Note 3. Loans, Allowance for Credit Losses and Impaired Loans

Major categories of loans as of June 30, 2019 and December 31, 2018 are as follows:


(Dollars in thousands)	At June 30, 2019		At December 31, 2018
Originated Loans
Other real estate secured	$	373,082	$	356,141
1 - 4 Family residential secured		119,036		116,771
Other		52,612		48,960
		544,730		521,872
Acquired Loans
Other real estate secured	$	63,310	$	70,080
1 - 4 Family residential secured		27,493		29,532
Other		12,075		12,420
		102,878		112,032
Total Loans
Other real estate secured	$	436,392	$	426,221
1 - 4 Family residential secured		146,529		146,303
Other		64,687		61,379
		647,608		633,903
Less: Unamortized discounts on acquired loans		(893)		(1,327)
Less: Allowance for loan losses		(7,066)		(7,063)
	$	639,649	$	625,513

Allowance for Loan Losses

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented the loan portfolio into the following classifications:

Other Real Estate Secured

Commercial Real Estate

Construction and Land Development

Farmland

Multifamily

1 – 4 Family Residential Secured

Other

Commercial and Industrial

Consumer Loans

Other Loans

Each of these segments are reviewed and analyzed quarterly using the weighted average historical charge‑offs over a current three year period for their respective segments as well as the following qualitative factors:

Changes in the levels and trends in delinquencies, non‑accruals, classified assets and troubled debt restructurings

Changes in the nature and volume of the portfolio

Effects of any changes in lending policies, procedures, including underwriting standards and collections, charge off and recovery practices

Changes in the experience, depth and ability of management

Changes in the national and local economic conditions and developments, including the condition of various market segments

Changes in the concentration of credits within each pool

Changes in the quality of the Bank's loan review system and the degree of oversight by the Board

Changes in external factors such as competition and the legal environment.

The above factors result in a FAS 5, as codified in FASB ASC 450‑10‑ 20, calculated reserve for environmental factors.

All credit exposures graded at a rating of “5”, “6”, “7” or “8” with outstanding balances less than or equal to $250,000 and credit exposures graded at a rating of “1”, “2”, “3” or “4” are reviewed and analyzed quarterly using the weighted average historical charge‑offs over a current three year period as a percentage of total charge‑offs for the same period for their respective segments as well as the qualitative factors discussed above. The weighted average historical percentage is further adjusted based on delinquency risk trend assessments and concentration risk assessments.

All credit exposures graded at a rating of “5”, “6”, “7” or “8” with outstanding balances greater than $250,000 are to be reviewed no less than quarterly for the purpose of determining if a specific allocation is needed for that credit. The determination for a specific reserve is measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases management uses the current fair value of the collateral, less selling cost when foreclosure is probable, instead of discounted cash flows. If management determines that the value of the loan is less than the recorded investment in the loan (net of previous charge‑offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge‑off to the allowance.

The establishment of a specific reserve does not necessarily mean that the credit with the specific reserve will definitely incur loss at the reserve level. It is only an estimation of potential loss based upon anticipated events. A specific reserve will not be established unless loss elements can be determined and quantified based on known facts. The total allowance reflects management's estimate of loan losses inherent in the loan portfolio as of June 30, 2019 and December 31, 2018.

The following tables include impairment information relating to loans and the allowance for credit losses as of June 30, 2019 and and December 31, 2018:


	Other		1 - 4 Family
	Real Estate		Residential
Dollars in Thousands	Secured		Secured		Other		Unallocated		Total
June 30, 2019
Individually evaluated for impairment:
Balance in allowance	$	164	$	265	$	169	$	—	$	598
Related loan balance		13,851		4,574		431		—		18,856
Collectively evaluated for impairment:
Balance in allowance	$	4,195	$	1,078	$	465	$	730	$	6,468
Related loan balance		422,082		141,703		64,074		—		627,859

Note: The balances above include unamortized discounts on acquired loans of $893,000.


	Other		1 - 4 Family
	Real Estate		Residential
Dollars in Thousands	Secured		Secured		Other		Unallocated		Total
December 31, 2018
Individually evaluated for impairment:
Balance in allowance	$	278	$	586	$	178	$	—	$	1,042
Related loan balance		14,947		8,775		1,732		—		25,454
Collectively evaluated for impairment:
Balance in allowance	$	3,998	$	1,057	$	476	$	490	$	6,021
Related loan balance		410,527		137,192		59,403		—		607,122

Note: The balances above include unamortized discounts on acquired loans of $1.3 million.

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, 2019 and 2018. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.


	June 30, 2019
	Other		1 - 4 Family
	Real Estate		Residential
Dollars in Thousands	Secured		Secured		Other		Unallocated		Total
Quarter Ended:
Beginning Balance	$	4,295	$	1,644	$	667	$	457	$	7,063
Charge-offs		(220)		(193)		(43)		—		(456)
Recoveries		8		139		12		—		159
Provision		276		(247)		(2)		273		300
Ending Balance		4,359		1,343		634		730		7,066
Six Months Ended:
Beginning Balance		4,276		1,643		654		490		7,063
Charge-offs		(421)		(198)		(178)		—		(797)
Recoveries		13		141		46		—		200
Provision		491		(243)		112		240		600
Ending Balance		4,359		1,343		634		730		7,066


	June 30, 2018
	Other		1 - 4 Family
	Real Estate		Residential
Dollars in Thousands	Secured		Secured		Other		Unallocated		Total
Quarter Ended:
Beginning Balance	$	4,249	$	1,802	$	514	$	459	$	7,024
Charge-offs		(204)		(8)		(71)		—		(283)
Recoveries		3		55		22		—		80
Provision		386		38		(21)		(128)		275
Ending Balance		4,434		1,887		444		331		7,096
Six Months Ended:
Beginning Balance		3,858		1,744		536		565		6,703
Charge-offs		(204)		(52)		(118)		—		(374)
Recoveries		68		124		50		—		242
Provision		712		71		(24)		(234)		525
Ending Balance		4,434		1,887		444		331		7,096

The Bank had an unallocated amount (overage) of approximately $730,000 in the allowance that is reflected in the above table as of June 30, 2019. The Bank had an unallocated amount (overage) of approximately $331,000 in the allowance that is reflected in the above table as of June 30, 2018. Management is comfortable with this amount as they feel it is adequate to absorb additional inherent but as yet unidentified losses in the loan portfolio.

Credit Quality Information

The following table represents credit exposures by creditworthiness category at June 30, 2019 and December 31, 2018. The use of creditworthiness categories to grade loans permits management to estimate a portion of credit risk. The Bank's internal creditworthiness is based on experience with similarly graded credits. Loans that trend upward toward higher credit grades typically have less credit risk and loans that migrate downward typically have more credit risk.

The Bank's internal risk ratings are as follows:

Excellent — minimal risk. Normally supported by pledged deposits, United States government securities, etc.

Superior — low risk. All of the risks associated with this credit based on each of the bank's creditworthiness criteria are minimal.

Good — moderately low risk. Most of the risks associated with this credit based on each of the bank's creditworthiness criteria are minimal.

Fair/Watch — moderate risk. The weighted overall risk associated with this credit based on each of the bank's creditworthiness criteria is acceptable.

Marginal — moderately high risk. (possesses deficiencies which corrective action by the bank would remedy; potential watch list)

Substandard — The bank is inadequately protected and there exists the distinct possibility of sustaining some loss if not corrected.

Doubtful — Weaknesses make collection or liquidation in full, based on currently existing facts, improbable.

Loss — Of little value; not warranted as a bankable asset.

Non‑accruals

In general, a loan will be placed on non‑accrual status at the end of the reporting month in which the interest or principal is past due more than 90 days. Exceptions to the policy are those loans that are in the process of collection and are well-secured. A well‑secured loan is secured by collateral with sufficient market value to repay principal and all accrued interest.

A summary of loans by risk rating is as follows:


			1 - 4 Family
	Other Real		Residential
June 30, 2019	Estate Secured		Secured		Other		Total
	Dollars in Thousands
Excellent	$	1,114	$	—	$	11,187	$	12,301
Superior		3,844		255		1,923		6,022
Good		418,145		139,073		48,436		605,654
Fair		5,381		3,503		1,206		10,090
Marginal		—		117		—		117
Substandard		7,449		3,329		1,753		12,531
TOTAL	$	435,933	$	146,277	$	64,505	$	646,715
Non-Accrual	$	2,713	$	2,100	$	169	$	4,982
Troubled debt restructures	$	7,460	$	2,468	$	1,194	$	11,122
Breakdown of TDRs
TDRs on Non-accrual	$	1,123	$	932	$	169	$	2,224
TDRs Past Due 30-89		—		404		—		404
Performing TDRs		6,337		1,132		1,025		8,494
TOTAL	$	7,460	$	2,468	$	1,194	$	11,122
Total Non-performing TDR accounts	$	1,123	$	1,336	$	169	$	2,628


			1 - 4 Family
	Other Real		Residential
December 31, 2018	Estate Secured		Secured		Other		Total
	Dollars in Thousands
Excellent	$	1,143	$	—	$	9,756	$	10,899
Superior		7,523		267		2,015		9,805
Good		402,092		133,401		45,802		581,295
Fair		8,084		4,598		2,106		14,788
Marginal		407		112		268		787
Substandard		7,071		7,589		343		15,003
TOTAL	$	426,319	$	145,967	$	60,290	$	632,576
Non-Accrual	$	4,423	$	4,547	$	178	$	9,148
Troubled debt restructures	$	10,341	$	7,269	$	206	$	17,816
Breakdown of TDRs
TDRs on Non-accrual	$	2,546	$	3,290	$	175	$	6,012
TDRs Past Due 30-89		640		—		31		671
Performing TDRs		7,155		3,979		—		11,134
TOTAL	$	10,341	$	7,269	$	206	$	17,816
Total Non-performing TDR accounts	$	3,186	$	3,290	$	206	$	6,682

The following table includes an aging analysis of the recorded investment of past due financing receivables as of June 30, 2019 and December 31, 2018:


													Recorded
													Investment
					Greater than						Total		>90 Days
	30 - 59 Days		60 - 89 Days		90 Days		Total		Current		Financing		Past Due
At June 30, 2019	Past Due*		Past Due		Past Due**		Past Due		Balance		Receivables		and Accruing
	Dollars in Thousands
Other Real Estate Secured	$	777	$	1,195	$	1,718	$	3,690	$	432,702	$	436,392	$	—
1 - 4 Family Residential		1,708		517		1,006		3,231		143,298		146,529		156
Other		105		485		—		590		64,097		64,687		—
TOTAL	$	2,590	$	2,197	$	2,724	$	7,511	$	640,097	$	647,608	$	156

* Includes $817,000 of non‑accrual loans.

** Includes $2.5 million of non-accrual loans.

Total financing receivable balances do not include unamortized discounts of $893,000.


													Recorded
													Investment
					Greater than						Total		>90 Days
	30 - 59 Days		60 - 89 Days		90 Days		Total		Current		Financing		Past Due
At December 31, 2018	Past Due		Past Due		Past Due*		Past Due		Balance		Receivables		and Accruing
	Dollars in Thousands
Other Real Estate Secured	$	876	$	1,742	$	3,129	$	5,747	$	420,474	$	426,221	$	338
1 - 4 Family Residential		1,292		383		1,722		3,397		142,906		146,303		—
Other		1,035		33		268		1,336		60,043		61,379		268
TOTAL	$	3,203	$	2,158	$	5,119	$	10,480	$	623,423	$	633,903	$	606

* Includes $4.5 million of non‑accrual loans.

Total financing receivable balances do not include unamortized discounts of $1.3 million.

Impaired Loans

Impaired loans are defined as non‑accrual loans, troubled debt restructurings, purchase credit impaired loans (“PCI”) and loans risk rated a “6” or above. When management identifies a loan as impaired, the impairment is measured for potential loss based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases management used the current fair value of the collateral, less selling cost when foreclosure is probable, instead of discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge‑offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge‑off to the allowance.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on non‑accrual status, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on non‑accrual status, contractual interest is credited to interest income when received, under the cash basis method.

The following table includes the recorded investment and unpaid principal balances for impaired financing receivables with the associated allowance amount, if applicable. Management determined the specific reserve in the allowance based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the remaining source of repayment for the loan is the operation or liquidation of the collateral. In those cases, the current fair value of the collateral, less selling costs was used to determine the specific allowance recorded.

Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on non‑accrual status, all payments are applied to principal, under the cost recovery method.


			Unpaid		Interest				Average
	Recorded		Principal		Income		Specific		Recorded
June 30, 2019	Investment		Balance		Recognized		Reserve		Investment
	Dollars in Thousands
Impaired loans with specific reserves:
Other Real Estate Secured	$	2,528	$	2,528	$	118	$	164	$	2,902
1 - 4 Family Residential Secured		749		749		—		265		2,348
Other		169		169		—		169		107
Total impaired loans with specific reserves	$	3,446	$	3,446	$	118	$	598	$	5,357
Impaired loans with no specific reserve:
Other Real Estate Secured	$	12,121	$	12,605	$	493	$	—	$	12,485
1 - 4 Family Residential Secured		4,209		5,443		113		—		4,985
Other		1,583		1,583		59		—		1,694
Total impaired loans with no specific reserve	$	17,913	$	19,631	$	665	—	—	$	19,164
TOTAL	$	21,359	$	23,077	$	783	$	598	$	24,521

Total impaired loans of $21.4 million at June 30, 2019 include PCI loan balances of $1.0 million, which are net of a discount of $379,000. Total impaired loans also included $1.4 million of loans which did not meet the criteria whereby an individual evaluation for impairment was required. These loans were pooled with all other loans not requiring an evaluation for individual impairment and reviewed and analyzed using the weighted average historical charge‑offs over a current three year period for their respective segments along with the qualitative factors stated previously in this disclosure, to result in a ASC 450‑10‑20 (FAS 5) calculated reserve.


			Unpaid		Interest				Average
	Recorded		Principal		Income		Specific		Recorded
December 31, 2018	Investment		Balance		Recognized		Reserve		Investment
	Dollars in Thousands
Impaired loans with specific reserves:
Other Real Estate Secured	$	3,276	$	3,276	$	246	$	412	$	3,690
1 - 4 Family Residential Secured		3,947		4,075		174		586		4,989
Other		44		44		2		44		22
Total impaired loans with specific reserves	$	7,267	$	7,395	$	422	$	1,042	$	8,701
Impaired loans with no specific reserve:
Other Real Estate Secured	$	12,849	$	13,905	$	1,016	$	—	$	10,691
1 - 4 Family Residential Secured		5,761		7,011		256		—		3,902
Other		1,805		1,805		112		—		1,080
Total impaired loans with no specific reserve	$	20,415	$	22,721	$	1,384	$	—	$	15,672
TOTAL	$	27,682	$	30,116	$	1,806	$	1,042	$	24,374

All acquired loans were initially recorded at fair value at the acquisition date. The outstanding balance and the carrying amount of acquired loans included in the consolidated balance sheet are as follows:


Dollars in Thousands	June 30, 2019		December 31, 2018
Accountable for under ASC 310-30 (PCI loans)
Outstanding balance	$	1,424	$	1,692
Carrying amount		1,045		1,110
Accountable for under ASC 310-20 (non-PCI loans)
Outstanding balance	$	101,454	$	110,340
Carrying amount		100,940		109,595
Total acquired loans
Outstanding balance	$	102,878	$	112,032
Carrying amount		101,985		110,705

The following table provides changes in accretable yield for all acquired loans accounted for under ASC 310‑20:


Dollars in Thousands	June 30, 2019		December 31, 2018
Balance at beginning of period	$	745	$	—
Acquisitions		—		1,703
Accretion		(231)		(958)
Balance at end of period	$	514	$	745

During the three months and six months ended June 30, 2019, the Company recorded $28,000 and $56,000, respectively in accretion on acquired loans accounted for under ASC 310-30. During the three months and six months ended June 30, 2018, the Company recorded $32,000 in accretion on acquired loans accounted for under ASC 310-30.

Non‑accretable yield on purchased credit impaired loans was $323,000 and $463,000 at June 30, 2019 and December 31, 2018, respectively.

Concentration of Risk:

The Bank makes loans to customers located primarily within Wicomico and Worcester Counties, Maryland, Sussex County, Delaware and Camden and Burlington Counties, New Jersey. A substantial portion of its loan portfolio consists of residential and commercial real estate mortgages.

The Bank had no commitments to loan additional funds to the borrowers of restructured, impaired, or non‑accrual loans as of June 30, 2019 and December 31, 2018.