LOANS

Loans consist of the following:



	September 30, 2019										December 31, 2018
(dollars in thousands)	PCI		All other loans**			Total			% of Gross Loans		PCI		All other loans**			Total			% of Gross Loans
Commercial real estate	$	1,732	$	930,612		$	932,344		65.86	%	$	1,785	$	876,231		$	878,016		65.18	%
Residential first mortgages	451		163,276			163,727			11.57	%	466		156,243			156,709			11.63	%
Residential rentals	317		120,853			121,170			8.56	%	897		123,401			124,298			9.23	%
Construction and land development	—		30,774			30,774			2.17	%	—		29,705			29,705			2.21	%
Home equity and second mortgages	303		35,879			36,182			2.56	%	72		35,489			35,561			2.64	%
Commercial loans	—		69,179			69,179			4.89	%	—		71,680			71,680			5.32	%
Consumer loans	—		937			937			0.07	%	—		751			751			0.06	%
Commercial equipment	—		61,104			61,104			4.32	%	—		50,202			50,202			3.73	%
Gross loans	2,803		1,412,614			1,415,417			100.00	%	3,220		1,343,702			1,346,922			100.00	%
Net deferred costs	—		1,691			1,691			0.12	%	—		1,183			1,183			0.09	%
Total loans, net of deferred costs	$	2,803	$	1,414,305		$	1,417,108				$	3,220	$	1,344,885		$	1,348,105
Less: allowance for loan losses	—		(11,252		)	(11,252		)	(0.79	)%	—		(10,976		)	(10,976		)	(0.81	)%
Net loans	$	2,803	$	1,403,053		$	1,405,856				$	3,220	$	1,333,909		$	1,337,129

______________________________________

** All other loans include acquired Non-PCI pools.

At September 30, 2019 and December 31, 2018, the Bank’s allowance for loan losses totaled $11.3 million and $11.0 million, or 0.79% and 0.81%, respectively, of loan balances. Management’s determination of the adequacy of the allowance is based on periodic evaluations 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 $1.7 million at September 30, 2019 included deferred fees paid by customers of $3.2 million offset by deferred costs of $4.9 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 deferred fees paid by customers of $3.1 million offset by 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 September 30, 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 8.4% and 5.9% of the CRE portfolio at September 30, 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 nine months ended September 30, 2019 and the year ended December 31, 2018, the Bank purchased residential first mortgages of $28.1 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 $53.3 million or 3.8% of total gross loans of $1.4 billion at September 30, 2019 compared to $54.2 million or 4.0% of total gross loans of $1.3 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 September 30, 2019 and December 31, 2018, $91.6 million and $96.6 million, respectively, were 1‑4 family units and $29.6 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 $100.6 million or 7.1% of total gross loans of $1.4 billion at September 30, 2019 compared to $97.4 million or 7.2% of total gross loans of $1.3 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 adverse conditions in the rental real estate market or the economy to a greater extent 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.

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, 2019 and December 31, 2018 were as follows:



	September 30, 2019
(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	$	10,256	10	$	1,603	4	$	11,859	14
Residential first mortgages	146		1	841		3	987		4
Residential rentals	—		—	956		5	956		5
Home equity and second mortgages	211		5	310		3	521		8
Commercial loans	822		2	—		—	822		2
Commercial equipment	280		5	8		2	288		7
	$	11,715	23	$	3,718	17	$	15,433	40



	December 31, 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	$	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 $3.8 million from $19.3 million or 1.43% of total loans at December 31, 2018 to $15.4 million or 1.09% of total loans at September 30, 2019. 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, such interest income is recognized on a cash basis or cost-recovery method, until qualifying for return to accrual status.

At September 30, 2019, non-accrual loans of $15.4 million included 40 loans, of which $12.9 million, or 84% represented 14 loans and 6 customer relationships. Non-accrual loans of $3.7 million (24%) were current with all payments of principal and interest with no impairment at September 30, 2019. Delinquent non-accrual loans were $11.7 million (76%) with specific reserves of $1.4 million at September 30, 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 4 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 TDRs totaling $1.4 million and $29,000 at September 30, 2019 and December 31, 2018, respectively. These loans were classified solely as non-accrual for the calculation of financial ratios. Loan delinquency (90 days or greater delinquent and 31‑89 days delinquent) increased $1.7 million from $12.2 million, or 0.91% of loans, at December 31, 2018 to $13.9 million, or 0.98% of loans, at September 30, 2019.

Non-accrual loans, which did not have a specific allowance for impairment, amounted to $9.8 million and $17.4 million at September 30, 2019 and December 31, 2018, respectively. Interest due but not recognized on these balances at September 30, 2019 and December 31, 2018 was $209,000 and $456,000, respectively. Non-accrual loans with a specific allowance for impairment amounted to $5.6 million and $1.9 million at September 30, 2019 and December 31, 2018, respectively. Interest due but not recognized on these balances at September 30, 2019 and December 31, 2018 was $302,000 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 September 30, 2019 and December 31, 2018 were as follows:



	September 30, 2019
(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	$	—	$	—	$	10,255	$	10,255	$	1,732	$	920,357	$	932,344
Residential first mortgages	—		—		146		146		451		163,130		163,727
Residential rentals	—		317		—		317		317		120,536		121,170
Construction and land dev.	—		—		—		—		—		30,774		30,774
Home equity and second mtg.	5		76		210		291		303		35,588		36,182
Commercial loans	1,807		3		819		2,629		—		66,550		69,179
Consumer loans	—		1		—		1		—		936		937
Commercial equipment	38		5		243		286		—		60,818		61,104
Total	$	1,850	$	402	$	11,673	$	13,925	$	2,803	$	1,398,689	$	1,415,417



	December 31, 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	$	—	$	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

There were no loans greater than 90 days past due accruing interest at September 30, 2019 and December 31, 2018.

Impaired Loans and Troubled Debt Restructures (“TDRs”)

Impaired loans, including TDRs, at September 30, 2019 and 2018 and at December 31, 2018 were as follows:



	September 30, 2019
(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	$	21,159	$	16,175	$	4,799	$	20,974	$	444	$	21,023	$	183	$	21,309	$	591
Residential first mortgages	2,089		2,089		—		2,089		—		2,098		23		2,125		66
Residential rentals	956		956		—		956		—		961		14		977		44
Construction and land dev.	—		—		—		—		—		—		—		—		—
Home equity and second mtg.	588		577		—		577		—		580		5		579		21
Commercial loans	2,641		1,807		822		2,629		822		2,648		9		2,669		65
Commercial equipment	830		601		210		811		210		822		8		846		32
Total	$	28,263	$	22,205	$	5,831	$	28,036	$	1,476	$	28,132	$	242	$	28,505	$	819



	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, 2018
(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	$	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

TDRs included in the impaired loan schedules above, as of September 30, 2019 and December 31, 2018 were as follows:



	September 30, 2019					December 31, 2018
(dollars in thousands)	Dollars			Number of Loans		Dollars			Number of Loans
Commercial real estate	$	1,438		4		$	5,612		7
Residential first mortgages	64			1		66			1
Residential rentals	—			—		216			1
Construction and land development	—			—		729			2
Commercial loans	—			—		53			1
Commercial equipment	571			3		29			1
Total TDRs	$	2,073		8		$	6,705		13
Less: TDRs included in non-accrual loans	(1,418		)	(2	)	(29		)	(1	)
Total accrual TDR loans	$	655		6		$	6,676		12

TDRs decreased $4.6 million during the nine months ended September 30, 2019 due to principal paydowns and refinancing. One TDR of $25,000 was added during the nine months ended September 30, 2019. The Company fully-reserved three TDRs totaling $91,000 at September 30, 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, included 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 and nine months ended September 30, 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. There is no allowance for loan loss on the PCI portfolios. A more detailed rollforward schedule will be presented if an PCI allowance is required.



Three Months Ended	September 30, 2019
(dollars in thousands)	Beginning Balance		Charge-offs			Recoveries		Provisions			Ending Balance
Commercial real estate	$	7,009	$	(144	)	$	—	$	238		$	7,103
Residential first mortgages	709		—			—		(80		)	629
Residential rentals	458		—			—		(51		)	407
Construction and land development	246		—			—		(52		)	194
Home equity and second mortgages	131		—			1		(7		)	125
Commercial loans	1,402		—			10		189			1,601
Consumer loans	9		—			—		(1		)	8
Commercial equipment	954		—			17		214			1,185
	$	10,918	$	(144	)	$	28	$	450		$	11,252

Nine Months Ended	September 30, 2019
(dollars in thousands)	Beginning Balance		Charge-offs			Recoveries		Provisions			Ending Balance
Commercial real estate	$	6,882	$	(148	)	$	15	$	354		$	7,103
Residential first mortgages	755		—			—		(126		)	629
Residential rentals	498		(53		)	46		(84		)	407
Construction and land development	310		(329		)	—		213			194
Home equity and second mortgages	133		—			5		(13		)	125
Commercial loans	1,482		—			20		99			1,601
Consumer loans	6		(4		)	2		4			8
Commercial equipment	910		(685		)	82		878			1,185
	$	10,976	$	(1,219	)	$	170	$	1,325		$	11,252



Three Months Ended	September 30, 2018
(dollars in thousands)	Beginning Balance		Charge-offs			Recoveries		Provisions			Ending Balance
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

Nine Months Ended	September 30, 2018
(dollars in thousands)	Beginning Balance		Charge-offs			Recoveries		Provisions			Ending Balance
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

The following tables detail loan receivable and allowance balances disaggregated on the basis of the Company’s impairment methodology at September 30, 2019 and 2018 and December 31, 2018.



	September 30, 2019								December 31, 2018								September 30, 2018
(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		Purchase Credit Impaired		Total		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment		Purchase Credit Impaired		Total
Loan Receivables:
Commercial real estate	$	20,974	$	909,638	$	1,732	$	932,344	$	27,540	$	848,691	$	1,785	$	878,016	$	26,225	$	820,257	$	1,463	$	847,945
Residential first mortgages	2,089		161,187		451		163,727		2,527		153,716		466		156,709		2,616		153,481		468		156,565
Residential rentals	956		119,897		317		121,170		1,745		121,656		897		124,298		1,377		122,745		1,261		125,383
Construction and land development	—		30,774		—		30,774		729		28,976		—		29,705		729		28,059		—		28,788
Home equity and second mortgages	577		35,302		303		36,182		288		35,201		72		35,561		293		35,748		319		36,360
Commercial loans	2,629		66,550		—		69,179		2,751		68,929		—		71,680		2,773		59,310		—		62,083
Consumer loans	—		937		—		937		1		750		—		751		1		729		—		730
Commercial equipment	811		60,293		—		61,104		1,299		48,903		—		50,202		1,534		48,349		—		49,883
	$	28,036	$	1,384,578	$	2,803	$	1,415,417	$	36,880	$	1,306,822	$	3,220	$	1,346,922	$	35,548	$	1,268,678	$	3,511	$	1,307,737
Allowance for loan losses:
Commercial real estate	$	444	$	6,659	$	—	$	7,103	$	326	$	6,556	$	—	$	6,882	$	174	$	6,538	$	—	$	6,712
Residential first mortgages	—		629		—		629		—		755		—		755		—		691		—		691
Residential rentals	—		407		—		407		—		498		—		498		—		585		—		585
Construction and land development	—		194		—		194		—		310		—		310		—		295		—		295
Home equity and second mortgages	—		125		—		125		—		133		—		133		—		177		—		177
Commercial loans	822		779		—		1,601		700		782		—		1,482		458		756		—		1,214
Consumer loans	—		8		—		8		1		5		—		6		1		4		—		5
Commercial equipment	210		975		—		1,185		153		757		—		910		377		683		—		1,060
	$	1,476	$	9,776	$	—	$	11,252	$	1,180	$	9,796	$	—	$	10,976	$	1,010	$	9,729	$	—	$	10,739

Credit Quality Indicators

Credit quality indicators as of September 30, 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)	9/30/2019		12/31/2018		9/30/2019		12/31/2018		9/30/2019		12/31/2018
Unrated	$	103,996	$	112,280	$	1,654	$	2,172	$	39,187	$	37,478
Pass	806,267		741,037		29,120		26,805		81,317		85,551
Special mention	—		—		—		—		—		—
Substandard	22,081		24,699		—		728		666		1,269
Doubtful	—		—		—		—		—		—
Loss	—		—		—		—		—		—
Total	$	932,344	$	878,016	$	30,774	$	29,705	$	121,170	$	124,298



	Commercial Loans				Commercial Equipment				Total Commercial Portfolios
(dollars in thousands)	9/30/2019		12/31/2018		9/30/2019		12/31/2018		9/30/2019		12/31/2018
Unrated	$	17,792	$	19,157	$	24,390	$	15,373	$	187,019	$	186,460
Pass	48,758		49,828		36,504		33,685		1,001,966		936,906
Special mention	—		—		—		—		—		—
Substandard	2,629		2,695		210		1,144		25,586		30,535
Doubtful	—		—		—		—		—		—
Loss	—		—		—		—		—		—
Total	$	69,179	$	71,680	$	61,104	$	50,202	$	1,214,571	$	1,153,901



	Non-Commercial Portfolios **				Total All Portfolios
(dollars in thousands)	9/30/2019		12/31/2018		9/30/2019		12/31/2018
Unrated	$	157,831	$	146,889	$	344,850	$	333,349
Pass	41,630		44,441		1,043,596		981,347
Special mention	—		—		—		—
Substandard	1,385		1,691		26,971		32,226
Doubtful	—		—		—		—
Loss	—		—		—		—
Total	$	200,846	$	193,021	$	1,415,417	$	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)	9/30/2019		12/31/2018		9/30/2019		12/31/2018		9/30/2019		12/31/2018
Performing	$	163,581	$	156,563	$	35,972	$	35,414	$	937	$	751
Nonperforming	146		146		210		147		—		—
Total	$	163,727	$	156,709	$	36,182	$	35,561	$	937	$	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 $3.4 million and a carrying value of $2.8 million at September 30, 2019. The carrying value of PCI loans represented 0.15% of total assets at September 30, 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 considering 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 and nine months ended September 30, 2019 and 2018 and the year ended December 31, 2018 follows:



	Three Months Ended September 30,						Nine Months Ended September 30,						Year Ended
(dollars in thousands)	2019			2018			2019			2018			December 31, 2018
Accretable yield, beginning of period	$	779		$	401		$	734		$	—		$	—
Additions	—			—			—			517			517
Accretion	(124		)	(54		)	(246		)	(170		)	(230		)
Reclassification from (to) nonaccretable difference	—			—			156			—			134
Other changes, net	—			—			11			—			313
Accretable yield, end of period	$	655		$	347		$	655		$	347		$	734

At September 30, 2019 performing acquired loans, which totaled $82.6 million, included a $1.3 million net acquisition accounting fair market value adjustment, representing a 1.61% discount; and PCI loans which totaled $2.8 million, included a $597,000 adjustment, representing a 17.56% discount. At December 31, 2018 acquired performing loans, which totaled $103.7 million, included a $1.9 million net acquisition accounting fair market value adjustment, representing a 1.76% discount; and PCI loans which totaled $3.2 million, included a $696,000 adjustment, representing a 17.77% discount.

During the three months ended September 30, 2019 and 2018 there was $242,000 and $161,000, respectively, of accretion interest. During the nine months ended September 30, 2019 and 2018 there was $624,000 and $635,000, respectively 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 second quarter of 2019 which resulted in a reclassification of $156,000 from the credit (nonaccretable) portion of the discount to the liquidity (accretable) portion of the discount.

The following is a summary of acquired and non-acquired loans as of September 30, 2019 and December 31, 2018:



BY ACQUIRED AND NON-ACQUIRED	September 30, 2019		%		December 31, 2018		%
Acquired loans - performing	$	82,629	5.84	%	$	103,667	7.70	%
Acquired loans - purchase credit impaired ("PCI")	2,803		0.20	%	3,220		0.24	%
Total acquired loans	85,432		6.04	%	106,887		7.94	%
Non-acquired loans**	1,329,985		93.96	%	1,240,035		92.06	%
Gross loans	1,415,417				1,346,922
Net deferred costs (fees)	1,691		0.12	%	1,183		0.09	%
Total loans, net of deferred costs	$	1,417,108			$	1,348,105

______________________________

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