer”, “accelerated filer”,  “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act). 

(Check one):Large accelerated filer ☐Accelerated filer ☐Non-accelerated filer ☐    (Do not check if a smaller reporting company)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 theAct). Yes ☐ No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, at the latest practicable date:  At August 8, 2017, the number of shares outstanding of the registrant’s common stock was 10,713,832.

BAY BANCORP, INC.

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION	PAGE
Item 1.	Financial Statements
	Consolidated Balance Sheets at June 30, 2017 (unaudited) and December 31, 2016	3
	Consolidated Statements of Income for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)	4
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)	5
	Consolidated Statements of Stockholders’ Equity for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)	6
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016 (unaudited)	7
	Notes to Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	62
Item 4.	Controls and Procedures	62
PART II	OTHER INFORMATION	63
Item 1.	Legal Proceedings	63
Item 1A.	Risk Factors	63
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63
Item 3.	Defaults Upon Senior Securities	63
Item 4.	Mine Safety Disclosures	63
Item 5.	Other Information	63
Item 6.	Exhibits	63
SIGNATURES		63
EXHIBIT INDEX		64

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

	June 30,
	2017		December 31,
	(unaudited)		2016
ASSETS
Cash and due from banks	$	8,137,129	$	7,591,685
Interest bearing deposits with banks and federal funds sold		33,529,073		32,435,771
Total Cash and Cash Equivalents		41,666,202		40,027,456
Investment securities available for sale, at fair value		62,462,091		60,232,727
Investment securities held to maturity, at amortized cost		1,116,070		1,158,238
Restricted equity securities, at cost		2,364,795		1,823,195
Loans held for sale		2,893,943		1,613,497
Loans, net of deferred fees and costs		509,595,599		487,103,713
Less: Allowance for loan losses		(3,608,484)		(2,823,153)
Loans, net		505,987,115		484,280,560
Real estate acquired through foreclosure		1,147,546		1,224,939
Premises and equipment, net		3,717,494		3,882,343
Bank owned life insurance		15,963,231		15,729,302
Core deposit intangibles		2,596,967		3,030,309
Deferred tax assets, net		2,715,618		2,984,718
Accrued interest receivable		1,870,876		1,884,945
Accrued taxes receivable		259,386		1,153,102
Prepaid expenses		842,871		1,001,723
Other assets		335,363		276,540
Total Assets	$	645,939,568	$	620,303,594
LIABILITIES
Noninterest-bearing deposits	$	120,486,976	$	111,378,694
Interest-bearing deposits		415,434,706		415,079,700
Total Deposits		535,921,682		526,458,394
Short-term borrowings		35,000,000		20,000,000
Defined benefit pension liability		670,712		994,156
Accrued expenses and other liabilities		5,082,542		6,923,818
Total Liabilities		576,674,936		554,376,368
STOCKHOLDERS’ EQUITY
Common stock - par $1.00 per shares, authorized 20,000,000 shares, issued and outstanding 10,709,597 and 10,626,290 shares at June 30, 2017 and December 31, 2016, respectively.		10,642,372		10,456,098
Additional paid-in capital		41,557,518		40,814,285
Retained earnings		16,609,138		14,426,969
Accumulated other comprehensive income		455,604		30,383
Total controlling interest		69,264,632		65,727,735
Non-controlling interest		—		199,491
Total Stockholders' Equity		69,264,632		65,927,226
Total Liabilities and Stockholders' Equity	$	645,939,568	$	620,303,594

See accompanying notes to unaudited consolidated financial statements.

3

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
INTEREST INCOME
Interest and fees on loans	$	6,429,464	$	4,994,892	$	12,349,608	$	9,839,212
Interest on loans held for sale		13,025		38,786		19,908		78,452
Interest and dividends on securities		388,435		205,639		739,319		417,023
Interest on deposits with banks and federal funds sold		67,334		12,181		145,009		31,226
Total Interest Income		6,898,258		5,251,498		13,253,844		10,365,913
INTEREST EXPENSE
Interest on deposits		444,997		292,480		900,847		601,657
Interest on federal funds purchased		89		28		89		28
Interest on short-term borrowings		107,931		79,784		168,134		143,579
Total interest expense		553,017		372,292		1,069,070		745,264
Net interest income		6,345,241		4,879,206		12,184,774		9,620,649
Provision for loan losses		522,323		357,533		962,844		655,533
Net interest income after provision for loan losses		5,822,918		4,521,673		11,221,930		8,965,116
NONINTEREST INCOME
Payment sponsorship fees		844,810		591,550		1,501,002		1,142,559
Mortgage banking fees and gains		199,447		262,736		382,391		421,283
Service charges on deposit accounts		79,637		77,013		142,269		147,627
Gain on securities sold		—		213,571		5,521		486,534
Other income		228,776		180,133		647,849		318,077
Total Noninterest Income		1,352,670		1,325,003		2,679,032		2,516,080
NONINTEREST EXPENSES
Salary and employee benefits		2,924,599		2,784,504		5,781,843		5,673,960
Occupancy and equipment expenses		667,228		809,075		1,424,873		1,680,270
Legal, accounting and other professional fees		295,493		217,453		528,449		528,014
Data processing and item processing services		304,718		252,822		632,512		534,814
FDIC insurance costs		101,928		86,702		166,942		164,181
Advertising and marketing related expenses		122,849		108,211		147,169		140,739
Foreclosed property expenses and REO sales, net		21,234		96,106		38,093		170,585
Loan collection costs		36,176		13,790		70,842		34,590
Core deposit intangible amortization		197,877		155,325		433,342		348,132
Merger related expenses		—		131,333		149,543		188,590
Other expenses		531,494		450,654		1,011,549		972,097
Total Noninterest Expenses		5,203,596		5,105,975		10,385,157		10,435,972
Income before income taxes		1,971,992		740,701		3,515,805		1,045,224
Income tax expense		746,633		291,597		1,333,638		409,721
NET INCOME	$	1,225,359	$	449,104	$	2,182,167	$	635,503
Net income available to common stockholders	$	1,225,359	$	449,104	$	2,182,167	$	635,503
Weighted average shares outstanding
Basic		10,597,629		10,908,156		10,549,229		10,956,698
Diluted		10,718,725		11,007,113		10,671,622		11,053,383
Earnings per share
Basic	$	0.12	$	0.04	$	0.21	$	0.06
Diluted	$	0.11	$	0.04	$	0.20	$	0.06

See accompanying notes to unaudited consolidated financial statements

4

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
Net income	$	1,225,359	$	449,104	$	2,182,167	$	635,503
Other comprehensive income (loss):
Net unrealized gain on securities available for sale:
Net unrealized gain on securities during the period		178,858		224,056		403,265		878,312
Reclassification adjustment for gain on sales of securities included in net income		—		(213,571)		(5,521)		(486,534)
Income tax expense relating to items above		(67,186)		(4,049)		(149,452)		(154,377)
Net effect on other comprehensive income (loss)		111,672		6,436		248,292		237,401
Unrealized gain (loss) on defined benefit pension plan		285,369		—		285,369		(558,690)
Income tax (expense) benefit relating to item above		(108,440)		—		(108,440)		220,375
Net effect on other comprehensive income (loss)		176,929		—		176,929		(338,315)
Other comprehensive income (loss)		288,601		6,436		425,221		(100,914)
Comprehensive income	$	1,513,960	$	455,540	$	2,607,388	$	534,589

See accompanying notes to unaudited consolidated financial statements

5

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Six Months Ended June 30, 2017 and 2016 (unaudited)

							Accumulated
			Additional				Other
	Common		Paid-in		Retained		Comprehensive		Non-controlling
	Stock		Capital		Earnings		Income (Loss)		Interest		Total
Balance December 31, 2015	$	11,062,932	$	43,378,927	$	12,667,070	$	573,560	$	—	$	67,682,489
Net income		—		—		635,503		—		—		635,503
Other comprehensive income (loss)		—		—		—		(100,914)		—		(100,914)
Stock-based compensation		—		68,773		—		—		—		68,773
Issuance of restricted common stock		15,296		(15,296)
Issuance of common stock under stock option plan		15,000		56,250		—		—		—		71,250
Repurchase of common stock		(175,000)		(684,500)		—		—		—		(859,500)
Balance June 30, 2016	$	10,918,228	$	42,804,154	$	13,302,573	$	472,646	$	—	$	67,497,601
							Accumulated
			Additional				Other
	Common		Paid-in		Retained		Comprehensive		Non-controlling
	Stock		Capital		Earnings		Income (Loss)		Interest		Total
Balance December 31, 2016	$	10,456,098	$	40,814,285	$	14,426,969	$	30,383	$	199,491	$	65,927,226
Net income		—		—		2,182,167		—		—		2,182,167
Other comprehensive income (loss)		—		—		—		425,221		—		425,221
Stock-based compensation		—		128,079		—		—		—		128,079
Sale of iReverse		—		—		2		—		(199,491)		(199,489)
Issuance of common stock under stock-based compensation plan		186,274		615,154		—		—		—		801,428
Repurchase of common stock		—		—		—		—		—		—
Balance June 30, 2017	$	10,642,372	$	41,557,518	$	16,609,138	$	455,604	$	—	$	69,264,632

See accompanying notes to unaudited consolidated financial statements

6

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Six Months Ended June 30,
	2017		2016
Cash flows from operating activities:
Net income	$	2,182,167	$	635,503
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment		297,449		337,544
Stock-based compensation		128,079		68,773
Amortization of investment premiums and discounts, net		134,562		55,772
Accretion of net discounts on loans		(1,209,592)		(796,072)
Amortization of core deposit intangibles		433,342		348,132
Amortization of deposit premiums		(18,233)		14,503
Provision for loan losses		962,844		655,533
Increase in cash surrender value of bank owned life insurance		(233,929)		(59,588)
Gain on sale and redemption of securities		(5,521)		(486,534)
Loss on disposal of premises and equipment		—		709
Write down of real estate acquired through foreclosure		80,374		106,853
Gain on sale of real estate acquired through foreclosure		(76,966)		(5,726)
Origination of loans held for sale		(16,189,014)		(22,675,801)
Proceeds from sales of loans held for sale		15,470,178		22,787,638
Gains on sales of loans held for sale		(561,611)		(629,987)
Deferred income taxes		162,751		—
Net decrease (increase) in accrued interest receivable		14,069		(62,233)
Net decrease in accrued taxes receivable		893,716		929,898
Net decrease in accrued pension plan liability		(189,619)		(59,642)
Net decrease (increase) in prepaid expenses and other assets		311,145		(197,309)
Net (decrease) increase in accrued expenses and other liabilities		(2,040,765)		95,090
Net cash provided by operating activities		545,426		1,063,056
Cash flows from investing activities:
Purchases of investment securities available for sale		(8,308,578)		(5,926,875)
Redemptions and maturities of investment securities available for sale		6,346,087		17,656,101
Redemption and maturities of investment securities held to maturity		43,997		392,419
Net purchase of Federal Home Loan Bank Stock		(541,600)		(316,000)
Net increase in loans		(22,119,683)		(23,535,322)
Proceeds from sale of real estate acquired through foreclosure		733,861		158,277
Purchases of premises and equipment		(343,713)		(18,655)
Net cash used in by investing activities		(24,189,629)		(11,590,055)
Cash flows from financing activities:
Net increase (decrease) in deposits		9,481,521		(4,256,085)
Net increase in short-term borrowings		15,000,000		8,275,000
Repurchase of common stock		—		(859,500)
Exercise of stock options		801,428		71,250
Net cash provided by financing activities		25,282,949		3,230,665
Net increase (decrease) increase in cash and cash equivalents		1,638,746		(7,296,334)
Cash and cash equivalents at beginning of period		40,027,456		34,413,222
Cash and cash equivalents at end of period	$	41,666,202	$	27,116,888
Supplemental Disclosures of Cash Flow information:
Interest paid on deposits and borrowings	$	1,062,165	$	707,512
Net income tax paid (refunded)		72,000		(525,211)
Non Cash activities:
Transfer of loans to real estate acquired through foreclosure	$	659,876	$	266,776

See accompanying notes to unaudited consolidated financial statements

7

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS  

NOTE 1 – ORGANIZATIONAL

Nature of Business

Bay Bancorp, Inc. is a savings and loan holding company.  Through its subsidiary, Bay Bank, FSB (the “Bank”), a federal savings bank (an “FSB”), Bay Bancorp, Inc. serves the community with a network of 11 branches strategically located throughout the Baltimore Metropolitan Statistical Area, particularly Baltimore City and the Maryland counties of Baltimore, Anne Arundel, Howard, and Harford, as well as south along the Baltimore-Washington corridor with an expanded focus on Prince George’s County and Montgomery Counties.  The Bank serves local consumers, small and medium size businesses, professionals and other valued customers by offering a broad suite of financial products and services, including on-line and mobile banking, commercial banking, cash management, mortgage lending and retail banking.  The Bank funds a variety of loan types including commercial and residential real estate loans, commercial term loans and lines of credit, consumer loans and letters of credit.

As used in these notes, the term “the Company” refers to Bay Bancorp, Inc. and, unless the context clearly requires otherwise, its consolidated subsidiaries.  

NOTE 2 – BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Bay Bancorp, Inc., the Bank and the Bank’s consolidated subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation. 

From July 8, 2016 until March 31, 2017, the Bank had an investment in a reverse home loan mortgage brokerage firm named iReverse Home Loan, LLC (“iReverse”).  The Bank owned 51% of iReverse and reported its non-controlling interest in iReverse separately in the consolidated balance sheet at December 31, 2016.  The Company reported the income of iReverse attributable to the Bank on the consolidated statement of income for the year ended December 31, 2016 as discontinued operations. The Bank entered into an agreement with the other owner of iReverse pursuant to which the Bank sold, effective March 31, 2017, the Bank’s interest in iReverse to the other owner for $70,000. The Company reported no discontinued operations for the six-month and three-month periods ended June 30, 2017.

In management’s opinion, the accompanying unaudited consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim period reporting, reflect all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial position at June 30, 2017 and December 31, 2016, the results of operations for the three- and six-month periods ended June 30, 2017 and 2016, and the statements of cash flows for the six-month periods ended June 30, 2017 and 2016.  The results of the three-month and six-month periods ended June 30, 2017 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2017 or any future interim period.  The condensed consolidated balance sheet at December 31, 2016 has been derived from the audited financial statements included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (the “SEC”) on April 5, 2016.  The unaudited consolidated financial statements for June 30, 2017 and 2016, the condensed consolidated balance sheet at December 31, 2016, and accompanying notes should be read in conjunction with the Company’s audited consolidated financial statements and the accompanying notes thereto that are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Reclassifications

Certain items in the unaudited consolidated financial statements have been reclassified to conform to the 2017 classification. The reclassifications had no effect on previously reported results of operations or retained earnings.

8

Use of Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ materially from those estimates.

Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses (the “allowance”); the fair value of financial instruments, such as loans, investment securities, and derivatives; measurement and assessment of intangible assets and other purchase accounting related adjustments; benefit plan obligations and expenses; the valuation of deferred tax assets; real estate acquired through foreclosure; and the estimate of expected cash flows for loans acquired with deteriorated credit quality.

Recent Accounting Pronouncements and Developments

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which will supersede the revenue recognition requirements in Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition, and most industry-specific revenue recognition guidance throughout the ASC.  The amendments in this update affect any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets unless those contracts, including leases and insurance contracts, are within the scope of other standards.  The amendments establish a core principle requiring the recognition of revenue to depict the transfer of goods or services to customers in an amount reflecting the consideration to which the entity expects to be entitled in exchange for such goods or services.  The amendments also require expanded disclosures concerning the nature, amount, timing and uncertainty of revenues and cash flows arising from contracts with customers.  In August 2016, the FASB deferred the effective date by one year from the date in the original guidance.  The guidance is effective for fiscal years and interim periods beginning after December 15, 2018.  The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which amended guidance related to recognition and measurement of financial assets and liabilities.  The amended guidance requires that equity investments (excluding those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income.  An entity can elect to measure equity investments that do not have readily determinable fair values at cost less impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer.  The impairment assessment of equity investments without readily determinable fair values is simplified by requiring a qualitative assessment to identify impairment.  When a qualitative assessment indicates impairment exists, an entity is required to measure the investment at fair value.  The guidance eliminates the requirement for public business entities to disclose the method 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.  Further, the guidance requires public entities to use the exit price when measuring the fair value of financial instruments for disclosure purposes.  The guidance also requires an entity to present separately in other comprehensive income, a change in the instrument-specific credit risk when the entity has elected to measure a liability at fair value in accordance with the fair value option.  Separate presentation of financial assets and financial liabilities by measurement category and type of instrument on the balance sheet or accompanying notes to the financial statements is required.  The guidance also clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.  This guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017.  The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements, but does expect a change in the fair value of loans reported in Note 15 – Fair Value.

In February 2016, the FASB issued ASU 2016-02, Leases.  From the lessee’s perspective, the new standard establishes a right-of-use (“ROU”) model that requires a lessee to record an ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  Leases will be classified as either finance or operating,

9

with classification affecting the pattern of expense recognition in the income statement for a lessees.  From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating.  A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee.  If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease.  If the lessor does not convey risks and rewards or control, an operating lease results.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.         A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  The Company is currently evaluating the impact that the adoption of this guidance could have on its consolidated financial statements. 

In June 2016, FASB issued ASU No. 2016-13 Financial Instruments-Credit Losses (Topic 326).  The ASU improves financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by the Company.  The ASU requires the Company to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.  Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses.  The Company will continue to use judgment to determine which loss estimation method is appropriate for their circumstances.  The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements.  Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.  The ASU will take effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.  Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  The Company’s finance team has begun the process of reviewing its procedures and researching additional software resources for measuring credit losses and the effect of the ASU on its consolidated balance sheets and consolidated statements of operations.

In August 2016, FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU addresses the appropriate classification of eight specific cash flow issues on the cash flow statement. Debt prepayment costs should be classified as an outflow for financing activities. Settlement of zero-coupon debt instruments divides the interest portion as an outflow for operating activities and the principal portion as an outflow for financing activities. Contingent consideration payments made after a business combination should be classified as outflows for financing and operating activities. Proceeds from the settlement of bank-owned life insurance policies should be classified as inflows from investing activities. Other specific areas are identified in the ASU as to the appropriate classification of the cash inflows or outflows. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted and must be applied using a retrospective transition method to each period presented. The Company's finance team is in the process of developing an understanding of this pronouncement, evaluating the impact of this pronouncement and researching additional software resources that could assist with the implementation.

In November 2016, FASB issued ASU No. 2016-18, “Statement of Cash Flows – Restricted Cash.” This ASU provides guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows and is effective for the first quarter of 2018. Earlier application is permitted. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment.”  The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. ASU No. 2017-04 is effective for interim and annual reporting periods beginning after December 15, 2019, applied

10

prospectively. Early adoption is permitted for any impairment tests performed after January 1, 2017. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.”   Under the new guidance, employers will present the service cost component of the net periodic benefit cost in the same income statement line item (e.g., Salaries and Benefits) as other employee compensation costs arising from services rendered during the period. In addition, only the service cost component will be eligible for capitalization in assets. Employers will present the other components separately (e.g., Other Noninterest Expense) from the line item that includes the service cost. ASU No. 2017-07 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, however, the Company has decided not to early adopt. Employers will apply the guidance on the presentation of the components of net periodic benefit cost in the income statement retrospectively. The guidance limiting the capitalization of net periodic benefit cost in assets to the service cost component will be applied prospectively. The Company expects to utilize the ASU’s practical expedient allowing entities to estimate amounts for comparative periods using the information previously disclosed in their pension and other postretirement benefit plan footnote. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-08, “Premium Amortization on Purchased Callable Debt Securities.”   This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. Today, entities generally amortize the premium over the contractual life of the security. The new guidance does not change the accounting for purchased callable debt securities held at a discount; the discount continues to be amortized to maturity. ASU No. 2017-08 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently evaluating the provisions of ASU No. 2017-08 to determine the potential impact the new standard will have on the Company’s consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, “Stock Compensation, Scope of Modification Accounting.” This ASU clarifies when changes to the terms of conditions of a share-based payment award must be accounted for as modifications. Companies will apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. The new guidance should reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications, as the guidance will allow companies to make certain non-substantive changes to awards without accounting for them as modifications. It does not change the accounting for modifications. ASU No. 2017-09 is effective for interim and annual reporting periods beginning after December 15, 2017; early adoption is permitted. ASU No. 2017-09 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

NOTE 3 – INVESTMENT SECURITIES

Investment securities are accounted for according to their purpose and holding period.  Trading securities are those that are bought and held principally for the purpose of selling them in the near term.  The Company held no trading securities at June 30, 2017 or December 31, 2016.  Available-for-sale investment securities, comprised of debt and mortgage-backed securities, are those that may be sold before maturity due to changes in the Company's interest rate risk profile or funding needs, and are reported at fair value with unrealized gains and losses, net of taxes, reported as a component of other comprehensive income.  Held-to-maturity investment securities, comprised of debt and mortgage-backed securities, are those that management has the positive intent and ability to hold to maturity and are reported at amortized cost.

Realized gains and losses are recorded in noninterest income and are determined on a trade date basis using the specific identification method.  Interest and dividends on investment securities are recognized in interest income on an accrual basis.  Premiums and discounts are amortized or accreted into interest income using the interest method over the expected lives of the individual securities.

11

The following table summarizes the amortized cost and estimated fair value of the Company’s investment securities portfolio at June 30, 2017 and December 31, 2016:

Available for Sale	Amortized		Gross Unrealized				Estimated
June 30, 2017	cost		Gains		Losses		Fair Value
U.S. government agency	$	6,762,189	$	74,221	$	(6,135)	$	6,830,275
U.S. treasury securities		8,742,735		37,955		(56,780)		8,723,910
Residential mortgage-backed securities		35,425,931		269,650		(257,238)		35,438,343
State and municipal		2,602,221		6,333		(586)		2,607,968
Corporate bonds		8,752,503		76,132		(4,320)		8,824,315
Total debt securities		62,285,579		464,291		(325,059)		62,424,811
Equity securities		78,752		—		(41,472)		37,280
Totals	$	62,364,331	$	464,291	$	(366,531)	$	62,462,091
Held-to-Maturity	Amortized		Gross Unrealized				Estimated
June 30, 2017	cost		Gains		Losses		Fair Value
Residential mortgage-backed securities		1,116,070				(5,635)		1,110,435
Total debt securities		1,116,070		—		(5,635)		1,110,435
Totals	$	1,116,070	$	—	$	(5,635)	$	1,110,435
Available for Sale	Amortized		Gross Unrealized				Estimated
December 31, 2016	cost		Gains		Losses		Fair Value
U.S. government agency	$	7,748,481	$	68,493	$	(43,856)	$	7,773,118
U.S. treasury securities		8,728,284		14,812		(119,837)		8,623,259
Residential mortgage-backed securities		30,952,601		197,495		(336,615)		30,813,481
State and municipal		2,638,214		2,421		(3,355)		2,637,280
Corporate bonds		10,372,549		1,647		(45,741)		10,328,455
Total debt securities		60,440,129		284,868		(549,404)		60,175,593
Equity securities		92,585		6,021		(41,472)		57,134
Totals	$	60,532,714	$	290,889	$	(590,876)	$	60,232,727
Held-to-Maturity	Amortized		Gross Unrealized				Estimated
December 31, 2016	cost		Gains		Losses		Fair Value
Residential mortgage-backed securities	$	1,158,238	$	—	$	(8,896)	$	1,149,342
Total debt securities		1,158,238		—		(8,896)		1,149,342
Totals	$	1,158,238	$	—	$	(8,896)	$	1,149,342

12

The following table provides information about securities with unrealized losses segregated by length of impairment at June 30, 2017:

	Less than 12 months				12 months or longer				Total
Available for Sale	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
June 30, 2017	Value		Losses		Value		Losses		Value		Losses
U.S. government agency	$	2,170,163	$	(6,135)	$	—	$	—	$	2,170,163	$	(6,135)
U.S. treasury securities		2,806,530		(56,780)		—		—		2,806,530		(56,780)
Residential mortgage-backed securities		15,949,453		(233,207)		508,676		(24,031)		16,458,129		(257,238)
State and municipals		324,984		(586)		—		—		324,984		(586)
Corporate bonds		5,498,310		(4,320)		—		—		5,498,310		(4,320)
Total debt securities		26,749,440		(301,028)		508,676		(24,031)		27,258,116		(325,059)
Equity securities		—		—		25,180		(41,472)		25,180		(41,472)
Totals	$	26,749,440	$	(301,028)	$	533,856	$	(65,503)	$	27,283,296	$	(366,531)
	Less than 12 months				12 months or longer				Total
Held-to-Maturity	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
June 30, 2017	Value		Losses		Value		Losses		Value		Losses
Residential mortgage-backed securities		1,110,435		(5,635)		—		—		1,110,435		(5,635)
Total debt securities	$	1,110,435	$	(5,635)	$	—	$	—	$	1,110,435	$	(5,635)

The following table provides information about securities with unrealized losses segregated by length of impairment at December 31, 2016:

	Less than 12 months				12 months or longer				Total
Available for Sale	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2016	Value		Losses		Value		Losses		Value		Losses
U.S. government agency	$	3,983,930	$	(43,856)	$	—	$	—	$	3,983,930	$	(43,856)
U.S. treasury securities		5,645,640		(119,837)		—		—		5,645,640		(119,837)
Residential mortgage-backed securities		17,368,416		(315,284)		563,545		(21,331)		17,931,961		(336,615)
State and municipals		1,042,964		(3,355)		—		—		1,042,964		(3,355)
Corporate bonds		7,973,405		(45,741)		—		—		7,973,405		(45,741)
Total debt securities		36,014,355		(528,073)		563,545		(21,331)		36,577,900		(549,404)
Equity securities		—		—		25,180		(41,472)		25,180		(41,472)
Totals	$	36,014,355	$	(528,073)	$	588,725	$	(62,803)	$	36,603,080	$	(590,876)
	Less than 12 months				12 months or longer				Total
Held-to-Maturity	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2016	Value		Losses		Value		Losses		Value		Losses
Residential mortgage-backed securities		1,149,342		(8,896)		—		—		1,149,342		(8,896)
Total debt securities	$	1,149,342	$	(8,896)	$	—	$	—	$	1,149,342	$	(8,896)

At June 30, 2017, the Company recorded unrealized losses in its portfolio of debt securities totaling $325,059 related to 68 securities, which resulted from increases in market interest rates, spread volatility, and other factors that management deems to be temporary.  Since management believes that it is more likely than not that the Company will

13

not be required to sell these securities prior to maturity or a full recovery of the amortized cost, the Company does not consider these securities to be other-than-temporarily impaired.

At June 30, 2017, the Company recorded unrealized losses in its portfolio of equity securities totaling $41,472, related to one security, which management considers to be temporary.  Since management believes that it is more likely than not that the Company will not be required to sell this equity position for a reasonable period of time sufficient for recovery of fair value, the Company does not consider this equity security to be other-than-temporarily impaired.

At December 31, 2016, the Company recorded unrealized losses in its portfolio of debt securities totaling $549,404, related to 73 securities, which were caused by increases in market interest rates, spread volatility and other factors that management deems to be temporary.  Since management believes that it is more likely than not that the Company will not be required to sell these securities prior to maturity or a full recovery of the amortized cost, the Company does not consider these securities to be other-than-temporarily impaired.

At December 31, 2016, the Company recorded unrealized losses in its portfolio of equity securities totaling $41,472, related to one security, which management considers to be temporary.  Since management believes that it is more likely than not that the Company will not be required to sell these equity positions for a reasonable period of time sufficient for recovery of fair value, the Company does not consider these equity securities to be other-than-temporarily impaired.

At June 30, 2017, except for the U.S. Treasury, the outstanding balance of no single issuer exceeded 10% of stockholders’ equity.  At December 31, 2016, the outstanding balance of no single issuer exceeded 10% of stockholders’ equity.

No investment securities held by the Company at June 30, 2017 or December 31, 2016 were subject to a write-down due to credit related other-than-temporary impairment.

Contractual maturities of debt securities at June 30, 2017 and at December 31, 2016 are shown below.  Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

	2017				2016
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Available for sale
Within one year	$	7,279,754	$	7,273,105	$	6,122,743	$	6,100,576
Over one to five years		8,766,063		8,906,031		12,570,847		12,642,656
Over five to ten years		7,776,206		7,758,410		7,765,282		7,627,060
Over ten years		3,037,626		3,048,923		3,028,656		2,991,820
Residential mortgage-backed securities		35,425,930		35,438,342		30,952,601		30,813,481
Totals	$	62,285,579	$	62,424,811	$	60,440,129	$	60,175,593
	2017				2016
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Held to maturity
Over ten years		1,116,070		1,110,435		1,158,238		1,149,342
Totals	$	1,116,070	$	1,110,435	$	1,158,238	$	1,149,342

The Company’s residential mortgage-backed securities portfolio is presented as a separate line within the maturity table, since borrowers have the right to prepay obligations without prepayment penalties.

14

For the six-month period ended June 30, 2017, there were three redemptions of investment securities available for sale resulting in no gains or losses. For the six-month period ended June 30, 2016, there were 11 sales and other redemptions of investment securities available for sale resulting in net gains of $486,534.    

For the six-month period ended June 30, 2017, there was one sale of equity securities resulting in a net gain of $5,521. For the six-month period ended June 30, 2016, there was no activity of equity securities resulting in gains or losses.

At June 30, 2017, securities with an amortized cost of $40,831,982 (fair value of $40,971,361) were pledged as collateral for potential borrowings from the Federal Home Loan Bank of Atlanta (the “FHLB”) and the Federal Reserve Bank of Richmond (the “Reserve Bank”).  At December 31, 2016, securities with an amortized cost of $10,479,133 (fair value of $10,604,335) were pledged as collateral for potential borrowings from the FHLB and the Reserve Bank.

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES

The fundamental lending business of the Company is based on understanding, measuring, and controlling the credit risk inherent in the loan portfolio.  The Company's loan portfolio is subject to varying degrees of credit risk.  These risks entail both general risks, which are inherent in the lending process, and risks specific to individual borrowers.  The Company's credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry or collateral type.  The loan portfolio segment balances are presented in the following table:

	June 30,		December 31,
	2017		2016
Commercial & Industrial	$	69,901,427	$	67,234,642
Commercial Real Estate		226,287,060		205,495,337
Residential Real Estate		148,333,597		153,368,115
Home Equity Line of Credit		34,052,780		33,256,012
Land		4,187,897		5,870,999
Construction		24,915,461		19,804,912
Consumer & Other		1,917,377		2,073,696
Total Loans		509,595,599		487,103,713
Less: Allowance for Loan Losses		(3,608,484)		(2,823,153)
Net Loans	$	505,987,115	$	484,280,560

At June 30, 2017 and December 31, 2016, loans not considered to have deteriorated credit quality at acquisition had a total remaining unamortized discount of $3,395,116 and $3,793,033, respectively, and carrying values of $162,758,426 and $187,483,532, respectively.

Portfolio Segments:

The Company currently manages its credit products and the respective exposure to loan losses by the following specific portfolio segments, which are levels at which the Company develops and documents its systematic methodology to determine the allowance for loan losses.  The Company considers each loan type to be a portfolio segment having unique risk characteristics.

Commercial & Industrial

Commercial & Industrial (“C&I”) loans are made to provide funds for equipment and general corporate needs.  Repayment of these loans depends primarily on the funds generated from the operation of the borrower's business.  C&I loans also include lines of credit that are utilized to finance a borrower's short-term credit needs and/or to finance a percentage of eligible receivables or inventory.  Of primary concern in C&I lending is the borrower's creditworthiness and ability to successfully generate sufficient cash flow from its business to service the debt.

15

Commercial Real Estate

Commercial Real Estate loans are bifurcated into Investor and Owner Occupied types (classes).  Commercial Real Estate - Investor loans consist of loans secured by non-owner occupied properties and involve investment properties for warehouse, retail, apartment, and office space with a history of occupancy and cash flow.  This commercial real estate class includes mortgage loans to the developers and owners of commercial real estate where the borrower intends to operate or sell the property at a profit and use the income stream or proceeds from the sale(s) to repay the loan.  Commercial Real Estate - Owner Occupied loans consist of commercial mortgage loans secured by owner occupied properties and involves a variety of property types to conduct the borrower's operations.  The primary source of repayment for this type of loan is the cash flow from the business and is based upon the borrower's financial health and the ability of the borrower and the business to repay.  At June 30, 2017 and December 31, 2016, Commercial Real Estate – Investor loans had a total balance of $148,236,433 and $138,527,163, respectively.  At June 30, 2017 and December 31, 2016, Commercial Real Estate – Owner Occupied loans had a total balance of $78,050,627 and $66,968,174, respectively.

Residential Real Estate

Residential Real Estate loans are bifurcated into Investor and Owner Occupied types (classes).  Residential Real Estate -Investor loans consist of loans secured by non-owner occupied residential properties and usually carry higher credit risk than Residential Real Estate – Owner Occupied loans due to their reliance on stable rental income and due to a lower incentive for the borrower to avoid foreclosure.  Payments on loans secured by rental properties often depend on the successful operation and management of the properties and the payment of rent by tenants.  At June 30, 2017 and December 31, 2016, Residential Real Estate – Investor loans had a total balance of $41,627,020 and $44,787,040, respectively.  At June 30, 2017 and December 31, 2016, Residential Real Estate – Owner Occupied loans had a total balance of $106,706,576 and $108,581,075, respectively.

Home Equity Line of Credit

Home Equity Lines of Credit (“HELOCs”) are a form of revolving credit in which a borrower's primary residence serves as collateral.  Borrowers use HELOCs primarily for education, home improvements, and other significant personal expenditures.  The borrower will be approved for a specific credit limit set at a percentage of the home's appraised value less the balance owed on the existing first mortgage.  Major risks in HELOC lending include the borrower's ability to service the existing first mortgage plus the HELOC, the Company's ability to pursue collection in a second lien position upon default, and overall risks in fluctuation in the value of the underlying collateral property.

Land

Land loans are secured by underlying properties that usually consist of tracts of undeveloped land that do not produce income.  These loans carry the risk that there will be inadequate demand to ensure the sale of the property within an acceptable time.  As a result, land loans carry the risk that the builder will have to pay the property taxes and other carrying costs of the property until a buyer is identified.

Construction

Construction loans, which include land development loans, are generally considered to involve a higher degree of credit risk than long-term financing on improved, occupied real estate.  Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property's value at completion of construction and estimated costs of construction, as well as the property’s ability to attract and retain tenants.  Loan funds are disbursed periodically as pre-specified stages of completion are attained based upon site inspections.  If the Company is forced to foreclose on a building before or at completion due to a default, it may be unable to recover all of the unpaid balance of and accrued interest on the loan as well as related foreclosure and holding costs.

16

Consumer & Other

Consumer & Other loans include installment loans, personal lines of credit, and automobile loans.  Payment on these loans often depends on the borrower's creditworthiness and ability to generate sufficient cash flow to service the debt.

Allowance for Loan Losses

To control and monitor credit risk, management has an internal credit process in place to determine whether credit standards are maintained along with in-house loan administration accompanied by oversight and review procedures.  The primary purpose of loan underwriting is the evaluation of specific lending risks that involves the analysis of the borrower's ability to service the debt as well as the assessment of the underlying collateral.  Oversight and review procedures include the monitoring of the portfolio credit quality, early identification of potential problem credits and the management of the problem credits.  As part of the oversight and review process, the Company maintains an allowance for loan losses to absorb estimated and probable losses inherent in the loan portfolio. 

For purposes of calculating the allowance, the Company segregates its loan portfolio into segments based primarily on the type of supporting collateral.  The Commercial Real Estate and Residential Real Estate segments, which both exclude any collateral property currently under construction, are further segregated into Owner Occupied and Investor classes for each.  Further, all segments are also segregated as either purchased credit impaired (“PCI”) loans, purchased loans not deemed impaired, troubled debt restructurings (“TDR”s), or new originations.

The analysis for determining the allowance is consistent with guidance set forth in U.S. GAAP and the Interagency Policy Statement on the Allowance for Loan and Lease Losses.  Pursuant to Bank policy, the allowance is evaluated quarterly by management and is based upon management's review of the collectability of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers' ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  The allowance consists of specific and general reserves.  The specific reserves relate to loans classified as impaired consisting primarily of nonaccrual loans, TDR and PCI loans where cash flows have deteriorated from those forecasted as of the acquisition date.  The reserve for these loans is established when the discounted cash flows, collateral value, or observable market price, whichever is appropriate, of the impaired loan is lower than the carrying value.  For impaired loans, any measured impairment is charged-off against the loan and allowance for those loans that are collateral dependent in the applicable reporting period.

The general reserve covers loans that are not classified as impaired and primarily includes purchased loans not deemed impaired and new loan originations.  The general reserve requirement is based on historical loss experience and several qualitative factors derived from economic and market conditions that have been determined to have an effect on the probability and magnitude of a loss.  Since the Bank does not have sufficient historical loss experience, management also references the historical net charge-off experience of peer groups to determine a reasonable range of reserve values, which is permissible per Bank policy.  The peer groups consist of competing Maryland-based financial institutions with established ranges in total asset size.  Management will continue to evaluate the appropriateness of the peer group data used with each quarterly allowance analysis until such time that the Bank has sufficient loss experience to provide a foundation for the general reserve requirement.  The qualitative analysis incorporates global environmental factors in the following trends:  national and local economic metrics; portfolio risk ratings and composition; and concentrations in credit.

The following tables provides information on the activity in the allowance for loan losses by the respective loan portfolio segment for the three- and six-month periods ended June 30, 2017:

Three Months:	Commercial		Commercial		Residential		Home Equity						Consumer
	& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	414,045	$	1,293,859	$	1,088,063	$	199,678	$	21,357	$	130,701	$	12,066	$	3,159,769
Charge-offs		—		—		(97,505)		—		—		(15,593)		—		(113,098)
Recoveries		75		—		39,415		—		—		—		—		39,490
Provision		49,672		145,562		260,185		24,830		(9,169)		50,408		835		522,323
Ending balance	$	463,792	$	1,439,421	$	1,290,158	$	224,508	$	12,188	$	165,516	$	12,901	$	3,608,484

17

Six Months:	Commercial		Commercial		Residential		Home Equity						Consumer
	& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	369,857	$	1,082,855	$	1,043,778	$	184,296	$	19,159	$	111,503	$	11,705	$	2,823,153
Charge-offs		—		—		(225,940)		—		—		(15,593)		—		(241,533)
Recoveries		188		—		63,732		—		—		—		100		64,020
Provision		93,747		356,566		408,588		40,212		(6,971)		69,606		1,096		962,844
Ending balance	$	463,792	$	1,439,421	$	1,290,158	$	224,508	$	12,188	$	165,516	$	12,901	$	3,608,484

The following table presents loans and the related allowance for loan losses, by respective loan portfolio segment at June 30, 2017:

	Commercial		Commercial		Residential		Home Equity						Consumer
	& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Ending balance:
individually
evaluated for
impairment	$	—	$	—	$	392,120	$	—	$	—	$	—	$	—	$	392,120
Ending balance:
collectively
evaluated
for impairment		463,792		1,439,421		898,038		224,508		12,188		165,516		12,901		3,216,364
Totals	$	463,792	$	1,439,421	$	1,290,158	$	224,508	$	12,188	$	165,516	$	12,901	$	3,608,484
Loans:
Ending balance:
individually
evaluated for
impairment	$	501,474	$	—	$	4,969,305	$	57,624	$	—	$	—	$	5,798	$	5,534,201
Ending balance:
collectively
evaluated
for impairment		68,720,673		213,280,908		133,063,505		33,265,591		1,805,895		24,524,693		1,911,579		476,572,844
Ending balance: loans
acquired with
deteriorated credit
quality(1)		679,280		13,006,152		10,300,787		729,565		2,382,002		390,768		—		27,488,554
Totals	$	69,901,427	$	226,287,060	$	148,333,597	$	34,052,780	$	4,187,897	$	24,915,461	$	1,917,377	$	509,595,599

(1) Includes one loan acquired with deteriorated credit quality of $6,859  that have current period charge offs.

The following tables provides information on the activity in the allowance for loan losses by the respective loan portfolio segment for the three- and six-month periods ended June 30, 2016:

18

Three Months:	Commercial		Commercial		Residential		Home Equity						Consumer
	& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	220,569	$	792,847	$	693,085	$	164,313	$	16,016	$	56,360	$	5,346	$	1,948,536
Charge-offs		—		—		(54,604)		—		—		—		—		(54,604)
Recoveries		—		—		41,485		—		—		—		—		41,485
Provision		63,437		147,041		120,943		10,691		1,451		12,821		1,149		357,533
Ending balance	$	284,006	$	939,888	$	800,909	$	175,004	$	17,467	$	69,181	$	6,495	$	2,292,950

Six Months:	Commercial		Commercial		Residential		Home Equity						Consumer
	& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	210,798	$	727,869	$	593,084	$	157,043	$	15,713	$	62,967	$	5,535	$	1,773,009
Charge-offs		—		—		(174,414)		(2,183)		—		—		(480)		(177,077)
Recoveries		—		—		41,485		—		—		—		—		41,485
Provision		73,208		212,019		340,754		20,144		1,754		6,214		1,440		655,533
Ending balance	$	284,006	$	939,888	$	800,909	$	175,004	$	17,467	$	69,181	$	6,495	$	2,292,950

19

The following table presents loans and the related allowance for loan losses, by respective loan portfolio segment at December 31, 2016:

	Commercial		Commercial		Residential		Home Equity						Consumer
	& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Ending balance:
individually
evaluated for
impairment	$	—	$	—	$	270,526	$	—	$	—	$	—	$	—	$	270,526
Ending balance:
collectively
evaluated
for impairment		369,857		1,082,855		773,252		184,296		19,159		111,503		11,705		2,552,627
Totals	$	369,857	$	1,082,855	$	1,043,778	$	184,296	$	19,159	$	111,503	$	11,705	$	2,823,153
Loans:
Ending balance:
individually
evaluated for
impairment	$	641,774	$	277,515	$	4,521,110	$	55,552	$	—	$	—	$	5,798	$	5,501,749
Ending balance:
collectively
evaluated
for impairment		65,341,316		191,303,934		136,607,497		32,558,837		3,384,741		19,698,823		2,067,898		450,963,046
Ending balance: loans
acquired with
deteriorated credit
quality(1)		1,251,552		13,913,888		12,239,508		641,623		2,486,258		106,089		—		30,638,918
Totals	$	67,234,642	$	205,495,337	$	153,368,115	$	33,256,012	$	5,870,999	$	19,804,912	$	2,073,696	$	487,103,713

(1) Includes loans acquired with deteriorated credit quality of $104,460 that have current period charge-offs.

20

The following table presents information with respect to impaired loans, which includes loans acquired with deteriorated credit quality that have current period charge-offs, at June 30, 2017 and for the three- and six-month periods ended June 30, 2017:

							For the three months ended				For the Six Months Ended
	At June 30, 2017						June 30, 2017				June 30, 2017
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Commercial & Industrial	$	501,474	$	588,656	$	—	$	567,298	$	9,720	$	588,963	$	31,027
Commercial Real Estate - Owner occupied		—		—		—		—		—		—		—
Commercial Real Estate - Investor		—		—		—		—		—		—		—
Residential Real Estate - Investor		761,048		852,663		—		827,594		787		882,220		12,909
Residential Real Estate - Owner occupied		3,221,832		3,420,867		—		3,435,168		29,259		3,475,250		98,238
Home Equity Line of Credit		57,624		87,331		—		73,771		(3)		74,454		(11)
Consumer & Other		5,798		189,204		—		97,501		—		97,501		—
With an allowance recorded:
Residential Real Estate - Investor		592,598		627,785		219,366		617,502		1,992		626,619		3,980
Residential Real Estate - Owner occupied		587,589		563,226		172,754		582,540		—		582,540		(264)
Total		5,727,963		6,329,732		392,120		6,201,374		41,755		6,327,547		145,879
Total impaired loans:
Commercial & Industrial	$	501,474	$	588,656	$	—	$	567,298	$	9,720	$	588,963	$	31,027
Commercial Real Estate		—		—		—		—		—		—		—
Residential Real Estate		5,163,067		5,464,541		392,120		5,462,804		32,038		5,566,629		114,863
Home Equity Line of Credit		57,624		87,331		—		73,771		(3)		74,454		(11)
Consumer & Other		5,798		189,204		—		97,501		—		97,501		—
Total	$	5,727,963	$	6,329,732	$	392,120	$	6,201,374	$	41,755	$	6,327,547	$	145,879

21

The following table presents information with respect to impaired loans, which includes loans acquired with deteriorated credit quality that have current period charge-offs, at December 31, 2016 and for the year ended December 31, 2016:

							For the year ended				For the Six Months Ended
	At December 31, 2016						December 31, 2016				June 30, 2016
			Unpaid		Average		Average				Average
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Commercial & Industrial	$	641,774	$	739,128	$	—	$	804,938	$	79,886	$	855,500	$	52,267
Commercial Real Estate - Investor		277,515		277,515		—		294,053		—		352,315		1,048
Residential Real Estate - Investor		785,500		890,719		—		994,674		11,748		1,149,681		35,973
Residential Real Estate - Owner occupied		3,008,832		3,196,027		—		3,225,912		103,916		2,331,172		70,245
Home Equity Line of Credit		55,552		85,470		—		73,026		(68)		112,616		(69)
Construction		—		—		—		—		—		71,459		—
Consumer & Other		5,798		189,204		—		97,501		—		189,204		—
With an allowance recorded:
Residential Real Estate - Investor		790,537		813,087		268,537		832,508		5,920		523,195		3,004
Residential Real Estate - Owner occupied		159,028		159,028		1,989		160,102		—		—		—
Total		5,724,536		6,350,178		270,526		6,482,714		201,402		5,585,142		162,468
Total impaired loans:
Commercial & Industrial	$	641,774	$	739,128	$	—	$	804,938	$	79,886	$	855,500	$	52,267
Commercial Real Estate		277,515		277,515		—		294,053		—		352,315		1,048
Residential Real Estate		4,743,897		5,058,861		270,526		5,213,196		121,584		4,004,048		109,222
Home Equity Line of Credit		55,552		85,470		—		73,026		(68)		112,616		(69)
Construction		—		—		—		—		—		71,459		—
Consumer & Other		5,798		189,204		—		97,501		—		189,204		—
Total	$	5,724,536	$	6,350,178	$	270,526	$	6,482,714	$	201,402	$	5,585,142	$	162,468

In addition to monitoring the performance status of the loan portfolio, the Company utilizes a risk rating scale (1-8) to evaluate loan asset quality for all loans.  Loans that are rated 1-4 are classified as pass credits.  Loans rated a 5 (Watch) are pass credits, but are loans that have been identified as warranting additional attention and monitoring.  Loans that are risk rated 5 or higher are placed on the Company's monthly watch list.  For the pass rated loans, management believes there is a low risk of loss related to these loans and, as necessary, credit may be strengthened through improved borrower performance and/or additional collateral.  Loans rated a 6 (Special Mention) or higher are considered criticized loans and represent an increased level of credit risk and are placed into these three categories: 

6 (Special Mention) - Borrowers exhibit potential credit weaknesses or downward trends that may weaken the credit position, if uncorrected.  The borrowers are considered marginally acceptable without potential for loss of principal or interest.

7 (Substandard) - Borrowers have well defined weaknesses or characteristics that present the possibility that the Company will sustain some loss if the deficiencies are not corrected.

8 (Doubtful) - Borrowers classified as doubtful have the same weaknesses found in substandard borrowers; however, these weaknesses indicate that the collection of debt in full (principal and interest), based on current conditions, is highly questionable and improbable.

22

In the normal course of loan portfolio management, relationship managers are responsible for continuous assessment of credit risk arising from the individual borrowers within their portfolio and assigning appropriate risk ratings.  Credit Administration is responsible for ensuring the integrity and operation of the risk rating system and maintenance of the watch list.  The Officer's Loan Committee meets monthly to discuss and monitor problem credits and internal risk rating downgrades that result in updates to the watch list.

The following table provides information with respect to the Company's credit quality indicators by class of the loan portfolio at June 30, 2017:

	Risk Rating
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial & Industrial	$	67,057,433	$	1,493,143	$	1,350,851	$	—	$	69,901,427
Commercial Real Estate - Investor		145,303,898		146,832		2,785,703		—		148,236,433
Commercial Real Estate - Owner Occupied		75,859,111		1,072,201		1,119,315		—		78,050,627
Residential Real Estate - Investor		35,503,640		232,778		5,890,603		—		41,627,021
Residential Real Estate - Owner Occupied		101,067,852		—		5,638,724		—		106,706,576
Home Equity Line of Credit		33,761,495		—		291,285		—		34,052,780
Land		1,915,511		—		2,272,386		—		4,187,897
Construction		24,524,693		—		390,768		—		24,915,461
Consumer & Other		1,911,579		—		5,798		—		1,917,377
Total	$	486,905,212	$	2,944,954	$	19,745,433	$	—	$	509,595,599

The following table provides information with respect to the Company's credit quality indicators by class of the loan portfolio at December 31, 2016:

	Risk Rating
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial & Industrial	$	63,961,379	$	688,595	$	2,584,668	$	—	$	67,234,642
Commercial Real Estate - Investor		134,601,346		2,958,695		967,122		—		138,527,163
Commercial Real Estate - Owner Occupied		64,761,020		1,126,705		1,080,449		—		66,968,174
Residential Real Estate - Investor		36,905,288		240,700		7,641,052		—		44,787,040
Residential Real Estate - Owner Occupied		102,367,880		—		6,213,195		—		108,581,075
Home Equity Line of Credit		32,969,668		—		286,344		—		33,256,012
Land		3,513,607		—		2,357,392		—		5,870,999
Construction		19,698,823		—		106,089		—		19,804,912
Consumer & Other		2,067,898		—		5,798		—		2,073,696
Total	$	460,846,909	$	5,014,695	$	21,242,109	$	—	$	487,103,713

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a payment is past due.

23

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans at June 30, 2017.  PCI loans are excluded from this aging and nonaccrual loans schedule.

	Accrual Loans
	30-59		60-89		90 or More
	Days		Days		Days		Total				Nonaccrual		Total
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Loans
Commercial & Industrial	$	—	$	59,129	$	—	$	59,129	$	68,905,297	$	257,721	$	69,222,147
Commercial Real Estate - Investor		—		—		—		—		140,504,962		—		140,504,962
Commercial Real Estate - Owner Occupied		—		—		—		—		72,775,947		—		72,775,947
Residential Real Estate - Investor		—		—		—		—		33,038,530		1,114,322		34,152,852
Residential Real Estate - Owner Occupied		27,934		451,120		—		479,054		99,740,351		3,660,552		103,879,957
Home Equity Line of Credit		—		253,439		—		253,439		33,012,152		57,624		33,323,215
Land		—		—		—		—		1,805,895		—		1,805,895
Construction		—		—		—		—		24,524,693		—		24,524,693
Consumer & Other		2,817		16,678		—		19,495		1,892,084		5,798		1,917,377
Total	$	30,751	$	780,366	$	—	$	811,117	$	476,199,911	$	5,096,017	$	482,107,045
Purchased credit impaired loans														27,488,554
Total Loans													$	509,595,599

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans at December 31, 2016.  PCI loans are excluded from this aging and nonaccrual loans schedule.

	Accrual Loans
	30-59		60-89		90 or More
	Days		Days		Days		Total				Nonaccrual		Total
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Loans
Commercial & Industrial	$	17,737	$	—	$	—	$	17,737	$	65,582,550	$	382,802	$	65,983,089
Commercial Real Estate - Investor		—		—		—		—		129,751,253		277,515		130,028,768
Commercial Real Estate - Owner Occupied		139,670		149,119		—		288,789		61,263,891		—		61,552,680
Residential Real Estate - Investor		702,856		—		—		702,856		34,114,611		1,260,961		36,078,428
Residential Real Estate - Owner Occupied		2,933,983		373,168		—		3,307,151		98,724,320		3,018,710		105,050,181
Home Equity Line of Credit		136,387		—		—		136,387		32,422,450		55,552		32,614,389
Land		—		—		—		—		3,384,741		—		3,384,741
Construction		173,105		—		—		173,105		19,525,718		—		19,698,823
Consumer & Other		—		—		—		—		2,067,898		5,798		2,073,696
Total	$	4,103,738	$	522,287	$	—	$	4,626,025	$	446,837,432	$	5,001,338	$	456,464,795
Purchased credit impaired loans														30,638,918
Total Loans													$	487,103,713

Troubled Debt Restructurings

The restructuring of a loan constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider in the normal course of business.  A concession may include an extension of repayment terms which would not normally be granted, a reduction of interest rate or the forgiveness of principal and/or accrued interest.  If the debtor is experiencing financial difficulty and the creditor has granted a concession, the Company will make the necessary disclosures related to the TDR.  In certain cases, a modification may be made in an effort to retain a customer who is not experiencing financial difficulty.  This type of modification is not considered to be a TDR.  Once a loan has been modified and is considered a TDR, it is reported as an impaired loan.  All TDRs are evaluated individually for impairment on a quarterly basis as part of the allowance for credit losses calculation.  A specific allowance for TDR loans is established when the discounted cash flows, collateral value or observable market price, whichever is appropriate, of the TDR is lower than the carrying value.  If a loan deemed a TDR has performed for at least six months at the level prescribed by the modification, it is not

24

considered to be non-performing; however, it will generally continue to be reported as impaired, but may be returned to accrual status.  A TDR is deemed in default on its modified terms once a contractual payment is 30 or more days past due.

The following tables present a breakdown of loans that the Company modified during the three- and six-month periods ended June 30, 2017 and 2016:

	Three Months Ended June 30, 2017					Three Months Ended June 30, 2016
		Pre-Modification		Post-Modification			Pre-Modification		Post-Modification
		Outstanding		Outstanding			Outstanding		Outstanding
	Number of	Recorded		Recorded		Number of	Recorded		Recorded
	Contracts	Investment		Investment		Contracts	Investment		Investment
Troubled Debt Restructurings:
Residential Real Estate - Owner Occupied	2	$	199,962	$	199,962	—	$	—	$	—
Totals	2	$	199,962	$	199,962	—	$	—	$	—

	Six Months Ended June 30, 2017					Six Months Ended June 30, 2016
		Pre-Modification		Post-Modification			Pre-Modification		Post-Modification
		Outstanding		Outstanding			Outstanding		Outstanding
	Number of	Recorded		Recorded		Number of	Recorded		Recorded
	Contracts	Investment		Investment		Contracts	Investment		Investment
Troubled Debt Restructurings:
Residential Real Estate - Investor	—	$	—	$	—	1	$	38,785	$	38,785
Residential Real Estate - Owner Occupied	2		199,962		199,962	—		—		—
Totals	2	$	199,962	$	199,962	1	$	38,785	$	38,785

For the three- and six-month periods ended June 30, 2017, there were two loans modified as a TDR. For the three- and six-month periods ended June 30, 2016, there were none and two loans modified, respectively, as a TDR.

None of the loans modified as a TDR during the previous 12 months were in default of their modified terms at the quarter ended June 30, 2017. 

At June 30, 2017 and December 31, 2016, the Bank had $1,866,688 and $1,824,206, respectively, in loans identified as TDRs of which $1,428,504 and $1,323,795, respectively, were on nonaccrual status.    

NOTE 5 – ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A TRANSFER

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired.  Evidence of credit quality deterioration as of the purchase date may include information such as past due and nonaccrual status, borrower credit scores and recent loan to value percentages.  Purchased credit-impaired loans are initially measured at fair value, which considers estimated future loan losses expected to be incurred over the life of the loan.  Accordingly, an allowance for loan losses related to these loans was not carried over and recorded at the acquisition date.  The Company monitors actual loan cash flows to determine any improvement or deterioration from those forecasted as of the acquisition date.

The following table reflects the carrying amount of purchased credit-impaired loans, which are included in the loan categories in Note 4 – Loans and Allowances for Loan Losses:

	June 30, 2017		December 31, 2016
Commercial & Industrial	$	679,280	$	1,251,552
Commercial Real Estate		13,006,152		13,913,888
Residential Real Estate		10,300,787		12,239,507
Home Equity Line of Credit		729,565		641,623
Land		2,382,002		2,486,259
Construction		390,768		106,089
Total Loans	$	27,488,554	$	30,638,918

25

The contractual amount outstanding for these loans totaled $30,784,392 and $34,915,206 at June 30, 2017 and December 31, 2016, respectively.

The following table reflects activity in the accretable discount for loans purchased with evidence of credit deterioration since origination for the three- and six-month periods ended June 30, 2017 and 2016:

	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
Balance at beginning of period	$	1,231,423	$	191,508	$	1,315,318	$	275,730
Reclassification from nonaccretable difference		454,599		366,662		638,521		491,969
Accretion into interest income		(475,378)		(275,651)		(711,901)		(485,180)
Disposals		(173,642)		(88,686)		(204,936)		(88,686)
Balance at end of period	$	1,037,002	$	193,833	$	1,037,002	$	193,833

The following table reflects activity in the allowance for loan losses for loans purchased with evidence of credit deterioration since origination for the three- and six-month periods ended June 30, 2017 and 2016:

	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
Balance at beginning of period	$	73,062	$	34,492	$	77,175	$	—
Charge-offs		(17,231)		18,507		(20,388)		(14,675)
Recoveries		32,736		—		54,161		—
Provision for loan losses		11,525		(18,507)		(10,856)		49,167
Balance at end of period	$	100,092	$	34,492	$	100,092	$	34,492

NOTE 6 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE

The following table reflects activity in real estate acquired through foreclosure for the three- and six-month periods ended June 30, 2017 and 2016.

	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
Balance at beginning of period	$	564,678	$	1,501,896	$	1,224,939	$	1,459,732
New transfers from loans		600,517		181,276		659,876		266,776
Sales		—		(152,551)		(656,895)		(152,551)
Write-downs		(17,649)		(63,517)		(80,374)		(106,853)
Balance at end of period	$	1,147,546	$	1,467,104	$	1,147,546	$	1,467,104

26

NOTE 7 – CORE DEPOSIT INTANGIBLE ASSETS 

The Company's core deposit intangible assets at June 30, 2017 had a remaining weighted average amortization period of approximately 6.1 years.  The following table presents the changes in the net book value of core deposit intangible assets for the six-month periods ended June 30, 2017 and 2016:

	Six Months Ended June 30,
	2017		2016
Balance at beginning of period	$	3,030,309	$	2,624,184
Amortization expense		(433,342)		(348,132)
Balance, at end of period	$	2,596,967	$	2,276,052

The following table presents the gross carrying amount, accumulated amortization, and net carrying amount of core deposit intangible assets at June 30, 2017 and December 31, 2016:

	June 30, 2017		December 31, 2016
Gross carrying amount	$	6,775,211	$	6,775,211
Accumulated amortization		(4,178,244)		(3,744,902)
Net carrying amount	$	2,596,967	$	3,030,309

The following table sets forth the future amortization expense for the Company’s core deposit intangible assets at June 30, 2017:

Six months ending December 31:	Amount
2017	$	355,841
Twelve months ending December 31:
2018		616,111
2019		540,682
2020		488,027
2021		380,430
Subsequent years		215,876
Total	$	2,596,967

27

NOTE 8 – DEPOSITS

The following table presents the composition of deposits at June 30, 2017 and December 31, 2016:

	June 30, 2017		December 31, 2016
Noninterest-bearing deposits	$	120,486,976	$	111,378,694
Interest-bearing deposits:
Checking		65,981,523		58,482,158
Savings		115,309,199		120,376,229
Money market		119,043,428		109,550,925
Total interest-bearing checking, savings and money market deposits		300,334,150		288,409,312
Time deposits $250,000 and below		104,184,307		114,871,256
Time deposits above $250,000		10,916,249		11,799,132
Total time deposits		115,100,556		126,670,388
Total interest-bearing deposits		415,434,706		415,079,700
Total Deposits	$	535,921,682	$	526,458,394

The following table sets forth the maturity distribution for the Company’s time deposits at June 30, 2017:

	Amount
Maturing within one year	$	50,745,046
Maturing over one to two years		41,445,796
Maturing over two to three years		11,402,905
Maturing over three to four years		6,210,727
Maturing over four to five years		5,141,775
Maturing over five years		154,307
Total Time Deposits	$	115,100,556

Interest expense on deposits for the six-month periods ended June 30, 2017 and 2016 is as follows:

	Six Months Ended June 30,
	2017		2016
Interest-bearing checking	$	30,580	$	26,335
Savings		208,885		22,440
Money market		183,289		125,258
Total interest-bearing checking, savings and money market deposits		422,754		174,033
Time deposits $250,000 and below		417,770		367,757
Time deposits above $250,000		60,323		59,867
Total time deposits		478,093		427,624
Total Interest Expense	$	900,847	$	601,657

The Company’s deposits include brokered deposits obtained through the Promontory Interfinancial Network, which consist of Certificate of Deposit Registry Service (“CDARS”) balances included in time deposits, and insured cash sweep service (“ICS”) balances included in money market deposits.  At June 30, 2017, CDARS and ICS deposits were $12 million.  At December 31, 2016, CDARS and ICS deposits were $11 million. 

28

NOTE 9 – SHORT-TERM BORROWINGS  

Short-term borrowings at June 30, 2017 and December 31, 2016 consisted of the following:

	June 30, 2017		December 31, 2016
Federal Home Loan Bank Advances
Due December, 2017, Daily Rate 0.80%	$	—	$	20,000,000
Due December, 2017, Daily Rate 1.32%		11,000,000		—
Due July, 2017, Fixed Rate 1.17%		24,000,000		—
Total	$	35,000,000	$	20,000,000

Interest expense on FHLB advances and Atlantic Community Bankers Bank (“ACBB”) advances for the six month periods ended June 30, 2017 and 2016 was $168,134 and $143,579, respectively.  The Company had no long-term borrowings at June 30, 2017 or December 31, 2016.

NOTE 10 – STOCK-BASED COMPENSATION

The Bay Bancorp, Inc. 2015 Equity Compensation Plan (the “2015 Plan”) was adopted by the Company’s Board of Directors in March 2015 and approved by the Company’s stockholders in May 2015.  The 2015 Plan is a broad-based plan that permits the grant of stock options, restricted stock awards and other stock-based awards.  The 2015 Plan is available to all employees of the Company and its subsidiaries, including employees who are officers or members of the Board, all non-employee directors of the Company, and consultants of the Company and its subsidiaries.  The Board’s Compensation Committee administers the 2015 Plan. An aggregate of 100,000 shares of common stock were reserved for issuance for awards granted under the 2015 Plan.  The 2015 Plan provides that the aggregate number of shares that may be issued or transferred pursuant to incentive options is 100,000.  In any calendar year, a participant may not be awarded grants covering more than 20,000 shares.  At June 30, 2017 and December 31, 2016, stock option awards for 30,000 and 40,000 shares, respectively, were outstanding under the 2015 Plan.

The Company assumed the Jefferson Bancorp, Inc. 2010 Stock Option Plan (the “Jefferson Plan”) in 2013 when it merged (the “Jefferson Merger”) with Jefferson Bancorp, Inc. (“Jefferson”).  The Jefferson Plan was approved by Jefferson’s Board of Directors in September 2010 and adopted by its stockholders in April 2011.  Awards were available for grant to officers, employees and non-employee directors, independent consultants and contractors of Jefferson and its affiliates, including the Bank.  The Jefferson Plan is administered by the Board’s Compensation Committee. The Jefferson Plan authorized the issuance of up to 577,642 shares of common stock (as adjusted for the Jefferson Merger’s exchange ratio of 2.2217) and had a term of 10 years.  In general, options granted under the Jefferson Plan have an exercise price equal to 100% of the fair market value of the common stock at the date of the grant and have a 10-year terms.  Options relating to a total of 55,544 and 156,072 shares of common stock were outstanding at June 30, 2017 and December 31, 2016, respectively. 

The Carrollton Bancorp 2007 Equity Plan (the “Carrollton Plan” and, together with the 2015 Plan and the Jefferson Plan, the “Equity Plans”) was adopted by the Board of Directors of Carrollton Bancorp in March 2007 and approved by the stockholders of Carrollton Bancorp in April 2007.  The Carrollton Plan is a broad-based plan that permits the grant of stock options, stock appreciation rights, stock awards and performance units.  The Carrollton Plan reserved 500,000 shares of common stock were issuance.  Options relating to a total of 91,000 and 191,558 shares of common stock were outstanding at June 30, 2017 and December 31, 2016, respectively.

29

The following table summarizes changes in the Company’s stock options outstanding and exercisable at June 30, 2017 and December 31, 2016.

		Weighted
		Average		Weighted Average
	Stock Options	Exercise		Remaining
	Outstanding	Price		Contractual Life (years)
Outstanding, December 31, 2016	387,630	$	5.32	6.1
Granted	10,000		7.00	9.6
Exercised	(170,306)		3.71
Forfeited or expired	(50,780)		4.30
Outstanding, June 30, 2017	176,544	$	5.13	6.2
Exercisable, June 30, 2017	108,544	$	5.45	5.4

Stock-based compensation expense is recognized on a straight-line basis over the service period of the stock options and is recorded in noninterest expense.  For the six-month periods ended June 30, 2017 and 2016, option award stock-based compensation expense applicable to the Plans was $22,860 and $28,775, respectively.  Unrecognized stock-based compensation expense attributable to non-vested options was $77,692 at June 30, 2017.  This amount is expected to be recognized over a remaining weighted average period of approximately 2.6 years.

Restricted Stock Awards

On June 26, 2013, the Company’s Board of Directors revised its director compensation policy to provide for an annual grant to each non-employee director of an award of shares of restricted common stock having a fair market value of $10,000 that will vest one year after the date of the grant.  The Company has an incentive stock award program (the “Program”) covering substantially all full-time employees. At June 30, 2017, 104,012 restricted shares of the Company’s common shares have been granted under the Program.

At June 30, 2017 and December 31, 2016, total restricted share grants relating to 67,225 shares and 66,093 shares, respectively, of unvested restricted common stock were outstanding.  A total of 13,250 shares of restricted common stock were granted to the eight eligible directors on May 24, 2017.  Total stock-based compensation expense attributable to the shares of restricted common stock was $105,220 and $39,999 for the six-month periods ended June 30, 2017 and 2016, respectively.   The total unrecognized compensation expense attributable to the shares of restricted common stock was $308,852 at June 30, 2017.This amount is expected to be recognized over a remaining weighted average period of approximately 1.4 years.

NOTE 11 – DEFINED BENEFIT PENSION PLAN

The Carrollton Bank Retirement Income Plan (the “Pension Plan”) provides defined benefits based on years of service and final average salary.  Effective December 31, 2004, all benefit accruals for existing employees were frozen and no new employees were eligible for benefits under the Pension Plan.

The components of net periodic pension benefit are as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
Net Periodic Pension Benefit	2017		2016		2017		2016
Service cost	$	21,943	$	18,225	$	40,110	$	36,449
Interest cost		68,010		112,891		136,020		225,781
Expected return on plan assets		(105,146)		(160,937)		(210,292)		(321,874)
Amortization of net loss/(gain)		(69)		—		(138)		—
Net periodic pension benefit	$	(15,262)	$	(29,821)	$	(34,300)	$	(59,644)

30

401(k) Plan

The Company has a 401(k) profit sharing plan covering substantially all full-time employees.  For 2015, the Company made a discretionary employer matching contribution that was paid in shares of the Company’s common stock, in an amount equal to 50% of a participant’s contributions made between July 1, 2015 and December 31, 2015 capped at 2% of his or her compensation for 2015. These contributions were made in 2016.  For 2016, the Company made a discretionary employer matching contribution, to be paid in cash in 2017, in an amount equal to 50% of employee participant’s annual contributions, capped at 3% of his or her compensation for 2016. The expense associated with this plan during the six-month periods ended June 30, 2017 and 2016 was $66,125 and $95,000, respectively.

NOTE 12 – INCOME TAXES

The differences between the statutory federal income tax rate of 34% and the effective tax rate for the Company are reconciled as follows:

	Three Months Ended June 30,				Six months ended June 30,
	2017		2016		2017		2016
Income tax expense at federal statutory rate	34.0	%	34.0	%	34.0	%	34.0	%
Increase (decrease) resulting from:
Tax exempt income	(2.1)	%	(1.1)	%	(2.1)	%	(1.5)	%
State income taxes, net of federal income tax benefit	5.3	%	5.6	%	5.3	%	5.6	%
Incentive stock options	0.4	%	0.3	%	0.5	%	0.6	%
Other nondeductible (income) expenses	0.3	%	0.6	%	0.2	%	0.7	%
Effective income tax rate	37.9	%	39.4	%	37.9	%	39.4	%

The effective tax rate for the three- and six-month periods ended June 30, 2017 was 37.9%.  The effective tax rate for the three- and six-month periods ended June 30, 2016 was 39.4%. In accordance with FASB ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at June 30, 2017 and 2016 based on the current estimate of the effective annual rate.

NOTE 13 - NET INCOME PER COMMON SHARE

Basic earnings per common share is derived by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents.  Diluted earnings per share is derived by dividing net income available to common stockholders by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding common stock equivalents.  There is no dilutive effect on earnings per share during a loss period. The calculations of net income per common share for the three- and six-month periods ended June 30, 2017 and 2016 are as follows:

	Three Months Ended June 30,				Six months ended June 30,
	2017		2016		2017		2016
Basic earnings per share:
Net income available to common shareholders	$	1,225,359	$	449,104	$	2,182,167	$	635,503
Weighted average shares outstanding		10,597,629		10,908,156		10,549,229		10,956,698
Net income per share - basic	$	0.12	$	0.04	$	0.21	$	0.06
Diluted earnings per share:
Net income available to common shareholders	$	1,225,359	$	449,104	$	2,182,167	$	635,503
Weighted average shares outstanding		10,597,629		10,908,156		10,549,229		10,956,698
Dilutive potential shares		121,096		98,957		122,393		96,685
Total diluted average shares outstanding		10,718,725		11,007,113		10,671,622		11,053,383
Net income per share - diluted	$	0.11	$	0.04	$	0.20	$	0.06

31

NOTE 14 - COMMITMENTS AND CONTINGENT LIABILITIES 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business.  These financial instruments include loan commitments, unused lines of credit, standby letters of credit and mortgage loan repurchase obligations.  The Company uses these financial instruments to meet the financing needs of its customers and provide the Company a source of fee income.  Financial instruments involve, to varying degrees, elements of credit, interest rate and liquidity risk.  These do not represent unusual risks and management does not anticipate any losses which would have a material effect on the accompanying consolidated financial statements.

Outstanding loan commitments, lines and letters of credit obligations and mortgage loan repurchase obligations at June 30, 2017 and December 31, 2016were as follows:

	June 30, 2017		December 31, 2016
Loan commitments	$	9,657,270	$	7,729,629
Unused lines of credit		99,300,077		93,883,713
Standby letters of credit		6,858,873		8,424,706
Mortgage loan repurchase obligations		5,290,696		7,177,755

Loan commitments and unused lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  The Company generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments.  The collateral requirement is based on management's credit evaluation of the counter party.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements.  Each customer's creditworthiness is evaluated on a case-by-case basis.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

On September 20, 2016, shortly after the Company’s merger with Hopkins Bancorp, Inc. (“Hopkins”) and the related merger of Hopkins Federal Savings Bank (“Hopkins Bank”) with and into the Bank (collectively, the “Hopkins Merger”), Alvin M. Lapidus, the former Chairman of Hopkins and Hopkins Bank, and Lois F. Lapidus, his wife, filed a lawsuit against the Bank in the United States District Court, District of Maryland, in which they alleged that a former employee of Hopkins Bank embezzled approximately $1.48 million from their deposit accounts at Hopkins Bank prior to the Hopkins Merger.  The complaint seeks damages in the amount that was allegedly embezzled plus interest, which is still accruing.  This former employee was criminally charged in federal court and plead guilty to Wire Fraud, in violation of 18 U.S.C. § 1343, and Embezzlement by a Bank Employee, in violation of 18 U.S.C. § 656, and the information supporting her plea agreement identifies Mr. and Mrs. Lapidus as victims.  This former employee was sentenced in May 2017.  The Bank is vigorously defending this case and, at this point, cannot assess the likelihood of success of any of its defenses or, thus, the outcome of this litigation.  If a judgment were to be entered against Bay Bank, then Bay Bank intends to pursue an indemnity claim against a fidelity bond.  The Bank believes that its insurance policies will cover a portion of its legal expenses relating to this litigation and has recorded appropriate accruals in the fair value accounting of the assets and liabilities acquired in the Hopkins Merger.

In the ordinary course of business, the Company has various outstanding contingent liabilities that are not reflected in the accompanying consolidated financial statements.  In the opinion of management, after consulting with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the financial condition of the Company.

The Company originates and sells mortgage loans, primarily to other financial institutions, and provides various representations and warranties related to, among other things, the ownership of the loans, the validity of the liens, the

32

loan selection and origination process, and the compliance to the origination criteria established by the purchasing institution.  In the event of a breach of the Company’s representations or warranties, the Company may be obligated to repurchase the loans with identified defects or to indemnify the buyers. The Company’s contractual obligation arises only when the breach of a representation or warranty is discovered and repurchase is demanded by the purchaser.  The loan balances subject to repurchase were $5.3 million and $7.2 million at June 30, 2017 and December 31, 2016, respectively.  Management does not expect losses resulting from repurchase requests to be material to reported financial results.

NOTE 15 – FAIR VALUE

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  In accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions.  If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate.  In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.  The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

The Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured 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 fair value.

Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.  Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets and liabilities.

Level 2 - Valuation is based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  The valuation may be based on quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. 

33

In accordance with FASB’s guidance, impaired loans where an allowance is established based on the fair value of collateral and real estate acquired through foreclosure requires classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company measures and records the loan or real estate acquired through foreclosure as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company measures and records the loan or real estate acquired through foreclosure as nonrecurring Level 3.  The value of real estate collateral is determined based on appraisals by qualified licensed appraisers hired by the Company.  Impaired loans and real estate acquired through foreclosure are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

Assets Recorded at Fair Value on a Recurring Basis

The following methods and assumptions were used by the Company to measure certain assets recorded at fair value on a recurring basis in the consolidated financial statements.

Investment Securities Available for Sale

The fair value of investment securities available for sale is the market value based on quoted market prices when available (Level 1).  If listed prices or quotes are not available, fair value is based upon quoted market prices for similar assets or, due to the limited market activity of the instrument, externally developed models that use significant observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).  It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities and market information from third party sources.  In the absence of current market activity, securities may be evaluated either by reference to similarly situated bonds or based on the liquidation value or restructuring value of the underlying assets.  There was no change in valuation techniques used to measure fair value of securities available for sale for the six-months ended June 30, 2017. The tables below present the recorded amount of assets measured at fair value on a recurring basis at June 30, 2017 and December 31, 2016:

					Significant Other		Significant Other
	Carrying Value		Quoted Prices		Observable Inputs		Unobservable
June 30, 2017	(Fair Value)		(Level 1)		(Level 2)		Inputs (Level 3)
U.S. government agency	$	6,830,275	$	—	$	6,830,275	$	—
U.S. treasury securities		8,723,910		—		8,723,910		—
Residential mortgage-backed securities		35,438,343		—		35,438,343		—
State and municipal		2,607,968		—		2,607,968		—
Corporate obligations		8,824,315		—		8,824,315		—
Equity securities		37,280		37,280		—		—
	$	62,462,091	$	37,280	$	62,424,811	$	—

					Significant Other		Significant Other
	Carrying Value		Quoted Prices		Observable Inputs		Unobservable
December 31, 2016	(Fair Value)		(Level 1)		(Level 2)		Inputs (Level 3)
U.S. government agency	$	7,773,118	$	—	$	7,773,118	$	—
U.S. treasury securities		8,623,259		—		8,623,259		—
Residential mortgage-backed securities		30,813,481		—		30,813,481		—
State and municipal		2,637,280		—		2,637,280		—
Corporate obligations		10,328,455		—		10,328,455		—
Equity securities		57,134		57,134		—		—
	$	60,232,727	$	57,134	$	60,175,593	$	—

34

Assets Recorded at Fair Value on a Nonrecurring Basis

On a nonrecurring basis, the Company may be required to measure certain assets at fair value in accordance with U.S. GAAP.  These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets due to impairment.

The following methods and assumptions were used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:

Loans Held for Sale

Loans held for sale are recorded at the lower of cost or estimated market value on an aggregate basis.  Market value is determined based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.  As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the six-month period ended June 30, 2017 or the year ended December 31, 2016.

Impaired Loans

Loans for which it is probable that payment of principal and interest will not be made in accordance with the contractual terms of the loan are considered impaired.  Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310, using the present value of expected cash flows, the loan’s observable market price, or the fair value of collateral (less estimated selling costs) if the loan is collateral dependent.  A specific allowance for loan loss is then established or a charge-off is recorded if the loan is collateral dependent and the loan is classified at a Level 3 in the fair value hierarchy.  Appraised collateral 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 borrower’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 applied in prior periods.

Real Estate Acquired Through Foreclosure

Real estate acquired through foreclosure (“REO”) is adjusted to fair value upon transfer of the loan to REO and is classified at a Level 3 in the fair value hierarchy.  Subsequently, the REO is carried at the lower of carrying value or fair value.  The estimated fair value for REO included in Level 3 is determined by independent market based appraisals and other available market information, less estimated costs to sell, that may be reduced further based on market expectations or an executed sales agreement.  If the fair value of REO deteriorates subsequent to the period of transfer, the REO is also classified at a Level 3 in the fair value hierarchy.  Valuation techniques are consistent with those techniques applied in prior periods. 

35

The tables below presents the recorded assets measured at fair value on a nonrecurring basis at June 30, 2017 and December 31, 2016:

					Significant Other		Significant Other
	Carrying Value		Quoted Prices		Observable Inputs		Unobservable
June 30, 2017	(Fair Value)		(Level 1)		(Level 2)		Inputs (Level 3)
Impaired loans	$	788,067	$	—	$	—	$	788,067
Real estate acquired through foreclosure		1,147,546		—		—		659,876
	$	1,935,613	$	—	$	—		1,447,943

					Significant Other		Significant Other
	Carrying Value		Quoted Prices		Observable Inputs		Unobservable
December 31, 2016	(Fair Value)		(Level 1)		(Level 2)		Inputs (Level 3)
Impaired loans	$	819,877	$	—	$	—	$	819,877
Real estate acquired through foreclosure		1,224,939		—		—		1,224,939
	$	2,044,816	$	—	$	—		2,044,816

		Quantitative Information about Level 3 Fair Value Measurements
June 30, 2017		Fair Value		Valuation Technique	Unobservable Input	Range
Impaired loans	$	788,067		Appraisal of collateral (1)	Appraisal adjustments (2)	0% - 10%
Real estate acquired through foreclosure	$	1,147,546		Appraisal of collateral (1)	Appraisal adjustments (2)	0% - 10%
					Estimated selling cost (2)	0% - 10%
		Quantitative Information about Level 3 Fair Value Measurements
December 31, 2016		Fair Value		Valuation Technique	Unobservable Input	Range
Impaired loans	$	819,877	$	Appraisal of collateral (1)	Appraisal adjustments (2)	0% - 10%
Real estate acquired through foreclosure	$	1,224,939		Appraisal of collateral (1)	Appraisal adjustments (2)	0% - 10%
					Estimated selling cost (2)	0% - 10%

(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not observable.

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

Fair Value of Financial Instruments

The Company discloses fair value information about financial instruments, for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheets.  Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by a quoted market price, if one exists.

Quoted market prices, where available, are shown as estimates of fair market values.  Because no quoted market prices are available for a significant part of the Company's financial instruments, the fair values of such instruments have been derived based on the amount and timing of estimated future cash flows and using market discount rates.

Present value techniques used in estimating the fair value of many of the Company's financial instruments are significantly affected by the assumptions used.  In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate cash settlement of the instrument.  Additionally, the accompanying estimates of fair values are only representative of the fair values of the individual financial assets and liabilities and should not be considered an indication of the fair value of the Company.

36

The following disclosure of estimated fair values of the Company's financial instruments at June 30, 2017 and December 31, 2016 is made in accordance with the requirements of ASC Topic 820:

	Level in Fair	June 30, 2017				December 31, 2016
	Value	Carrying		Estimated fair		Carrying		Estimated fair
	Hierarchy	Amount		value		Amount		value
Financial assets:
Cash and cash equivalents	Level 1	$	41,666,202	$	41,666,202	$	40,027,456	40,027,456
Investment securities available for sale (debt)	Level 2		62,424,811		62,424,812		60,175,593	60,175,593
Investment securities available for sale (equity)	Level 1		37,280		37,280		57,134	57,134
Investment securities held to maturity (debt)	Level 2		1,116,070		1,110,435		1,158,238	1,149,342
Restricted equity securities	Level 2		2,364,795		2,364,795		1,823,195	1,823,195
Loans held for sale	Level 2		2,893,943		2,893,943		1,613,497	1,613,497
Loans, net of allowance	Level 3		505,987,115		506,743,662		484,280,560	487,325,072
Accrued interest receivable	Level 2		1,870,876		1,870,876		1,884,945	1,884,945
Financial liabilities:
Deposits	Level 3		535,921,682		536,188,844		526,458,394	526,119,460
Accrued interest payable	Level 2		41,545		41,545		16,406	16,406
Borrowings	Level 2		35,000,000		35,000,000		20,000,000	20,000,000

The following methods and assumptions were used to estimate the fair value of each category of financial instruments for which it is practicable to estimate that value:

Cash and due from banks, federal funds sold and overnight investments.  The carrying amount approximated the fair value.

Investment securities (available for sale).  See recurring fair value measurements above for methods.

Investment securities (held to maturity).  The fair value of debt securities is based upon quoted prices for similar assets or externally developed models that use significant observable inputs.

Restricted equity securities.  Since these stocks are restricted as to marketability, the carrying value approximated fair value.

Loans held for sale.  The carrying amount approximated the fair value.  Loans held for sale are recorded at the lower of cost or estimated market value on an aggregate basis.  Market value is determined based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.

Loans.  The fair value of loans, except for PCI loans that are collateral-dependent, was estimated by computing the discounted value of estimated cash flows, adjusted for probable credit losses, for pools of loans having similar characteristics.  The discount rate was based upon the current market rate for a similar loan.  The fair value of PCI loans that are collateral-dependent was determined based on the estimated fair value of collateral less estimated costs to sell.  Nonperforming loans have an assumed interest rate of 0%.

Accrued interest receivable and payable.  The carrying amount approximated the fair value of accrued interest, considering the short-term nature of the instrument and its expected collection.

Deposit liabilities.  The fair value of demand, money market savings and regular savings deposits, which have no stated maturity, were considered equal to their carrying amount, representing the amount payable on demand.  The fair value of

37

time deposits was based upon the discounted value of contractual cash flows at current rates for deposits of similar remaining maturity.

Short-term borrowings.  The carrying amount of fixed rate FHLB advances and ACBB borrowings approximated fair value due to the short-term nature of the instrument.  The carrying amount of variable rate FHLB advances and ACBB borrowings approximated the fair value.

Off-balance sheet instruments.  The Company charges fees for commitments to extend credit.  Interest rates on loans, for which these commitments are extended, are normally committed for periods of less than one month.  Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused.  It is impractical to assign any fair value to these commitments.

NOTE 16 – REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered by federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.  The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

In July 2013, federal bank regulatory agencies issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”).  On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019.  Under the final rules, the effects of certain accumulated other comprehensive items are not excluded; however, banking organizations like the Company and the Bank that are not considered “advanced approaches” banking organizations may make a one-time permanent election to continue to exclude these items.  With the submission of the Call Report for the first quarter of 2015, the Company and the Bank made this election in order to avoid significant variations in the level of capital that can be caused by interest rate fluctuations on the fair value of the Bank’s available for sale securities portfolio and by fluctuations in the net periodic pension benefit/obligation attributable to the Bank’s defined benefit pension plan.

In addition, the Office of the Comptroller of the Currency (the “OCC”) requires that FSBs, like the Bank, maintain a minimum level of Tier 1 capital to average total assets excluding intangibles.  This measure is known as the leverage ratio.  The current regulatory minimum for the leverage ratio for institutions to be considered “well capitalized” is 5%, but an individual institution could be required to maintain a higher level.  In connection with the merger of Carrollton Bank with and into the Bank, the Bank entered into an Operating Agreement with the OCC (the “Operating Agreement”) pursuant to which the Bank agreed, among other things, to maintain a leverage ratio of 10% for the term of the Operating Agreement.  In 2016, the OCC reduced the required leverage ratio for the Bank to at least 8.5%.The Operating Agreement will remain in effect until it is terminated by the OCC or the Bank ceases to be an FSB.

The following table summarizes capital ratios and related information in accordance with Basel III as measured at June 30, 2017 and December 31, 2016.  For disclosure regarding changes resulting from Basel III see the Item 2 of Part I of this report under the heading, “CAPITAL RESOURCES”. The Bank was classified in the well capitalized category at both June 30, 2017 and December 31, 2016 under the regulatory capital rules in effect at each date. The capital levels of the Bank at June 30, 2017 also exceeded the minimum capital requirements shown in the table below including the currently applicable Conservation Buffer of 1.2500%.  Since June 30, 2017, no conditions or events have occurred, of which the Company is aware, that have resulted in a material change in the Bank's regulatory risk category other than as reported in this report.

38

Actual capital amounts and ratios for the Bank are presented on the following tables (dollars in thousands):

													To Be Well
									Minimum Capital				Capitalized Under
					Minimum				Requirements with				Prompt Corrective
	Actual				Capital Requirements				Conservation Buffer				Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
At June 30, 2017:
Common Equity Tier 1 Capital	$	65,463	12.15	%	$	24,240	4.50	%	$	30,974	5.75	%	$	35,014	6.50	%
Tier I Risk-Based Capital Ratio	$	65,463	12.15	%	$	32,320	6.00	%	$	39,054	7.25	%	$	43,094	8.00	%
Total Risk-Based Capital Ratio	$	69,071	12.82	%	$	43,094	8.00	%	$	49,827	9.25	%	$	53,867	10.00	%
Tier 1 Leverage Ratio	$	65,463	10.44	%	$	25,086	4.00	%	$	32,925	5.25	%	$	31,357	5.00	%
At December 31, 2016:
Common Equity Tier 1 Capital	$	63,057	12.32	%	$	23,039	4.50	%	$	26,239	5.125	%	$	33,279	6.50	%
Tier I Risk-Based Capital Ratio	$	63,057	12.32	%	$	30,719	6.00	%	$	33,919	6.625	%	$	40,959	8.00	%
Total Risk-Based Capital Ratio	$	65,883	12.87	%	$	40,959	8.00	%	$	44,159	8.625	%	$	51,199	10.00	%
Tier 1 Leverage Ratio	$	63,057	10.45	%	$	24,133	4.00	%	$	27,904	4.625	%	$	30,166	5.00	%

Banking regulations also limit the amount of dividends that may be paid without prior approval by an FSB's regulatory agencies.  In addition to these regulations, the Bank agreed in the Operating Agreement that it would not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including the minimum capital requirements.  The Bank received regulatory approval to pay a $23.27 million one-time cash dividend to the Company to be used to purchase all of the outstanding shares of Hopkins common stock in the Hopkins Merger.  Due to the Bank’s desire to preserve capital to fund its growth, the Company currently does not anticipate paying dividends beyond the foregoing described need for the foreseeable future.  In addition to these regulatory restrictions, it should be noted that the declaration of dividends is at the discretion of the Company’s Board of Directors and will depend, in part, on the Company’s earnings and future capital needs.  Accordingly, there can be no assurance that dividends will be declared in any future period.

The Bank is required to maintain reserves against certain deposit liabilities which was satisfied with vault cash and balances on deposit with the Reserve Bank during the reserve maintenance periods that included June 30, 2017 and December 31, 2016.

Under current Federal Reserve regulations, the Bank is limited in the amount it may lend to the parent company and its nonbank subsidiaries.  Loans to a single affiliate may not exceed 10%, and loans to all affiliates may not exceed 20% of the Bank’s capital stock, surplus, and undivided profits, plus the allowance for loan and lease losses.  Loans from the Bank to nonbank affiliates, including the parent company, are also required to be collateralized according to regulatory guidelines.  At June 30, 2017, there were no loans from the Bank to any nonbank affiliate, including the parent company.

39

NOTE 17 – OTHER COMPREHENSIVE INCOME

Comprehensive income is defined as net income plus transactions and other occurrences that are the result of non-owner changes in equity.  For financial statements presented by the Company, non-equity changes are comprised of unrealized gains or losses on available for sale debt securities and any minimum pension liability adjustments.  These items do not have an impact on the Company’s net income.  The Company reflects the funded status of defined benefit pension plan liabilities on the balance sheet, which at June 30, 2017 was $0.6 million. The following table presents the activity in net accumulated other comprehensive income for the periods indicated.

	Unrealized Gains on
	Investments Available		Defined Benefit
	for Sale		Pension Plan		Total
Balance at December 31, 2016	$	(202,262)	$	232,645	$	30,383
Other comprehensive income:
Other comprehensive income (loss) before reclassification adjustments		251,611		176,929		428,540
Amounts reclassified from comprehensive loss		(3,319)		—		(3,319)
Other comprehensive income		248,292		176,929		425,221
Balance at June 30, 2017	$	46,030	$	409,574	$	455,604
	Unrealized Gains on
	Investments Available		Defined Benefit
	for Sale		Pension Plan		Total
Balance at December 31, 2015	$	168,814	$	404,746	$	573,560
Other comprehensive loss:
Other comprehensive income (loss) before reclassification adjustments		529,905		(338,315)		191,590
Amounts reclassified from comprehensive loss		(292,504)		—		(292,504)
Other comprehensive income (loss)		237,401		(338,315)		(100,914)
Balance at June 30,  2016	$	406,215	$	66,431	$	472,646
	Before Tax Amount		Tax (Expense) Benefit		Net of Tax Amount
For the three months ended June 30, 2017
Other comprehensive income:
Unrealized gain on AFS debt securities:
Net AFS debt securities gain	$	178,858	$	(67,186)	$	111,672
Reclassification adjustments		—		—		—
Net income recognized in other comprehensive loss		178,858		(67,186)		111,672
Defined benefit pension plan adjustments:
Net actuarial income		285,369		(108,440)		176,929
Net income recognized in other comprehensive income		285,369		(108,440)		176,929
Other comprehensive income	$	464,227	$	(175,626)	$	288,601
	Before Tax Amount		Tax (Expense) Benefit		Net of Tax Amount
For the three months ended June 30, 2016
Other comprehensive income:
Unrealized loss on AFS debt securities
Net AFS debt securities gain		224,056		(89,221)		134,835
Reclassification adjustments		(213,571)		85,172		(128,399)
Other comprehensive income:	$	10,485	$	(4,049)	$	6,436

40

	Before Tax Amount		Tax (Expense) Benefit		Net of Tax Amount
For the Six months ended June 30, 2017
Other comprehensive income:
Unrealized gain on AFS debt securities:
Gross AFS securities gain	$	403,265	$	(151,654)	$	251,611
Reclassification adjustments		(5,521)		2,202		(3,319)
Net income recognized in other comprehensive loss		397,744		(149,452)		248,292
Defined benefit pension plan adjustments:
Net actuarial income		285,369		(108,440)		176,929
Net income recognized in other comprehensive income		285,369		(108,440)		176,929
Other comprehensive income:	$	683,113	$	(257,892)	$	425,221
		Before Tax Amount		Tax (Expense) Benefit		Net of Tax Amount
For the Six months ended June 30, 2016
Other comprehensive loss:
Unrealized gain on AFS debt securities:
Gross AFS securities gain	$	878,312	$	(348,407)	$	529,905
Reclassification adjustments		(486,534)		194,030		(292,504)
Net income recognized in other comprehensive loss		391,778		(154,377)		237,401
Defined benefit pension plan adjustments:
Net actuarial losses		(558,690)		220,375		(338,315)
Net loss recognized in other comprehensive loss		(558,690)		220,375		(338,315)
Other comprehensive loss	$	(166,912)	$	65,998	$	(100,914)

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

As used in this Quarterly Report, the term “the Company” refers to Bay Bancorp, Inc. and, unless the context clearly requires otherwise, the terms “we,” “us,” and “our,” refer to Bay Bancorp, Inc. and its consolidated subsidiaries.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Such statements include projections, predictions, expectations or statements as to beliefs or future events or results, or refer to other matters that are not purely statements of historical facts.  Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements.  The forward-looking statements contained in this Quarterly Report are based on various factors and were derived using numerous assumptions.  In some cases, you can identify these forward-looking statements by words like “may”, “will”, “should”, “expect”, “plan”, “anticipate”, “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words.  You should be aware that those statements reflect only our predictions.  If known or unknown risks or uncertainties should materialize, or if underlying assumptions should prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. Further, factors or events that could cause our actual results to differ from our forward-looking statements may emerge from time to time, and it is not possible for us to predict all of them.  In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination

41

of factors, may cause actual results to differ materially from those contained in any forward-looking statements.  Factors that might cause such differences include, but are not limited to:

· changes in our plans and strategies and the results thereof;

· the impact of acquisitions and other strategic transactions;

· unexpected changes in the housing market, business markets, and/or general economic conditions in our market area, or a slower-than-anticipated economic recovery, which might lead to increased or decreased demand for loans, deposits and other products and services;

· unexpected changes in market interest rates or monetary policy;

· the impact of new laws, regulations and governmental policies and guidelines that might require changes to our business model;

· changes in laws, regulations and governmental policies and guidelines that might impact our ability to collect on outstanding loans or otherwise negatively impact our business;

· higher than anticipated loan losses or the insufficiency of the allowance for credit losses;

· our potential exposure to various types of market risks, such as interest rate risk and credit risk;

· our ability to recover the fair values of available for sale securities;

· our obligation to fund commitments to extend credit and unused lines of credit;

· changes in consumer confidence, spending and savings habits relative to the services we provide;

· continued relationships with major customers;

· competition from other financial institutions in originating loans, attracting deposits, and providing various financial services that may affect our profitability;

· the ability to continue to grow our business internally and through acquisition and successful integration of bank entities while controlling our costs;

· changes in competitive, governmental, regulatory, accounting, technological and other factors that may affect us specifically or the banking industry generally, including as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”);

· changes in our sources and availability of liquidity;

· the impact of pending and future legal proceedings; and

· losses that we may realize from off-balance sheet arrangements.

You should also consider carefully the risk factors discussed in detail in the periodic reports that Bay Bancorp, Inc. files with the Securities and Exchange Commission (the “SEC”), which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition (see Item 1A of Part II of this report for further information).  The risks discussed are factors that, individually or in the aggregate, management believes could cause our actual results to differ materially from expected and historical results.  You should understand that it is not possible to predict or identify all such factors.  Consequently, you should not consider such disclosures to be a complete discussion of all potential risks or uncertainties.

The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.  In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

GENERAL 

Bay Bancorp, Inc., a Maryland corporation organized in 1990, is a savings and loan holding company headquartered in Columbia, Maryland, that is the parent company of Bay Bank, FSB, a federal savings bank (“FSB”) that is also headquartered in Columbia, Maryland (the “Bank”).  Until November 1, 2013, the Company operated under the name Carrollton Bancorp.  Effective November 1, 2013, the Company’s name was changed to Bay Bancorp, Inc.

42

We are focused on providing superior financial and customer service to small and medium-sized commercial and retail businesses, owners of these businesses and their employees, to business professionals and to individual consumers located in the central Maryland region, through our network of 11 branch locations.  We attract deposit customers from the general public and use such funds, together with other borrowed funds, to make loans.  Our results of operations are primarily determined by the difference between interest income earned on our interest-earning assets, primarily interest and fee income on loans, and interest paid on our interest-bearing liabilities, including deposits and borrowings.

Our mortgage division is in the business of originating residential mortgage loans and then selling them to investors.  The mortgage banking business is structured to provide a source of fee income largely from the process of originating residential mortgage loans for sale in the secondary market.  Mortgage banking products include Federal Housing Administration and Federal Veterans Administration loans, conventional and nonconforming first and second mortgages, and construction and permanent financing.  Loans originated by the mortgage division are generally sold into the secondary market or retained by us as part of our balance sheet strategy.

Investments in joint ventures are accounted for using the equity method.  The total investment in joint ventures at June 30, 2017 and December 31, 2016 is not considered material to the consolidated financial statements as a whole.

On July 8, 2016, the Company completed its merger with Hopkins Bancorp, Inc. (“Hopkins”), the parent company of Hopkins Federal Savings Bank (“Hopkins Bank”), in which Hopkins was merged into the Company, with the Company as the surviving corporation.  Immediately following that merger, Hopkins Bank was merged into the Bank, with the Bank as the surviving FSB (these merger transactions are collectively referred to as the “Hopkins Merger”).  In the Hopkins Merger, the Company acquired all of the outstanding shares of common stock of Hopkins for $23,855,141 in cash, with each outstanding share of Hopkins common stock converted into the right to receive $98.7578 in cash. The Bank acquired Hopkins Bank’s 51% interest in iReverse Home Loans, LLC (“iReverse”), which is engaged in the business of brokering reverse mortgage loans.  The Bank entered into an agreement with the other owner of iReverse pursuant to which the Bank sold, effective March 31, 2017, the Bank’s interest in iReverse to the other owner for $70,000.

The Bank has eight wholly-owned subsidiaries including three acquired in the Hopkins Merger. Carrollton Community Development Corporation is a subsidiary that was created to promote, develop, and improve the housing and economic conditions of people in Maryland through the origination of loans, but that has been inactive since 2015. Three limited liability company subsidiaries are used to manage and dispose of real estate acquired through foreclosure or by deed in lieu of foreclosure. Bay Financial Services, Inc. is an inactive subsidiary that was established to provide brokerage services and a variety of financial planning and investment options to customers. Hopkins Financial Corporation, Hopkins Properties, Inc. and Encore Mortgage, Inc. are subsidiaries that were acquired in the Hopkins Merger and engage in the business of investing excess cash in certificates of deposit issued by other depository institutions.

AVAILABILITY OF INFORMATION

We make available through the Investor Relations area of our website, at www.baybankmd.com, annual reports on Form 10-K, quarterly reports on Form 10-Q, news releases on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act.  In general, we intend that these reports be available as soon as practicable after they are filed with or furnished to the SEC.  The SEC maintains a website (www.sec.gov) where these filings are also available through the SEC’s EDGAR system.  There is no charge for access to these filings through either our site or the SEC’s site.

MARKET AREA

We consider our core markets to be the communities within the Baltimore Metropolitan Statistical Area, particularly Baltimore City and the Maryland counties of Baltimore, Anne Arundel, Howard and Harford, as well as south along the Baltimore-Washington corridor with an expanded focus on Prince George’s and Montgomery counties.  To this end, in 2015, we added a Corridor Market President and two Directors to the bank and holding company board of

43

directors who are active in these counties and relocated the corporate headquarters to our Columbia, Maryland location.  In 2016, we added a Baltimore Market President to the bank and a Director to the bank and holding company board of directors who is active in investment banking, capital raising and financial advisory services.  Lending activities are broader, including the entire State of Maryland, and, to a limited extent, the surrounding states.  All of our revenue is generated within the United States.

COMPETITION

Our principal competitors for deposits are other financial institutions, including other savings institutions, commercial banks, credit unions, and local banks and branches or affiliates of other larger banks located in our primary market area.  Competition among these institutions is based primarily on interest rates and other terms offered, service charges imposed on deposit accounts, the quality of services rendered, and the convenience of banking facilities.  Additional competition for depositors' funds comes from mutual funds, U.S. Government securities, insurance companies and private issuers of debt obligations and suppliers of other investment alternatives for depositors such as securities firms.  Competition from credit unions has intensified in recent years as historical federal limits on membership have been relaxed.  Because federal law subsidizes credit unions by giving them a general exemption from federal income taxes, credit unions have a significant cost advantage over banks and savings associations, which are fully subject to federal income taxes.  Credit unions may use this advantage to offer rates that are highly competitive with those offered by banks and thrifts.

Current federal law allows the acquisition of banks by bank holding companies nationwide. Further, federal and Maryland law permit interstate banking. Recent legislation has broadened the extent to which financial services companies, such as investment banks and insurance companies, may control commercial banks. As a consequence of these developments, competition in our principal market may increase, and a further consolidation of financial institutions in Maryland may occur.

STRATEGY

We operate on the premise that the consolidation activities in the banking industry have created an opportunity for a well-capitalized community bank to satisfy banking needs that are no longer being adequately met in the local market.  Large national and regional banks are catering to larger customers and provide an impersonal experience, and typical community banks, because of their limited capacity, are unable to meet the needs of many small-to-medium-sized businesses.  Specifically, as a result of bank mergers in the 1990s, many banks in the Baltimore metropolitan area became local branches of large regional and national banks.  Although size gave the larger banks some advantages in competing for business from large corporations, including economies of scale and higher lending limits, we believe that these larger, national banks remain focused on a mass market approach which de-emphasizes personal contact and service.  We also believe that the centralization of decision-making power at these large institutions has resulted in a lack of customer service.  At many of these institutions, determinations are made at the out-of-state “home office" by individuals who lack personal contact with customers as well as an understanding of the customers' needs and scope of the relationship with the institution.  We believe that this trend is ongoing, and continues to be particularly frustrating to owners of small and medium-sized businesses, business professionals and individual consumers who traditionally have been accustomed to dealing directly with a bank executive who had an understanding of their banking needs with the ability to deliver a prompt response.

We attempt to differentiate ourselves from the competition through personalized service, flexibility in meeting the needs of customers, prompt decision making and the availability of senior management to meet with customers and prospective customers.

OVERVIEW

The mergers and acquisitions completed over the last several years have strengthened our market position geographically and enhanced our delivery channels, allowing us to provide extraordinary customer service while delivering a fuller range of products and services and lessened our dependence on net interest income by adding fee-based sources of revenue including a mortgage origination division, and an electronic banking division.  We plan to

44

increase our focus on organic growth primarily through new loan originations while continuing our focus on a high quality balance sheet, improved operational efficiencies and cost savings from prior acquisitions.

The Bank continued organic net growth in the first half of 2017. Net loan growth was favorable and targeted core deposit growth was strong. Planned declines in certificate of deposit balances following the closing of the Hopkins Merger led to an attractive 0.39% cost of funds for the first quarter of 2017. The Bank has strong liquidity and capital positions along with capacity for future growth, with total regulatory capital to risk weighted assets of 12.82% at June 30, 2017. We have a record of success in acquisitions and acquired problem asset resolutions and had $7.3 million in remaining net purchase discounts on acquired loan portfolios at June 30, 2017.

Net income for the three-month period ended June 30, 2017 was $1.23 million, or $0.12 per basic and $0.11 per diluted common share, compared to $0.45 million, or $0.04 per basic and diluted common share, for the same period of 2016.  Net income for the six-month period ended June 30, 2017 was $2.18 million, or $0.21 per basic and $0.20 per diluted common share, compared to $0.64 million, or $0.06 per basic and diluted common share, for the same period of 2016.  While the results recorded for the second quarter and first half of 2017 exceeded the same periods of 2016 due primarily to the growth resulting from the Hopkins Merger, the results also provided growth from added net loans during the periods.  Total loans were $510 million at June 30, 2017, an increase of 22% from $417 million at June 30, 2016. Total loans increased by $23 million, or 5%, when compared to $487 million at December 31, 2016 and highlights our transition from reliance on favorable net discount accretion assisted results to a bank with loan growth and improving efficiency metrics.    

Net interest income for the three-month period ended June 30, 2017 totaled $6.3 million, compared to $4.9 million for the same period of 2016. Net interest income for the six-month period ended June 30, 2017 totaled $12.2 million, compared to $9.6 million for the same period of 2016. Interest income associated with discount accretion on purchased loans, deferred costs and deferred fees will vary due to the timing and nature of loan principal payments. Earning asset leverage was the primary driver in year-over-year results, as average earning assets increased to $596 from $452 million for the three-month periods ended June 30, 2017 and 2016, respectively,  and increased to $591 from $453 million for the six-month periods ended June 30, 2017 and 2016, respectively,.

The return on average assets for the three-month periods ended June 30, 2017 and 2016 was 0.78% and 0.28%, respectively. The return on average assets for the six-month periods ended June 30, 2017 and 2016 was 0.71% and 0.27%, respectively.  The return on average equity for the three-month periods ended June 30, 2017 and 2016 was 7.38% and 2.70%, respectively. The return on average equity for the six-month periods ended June 30, 2017 and 2016 was 6.63% and 1.91%, respectively.

Total deposits were $536 million at June 30, 2017, an increase of 47% from $363 million at June 30, 2016, and an increase of $10 million from $526 million at December 31, 2016. Non-interest bearing deposits were $120 million at June 30, 2017, an increase of 25% from $96 million at June 30, 2016 and an increase of 8% from $111 million at December 31, 2016.

Short-term borrowings from the Federal Home Loan Bank of Atlanta (the “FHLB”) were $35 million at June 30, 2017, an increase of $15 million when compared to the $20 million at December 31, 2016.

Net interest margin for the three-month periods ended June 30, 2017 and 2016 was 4.27% and 4.34%, respectively.  Net interest margin for the six-month periods ended June 30, 2017 and 2016 was 4.16% and 4.28%, respectively.  The margins for the three- and six-month periods ended June 30, 2017 reflect the higher rates on short-term borrowings, the variable pace of discount accretion recognition within interest income, the impact of fair value amortization on the interest expense of acquired deposits, and the higher level of investments, including interest bearing federal funds sold acquired in the Hopkins Merger.

Nonperforming assets decreased to $14.6 million at June 30, 2017 from $15.8 million at December 31, 2016, and increased from $9.1 million at June 30,  2016. The decrease during the first half of 2017 resulted primarily from the continued resolution of acquired nonperforming loans.

45

The provision for loan losses for the three-month period ended June 30, 2017 was $0.5 million, compared to $0.4 million for the same period of 2016. The provision for loan losses for the six-month period ended June 30, 2017 was $1.0 million, compared to $0.7 million for the same period of 2016. The increases for the 2017 periods were primarily the result of increases in loan originations and the continued transition from an acquired loan portfolio to an originated portfolio. As a result, the allowance for loan losses was $3.61 million at June 30, 2017, representing 0.71% of loans, compared to $2.29 million, or 0.55% of loans, at June 30, 2016 and $2.82 million, or 0.58% of loans, at December 31, 2016. The allowance for loan losses at June 30, 2017 represented 1.01% of the Bank’s originated portfolio, with the remaining discount on acquired loans mitigating the need for additional loan loss reserves on these portfolios. Management expects both the allowance for loan losses and the related provision for loan losses to increase in the future due to the gradual accretion of the discount on the acquired loan portfolios and an increase in new loan originations.

At June 30, 2017, the Bank is estimated to remain above all “well-capitalized” regulatory requirement levels.  The Bank’s tier 1 risk-based capital ratio was 12.15% at June 30, 2017 as compared to 15.56% at June 30, 2016 and 12.32% at December 31, 2016.  Liquidity remains strong due to available cash and cash equivalents, borrowing lines with the FHLB, the Federal Reserve Bank of Richmond (the “Reserve Bank”), and correspondent banks, and the size and composition of the investment portfolio.

CRITICAL ACCOUNTING POLICIES 

Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”).  All intercompany transactions are eliminated in consolidation and certain reclassifications are made when necessary in order to conform the previous year’s financial statements to the current year’s presentation.  In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented.  Therefore, actual results could differ from these estimates.  Our financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain.  When applying accounting policies in areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets.  The most critical accounting policies applied relate to treatment of the allowance for loan losses, accounting for acquired loans, valuation of the securities portfolio, and accounting for income taxes.

Allowance for Loan Losses

The allowanceinvolves a higher degree of judgment and complexity than other significant accounting policies.  The allowance is calculated with the objective of maintaining a reserve level believed by us to be sufficient to absorb estimated probable loan losses.  Our determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors.  However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, expected loan commitment usage, the amounts and timing of expected future cash flows on impaired and purchased credit impaired loans, value of collateral, estimated losses on consumer loans and residential mortgages and general amounts for historical loss experience. The process also considers economic conditions and inherent risks in the loan portfolio.  All of these factors may be susceptible to significant change.  To the extent actual outcomes differ from our estimates, an additional provision for loan losses may be required that would adversely impact earnings in future periods. See discussion under the heading, “Allowance for Loan Losses and Credit Risk Management” in the section of this Item 2 entitled “FINANCIAL CONDITION”.

Accounting for Acquired Loans

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired.  Evidence of credit quality deterioration as of the purchase date may include information such as past due and nonaccrual status, borrower credit scores and recent loan to value percentages.  Purchased credit impaired loans are initially measured at fair value, which considers estimated future credit losses expected to be incurred over the life of the loan.  Accordingly, an allowance related to these loans was not carried over and recorded at the acquisition date.  We monitor actual loan cash flows to determine any improvement or deterioration from those forecasted as of the acquisition date.  Our acquired loans with specific credit deterioration are accounted for in accordance with Financial Accounting Standards Board (“FASB”)

46

Accounting Standards Codification (“ASC”)310-30.  Certain acquired loans, those for which specific credit related deterioration subsequent to origination is identified, are recorded at fair value reflecting the present value of the amounts expected to be collected.  Income recognition on purchased credit impaired loans is based on a reasonable expectation about the timing and amount of cash flows to be collected.

Valuation of the Securities Portfolio

Securities are evaluated periodically to determine whether a decline in their value is other than temporary.  The term “other than temporary” is not intended to indicate a permanent decline in value.  Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of an investment.  We review other criteria such as magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary.  Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Accounting for Income Taxes

We use the liability method of accounting for income taxes.  Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates in effect when these differences reverse.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  We exercise significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities.  The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws.  If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods.  Realization of deferred tax assets is dependent on generating sufficient taxable income in the future.

47

RESULTS OF OPERATIONS

Net Interest Income

The following tables sets forth, for the periods indicated, information regarding the average balances of interest earning assets and interest bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest earning assets and rates paid on average interest bearing liabilities.  No tax equivalent yield adjustments were made, as the effect thereof was not material.

	Three Months Ended June 30, 2017						Three Months Ended June 30, 2016
	Average						Average
	Balance		Interest		Yield/Rate		Balance		Interest		Yield/Rate
ASSETS
Interest-earning assets:
Interest bearing deposits with banks and federal funds sold	$	30,222,415	$	67,334	0.89	%	$	13,387,954	$	12,182	0.37	%
Investment securities available for sale		64,389,262		360,544	2.25	%		27,000,377		168,277	2.51	%
Investment securities held to maturity		1,132,104		6,505	2.30	%		1,211,262		9,280	3.08	%
Restricted equity securities		2,229,038		21,385	3.85	%		2,192,459		28,081	5.15	%
Total interest-bearing deposits with banks, fed funds sold, and investments		97,972,819		455,768	1.87	%		43,792,052		217,820	2.00	%
Loans held for sale		776,522		13,026	6.71	%		4,282,873		38,786	3.62	%
Loans, net
Commercial & Industrial		70,640,752		876,661	4.98	%		49,176,865		622,604	5.09	%
Commercial Real Estate		220,035,285		2,845,545	5.19	%		179,312,082		2,327,399	5.22	%
Residential Real Estate		146,600,221		1,963,500	5.36	%		123,668,425		1,485,567	4.81	%
HELOC		32,042,932		376,097	4.69	%		32,413,954		352,641	4.35	%
Construction		20,600,539		275,748	5.37	%		12,753,804		146,712	4.63	%
Land		4,626,996		27,338	2.37	%		5,189,661		36,325	2.82	%
Consumer & Other		2,225,235		64,575	11.64	%		1,231,689		23,644	7.72	%
Total loans, net (1)		496,771,960		6,429,464	5.19	%		403,746,480		4,994,892	4.98	%
Total earning assets		595,521,301	$	6,898,258	4.65	%		451,821,405	$	5,251,498	4.67	%
Cash		6,978,052						3,766,186
Allowance for loan losses		(3,304,004)						(2,010,853)
Market valuation		65,526						563,946
Other assets		27,294,565						19,290,722
Total non-earning assets		31,034,139						21,610,001
Total Assets	$	626,555,440					$	473,431,406
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing checking and savings	$	177,676,859	$	119,610	0.27	%	$	89,118,070	$	25,325	0.11	%
Money market		113,641,808		97,823	0.35	%		95,990,130		62,357	0.26	%
Time deposits		111,814,245		227,564	0.82	%		80,992,250		204,798	1.02	%
Total interest-bearing deposits		403,132,912		444,997	0.44	%		266,100,450		292,480	0.44	%
Borrowed funds:
Federal funds purchased				89	—	%		10,989		28	1.02	%
FHLB advances and other borrowed funds		39,311,476		107,931	1.10	%		41,063,736		79,784	0.78	%
Total borrowed funds		39,311,476		108,020	1.10	%		41,074,725		79,812	0.78	%
Total interest-bearing funds		442,444,388		553,017	0.50	%		307,175,175		372,292	0.49	%
Noninterest-bearing deposits		112,395,788		—				95,722,661		—
Total cost of funds		554,840,176	$	553,017	0.40	%		402,897,836	$	372,292	0.37	%
Other liabilities and accrued expenses		5,111,107						3,707,237
Total Liabilities		559,951,283						406,605,073
Stockholders' Equity		66,604,157						66,826,333
Total Liabilities and Stockholders' Equity	$	626,555,440					$	473,431,406
Net interest income and spread (2)			$	6,345,241	4.14	%			$	4,879,206	4.19	%
Net interest margin (3)					4.27	%					4.34	%

48

	Six Months Ended June 30, 2017						Six Months Ended June 30, 2016
	Average						Average
	Balance		Interest (1)		Yield/Rate		Balance		Interest (1)		Yield/Rate
ASSETS
Interest-earning assets:
Interest bearing deposits with banks and federal funds sold	$	30,629,967	$	145,009	0.95	%	$	17,469,718	$	35,938	0.41	%
Investment securities available for sale		63,000,662		696,360	2.23	%		27,618,014		344,900	2.51	%
Investment securities held to maturity		1,142,891		13,063	2.30	%		1,221,110		19,000	3.13	%
Restricted equity securities		1,984,170		29,896	3.04	%		2,255,778		48,411	4.32	%
Total interest-bearing deposits with banks, fed funds sold, and investments		96,757,690		884,328	1.84	%		48,564,620		448,249	1.86	%
Loans held for sale		770,321		19,908	5.17	%		4,169,722		78,452	3.76	%
Loans, net
Commercial & Industrial		69,307,946		1,668,931	4.86	%		48,351,590		1,180,325	4.91	%
Commercial Real Estate		214,140,178		5,388,627	5.07	%		175,804,610		4,485,312	5.13	%
Residential Real Estate		149,292,238		3,887,633	5.21	%		123,338,317		3,044,286	4.94	%
HELOC		32,163,176		726,685	4.52	%		32,995,613		705,851	4.28	%
Construction		20,048,136		512,772	5.16	%		12,791,234		300,772	4.73	%
Land		5,444,903		68,198	2.53	%		5,257,589		75,179	2.88	%
Consumer & Other		2,836,142		96,762	6.88	%		1,254,119		47,487	7.61	%
Total loans, net (1)		493,232,719		12,349,608	5.05	%		399,793,072		9,839,212	4.95	%
Total earning assets		590,760,730	$	13,253,844	4.52	%		452,527,414	$	10,365,913	4.61	%
Cash		7,314,188						4,043,703
Allowance for loan losses		(3,115,004)						(1,900,991)
Market valuation		(94,746)						577,814
Other assets		28,279,471						19,841,386
Total non-earning assets		32,383,909						22,561,912
Total Assets	$	623,144,639					$	475,089,326
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing checking and savings	$	175,830,909	$	239,465	0.27	%	$	87,060,384	$	48,775	0.11	%
Money market		114,330,906		183,289	0.32	%		95,993,335		125,258	0.26	%
Time deposits		116,056,551		478,093	0.83	%		82,861,994		427,624	1.04	%
Total interest-bearing deposits		406,218,366		900,847	0.45	%		265,915,713		601,657	0.46	%
Borrowed funds:
Federal funds purchased				89	—	%		5,495		28	1.02	%
FHLB advances and other borrowed funds		32,324,503		168,134	1.05	%		42,664,834		143,579	0.68	%
Total borrowed funds		32,324,503		168,223	1.05	%		42,670,329		143,607	0.68	%
Total interest-bearing funds		438,542,869		1,069,070	0.49	%		308,586,042		745,264	0.49	%
Noninterest-bearing deposits		112,107,160		—				95,800,866		—
Total cost of funds		550,650,029	$	1,069,070	0.39	%		404,386,908	$	745,264	0.37	%
Other liabilities and accrued expenses		6,127,792						3,506,916
Total Liabilities		556,777,821						407,893,824
Stockholders' Equity		66,366,818						67,195,502
Total Liabilities and Stockholders' Equity	$	623,144,639					$	475,089,326
Net interest income and spread(2)			$	12,184,774	4.03	%			$	9,620,649	4.12	%
Net interest margin(3)					4.16	%					4.28	%

(1) Non-accrual loans are included in average loans.

(2) Net interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(3) Net interest margin represents net interest income as a percentage of average interest-earning assets.

Net interest income, the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities, is the most significant component of our earnings.  Net interest income is a function of several factors, including the volume and mix of interest-earning assets and funding sources, as well as the relative level of market interest rates.  While management’s policies influence some of these factors, external forces, including customer

49

needs and demands, competition, the economic policies of the federal government and the monetary policies of the Federal Reserve also affect net interest income.

Net interest income increased $1.5 million to $6.3 million for the three-month period ended June 30, 2017, as compared to $4.9 million for the same period of 2016.  The increase was largely the result of growth in earning assets resulting from the Hopkins Merger and legacy Bank net loan growth.  The net interest margin for the three-month period ended June 30, 2017 decreased to 4.27%, as compared to 4.34% for the same period of 2016 due to the decline in net discount accretion on loans and deposits.  At June 30, 2017, the remaining net loan discounts on the Bank’s acquired loan portfolio totaled $7.3 million. 

Total interest income increased by $1.6 million to $6.9 million for the three-month period ended June 30, 2017 when compared to $5.3 million for the same period of 2016.  Interest income on loans increased by $1.4 million for the three-month period ended June 30, 2017 when compared to the same period of 2016.  The average balance of loans increased by $93 million, or 23%, primarily due to the Hopkins Merger and growth in Bank originated loans, and a 0.21% increase in average loan yield when compared to the same period of 2016.  The average balance of loans held for sale for the three-month period ended June 30, 2017 decreased by $4 million when compared to the same period of 2016 due to fewer loans held for sale related to the Hopkins Merger.

Total interest expense increased by $0.1 million for the three-month period ended June 30, 2017 when compared to the same period of 2016.  Average interest-bearing liabilities increased by $135 million, or 44%, for the three-month period ended June 30, 2017 when compared to the same period of 2016.  The cost of interest-bearing liabilities increased to 0.50  % for the three-month period ended June 30, 2017 as compared to 0.49% for the same period of 2016.  The increase in interest expense is primarily related to the $137 million increase in average interest-bearing deposit balances acquired in the Hopkins Merger.  Average noninterest-bearing deposits increased by $17 million for the three-month period ended June 30, 2017  when compared to the same period in 2016.

Net interest income increased $2.6 million to $12.2 million for the six-month period ended June 30, 2017, as compared to $9.6 million for the same period of 2016.  The increase was largely the result of growth in earning assets resulting from the Hopkins Merger and legacy Bank net loan growth.  The net interest margin for the six-month period ended June 30, 2017 decreased to 4.16%, as compared to 4.28% for the same period of 2016 due to the decline in net discount accretion on loans and deposits. 

Total interest income increased by $2.9 million to $13.3 million for the six-month period ended June 30, 2017 when compared to $10.4 million for the same period of 2016.  Interest income on loans increased by $2.5 million for the six-month period ended June 30, 2017 when compared to the same period of 2016.  The average balance of loans increased by $93 million, or 31%, primarily due to the Hopkins Merger and growth in Bank originated loans, and a 0.10% increase in average loan yield when compared to the same period of 2016.  The average balance of loans held for sale for the three-month period ended June 30, 2017 decreased by $3 million when compared to the same period of 2016 due to fewer loans held for sale related to the Hopkins Merger.

Total interest expense increased by $0.3 million for the six-month period ended June 30, 2017 when compared to the same period of 2016.  Average interest-bearing liabilities increased by $130 million, or 42%, for the six-month period ended June 30, 2017 when compared to the same period of 2016.  The 0.49% cost of interest-bearing liabilities did not change for the six-month period ended June 30, 2017 when compared to the same period of 2016.  The increase in interest expense is primarily related to the $140 million increase in average interest-bearing deposit balances acquired in the Hopkins Merger.  Average noninterest-bearing deposits increased by $16 million for the six-month period ended June 30, 2017  when compared to the same period in 2016.

Provision for Loan Losses

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management's best estimate, is necessary to absorb probable losses within the existing loan portfolio.  On a monthly basis, management reviews all loan portfolios to determine trends and monitor asset quality.  For consumer loan portfolios, this review generally consists of reviewing delinquency levels on an aggregate basis with timely follow-up on accounts that become delinquent.  In commercial loan portfolios, delinquency information is monitored and periodic reviews of business and property leasing

50

operations are performed on an individual loan basis to determine potential collection and repayment problems.  See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.

The provision for loan losses for the three-month periods ended June 30, 2017 and 2016 was $0.5 million and $0.4 million, respectively. The provision for loan losses for the six-month periods ended June 30, 2017 and 2016 was $1.0 million and $0.7 million, respectively.  The increase for the 2017 periods was primarily the result of increases in loan originations and adjustments in certain qualitative factors.As a result, the allowance for loan losses was $3.6 million at June 30, 2017, representing 0.71% of total loans, compared to $2.3 million, or 0.55% of total loans, at June 30, 2016 and $2.8 million, or 0.58% of total loans, at December 31, 2016.  Management expects both the allowance for loan losses and the related provision for loan losses to increase in the future due to the gradual accretion of the discount on the acquired loan portfolios and an increase in new loan originations.

Noninterest Income

The following tables reflect the amounts and changes in noninterest income for the three- and six-month periods ended June 30, 2017 and 2016.

	Three Months Ended June 30,				2017 vs 2016
	2017		2016		$ Change		% Change
Payment sponsorship fees	$	844,810	$	591,550	$	253,260	43	%
Mortgage banking fees and gains		199,447		262,736		(63,289)	(24)	%
Service charges on deposit accounts		79,637		77,013		2,624	3	%
Gain on securities sold		—		213,571		(213,571)	—	%
Other noninterest income		228,776		180,133		48,643	27	%
Total Noninterest Income	$	1,352,670	$	1,325,003	$	27,667	2	%

	Six Months Ended June 30,				2017 vs 2016
	2017		2016		$ Change		% Change
Payment sponsorship fees	$	1,501,002	$	1,142,559	$	358,443	31	%
Mortgage banking fees and gains		382,391		421,283		(38,892)	(9)	%
Service charges on deposit accounts		142,269		147,627		(5,358)	(4)	%
Gain on securities sold		5,521		486,534		(481,013)	(99)	%
Other noninterest income		647,849		318,077		329,772	104	%
Total Noninterest Income	$	2,679,032	$	2,516,080	$	162,952	6	%

Noninterest income for the three-month periods ended June 30, 2017 and 2016 was $1.4 million and $1.3 million, respectively. Noninterest income for the six-month periods ended June 30, 2017 and 2016 was $2.7 million and $2.5 million, respectively. The increase for the three-month period ended June 30, 2017 when compared to the same period in 2016 was primarily the result of a $0.3 million increase in payment sponsorship fees offset by a $0.2 million decrease in gain on securities sold as a result of fewer sales and redemptions of available for sale securities. The increase for the six-month period ended June 30, 2017 when compared to the same period in 2016 was primarily the result of a $0.4 million increase in payment sponsorship fees and a $0.3 million increase in other noninterest income primarily related to FDIC rebates adjustments in the first quarter of 2017 offset by a $0.5 million decrease in gain on securities sold as a result of fewer sales and redemptions of available for sale securities.   

51

Noninterest Expenses

The following table reflects the amounts and changes in noninterest expense for the three- and six-month periods ended June 30, 2017 and 2016.

	Three Months Ended June 30:				2017 vs 2016
	2017		2016		$ Change		% Change
Salary and employee benefits	$	2,924,599	$	2,784,504	$	140,095	5	%
Occupancy and equipment expenses		667,228		809,075		(141,847)	(18)	%
Legal, accounting and other professional fees		295,493		217,453		78,040	36	%
Data processing and item processing services		304,718		252,822		51,896	21	%
FDIC insurance costs		101,928		86,702		15,226	18	%
Advertising and marketing related expenses		122,849		108,211		14,638	14	%
Foreclosed property expenses		21,234		96,106		(74,872)	(78)	%
Loan collection costs		36,176		13,790		22,386	162	%
Core deposit intangible amortization		197,877		155,325		42,552	27	%
Merger related expenses		—		131,333		(131,333)	(100)	%
Other expenses		531,494		450,654		80,840	18	%
Total Noninterest Expenses	$	5,203,596	$	5,105,975	$	97,621	2	%

	Six Months Ended June 30,				2017 vs 2016
	2017		2016		$ Change		% Change
Salary and employee benefits	$	5,781,843	$	5,673,960	$	107,883	2	%
Occupancy and equipment expenses		1,424,873		1,680,270		(255,397)	(15)	%
Legal, accounting and other professional fees		528,449		528,014		435	0	%
Data processing and item processing services		632,512		534,814		97,698	18	%
FDIC insurance costs		166,942		164,181		2,761	2	%
Advertising and marketing related expenses		147,169		140,739		6,430	5	%
Foreclosed property expenses		38,093		170,585		(132,492)	(78)	%
Loan collection costs		70,842		34,590		36,252	105	%
Core deposit intangible amortization		433,342		348,132		85,210	24	%
Merger related expenses		149,543		188,590		(39,047)	100	%
Other expenses		1,011,549		972,097		39,452	4	%
Total Noninterest Expenses	$	10,385,157	$	10,435,972	$	(50,815)	0	%

For the three-month period ended June 30, 2017, noninterest expense was $5.2 million, representing an increase of $0.1 million when compared to the same period in 2016. For the six-month period ended June 30, 2017, noninterest expense was $10.4 million, with a $0.1 million decrease when compared to the same period in 2016.  The primary contributors to the decreases for both periods were lower occupancy, equipment, foreclosed property, and merger expenses offset by increases in salary and employee benefits and data processing services.  

Income Taxes

The effective tax rate for the three-month periods ended June 30, 2017 and 2016 was 37.9% and 39.4%, respectively.  The effective tax rate for the six-month periods ended June 30, 2016 was 37.9% and 39.2%, respectively. In accordance with FASB ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at June 30, 2017 and 2016 based on the current estimate of the effective annual rate.

The Company uses the current federal statutory tax rate of 34.0% to value its deferred tax assets and liabilities. On April 26, 2017, the Trump Administration announced a comprehensive tax reform proposal that includes a reduction in the U.S. corporate income tax rate to 15.0%. If corporate tax rates were reduced, management expects the Company would be required to record an initial charge against earnings to lower the carrying amount of its net deferred tax asset,

52

and then, going forward, would record lower tax provisions on an ongoing basis. It is too early in the process to determine if any of the proposals are actionable. Accordingly, management cannot assess the effect a change in the corporate tax rate would have on Company’s operating results or financial position at the present time.

FINANCIAL CONDITION

Total assets were $646 million at June 30, 2017, an increase of $26 million, or 4%, when compared to December 31, 2016 primarily due to the $22 million net increase in loans for the period.  When comparing June 30, 2017 to December 31, 2016, investment securities increased by $3 million or 4%,  loans held for sale decreased by $1 million, and cash and interest-bearing deposits with banks increased by $2 million. 

Total deposits were $536 million at June 30, 2017, an increase of $9 million, or 2%, when compared to December 31, 2016.

Stockholders’ equity was $69 million at June 30, 2017, compared to $66 million at December 31, 2016.  The $3 million increase was primarily related to corporate earnings and the exercise of stock options.  This activity improved the book value of the Company’s common stock to $6.52 per share at June 30, 2017, compared to $6.29 per share at December 31, 2016.

Investment Securities

Our investment policy authorizes management to invest in traditional securities instruments in order to provide ongoing liquidity, income and a ready source of collateral that can be pledged in order to access other sources of funds.  The investment portfolio consists of available for sale and held to maturity securities.  Available for sale securities are those securities that we intend to hold for an indefinite period of time but not necessarily until maturity.  These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors.  Held to maturity securities are securities we have the intent and ability to hold until maturity.  These securities are carried at amortized cost.

The investment portfolio consists primarily of U.S. Government agency securities, U.S. Treasury securities, residential mortgage-backed securities, corporate bonds and state and municipal obligations.  The income from state and municipal obligations is exempt from federal income tax.  Certain agency securities are exempt from state income taxes.  We use the investment portfolio as a source of both liquidity and earnings.  Management continues to evaluate investment options that will produce income without assuming significant credit or interest rate risk and to look for opportunities to use liquidity from maturing investments to reduce our use of high cost time deposits and borrowed funds.

Investment securities increased $2 million to $63 million at June 30, 2017, from $61 million at December 31, 2016.  This increase was primarily related to additional investments in mortgage backed securities.

Restricted Equity Securities

Restricted equity securities did not change significantly at June 30, 2017 from the $2 million recorded at December 31, 2016. 

Loans Held for Sale

Loans held for sale were $3 million at June 30, 2017, compared to $2 million at December 31, 2016.  The increase in loans held for sale was primarily due to new originated loans designated to held for sale.

53

Loans

Loans, net of deferred fees and costs, increased by $23 million, or 5%, to $510 million at June 30, 2017 from $487 million at December 31, 2016, primarily due to the added loan originations for commercial real estate loans offset by repayments.

Loans are placed on nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of all interest and/or principal is in doubt.  Placing a loan on nonaccrual status means that we no longer accrue interest on such loan and reverse any interest previously accrued but not collected.  Management may grant a waiver from nonaccrual status for a 90-day past-due loan that is both well secured and in the process of collection.  A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to make payments in accordance with the terms of the loanand remain current.

A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans are measured based on the fair value of the collateral for collateral dependent loans and at the present value of expected future cash flows using the loans’ effective interest rates for loans that are not collateral dependent.

At June 30, 2017, we had 238 impaired loans totaling $33 million (including PCI, loans of $27 million).  Of this number, 128 impaired loans totaling $12 million were classified as nonaccrual loans.  At June 30, 2017,  troubled debt restructurings, or TDRs, included in impaired loans totaled $2 million, 11 loans of which were included in nonaccrual loans having a total balance of $1 million.  Borrowers under all other restructured loans are paying in accordance with the terms of the modified loan agreement and have been placed on accrual status after a period of performance with the restructured terms. 

The following table presents details of our nonperforming loans and nonperforming assets, as these asset quality metrics are evaluated by management, at the dates indicated:

	June 30, 2017		December 31, 2016
Nonaccrual loans excluding PCI loans	$	5,096,017	$	5,001,338
Nonaccrual PCI loans		7,345,127		6,686,085
TDR loans excluding those in nonaccrual loans		438,184		500,411
Accruing PCI loans past due 90+ days		565,648		2,421,735
Total nonperforming loans		13,444,976		14,609,569
Real estate acquired through foreclosure		1,147,546		1,224,939
Total nonperforming assets	$	14,592,522	$	15,834,508

Nonperforming assets, which consist of nonaccrual loans, troubled debt restructurings, accruing loans past due 90 days or more, and real estate acquired through foreclosure, decreased to $14.6 million at June 30, 2017 from $15.8 million at December 31, 2016.  The $1.2 million decrease was primarily due to a $1.9 million decrease in accruing purchased credit impaired (“PCI”) loans past due 90 days or more, offset by a $0.7 million increase in nonaccrual PCI loans.Nonperforming assets constituted 2.3% of total assets at June 30, 2017, which represents a 0.3% decrease from the 2.6% recorded at December 31, 2016.

Potential problem loans consist of loans that are performing under contract but for which credit problems have caused us to place them on our list of criticized loans.  These loans have a risk rating of 6 (Special Mention) or higher, and exclude all nonaccrual loans and accruing loans past due 90+ days.  At June 30, 2017, these loans totaled $9.8 million and consisted primarily of Commercial & Industrial loans, Commercial Real Estate loans and Residential Real Estate loans which had balances of $2.6 million, $4.3 million and $2.8 million, respectively.  Difficulties in the economy and the accompanying impact on these borrowers, as well as future events, such as regulatory examination assessments, may result in these loans and others being classified as nonperforming assets in the future. 

54

Allowance for Loan Losses and Credit Risk Management

The allowance for loan losses is established to estimate losses that may occur on loans by recording a provision for loan losses that is charged to earnings in the current period.  The allowance is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historic experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.  Measured impairment and credit losses are charged against the allowance when management believes the loan or a portion of the loan’s balance is not collectable.  Subsequent recoveries, if any, are credited to the allowance.

The allowance consists of specific and general components.  The specific component relates to individual loans that are classified as impaired.  A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement and primarily includes nonaccrual, TDRs, and PCI loans where cash flows have deteriorated from those forecasted as of the acquisition date.  For those loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price, whichever is appropriate, of the impaired loan is lower than the carrying value of the loan.  For collateral-dependent impaired loans, any measured impairment is properly charged off against the loan and allowance in the applicable reporting period.  The specific component may fluctuate from period to period if changes occur in the nature and volume of impaired loans.

The general component covers pools of similar loans, including purchased loans that did not have deteriorated credit quality at acquisition and new loan originations, and is based upon historical loss experience of the Bank or peer bank group if the Bank’s loss experience is deemed by management to be insufficient and several qualitative factors.  These qualitative factors address various risk characteristics in the Bank’s loan portfolio after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data.  Management will continue to evaluate the appropriateness of the peer group data used with each quarterly allowance analysis until such time as the Bank has sufficient loss experience to provide a foundation for the general reserve requirement.  The general component may fluctuate from period to period if changes occur in the mix of the Bank’s loan portfolio, economic conditions, or specific industry conditions.

A test of the adequacy of the allowance, using the methodology outlined above, is performed by management and reported to the Board of Directors on at least a quarterly basis.  The complex evaluations involved in such testing require significant estimates.  Management uses available data to establish the allowance at a prudent level, recognizing that the determination is inherently subjective, and that future adjustments may be necessary, depending upon many items including a change in economic conditions affecting specific borrowers, or in general economic conditions, and new information that becomes available.  However, there are no assurances that the allowance will be sufficient to absorb losses on nonperforming loans, or that the allowance will be sufficient to cover losses on nonperforming loans in the future.

The allowance was $3,608,484 at June 30, 2017, compared to $2,823,153 at December 31, 2016.  The allowance as a percentage of total portfolio loans was 0.71% at June 30, 2017 and 0.58% at December 31, 2016.  The allowance as a percentage of Bank originated loans was 1.01% at June 30, 2017 and 0.86% at December 31, 2016.  Management expects continued gradual increases in our allowance for loan losses due to the gradual runoff of the discount on the acquired loan portfolio and an increase in new loan originations.

For non-impaired loans acquired by the Bank from Bay National Bank, without evidence of deteriorated credit quality, there was net unamortized discount of $0.3 million and $0.4 million at June 30, 2017 and December 31, 2016 which represented 2.5% and 3.3%, respectively, of the related loan balance at such dates.  For non-impaired acquired legacy Carrollton Bank portfolio loans without evidence of deteriorated credit quality, there was net unamortized discount of $1.0 million at both June 30, 2017 and December 31, 2016, which represented 1.3% and 1.2%, respectively, For non-impaired acquired legacy Hopkins Bank portfolio loans without evidence of deteriorated credit quality, there was net unamortized discount of $0.4 million at both June 30, 2017 and December 31, 2016, which represented 1.1% and 0.8%, respectively, of the related loan balance at such dates.

During the six-month periods ended June 30, 2017 and 2016, we recorded net charge-offs of $177,513 and $135,592, respectively.    

55

The following table reflects activity in the allowance for loan losses for the periods indicated:

	Six Months Ended June 30,
	2017			2016
Balance at beginning of year	$	2,823,153		$	1,773,009
Charge offs:
Commercial & Industrial		—
Commercial Real Estate		—
Residential Real Estate		225,941			174,414
Home Equity Line of Credit		—			2,183
Construction		15,593			—
Consumer & Other		—			(480)
Total charge offs		241,534			176,117
Recoveries:
Commercial & Industrial		188			—
Commercial Real Estate		—			—
Residential Real Estate		63,733			41,485
Home Equity Line of Credit		—			—
Land		—			—
Construction		—			—
Consumer & Other		100			—
Total recoveries		64,021			41,485
Net charge offs		(177,513)			(135,592)
Provision for loan loss		962,844			655,533
Balance at end of year	$	3,608,484		$	2,292,950
Net charge offs as a percentage of average loans		0.07	%		0.07	%

Deposits

The following deposit table presents the composition of deposits at the dates indicated.

	June 30, 2017				December 31, 2016				2017 vs 2016
	Amount		% of Total		Amount		% of Total		$ Change		% Change
Noninterest-bearing deposits	$	120,486,976	22	%	$	111,378,694	21	%	$	9,108,282	8	%
Interest-bearing deposits:
Checking		65,981,523	12	%		58,482,158	11	%		7,499,365	13	%
Savings		115,309,199	22	%		120,376,229	23	%		(5,067,030)	(4)	%
Money market		119,043,428	22	%		109,550,925	21	%		9,492,503	9	%
Total interest-bearing checking, savings and money market deposits		300,334,150	56	%		288,409,312	55	%		11,924,838	4	%
Time deposits $250,000 and below		104,184,307	19	%		114,871,256	22	%		(10,686,949)	(9)	%
Time deposits above $250,000		10,916,249	2	%		11,799,132	2	%		(882,883)	(7)	%
Total time deposits		115,100,556	22	%		126,670,388	24	%		(11,569,832)	(9)	%
Total interest bearing deposits		415,434,706	78	%		415,079,700	79	%		355,006	1	%
Total Deposits	$	535,921,682	100	%	$	526,458,394	100	%	$	9,463,288	2	%

56

Total deposits were $536 million at June 30, 2017, an increase of $10 million, or 2% when compared to $526 million at December 31, 2016.  Within the deposit base, interest bearing checking account balances increased $7 million, or 13%, interest money market balances increased $9 million, or 9%, and time deposit balances decreased by $12 million, or 9%, and savings deposits decreased $5 million, or 4% when compared to the amounts at December 31, 2016.

The ratio of noninterest bearing deposits to total deposits was 22% at June 30, 2017, or 1% lower than at December 31, 2016.  Included in our deposit portfolio are brokered deposits acquired through the Promontory Interfinancial Network (the “Network”).  The Network, which includes Certificate of Deposit Registry Service (“CDARS“) and Insured Cash Sweep Service (“ICS”) deposits, gives us the ability to offer our customers access to FDIC-insured deposit products in aggregate amounts exceeding current insurance limits.  When we place funds through the Network on behalf of a customer, we typically receive matching deposits through the Network’s reciprocal deposit program.  At June 30, 2017, we had $12 million in deposits through the Network compared to $11 million at December 31, 2016.  We can also choose to place deposits through the Network without receiving matching deposits.  We had placed no deposits through the Network at June 30, 2017 or December 31, 2016 for which we received no matching deposits. 

Borrowings

Borrowings at June 30, 2017 consisted of $35 million in FHLB advances compared to $20 million in FHLB advances at December 31, 2016.  The $15 million increase in FHLB borrowings at June 30, 2017 when compared to December 31, 2016 was primarily a result of the Bank’s net increase in loan originations during the six-month period ended June 30, 2017.

CAPITAL RESOURCES 

Ample capital is necessary to sustain growth, provide a measure of protection against unanticipated declines in asset values and safeguard the funds of depositors.  Capital also provides a source of funds to meet loan demand and enables us to manage assets and liabilities effectively.

At June 30, 2017, our total stockholders’ equity was $69 million, an increase or $3 million from the $66 million recorded at December 31, 2016.  The increase was primarily attributable to corporate earnings and the exercise of common stock under our stock option plan.

The Bank is subject to various regulatory capital requirements administered by federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.  The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

In July 2013, federal bank regulatory agencies issued a final rule that revises their risk based capital requirements and the method for calculating risk weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act.  These Basel III capital rules were applicable to the Bank effective January 1, 2015, but they do not apply to the Company since it is a small bank holding company with less than $1.0 billion in total consolidated assets.  The Board of Governers of the Federal Reserve System raised the threshold for the small bank holding company exclusion from $500 million to $1 billion in April 2015.

The rule imposes higher risk based capital and leverage requirements than those in place at the time the rule was issued.  Specifically, the rule imposes the following minimum capital requirements to be considered adequately capitalized:

· A new common equity Tier 1 risk based capital ratio of 4.5%;

57

· A Tier 1 risk-based capital ratio of 6% (increased from the previous 4% requirement);

· A total risk-based capital ratio of 8% (unchanged from previous requirements); and

· A leverage ratio of 4%.

The rule also includes changes in what constitutes regulatory capital, some of which are subject to a transition period.  These changes include the phasing out of certain instruments as qualifying capital.  In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital.  Certain deferred tax assets over designated percentages of common stock are required to be deducted from capital, subject to a transition period.  Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized net gains and losses on available for sale debt and equity securities and all unrealized net gain or loss on our defined benefit pension plan), subject to a transition period and a one-time opt-out election.  The Bank elected to opt-out of this provision.  As such, accumulated comprehensive income is not included in determining the Bank’s regulatory capital ratios.

The rule also includes changes in the risk weights of assets to better reflect credit risk and other risk exposures.  These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisitions, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for deferred tax assets that are not deducted from capital and increased risk weights (from 0% to up to 600%) for certain equity exposures.

Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% (once fully phased in) of common equity Tier 1 capital to risk weighted assets in addition to the amount necessary to meet its minimum risk based capital requirements. The capital levels of the Bank at June 30, 2017 also exceeded the minimum capital requirements including the currently applicable Conservation Buffer of 1.2500%.

The final rule became effective on January 1, 2015, and the requirements in the rule will be fully phased-in by January 1, 2019.  While the ultimate impact of the fully phased-in capital standards on the Company and the Bank is currently being reviewed, we currently do not believe that compliance with the Basel III Capital Rules will have a material impact once fully implemented.

For regulatory capital purposes after March 31, 2015, deferred tax assets that arise from net operating loss and tax credit carryforwards (net of any related valuations allowances and net of deferred tax liabilities) are excluded from regulatory capital, in addition to certain overall limits on net deferred tax assets as a percentage of common equity Tier 1 capital.  At June 30, 2017, $0.7 million of the Bank’s net deferred tax assets were excluded from common equity Tier 1, Tier 1 and total regulatory capital.  We will continue to evaluate the realizability of our net deferred tax asset on a quarterly basis for both financial reporting and regulatory capital purposes.  This evaluation may result in the inclusion of a deferred tax asset in regulatory capital in an amount that is different from the amount determined under GAAP.

In addition, the Office of the Comptroller of the Currency (the “OCC”) requires that FSBs, like the Bank, maintain a minimum level of Tier 1 capital to average total assets excluding intangibles.  This measure is known as the leverage ratio.  The current regulatory minimum for the leverage ratio for institutions to be considered “well capitalized” is 5%, but an individual institution could be required to maintain a higher level.  In connection with the merger of Carrollton Bank with and into the Bank, the Bank entered into an Operating Agreement with the OCC (the “Operating Agreement”) pursuant to which the Bank agreed, among other things, to maintain a leverage ratio of 10% for the term of the Operating Agreement. In 2016, the OCC reduced the required leverage ratio for the Bank to at least 8.5%. The Operating Agreement will remain in effect until it is terminated by the OCC or the Bank ceases to be an FSB.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios (set forth in the table below) of total, common equity Tier 1 and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and a leverage ratio of Tier 1 capital (as defined) to average tangible assets (as defined). At June 30, 2017 and December 31, 2016, the Bank had regulatory capital in excess of that required under each requirement and was classified as “well capitalized”. 

58

For additional information on the regulatory capital ratios of the Bank at June 30, 2017, see Note 16 to the Company’s unaudited consolidated financial statements presented elsewhere in this report.

Actual capital amounts and ratios for the Bank are presented in the following table (dollars in thousands):

													To Be Well
									Minimum Capital				Capitalized Under
					Minimum				Requirements with				Prompt Corrective
	Actual				Capital Requirements				Conservation Buffer				Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
At June 30, 2017:
Common Equity Tier 1 Capital	$	65,463	12.15	%	$	24,240	4.50	%	$	30,974	5.75	%	$	35,014	6.50	%
Tier I Risk-Based Capital Ratio	$	65,463	12.15	%	$	32,320	6.00	%	$	39,054	7.25	%	$	43,094	8.00	%
Total Risk-Based Capital Ratio	$	69,071	12.82	%	$	43,094	8.00	%	$	49,827	9.25	%	$	53,867	10.00	%
Tier 1 Leverage Ratio	$	65,463	10.44	%	$	25,086	4.00	%	$	32,925	5.25	%	$	31,357	5.00	%
At December 31, 2016:
Common Equity Tier 1 Capital	$	63,057	12.32	%	$	23,039	4.50	%	$	26,239	5.125	%	$	33,279	6.50	%
Tier I Risk-Based Capital Ratio	$	63,057	12.32	%	$	30,719	6.00	%	$	33,919	6.625	%	$	40,959	8.00	%
Total Risk-Based Capital Ratio	$	65,883	12.87	%	$	40,959	8.00	%	$	44,159	8.625	%	$	51,199	10.00	%
Tier 1 Leverage Ratio	$	63,057	10.45	%	$	24,133	4.00	%	$	27,904	4.625	%	$	30,166	5.00	%

The OCC is required to take certain supervisory actions against an undercapitalized FSB, the severity of which depends upon the FSB’s degree of capitalization.  Failure to maintain an appropriate level of capital could cause the OCC to take any one or more of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

Banking regulations also limit the amount of dividends that may be paid without prior approval by an FSB's regulatory agencies.  In addition to these regulations, the Bank agreed in the Operating Agreement that it would not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including the minimum capital requirements.  The Bank received regulatory approval to pay a $23.27 million one-time cash dividend to the Company to be used to purchase all of the outstanding shares of Hopkins common stock in the Hopkins Merger.  Due to the Bank’s desire to preserve capital to fund its growth, the Company currently does not anticipate paying dividends beyond the foregoing described need for the foreseeable future.  In addition to these regulatory restrictions, it should be noted that the declaration of dividends is at the discretion of our Board of Directors and will depend, in part, on our earnings and future capital needs.

59

LIQUIDITY

Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business.  Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the Company’s customers, as well as to meet current and planned expenditures.  Management monitors the liquidity position daily.

Our liquidity is derived primarily from our deposit base, scheduled amortization and prepayments of loans and investment securities, funds provided by operations and capital.  Additionally, liquidity is provided through our portfolios of cash and interest-bearing deposits in other banks, federal funds sold, loans held for sale, and securities available for sale.  While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by the Bank’s competition.

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled $109 million at June 30, 2017.  Management notes that, historically, a small percentage of unused lines of credit are actually drawn down by customers within a 12-month period.

Our most liquid assets are cash and assets that can be readily converted into cash, including interest-bearing deposits with banks and federal funds sold, and investment securities.  At June 30, 2017, we had $8 million in cash and due from banks, $34 million in interest bearing deposits with banks and federal funds sold, and $62 million in investment securities available for sale.

The Bank also has external sources of funds through the Reserve Bank and FHLB, which can be drawn upon when required.  The Bank has a line of credit totaling approximately $158 million with the FHLB of which $42 million was available to be drawn on June 30, 2017 based on outstanding advances and qualifying loans pledged as collateral.  In addition, the Bank can pledge securities at the Reserve Bank and FHLB and, depending on the type of security, may borrow approximately 50% to 97% of the fair market value of the securities.  The Bank had $41 million of securities pledged at the FHLB, $25 thousand of securities pledged at the Reserve Bank, and an additional $27 million of unpledged securities.  Using all securities as collateral, the Bank could borrow approximately $48 million at June 30, 2017.

Additionally, the Bank has unsecured federal funds lines of credit totaling $8.0 million with two institutions and a $4.0 million secured federal funds line of credit with another institution.  The secured federal funds line of credit with another institution would require the Bank to transfer securities currently pledged at the FHLB or the Federal Reserve Bank or to pledge unpledged securities to this institution before it could borrow against this line. In March 2016, the Company and the lender under its unsecured revolving line of credit amended that line to increase the available borrowing limit from $1.0 million to $2.5 million.  The proceeds of the Company’s line of credit may be used for general corporate purposes.  At June 30, 2017, there were outstanding balances of $35 million under the Bank’s FHLB line and $0 under the Company’s other line of credit.

To further aid in managing liquidity, the Bank’s Board of Directors has an Asset/Liability Management Committee (“ALCO”) to review and discuss recommendations for the use of available cash and to maintain an investment portfolio.  By limiting the maturity of securities and maintaining a conservative investment posture, management can rely on the investment portfolio to help meet short-term funding needs.

We believe the Bank has adequate cash on hand and available through liquidation of investment securities and available borrowing capacity to meet our liquidity needs.  Although we believe sufficient liquidity exists, if economic conditions and consumer confidence deteriorate, this liquidity could be depleted, which would then materially affect our ability to meet operating needs and to raise additional capital.

60

MARKET RISK AND INTEREST RATE SENSITIVITY 

Our primary market risk is interest rate fluctuation.  Interest rate risk results primarily from the traditional banking activities in which the Bank engages, such as gathering deposits and extending loans.  Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on liabilities.  Our interest rate risk represents the level of exposure we have to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates.  The ALCO oversees our management of interest rate risk.  The objective of the management of interest rate risk is to maximize stockholder value, enhance profitability and increase capital, serve customer and community needs, and protect us from any material financial consequences associated with changes in interest rate risk.

Interest rate risk is that risk to earnings or capital arising from movement of interest rates.  It arises from differences between the timing of rate changes and the timing of cash flows (repricing risk); from changing rate relationships across yield curves that affect bank activities (basis risk); from changing rate relationships across the spectrum of maturities (yield curve risk); and from interest rate related options embedded in certain bank products (option risk).  Changes in interest rates may also affect a bank’s underlying economic value.  The value of a bank’s assets, liabilities, and interest-rate related, off-balance sheet contracts is affected by a change in rates because the present value of future cash flows, and in some cases the cash flows themselves, is changed.

We believe that accepting some level of interest rate risk is necessary in order to achieve realistic profit goals.  Management and the Board have chosen an interest rate risk profile that is consistent with our strategic business plan.

The Company’s board of directors has established a comprehensive interest rate risk management policy, which is administered by our ALCO.  The policy establishes limits on risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity or “EVE” at risk) resulting from a hypothetical change in U.S. Treasury interest rates.  We measure the potential adverse impacts that changing interest rates may have on our short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling.  The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts.  As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology we employ.  When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model.  Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan customers’ ability to service their debts, or the impact of rate changes on demand for loan and deposit products.

We prepare a current base case and eight alternative simulations at least once a quarter and report the analysis to the board of directors.  In addition, more frequent forecasts are produced when the direction or degree of change in interest rates are particularly uncertain to evaluate the impact of balance sheet strategies or when other business conditions so dictate.

The statement of condition is subject to quarterly testing for eight alternative interest rate shock possibilities to indicate the inherent interest rate risk.  Average interest rates are shocked by +/ - 100, 200, 300, and 400 basis points (“bp”), although we may elect not to use particular scenarios that we determine are impractical in the current rate environment.  It is our goal to structure the balance sheet so that net interest-earnings at risk over a 12-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels.

At June 30, 2017, the simulation analysis reflected that the Bank is in a neutral to slightly liability sensitive position.  Management currently strives to manage higher costing fixed rate funding instruments, while seeking to increase assets that are more fluid in their repricing.  An asset sensitive position, theoretically, is favorable in a rising rate environment since more assets than liabilities will re-price in a given time frame as interest rates rise.  Similarly, a liability sensitive position, theoretically, is favorable in a declining interest rate environment since more liabilities than

61

assets will re-price in a given time frame as interest rates decline.  Management works to maintain a consistent spread between yields on assets and costs of deposits and borrowings, regardless of the direction of interest rates. 

OFF-BALANCE SHEET ARRANGEMENTS 

We also enter into off-balance sheet arrangements in the normal course of business.  These arrangements consist primarily of commitments to extend credit, lines of credit, letters of credit and mortgage loan repurchase obligations.  Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract.  Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee.  Lines of credit generally have variable interest rates.  Such lines generally do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time.  Letters of credit are commitments issued to guarantee the performance of a customer to a third party.  Mortgage loan repurchase obligations arise when loans previously sold by the Bank are required to be repurchased.

Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment.  Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans.  Management is not aware of any accounting loss that we would incur by funding these commitments.

We originate and sell mortgage loans, primarily to other financial institutions, and provide various representations and warranties related to, among other things, the ownership of the loans, the validity of the liens, the loan selection and origination process, and our compliance with the origination criteria established by the purchasing institution.  In the event of a breach of our representations and warranties, we may be obligated to repurchase the loans with identified defects or to indemnify the buyers.  Our contractual obligation arises only when the breach of representations and warranties are discovered and repurchase is demanded.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is a “smaller reporting company” and, as such, disclosure pursuant to this Item 3 is not required.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files under the Exchange Act with the SEC, such as this Quarterly Report on Form 10-Q, 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 the Company’s principal executive officer (“PEO”) 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, a control 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 at June 30, 2017 was carried out under the supervision and with the participation of management, including the PEO and the PAO.  Based on that evaluation, management, including the PEO and the PAO, has concluded that the Company’s disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended June 30, 2017, there were no changes in the Company’s internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

62

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In addition to the legal proceeding disclosed in Item 1 of Part II of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, as updated in Item 3 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, we are at times, in the ordinary course of business, subject to legal actions.  Management, upon the advice of counsel, believes that losses, if any, resulting from current legal actions will not have a material adverse effect on our financial condition or results of operations. 

ITEM 1A. RISK FACTORS

The risks and uncertainties to which the Company’s financial condition and results of operations are subject were discussed in Bay’s Annual Report on Form 10-K for the year ended December 31, 2016.  Management does not believe that any material changes in these risk factors have occurred since they were last disclosed.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4 MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The exhibits filed or furnished with this quarterly report are listed in the exhibit index that immediately follows the signature hereto, 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.

		BAY BANCORP, INC
Date	August 14, 2017	By:	/s/Joseph J. Thomas
			Joseph J. Thomas
			President and Chief Executive Officer
			(Principal Executive Officer)

Date	August 14, 2017	By:	/s/ Larry D. Pickett
			Larry D. Pickett
			Executive Vice President and Chief Financial Officer
			(Principal Accounting Officer)

63

EXHIBIT INDEX

Exhibit No.	Description
10.1	Employment Agreement, dated as of April 14, 2017, among Joseph J. Thomas, Bay Bank, FSB and  Bay Bancorp, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 14, 2017)
31.1	Rule 13a-14(a) Certification by the Principal Accounting Officer (filed herewith)
31.2	Rule 13a-14(a) Certification by the Principal Accounting Officer (filed herewith)
32.1	Certification by the Principal Executive Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)
32.2	Certification by the Principal Accounting Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)
101	Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith)

64