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

Major categories of loans as of September 30, 2020 and December 31, 2019 are as follows:


(Dollars in thousands)	At September 30, 2020		At December 31, 2019
Originated Loans
Real Estate Mortgage
Construction and land development	$	70,798	$	59,236
Residential real estate		120,746		108,590
Nonresidential		373,734		325,916
Home equity loans		16,072		13,736
Commercial		135,131		52,838
Consumer and other loans		3,032		2,669
		719,513		562,985
Acquired Loans
Real Estate Mortgage
Construction and land development	$	3,394	$	25,515
Residential real estate		81,032		100,696
Nonresidential		191,289		218,633
Home equity loans		17,286		23,979
Commercial		39,957		59,159
Consumer and other loans		2,065		3,021
		335,023		431,003
Total Loans
Real Estate Mortgage
Construction and land development	$	74,193	$	84,751
Residential real estate		201,779		209,286
Nonresidential		565,024		544,549
Home equity loans		33,358		37,715
Commercial		175,088		111,997
Consumer and other loans		5,097		5,690
		1,054,539		993,988
Less: Allowance for credit losses		(11,396)		(7,304)
	$	1,043,143	$	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:

Real Estate Mortgage (which includes Construction and Land Development, Residential Real Estate, Nonresidential Real Estate and Home Equity Loans)

Commercial

Consumer and other loans

Each of these segments are reviewed and analyzed quarterly using historical charge‑off experience 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 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 historical charge-off experience for their respective segments as well as the qualitative factors discussed above. The historical charge-off experience 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 for credit losses estimate or a charge‑off to the allowance for credit losses.

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 the 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 September 30, 2020 and December 31, 2019.

The following tables include impairment information relating to loans and the allowance for credit losses as of September 30, 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 September 30, 2020
Purchased credit impaired loans
Balance in allowance	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Related loan balance		44		1,855		2,248		—		407		—		—		4,554
Individually evaluated for impairment:
Balance in allowance	$	—	$	198	$	23	$	—	$	550	$	—	$	—	$	771
Related loan balance		176		3,029		8,690		—		539		—		—		12,434
Collectively evaluated for impairment:
Balance in allowance	$	907	$	1,736	$	6,114	$	216	$	1,039	$	20	$	593	$	10,625
Related loan balance		73,973		196,895		554,086		33,358		174,142		5,097		—		1,037,551

Note: The balances above include unamortized discounts on acquired loans of $4.1 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, 2019
Purchased credit impaired loans
Balance in allowance	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Related loan balance		44		1,986		2,323		—		1,020		—		—		5,373
Individually evaluated for impairment:
Balance in allowance	$	—	$	216	$	82	$	—	$	274	$	—	$	—	$	572
Related loan balance		177		3,123		9,504		—		1,274		—		—		14,078
Collectively evaluated for impairment:
Balance in allowance	$	602	$	1,164	$	3,991	$	142	$	552	$	14	$	267	$	6,732
Related loan balance		84,530		204,177		532,722		37,715		109,703		5,690		—		974,537

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 and nine months ended September 30, 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.


	September 30, 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	$	898	$	1,893	$	5,487	$	184	$	1,430	$	20	$	89	$	10,001
Charge-offs		—		—		(38)		—		(497)		(55)		—		(590)
Recoveries		—		2		6		—		1		9		—		18
Provision		9		39		682		32		655		46		504		1,967
Ending Balance	$	907	$	1,934	$	6,137	$	216	$	1,589	$	20	$	593	$	11,396
Nine Months Ended
Beginning Balance		602		1,380		4,073		142		826		14		267		7,304
Charge-offs		—		(25)		(163)		(13)		(828)		(103)		—		(1,132)
Recoveries		1		10		10		10		20		31		—		82
Provision		304		569		2,217		77		1,571		78		326		5,142
Ending Balance		907		1,934		6,137		216		1,589		20		593		11,396


	September 30, 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	$	575	$	1,203	$	3,784	$	144	$	624	$	10	$	726	$	7,066
Charge-offs		—		—		—		—		(425)		(28)		—		(453)
Recoveries		5		24		80		—		23		9		—		141
Provision		15		86		(66)		8		504		20		(267)		300
Ending Balance	$	595	$	1,313	S	3,798	$	152	$	726	$	11	$	459	$	7,054
Nine Months Ended
Beginning Balance		647		1,521		3,629		122		641		13		490		7,063
Charge-offs		(11)		(193)		(410)		(4)		(534)		(99)		—		(1,251)
Recoveries		9		165		88		—		43		37		—		342
Provision		(50)		(180)		491		34		576		60		(31)		900
Ending Balance		595		1,313		3,798		152		726		11		459		7,054

The Company had an unallocated amount of approximately $593 thousand in the allowance that is reflected in the above table as of September 30, 2020. The Company had an unallocated amount of approximately $459 thousand in the allowance that is reflected in the above table as of September 30, 2019. Management believes this amount is adequate to absorb additional inherent, but as yet unidentified, losses in the loan portfolio.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law, which established the Paycheck Protection Program (“PPP”) and allocated $349.0 billion of loans to be issued by financial institutions. Under the program, the Small Business Administration (“SBA”) will forgive loans, in whole or in part, made by approved lenders to eligible borrowers for Paycheck and other permitted purposes in accordance with the requirements of the program. These loans carry a fixed rate of 1.00% and a term of two years, if not forgiven, in whole or in part. The loans are 100% guaranteed by the SBA and payments are deferred for the first six months of the loan. The Bank receives a processing fee ranging from 1% to 5% based on the size of the loan from the SBA. The Paycheck Protection Program and Health Care Enhancement Act (“PPP/ HCEA Act”) was signed into law on April 24, 2020. The PPP/HCEA Act authorized additional funding under the CARES Act of $310.0 billion for PPP loans to be issued by financial institutions through the SBA. The Company has provided $64.2 million in funding to over 600 customers through the PPP as of September 30, 2020. Because these loans are 100% guaranteed by the SBA and did not undergo the Bank’s typical underwriting process, they are not graded and do not have an associated reserve at this time.

Credit Quality Information

The following tables represent credit exposures by creditworthiness category at September 30, 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. The Company uses the definitions below for categorizing and managing its criticized loans. Loans catergorized as “Pass” do not meet the criteria set forth below and are not considered criticized.

Marginal — Loans in this category are presently protected from loss, but weaknesses are apparent which, if not corrected, could cause future problems. Loans in this category may not meet required underwriting criteria and have no mitigating factors. More than the ordinary amount of attention is warranted for these loans.

Substandard — Loans in this category exhibit well-defined weaknesses that would typically bring normal repayment into jeopardy. These loans are no longer adequately protected due to well-defined weaknesses that affect the repayment capacity of the borrower. The possibility of loss is much more evident and above average supervision is required for these loans.

Doubtful — Loans in this category have all the weaknesses inherent in a loan categorized as Substandard, with the characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss — Loans in this category are of little value and are 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 &
September 30, 2020	Development		Real Estate		Nonresidential		Home Equity		Commercial		Other		Total
	Dollars in Thousands
Pass	$	74,017	$	198,513	$	557,334	$	33,304	$	174,349	$	5,097	$	1,042,614
Marginal		—		—		3,339		—		89		—		3,428
Substandard		176		3,266		4,351		54		650		—		8,497
TOTAL	$	74,193	$	201,779	$	565,024	$	33,358	$	175,088	$	5,097	$	1,054,539
Non-Accrual	$	176	$	3,215	$	412	$	54	$	489	$	—	$	4,346


	Real Estate Secured
	Construction &
	Land		Residential								Consumer &
December 31, 2019	Development		Real Estate		Nonresidential		Home Equity		Commercial		Other		Total
	Dollars in Thousands
Pass	$	84,574	$	206,150	$	539,259	$	37,715	$	110,349	$	5,690	$	983,737
Marginal		—		—		—		—		—		—		—
Substandard		177		3,136		5,290		—		1,648		—		10,251
TOTAL	$	84,751	$	209,286	$	544,549	$	37,715	$	111,997	$	5,690	$	993,988
Non-Accrual	$	177	$	1,620	$	2,608	$	5	$	131	$	—	$	4,541

A summary of loans that were modified under the terms of a TDR during the three and nine month periods ended September 30, 2020 is shown below by class. The post-modification recorded balance reflects the period end balances, inclusive of any interest capitalized to principal, partial principal pay-downs, and principal charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged off, or foreclosed upon by period end are not reported. There were no loans modified under the terms of a TDR during the three and nine months ended September 30, 2019.


	Real Estate Secured
	Construction &
	Land		Residential								Consumer &
	Development		Real Estate		Nonresidential		Home Equity		Commercial		Other		Total
	Dollars in Thousands
Three months ended September 30, 2020
Number of loans modified during the period		—		—		—		—		—		—		—
Pre-modification recorded balance	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Post- modification recorded balance		—		—		—		—		—		—		—
Nine months ended September 30, 2020
Number of loans modified during the period		—		—		—		—		1		—		1
Pre-modification recorded balance	$	—	$	—	$	—	$	—	$	1,196	$	—	$	1,196
Post- modification recorded balance		—		—		—		—		489		—		489

During the nine months ended September 30, 2020, 2020, there was one loan modified as a TDRs that subsequently defaulted which had been modified as a TDR during the twelve months prior to default. This loan had a balance of $1.2 million prior to charge-offs of $707 thousand. There were no loans modified as TDRs that subsequently defaulted during the year ended December 31, 2019 which had been modified as TDRs during the twelve months prior to default.

There were two loans secured by 1-4 family residential properties with an aggregrate balance of $362 thousand that were in the process of foreclosure at September 30, 2020. There were three loans secured by 1-4 family residential properties with aggregrate balances of $1.2 million that were in the process of foreclosure at December 31, 2019.

The following tables include an aging analysis of the recorded investment of past due financing receivables as of September 30, 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 September 30, 2020	Past Due*		Past Due		Past Due**		Past Due		Balance		Receivables		and Accruing
	Dollars in Thousands
Real Estate
Construction and land development	$	66	$	—	$	176	$	242	$	73,951	$	74,193	$	—
Residential real estate		1,157		85		698		1,940		199,839		201,779		286
Nonresidential		207		871		1,327		2,405		562,619		565,024		—
Home equity loans		—		—		54		54		33,304		33,358		—
Commercial		129		50		489		668		174,420		175,088		—
Consumer and other loans		3		—		—		3		5,094		5,097		—
TOTAL	$	1,562	$	1,006	$	2,744	$	5,312	$	1,049,227	$	1,054,539	$	286

* Includes $901 thousand of non‑accrual loans.

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


													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	$	84,150	$	84,751	$	—
Residential real estate		1,296		677		702		2,675		206,611		209,286		—
Nonresidential		635		144		1,823		2,602		541,947		544,549		—
Home equity loans		—		—		—		—		37,715		37,715		—
Commercial		231		1,207		94		1,532		110,465		111,997		—
Consumer and other loans		1		19		—		20		5,670		5,690		5
TOTAL	$	2,587	$	2,047	$	2,796	$	7,430	$	986,558	$	993,988	$	5

* Includes $956 thousand of non‑accrual loans.

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

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

Impaired Loans

Impaired loans are defined as non‑accrual loans, TDRs, purchased credit impaired loans (“PCI”) and loans risk rated substandard 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, excluding purchased credit impaired, with the associated allowance amount, if applicable. 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.


			Unpaid		Interest				Average
	Recorded		Principal		Income		Specific		Recorded
September 30, 2020	Investment		Balance		Recognized		Reserve		Investment
	Dollars in Thousands
Impaired loans with specific reserves:
Real Estate Mortgage
Construction and land development	$	—	$	—	$	—	$	—	$	—
Residential real estate		938		938		5		198		833
Nonresidential		2,306		2,306		155		23		2,381
Home equity loans		—		—		—		—		—
Commercial		539		1,246		12		550		906
Consumer and other loans		—		—		—		—		—
Total impaired loans with specific reserves	$	3,783	$	4,490	$	172	$	771	$	4,120
Impaired loans with no specific reserve:
Real Estate Mortgage
Construction and land development	$	176	$	176	$	—	$	—	$	176
Residential real estate		2,091		2,141		76		—		2,244
Nonresidential		6,384		6,485		302		—		6,717
Home equity loans		—		—		—		—		—
Commercial		—		—		—		—		—
Consumer and other loans		—		—		—		—		—
Total impaired loans with no specific reserve	$	8,651	$	8,802	$	378	$	—	$	9,137
TOTAL	$	12,434	$	13,292	$	550	$	771	$	13,257

Total impaired loans of $12.4 million at September 30, 2020 do not include PCI loan balances of $4.6 million, which are net of a discount of $642,000.


			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	$	177	$	177	$	—	$	—	$	198
Residential real estate		2,396		3,069		132		—		3,733
Nonresidential		7,048		7,326		501		—		9,839
Home equity loans		—		—		—		—		347
Commercial		—		—		—		—		902
Consumer and other loans		—		—		—		—		—
Total impaired loans with no specific reserve	$	9,621	$	10,572	$	633	$	—	$	15,019
TOTAL	$	14,078	$	15,029	$	946	$	572	$	20,881

Total impaired loans of $14.1 million at December 31, 2019 do not include PCI loan balances of $5.4 million, which are net of a discount of $1.1 million.

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 sheets are as follows:


Dollars in Thousands	September 30, 2020		December 31, 2019
Accountable for under ASC 310-30 (PCI loans)
Outstanding balance	$	5,196	$	6,426
Carrying amount		4,554		5,373
Accountable for under ASC 310-20 (non-PCI loans)
Outstanding balance	$	334,173	$	430,711
Carrying amount		330,469		425,630
Total acquired loans
Outstanding balance	$	339,369	$	437,137
Carrying amount		335,023		431,003

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


Dollars in Thousands	September 30, 2020		December 31, 2019
Balance at beginning of period	$	5,081	$	745
Acquisitions		—		4,990
Accretion		(1,376)		(654)
Other changes, net		(1)		—
Balance at end of period	$	3,704	$	5,081

During the three and nine months ended September 30, 2020, the Company recorded $54 thousand and $180 thousand, respectively, in accretion on acquired loans accounted for under ASC 310-30. During the three and nine months ended September 30, 2019, the Company recorded $24 thousand and $80 thousand, respectively, in accretion on acquired loans accounted for under ASC 310-30.

Non‑accretable yield on PCI loans was $1.6 million at September 30, 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 September 30, 2020 and December 31, 2019.