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

Major categories of loans as of March 31, 2020 and December 31, 2019 are as follows:


(Dollars in thousands)	At March 31, 2020		At December 31, 2019
Originated Loans
Real Estate Mortgage
Construction and land development	$	69,455	$	59,236
Residential real estate		114,748		108,590
Nonresidential		347,059		325,916
Home equity loans		16,177		13,736
Commercial		61,952		52,838
Consumer and other loans		3,114		2,669
		612,505		562,985
Acquired Loans
Real Estate Mortgage
Construction and land development	$	21,417	$	26,034
Residential real estate		92,084		101,088
Nonresidential		211,435		222,075
Home equity loans		21,419		24,176
Commercial		58,964		60,675
Consumer and other loans		2,898		3,091
		408,217		437,139
Total Loans
Real Estate Mortgage
Construction and land development	$	90,872	$	85,270
Residential real estate		206,832		209,678
Nonresidential		558,494		547,991
Home equity loans		37,596		37,912
Commercial		120,916		113,513
Consumer and other loans		6,012		5,760
		1,020,722		1,000,124
Less: Unamortized discounts on acquired loans		(5,533)		(6,136)
Less: Allowance for credit losses		(7,819)		(7,304)
	$	1,007,370	$	986,684

Allowance for Credit Losses

Management has an established methodology to determine the adequacy of the allowance for credit losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for credit losses, the Company 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 TDRs

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 Company’s Board of Directors

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 “non-pass” with outstanding balances less than or equal to $250 thousand and credit exposures graded at a rating of “pass” 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 “non-pass” 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 credit losses inherent in the loan portfolio as of March 31, 2020 and December 31, 2019.

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


	Real Estate Mortgage
	Construction
	and Land		Residential								Consumer
Dollars in Thousands	Development		Real Estate		Nonresidential		Home Equity		Commercial		and Other		Unallocated		Total
Balance at March 31, 2020
Individually evaluated for impairment:
Balance in allowance	$	—	$	181	$	90	$	—	$	207	$	—	$	—	$	478
Related loan balance		388		4,417		14,287		56		2,086		17		—		21,251
Collectively evaluated for impairment:
Balance in allowance	$	718	$	1,238	$	4,253	$	169	$	678	$	19	$	266	$	7,341
Related loan balance		90,106		202,064		540,973		37,373		117,485		5,937		—		993,938

Note: The balances above include unamortized discounts on acquired loans of $5.5 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, 2019
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	$	3,991	$	142	$	552	$	14	$	267	$	6,732
Related loan balance		84,028		205,381		533,100		37,706		109,759		5,690		—		975,664

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

The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three months ended March 31, 2020 and 2019. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.


	March 31, 2020
	Real Estate Mortgage
	Construction
	and Land		Residential								Consumer
Dollars in Thousands	Development		Real Estate		Nonresidential		Home Equity		Commercial		and Other		Unallocated		Total
Quarter Ended
Beginning Balance	$	602	$	1,380	$	4,074	$	142	$	826	$	14	$	266	$	7,304
Charge-offs		—		(25)		(38)		—		(66)		(41)		—		(170)
Recoveries		—		4		3		10		7		13		—		37
Provision		116		60		304		17		118		33		—		648
Ending Balance	$	718	$	1,419	$	4,343	$	169	$	885	$	19	$	266	$	7,819


	March 31, 2019
	Real Estate Mortgage
	Construction
	and Land		Residential								Consumer
Dollars in Thousands	Development		Real Estate		Nonresidential		Home Equity		Commercial		and Other		Unallocated		Total
Quarter Ended
Beginning Balance	$	647	$	1,521	$	3,629	$	122	$	641	$	13	$	490	$	7,063
Charge-offs		(11)		—		(191)		(4)		(98)		(37)		—		(341)
Recoveries		1		2		4		—		18		16		—		41
Provision		(39)		(14)		254		29		94		19		(43)		300
Ending Balance	$	598	$	1,509	S	3,696	$	147	$	655	$	11	$	447	$	7,063

The Company had an unallocated amount (overage) of approximately $266 thousand in the allowance that is reflected in the above table as of March 31, 2020. The Company had an unallocated amount (overage) of approximately $447 thousand in the allowance that is reflected in the above table as of March 31, 2019. Management believes this amount is adequate to absorb additional inherent, but as yet unidentified, losses in the loan portfolio.

Credit Quality Information

The following tables represent credit exposures by creditworthiness category at March 31, 2020 and 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 Subsidiaries 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. The credit possesses deficiencies which corrective action by the bank would remedy and; should potentially be included on a 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:


	Real Estate Secured
	Construction &
	Land		Residential								Consumer &
March 31, 2020	Development		Real Estate		Nonresidential		Home Equity		Commercial		Other		Total
	Dollars in Thousands
Excellent	$	—	$	—	$	397	$	—	$	6,044	$	107	$	6,548
Superior		—		134		3,580		122		2,071		—		5,907
Good		89,498		199,142		534,658		37,243		107,471		5,831		973,843
Fair		819		4,207		12,003		64		2,429		16		19,538
Marginal		—		—		—		—		—		—		—
Substandard		177		2,998		4,622		—		1,556		—		9,353
TOTAL	$	90,494	$	206,481	$	555,260	$	37,429	$	119,571	$	5,954	$	1,015,189
Non-Accrual	$	177	$	1,508	$	2,346	$	—	$	1,280	$	—	$	5,311
TDRs	$	—	$	2,269	$	7,437	$	—	$	1,207	$	—	$	10,913
Number of TDR accounts		—		11		18		—		1		—		30
Breakdown of TDRs
TDRs on Non-accrual	$	—	$	866	$	575	$	—	$	1,207	$	—	$	2,648
TDRs Past Due 30-89 days		—		15		—		—		—		—		15
Performing TDRs		—		1,388		6,862		—		—		—		8,250
TOTAL	$	—	$	2,269	$	7,437	$	—	$	1,207	$	—	$	10,913
Total Non-performing TDR accounts	$	—	$	881	$	575	$	—	$	1,207	$	—	$	2,663
Number of non‑performing TDRs		—		3		2		—		1		—		6


	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		202,690		525,465		37,528		99,973		5,557		954,986
Fair		801		3,321		9,739		64		2,469		20		16,414
Marginal		—		—		—		—		—		—		—
Substandard		177		3,136		5,290		—		1,648		—		10,251
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

The following tables include an aging analysis of the recorded investment of past due financing receivables as of March 31, 2020 and December 31, 2019:


													Recorded
													Investment
					Greater than						Total		>90 Days
	30 - 59 Days		60 - 89 Days		90 Days		Total		Current		Financing		Past Due
At March 31, 2020	Past Due*		Past Due**		Past Due***		Past Due		Balance		Receivables***		and Accruing
	Dollars in Thousands
Real Estate
Construction and land development	$	—	$	40	$	177	$	217	$	90,655	$	90,872	$	—
Residential real estate		2,008		155		915		3,078		203,754		206,832		293
Nonresidential		1,631		42		1,570		3,243		555,251		558,494		—
Home equity loans		19		—		—		19		37,577		37,596		—
Commercial		247		—		1,280		1,527		119,389		120,916		—
Consumer and other loans		6		—		—		6		6,006		6,012		—
TOTAL	$	3,911	$	237	$	3,942	$	8,090	$	1,012,632	$	1,020,722	$	293

* Includes $1.5 million of non‑accrual loans.

** Includes $155 thousand of non-accrual loans.

*** Includes $3.6 million of non-accrual loans.

Total financing receivable balances do not include unamortized discounts on acquired loans of $5.5 million.


													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
Construction and land development	$	424	$	—	$	177	$	601	$	84,669	$	85,270	$	—
Residential real estate		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 on acquired loans of $6.1 million.

Impaired Loans

Impaired loans are defined as non‑accrual loans, TDRs, purchased 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 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 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 tables include 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
March 31, 2020	Investment		Balance		Recognized		Reserve		Investment
	Dollars in Thousands
Impaired loans with specific reserves:
Real Estate Mortgage
Construction and land development	$	—	$	—	$	—	$	—	$	—
Residential real estate		691		691		—		181		709
Nonresidential		2,411		2,449		69		90		2,433
Home equity loans		—		—		—		—		—
Commercial		1,207		1,207		11		207		1,240
Consumer and other loans		—		—		—		—		—
Total impaired loans with specific reserves	$	4,309	$	4,347	$	80	$	478	$	4,382
Impaired loans with no specific reserve:
Real Estate Mortgage
Construction and land development	$	388	$	388	$	3	$	—	$	556
Residential real estate		4,528		5,299		57		—		4,296
Nonresidential real estate		12,365		12,697		182		—		11,050
Home equity loans		56		56		1		—		32
Commercial		991		991		17		—		1,034
Consumer and other loans		17		17		—		—		8
Total impaired loans with no specific reserve	$	18,345	$	19,448	$	260	$	—	$	16,976
TOTAL	$	22,654	$	23,795	$	340	$	478	$	21,358

Total impaired loans of $22.7 million at March 31, 2020 include PCI loan balances of $5.1 million, which are net of a discount of $989 thousand. Total impaired loans also included $620 thousand 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 calculated reserve.


			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		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		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

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	March 31, 2020		December 31, 2019
Accountable for under ASC 310-30 (PCI loans)
Outstanding balance	$	6,123	$	6,428
Carrying amount		5,134		5,373
Accountable for under ASC 310-20 (non-PCI loans)
Outstanding balance	$	402,094	$	430,711
Carrying amount		397,550		425,630
Total acquired loans
Outstanding balance	$	408,217	$	437,139
Carrying amount		402,684		431,003

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


Dollars in Thousands	March 31, 2020		December 31, 2019
Balance at beginning of period	$	5,081	$	745
Acquisitions		—		4,990
Accretion		(537)		(654)
Balance at end of period	$	4,544	$	5,081

During the three months ended March 31, 2020, the Company recorded $70 thousand in accretion on acquired loans accounted for under ASC 310-30. During the three months ended March 31, 2019, the Company recorded $28 thousand in accretion on acquired loans accounted for under ASC 310-30.

Non‑accretable yield on PCI loans was $1.6 million at March 31, 2020 and December 31, 2019.

Concentration of Risk:

The Company makes loans to customers located primarily within Anne Arundel, Charles, Calvert, St. Mary’s, Wicomico, and Worcester Counties, Maryland; Sussex County, Delaware; Camden and Burlington Counties, New Jersey; Stafford, Spotsylvania, King George, and Caroline Counties, Virginia; and the City of 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.

The Company had no commitments to loan additional funds to the borrowers of restructured, impaired, or non‑accrual loans as of March 31, 2020 and December 31, 2019.