
	NOTE 11 – LOANS

Loans consist of the following:


	September 30, 2018				December 31, 2017
(dollars in thousands)	PCI	All other loans**	Total	% of Gross Loans	Total	% of Gross Loans

Commercial real estate	$ 1,463	$ 846,482	$ 847,945	64.84%	$ 727,314	63.25%
Residential first mortgages	468	156,097	156,565	11.97%	170,374	14.81%
Residential rentals	1,261	124,122	125,383	9.59%	110,228	9.58%
Construction and land development	-	28,788	28,788	2.20%	27,871	2.42%
Home equity and second mortgages	319	36,041	36,360	2.78%	21,351	1.86%
Commercial loans	-	62,083	62,083	4.75%	56,417	4.91%
Consumer loans	-	730	730	0.06%	573	0.05%
Commercial equipment	-	49,883	49,883	3.81%	35,916	3.12%
Gross loans	3,511	1,304,226	1,307,737	100.00%	1,150,044	100.00%
Net deferred costs (fees)	-	917	917	0.07%	1,086	0.09%
Total loans, net of deferred costs	$ 3,511	$ 1,305,143	$ 1,308,654		$ 1,151,130
Less: allowance for loan losses	-	(10,739)	(10,739)	-0.82%	(10,515)	-0.91%
Net loans	$ 3,511	$ 1,294,404	$ 1,297,915		$ 1,140,615

**All other loans include acquired Non-PCI pools at fair value.

At September 30, 2018 and December 31, 2017, the Bank’s allowance for loan losses totaled $10.7 million and $10.5 million, or 0.82% and 0.91%, respectively, of loan balances. Allowance for loan loss percentage levels decreased in first nine months of 2018, primarily due to the addition of County First loans, after consummation of the legal merger on January 1, 2018, for which no allowance was provided for in accordance with purchase accounting standards. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience, current economic conditions, size, growth and composition of the loan portfolio, financial condition of the borrowers and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance.

Net deferred loan fees and premiums of $917,000 at September 30, 2018 included net deferred fees paid by customers of $3.1 million offset by net deferred premiums paid for the purchase of residential first mortgages and deferred costs of $4.0 million. Net deferred loan fees and premiums of $1.1 million at December 31, 2017 included net deferred fees paid by customers of $2.8 million offset by net deferred premiums paid for the purchase of residential first mortgages and deferred costs of $3.9 million.

Risk Characteristics of Portfolio Segments

Concentrations of Credit - Loans are primarily made within the Company’s operating footprint of Southern Maryland, Annapolis, Maryland and the greater Fredericksburg area of Virginia. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial loans can be affected by the local economic conditions. The commercial loan portfolio has concentrations in business loans secured by real estate and real estate development loans. At September 30, 2018 and December 31, 2017, the Company had no loans outstanding with foreign entities.

The Company manages its credit products and exposure to credit losses (credit risk) by the following specific portfolio segments (classes), which are levels at which the Company develops and documents its allowance for loan loss methodology. These segments are:

Commercial Real Estate (“CRE”)

Commercial and other real estate projects include office buildings, retail locations, churches, other special purpose buildings and commercial construction. Commercial construction balances were 6.7% and 6.2% of the CRE portfolio at September 30, 2018 and December 31, 2017, respectively. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years.

Loans secured by commercial real estate are larger and involve greater risks than one-to four-family residential mortgage loans. Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.

Residential First Mortgages

Residential first mortgage loans are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The contractual loan payment period for residential loans typically ranges from ten to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter time periods than their contractual terms. Borrowers may refinance or prepay loans at their option, without penalty. The Bank’s residential portfolio has both fixed-rate and adjustable-rate residential first mortgages. During the nine months ended September 30, 2018 and the year ended December 31, 2017, the Bank purchased residential first mortgages of $4.7 million and $25.5 million, respectively.

The annual and lifetime limitations on interest rate adjustments may limit the increases in interest rates on these loans. There are also credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. The Bank’s adjustable rate residential first mortgage portfolio was $53.6 million or 4.1% of total gross loans of $1.31 billion at September 30, 2018 compared to $56.9 million or 5.0% of total gross loans of $1.15 billion at December 31, 2017.

Residential Rentals

Residential rental mortgage loans are amortizing, with principal and interest due each month. The loans are secured by income-producing 1-4 family units and apartments. As of September 30, 2018, and December 31, 2017, $97.5 million and $85.0 million, respectively, were 1-4 family units and $27.9 million and $25.2 million, respectively, were apartment buildings or multi-family units. Loans secured by residential rental properties are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years. The primary security on a residential rental loan is the property and the leases that produce income. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. The Bank’s adjustable rate residential rental portfolio was $97.5 million or 7.5% of total gross loans of $1.31 billion at September 30, 2018 compared to $93.4 million or 8.1% of total gross loans of $1.15 billion at December 31, 2017.

Loans secured by residential rental properties involve greater risks than 1-4 family residential mortgage loans. Although, there are similar risk characteristics shared with commercial real estate loans, the balances for the loans secured by residential rental properties are generally smaller. Because payments on loans secured by residential rental properties are often dependent on the successful operation or management of the properties, repayment of these loans may be subject to a greater extent to adverse conditions in the rental real estate market or the economy than similar owner-occupied properties.

Construction and Land Development

The Bank offers loans for the construction of one-to-four family dwellings. Generally, these loans are secured by the real estate under construction as well as by guarantees of the principals involved. In addition, the Bank offers loans to acquire and develop land, as well as loans on undeveloped, subdivided lots for home building.

A decline in demand for new housing might adversely affect the ability of borrowers to repay these loans. Construction and land development loans are inherently riskier than financing owner-occupied real estate. The Bank’s risk of loss is affected by the accuracy of the initial estimate of the market value of the completed project as well as the accuracy of the cost estimates made to complete the project. In addition, the volatility of the real estate market has made it increasingly difficult to ensure that the valuation of land associated with these loans is accurate. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, a project’s value might be insufficient to assure full repayment. As a result of these factors, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the project rather than the ability of the borrower or guarantor to repay principal and interest. If the Bank forecloses on a project, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

Home Equity and Second Mortgage Loans

The Bank maintains a portfolio of home equity and second mortgage loans. These products contain a higher risk of default than residential first mortgages as in the event of foreclosure, the first mortgage would need to be paid off prior to collection of the second mortgage. This risk is heightened as the market value of residential property has not fully returned to pre-financial crisis levels and interest rates began to increase in 2017.

Commercial Loans

The Bank offers its business customers a variety of commercial loan products including term loans and lines of credit. Such loans are generally made for terms of five years or less. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. When making commercial business loans, the Bank considers the financial condition of the borrower, the borrower’s payment history of both corporate and personal debt, the projected cash flows of the business, the viability of the industry in which the borrower operates, the value of the collateral, and the borrower’s ability to service the debt from income. These loans are primarily secured by equipment, real property, accounts receivable or other security as determined by the Bank.

Commercial loans are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself.

Consumer Loans

Consumer loans consist of loans secured by automobiles, boats, recreational vehicles and trucks. The Bank also makes home improvement loans and offers both secured and unsecured personal lines of credit. Consumer loans entail greater risk from other loan types due to being secured by rapidly depreciating assets or the reliance on the borrower’s continuing financial stability.

Commercial Equipment Loans

These loans consist primarily of fixed-rate, short-term loans collateralized by a commercial customer’s equipment or secured by real property, accounts receivable, or other security as determined by the Bank. When making commercial equipment loans, the Bank considers the same factors it considers when underwriting a commercial business loan. Commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized nature of collateral equipment would make full recovery from the sale of collateral problematic.

Non-accrual and Aging Analysis of Current and Past Due Loans

Non-accrual loans as of September 30, 2018 and December 31, 2017 were as follows:


	September 30, 2018
(dollars in thousands)	Non- accrual Delinquent Loans	Number of Loans	Non-accrual Current Loans	Number of Loans	Total Non-accrual Loans	Total Number of Loans

Commercial real estate	$ 11,148	11	$ 655	3	$ 11,803	14
Residential first mortgages	850	4	357	1	1,207	5
Residential rentals	756	4	14	1	770	5
Construction and land development	-	-	-	-	-	-
Home equity and second mortgages	150	2	-	-	150	2
Commercial loans	887	3	-	-	887	3
Consumer loans	-	-	-	-	-	-
Commercial equipment	1,521	7	12	1	1,533	8
	$ 15,312	31	$ 1,038	6	$ 16,350	37


	December 31, 2017
(dollars in thousands)	Non- accrual Delinquent Loans	Number of Loans	Non-accrual Current Loans	Number of Loans	Total Non-accrual Loans	Total Number of Loans

Commercial real estate	$ 1,148	4	$ 839	3	$ 1,987	7
Residential first mortgages	478	3	507	1	985	4
Residential rentals	84	1	741	3	825	4
Construction and land development	-	-	-	-	-	-
Home equity and second mortgages	134	3	123	1	257	4
Commercial loans	172	2	-	-	172	2
Consumer loans	-	-	-	-	-	-
Commercial equipment	467	3	-	-	467	3
	$ 2,483	16	$ 2,210	8	$ 4,693	24

Non-accrual loans increased $11.7 million from $4.7 million or 0.41% of total loans at December 31, 2017 to $16.4 million or 1.25% of total loans at September 30, 2018. Non-accrual loans can be current but classified as non-accrual due to customer operating results or payment history. All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. In accordance with the Company’s policy, interest income is recognized on a cash basis or cost-recovery method, until qualifying for return to accrual status.

At September 30, 2018, non-accrual loans of $16.4 million included 37 loans, of which $13.4 million, or 82% represented 12 loans and three customer relationships. At December 31, 2017, non-accrual loans of $4.7 million included 24 loans, of which $3.3 million, or 71% represented 10 loans and five customer relationships. During the nine months ended September 30, 2018, non-accrual loans increased $11.7 million primarily as a result of one well-secured classified relationship of $10.3 million that was placed on non-accrual during the second quarter of 2018. During the year ended December 31, 2017 non-accrual loans decreased $3.0 million due to the foreclosure of a stalled residential development project. The Bank is working with a construction manager to stabilize and market the project. Before the foreclosure, the loans in this relationship were troubled debt restructures (“TDRs”). Additionally, during the third quarter of 2017, non-accrual loans decreased $607,000 due to the foreclosure of a commercial office building.

Non-accrual loans included no TDRs at September 30, 2018 and one TDR totaling $769,000 at December 31, 2017. This loan was classified solely as non-accrual for the calculation of financial ratios. Loan delinquency (90 days or greater delinquent and 31-89 days delinquent) increased $4.5 million from $11.7 million, or 1.02% of loans, at December 31, 2017 to $16.2 million, or 1.24% of loans, at September 30, 2018.

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $15.1 million and $3.8 million at September 30, 2018 and December 31, 2017, respectively. Interest due but not recognized on these balances at September 30, 2018 and December 31, 2017 was $375,000 and $85,000, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $1.3 million and $876,000 at September 30, 2018 and December 31, 2017, respectively. Interest due but not recognized on these balances at September 30, 2018 and December 31, 2017 was $50,000 and $100,000, respectively.

The Company considers a loan to be past due or delinquent when the terms of the contractual obligation are not met by the borrower. PCI loans are included as a single category in the table below as management believes, regardless of their age, there is a lower likelihood of aggregate loss related to these loan pools. Additionally, PCI loans are discounted to allow for the accretion of income on a level yield basis over the life of the loan based on expected cash flows. Regardless of payment status, as long as cash flows can be reasonably estimated, the associated discount on these loan pools results in income recognition.

Past due and PCI loans as of September 30, 2018 and December 31, 2017 were as follows:


	September 30, 2018
(dollars in thousands)	31-60 Days	61-89 Days	90 or Greater Days	Total Past Due	PCI Loans	Current	Total Loan Receivables
Commercial real estate	$ -	$ 4,399	$ 6,918	$ 11,317	$ 1,463	$ 835,165	$ 847,945
Residential first mortgages	-	794	203	997	468	155,100	156,565
Residential rentals	-	976	30	1,006	1,261	123,116	125,383
Construction and land dev.	-	-	-	-	-	28,788	28,788
Home equity and second mtg.	256	11	150	417	319	35,624	36,360
Commercial loans	-	8	879	887	-	61,196	62,083
Consumer loans	-	-	-	-	-	730	730
Commercial equipment	55	-	1,486	1,541	-	48,342	49,883
Total	$ 311	$ 6,188	$ 9,666	$ 16,165	$ 3,511	$ 1,288,061	$ 1,307,737


	December 31, 2017
(dollars in thousands)	31-60 Days	61-89 Days	90 or Greater Days	Total Past Due	PCI Loans	Current	Total Loan Receivables
Commercial real estate	$ -	$ 6,711	$ 1,148	$ 7,859	$ -	$ 719,455	$ 727,314
Residential first mortgages	-	68	478	546	-	169,828	170,374
Residential rentals	-	207	84	291	-	109,937	110,228
Construction and land dev.	-	-	-	-	-	27,871	27,871
Home equity and second mtg.	19	18	134	171	-	21,180	21,351
Commercial loans	892	299	172	1,363	-	55,054	56,417
Consumer loans	-	1	-	1	-	572	573
Commercial equipment	1,012	-	467	1,479	-	34,437	35,916
Total	$ 1,923	$ 7,304	$ 2,483	$ 11,710	$ -	$ 1,138,334	$ 1,150,044

Impaired Loans and Troubled Debt Restructures (“TDRs”)

Impaired loans, including TDRs, at September 30, 2018 and 2017 and at December 31, 2017 were as follows:



	September 30, 2018
(dollars in thousands)	Unpaid Contractual Principal Balance	Recorded Investment With No Allowance	Recorded Investment With Allowance	Total Recorded Investment	Related Allowance	Quarter Average Recorded Investment	Quarter Interest Income Recognized	YTD Average Recorded Investment	YTD Interest Income Recognized

Commercial real estate	$ 26,588	$ 24,664	$ 1,561	$ 26,225	$ 174	$ 26,297	$ 340	$ 26,499	$ 763
Residential first mortgages	2,655	2,616	-	2,616	-	2,627	31	2,651	90
Residential rentals	1,431	1,377	-	1,377	-	1,382	11	1,400	47
Construction and land dev.	729	729	-	729	-	729	11	729	30
Home equity and second mtg.	298	293	-	293	-	300	4	304	10
Commercial loans	2,784	1,890	883	2,773	458	2,775	38	2,779	89
Consumer loans	1	-	1	1	1	1	-	1	-
Commercial equipment	1,577	1,132	402	1,534	377	1,546	3	1,588	33
Total	$ 36,063	$ 32,701	$ 2,847	$ 35,548	$ 1,010	$ 35,657	$ 438	$ 35,951	$ 1,062


	December 31, 2017
(dollars in thousands)	Unpaid Contractual Principal Balance	Recorded Investment With No Allowance	Recorded Investment With Allowance	Total Recorded Investment	Related Allowance	YTD Average Recorded Investment	YTD Interest Income Recognized

Commercial real estate	$ 33,180	$ 30,921	$ 2,008	$ 32,929	$ 370	$ 33,575	$ 1,379
Residential first mortgages	2,455	1,978	459	2,437	2	2,479	91
Residential rentals	2,389	1,981	395	2,376	18	2,432	111
Construction and land dev.	729	-	729	729	163	729	26
Home equity and second mtg.	317	317	-	317	-	318	12
Commercial loans	3,010	2,783	168	2,951	168	3,048	137
Commercial equipment	1,538	1,048	467	1,515	303	1,578	73
Total	$ 43,618	$ 39,028	$ 4,226	$ 43,254	$ 1,024	$ 44,159	$ 1,829


	September 30, 2017
(dollars in thousands)	Unpaid Contractual Principal Balance	Recorded Investment With No Allowance	Recorded Investment With Allowance	Total Recorded Investment	Related Allowance	Quarter Average Recorded Investment	Quarter Interest Income Recognized	YTD Average Recorded Investment	YTD Interest Income Recognized

Commercial real estate	$ 24,233	$ 19,824	$ 4,211	$ 24,035	$ 155	$ 24,153	$ 319	$ 24,399	$ 799
Residential first mortgages	2,277	1,808	463	2,271	7	2,284	18	2,302	67
Residential rentals	2,669	2,271	397	2,668	21	2,673	22	2,711	77
Construction and land dev.	729	-	729	729	163	729	9	729	16
Home equity and second mtg.	225	225	-	225	-	225	2	226	5
Commercial loans	2,324	2,096	169	2,265	169	2,298	24	2,317	71
Commercial equipment	530	40	467	507	303	522	1	530	10
Total	$ 32,987	$ 26,264	$ 6,436	$ 32,700	$ 818	$ 32,884	$ 395	$ 33,214	$ 1,045

TDRs, included in the impaired loan schedules above, as of September 30, 2018 and December 31, 2017 were as follows:


	September 30, 2018		December 31, 2017
(dollars in thousands)	Dollars	Number of Loans	Dollars	Number of Loans

Commercial real estate	$ 8,345	8	$ 9,273	9
Residential first mortgages	512	2	527	2
Residential rentals	218	1	221	1
Construction and land development	729	2	729	2
Commercial loans	3	1	4	1
Commercial equipment	32	1	36	1
Total TDRs	$ 9,839	15	$ 10,790	16
Less: TDRs included in non-accrual loans	-	-	(769)	(1)
Total accrual TDR loans	$ 9,839	15	$ 10,021	15

TDRs decreased $951,000 due to principal paydowns and payoffs for the nine months ended September 30, 2018. There were no TDRs added during the nine months ended September 30, 2018. The Company had specific reserves of $174,000 on one TDRs totaling $1.6 million at September 30, 2018. The Company had specific reserves of $413,000 on seven TDRs totaling $3.0 million at December 31, 2017. During the year ended December 31, 2017, TDR disposals, which included payoffs and refinancing decreased by seven loans totaling $3.9 million, of which $3.0 million related to the foreclosure of a stalled residential development project. TDR loan principal curtailment was $385,000 for the year ended December 31, 2017. There were no TDRs added during the year ended December 31, 2017.

Allowance for Loan Losses

The following tables detail activity in the allowance for loan losses at and for the three and nine months ended September 30, 2018 and 2017, respectively. An allocation of the allowance to one category of loans does not prevent the Company from using that allowance to absorb losses in a different category.


	September 30, 2018
(dollars in thousands)	Beginning Balance	Charge-offs	Recoveries	Provisions	Ending Balance
Three Months Ended
Commercial real estate	$ 6,563	$ (32)	$ 2	$ 179	$ 6,712
Residential first mortgages	737	(2)	-	(44)	691
Residential rentals	469	(54)	-	170	585
Construction and land development	498	-	-	(203)	295
Home equity and second mortgages	104	-	2	71	177
Commercial loans	1,203	2	176	(167)	1,214
Consumer loans	7	(1)	-	(1)	5
Commercial equipment	1,144	(132)	13	35	1,060
	$ 10,725	$ (219)	$ 193	$ 40	$ 10,739

Purchase Credit Impaired**	$ -	$ -	$ -	$ -	$ -


Nine Months Ended
Commercial real estate	$ 6,451	$ (268)	$ 8	$ 521	$ 6,712
Residential first mortgages	1,144	(115)	-	(338)	691
Residential rentals	512	(54)	-	127	585
Construction and land development	462	-	-	(167)	295
Home equity and second mortgages	162	(7)	16	6	177
Commercial loans	1,013	(86)	176	111	1,214
Consumer loans	7	(2)	-	-	5
Commercial equipment	764	(431)	47	680	1,060
	$ 10,515	$ (963)	$ 247	$ 940	$ 10,739

Purchase Credit Impaired**	$ -	$ -	$ -	$ -	$ -

** There is no allowance for loan loss on the PCI portfolios. A more detailed rollforward schedule will be presented if an allowance is required.


	September 30, 2017
(dollars in thousands)	Beginning Balance	Charge-offs	Recoveries	Provisions	Ending Balance
Three Months Ended
Commercial real estate	$ 6,085	$ (217)	$ 4	$ 436	$ 6,308
Residential first mortgages	1,300	-	-	(43)	1,257
Residential rentals	335	-	-	289	624
Construction and land development	720	(1)	-	(73)	646
Home equity and second mortgages	112	(13)	1	28	128
Commercial loans	814	-	-	(23)	791
Consumer loans	5	-	-	2	7
Commercial equipment	1,063	(22)	25	(392)	674
	$ 10,434	$ (253)	$ 30	$ 224	$ 10,435

Nine Months Ended
Commercial real estate	$ 5,212	$ (217)	$ 13	$ 1,300	$ 6,308
Residential first mortgages	1,406	-	-	(149)	1,257
Residential rentals	362	(42)	-	304	624
Construction and land development	941	(26)	-	(269)	646
Home equity and second mortgages	138	(14)	1	3	128
Commercial loans	794	-	1	(4)	791
Consumer loans	3	(2)	-	6	7
Commercial equipment	1,004	(168)	49	(211)	674
	$ 9,860	$ (469)	$ 64	$ 980	$ 10,435

The following tables detail loan receivable and allowance balances disaggregated on the basis of the Company’s impairment methodology at September 30, 2018 and 2017 and December 31, 2017.


	September 30, 2018				December 31, 2017			September 30, 2017
(dollars in thousands)	Ending balance: individually evaluated for impairment	Ending balance: collectively evaluated for impairment	Purchase Credit Impaired	Total	Ending balance: individually evaluated for impairment	Ending balance: collectively evaluated for impairment	Total	Ending balance: individually evaluated for impairment	Ending balance: collectively evaluated for impairment	Total
Loan Receivables:
Commercial real estate	$ 26,225	$ 820,257	$ 1,463	$ 847,945	$ 32,929	$ 694,385	$ 727,314	$ 24,035	$ 688,805	$ 712,840
Residential first mortgages	2,616	153,481	468	156,565	2,437	167,937	170,374	2,271	173,545	175,816
Residential rentals	1,377	122,745	1,261	125,383	2,376	107,852	110,228	2,668	108,237	110,905
Construction and land development	729	28,059	-	28,788	729	27,142	27,871	729	30,365	31,094
Home equity and second mortgages	293	35,748	319	36,360	317	21,034	21,351	225	22,109	22,334
Commercial loans	2,773	59,310	-	62,083	2,951	53,466	56,417	2,265	54,111	56,376
Consumer loans	1	729	-	730	-	573	573	-	541	541
Commercial equipment	1,534	48,349	-	49,883	1,515	34,401	35,916	507	34,993	35,500
	$ 35,548	$ 1,268,678	$ 3,511	$ 1,307,737	$ 43,254	$ 1,106,790	$ 1,150,044	$ 32,700	$ 1,112,706	$ 1,145,406

Allowance for loan losses:
Commercial real estate	$ 174	$ 6,538	$ -	$ 6,712	$ 370	$ 6,081	$ 6,451	$ 155	$ 6,153	$ 6,308
Residential first mortgages	-	691	-	691	2	1,142	1,144	7	1,250	1,257
Residential rentals	-	585	-	585	18	494	512	21	603	624
Construction and land development	-	295	-	295	163	299	462	163	483	646
Home equity and second mortgages	-	177	-	177	-	162	162	-	128	128
Commercial loans	458	756	-	1,214	168	845	1,013	169	622	791
Consumer loans	1	4	-	5	-	7	7	-	7	7
Commercial equipment	377	683	-	1,060	303	461	764	303	371	674
	$ 1,010	$ 9,729	$ -	$ 10,739	$ 1,024	$ 9,491	$ 10,515	$ 818	$ 9,617	$ 10,435

During the fourth quarter of 2016, the Company expanded its factor scoring categories from three levels to five levels to capture additional movements in qualitative factors used to calculate the general allowance of each portfolio segment. No additional qualitative factors were added to the Company’s methodology as part of this change. There were no material changes to the existing allowance for loan losses by portfolio segment or in the aggregate as a result of the change.

Credit Quality Indicators

Credit quality indicators as of September 30, 2018 and December 31, 2017 were as follows:


Credit Risk Profile by Internally Assigned Grade

	Commercial Real Estate		Construction and Land Dev.		Residential Rentals
(dollars in thousands)	9/30/2018	12/31/2017	9/30/2018	12/31/2017	9/30/2018	12/31/2017

Unrated	$ 111,356	$ 75,581	$ 2,320	$ 1,775	$ 36,332	$ 28,428
Pass	715,844	619,604	25,739	25,367	87,905	80,279
Special mention	-	-	-	-	-	-
Substandard	20,745	32,129	729	729	1,146	1,521
Doubtful	-	-	-	-	-	-
Loss	-	-	-	-	-	-
Total	$ 847,945	$ 727,314	$ 28,788	$ 27,871	$ 125,383	$ 110,228

	Commercial Loans		Commercial Equipment		Total Commercial Portfolios
(dollars in thousands)	9/30/2018	12/31/2017	9/30/2018	12/31/2017	9/30/2018	12/31/2017

Unrated	$ 19,507	$ 14,356	$ 14,495	$ 10,856	$ 184,010	$ 130,996
Pass	39,811	39,118	33,934	23,581	903,233	787,949
Special mention	-	-	-	-	-	-
Substandard	2,765	2,943	1,454	1,479	26,839	38,801
Doubtful	-	-	-	-	-	-
Loss	-	-	-	-	-	-
Total	$ 62,083	$ 56,417	$ 49,883	$ 35,916	$ 1,114,082	$ 957,746

	Non-Commercial Portfolios **		Total All Portfolios
(dollars in thousands)	9/30/2018	12/31/2017	9/30/2018	12/31/2017

Unrated	$ 144,803	$ 152,616	$ 328,813	$ 283,612
Pass	47,051	38,081	950,284	826,030
Special mention	-	96	-	96
Substandard	1,801	1,505	28,640	40,306
Doubtful	-	-	-	-
Loss	-	-	-	-
Total	$ 193,655	$ 192,298	$ 1,307,737	$ 1,150,044

** Non-commercial portfolios are generally evaluated based on payment activity, but may be risk graded if part of a larger commercial relationship or are credit impaired (e,g. non-accrual loans, TDRs).


Credit Risk Profile Based on Payment Activity

	Residential First Mortgages		Home Equity and Second Mtg.		Consumer Loans
(dollars in thousands)	9/30/2018	12/31/2017	9/30/2018	12/31/2017	9/30/2018	12/31/2017

Performing	$ 156,362	$ 169,896	$ 36,210	$ 21,217	$ 730	$ 573
Nonperforming	203	478	150	134	-	-
Total	$ 156,565	$ 170,374	$ 36,360	$ 21,351	$ 730	$ 573

A risk grading scale is used to assign grades to commercial relationships, which include commercial real estate, residential rentals, construction and land development, commercial loans and commercial equipment loans. Loans are graded at inception, annually thereafter when financial statements are received and at other times when there is an indication that a credit may have weakened or improved. Only commercial loan relationships with an aggregate exposure to the Bank of $1,000,000 or greater are subject to being risk rated.

Home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored based on borrower payment history. Residential first mortgages are evaluated for creditworthiness during credit due diligence before being purchased. Residential first mortgages, home equity and second mortgages and consumer loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are TDRs or nonperforming loans with an Other Assets Especially Mentioned (“OAEM”) or higher risk rating due to a delinquent payment history.

Management regularly reviews credit quality indicators as part of its individual loan reviews and on a monthly and quarterly basis. The overall quality of the Bank’s loan portfolio is assessed using the Bank’s risk grading scale, the level and trends of net charge-offs, nonperforming loans and delinquencies, the performance of TDRs and the general economic conditions in the Company’s geographical market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. Credit quality indicators and allowance factors are adjusted based on management’s judgment during the monthly and quarterly review process. Loans subject to risk ratings are graded on a scale of one to ten. The Company considers loans rated substandard, doubtful and loss as classified assets for regulatory and financial reporting.

Ratings 1 thru 6 - Pass

Ratings 1 thru 6 have asset risks ranging from excellent low risk to adequate. The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks.

Rating 7 - OAEM (Other Assets Especially Mentioned) – Special Mention

These credits, while protected by the financial strength of the borrowers, guarantors or collateral, have reduced quality due to economic conditions, less than adequate earnings performance or other factors which require the lending officer to direct more than normal attention to the credit. Financing alternatives may be limited and/or command higher risk interest rates. OAEM loans are the first adversely classified assets on our watch list. These relationships will be reviewed at least quarterly.

Rating 8 - Substandard

Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. The loans may have a delinquent history or combination of weak collateral, weak guarantor strength or operating losses. When a loan is assigned to this category the Bank may estimate a specific reserve in the loan loss allowance analysis. These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies. These relationships will be reviewed at least quarterly.

Rating 9 - Doubtful

Doubtful assets have many of the same characteristics of Substandard with the exception that the Bank has determined that loss is not only possible but is probable and the risk is close to certain that loss will occur. When a loan is assigned to this category the Bank will identify the probable loss and the loan will receive a specific reserve in the loan loss allowance analysis. These relationships will be reviewed at least quarterly.

Rating 10 – Loss

Once an asset is identified as a definite loss to the Bank, it will receive the classification of “loss.” There may be some future potential recovery; however, it is more practical to write off the loan at the time of classification. Losses will be taken in the period in which they are determined to be uncollectable.

Purchased Credit-Impaired Loans and Acquired Loans

PCI loans had an unpaid principal balance of $4.5 million and a carrying value of $3.5 million at September 30, 2018. PCI loans represented 0.20% of total assets at September 30, 2018. Determining the fair value of the PCI loans at the time of acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest taking into account prepayment assumptions. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carryover of previously established allowance for loan losses from acquisition. In conjunction with the acquisition of County First, the PCI loan portfolio was accounted for at fair value as follows:


(dollars in thousands)		January 1, 2018

Contractual principal and interest at acquisition		$ 6,126
Nonaccretable difference		(1,093)
Expected cash flows at acquisition		5,033
Accretable yield		(517)
Basis in PCI loans at acquisition - estimated fair value		$ 4,516

A summary of changes in the accretable yield for PCI loans for the three and nine months ended September 30, 2018 follows:


	Three Months Ended	Nine Months Ended
(dollars in thousands)	September 30, 2018	September 30, 2018
Accretable yield, beginning of period	$ 401	$ -
Additions	-	517
Accretion	(54)	(170)
Reclassification from (to) nonaccretable difference	-	-
Other changes, net	-	-
Accretable yield, end of period	$ 347	$ 347

Loans consist of: (i) non-acquired loans, which include certain renewed and/or restructured acquired performing loans that are re-designated as non-acquired of $1,197.1 million at September 30, 2018; (ii) acquired performing loans were $107.1 million at September 30, 2018; and (iii) purchase credit impaired (“PCI”) loans were $3.5 million at September 30, 2018. At September 30, 2018, performing acquired loans, which totaled $107.1 million, included a $2.0 million net acquisition accounting fair market value adjustment, representing a 1.83% “mark;” and PCI loans which totaled $3.5 million, included a $671,000 adjustment, representing a 16.04% “mark.” During the three and nine months ended September 30, 2018 there was $161,000 and $635,000, respectively, of accretion interest.

The following is a summary of acquired and non-acquired loans as of September 30, 2018 and December 31, 2017:



BY ACQUIRED AND NON-ACQUIRED	September 30, 2018	%	December 31, 2017	%

Acquired loans - performing	$ 107,142	8.19%	$ -	0.00%
Acquired loans - purchase credit impaired ("PCI")	3,511	0.27%	-	0.00%
Total acquired loans	110,653	8.46%	-	0.00%
Non-acquired loans**	1,197,084	91.54%	1,150,044	100.00%
Gross loans	1,307,737		1,150,044
Net deferred costs (fees)	917	0.07%	1,086	0.09%
Total loans, net of deferred costs	$ 1,308,654		$ 1,151,130


** Non-acquired loans include loans transferred from acquired pools following release of acquisition accounting FMV adjustments.