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Loans and Allowance for Credit Losses

6 Months Ended

Jun. 30, 2020

Loans and Allowance for Credit Losses [Abstract]

Note 5 – Loans and Allowance for Credit Losses

The Company makes residential mortgage, commercial and consumer loans to customers primarily in Talbot County, Queen Anne’s County, Kent County, Caroline County, Dorchester County, Wicomico County, Baltimore County and Howard County in Maryland, Kent County, Delaware and Accomack County, Virginia. The following table provides information about the principal classes of the loan portfolio at June 30, 2020 and December 31, 2019.


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

Loans are stated at their principal amount outstanding net of any purchase premiums/discounts, deferred fees and costs. Loans included deferred costs, net of deferred fees, of $470 thousand and discounts on acquired loans of $912 thousand at June 30, 2020. Loans included deferred costs, net of deferred fees, of $1.8 million and discounts on acquired loans of $1.1 million at December 31, 2019. At June 30, 2020 and December 31, 2019, included in total loans were $72.9 million and $79.2 million in loans, respectively, acquired as part of the NWBI branch acquisition in 2017. Interest income on loans is accrued at the contractual rate based on the principal amount outstanding. Fees charged and costs capitalized for originating loans are being amortized substantially on the interest method over the term of the loan. A loan is placed on nonaccrual (i.e., interest income is no longer accrued) when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more, unless the loan is well secured and in the process of collection. Any unpaid interest previously accrued on those loans is reversed from income.

Interest payments received on nonaccrual loans are applied as a reduction of the loan principal balance unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

A loan is considered impaired if it is probable that the Company will not collect all principal and interest payments according to the loan’s contractual terms when due. An impaired loan may show deficiencies in the borrower’s overall financial condition, payment history, support available from financial guarantors and/or the fair market value of collateral.

The impairment of a loan is measured at the present value of expected future cash flows using the loan’s effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Generally, the Company measures impairment on such loans by reference to the fair value of the collateral. Once the amount of impairment has been determined, the uncollectible portion is charged off. Loan payments received on nonaccrual impaired loans are generally applied to the outstanding principal balance. In certain circumstances, income may be recognized on a cash basis. Generally, interest income is not recognized on impaired loans unless the likelihood of further loss is remote. The allowance for credit losses may include specific reserves related to impaired loans. Specific reserves remain until charge offs are made. Impaired loans do not include groups of smaller balance homogenous loans such as residential mortgage and consumer installment loans that are evaluated collectively for impairment. Reserves for probable credit losses related to these loans are based on historical loss ratios and are included in the formula portion of the allowance for credit losses. See additional discussion under the caption “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

A loan is considered a TDR if a borrower is experiencing financial difficulties and a creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Loans are identified to be restructured when signs of impairment arise such as borrower interest rate reduction request, slowness to pay, or when an inability to repay becomes evident. The terms being offered are evaluated to determine if they are more liberal than those that would be indicated by policy or industry standards for similar, untroubled credits. In those situations where the terms or the interest rates are considered to be more favorable than industry standards or the Bank’s current underwriting guidelines the loan is classified as a TDR. All loans designated as TDRs are considered impaired loans and may be on either accrual or nonaccrual status. In instances where the loan has been placed on nonaccrual status, six consecutive months of timely payments are required prior to returning the loan to accrual status.

All loans classified as TDRs which are restructured and accrue interest under revised terms require a full and comprehensive review of the borrower’s financial condition, capacity for repayment, realistic assessment of collateral values, and the assessment of risk entered into any workout agreement. Current financial information on the borrower, guarantor, and underlying collateral is analyzed to determine if it supports the ultimate collection of principal and interest. For commercial loans, the cash flows are analyzed, both for the underlying project and globally. For consumer loans, updated salary, credit history and cash flow information is obtained. Current market conditions are also considered. Following a full analysis, the determination of the appropriate loan structure is made.

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

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

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

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

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

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

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

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer

Total

June 30, 2020

Loans individually evaluated for impairment

335

7,775

10,884

571

—

19,565

Loans collectively evaluated for impairment

110,322

422,661

615,455

214,045

25,201

1,387,684

Total loans

110,657

430,436

626,339

214,616

25,201

1,407,249

Allowance for credit losses allocated to:

Loans individually evaluated for impairment

—

265

—

346

Loans collectively evaluated for impairment

1,497

2,374

4,016

2,355

502

10,744

Total allowance

1,497

2,639

4,097

2,355

502

11,090


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

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

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

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

The following tables provide information on impaired loans and any related allowance by loan class as of June 30, 2020 and December 31, 2019. The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken and interest paid on nonaccrual loans that has been applied to principal.



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

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

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

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



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

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

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

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

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


	1/1/2020												6/30/2020
	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For six months ended
June 30, 2020
Accruing TDRs
Construction	$	41	$	—	$	(3)	$	—	$	—	$	—	$	38	$	—
Residential real estate		4,041		—		(53)		—		—		(83)		3,905		190
Commercial real estate		3,419		—		(50)		—		—		—		3,369		14
Commercial		—		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—		—
Total	$	7,501	$	—	$	(106)	$	—	$	—	$	(83)	$	7,312	$	204

Nonaccrual TDRs
Construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate		1,393		—		(51)		—		—		—		1,342		75
Commercial real estate		—		1,506		(373)		—		—		—		1,133		—
Commercial		299		—		(19)		—		—		—		280		—
Consumer		—		—		—		—		—		—		—		—
Total	$	1,692	$	1,506	$	(443)	$	—	$	—	$	—	$	2,755	$	75

Total	$	9,193	$	1,506	$	(549)	$	—	$	—	$	(83)	$	10,067	$	279


	1/1/2019												6/30/2019
	TDR		New		Disbursements		Charge-		Reclassifications/				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		Transfer In/(Out)		Payoffs		Balance		Allowance
For six months ended
June 30, 2019
Accruing TDRs
Construction	$	51	$	—	$	(6)	$	—	$	—	$	—	$	45	$	—
Residential real estate		4,454		—		(45)		—		—		(197)		4,212		230
Commercial real estate		4,158		—		(647)		—		—		—		3,511		25
Commercial		—		—		—		—		—		—		—		—
Consumer		—		—		—		—		—		—		—		—
Total	$	8,663	$	—	$	(698)	$	—	$	—	$	(197)	$	7,768	$	255

Nonaccrual TDRs
Construction	$	2,798	$	—	$	(1,346)	$	(3)	$	—	$	—	$	1,449	$	152
Residential real estate		—		—		—		—		—		—		—		—
Commercial real estate		—		—		—		—		—		—		—		—
Commercial		320		—		(9)		—		—		—		311		7
Consumer		—		—		—		—		—		—		—		—
Total	$	3,118	$	—	$	(1,355)	$	(3)	$	—	$	—	$	1,760	$	159

Total	$	11,781	$	—	$	(2,053)	$	(3)	$	—	$	(197)	$	9,528	$	414

There were no loans modified and considered TDRs during the three months ended June 30, 2020 and 2019. The following tables provide information on loans that were modified and considered TDRs during the six months ended June 30, 2020 and June 30, 2019.


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

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

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

There were no TDRs which subsequently defaulted within 12 months of modification for the three and six months ended June 30, 2020 and 2019. Generally, a loan is considered in default when principal or interest is past due 90 days or more, the loan is placed on nonaccrual, the loan is charged off, or there is a transfer to OREO or repossessed assets.

Management uses risk ratings as part of its monitoring of the credit quality in the Company’s loan portfolio. Loans that are identified as special mention, substandard or doubtful are adversely rated. These loans and the pass/watch loans are assigned higher qualitative factors than favorably rated loans in the calculation of the formula portion of the allowance for credit losses. At June 30, 2020, there were no nonaccrual loans classified as special mention or doubtful and $11.6 million of nonaccrual loans were classified as substandard. Similarly, at December 31, 2019, there were no nonaccrual loans classified as special mention or doubtful and $10.6 million of nonaccrual loans were classified as substandard.

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

Special

(Dollars in thousands)

Pass/Performing

Pass/Watch

Mention

Substandard

Doubtful

Total

June 30, 2020

Construction

91,746

16,551

2,063

297

—

110,657

Residential real estate

392,692

29,518

3,845

4,381

—

430,436

Commercial real estate

488,095

120,113

6,303

11,828

—

626,339

Commercial

184,908

26,023

3,105

580

—

214,616

Consumer

24,864

332

—

25,201

Total

1,182,305

192,537

15,316

17,091

—

1,407,249


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

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

Accruing

30‑59 days

60‑89 days

Greater than

Total

(Dollars in thousands)

Current

past due

90 days

past due

Nonaccrual

Total

June 30, 2020

Construction

110,259

101

—

101

297

110,657

Residential real estate

425,440

663

463

1,180

3,816

430,436

Commercial real estate

618,524

—

300

527

827

6,988

626,339

Commercial

213,919

121

—

149

548

214,616

Consumer

25,134

—

25,201

Total

1,393,276

900

820

604

2,324

11,649

1,407,249

Percent of total loans

99.0

0.1

—

0.2

0.8

100.0


	Accruing
				30‑59 days			60‑89 days			Greater than			Total
(Dollars in thousands)	Current			past due			past due			90 days			past due			Nonaccrual			Total
December 31, 2019
Construction	$	99,234		$	595		$	—		$	—		$	595		$	—		$	99,829
Residential real estate		435,671			3,021			783			556			4,360			2,475			442,506
Commercial real estate		577,015			743			217			770			1,730			7,817			586,562
Commercial		101,476			246			—			—			246			298			102,020
Consumer		17,680			57			—			—			57			—			17,737
Total	$	1,231,076		$	4,662		$	1,000		$	1,326		$	6,988		$	10,590		$	1,248,654
Percent of total loans		98.6	%		0.4	%		0.1	%		0.1	%		0.6	%		0.8	%		100.0	%

The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three and six months ended June 30, 2020 and June 30, 2019. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer

Total

For three months ended

June 30, 2020

Allowance for credit losses:

Beginning Balance

1,128

2,482

3,965

2,263

540

10,378

Charge-offs

—

(331)

(37)

—

(368)

Recoveries

—

Net charge-offs

(331)

(288)

Provision

364

153

463

(48)

1,000

Ending Balance

1,497

2,639

4,097

2,355

502

11,090


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

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

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

Residential

Commercial

(Dollars in thousands)

Construction

real estate

Commercial

Consumer

Total

For six months ended

June 30, 2020

Allowance for credit losses:

Beginning Balance

1,576

2,501

4,032

1,929

469

10,507

Charge-offs

—

(191)

(601)

(119)

(7)

(918)

Recoveries

—

124

151

Net charge-offs

(184)

(601)

(767)

Provision

(87)

322

666

421

1,350

Ending Balance

1,497

2,639

4,097

2,355

502

11,090


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

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

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

Foreclosure Proceedings

Consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure totaled $23 thousand as of June 30, 2020 and December 31, 2019, respectively. There were no residential real estate properties included in the balance of other real estate owned at June 30, 2020 and December 31, 2019.

All accruing TDRs were in compliance with their modified terms. Both performing and non-performing TDRs had no further commitments associated with them as of June 30, 2020 and December 31, 2019.