NOTE 3 – LOANS

Loans consist of the following:


	March 31, 2019									December 31, 2018
							% of								% of
			All other				Gross				All other				Gross
(dollars in thousands)	PCI		loans**		Total		Loans		PCI		loans**		Total		Loans
Commercial real estate	$	1,750	$	889,415	$	891,165	65.37	%	$	1,785	$	876,231	$	878,016	65.19	%
Residential first mortgages		468		156,185		156,653	11.49	%		466		156,243		156,709	11.63	%
Residential rentals		886		123,632		124,518	9.13	%		897		123,401		124,298	9.23	%
Construction and land development		—		32,798		32,798	2.41	%		—		29,705		29,705	2.21	%
Home equity and second mortgages		123		36,623		36,746	2.70	%		72		35,489		35,561	2.64	%
Commercial loans		—		70,725		70,725	5.19	%		—		71,680		71,680	5.32	%
Consumer loans		—		851		851	0.06	%		—		751		751	0.06	%
Commercial equipment		—		49,720		49,720	3.65	%		—		50,202		50,202	3.73	%
Gross loans		3,227		1,359,949		1,363,176	100.00	%		3,220		1,343,702		1,346,922	100.00	%
Net deferred costs		—		1,261		1,261	0.09	%		—		1,183		1,183	0.09	%
Total loans, net of deferred costs	$	3,227	$	1,361,210	$	1,364,437			$	3,220	$	1,344,885	$	1,348,105
Less: allowance for loan losses		—		(10,846)		(10,846)	(0.80)	%		—		(10,976)		(10,976)	(0.81)	%
Net loans	$	3,227	$	1,350,364	$	1,353,591			$	3,220	$	1,333,909	$	1,337,129

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

At March 31, 2019 and December 31, 2018, the Bank’s allowance for loan losses totaled $10.8 million and $11.0 million, or 0.80% and 0.81%, respectively, of loan balances. 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 costs of $1.3 million at March 31, 2019 included net deferred fees paid by customers of $3.1 million offset by net deferred costs of $4.4 million, which include premiums paid for the purchase of residential first mortgages and deferred costs recorded in accordance with ASC 310-20 to capture loan origination costs. Net deferred loan costs of $1.2 million at December 31, 2018 included net deferred fees paid by customers of $3.1 million offset by net deferred costs of $4.3 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 March 31, 2019 and December 31, 2018, 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 6.0% and 5.9% of the CRE portfolio at March 31, 2019 and December 31, 2018, 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 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 three months ended March 31, 2019 and the year ended December 31, 2018, the Bank purchased residential first mortgages of $5.9 million and $11.0 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 $56.8 million or 4.2% of total gross loans of $1.36 billion at March 31, 2019 compared to $54.2 million or 4.0% of total gross loans of $1.35 billion at December 31, 2018.

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 March 31, 2019, and December 31, 2018, $95.5 million and $96.6 million, respectively, were 1‑4 family units and $29.0 million and $27.7 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 $98.3 million or 7.2% of total gross loans of $1.36 billion at March 31, 2019 compared to $97.4 million or 7.2% of total gross loans of $1.35 billion at December 31, 2018.

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. Although residential real estate values have increased over the last several years, default risks remain 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 and 2018.

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 March 31, 2019 and December 31, 2018 were as follows:


	March 31, 2019
	Non-accrual			Non-accrual			Total		Total
	Delinquent		Number	Current		Number	Non-accrual		Number
(dollars in thousands)	Loans		of Loans	Loans		of Loans	Loans		of Loans
Commercial real estate	$	4,022	8	$	6,088	6	$	10,110	14
Residential first mortgages		149	2		1,217	4		1,366	6
Residential rentals		258	2		737	4		995	6
Home equity and second mortgages		193	3		—	—		193	3
Commercial loans		829	2		—	—		829	2
Commercial equipment		287	4		35	2		322	6
	$	5,738	21	$	8,077	16	$	13,815	37


	December 31, 2018
	Non-accrual			Non-accrual			Total		Total
	Delinquent		Number	Current		Number	Non-accrual		Number
(dollars in thousands)	Loans		of Loans	Loans		of Loans	Loans		of Loans
Commercial real estate	$	8,474	11	$	6,158	6	$	14,632	17
Residential first mortgages		146	1		1,228	4		1,374	5
Residential rentals		260	2		703	3		963	5
Home equity and second mortgages		147	2		—	—		147	2
Commercial loans		866	2		—	—		866	2
Commercial equipment		1,259	5		41	2		1,300	7
	$	11,152	23	$	8,130	15	$	19,282	38

Non-accrual loans decreased $5.5 million from $19.3 million or 1.43% of total loans at December 31, 2018 to $13.8 million or 1.01% of total loans at March 31, 2019. 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 March 31, 2019, non-accrual loans of $13.8 million included 37 loans, of which $10.9 million, or 79% represented 12 loans and four customer relationships. The decrease in non-accrual loans during the first quarter of 2019, was largely the result of approximately $3.8 million of one classified relationship that was moved into OREO. In addition, a $1.8 million non-accrual loan was sold at carrying value with no charge-offs during the three months ended March 31, 2019. Non-accrual loans of $8.1 million (58%) were current with all payments of principal and interest with no impairment at March 31, 2019. Delinquent non-accrual loans were $5.7 million (42%) with specific reserves of $893,000 at March 31, 2019.

At December 31, 2018, non-accrual loans of $19.3 million included 38 loans, of which $15.3 million, or 79% represented 13 loans and four customer relationships. During the year ended December 31, 2018, non-accrual loans increased $14.6 million primarily as a result of one well-secured classified relationship of $10.1 million that was placed on non-accrual during the second quarter of 2018. At December 31, 2018, there were $8.1 million (42%) of non-accrual loans current with all payments of principal and interest with no impairment and $11.2 million (58%) of delinquent non-accrual loans with a total of $978,000 specifically reserved.

Non-accrual loans included one TDR totaling $26,000 and $29,000 at March 31, 2019 and December 31, 2018, respectively. 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) decreased $5.7 million from $12.2 million, or 0.91% of loans, at December 31, 2018 to $6.5 million, or 0.47% of loans, at March 31, 2019.

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $12.1 million and $17.4 million at March 31, 2019 and December 31, 2018, respectively. Interest due but not recognized on these balances at March 31, 2019 and December 31, 2018 was $193,000 and $456,000, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $1.7 million and $1.9 million at March 31, 2019 and December 31, 2018, respectively. Interest due but not recognized on these balances at March 31, 2019 and December 31, 2018 was $122,000 and $81,000, 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 March 31, 2019 and December 31, 2018 were as follows:


	March 31, 2019
													Total
	31‑60		61‑89		90 or Greater		Total						Loan
(dollars in thousands)	Days		Days		Days		Past Due		PCI Loans		Current		Receivables
Commercial real estate	$	364	$	—	$	4,023	$	4,387	$	1,750	$	885,028	$	891,165
Residential first mortgages		—		—		150		150		468		156,035		156,653
Residential rentals		12		—		245		257		886		123,375		124,518
Construction and land dev.		—		—		—		—		—		32,798		32,798
Home equity and second mtg.		260		—		193		453		123		36,170		36,746
Commercial loans		90		—		829		919		—		69,806		70,725
Consumer loans		1		—		—		1		—		850		851
Commercial equipment		44		—		261		305		—		49,415		49,720
Total	$	771	$	—	$	5,701	$	6,472	$	3,227	$	1,353,477	$	1,363,176


	December 31, 2018
													Total
	31‑60		61‑89		90 or Greater		Total						Loan
(dollars in thousands)	Days		Days		Days		Past Due		PCI Loans		Current		Receivables
Commercial real estate	$	—	$	677	$	8,474	$	9,151	$	1,785	$	867,080	$	878,016
Residential first mortgages		—		66		146		212		466		156,031		156,709
Residential rentals		13		53		247		313		897		123,088		124,298
Construction and land dev.		—		—		—		—		—		29,705		29,705
Home equity and second mtg.		266		—		147		413		72		35,076		35,561
Commercial loans		—		—		866		866		—		70,814		71,680
Consumer loans		1		4		—		5		—		746		751
Commercial equipment		25		29		1,230		1,284		—		48,918		50,202
Total	$	305	$	829	$	11,110	$	12,244	$	3,220	$	1,331,458	$	1,346,922

Impaired Loans and Troubled Debt Restructures (“TDRs”)

Impaired loans, including TDRs, at March 31, 2019 and 2018 and at December 31, 2018 were as follows:


	March 31, 2019
	Unpaid		Recorded		Recorded						Quarter		Quarter
	Contractual		Investment		Investment		Total				Average		Interest
	Principal		With No		With		Recorded		Related		Recorded		Income
(dollars in thousands)	Balance		Allowance		Allowance		Investment		Allowance		Investment		Recognized
Commercial real estate	$	22,320	$	20,019	$	2,274	$	22,293	$	208	$	22,373	$	184
Residential first mortgages		2,507		2,505		—		2,505		—		2,518		27
Residential rentals		1,773		1,768		—		1,768		—		1,779		21
Construction and land dev.		729		729		—		729		—		729		11
Home equity and second mtg.		257		250		—		250		—		250		2
Commercial loans		2,672		1,834		827		2,661		700		2,669		27
Commercial equipment		390		199		174		373		150		381		2
Total	$	30,648	$	27,304	$	3,275	$	30,579	$	1,058	$	30,699	$	274


	December 31, 2018
	Unpaid		Recorded		Recorded						YTD		YTD
	Contractual		Investment		Investment		Total				Average		Interest
	Principal		With No		With		Recorded		Related		Recorded		Income
(dollars in thousands)	Balance		Allowance		Allowance		Investment		Allowance		Investment		Recognized
Commercial real estate	$	27,835	$	24,515	$	3,025	$	27,540	$	326	$	27,833	$	1,275
Residential first mortgages		2,527		2,527		—		2,527		—		2,573		126
Residential rentals		1,745		1,745		—		1,745		—		1,792		85
Construction and land dev.		729		729		—		729		—		729		45
Home equity and second mtg.		294		288		—		288		—		291		13
Commercial loans		2,762		1,888		863		2,751		700		2,804		118
Consumer loans		1		—		1				1		1		—
Commercial equipment		1,315		1,121		178		1,299		153		1,354		31
Total	$	37,208	$	32,813	$	4,067	$	36,880	$	1,180	$	37,377	$	1,693


	March 31, 2018
	Unpaid		Recorded		Recorded						Quarter		Quarter
	Contractual		Investment		Investment		Total				Average		Interest
	Principal		With No		With		Recorded		Related		Recorded		Income
(dollars in thousands)	Balance		Allowance		Allowance		Investment		Allowance		Investment		Recognized
Commercial real estate	$	27,398	$	25,156	$	1,750	$	26,906	$	290	$	26,964	$	279
Residential first mortgages		2,435		1,916		454		2,370		2		2,403		23
Residential rentals		1,424		1,401		—		1,401		—		1,428		16
Construction and land dev.		729		—		729		729		210		729		10
Home equity and second mtg.		309		306		—		306		—		309		2
Commercial loans		3,008		1,889		1,061		2,950		419		2,950		20
Commercial equipment		1,333		1,023		301		1,324		239		1,341		12
Total	$	36,637	$	31,691	$	4,296	$	35,987	$	1,161	$	36,125	$	362

TDRs, included in the impaired loan schedules above, as of March 31, 2019 and December 31, 2018 were as follows:


	March 31, 2019			December 31, 2018
			Number			Number
(dollars in thousands)	Dollars		of Loans	Dollars		of Loans
Commercial real estate	$	5,590	7	$	5,612	7
Residential first mortgages		66	1		66	1
Residential rentals		215	1		216	1
Construction and land development		729	2		729	2
Commercial loans		—	—		53	1
Commercial equipment		78	2		29	1
Total TDRs	$	6,678	13	$	6,705	13
Less: TDRs included in non-accrual loans		(26)	(1)		(29)	(1)
Total accrual TDR loans	$	6,652	12	$	6,676	12

TDRs decreased $24,000 during the first quarter of 2019 due to principal paydowns. There were no TDRs added during the three months ended March 31, 2019. The Company had specific reserves of $164,000 on one TDR totaling $1.5 million at March 31, 2019.

The Company had specific reserves of $165,000 on one TDR totaling $1.6 million at December 31, 2018. During the year ended December 31, 2018, TDR disposals, which included payoffs and refinancing decreased by three loans totaling $3.9 million. TDR loan principal curtailment was $176,000 for the year ended December 31, 2018. There were no TDRs added during the year ended December 31, 2018.

Allowance for Loan Losses

The following tables detail activity in the allowance for loan losses at and for the three months ended March 31, 2019 and 2018, 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.


Three Months Ended	March 31, 2019
	Beginning								Ending
(dollars in thousands)	Balance		Charge-offs		Recoveries		Provisions		Balance
Commercial real estate	$	6,882		—		2		(142)		6,742
Residential first mortgages		755		—		—		(33)		722
Residential rentals		498		(53)		46		(29)		462
Construction and land development		310		—		—		(162)		148
Home equity and second mortgages		133		—		2		(3)		132
Commercial loans		1,482		—		5		(81)		1,406
Consumer loans		6		(4)		1		5		8
Commercial equipment		910		(685)		56		945		1,226
	$	10,976	$	(742)	$	112	$	500	$	10,846

Purchase Credit Impaired**	$	—	$	—	$	—	$	—	$	—


Three Months Ended	March 31, 2018
	Beginning								Ending
(dollars in thousands)	Balance		Charge-offs		Recoveries		Provisions		Balance
Commercial real estate	$	6,451	$	(236)	$	2	$	447	$	6,664
Residential first mortgages		1,144		(37)		—		(170)		937
Residential rentals		512		—		—		(53)		459
Construction and land development		462		—		—		20		482
Home equity and second mortgages		162		(7)		9		(46)		118
Commercial loans		1,013		—		—		32		1,045
Consumer loans		7		(1)		—		1		7
Commercial equipment		764		(299)		25		269		759
	$	10,515	$	(580)	$	36	$	500	$	10,471

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.

The following tables detail loan receivable and allowance balances disaggregated on the basis of the Company’s impairment methodology at March 31, 2019 and 2018 and December 31, 2018.


	March 31, 2019								December 31, 2018								March 31, 2018
	Ending balance:		Ending balance:						Ending balance:		Ending balance:						Ending balance:		Ending balance:
	individually		collectively						individually		collectively						individually		collectively
	evaluated for		evaluated for		Purchase Credit				evaluated for		evaluated for		Purchase Credit				evaluated for		evaluated for		Purchase Credit
(dollars in thousands)	impairment		impairment		Impaired		Total		impairment		impairment		Impaired			Total	impairment		impairment		Impaired		Total
Loan Receivables:
Commercial real estate	$	22,293	$	867,122	$	1,750	$	891,165	$	27,540	$	848,691	$	1,785	$	878,016	$	26,906	$	789,133	$	1,537	$	817,576
Residential first mortgages		2,505		153,680		468		156,653		2,527		153,716		466		156,709		2,370		164,020		—		166,390
Residential rentals		1,768		121,864		886		124,518		1,745		121,656		897		124,298		1,401		125,869		1,756		129,026
Construction and land development		729		32,069		—		32,798		729		28,976		—		29,705		729		27,387		110		28,226
Home equity and second mortgages		250		36,373		123		36,746		288		35,201		72		35,561		306		38,707		468		39,481
Commercial loans		2,661		68,064		—		70,725		2,751		68,929		—		71,680		2,950		49,248		—		52,198
Consumer loans		—		851		—		851		1		750		—		751		1		852		—		853
Commercial equipment		373		49,347		—		49,720		1,299		48,903		—		50,202		1,324		44,581		—		45,905
	$	30,579	$	1,329,370	$	3,227	$	1,363,176	$	36,880	$	1,306,822	$	3,220	$	1,346,922	$	35,987	$	1,239,797	$	3,871	$	1,279,655

Allowance for loan losses:
Commercial real estate	$	208	$	6,534	$	—	$	6,742	$	326	$	6,556	$	—		6,882	$	290	$	6,374	$	—	$	6,664
Residential first mortgages		—		722		—		722		—		755		—		755		2		935		—		937
Residential rentals		—		462		—		462		—		498		—		498		—		459		—		459
Construction and land development		—		148		—		148		—		310		—		310		210		272		—		482
Home equity and second mortgages		—		132		—		132		—		133		—		133		—		118		—		118
Commercial loans		700		706		—		1,406		700		782		—		1,482		419		626		—		1,045
Consumer loans		—		8		—		8		1		5		—		6		1		6		—		7
Commercial equipment		150		1,076		—		1,226		153		757		—		910		239		520		—		759
	$	1,058	$	9,788	$	—	$	10,846	$	1,180	$	9,796	$	—	$	10,976	$	1,161	$	9,310	$	—	$	10,471

Credit Quality Indicators

Credit quality indicators as of March 31, 2019 and December 31, 2018 were as follows:

Credit Risk Profile by Internally Assigned Grade


	Commercial Real Estate				Construction and Land Dev.				Residential Rentals
(dollars in thousands)	3/31/2019		12/31/2018		3/31/2019		12/31/2018		3/31/2019		12/31/2018
Unrated	$	109,399	$	112,280	$	1,616	$	2,172	$	37,865	$	37,478
Pass		762,790		741,037		31,182		26,805		85,407		85,551
Special mention		—		—		—		—		—		—
Substandard		18,976		24,699		—		728		1,246		1,269
Doubtful		—		—		—		—		—		—
Loss		—		—		—		—		—		—
Total	$	891,165	$	878,016	$	32,798	$	29,705	$	124,518	$	124,298


	Commercial Loans				Commercial Equipment				Total Commercial Portfolios
(dollars in thousands)	3/31/2019		12/31/2018		3/31/2019		12/31/2018		3/31/2019		12/31/2018
Unrated	$	19,657	$	19,157	$	15,731	$	15,373	$	184,268	$	186,460
Pass		48,409		49,828		33,815		33,685		961,603		936,906
Special mention		—		—		—		—		—		—
Substandard		2,659		2,695		174		1,144		23,055		30,535
Doubtful		—		—		—		—		—		—
Loss		—		—		—		—		—		—
Total	$	70,725	$	71,680	$	49,720	$	50,202	$	1,168,926	$	1,153,901


	Non-Commercial Portfolios **				Total All Portfolios
(dollars in thousands)	3/31/2019		12/31/2018		3/31/2019		12/31/2018
Unrated	$	148,077	$	146,889	$	332,345	$	333,349
Pass		44,951		44,441		1,006,554		981,347
Special mention		—		—		—		—
Substandard		1,222		1,691		24,277		32,226
Doubtful		—		—		—		—
Loss		—		—		—		—
Total	$	194,250	$	193,021	$	1,363,176	$	1,346,922

** 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)	3/31/2019		12/31/2018		3/31/2019		12/31/2018		3/31/2019		12/31/2018
Performing	$	156,504	$	156,563	$	36,552	$	35,414	$	851	$	751
Nonperforming		149		146		194		147		—		—
Total	$	156,653	$	156,709	$	36,746	$	35,561	$	851	$	751

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 have impairment quantified because of an event (e.g., TDRs or nonperforming loans).

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 are 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 $3.9 million and a carrying value of $3.2 million at March 31, 2019. PCI loans represented 0.19% of total assets at March 31, 2019. 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 a previously established allowance for loan losses from acquisition.

A summary of changes in the accretable yield for PCI loans for the three months ended March 31, 2019 and 2018 and the year ended December 31, 2018 follows:


	Three Months Ended				Year Ended
(dollars in thousands)	March 31, 2019		March 31, 2018		December 31, 2018
Accretable yield, beginning of period	$	734	$	—	$	—
Additions		—		517		517
Accretion		(54)		(58)		(230)
Reclassification from (to) nonaccretable difference		—		—		134
Other changes, net		—		—		313
Accretable yield, end of period	$	680	$	459	$	734

At March 31, 2019, performing acquired loans, which totaled $98.1 million, included a $1.7 million net acquisition accounting fair market value adjustment, representing a 1.70% discount; and PCI loans which totaled $3.2 million, included a $694,000 adjustment, representing a 17.70% discount. During the three months ended March 31, 2019 there was $172,000 of accretion interest.

Accounting standards require a periodic recast of the expected cash flows on the PCI loan portfolio. The recast was performed during the fourth quarter of 2018 which resulted in a reclassification of $134,000 from the credit (nonaccretable) portion of the discount to the liquidity (accretable) portion of the discount. Also, based on the recast, the change in future expected cash flows not related to the reclassification was $313,000. There was no recast for the three months ended March 31, 2019 based on the small size of the PCI portfolio and management’s judgement that expected cash flows would not have changed materially since the fourth quarter 2018 recast.

The following is a summary of acquired and non-acquired loans as of March 31, 2019 and December 31, 2018:


BY ACQUIRED AND NON-ACQUIRED	March 31, 2019		%		December 31, 2018		%
Acquired loans - performing	$	98,136	7.20	%	$	103,667	7.70	%
Acquired loans - purchase credit impaired ("PCI")		3,227	0.24	%		3,220	0.24	%
Total acquired loans		101,363	7.44	%		106,887	7.94	%
Non-acquired loans**		1,261,813	92.56	%		1,240,035	92.06	%
Gross loans		1,363,176				1,346,922
Net deferred costs (fees)		1,261	0.09	%		1,183	0.09	%
Total loans, net of deferred costs	$	1,364,437			$	1,348,105

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