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

Major categories of loans as of December 31 are as follows:


(Dollars in thousands)	At December 31, 2019		At December 31, 2018
Originated Loans
Real Estate Mortgage
Construction and land development	$	59,236	$	63,376
Residential real estate		108,590		102,970
Nonresidential		325,916		292,766
Home equity loans		13,736		13,801
Commercial		52,838		46,059
Consumer and other loans		2,669		2,900
		562,985		521,872
Acquired Loans
Real Estate Mortgage
Construction and land development	$	26,034	$	10,276
Residential real estate		101,088		22,431
Nonresidential		222,075		59,804
Home equity loans		24,176		7,101
Commercial		60,675		12,406
Consumer and other loans		3,091		13
		437,139		112,031
Total Loans
Real Estate Mortgage
Construction and land development	$	85,270	$	73,652
Residential real estate		209,678		125,401
Nonresidential		547,991		352,570
Home equity loans		37,912		20,902
Commercial		113,513		58,465
Consumer and other loans		5,760		2,913
		1,000,124		633,903
Less: Unamortized discounts on acquired loans		(6,136)		(1,327)
Less: Allowance for loan losses		(7,304)		(7,063)
	$	986,684	$	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 Company has segmented the loan portfolio into the following classifications:

Real Estate Mortgage

Construction and Land Development

Residential Real Estate

Nonresidential

Home Equity Loans

Commercial

Consumer and 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 Company'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 considered to have a non-pass rating with outstanding balances less than $250 thousand and all credit exposures considered to have a pass rating 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 considered to have non-pass rating with outstanding balances greater than $250 thousand 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 December 31, 2019 and 2018.

The following table presents the total allowance by loan segment.


	Real Estate Mortgage
	Construction
	and Land		Residential								Consumer
Dollars in Thousands	Development		Real Estate		Nonresidential		Home Equity		Commercial		and Other		Unallocated		Total
Balance at December 31, 2018
Beginning Balance - originated loans	$	647	$	1,521	$	3,620	$	115	$	625	$	13	$	490	$	7,031
Charge‑offs—originated loans		(11)		(193)		(460)		(105)		(689)		(126)		—		(1,584)
Recoveries—originated loans		11		182		92		—		51		48		—		384
Provision—originated loans		(45)		(130)		813		125		823		79		(224)		1,441
Allowance allocation adjustment		(5)		(17)		(6)		7		(26)		—		—		(47)
Total Allowance on originated loans		597		1,363		4,059		142		784		14		266		7,225
Beginning Balance - acquired loans		—		—		9		7		16		—		—		32
Charge‑offs—acquired loans		—		—		—		—		—		—		—		—
Recoveries—acquired loans		—		—		—		—		—		—		—		—
Provision—acquired loans		—		—		—		—		—		—		—		—
Allowance allocation adjustment		5		17		6		(7)		26		—		—		47
Total Allowance on acquired loans		5		17		15		—		42		—		—		79
Balance at December 31, 2019		602		1,380		4,074		142		826		14		266		7,304
Individually evaluated for impairment:
Balance in allowance	$	—	$	216	$	82	$	—	$	274	$	—	$	—	$	572
Related loan balance		723		3,905		11,449		9		2,238		—		—		18,324
Collectively evaluated for impairment:
Balance in allowance	$	602	$	1,164	$	3,992	$	142	$	552	$	14	$	266	$	6,732
Related loan balance		84,027		205,381		533,101		37,706		109,759		5,690		—		975,664

Note: The balances above include unamortized discounts on acquired loans of $6.1 million.


	Real Estate Mortgage
	Construction
	and Land		Residential								Consumer
Dollars in Thousands	Development		Real Estate		Nonresidential		Home Equity		Commercial		and Other		Unallocated		Total
Balance at December 31, 2017	$	589	$	1,583	$	3,269	$	161	$	520	$	16	$	565	$	6,703
Charge‑offs—originated loans		(58)		(332)		(453)		(20)		(129)		(161)		—		(1,153)
Recoveries—originated loans		9		109		80		41		48		51		—		338
Provision—originated loans		107		161		733		(60)		202		107		(75)		1,175
Allowance allocation adjustment		—		—		(9)		(7)		(16)		—		—		(32)
Total Allowance on originated loans		647		1,521		3,620		115		625		13		490		7,031
Charge‑offs—acquired loans		—		—		—		—		—		—		—		—
Recoveries—acquired loans		—		—		—		—		—		—		—		—
Provision—acquired loans		—		—		—		—		—		—		—		—
Allowance allocation adjustment		—		—		9		7		16		—		—		32
Total Allowance on acquired loans		—		—		9		7		16		—		—		32
Balance at December 31, 2018		647		1,521		3,629		122		641		13		490		7,063
Individually evaluated for impairment:
Balance in allowance	$	—	$	580	$	278	$	6	$	178	$	—	$	—	$	1,042
Related loan balance		8,708		8,082		6,239		693		1,732		—		—		25,454
Collectively evaluated for impairment:
Balance in allowance	$	647	$	941	$	3,351	$	116	$	463	$	13	$	490	$	6,021
Related loan balance		64,943		117,104		345,583		20,088		56,490		2,914		—		607,122

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

The Company had an unallocated amount (overage) of approximately $266 thousand in the allowance that is reflected in the above table as of December 31, 2019. The Company had an unallocated amount (overage) of approximately $490 thousand in the allowance that is reflected in the above table as of December 31, 2018. Management is comfortable with this amount as they feel it is adequate to absorb additional inherent potential losses in the loan portfolio.

Credit Quality Information

The following table represents credit exposures by creditworthiness category for the period ending December 31, 2019. The use of creditworthiness categories to grade loans permits management to estimate a portion of credit risk. The Company'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 Company'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. Interest that would have accrued under the terms of loans that were placed on nonaccrual totaled $255 thousand and $329 thousand for the years ended December 31, 2019 and 2018, respectively. Loans past due 90 days or more and still accruing interest totaled $5 thousand and $606 thousand for the years ended December 31, 2019 and 2018 respectively. Management believes these particular loans are well secured and are in the process of collection of all amounts owed.

A summary of loans by risk rating is as follows:


	Real Estate Secured
	Construction &
	Land		Residential								Consumer &
December 31, 2019	Development		Real Estate		Nonresidential		Home Equity		Commercial		Other		Total
	Dollars in Thousands
Excellent	$	—	$	—	$	405	$	—	$	6,089	$	111	$	6,605
Superior		—		139		3,652		122		1,818		1		5,732
Good		83,773		200,999		525,465		37,528		99,973		5,557		953,295
Fair		757		3,373		7,710		64		1,710		20		13,634
Marginal		—		511		—		—		—		—		511
Substandard		221		4,264		7,319		—		2,407		—		14,211
TOTAL	$	84,751	$	209,286	$	544,551	$	37,714	$	111,997	$	5,689	$	993,988
Non-Accrual	$	177	$	1,620	$	2,608	$	5	$	131	$	—	$	4,541
Troubled debt restructures	$	—	$	2,323	$	7,934	$	—	$	38	$	—	$	10,295
Number of TDR accounts		—		12		20		—		1		—		33
Breakdown of TDRs
TDRs on Non-accrual	$	—	$	904	$	926	$	—	$	38	$	—	$	1,868
TDRs Past Due 30-89		—		—		—		—		—		—		—
Performing TDRs		—		1,419		7,008		—		—		—		8,427
TOTAL	$	—	$	2,323	$	7,934	$	—	$	38	$	—	$	10,295
Total Non-performing TDR accounts	$	—	$	904	$	926	$	—	$	38	$	—	$	1,868
Number of non‑performing TDRs		—		3		3		—		1		—		7


	Real Estate Secured
	Construction &
	Land		Residential								Consumer &
December 31, 2018	Development		Real Estate		Nonresidential		Home Equity		Commercial		Other		Total
	Dollars in Thousands
Excellent	$	—	$	—	$	1,143	$	—	$	9,631	$	125	$	10,899
Superior		—		156		7,523		110		2,011		4		9,805
Good		73,069		113,777		328,178		19,624		43,863		2,785		581,295
Fair		25		3,658		8,059		941		2,106		—		14,788
Marginal		338		112		69		—		268		—		787
Substandard		220		7,482		6,851		107		343		—		15,003
TOTAL	$	73,652	$	125,185	$	351,823	$	20,782	$	58,222	$	2,914	$	632,576
Non-Accrual	$	220	$	4,440	$	4,203	$	107	$	178	$	—	$	9,148
Troubled debt restructures	$	40	$	7,162	$	10,301	$	107	$	—	$	206	$	17,816
Number of TDR accounts		1		20		27		1		—		3		52
Breakdown of TDRs
TDRs on Non-accrual	$	40	$	3,183	$	2,506	$	107	$	—	$	175	$	6,012
TDRs Past Due 30-89		—		—		640		—		—		31		671
Performing TDRs		—		3,979		7,155		—		—		—		11,134
TOTAL	$	40	$	7,162	$	10,301	$	107	$	—	$	206	$	17,816
Total Non-performing TDR accounts	$	40	$	3,183	$	3,146	$	107	$	—	$	206	$	6,682
Number of non‑performing TDRs		1		9		9		1		—		3		23

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


													Recorded
													Investment
					Greater than						Total		>90 Days
	30 - 59 Days		60 - 89 Days		90 Days		Total		Current		Financing		Past Due
At December 31, 2019	Past Due*		Past Due**		Past Due***		Past Due		Balance		Receivables**		and Accruing
	Dollars in Thousands
Real Estate
Constructions and land development	$	424	$	—	$	177	$	601	$	84,669	$	85,270	$	—
Residential		1,296		677		702		2,675		207,003		209,678		—
Nonresidential		635		144		1,823		2,602		545,389		547,991		—
Home equity loans		—		—		—		—		37,912		37,912		—
Commercial		231		1,207		94		1,532		111,981		113,513		—
Consumer and other loans		1		19		—		20		5,740		5,760		5
TOTAL	$	2,587	$	2,047	$	2,796	$	7,430	$	992,694	$	1,000,124	$	5

* Includes $956 thousand of non‑accrual loans.

** Includes $81 thousand of non-accrual loans.

*** Includes $2.6 million of non-accrual loans.

Total financing receivable balances do not include unamortized discounts of $6.1 million.


													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
Real Estate
Constructions and land development	$	9	$	200	$	378	$	587	$	73,065	$	73,652	$	338
Residential		1,277		383		1,615		3,275		122,126		125,401		—
Nonresidential		867		1,542		2,751		5,160		347,410		352,570		—
Home equity loans		15		—		107		122		20,780		20,902		—
Commercial		1,028		33		268		1,329		57,136		58,465		268
Consumer and other loans		7		—		—		7		2,906		2,913		—
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 $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
December 31, 2019	Investment		Balance		Recognized		Reserve		Investment
	Dollars in Thousands
Impaired loans with specific reserves:
Real Estate Mortgage
Construction and land development	$	—	$	—	$	—	$	—	$	—
Residential real estate		727		727		—		216		2,337
Nonresidential real estate		2,456		2,456		260		82		2,866
Home equity loans		—		—		—		—		—
Commercial		1,274		1,274		53		274		659
Consumer and other loans		—		—		—		—		—
Total impaired loans with specific reserves	$	4,457	$	4,457	$	313	$	572	$	5,862
Impaired loans with no specific reserve:
Real Estate Mortgage
Construction and land development	$	723	$	545	$	34	$	—	$	471
Residential real estate		4,064		4,717		243		—		4,566
Nonresidential real estate		9,734		9,266		909		—		11,181
Home equity loans		9		9		17		—		351
Commercial		1,078		1,078		87		—		1,441
Consumer and other loans		—		—		—		—		—
Total impaired loans with no specific reserve	$	15,608	$	15,615	$	1,290	—	—	$	18,010
TOTAL	$	20,065	$	20,072	$	1,603	$	572	$	23,872

Total impaired loans of $20.1 million at December 31, 2019 include PCI loan balances of $5.4 million, which are net of a discount of $812 thousand. Total impaired loans also included $946 thousand of loans which did not meet the criteria whereby an individual evaluation for impairment was required. Total impaired loans of $27.7 million at December 31, 2018 include PCI loan balances of $1.1 million, which are net of a discount of $582 thousand. Total impaired loans also included $1.1 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:
Real Estate Mortgage
Construction and land development	$	—	$	—	$	—	$	—	$	16
Residential real estate		3,947		4,075		174		586		4,934
Nonresidential real estate		3,276		3,276		246		412		3,674
Home equity loans		—		—		—		—		55
Commercial		44		44		2		44		22
Consumer and other loans		—		—		—		—		—
Total impaired loans with specific reserves	$	7,267	$	7,395	$	422	$	1,042	$	8,701
Impaired loans with no specific reserve:
Real Estate Mortgage
Construction and land development	$	220	$	360	$	1	$	—	$	264
Residential real estate		5,068		6,318		228		—		3,555
Nonresidential real estate		12,629		13,545		1,015		—		10,427
Home equity loans		693		693		28		—		347
Commercial		1,805		1,805		112		—		1,080
Consumer and other loans		—		—		—		—		—
Total impaired loans with no specific reserve	$	20,415	$	22,721	$	1,384	$	—	$	15,673
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	December 31, 2019		December 31, 2018
Accountable for under ASC 310-30 (PCI loans)
Outstanding balance	$	6,428	$	1,692
Carrying amount		5,373		1,110
Accountable for under ASC 310-20 (non-PCI loans)
Outstanding balance	$	430,711	$	110,339
Carrying amount		425,630		109,594
Total acquired loans
Outstanding balance	$	437,139	$	112,031
Carrying amount		431,003		110,704

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


Dollars in Thousands	December 31, 2019		December 31, 2018
Balance at beginning of period	$	745	$	—
Acquisitions		673		1,703
Accretion		(415)		(958)
Balance at end of period	$	1,003	$	745

Non‑accretable yield on purchased credit impaired loans was $401 thousand and $463 thousand at December 31, 2019 and 2018, respectively.

The Company makes loans to customers located primarily within Wicomico and Worcester Counties, Maryland, Sussex County, Delaware, Camden and Burlington Counties, New Jersey, and Fredericksburg, Virginia. A substantial portion of its loan portfolio consists of residential and commercial real estate mortgages. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in these areas.

Included in the amounts listed above are loans receivable from directors, principal officers, and stockholders of $17.9 million and $5.2 million at December 31, 2019 and 2018, respectively. During 2019 and 2018 loan additions totaled $17.1 million and $120 thousand, respectively. Of this amount, $11.2 million was due to the existing related party loans on Partners books that the Company assumed during the share exchange. During 2019 and 2018 repayments totaled $3.2 million and $2.2 million, respectively. There were also loan balances of $1.2 million that were receivable from prior directors who retired effective at the end of 2018. These loans were made in the ordinary course of business on substantially the same terms and conditions as those prevailing at the same time for comparable transactions with other customers, including interest rates and collateral. They do not involve more than normal risk of collectability or present other unfavorable terms.

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