10-K 1 form10k.htm SEVERN BANCORP, INC 10-K 12-31-2016

 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016
or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                           to                                              .

Commission File Number 0-49731

SEVERN BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
Maryland
 
52-1726127
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
     
200 Westgate Circle, Suite 200,  Annapolis, Maryland
 
21401
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (410) 260-2000

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
     
Common Stock, par value $.01 per share
 
 The Nasdaq Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ☐ No ☑

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ☐ No ☑

Note - Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 of 15(d) of the Exchange Act from their obligations under those Sections.
 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ☑ No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☐ (Do not
 
Smaller reporting company ☑
check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Act).  Yes ☐ No ☑

 The aggregate market value of the 8,258,193 shares of common stock held by non-affiliates of the registrant, based on the closing sale price of the registrant’s common stock on June 30, 2016 of $6.00 per share was $49,549,158.

(APPLICABLE ONLY TO CORPORATE REGISTRANTS)

Indicate the number of shares outstanding for each of the registrant’s classes of common stock, as of the latest practicable date.

As of March 22, 2017, there were issued and outstanding 12,124,965 shares of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Definitive Proxy Statement for its 2016 Annual Meeting of Stockholders, which Definitive Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the registrant’s fiscal year-ended December 31, 2016, are incorporated by reference into Part III of this Form 10-K; provided, however, that the Audit Committee Report and any other information in such proxy statement that is not required to be included in this Annual Report on Form 10-K, shall not be deemed to be incorporated herein by reference or filed as a part of this Annual Report on Form 10-K.
 
Table of Contents

Section
 
Page No.
     
PART I
   
     
Item 1
1
Item 1A
33
Item 1B
41
Item 2
41
Item 3
42
Item 4
42
     
PART II
   
     
Item 5
42
Item 6
43
Item 7
47
Item 7A
56
Item 8
57
Item 9
57
Item 9A
57
Item 9B
58
     
PART III
   
     
Item 10
58
Item 11
59
Item 12
59
Item 13
59
Item 14
60
     
PART IV
   
     
Item 15
60
Item 16
61
     
62
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Severn Bancorp, Inc. (the “Company”) may from time to time make written or oral “forward-looking statements”, (as defined in the Securities Exchange Act of 1934, as amended, and the regulations thereunder) including statements contained in the Company’s filings with the Securities and Exchange Commission (including this Annual Report on Form 10-K and the exhibits thereto), in its reports to stockholders and in other communications by the Company, pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements include, but are not limited to:

·
Statements contained in “Item 1A. Risk Factors;”
 
·
Statements contained in “Business” concerning strategy, competitive strengths, liquidity and business plans;
 
·
Statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the notes to the Company’s consolidated financial statements, such as statements concerning allowance for loan losses, liquidity, capital adequacy requirements, unrealized losses, guarantees, the Bank being well-capitalized, and impact of accounting pronouncements; and
 
·
Statements as to trends or the Company’s or management’s beliefs, expectations and opinions.
 
The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” “would,” “could,” “should,” “guidance,” “potential,” “continue,” “project,” “forecast,” “confident,” and similar expressions are typically used to identify forward-looking statements.  These statements are based on assumptions and assessments made by management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate.  Any forward-looking statements are not guarantees of the Company’s future performance and are subject to risks and uncertainties and may be affected by various factors that may cause actual results, developments and business decisions to differ materially from those in the forward-looking statements.  Some of the factors that may cause actual results, developments and business decisions to differ materially from those contemplated by such forward-looking statements include the risk factors discussed under “Item 1A. Risk Factors” and the following:

·
Changes in general economic and political conditions and by governmental monetary and fiscal policies;
 
·
Changes in the economic conditions of the geographic areas in which  the Company conducts business;
 
·
Changes in interest rates;
 
·
A downturn in the real estate markets in which  the Company conducts business;
 
·
The high degree of risk exhibited by  the Company’s loan portfolio;
 
·
Environmental liabilities with respect to properties of which  the Company has title;
 
·
Changes in federal and state regulation, including recent changes in capital requirements;
 
·
The Company’s ability to estimate loan losses;
 
·
Competition;
 
·
Breaches in security or interruptions in  the Company’s information systems, including cyber security risks;
 
·
The Company’s ability to timely develop and implement technology;
 
·
The Company’s ability to retain its management team;
 
·
Perception of  the Company in the marketplace;
 
·
The Company’s ability to maintain effective internal controls over financial reporting and disclosure controls and procedures; and
 
·
Terrorist attacks and threats or actual war.

The Company can give no assurance that any of the events anticipated by the forward-looking statements will occur or, if any of them does, what impact they will have on the Company’s results of operations and financial condition.  The Company disclaims any intent or obligation to publicly update or revise any forward-looking statements, regardless of whether new information becomes available, future developments occur or otherwise.
 
PART I

Item 1.  Business

General

The Company is a savings and loan holding company chartered as a corporation in the state of Maryland in 1990.  It conducts business primarily through two subsidiaries, Severn Savings Bank, FSB (“Bank”) and SBI Mortgage Company (“SBI”).  The Bank’s principal subsidiary Louis Hyatt, Inc. (“Hyatt Commercial”), conducts business as Hyatt Commercial, a commercial real estate brokerage and property management company.  SBI holds mortgages that do not meet the underwriting criteria of the Bank, and is the parent company of Crownsville Development Corporation (“Crownsville”), which is doing business as Annapolis Equity Group, which acquires real estate for syndication and investment purposes.

The Bank has five branches in Anne Arundel County, Maryland, which offer a full range of deposit products, and originate mortgages in its primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware and Virginia.

The Bank operated under a Formal Agreement dated April 13, 2013, (the “Formal Agreement”), with the Office of the Comptroller of the Currency (the “OCC”). This agreement replaced the former Supervisory Agreement dated November 23, 2009 that the Bank had with the now defunct Office of Thrift Supervision (the “OTS”). The Bank satisfied all of the conditions of the Formal Agreement and on October 15, 2015 it was notified by the OCC that the agreement was terminated.

The Company previously operated under a Supervisory Agreement dated November 23, 2009, (the “Supervisory Agreement”) with the now defunct OTS. Upon the abolishment of the OTS on July 21, 2011, the Federal Reserve Bank assumed the regulation of the Company. The Company satisfied all of the conditions of the Supervisory Agreement and on January 21, 2016 it was notified by the Federal Reserve Bank that the Supervisory Agreement was terminated.

On April 23, 2013, the Bank was notified by the OCC that the OCC established minimum capital ratios for the Bank requiring it to immediately maintain a Tier I Leverage Capital Ratio to Adjusted Total Assets of at least 10% and a Total Risk-Based Capital to Risk-Weighted Assets ratio of at least 15%.  On October 15, 2015, the Bank was notified by the OCC that these additional minimum capital ratios were no longer required.

As of December 31, 2016 the Bank was well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized the Bank must maintain the following minimum ratios: Total Risk-Based Capital – 10.0%, Common Equity Tier 1 Capital – 6.5%, Tier 1 Capital (to risk-weighted assets) – 8%, Tier 1 Capital (to adjusted total assets) – 5.0%.

As of December 31, 2016, the Company had consolidated total assets of $787,485,000, total deposits of $571,946,000, and total stockholders’ equity of $87,930,000. The Company’s net income for the year ended December 31, 2016 was $15,540,000.  For more information, see “Item 6. Selected Financial Data.”

The Company’s internet address is www.severnbank.com.   The Company makes available free of charge on www.severnbank.com its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC.
 
In addition, we will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC.  Requests should be directed to:

Paul B. Susie
Executive Vice President
Severn Bancorp, Inc.
200 Westgate Circle, Suite 200
Annapolis, Maryland 21401

The information on the website listed above, is not and should not be considered part of this Annual Report on Form 10-K and is not incorporated by reference in this document.  This website is and is only intended to be an inactive textual reference.
 
Business of the Bank

The Bank was organized in 1946 in Baltimore, Maryland as Pompeii Permanent Building and Loan Association.  It relocated to Annapolis, Maryland in 1980 and its name was changed to Severn Savings Association.  Subsequently, the Bank obtained a federal charter and changed its name to Severn Savings Bank, FSB.  The Bank operates five full-service branch offices and one administrative office.  The Bank operates as a federally chartered savings bank whose principal business is attracting deposits from the general public and investing those funds in mortgage and commercial loans. The Bank also uses advances, or loans, from the Federal Home Loan Bank of Atlanta, (“FHLB-Atlanta”) to fund its lending activities.  The Bank provides a wide range of personal and commercial banking services. Personal services include mortgage lending and various other lending services as well as checking, savings, money market, time deposit and individual retirement accounts. Commercial services include commercial secured and unsecured lending services as well as business internet banking, corporate cash management services and deposit services.  The Bank also provides safe deposit boxes, ATMs, debit cards, credit cards, personal internet banking including on-line bill pay, mortgage lending, and telephone banking, among other products and services.

The Bank’s revenues are derived principally from interest earned on mortgage, commercial and other loans, and fees charged in connection with the loans and banking services.  The Bank’s primary sources of funds are deposits, advances from the FHLB-Atlanta, proceeds from loans sold on the secondary market, and repayments and principal prepayment of its loans.  The principal executive offices of the Bank are maintained at 200 Westgate Circle, Suite 200, Annapolis Maryland, 21401. Its telephone number is 410-260-2000 and its website address is www.severnbank.com.
 
Earnings

The Bank’s earnings depend primarily on the difference between the income from interest-earning assets, such as loans and investments, and interest paid on interest-bearing liabilities such as deposits and borrowings.  The Bank also originates and sells residential mortgages into the secondary market, generating gains on the loans sold. Rapid changes in interest rates may adversely affect the Bank’s earnings. The Bank monitors and manages this risk through its asset/liability committee.

Competition

The Annapolis, Maryland area has a high density of financial institutions, many of which are significantly larger and have greater financial resources than the Bank, and all of which are competitors of the Bank to varying degrees.  The Bank’s competition for loans comes primarily from savings and loan associations, savings banks, mortgage banking companies, insurance companies, and commercial banks.  Many of the Bank’s competitors have higher legal lending limits than the Bank.  The Bank’s most direct competition for deposits has historically come from savings and loan associations, savings banks, commercial banks, and credit unions.  The Bank faces additional competition for deposits from short-term money market funds and other corporate and government securities funds.  The Bank also faces increased competition for deposits from other financial institutions such as brokerage firms, insurance companies and mutual funds.  The Bank is a community-oriented financial institution serving its market area with a wide selection of mortgage loans and other consumer and commercial financial products and services.  Management considers the Bank’s reputation for financial strength and customer service as its major competitive advantage in attracting and retaining customers in its market area.  The Bank also believes it benefits from its community engagement activities.

Net Interest Income

Net interest income increases during periods when the spread between the Company’s weighted average rate at which new interest-earning assets such as loans and securities are originated or purchased and the weighted average cost of interest-bearing liabilities widens.  Market factors such as interest rates, competition, consumer preferences, the supply of and demand for housing, and the availability of funds affect the Bank’s ability to originate loans.

The Company has supplemented its interest income through purchases of investments when appropriate.  This activity is intended to generate positive interest rate spreads on large principal balances with minimal administrative expense.

Interest Rate and Volume of Interest-Related Assets and Liabilities

Both changes in rate and changes in the composition of the Company’s interest-earning assets and interest-bearing liabilities can have a significant effect on net interest income.

For information concerning the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected  the Company’s interest income and expense during the fiscal years ended December 31, 2016 and 2015, refer to Item 6, “Selected Financial Data - Rate Volume Table”.
 
Market Area

The Bank’s market area is primarily Anne Arundel County, Maryland and nearby areas, and its five branch locations are all located in Anne Arundel County.

The Bank continues to expand its business relationship banking department by focusing on the needs of the business community in Anne Arundel County, Maryland.  In addition, the Bank increased its offerings to businesses and consumers, including additional commercial lending products, business internet banking, and an expanded line of consumer deposit products.  The Bank has traditionally focused its lending activities on first mortgage loans secured by real estate for the purpose of purchasing, refinancing, developing and constructing one-to-four family residences and commercial properties in and near Anne Arundel County, Maryland. The Bank originates residential mortgage loans for sale into the secondary market. It generally sells the loans with the servicing rights released. However, for loans sold to Federal National Mortgage Association (“FNMA”) or Federal Home Loan Mortgage Corporation (“FHLMC”), the servicing rights have been retained.
 
Loan Portfolio Composition

The following table sets forth the composition of the Company’s loan portfolios by type of loan at the dates indicated.  The table includes a reconciliation of total net loans receivable, including loans held for sale, after consideration of undisbursed portion of loans, deferred loan fees and discounts, and allowance for loan losses as of December 31:

   
2016
   
2015
   
2014
   
2013
   
2012
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(dollars in thousands)
 
                                                             
Residential mortgage
 
$
260,603
     
40.77
%
 
$
285,930
     
45.00
%
 
$
309,461
     
44.91
%
 
$
258,919
     
39.56
%
 
$
269,405
     
38.60
%
Construction, land acquisition and development
   
57,166
     
8.94
%
   
77,478
     
12.19
%
   
84,325
     
12.24
%
   
75,539
     
11.54
%
   
71,523
     
10.25
%
Land
   
48,664
     
7.61
%
   
28,677
     
4.51
%
   
30,426
     
4.42
%
   
34,429
     
5.26
%
   
50,900
     
7.29
%
Lines of credit
   
29,657
     
4.64
%
   
20,188
     
3.18
%
   
19,251
     
2.79
%
   
21,598
     
3.30
%
   
31,428
     
4.50
%
Commercial real estate
   
195,710
     
30.62
%
   
174,912
     
27.53
%
   
198,539
     
28.81
%
   
220,160
     
33.64
%
   
222,038
     
31.81
%
Commercial non-real estate
   
16,811
     
2.63
%
   
9,296
     
1.46
%
   
10,167
     
1.47
%
   
8,583
     
1.31
%
   
6,120
     
0.88
%
Home equity
   
19,129
     
2.99
%
   
24,529
     
3.86
%
   
28,750
     
4.17
%
   
30,339
     
4.64
%
   
34,609
     
4.96
%
Consumer
   
1,210
     
0.19
%
   
1,224
     
0.19
%
   
1,040
     
0.15
%
   
1,185
     
0.18
%
   
858
     
0.12
%
Loans held for sale
   
10,307
     
1.61
%
   
13,203
     
2.08
%
   
7,165
     
1.04
%
   
3,726
     
0.57
%
   
11,116
     
1.59
%
                                                                                 
Total gross loans
   
639,257
     
100.00
%
   
635,437
     
100.00
%
   
689,124
     
100.00
%
   
654,478
     
100.00
%
   
697,997
     
100.00
%
                                                                                 
Deferred loan origination fees and costs, net
   
(2,944
)
           
(2,719
)
           
(2,480
)
           
(2,131
)
           
(2,047
)
       
                                                                                 
Loans in process
   
(15,728
)
           
(21,101
)
           
(36,162
)
           
(34,069
)
           
(15,647
)
       
                                                                                 
Allowance for loan losses
   
(8,969
)
           
(8,758
)
           
(9,435
)
           
(11,739
)
           
(17,478
)
       
                                                                                 
Total loans net
 
$
611,616
           
$
602,859
           
$
641,047
           
$
606,539
           
$
662,825
         
 
Lending Activities

General

The Bank originates mortgage loans of all types, including residential, home equity and lines of credit, residential-construction, commercial-construction, commercial, land and residential lot loans.  The Bank also originates non-mortgage loans, which include consumer, lines of credit and commercial loans.  These loans constitute less than 8 percent of the Bank’s portfolio.

The Bank originated and funded $345,437,000 and $282,828,000 of loans for the years ended December 31, 2016 and 2015, respectively.

Loan Origination

The following table contains information on the activity of the Bank’s loans held for sale and its loans held for investment in its portfolio:
 
   
For the Years Ended December 31,
 
   
2016
   
2015
   
2014
 
   
(dollars in thousands)
 
Held for Sale:
                 
Beginning balance
 
$
13,203
   
$
7,165
   
$
3,726
 
Originations
   
147,094
     
163,347
     
93,999
 
Net sales
   
(149,990
)
   
(157,309
)
   
(90,560
)
                         
Ending balance
 
$
10,307
   
$
13,203
   
$
7,165
 
                         
Held for investment:
                       
Beginning balance
 
$
622,234
   
$
681,959
   
$
650,752
 
Originations and purchases
   
198,343
     
119,481
     
138,782
 
Transfers to foreclosed real estate
   
(1,575
)
   
(2,234
)
   
(847
)
Repayments/payoffs
   
(190,052
)
   
(176,972
)
   
(106,728
)
                         
Ending balance
 
$
628,950
   
$
622,234
   
$
681,959
 

The Bank originates residential mortgage loans that are to be held in the Bank’s loan portfolio as well as loans that are intended for sale in the secondary market.  Loans sold in the secondary market are primarily sold to investors with which the Bank maintains a correspondent relationship.  These loans are made in conformity with standard underwriting criteria per the investors to assure maximum eligibility for possible resale in the secondary market, and are approved either by the Bank’s underwriter or the correspondent’s underwriter.  Loans considered for the Bank’s portfolio with borrowers that have lending relationships less than $500,000 are approved by any of the Bank’s Officers, which includes the Chief Executive Officer, the Chief Financial Officer, the Chief Credit Officer and the Chief Lending Officer.  Loans considered for the Bank’s portfolio with borrowers that have lending relationships of $500,000 or greater are approved by the Bank’s Directors Loan Committee.  Meetings of the Directors Loan Committee are open to attendance by any member of the Bank’s Board of Directors who wishes to attend.  The loan committee reports to and consults with the Board of Directors in interpreting and applying the Bank’s lending policy.  Single loans greater than $2,000,000, or loans to one borrower aggregating more than $4,000,000, up to $14,846,000 (the maximum amount of loans to one borrower as of December 31, 2016), must also have Board of Directors’ approval.
 
Loans that are sold into the secondary market are typically residential long-term (15 or more years) with fixed, and occasionally variable, rates of interest.  Loans retained for the Company’s portfolio typically include construction loans, commercial loans and loans that periodically reprice or mature prior to the end of an amortized term.  Generally, loans are sold with servicing released, however for loans sold to FHLMC or FNMA, the servicing has been retained. As of December 31, 2016, the Bank was servicing $18,288,000 in loans for FHLMC, $39,095,000 in loans for FNMA and $17,844,000 in loans for other investors.

The following table contains information, as of December 31, 2016, on the percentage of fixed-rate single-family loans serviced for others by the Bank, by interest rate category.

Interest rate range
   
Percentage of Portfolio
 
Less than 5.00%
     
92.4
%
5.00 – 6.00%
 
   
7.4
%
6.01 – 7.00%
 
   
0.1
%
7.01 – 8.00%
 
   
0.0
%
Over 8.00%
     
0.1
%
        
100.0
%

The Bank’s mortgage loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the property that will secure the loan.  The authority of the Directors Loan Committee to approve loans is established by the Board of Directors and currently is commensurate with the Bank’s limitation on loans to one borrower.  The Bank’s maximum amount of loans to one borrower currently is equal to 15% of the Bank’s unimpaired capital, or $14,846,000 as of December 31, 2016.  Loans greater than this amount require participation by one or more additional lenders.  Letters of credit are subject to the same limitations as direct loans.  The Bank utilizes independent qualified appraisers approved by the Board of Directors to appraise the properties securing its loans and requires title insurance or title opinions so as to insure that the Bank has a valid lien on the mortgaged real estate.  The Bank requires borrowers to maintain fire and casualty insurance on its secured properties.

The procedure for approval of construction loans is the same for residential mortgage loans, except that the appraiser evaluates the building plans, construction specifications, and estimates of construction costs.  The Bank also evaluates the feasibility of the proposed construction project and the experience and track record of the developer.  In addition, all construction loans generally require a commitment from a third-party lender or from the Bank for a permanent long-term loan to replace the construction loan upon completion of construction.

Residential Mortgage Loans

At December 31, 2016, the Company’s residential mortgage loan portfolio totaled $260,603,000, or 40.8% of the Company’s loan portfolio.  All of the Company’s residential mortgage loans are secured by one to four family residential properties and are primarily located in the Bank’s market area.

Commercial Real Estate Loans

At December 31, 2016, the Company’s commercial real estate loan portfolio totaled $195,710,000, or 30.6% of the Company’s loan portfolio.  All of the Company’s commercial real estate loans are secured by improved property such as office buildings, retail strip shopping centers, industrial condominium units and other small businesses, most of which are located in the Bank’s primary lending area.  The largest commercial real estate loan outstanding at December 31, 2016 was a $14,100,000 loan secured by commercial property in Middle River, Maryland.  This loan has consistently performed in accordance with the terms of the debt instrument.

Loans secured by commercial real estate properties generally involve a greater degree of risk than residential mortgage loans.  Because payments on loans secured by commercial real estate 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 real estate market or the economy.
 
Construction and Land Acquisition and Development Loans

The Bank originates loans to finance the construction of one-to-four family dwellings, and to a lesser extent, commercial real estate.  It also originates loans for the acquisition and development of unimproved property to be used for residential and/or commercial purposes in cases where the Bank is to provide the construction funds to improve the properties.  As of December 31, 2016, the Company had 91 construction loans outstanding in the gross aggregate amount of $57,166,000, representing 8.9% of its loan portfolio.  Included in that total were commitments to advance an additional $15,728,000.

Construction loan amounts are based on the appraised value of the property and, for builder loans, a feasibility study as to the potential marketability and profitability of the project.  Construction loans generally have terms of up to one year, with reasonable extensions as needed, and typically have interest rates that float monthly at margins ranging from the prime rate to 2 percent above the prime rate.   In addition to builders’ projects, the Bank finances the construction of single family, owner-occupied houses where qualified contractors are involved and on the basis of strict written underwriting and construction loan guidelines.  Construction loans are structured either to be converted to permanent loans with the Bank upon the expiration of the construction phase or to be paid off by financing from another financial institution.

Construction loans afford the Bank the opportunity to increase the interest rate sensitivity of its loan portfolio and to receive yields higher than those obtainable on loans secured by existing residential properties.  These higher yields correspond to the higher risks associated with construction lending.   Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of the project under construction that is of uncertain value prior to its completion.  Because of the uncertainties inherent in estimating construction costs as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to value accurately the total funds required to complete a project and the related loan-to-value ratio.  As a result, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the ultimate success of the project rather than the ability of the borrower or guarantor to repay principal and interest.  If the Bank is forced to foreclose on a project prior to or at completion, due to a default, there can be no assurance that the Bank will be able to recover all of the unpaid balance of the loan as well as related foreclosure and holding costs.  In addition, the Bank may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time.  The Bank has attempted to address these risks through its underwriting procedures and its limited amount of construction lending on multi-family and commercial real estate properties.

It is the policy of the Bank to conduct physical inspections of each property secured by a construction or rehabilitation loan for the purpose of reporting upon the progress of the construction of improvements.  These inspections, referred to as “construction draw inspections,” are to be performed at the time of a request for an advance of construction funds.  If no construction advance has been requested, a construction inspector or senior officer of the institution makes an inspection of the subject property at least quarterly.

Land and Residential Building Lots

Land loans include loans to developers for the development of residential subdivisions and loans on unimproved lots primarily to individuals.  At December 31, 2016, the Company had outstanding land and residential building lot loans totaling $48,664,000, or 7.6% of the total loan portfolio.  The largest of these loans is for $4,745,000, is secured by residential lots in Severn, Maryland, and has performed in accordance with the terms of the debt instrument.  Land development loans typically are short-term loans; the duration of these loans is typically not greater than three years.  The interest rate on land loans is generally at least 1% or 2% over the prime rate.   The loan-to-value ratio generally does not exceed 75% at the time of loan origination. Land and residential building lot loans typically are made to customers of the Bank and developers and contractors with whom the Bank has had previous lending experience.  In addition to the customary requirements for these types of loans, the Bank may also require a satisfactory Phase I environmental study and feasibility study to determine the profit potential of the development.
 
Lines of Credit and Commercial Non-Real Estate Loans

The Bank also offers other business and commercial loans.  These are loans to businesses are typically lines of credit or other loans that are not secured by real estate, although equipment, securities, or other collateral may secure them.  They typically are offered to customers with long-standing relationships with the Bank.  At December 31, 2016, $46,468,000, or 7.3%, of the loan portfolio consisted of lines of credit and other commercial loans.

Home Equity and Other Consumer Loans

The Bank also offers other loans to consumers, including home equity loans, home equity lines of credit and other consumer loans.  At December 31, 2016, $20,339,000, or 3.2% of the loan portfolio consisted of these loans.

Loan Portfolio Cash Flows

The following table sets forth the estimated maturity of the Company’s loan portfolios by type of loan at December 31, 2016.  The estimated maturity reflects contractual terms at December 31, 2016.  Contractual principal repayments of loans do not necessarily reflect the actual life of the Bank’s loan portfolios.  The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and because of enforcement of “due on sale” clauses.  The average life of mortgage loans tends to increase, however, when current mortgage loan rates substantially exceed rates on existing mortgage loans.

   
Due
Within one
year or less
   
Due after
1 through
5 years
   
Due after
5 years
   
Total
 
   
(dollars in thousands)
 
Residential mortgage*
 
$
18,627
   
$
19,505
   
$
232,778
   
$
270,910
*
Construction, land acquisition and development
   
38,670
     
17,698
     
798
     
57,166
 
Land
   
13,181
     
24,601
     
10,882
     
48,664
 
Lines of credit
   
20,277
     
8,210
     
1,170
     
29,657
 
Commercial real estate
   
20,156
     
42,931
     
132,623
     
195,710
 
Commercial, non-real estate
   
552
     
8,134
     
8,125
     
16,811
 
Home equity
   
-
     
-
     
19,129
     
19,129
 
Consumer
   
36
     
624
     
550
     
1,210
 
Total
 
$
111,499
   
$
121,703
   
$
406,055
   
$
639,257
 

*Includes loans categorized as held for sale.
 
The following table contains certain information as of  December 31, 2016 relating to the loan portfolio of  the Company with the dollar amounts of loans due after one year that have fixed and floating rates.  All loans are shown maturing based upon contractual maturities and include scheduled payments but not possible prepayments.

   
Fixed
   
Floating
   
Total
 
   
(dollars in thousands)
 
Residential mortgage*
 
$
101,982
   
$
150,301
   
$
252,283
*
Construction, land acquisition and development
   
5,941
     
12,555
     
18,496
 
Land
   
17,808
     
17,675
     
35,483
 
Lines of credit
   
731
     
8,649
     
9,380
 
Commercial real estate
   
81,620
     
93,934
     
175,554
 
Commercial, non-real estate
   
11,312
     
4,947
     
16,259
 
Home equity
   
-
     
19,129
     
19,129
 
Consumer
   
1,174
     
-
     
1,174
 
Total
 
$
220,568
   
$
307,190
   
$
527,758
 

*Includes loans categorized as held for sale.
 
Loans to One Borrower

Under regulatory guidelines, the aggregate amount of loans that the Bank may make to one borrower was $14,846,000 at December 31, 2016, which is 15% of the Bank’s unimpaired capital and unimpaired surplus.  The Bank’s three largest loans at December 31, 2016 were a $14,100,000 loan secured by commercial property located in Middle River, Maryland, an $8,500,000 loan secured by commercial property in Landover, Maryland and a $7,431,000 loan secured by commercial property located in Edgewater, Maryland.  At December 31, 2016, all three loans were performing as agreed.

Origination and Sale of Loans

The Bank originates residential loans in conformity with standard underwriting criteria per its loan investors to assure maximum eligibility for possible resale in the secondary market.  Although the Bank has authority to lend anywhere in the United States, it has confined its loan origination activities primarily to the states of Maryland, Virginia and Delaware.

Loan originations are developed from a number of sources, primarily from referrals from real estate brokers, internet leads, builders, and existing and walk‑in customers.

The Bank’s mortgage loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan, and the adequacy of the value of the property that will secure the loan.  Loans considered for the Bank’s portfolio with borrowers that have lending relationships less than $500,000 are approved by any of the Bank’s Officers, which includes the Chief Executive Officer, the Chief Operating Officer, the Chief Financial Officer, the Chief Credit Officer and the Chief Lending Officer.  Loans considered for the Bank’s portfolio with borrowers that have lending relationships of $500,000 or greater are approved by the Bank’s Directors Loan Committee.  Meetings of the Directors’ Loan Committee are open to attendance by any member of the Bank’s Board of Directors who wishes to attend.  The loan committee reports to and consults with the Board of Directors in interpreting and applying the Bank’s lending policy.  Single loans greater than $2,000,000, or loans to one borrower aggregating more than $4,000,000, up to $14,846,000 (the maximum amount of loans to one borrower as of December 31, 2016), must also have Board of Directors’ approval. The Bank utilizes independent qualified appraisers approved by the Board of Directors to appraise the properties securing its loans and requires title insurance or title opinions so as to insure that the Bank has a valid lien on the mortgaged real estate. The Bank requires borrowers to maintain fire and casualty insurance on its secured properties.
 
The procedure for approval of construction loans is the same as for residential mortgage loans, except that the appraiser evaluates the building plans, construction specifications, and estimates of construction costs.  The Bank also evaluates the feasibility of the proposed construction project and the experience and track record of the developer.  In addition, all construction loans generally require a commitment from a third-party lender or from the Bank for a permanent long-term loan to replace the construction loan upon completion of construction.

Consumer loans are underwritten on the basis of the borrower's credit history and an analysis of the borrower's income and expenses, ability to repay the loan, and the value of the collateral, if any.

Currently, it is the Bank’s policy to originate both fixed-rate and adjustable-rate loans. The Bank is currently active in the secondary market and sells a portion of its fixed-rate, and occasionally adjustable-rate, loans.

Interest Rates, Points and Fees

The Bank realizes interest, point, and fee income from its lending activities.  The Bank also realizes income from commitment fees for making commitments to originate loans, and from prepayment and late charges, loan fees, application fees, and fees for other miscellaneous services.

The Bank accounts for loan origination fees in accordance with standards set on the accounting for deferred costs and fees. These standards prohibit the immediate recognition of loan origination fees as revenues and require that such income (net of certain direct loan origination costs) for each loan be amortized, generally by the interest method, over the estimated life of the loan as an adjustment of yield.  The Bank also realizes income from gains on sales of loans, and servicing released fees for loans sold with servicing released.

Delinquencies, Allowance for Loan Losses and Classified Assets

Delinquencies

Management reviews delinquencies on all loans monthly.  The Company’s collection procedures include sending a past due notice to the borrower on the 17th day of nonpayment, making telephone contact with the borrower between 20 and 30 days after nonpayment, and sending a letter after the 30th day of nonpayment. A notice of intent to foreclose is generally sent between 60 and 90 days after delinquency.  When the borrower is contacted, the Company attempts to obtain full payment of the past due amount.  However, the Company generally will seek to reach agreement with the borrower on a payment plan to avoid foreclosure.

Allowance for Loan Losses

An allowance for loan losses is provided through charges to income in an amount that management believes will be adequate to absorb losses on existing loans that may become uncollectible, based on evaluations of the collectability of loans and prior loan loss experience.  The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay.  Determining the amount of the allowance for loan losses requires the use of estimates and assumptions, which is permitted under generally accepted accounting principles. Actual results could differ significantly from those estimates.  While management uses available information to estimate losses on loans, future additions to the allowances may be necessary based on changes in economic conditions, particularly in the State of Maryland.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for losses on loans.  Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

The allowance consists of specific and general components.  The specific component relates to loans that are classified as impaired.  When a real estate secured loan becomes impaired, a decision is made as to whether an updated certified appraisal of the real estate is necessary.  This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property.  Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value.  The discounts also include estimated costs to sell the property.
 
For loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices.  Indications of value from these sources are generally discounted based on the age of the financial information and the quality of the assets.

For such loans that are classified as impaired, an allowance is established when the current market value of the underlying collateral less its estimated disposal costs has not been finalized, but management determines that it is likely that the value is lower than the carrying value of that loan.  Once the net collateral value has been determined, a charge-off is taken for the difference between the net collateral value and the carrying value of the loan. For loans that are not solely collateral dependent, an allowance is established when the present value of the expected future cash flows of the impaired loan is lower than the carrying value of that loan.  The general component relates to loans that are classified as doubtful, substandard or special mention that are not considered impaired, as well as non-classified loans.  The general reserve is based on historical loss experience adjusted for qualitative factors.  These qualitative factors include:

·
Levels and trends in delinquencies and nonaccruals;
·
Inherent risk in the loan portfolio;
·
Trends in volume and terms of loans;
·
Effects of any change in lending policies and procedures;
·
Experience, ability and depth of management;
·
National and local economic trends and conditions; and
·
Effect of any changes in concentration of credit.

A loan is generally considered impaired if it meets either of the following two criteria:

·
Loans that are 90 days or more in arrears (nonaccrual loans); or
·
Loans where, based on current information and events, it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement.

Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss.  Loans classified as special mention have potential weaknesses that deserve management’s close attention.  If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects.  Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable.  Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses.  Loans not classified are rated pass.

A loan is considered a troubled debt restructuring, sometimes referred to as a TDR, when the Bank, for economic or legal reasons relating to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider.  Loan modifications made with terms consistent with current market conditions that the borrower could obtain in the open market are not considered a TDR.

Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
 
The Bank discontinues the accrual of interest on loans 90 days or more past due, at which time all previously accrued but uncollected interest is deducted from income.  $506,000 in interest income would have been recorded for the year ended December 31, 2016 if the loans had been current in accordance with their original terms and had been outstanding throughout the year ended December 31, 2016 or since their origination (if held for only part of the fiscal year).  For the year ended December 31, 2016, $427,000 in interest income on such loans was actually included in net income.  The following table sets forth information as to non-accrual loans and other non-performing assets.

   
At December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
   
(dollars in thousands)
 
Loans accounted for on a non-accrual basis:
                             
Residential mortgage
 
$
3,580
   
$
3,191
   
$
6,052
   
$
6,802
   
$
14,436
 
Construction, land acquisition and development
   
-
     
244
     
115
     
814
     
8,564
 
Land
   
269
     
277
     
847
     
183
     
4,688
 
Lines of credit
   
150
     
483
     
388
     
304
     
1,877
 
Commercial real estate
   
2,938
     
2,681
     
652
     
1,155
     
5,793
 
Commercial non-real estate
   
1
     
-
     
1,775
     
-
     
111
 
Home Equity
   
2,914
     
2,098
     
3,016
     
1,777
     
2,000
 
Consumer
   
-
     
-
     
-
     
-
     
26
 
Total non-accrual loans
 
$
9,852
   
$
8,974
   
$
12,845
   
$
11,035
   
$
37,495
 
Accruing loans greater than 90 days past due
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Foreclosed real-estate
 
$
973
   
$
1,744
   
$
1,947
   
$
8,972
   
$
11,441
 
Total non-performing assets
 
$
10,825
   
$
10,718
   
$
14,792
   
$
20,007
   
$
48,936
 
Nonaccrual troubled debt restructurings (included above)
 
$
2,392
   
$
1,329
   
$
2,641
   
$
2,091
   
$
5,635
 
Accruing troubled debt restructurings
 
$
18,066
   
$
24,386
   
$
27,724
   
$
34,827
   
$
56,448
 
Total non-accrual loans to net loans
   
1.6
%
   
1.5
%
   
2.0
%
   
1.8
%
   
5.8
%
Allowance for loan losses to total non-performing loans, including loans contractually past due 90 days or more
   
91.0
%
   
97.6
%
   
73.5
%
   
106.4
%
   
46.6
%
Total non-accrual and accruing loans greater than 90 days past due to total assets
   
1.3
%
   
1.2
%
   
1.7
%
   
1.4
%
   
4.4
%
Total non-performing assets to total assets
   
1.4
%
   
1.4
%
   
1.9
%
   
2.5
%
   
5.7
%

Included in non-accrual residential mortgage loans at December 31, 2016, were thirteen loans totaling $3,580,000 to consumers and no loans to builders.  Included in non-accrual land loans at December 31, 2016 were three loans totaling $269,000.
 
Classified Assets

Federal regulations provide for the classification of loans and other assets, such as debt and equity securities, considered by the OCC to be of lesser quality, as “substandard,” “doubtful” or “loss assets.” An asset is considered substandard if the paying capacity and net worth of the obligor or the collateral pledged, if any, inadequately protects it.  Substandard assets include those characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions, and values.  Assets classified as loss assets are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Assets that do not currently expose the insured institution to a sufficient degree of risk to warrant classification in one of these categories but possess credit deficiencies or potential weakness are required to be designated special mention by management.

When an insured institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for losses in an amount deemed prudent by management.  General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets.  When an insured institution classifies problem assets as loss assets, it is to charge-off such amount.  An institution’s determination as to the classification of its assets is subject to scrutiny by the OCC, which can require the establishment of additional general or specific loss allowances.  The Bank reviews monthly the assets in its portfolio to determine whether any assets require classification in accordance with applicable regulations.

Total classified loans decreased $2,247,000 to $11,626,000 at December 31, 2016 from $13,873,000 at December 31, 2015 primarily due to an improving economy.  All of these loans were classified as substandard.   The allowance for loan losses as of December 31, 2016 was $8,969,000, which was 1.4% of gross loans receivable and 91.0% of total non-performing loans.

[see table on following page]
 
The following table summarizes the allocation of the allowance for loan losses by loan type and the percent of loans in each category compared to total loans (excluding loans held for sale) as of December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
   
Allowance
Amount
   
Percentage
of
Loans in
each
Category
to
Total
Loans
   
Allowance
Amount
   
Percentage
of
Loans in
each
Category
to
Total
Loans
   
Allowance
Amount
   
Percentage
of
Loans in
each
Category
to
Total
Loans
   
Allowance
Amount
   
Percentage
of
Loans in
each
Category
to
Total
Loans
   
Allowance
Amount
   
Percentage
of
Loans in
each
Category
to
Total
Loans
 
   
(dollars in thousands)
 
Residential mortgage
 
$
3,833
     
41.44
%
 
$
4,188
     
45.95
%
 
$
4,664
     
45.38
%
 
$
6,291
     
39.79
%
 
$
8,418
     
39.22
%
Construction, land acquisition and
development
   
527
     
9.09
%
   
446
     
12.45
%
   
362
     
12.37
%
   
414
     
11.61
%
   
2,120
     
10.41
%
Land
   
863
     
7.74
%
   
510
     
4.61
%
   
646
     
4.46
%
   
1,346
     
5.29
%
   
2,245
     
7.41
%
Lines of credit
   
57
     
4.71
%
   
57
     
3.24
%
   
12
     
2.82
%
   
36
     
3.32
%
   
87
     
4.57
%
Commercial real estate
   
2,535
     
31.12
%
   
2,792
     
28.11
%
   
2,504
     
29.11
%
   
2,512
     
33.83
%
   
3,295
     
32.33
%
Commercial non-real estate
   
421
     
2.67
%
   
234
     
1.50
%
   
280
     
1.49
%
   
135
     
1.32
%
   
46
     
0.89
%
Home equity
   
728
     
3.04
%
   
528
     
3.94
%
   
963
     
4.22
%
   
1,003
     
4.66
%
   
1,254
     
5.04
%
Consumer
   
5
     
0.19
%
   
3
     
0.20
%
   
4
     
0.15
%
   
2
     
0.18
%
   
13
     
0.13
%
Total
 
$
8,969
     
100.00
%
 
$
8,758
     
100.00
%
 
$
9,435
     
100.00
%
 
$
11,739
     
100.00
%
 
$
17,478
     
100.00
%
 
The following table contains information with respect to the Company’s allowance for loan losses for the years indicated:

   
As of or For the Year Ended
 
   
December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
   
(dollars in thousands)
 
Average loans outstanding, net*
 
$
613,337
   
$
618,309
   
$
622,935
   
$
648,959
   
$
692,831
 
Total gross loans outstanding at end of period*
 
$
639,257
   
$
635,437
   
$
689,124
   
$
654,478
   
$
697,997
 
Total net loans outstanding at end of period*
 
$
611,616
   
$
602,859
   
$
641,047
   
$
606,539
   
$
662,825
 
Allowance balance at beginning of period*
 
$
8,758
   
$
9,435
   
$
11,739
   
$
17,478
   
$
25,938
 
                                         
Provision (credit) for loan losses
   
(350
)
   
(280
)
   
831
     
16,520
     
765
 
Actual charge-offs
                                       
Residential real estate
   
151
     
454
     
844
     
7,919
     
4,299
 
Construction, land acquisition and development
   
13
     
-
     
63
     
2,439
     
1,395
 
Land
   
59
     
-
     
-
     
4,529
     
1,624
 
Lines of credit
   
-
     
-
     
1,324
     
521
     
182
 
Commercial real estate
   
178
     
80
     
92
     
8,343
     
416
 
Commercial non-real estate
   
17
     
154
     
1,410
     
687
     
20
 
Home Equity
   
50
     
834
     
261
     
809
     
1,407
 
Consumer
   
-
     
-
     
-
     
46
     
10
 
Total charge-offs
   
468
     
1,522
     
3,994
     
25,293
     
9,353
 
Recoveries
                                       
Residential real estate
   
324
     
629
     
306
     
1,034
     
18
 
Construction, land acquisition and development
   
97
     
-
     
-
     
66
     
-
 
Land
   
60
     
49
     
349
     
1,773
     
-
 
Lines of credit
   
10
     
235
     
15
     
60
     
-
 
Commercial real estate
   
23
     
-
     
25
     
54
     
-
 
Commercial non-real estate
   
44
     
49
     
159
     
8
     
110
 
Home Equity
   
421
     
163
     
-
     
15
     
-
 
Consumer
   
50
     
-
     
5
     
24
     
-
 
Total recoveries
   
1,029
     
1,125
     
859
     
3,034
     
128
 
Net charge offs (recoveries)
   
(561
)
   
397
     
3,135
     
22,259
     
9,225
 
                                         
Allowance balance at end of year
 
$
8,969
   
$
8,758
   
$
9,435
   
$
11,739
   
$
17,478
 
Net charge-offs (recoveries) as a percent of average loans*
   
(0.09
%)
   
0.06
%
   
0.50
%
   
3.43
%
   
1.33
%
Allowance for loan losses to total gross loans at end of year*
   
1.40
%
   
1.38
%
   
1.37
%
   
1.79
%
   
2.50
%
Allowance for loan losses to net loans at end of year*
   
1.47
%
   
1.45
%
   
1.47
%
   
1.94
%
   
2.64
%

*Includes held for sale loans.
 
Investment Activities

The Bank may invest in various types of liquid assets, including United States Treasury obliga-tions and securities of various federal agencies, including mortgage-backed securities, certificates of deposit at insured banks, bankers' acceptances and federal funds.  As a member of the FHLB System, the Bank must maintain minimum levels of liquid assets specified by the OCC, which vary from time to time.  Subject to various regulatory restrictions, banks may also invest a portion of their assets in certain commercial paper, corporate debt securities and mutual funds whose assets conform to the investments that a bank is authorized to make directly.

The amortized cost of the Bank’s investment securities which are all held to maturity as of the dates indicated, are presented in the following table (excluding FHLB Stock) :

   
At December 31,
 
   
2016
   
2015
   
2014
 
   
(dollars in thousands)
 
US Treasury securities
 
$
12,998
   
$
21,057
   
$
27,140
 
US Agency securities
   
20,027
     
20,011
     
17,044
 
US Government sponsored mortgage-backed securities
   
29,732
     
35,065
     
15,432
 
                         
Total Investment Securities Held to Maturity
 
$
62,757
   
$
76,133
   
$
59,616
 
 
Investment Scheduled Maturity Table

As of December 31, 2016

   
One Year or Less
   
More than One to
Five Years
   
More than Five to
Ten Years
   
More than
Ten Years
   
Total Investment Securities
 
   
Amortized
Cost
   
Weighted
Average
Yield
   
Amortized
Cost
   
Weighted
Average
Yield
   
Amortized
Cost
   
Weighted
Average
Yield
   
Amortized
Cost
   
Weighted
Average
Yield
   
Amortized
Cost
   
Weighted
Average
Yield
   
Fair
Value
 
   
(dollars in thousands)
 
                                                                   
US Treasury securities
 
$
7,999
     
1.45
%
 
$
4,999
     
2.41
%
 
$
-
     
-
   
$
-
     
-
   
$
12,998
     
1.82
%
 
$
13,165
 
US Agency securities
   
1,004
     
1.03
%
   
17,062
     
1.40
%
   
1,961
     
3.15
%
   
-
     
-
     
20,027
     
1.55
%
   
20,106
 
US Government sponsored
mortgage-backed securities*
   
-
     
-
     
29,460
     
1.96
%
   
272
     
5.20
%
   
-
     
-
     
29,732
     
1.99
%
   
29,556
 
Total securities
 
$
9,003
     
1.40
%
 
$
51,521
     
1.82
%
 
$
2,233
     
3.39
%
   
-
     
-
   
$
62,757
     
1.80
%
 
$
62,827
 

* The amortized cost of mortgage-backed securities as of December 31, 2016, by contractual maturity, is shown above.  Expected maturities may differ from contractual maturities because the securities may be called or prepaid with or without prepayment penalties.
 
Deposits

Deposits are attracted principally from within the Bank’s primary market areas through the offering of a variety of deposit instruments, including passbook and statement accounts and certificates of deposit ranging in terms from three months to five years.  Deposit account terms vary, principally on the basis of the minimum balance required; the time periods the funds must remain on deposit and the interest rate.  The Bank also offers individual retirement accounts.

The Bank’s policies are designed primarily to attract deposits from local residents rather than to solicit deposits from areas outside the Bank’s primary markets. As of December 31, 2016, the Bank had $6,364,000 in brokered deposits. Interest rates paid maturity terms, service fees and withdrawal penalties are established by the Bank on a periodic basis.  Determination of rates and terms are predicated upon funds acquisition and liquidity requirements, rates paid by competitors, growth goals and federal regulations.

Deposits in the Bank as of December 31, 2016, 2015 and 2014 consisted of the accounts described below:

   
2016
   
2015
   
2014
 
   
(dollars in thousands)
 
                   
NOW accounts
 
$
63,137
   
$
56,096
   
$
54,827
 
Money market accounts
   
66,356
     
47,690
     
39,579
 
Passbooks
   
110,492
     
111,992
     
126,062
 
Certificates of deposit
   
273,816
     
277,778
     
298,489
 
Non-interest bearing accounts
   
58,145
     
30,215
     
24,857
 
                         
Total deposits
 
$
571,946
   
$
523,771
   
$
543,814
 

The following table contains information pertaining to the certificates of deposit held by the Bank with a minimum denomination of $100,000 as of December 31, 2016.

Time Remaining Until Maturity
 
Jumbo Certificates
of Deposit
(dollars in thousands)
 
Less than three months
 
$
23,472
 
3 months to 6 months
   
29,508
 
Greater than 6 months to 12 months
   
36,790
 
Greater than 12 months
   
55,818
 
Total
 
$
145,588
 
 
Liquidity and Asset/Liability Management

Two major objectives of asset and liability management are to maintain adequate liquidity and to control the interest sensitivity of the balance sheet.

Liquidity is the measure of a company’s ability to maintain sufficient cash flow to fund operations and to meet financial obligations to depositors and borrowers.  Liquidity is provided by the ability to attract and retain deposits and by principal and interest payments on loans and maturing securities in the investment portfolio.  A strong core deposit base, supplemented by other deposits of varying maturities and rates, contributes to the Bank’s liquidity.

Management believes that funds available through short-term borrowings and asset maturities are adequate to meet all anticipated needs for the next twelve months, and management is continually monitoring the Bank’s liquidity position to meet projected needs.

Interest rate sensitivity is maintaining the ability to reprice interest earning assets and interest bearing liabilities in relationship to changes in the general level of interest rates.  Management attributes interest rate sensitivity to a steady net interest margin through all phases of interest rate cycles.  Management attempts to make the necessary adjustments to constrain adverse swings in net interest income resulting from interest rate movements through gap analysis and income simulation modeling techniques.

Borrowings

FHLB of Atlanta

The Bank’s credit availability under the FHLB of Atlanta’s credit availability program was $232,193,000 at December 31, 2016.  The Bank’s credit availability is based on the level of collateral pledged up to 30% of total assets. The Bank, from time to time, utilizes the line of credit when interest rates under the line are more favorable than obtaining deposits from the public.

Subordinated Debentures

As of December 31, 2016, the Company had outstanding approximately $20,619,000 in principal amount of Junior Subordinated Debt Securities Due 2035 (the “2035 Debentures”).  The 2035 Debentures were issued pursuant to an Indenture dated as of December 17, 2004 (the “2035 Indenture”) between the Company and Wells Fargo Bank, National Association as Trustee.  The 2035 Debentures pay interest quarterly at a floating rate of interest of 3-month LIBOR (0.88% at December 31, 2016) plus 200 basis points, and mature on January 7, 2035.  Payments of principal, interest, premium and other amounts under the 2035 Debentures are subordinated and junior in right of payment to the prior payment in full of all senior indebtedness of the Company, as defined in the 2035 Indenture.  The 2035 Debentures became redeemable, in whole or in part, by the Company on January 7, 2010.

The 2035 Debentures were issued and sold to Severn Capital Trust I (the “Trust”), of which 100% of the common equity is owned by the Company.  The Trust was formed for the purpose of issuing corporation-obligated mandatorily redeemable Capital Securities (“Capital Securities”) to third-party investors and using the proceeds from the sale of such Capital Securities to purchase the 2035 Debentures.  The 2035 Debentures held by the Trust are the sole assets of the Trust.  Distributions on the Capital Securities issued by the Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Trust on the 2035 Debentures.  The Capital Securities are subject to mandatory redemption, in whole or in part, upon repayment of the 2035 Debentures.   The Company has entered into an agreement which, taken collectively, fully and unconditionally guarantees the Capital Securities subject to the terms of the guarantee.

Under the terms of the 2035 Debenture, the Company is permitted to defer the payment of interest on the 2035 Debentures for up to 20 consecutive quarterly periods, provided that no event of default has occurred and is continuing.  As of December 31, 2015, the Company had deferred the payment of fifteen quarters of interest and the cumulative amount of interest in arrears not paid, including interest on unpaid interest, was $1,863,000.  During the second quarter of 2016, the Company paid all of the deferred interest and as of December 31, 2016, the Company is current on all interest due on the 2035 Debenture.
 
Subordinated Notes and Series A Preferred Stock

On November 15, 2008, the Company completed a private placement offering consisting of a total of 70 units, at an offering price of $100,000 per unit, for gross proceeds of $7,000,000. Each unit consists of 6,250 shares of the Company's Series A 8.0% Non-Cumulative Convertible Preferred Stock and the Company's Subordinated Notes (“Subordinated Notes”) in the original principal amount of $50,000. The Subordinated Notes earned interest at an annual rate of 8.0%, payable quarterly in arrears on the last day of March, June, September and December commencing December 31, 2008.  The Subordinated Notes were redeemable in whole or in part at the option of the Company at any time beginning on December 31, 2009 until maturity, which was December 31, 2018.  Dividends will not be paid on the Company’s common stock in any quarter until the dividend on the Series A Preferred Stock has been paid for such quarter; however, there is no requirement that the Company’s board of directors declare any dividends on the Series A Preferred Stock and any unpaid dividends are not cumulative.

Dividends on the Series A preferred stock have been declared and paid on June 30, 2016, September 30, 2016 and December 30, 2016 in the amount of $70,000 each quarter. Prior to that, the Company had not paid a dividend on the Series A Preferred Stock since the first quarter of 2012.

On September 30, 2016 the aggregate principal amount of Subordinated Notes outstanding of $3,500,000 was paid in full.  The Subordinated Notes were redeemable in whole or in part at the option of the Company at any time beginning on December 31, 2009 until maturity, which was December 31, 2018.  Debt issuance costs totaled $245,000 and were taken back into income upon the redemption.

Notes Payable

On September 30, 2016, the Company entered into a loan agreement with a commercial bank whereby the Company borrowed $3,500,000 for a term of 8 years. The unsecured note bears interest at a fixed rate of 4.25% for the first 36 months then, at the option of the Company, converts to either (1) floating rate of the Wall Street Journal Prime plus 0.50% or (2) fixed rate at two hundred seventy five (275) basis points over the five year amortizing Federal Home Loan Bank rate for the remaining five years. Repayment terms are monthly interest only payments for the first 36 months, then quarterly principal payments of $175,000 plus interest. The loan is subject to a prepayment penalty of 1% of the principal amount prepaid during the first 36 months. If the Company elects the 5 year fixed rate of 275 basis points over the Federal Home Loan Bank rate (“FHLB Rate Period”), the loan will be subject to a prepayment penalty of 2% during the first and second years of the FHLB Rate Period and 1% of the principal repaid during the third, fourth and fifth years of the FHLB Rate Period. The Company may make additional principal payments from internally generated funds of up to $875,000 per year during any fixed rate period without penalty. There is no prepayment penalty during any floating rate period.
 
A summary of all borrowings is presented below:
 
   
At or For the Years Ended December 31,
 
   
2016
   
2015
   
2014
 
   
(Dollars in thousands)
 
                   
Balance at end of year
 
$
124,119
   
$
139,119
   
$
139,119
 
Average balance during year
 
$
137,036
   
$
139,119
   
$
139,119
 
Maximum outstanding at any month end
 
$
149,119
   
$
139,119
   
$
139,119
 
Weighted average interest rate at end of year
   
3.30
%
   
3.55
%
   
3.38
%
Average interest rate during year
   
3.35
%
   
3.55
%
   
3.38
%
 
Employees
 
As of December 31, 2016, the Company and its subsidiaries had approximately 142 full-time equivalent employees. The Company’s employees are not represented by any collective bargaining group.

Hyatt Commercial

Hyatt Commercial is a subsidiary of the Bank and is a real estate brokerage company specializing in commercial real estate sales, leasing and property management.

SBI Mortgage Company

SBI Mortgage Company (“SBI”) is a subsidiary of the Company that has engaged in the origination of mortgages not suitable for the Bank.  It owns subsidiary companies that purchase real estate for investment purposes.  As of December 31, 2016, SBI had $1,407,000 in outstanding mortgage loans and it had $514,000 invested in subsidiaries, which funds were held in cash, pending potential acquisition of investment real estate.

Crownsville Development Corporation

Crownsville Development Corporation, which is doing business as Annapolis Equity Group, is a subsidiary of SBI and is engaged in the business of acquiring real estate for investment and syndication purposes.

HS West, LLC

HS West, LLC (“HS”) is a subsidiary of the Bank which constructed a building in Annapolis, Maryland that serves as the Company’s and the Bank’s administrative headquarters. A branch office of the Bank is also located in the building.  In addition, HS leases space to four unrelated companies and to a law firm of which the President of the Company and the Bank is a partner.

Severn Financial Services Corporation

Severn Financial Services Corporation is a subsidiary of the Bank that is part of a joint venture with a local insurance agency to provide various insurance products to customers of  the Company.

Federal Banking Regulation

The financial services industry in the Bank’s market area is highly competitive, including competition from commercial banks, savings banks, credit unions, finance companies and non-bank providers of financial services. Several of the Bank’s competitors have legal lending limits that exceed that of the Bank’s, as well as funding sources in the capital markets that exceeds the Bank’s availability. The increased competition has resulted from a changing legal and regulatory climate, as well as from the economic climate.
 
General.  Banks and their holding companies are extensively regulated under both federal and state law.  This regulation is intended primarily to protect depositors and the Deposit Insurance Fund (“DIF”), and not the stockholders of the Company.  The summary below describes briefly the regulation that is applicable to the Company and the Bank, does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

Federal Banking Regulation the Company
 
General. Severn Bancorp is a unitary savings and loan holding company within the meaning of the Home Owners’ Loan Act. As such, Severn Bancorp is registered with the FRB and is subject to regulations, examinations, supervision and reporting requirements applicable to savings and loan holding companies. In addition, the FRB has enforcement authority over Severn Bancorp and any non-savings bank subsidiaries. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.

Permissible Activities. As a unitary savings and loan holding company, Severn Bancorp generally is not subject to activity restrictions, provided the Bank satisfies the Qualified Thrift Lender (“QTL”) test (see “Qualified Thrift Lender Test” below).  If the Bank failed to meet the QTL test, then Severn Bancorp would become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the Bank qualified as a QTL within one year thereafter, Severn Bancorp would be required to register as, and would become subject to the restrictions applicable to, a bank holding company. Additionally, if Severn Bancorp acquired control of another savings association, other than in a supervisory acquisition where the acquired association also met the QTL test, Severn Bancorp would thereupon become a multiple savings and loan holding company and thereafter be subject to further restrictions on its activities.   The Company presently intends to continue to operate as a unitary savings and loan holding company.

Regulatory Capital Requirements. Under capital regulations adopted pursuant to the Dodd-Frank Act, savings and loan holding companies became subject to the additional regulatory capital requirements.  However, in May 2015, amendments to the FRB’s small bank holding company policy statement (the “SBHC Policy”) became effective. The amendments made the SBHC Policy applicable to savings and loan holding companies, such as Severn Bancorp, and increased the asset threshold to qualify to be subject to the provisions of the SBHC Policy from $500 million to $1.0 billion. Savings and loan holding companies that have total assets of $1.0 billion or less are subject to the SBHC Policy and are not required to comply with the regulatory capital requirements described below provided that such holding company (i) is not engaged in significant nonbanking activities either directly or through a nonbank subsidiary; (ii) does not conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; and (iii) does not have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the Securities and Exchange Commission. The FRB may in its discretion exclude any savings and loan holding company, regardless of asset size, from the SBHB Policy if such action is warranted for supervisory purposes.   The exemption continues until the Company’s total assets exceed $1.0 billion, does not meet the other requirements discussed above or the FRB deems it to be warranted for supervisory purposes.

Certain of the savings and loan holding company capital requirements promulgated by the FRB in 2013 became effective as of January 1, 2015. Those requirements establish the following four minimum capital ratios that savings and loan holding companies not subject to the SBHC Policy must comply with as of that date: (i) a common equity tier 1 capital to total risk-weighted assets ratio of 4.5%; (ii) a tier 1 capital to total risk-weighted assets ratio of 6.0% (up from 4%); (iii) a total capital to total risk-weighted assets ratio of 8%; and (iv) a tier 1 capital to total assets leverage ratio of 4%.  For more information, see “Regulatory Capital Requirements” under “Regulation of the Bank” below.
 
Restrictions on Acquisitions. Except under limited circumstances, savings and loan holding companies, such as  the Company, are prohibited from (i) acquiring, without approval of the FRB, control of a savings association or a savings and loan holding company or all or substantially all of the assets of any such association or holding company (ii) acquiring, without prior approval of the FRB, more than 5% of the voting shares of a savings association or a holding company which is not a subsidiary thereof or (iii) acquiring control of an uninsured institution, or retaining, for more than one year after the date of any savings association becomes uninsured, control of such association.  In evaluating proposed acquisitions of savings institutions by holding companies, the FRB considers the financial and managerial resources and future prospects of the holding company and the target institution, the effect of the acquisition on the risk to the DIF, the convenience and the needs of the community and competitive factors.

No director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company’s stock, may acquire control of any savings association, other than a subsidiary savings association, or of any other savings and loan holding company, without written approval of the FRB. Certain individuals, including Alan J. Hyatt, Louis Hyatt, and Melvin Hyatt, and their respective spouses (“Applicants”), filed an Application for Notice of Change In Control (“Notice”) in April 2001 pursuant to 12 CFR Section 574.3(b).  The Notice permitted the Applicants to acquire up to 32.32% of the Company’s issued and outstanding shares of stock of the Company by April 16, 2002.  Its then regulator, the Office of Thrift Supervision, approved requests by the Applicants to extend the time to consummate such acquisition of shares to December 16, 2011. The Applicants currently own approximately 29.86% of the total outstanding shares of the Company as of December 31, 2016.

The FRB is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions.  The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Federal Securities Law. The Company’s securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended.  As such, the Company is subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Securities Exchange Act of 1934.

Financial Services Modernization Legislation. In November 1999, the Gramm-Leach-Bliley Act of 1999 (“GLBA”) was enacted. The GLBA generally permits banks, other depository institutions, insurance companies and securities firms to enter into combinations that result in a single financial services organization to offer customers a wider array of financial services and products provided that they do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

The GLBA resulted in increased competition for the Company and the Bank from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than  the Company and the Bank.

Maryland Corporation Law. The Company is incorporated under the laws of the State of Maryland, and is therefore subject to regulation by the state of Maryland.  The rights of the Company’s stockholders are governed by the Maryland General Corporation Law.
 
Regulation of the Bank
 
General. As a federally chartered, DIF-insured savings association, the Bank is subject to extensive regulation, primarily by the OCC and secondarily the FDIC.  Lending activities and other investments of the Bank must comply with various statutory and regulatory requirements.  The Bank is also subject to certain reserve requirements promulgated by the FRB.  The OCC regularly examines the Bank and prepares reports for the consideration of the Bank’s Board of Directors on the operations of the Bank.  The relationship between the Bank and depositors and borrowers is also regulated by federal and state laws, especially in such matters as the ownership of savings accounts and the form and content of mortgage documents utilized by the Bank.
 
The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with or acquisitions of other financial institutions.

Regulatory Capital Requirements. Federal regulations require all FDIC-insured depository institutions to meet several minimum capital standards: a common equity tier 1 capital to total risk-based assets ratio of 4.5%; a tier 1 capital to total risk-based assets ratio of 6.0%, a total capital to total risk-based assets ratio of 8%, a tier 1 capital to total assets leverage ratio of 4%, and a tangible capital, measured as core capital (tier 1 capital), to average total assets ratio of 1.5%.

Common equity tier 1 capital generally consists of common stock and related surplus, retained earnings, accumulated other comprehensive income and, subject to certain adjustments, minority common equity interests in subsidiaries, reduced by goodwill and other intangible assets (other than certain mortgage servicing assets), net of associated deferred tax liabilities.

Tier 1 Capital means the sum of common equity tier 1 capital and additional tier 1 capital. Additional tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Under the amendments, cumulative preferred stock (other than cumulative preferred stock issued to the U.S. Treasury Department under the TARP Capital Purchase Program or the Small Business Lending Fund) no longer qualifies as additional tier 1 capital.  Trust preferred securities and other non-qualifying capital instruments issued prior to May 19, 2010 by bank and savings and loan holding companies with less than $15 billion in assets as of December 31, 2009 or by mutual holding companies may continue to be included in tier 1 capital but will be phased out over 10 years beginning in 2016 for all other banking organizations.

Total Capital includes tier 1 capital and tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock, and subordinated debt.

Tangible Capital means the amount of core capital (tier 1 capital), plus the amount of outstanding perpetual preferred stock (including related surplus) not included in tier 1 capital.

Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.

In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, and residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien residential mortgages, a risk weight of 100% is assigned to first lien residential mortgages not qualifying under the prudently underwritten standards as well as commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans, a risk weight of 250% is assigned to certain mortgage serving rights, and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.

In addition to higher capital requirements, the amended regulations provide that depository institutions and their holding companies are required to maintain a common equity tier 1 Capital conservation buffer of at least 2.5% of risk-weighted assets over and above the minimum risk-based capital requirements.  Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases or for the payment of discretionary bonuses to senior executive management.  The capital conservation buffer requirement will be phased in over four years beginning on January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019. For 2017, the capital conservation buffer will be 1.25% of risk-weighted assets. The capital conservation buffer requirement effectively raises the minimum required risk-based capital ratios to 7% common equity tier 1 capital, 8.5% tier 1 capital and 10.5% total capital on a fully phased-in basis.
 
In addition to requiring institutions to meet the applicable capital standards for savings institutions, the OCC may require institutions to meet capital standards in excess of the prescribed standards as the OCC determines necessary or appropriate for such institution in light of the particular circumstances of the institution. Such circumstances would include a high degree of exposure to interest rate risk, concentration of credit risk and certain risks arising from non-traditional activity. The OCC may treat the failure of any savings institution to maintain capital at or above such level as an unsafe or unsound practice and may issue a directive requiring any savings institution which fails to maintain capital at or above the minimum level required by the OCC to submit and adhere to a plan for increasing capital.

As shown below, the Bank’s regulatory capital exceeded all minimum regulatory capital requirements applicable to it as of December 31, 2016 and 2015.
 
   
Actual
   
Required For
Capital
Adequacy
Purposes
   
Minimum Capital
Adequacy with
Capital Buffer
   
Required To Be Well
Capitalized Under Prompt
Corrective Action
Provisions
 
   
Amount
   
%
   
Amount
   
%
   
Amount
   
%
   
Amount
   
%
 
         
(dollars in thousands)
 
December 31, 2016
                                         
Tangible (1)
 
$
98,970
     
12.9
%
 
$
11,488
     
1.5
%
   
N/A
     
N/A
     
N/A
     
N/A
 
Tier 1 capital (2)
   
98,970
     
16.5
%
   
35,977
     
6.0
%
 
$
39,725
     
6.6
%
 
$
47,969
     
8.0
%
Common Equity Tier 1(2) )
   
98,970
     
16.5
%
   
26,983
     
4.5
%
   
30,730
     
5.1
%
   
38,975
     
6.5
%
Leverage (1)
   
98,970
     
12.9
%
   
30,634
     
4.0
%
   
35,420
     
4.6
%
   
38,292
     
5.0
%
Total (2)
   
106,517
     
17.8
%
   
47,969
     
8.0
%
   
51,717
     
8.6
%
   
59,962
     
10.0
%
                                                                 
December 31, 2015
                                                               
Tangible (1)
 
$
112,959
     
14.8
%
 
$
11,423
     
1.5
%
   
N/A
     
N/A
     
N/A
     
N/A
 
Tier 1 capital (2)
   
112,959
     
19.6
%
   
34,626
     
6.0
%
   
N/A
     
N/A
   
$
46,168
     
8.0
%
Common Equity Tier 1(2) )
   
112,959
     
19.6
%
   
25,970
     
4.5
%
   
N/A
     
N/A
     
37,512
     
6.5
%
Leverage (1)
   
112,959
     
14.8
%
   
30,461
     
4.0
%
   
N/A
     
N/A
     
38,076
     
5.0
%
Total (2)
   
120,193
     
20.8
%
   
46,168
     
8.0
%
   
N/A
     
N/A
     
57,710
     
10.0
%
 

(1)
To adjusted total assets.
(2)
To risk-weighted assets.

Enforcement. The OCC has primary enforcement responsibility over federal savings associations and has the authority to bring enforcement action against the institution and all “institution-affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution.  Formal enforcement actions by the OCC may range from issuance of a capital directive or a cease and desist order, to removal of officers or directors of the institution and the appointment of a receiver or conservator.  The FDIC also has the authority to terminate deposit insurance or recommend to the director of the OCC that enforcement action be taken with respect to a particular savings institution.  If action is not taken by the director of the OCC, the FDIC has authority to take action under specific circumstances.

Safety and Soundness Standards.  Federal law requires each federal banking agency, including the OCC, to prescribe to certain standards relating to internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, fees and benefits.  In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.  The guidelines further provide that savings institutions should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss, and should take into account factors such as comparable compensation practices at comparable institutions.  If the OCC determines that a savings institution is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines.  A savings institution must submit an acceptable compliance plan to the OCC within 30 days of receipt of a request for such a plan. If the institution fails to submit an acceptable plan, the OCC must issue an order directing the institution to correct the deficiency.  Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions.
 
Prompt Corrective Action.  Under the prompt corrective action regulations, the OCC is required and authorized to take supervisory actions against undercapitalized savings associations.   For this purpose, a savings association is placed into one of the following five categories dependent on their respective capital ratios:

·
An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a tier 1 risk-based capital ratio of 8.0% or greater, a common equity tier 1 risk-based capital ratio of 6.5% or greater and a leverage ratio of 5.0% or greater.
·
An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a tier 1 risk-based capital ratio of 6.0% or greater, a common equity tier 1 risk-based capital ratio of 4.5% or greater and a leverage ratio of 4.0% or greater.
·
An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a tier 1 risk-based capital ratio of less than 6.0%, a common equity tier 1 risk-based capital ratio of less than 4.5% or a leverage ratio of less than 4.0%.
·
An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a tier 1 risk-based capital ratio of less than 4.0%, a common equity tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%.
·
An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.

Generally, the Federal Deposit Insurance Act requires the OCC to appoint a receiver or conservator for an institution within 90 days of that institution becoming “critically undercapitalized”.  The regulation also provides that a capital restoration plan must be filed with the OCC within 45 days after an institution receives notice that it is “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized”.  In addition, numerous mandatory supervisory actions become immediately applicable to the institution, including, but not limited to, restrictions on growth, investment activities, payment of dividends and other capital distributions, and affiliate transactions.  The OCC may also take any one of a number of discretionary supervisory actions against the undercapitalized institutions, including the issuance of a capital directive and, in the case of an institution that fails to file a required capital restoration plan, the replacement of senior executive officers and directors.

As of December 31, 2016, the Bank met the capital requirements of a “well capitalized” institution under applicable OCC regulations.

Premiums for Deposit Insurance. The Bank’s deposits are insured up to applicable limits by the DIF of the FDIC and are backed by the full faith and credit of the United States government. The FDIC regulations assess insurance premiums based on an institution’s risk.  Under this assessment system, the FDIC evaluates the risk of each financial institution based on its supervisory rating, financial ratios, and long-term debt issuer rating. The assessments are based on an institution’s total assets less tangible capital.  The base assessment rates range from 2.5 to 9 basis points for the least risky institutions to 30 to 45 basis points for the riskiest.  The rate schedules will automatically adjust in the future as the DIF reaches certain milestones.

Effective July 1, 2016, the FDIC adopted changes that eliminated the risk categories.  Assessments for most institutions are now based on financial measures and supervisory ratings derived from statistical modeling estimating the probability of failure within three years.  In conjunction with the Deposit Insurance Fund reserve ratio achieving 1.5%, the assessment range (inclusive of possible adjustments) was reduced for most banks and savings associations to 1.5 basis points to 30 basis points.

The maximum deposit insurance amount is $250,000 per depositor.
 
The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency.  The termination of deposit insurance for the Bank could have a material adverse effect on the Company’s earnings.

All FDIC-insured depository institutions pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board.  The bonds, commonly referred to as Financing Corporation (“FICO”) bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation.  The FICO assessment is based on total assets less tangible capital. The payment made in the fourth quarter of 2016 was based on a FICO assessment rate of 0.58 of a basis point and the first quarter of 2017 FICO assessment rate payment was 0.56 of a basis point.  FICO assessments will continue until the bonds mature in 2017 through 2019.

The FDIC has authority to increase insurance assessments.  A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operation of the Bank.

Privacy. The Bank is subject to the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records.  Additionally, the Gramm-Leach-Bliley Act (“GLBA”) places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties.  Pursuant to the GLBA and rules adopted thereunder, financial institutions must provide:

 
·
initial and annual notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates; and
 
·
a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.

Since the GLBA’s enactment, a number of states have implemented their own versions of privacy laws.  The Bank has implemented its privacy policies in accordance with applicable law.

Loans-to-One Borrower Limitations. With certain limited exceptions, the maximum amount that a savings association or a national bank may lend to any borrower (including certain related entities of the borrower) may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral.

At December 31, 2016, the Bank’s loans-to-one-borrower limit was $14,846,000 based upon the 15% of unimpaired capital and surplus measurement.

Qualified Thrift Lender Test. Savings associations must meet a QTL test, which may be met either by maintaining, on average, at least 65% of its portfolio assets in qualified thrift investments in at least nine of the most recent twelve month period, or meeting the definition of a “domestic building and loan association” as defined in the Code.  “Portfolio Assets” generally means total assets of a savings institution, less the sum of (i) specified liquid assets up to 20% of total assets, (ii) goodwill and other intangible assets, and (iii) the value of property used in the conduct of the savings association’s business.  Qualified thrift investments are primarily residential mortgages and related investments, including certain mortgage‑related securities.  Associations that fail to meet the QTL test must either convert to a bank charter or operate under specified restrictions. As of December 31, 2016, the Bank was in compliance with its QTL requirement and met the definition of a domestic building and loan association.
 
Affiliate Transactions. Transactions between savings associations and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act as made applicable to savings associations by Section 11 of the Home Owners’ Loan Act (HOLA).  A savings association affiliate includes any company or entity which controls the savings institution or that is controlled by a company that controls the savings association.  For example, the holding company of a savings association and any companies which are controlled by such holding company, are affiliates of the savings association.  Generally, Section 23A limits the extent to which the savings association or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such association’s capital stock and surplus, as well as contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus.  Section 23B applies to “covered transactions,” as well as certain other transactions and requires that all transactions be on terms substantially the same, or at least as favorable, to the savings association as those provided to a non-affiliate.  “Covered transaction” include the making of loans to, purchase of assets from and issuance of a guarantee to an affiliate and similar transactions.  Section 23B transactions also include the provision of services and the sale of assets by a savings association to an affiliate.  In addition to the restrictions imposed by Sections 23A and 23B, Section 11 of the Home Owners’ Loan Act prohibits a savings association from (i) making a loan or other extension of credit to an affiliate, except for any affiliate which engages only in certain activities which are permissible for bank holding companies, or (ii) purchasing or investing in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings association.

The Bank’s authority to extend credit to executive officers, directors, trustees and 10% stockholders, as well as entities under such person’s control, is currently governed by Section 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated by the FRB.  Among other things, these regulations generally require such loans to be made on terms substantially similar to those offered to unaffiliated individuals, place limits on the amounts of the loans the Bank may make to such persons based, in part, on the Bank’s capital position, and require certain board of directors’ approval procedures to be followed.

Capital Distribution Limitations. OCC regulations impose limitations upon all capital distributions by savings associations, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital.

The OCC regulations require a savings association to file an application for approval of a capital distribution if:

·
the association is not eligible for expedited treatment of its filings with the OCC;
·
the total amount of all of capital distributions, including the proposed capital distribution, for the applicable calendar year exceeds its net income for that year to date plus retained net income for the preceding two years;
·
the association would not be at least adequately capitalized, as determined under the capital requirements described above under “Prompt Corrective Action,” following the distribution; or
·
the proposed capital distribution would violate any applicable statute, regulation, or regulatory agreement or condition.

In addition, a savings association must give the OCC notice of a capital distribution if the savings association is not required to file an application, but:

·
would not be well capitalized, as determined under the capital requirements described above under “Prompt Corrective Action,” following the distribution;
·
the proposed capital distribution would reduce the amount of or retire any part of the savings association's common or preferred stock or retire any part of debt instruments such as notes or debentures included in capital, other than regular payments required under a debt instrument; or
·
the savings association is a subsidiary of a savings and loan holding company, is filing a notice of the distribution with the FRB and is not otherwise required to file an application or notice regarding the proposed distribution with the OCC, in which case an information copy of the notice filed by the holding company with the FRB needs to be simultaneously provided to the OCC.

Further, any savings association subsidiary of a savings and loan holding company, such as the Bank, also must file a notice with the FRB of any proposed dividend or distribution.

The application or notice, as applicable, must be filed with the regulators at least 30 days before the proposed declaration of dividend or approval of the proposed capital distribution by its board of directors.
 
The OCC or FRB may prohibit a proposed dividend or capital distribution that would otherwise be permitted if it determines that:

·
following the distribution, the savings association will be undercapitalized, significantly undercapitalized, or critically undercapitalized, as determined under the capital requirements described above under “Prompt Corrective Action;
·
the proposed distribution raises safety or soundness concerns; or
·
the proposed capital distribution would violate any applicable statute, regulation or regulatory agreement or condition.

In addition, as noted above, beginning in 2016, if the Bank does not have the required capital conservation buffer under the amended capital rules, its ability to pay dividends to the Company will be limited.

BranchingUnder OCC branching regulations, the Bank is generally authorized to open branches in any state of the United States (i) if the Bank qualifies as a “domestic building and loan association” under the Code, which qualification requirements are similar to those for a Qualified Thrift Lender under the Home Owners’ Loan Act, or (ii) if the law of the state in which the branch is located, or is to be located, would permit establishment of the branch if the savings association were a state savings association chartered by such state.  The OCC authority preempts any state law purporting to regulate branching by federal savings banks.

Community Reinvestment Act and the Fair Lending Laws. Federal savings banks have a responsibility under the Community Reinvestment Act and related regulations of the OCC to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution's failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities and the denial of applications. In addition, an institution's failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in the OCC, other federal regulatory agencies as well as the Department of Justice taking enforcement actions.  Based on an examination conducted June 30, 2015, the Bank received a satisfactory rating.

Federal Home Loan Bank System. The Bank is a member of the FHLB-Atlanta. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB.

Under the capital plan of the FHLB-Atlanta as of December 31, 2016, the Bank was required to own at least $4,933,000 of the capital stock of the FHLB-Atlanta.  As of such date, the Bank owned $4,933,000 of the capital stock of the FHLB-Atlanta and was in compliance with the capital plan requirements.

Federal Reserve System. The FRB requires all depository institutions to maintain non‑interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non‑personal time deposits.  For transaction accounts in 2017, the first $15.5 million, up from $15.2 million in 2016, will be exempt from reserve requirements.  A 3 percent reserve ratio will be assessed on transaction accounts over $15.5 million up to and including $115.1 million, up from $110.2 million in 2016.  A 10 percent reserve ratio will be assessed on transaction accounts in excess of $115.1 million.  At December 31, 2016, the Bank was in compliance with the reserve requirements.

Activities of Subsidiaries. A federal savings bank seeking to establish a new subsidiary, acquire control of an existing company or conduct a new activity through an existing subsidiary must provide 30 days prior notice to the OCC and conduct any activities of the subsidiary in compliance with regulations and orders of the OCC. The OCC has the power to require a savings association to divest any subsidiary or terminate any activity conducted by a subsidiary that the OCC determines to pose a serious threat to the financial safety, soundness or stability of the savings association or to be otherwise inconsistent with sound banking practices.
 
Tying Arrangements. Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other services, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.

Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:

·
Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
·
Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one-to four family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;
·
Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
·
Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
·
Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
·
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
·
Truth in Savings Act; and
·
rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

In addition, the Consumer Financial Protection Bureau issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and mortgage loan servicing and originator compensation standards. The Bank is evaluating recent regulations and proposals, and devotes significant compliance, legal and operational resources to compliance with consumer protection regulations and standards.

The operations of the Bank also are subject to the:

·
Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;
·
Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check; and
·
The USA PATRIOT Act, which requires savings associations to, among other things, establish broadened anti-money laundering compliance programs, and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations.
 
Item 1A.  Risk Factors

Unless the context indicates otherwise, all references to “we,” “us,” “our” in this subsection “Risk Factors” refer to the Company and its subsidiaries.  You should carefully consider the risks and uncertainties described below as well as elsewhere in this Annual Report on Form 10-K. If any of the risks or uncertainties actually occurs, our business, financial condition or results of future operations could be materially adversely affected. The risks and uncertainties described in this Form 10-K are not the only ones we face.  Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us.  This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of many factors, including the risks faced by us described below and elsewhere in this Annual Report on Form 10-K.
 
Changes in interest rates could adversely affect our financial condition and results of operations.

The operations of financial institutions, such as ours, are dependent to a large degree on net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings. Our net interest income is significantly affected by market rates of interest that in turn are affected by prevailing economic conditions, fiscal and monetary policies of the federal government and the policies of various regulatory agencies. Like all financial institutions, our balance sheet is affected by fluctuations in interest rates. Volatility in interest rates can also result in disintermediation, which is the flow of funds away from financial institutions into direct investments, such as U.S. Government bonds, corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than those offered by financial institutions such as ours.

In December 2015, the FRB raised the target range for the federal funds rate for the first time since 2006 and indicated that further interest rate hikes may be undertaken.  A second rate increase occurred in December 2016 and the Federal Reserve indicated that three more hikes may occur in 2017. Sharply rising interest rates could disrupt domestic and world markets and could adversely affect the value of our investment portfolio or our liquidity and results of operations.

We expect to experience continual competition for deposit accounts which may make it difficult to reduce the interest paid on some deposits.

We believe that, in the current market environment, we have adequate policies and procedures for maintaining a conservative interest rate sensitive position.   However, there is no assurance that this condition will continue.  A sharp movement up or down in deposit rates, loan rates, investment fund rates and other interest-sensitive instruments on our balance sheet could have a significant, adverse impact on our net interest income and operating results.

Most of our loans are secured by real estate located in our market area.  If there is a downturn in the real estate market, additional borrowers may default on their loans and we may not be able to fully recover our loans.

Although the real estate market has recovered from the financial crisis of 2008-2009, a subsequent downturn in the real estate market could adversely affect our business because most of our loans are secured by real estate.  Substantially all of our real estate collateral is located in the states of Maryland, Virginia and Delaware.  Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature.

In addition to the risks generally present with respect to mortgage lending activities, our operations are affected by other factors affecting our borrowers, including:

·
the ability of our mortgagors to make mortgage payments,
 
·
the ability of our borrowers to attract and retain buyers or tenants, which may in turn be affected by local conditions such as an oversupply of space or a reduction in demand for rental space in the area, the attractiveness of properties to buyers and tenants, and competition from other available space, or by the ability of the owner to pay leasing commissions, provide adequate maintenance and insurance, pay tenant improvements costs and make other tenant concessions,
·
interest rate levels and the availability of credit to refinance loans at or prior to maturity, and
·
increased operating costs, including energy costs, real estate taxes and costs of compliance with environmental controls and regulations.

As of December 31, 2016, approximately 96% of the book value of our loan portfolio consisted of loans collateralized by various types of real estate.  If real estate prices decline, the value of real estate collateral securing our loans will be reduced.   Our ability to recover defaulted loans by foreclosing and selling the real estate collateral would then be diminished, and we would be more likely to incur financial losses on defaulted loans.

In addition, approximately 47% of the book value of our loans consisted of construction, land acquisition and development loans, commercial real estate loans and land loans, which present additional risks described in “Item 1. Business - Construction Loans” of this Form 10-K.

Our loan portfolio exhibits a high degree of risk.

We have a significant amount of nonresidential loans, as well as construction and land loans granted on a speculative basis. Although permanent single-family, owner-occupied loans currently represent the largest single component of assets and impaired loans, we have a significant level of nonresidential loans, construction loans, and land loans that have an above-average risk exposure.

At December 31, 2016 and December 31, 2015, our non-accrual loans (those loans 90 or more days in arrears) equaled $9,852,000 and $8,974,000, respectively. There were twenty-three residential loans (including construction, land acquisition and development, land loans and home equity lines of credit) in non-accrual status totaling $6,763,000 and eight commercial loans in non-accrual status totaling $2,939,000 at December 31, 2016, compared to thirty-eight residential loans in non-accrual status totaling $5,810,000, and seven commercial loans in non-accrual status totaling $2,681,000 at December 31, 2015.  For the years ended December 31, 2016 and December 31, 2015, there were $(561,000) and $397,000 of net loan (recoveries) charge-offs, respectively.  At December 31, 2016, the total allowance for loan losses was $8,969,000, which was 1.47% of total net loans, compared with $8,758,000, which was 1.45% of total net loans, as of December 31, 2015.

We are exposed to risk of environmental liabilities with respect to properties to which we take title.

In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties.  We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property.  The costs associated with investigation or remediation activities could be substantial.  In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property.  If we become subject to significant environmental liabilities, our business, financial condition, results of operations and cash flows could be materially and adversely affected.

Our operations are located in Anne Arundel County, Maryland, which makes our business highly susceptible to local economic conditions.  An economic downturn or recession in this area may adversely affect our ability to operate profitably.

Unlike larger banking organizations that are geographically diversified, our operations are concentrated in Anne Arundel County, Maryland.  In addition, nearly all of our loans have been made to borrowers in the states of Maryland, Virginia and Delaware.  As a result of this geographic concentration, our financial results depend largely upon economic conditions in our market area.  A deterioration or recession in economic conditions in this market could result in one or more of the following:
 
·
a decrease in deposits;
·
an increase in loan delinquencies;
·
an increase in problem assets and foreclosures;
·
a decrease in the demand for our products and services; and
·
a decrease in the value of collateral for loans, especially real estate, and reduction in customers’ borrowing capacities.

Any of the foregoing factors may adversely affect our ability to operate profitably.

We are subject to federal and state regulation and the monetary policies of the FRB.  Such regulation and policies can have a material adverse effect on our earnings and prospects.

Our operations are heavily regulated and will be affected by present and future legislation and by the policies established from time to time by various federal and state regulatory authorities.  In particular, the monetary policies of the FRB have had a significant effect on the operating results of banks in the past, and are expected to continue to do so in the future.  Among the instruments of monetary policy used by the FRB to implement its objectives are changes in the discount rate charged on bank borrowings and changes in the reserve requirements on bank deposits.  In December 2015, the FRB raised the target range for the federal funds rate for the first time since 2006. A second rate increase occurred in December 2016 and the Federal Reserve indicated that three more hikes may occur in 2017.  It is not possible to predict what changes, if any, will be made to the monetary policies of the FRB or to existing federal and state legislation or the effect that such changes may have on our future business and earnings prospects.

The Dodd-Frank Act has significantly changed the bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress.  The federal agencies have been given significant discretion in drafting the implementing rules and regulations, many of which are not in final form.  Consequently, the full impact of the Dodd-Frank Act may not be known for years.

If the Bank becomes “undercapitalized” as determined under the “prompt corrective action” initiatives of the federal bank regulators, such regulatory authorities will have the authority to require the Bank to, among other things, alter, reduce or terminate any activity that the regulator determines poses an excessive risk to the Bank.  The Bank could further be directed to take any other action that the regulatory agency determines will better carry out the purpose of prompt corrective action. The Bank could be subject to these prompt corrective action restrictions if federal regulators determine that the Bank is in an unsafe or unsound condition or engaging in an unsafe or unsound practice.

The Company has become subject to more stringent capital requirements, which may adversely impact its return on equity, require it to raise additional capital, or constrain it from paying dividends or repurchasing shares.

Effective January 1, 2015, the OCC implemented a new rule that substantially amended the regulatory risk-based capital rules applicable to the Bank. The new rule implemented the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.

The rule includes new minimum risk-based capital and leverage ratios, and revised the definition of what constitutes “capital” for purposes of calculating these ratios. The new minimum capital requirements are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from  prior rules); and (iv) a Tier 1 leverage ratio of 4%. The new rule also establishes a “capital conservation buffer” of 2.5% above the new regulatory minimum capital ratios, and results in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 to risk-based assets capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement will be phased in beginning in January 2016 and in 2017 is 1.25% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions.
 
The application of more stringent capital requirements for the Bank could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions such as the inability to pay dividends or repurchase shares if we were to be unable to comply with such requirements.

The Bank’s reliance on brokered deposits could adversely affect its liquidity and operating results.

Among other sources of funds, we rely on brokered deposits to provide funds with which to make loans and provide for other liquidity needs. On December 31, 2016, brokered deposits totaled $6.4 million, or approximately 1.1% of total deposits. The Bank’s utilizes a variety of sources for brokered certificates of deposit.

Generally brokered deposits may not be as stable as other types of deposits. In the future, those depositors may not replace their brokered deposits with us as they mature, or we may have to pay a higher rate of interest to keep those deposits or to replace them with other deposits or other sources of funds. Not being able to maintain or replace those deposits as they mature would adversely affect our liquidity. Paying higher deposit rates to maintain or replace brokered deposits would adversely affect our net interest margin and operating results.

Income from secondary mortgage market operations is volatile, and we may incur losses with respect to our secondary mortgage market operations that could negatively affect our earnings.

A key component of our strategy is to sell in the secondary market the longer term, conforming fixed-rate residential mortgage loans that we originate, earning non-interest income in the form of gains on sale. When interest rates rise, the demand for mortgage loans tend to fall and may reduce the number of loans we can originate for sale. Weak or deteriorating economic conditions also tend to reduce loan demand. Although we sell, and intend to continue selling, most loans in the secondary market with limited or no recourse, we are required, and will continue to be required, to give customary representations and warranties to the buyers relating to compliance with applicable law. If we breach those representations and warranties, the buyers will be able to require us to repurchase the loans and we may incur a loss on the repurchase.

We may be adversely affected by changes in economic and political conditions and by governmental monetary and fiscal policies.

The banking industry is affected, directly and indirectly, by local, domestic, and international economic and political conditions, and by governmental monetary and fiscal policies.  Conditions such as inflation, recession, unemployment, volatile interest rates, tight money supply, real estate values, international conflicts and other factors beyond our control may adversely affect our potential profitability.  Any future rises in interest rates, while increasing the income yield on our earning assets, may adversely affect loan demand and the cost of funds and, consequently, our profitability.  Any future decreases in interest rates may adversely affect our profitability because such decreases may reduce the amounts that we may earn on our assets.  Economic downturns have resulted and may continue to result in the delinquency of outstanding loans.  We do not expect any one particular factor to materially affect our results of operations.  However, downtrends in several areas, including real estate, construction and consumer spending, have had and may continue to have a material adverse impact on our ability to remain profitable.  Further, there can be no assurance that the asset values of the loans included in our loan portfolio, the value of properties and other collateral securing such loans, or the value of foreclosed real estate will remain at current levels.

Our stock price may be volatile due to limited trading volume.

Our common stock is traded on the NASDAQ Capital Market. However, the average daily trading volume in the Company’s common stock has been relatively small, averaging less than 6,000 shares per day during 2016.  As a result, trades involving a relatively small number of shares may have a significant effect on the market price of the common stock, and it may be difficult for investors to acquire or dispose of large blocks of stock without significantly affecting the market price.
 
We have established an allowance for loan losses based on our management's estimates.  Actual losses could differ significantly from those estimates. If the allowance is not adequate, it could have a material adverse effect on our earnings and the price of our common stock.

We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management's best estimate of probable incurred losses within the existing portfolio of loans.  The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio.  The level of the allowance reflects management's continuing evaluation of specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; industry concentrations and other unidentified losses inherent in the current loan portfolio.  The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.

In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management.  If charge-offs in future periods exceed the allowance for loan losses, we may need additional provisions to increase the allowance for loan losses. Furthermore, growth in the loan portfolio would generally lead to an increase in the provision for loan losses.

Any increases in the allowance for loan losses will result in a decrease in net income and capital, and may have a material adverse effect on our financial condition, results of operations and cash flows.

We compete with a number of local, regional and national financial institutions for customers.

We face strong competition from savings and loan associations, banks, and other financial institutions that have branch offices or otherwise operate in our market area, as well as many other companies now offering a range of financial services. Many of these competitors have substantially greater financial resources and larger branch systems than us. In addition, many of our competitors have higher legal lending limits than us.  Particularly intense competition exists for sources of funds including savings and retail time deposits as well as for loans and other services offered by us.  In addition, over the last several years, the banking industry has undergone substantial consolidation, and this trend is expected to continue.  Significant ongoing consolidation in the banking industry may result in one or more large competitors emerging in our primary target market.  The financial resources, human capital and expertise of one or more large institutions could threaten our ability to maintain our competitiveness.

We face intense competitive pressure on customer pricing, which may materially and adversely affect revenues and profitability.

We generate net interest income, and charge our customers fees, based on prevailing market conditions for deposits, loans and other financial services.  In order to increase deposit, loan and other service volumes, enter new market segments and expand our base of customers and the size of individual relationships, we must provide competitive pricing for such products and services.  In order to stay competitive, we have had to intensify our efforts around attractively pricing our products and services.  To the extent that we must continue to adjust our pricing to stay competitive, we will need to grow our volumes and balances in order to offset the effects of declining net interest income and fee-based margins.  Increased pricing pressure also enhances the importance of cost containment and productivity initiatives, and we may not succeed in these efforts.
 
Our brand, reputation and relationship with our customers are key assets of our business and may be affected by how we are perceived in the marketplace.

Our brand and its attributes are key assets of our business.  The ability to attract and retain customers to  the Company’s products and services is highly dependent upon the external perceptions of us and the industry in which we operate.  Our business may be affected by actions taken by competitors, customers, third party providers, employees, regulators, suppliers or others that impact the perception of the brand, such as creditor practices that may be viewed as “predatory,” customer service quality issues, and employee relations issues.  Adverse developments with respect to our industry may also, by association, impair our reputation, or result in greater regulatory or legislative scrutiny.

The operations of our business, including our interaction with customers, are increasingly done via electronic means, and this has increased our risks related to cyber-attacks.

We are exposed to the risk of cyber-attacks in the normal course of business. In general, cyber incidents can result from deliberate attacks or unintentional events. There has been an increased level of attention focused recently on cyber-attacks against large corporations that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating cash, other assets or sensitive information, corrupting data, or causing operational disruption. Cyber-attacks may also be carried out in a manner that does not require gaining unauthorized access, such as by causing denial-of-service attacks on websites. Cyber-attacks may be carried out by third parties or insiders using techniques that range from highly sophisticated efforts to electronically circumvent network security or overwhelm websites to more traditional intelligence gathering and social engineering aimed at obtaining information necessary to gain access. The objectives of cyber-attacks vary widely and can include theft of financial assets, intellectual property, or other sensitive information, including the information belonging to our banking customers. Cyber-attacks may also be directed at disrupting our operations.

While we have not incurred any losses related to cyber-attacks, nor are we aware of any specific or threatened cyber-incidents as of the date of this report, we may incur substantial costs and suffer other negative consequences if we fall victim to successful cyber-attacks. Such negative consequences could include remediation costs that may include liability for stolen assets or information and repairing system damage that may have been caused; increased cybersecurity protection costs that may include organizational changes, deploying additional personnel and protection technologies, training employees, and engaging third party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; litigation; and reputational damage adversely affecting customer or investor confidence.

Our business is highly reliant on technology and our ability to manage the operational risks associated with technology.

We rely heavily on communications and information systems to conduct our business.  Our business involves storing and processing sensitive customer data.  Any failure, interruption or breach in security of these systems could result in theft of customer data or failures or disruptions in our customer relationship management, general ledger, deposit, loan, data storage, processing and other systems.  Our inability to access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations.  In addition, we operate a number of money transfer and related electronic, check and other payment connections that are vulnerable to individuals engaging in fraudulent activities that seek to compromise payments and related financial systems illegally.  While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed.  The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, result in increased expense to contain the event and/or require that we provide credit monitoring services for affected customers or expose us to civil litigation and regulatory fines and sanctions, any of which could have a material adverse effect on our financial condition and results of operations.
 
Our business is highly reliant on third party vendors and our ability to manage the operational risks associated with outsourcing those services.

We rely on third parties to provide services that are integral to our operations.  These vendors provide services that support our operations, including storage and processing of sensitive consumer date.  A cyber security breach of a vendor’s system may result in theft of our data or disruption of business processes.  A material breach of customer data at a service provider’s site may negatively impact our business reputation and cause a loss of customer business; result in increased expense to contain the event and/or require that we provide credit monitoring services for affected customers, result in regulatory fines and sanctions and may result in litigation.  In most cases, we will remain primarily liable to our customers for losses arising from a breach of a vendor’s data security system.  We rely on our outsourced service providers to implement and maintain prudent cyber security controls.  We have procedures in place to assess a vendor’s cyber security controls prior to establishing a contractual relationship and to periodically review assessments of those control systems; however, these procedures are not infallible and a vendor’s system can be breached despite the procedures we employ.

If our third party providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure you that we would be able to negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all.

We continually encounter technological change, and, if we are unable to develop and implement efficient and customer friendly technology, we could lose business.

The financial services industry is continually undergoing rapid technological change, with frequent introductions of new technology-driven products and services.  The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs.  Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to achieve additional efficiencies in our operations.  Many of our competitors have substantially greater resources to invest in technological improvements.  We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.  Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Our success depends on our senior management team, and if we are not able to retain our senior management team, it could have a material adverse effect on us.

We are highly dependent upon the continued services and experience of our senior management team, including Alan J. Hyatt, our Chairman, President and Chief Executive Officer. We depend on the services of Mr. Hyatt and the other members of our senior management team to, among other things, continue the development and implementation of our strategies, and maintain and develop our customer relationships.  We do not have an employment agreement with members of our senior management, nor do we maintain “key-man” life insurance on our senior management.  If we are unable to retain Mr. Hyatt and other members of our senior management team, our business could be materially and adversely affected.

If we fail to maintain an effective system of internal control over financial reporting and disclosure controls and procedures, we may be unable to accurately report our financial results and comply with the reporting requirements under the Securities Exchange Act of 1934.  As a result, current and potential stockholders may lose confidence in our financial reporting and disclosure required under the Securities Exchange Act of 1934, which could adversely affect our business and stock price and could subject us to regulatory scrutiny.
 
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, referred to as Section 404, we are required to include in our Annual Reports on Form 10-K, our management’s report on internal control over financial reporting.  We are currently not required to include an opinion of our independent registered public accounting firm as to our internal controls because we are a “smaller reporting company” under SEC rules and, therefore, stockholders do not have the benefit of such an independent review of our internal controls.  Compliance with the requirements of Section 404 is expensive and time-consuming. If, in the future, we fail to complete this evaluation in a timely manner, or, if required, our independent registered public accounting firm cannot timely attest to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal control over financial reporting.  In addition, any failure to maintain an effective system of disclosure controls and procedures could cause our current and potential stockholders and customers to lose confidence in our financial reporting and disclosure required under the Securities Exchange Act of 1934, which could adversely affect our business and stock price.

Terrorist attacks and threats or actual war may impact all aspects of our operations, revenues, costs and stock price in unpredictable ways.

Terrorist attacks in the United States and abroad, as well as future events occurring in response to or in connection with them, including, without limitation, future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the United States or its allies or military or trade disruptions, may impact our operations.  Any of these events could cause consumer confidence and savings to decrease or could result in increased volatility in the United States and worldwide financial markets and economy.  Any of these occurrences could have an adverse impact on our operating results, revenues and costs and may result in the volatility of the market price for our common stock and on the future price of our common stock.

There can be no assurance that we will pay dividends in the future.

Bank regulations govern and limit the payment of dividends and capital distributions to stockholders and purchases or redemption by the Company of its stock.  In addition, the Company suspended its common stock dividend in the fourth quarter of 2009 to preserve its capital.  Although we expect to be able to resume our policy of quarterly dividend payments sometime in the future, this dividend policy will be reviewed in light of future earnings, bank regulations and other considerations.  No assurance can be given, therefore, that cash dividends on our common stock will be paid in the future.

Our Series A preferred stock and 2035 Debentures contain restrictions on our ability to declare and pay dividends on, or repurchase our common stock.

Our ability to declare dividends on our common stock are limited by the terms of our 8.0% Non-Cumulative Convertible Preferred Stock, referred to as Series A preferred stock. We may not declare or pay any dividend on, make any distributions relating to, or redeem, purchase, acquire or make a liquidation payment relating to, or make any guarantee payment with respect to our common stock in any quarter until the dividend on the Series A preferred stock has been declared and paid for such quarter, subject to certain minor exceptions.  Dividends on the Series A preferred stock have been declared and paid on June 20, 2016, September 30, 2016 and December 30, 2016 in the amount of $70,000 each quarter. Prior to that, the Company had not paid a dividend on the Series A Preferred Stock since the first quarter of 2012.

Further, under the terms of our Junior Subordinated Debt Securities due 2035, referred to as the 2035 Debentures, if (i) there has occurred and is continuing an event of default, (ii) we are in default with respect to payment of any obligations under the related guarantee or (iii) we have given notice of our election to defer payments of interest on the 2035 Debentures by extending the interest distribution period as provided in the indenture governing the 2035 Debentures and such period, or any extension thereof, has commenced and is continuing, then we may not, among other things, declare or pay any dividends or distributions on, or redeem, purchase, acquire, or make a liquidation payment with respect to, any of our capital stock, including our common stock.  As permitted under the terms of the 2035 Debenture, as of December 31, 2015, the Company had deferred the payment of fifteen quarters of interest and the cumulative amount of interest in arrears not paid, including interest on unpaid interest, was $1,863,000.  During the second quarter of 2016, the Company paid all of the deferred interest and as of December 31, 2016, the Company was current on all interest due on the 2035 Debenture.
 
An investment in our securities is not insured against loss.

Investments in our common stock are not deposits insured against loss by the FDIC or any other entity.  As a result, an investor may lose some or all of his, her or its investment.
   
Conversion of our Series A preferred stock or exercise of the warrant issued to the Treasury Department will dilute the ownership interest of existing stockholders.

In two private placements conducted in November 2008, we issued Series A preferred stock convertible into 437,500 shares of our common stock, subject to adjustment. A warrant to purchase 556,976 shares of our common stock, subject to adjustment, was issued in relation to the placement of the Series B Preferred Stock.  The conversion of some or all of the Series A preferred stock or the exercise of the warrant will dilute the ownership interest of existing stockholders. Any sales in the public market of the common stock issuable upon such conversion or exercise could adversely affect prevailing market prices of our common stock. In addition, the existence of the Series A preferred stock or warrant may encourage short selling by market participants because the conversion of the Series A preferred stock or exercise of the warrant could depress the price of our common stock.

“Anti-takeover” provisions will make it more difficult for a third party to acquire control of us, even if the change in control would be beneficial to our equity holders.

Our charter presently contains certain provisions that may be deemed to be “anti-takeover” and “anti-greenmail” in nature in that such provisions may deter, discourage or make more difficult the assumption of control of us by another corporation or person through a tender offer, merger, proxy contest or similar transaction or series of transactions.  For example, currently, our charter provides that our Board of Directors may amend the charter, without stockholder approval, to increase or decrease the aggregate number of shares of our stock or the number of shares of any class that we have authority to issue.  In addition, our charter provides for a classified Board, with each Board member serving a staggered three-year term.  Directors may be removed only for cause and only with the approval of the holders of at least 75 percent of our common stock.  The overall effects of the “anti-takeover” and “anti-greenmail” provisions may be to discourage, make more costly or more difficult, or prevent a future takeover offer, prevent stockholders from receiving a premium for their securities in a takeover offer, and enhance the possibility that a future bidder for control of us will be required to act through arms-length negotiation with our Board of Directors.  These provisions may also have the effect of perpetuating incumbent management.

Item 1B.  Unresolved Staff Comments

Not applicable.

Item 2.  Properties

HS constructed a building in Annapolis, Maryland that serves as the Company’s and the Bank’s administrative headquarters. A branch office of the Bank is also included in the building.   The Company and the Bank lease their executive and administrative offices from HS.  In addition, HS leases space to four unrelated companies and to a law firm in which the President of the Company and the Bank is a partner.

The Company has five retail branch locations in Anne Arundel County, Maryland, of which it owns three and leases two from third parties.  The current terms of the leases expire in July 2020 and February 2026.  There is no option to renew the lease for any additional terms on the first lease and an option to renew every three to five years on the second lease for twenty-five years.  In addition, the Bank leases office space in Annapolis, Maryland from a third party.  The lease expires January 2017, and the option to renew the lease for one additional five year term was exercised.
 
Item 3.  Legal Proceedings

At December 31, 2016, there are no material pending legal proceedings to which the Company, the Bank or any subsidiary is a party or to which any of their property is subject.

Item 4.  Mine Safety Disclosures

Not applicable.
 
PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The common stock of the Company is traded on the Nasdaq Stock Market, LLC under the symbol “SVBI”.  As of March 8, 2017, there were 156 stockholders of record of the Company’s common stock.

Computershare, 211 Quality Circle, Suite 210, College Station, Texas 77845-4470, serves as the Transfer Agent and Registrar for the Company.

The following table sets forth the high and low sales prices per share of the Company’s common stock for the years indicated, as reported on the Nasdaq Stock Market, LLC:
 
Quarterly Stock Information

2016
 
2015
 
   
Stock Price Range
   
Per Share
     
Stock Price Range
   
Per Share
 
Quarter
 
Low
   
High
   
Dividend
 
Quarter
 
Low
   
High
   
Dividend
 
1st
 
$
4.99
   
$
5.78
   
$
-
 
1st
 
$
4.25
   
$
4.95
   
$
-
 
2nd
   
5.05
     
6.15
     
-
 
2nd
   
4.61
     
5.12
     
-
 
3rd
   
5.93
     
6.85
     
-
 
3rd
   
4.66
     
5.09
     
-
 
4th
   
6.25
     
8.07
     
-
 
4th
   
4.66
     
5.88
     
-
 

Dividend Policy

Federal banking regulations limit the amount of dividends that banking institutions may pay and may require prior approval or non-objection from federal banking regulators before any dividends, capital distributions or share redemptions can be made.

The Company’s main source of income is dividends from the Bank.  As a result,  any dividends ever paid by the Company to its common shareholders depends primarily upon regulatory approval and receipt of dividends from the Bank.

The Company suspended its common stock dividend in the fourth quarter of 2009 to preserve its capital.

The Company’s ability to declare a dividend on its common stock is also limited by the terms of the Company’s Series A preferred stock.  The Company may not declare or pay any dividend on, make any distributions relating to, or redeem, purchase, acquire or make a liquidation payment relating to, or make any guarantee payment with respect to its common stock in any quarter until the dividend on the Series A preferred stock has been declared and paid for such quarter, subject to certain minor exceptions.  Dividends on the Series A preferred stock have been declared and paid on June 20, 2016, September 30, 2016 and December 30, 2016 in the amount of $70,000 each quarter. Prior to that, the Company had not paid a dividend on the Series A Preferred Stock since the first quarter of 2012. As of December 31, 2016, the Company declared and paid dividends on its Series A preferred stock for the final 3 quarters of 2016.
 
Previously, the Series B Preferred Stock had limitations on the payments of dividends on common stock.  On May 11, 2016, the Company redeemed 10,000 shares of the Series B Preferred Stock for $10,000,000. On September 8, 2016, the Company redeemed the remaining 13,393 shares of stock for $13,393,000, thereby removing the common dividend restriction related to the Series B Preferred Stock.

Additionally, under the terms of  the Company's 2035 Debentures, if (i) there has occurred and is continuing an event of default, (ii)  the Company is in default with respect to payment of any obligations under the related guarantee or (iii)  the Company has given notice of its election to defer payments of interest on the 2035 Debentures by extending the interest distribution period as provided in the indenture governing the 2035 Debentures and such period, or any extension thereof, has commenced and is continuing, then  the Company may not, among other things, declare or pay any dividends or distributions on, or redeem, purchase, acquire, or make a liquidation payment with respect to, any of its capital stock, including common stock.  As permitted under the terms of the 2035 Debenture, as of December 31, 2015, the Company had deferred the payment of fifteen quarters of interest and the cumulative amount of interest in arrears not paid, including interest on unpaid interest, was $1,863,000.  During the second quarter of 2016, the Company paid all of the deferred interest and as of December 31, 2016, the Company is current on all interest due on the 2035 Debenture.

The Company did not repurchase any shares of common stock during the fourth quarter of 2016.

Item 6.  Selected Financial Data

The following summary financial information is derived from the audited consolidated financial statements of the Company, except as noted below.  The information is a summary and should be read in conjunction with the Company’s audited consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Summary Financial and Other Data
 
   
At December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
   
(dollars in thousands, except per share information)
 
Balance Sheet Data
                             
Total assets
 
$
787,485
   
$
762,079
   
$
776,328
   
$
799,603
   
$
852,118
 
Total loans, net
   
601,309
     
589,656
     
633,882
     
602,813
     
651,709
 
Investment securities held to maturity
   
62,757
     
76,133
     
59,616
     
44,661
     
34,066
 
Non-performing loans
   
9,852
     
8,974
     
12,845
     
11,035
     
37,495
 
Total non-performing assets
   
10,825
     
10,718
     
14,792
     
20,007
     
48,936
 
Deposits
   
571,946
     
523,771
     
543,814
     
571,249
     
599,394
 
Long-term debt
   
103,500
     
115,000
     
115,000
     
115,000
     
115,000
 
Total liabilities
   
699,555
     
675,623
     
692,518
     
716,834
     
743,122
 
Stockholders’ equity
   
87,930
     
86,456
     
83,810
     
82,769
     
108,996
 
Book value per common share
 
$
6.98
   
$
5.93
   
$
5.68
   
$
5.57
   
$
8.18
 
Common shares outstanding
   
12,123,179
     
10,088,879
     
10,067,379
     
10,066,679
     
10,066,679
 
                                         
Other Data:
                                       
Number of:
                                       
Full service retail banking facilities
   
5
     
4
     
4
     
4
     
4
 
Full-time equivalent employees
   
142
     
152
     
150
     
160
     
142
 
 
Summary of Operations

   
For the Year Ended December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
   
(dollars in thousands, except per share information)
 
Interest income
 
$
30,750
   
$
31,153
   
$
31,816
   
$
33,792
   
$
39,057
 
Interest expense
   
8,561
     
8,992
     
8,634
     
9,184
     
12,502
 
Net interest income
   
22,189
     
22,161
     
23,182
     
24,608
     
26,555
 
Provision (credit) for loan losses
   
(350
)
   
(280
)
   
831
     
16,520
     
765
 
Net interest income after provision for loan losses
   
22,539
     
22,441
     
22,351
     
8,088
     
25,790
 
Non-interest income
   
6,361
     
6,110
     
4,325
     
5,529
     
4,123
 
Non-interest expense
   
23,374
     
23,926
     
23,736
     
30,072
     
23,527
 
Income (loss)  before income tax (benefit) provision
   
5,526
     
4,625
     
2,940
     
(16,455
)
   
6,386
 
(Benefit) provision for income taxes
   
(10,014
)
   
90
     
31
     
8,710
     
2,658
 
Net income (loss)
 
$
15,540
   
$
4,535
   
$
2,909
   
$
(25,165
)
 
$
3,728
 
                                         
Per Common Share Data:
                                       
Basic earnings (loss) per common share
 
$
1.20
   
$
0.21
   
$
0.06
   
$
(2.64
)
 
$
0.22
 
Diluted earnings (loss) per common share
 
$
1.19
   
$
0.21
   
$
0.06
   
$
(2.64
)
 
$
0.22
 
Weighted number of common shares outstanding basic
   
11,522,333
     
10,083,942
     
10,067,379
     
10,066,679
     
10,066,679
 
Weighted number of common shares outstanding diluted
   
11,547,892
     
10,112,653
     
10,096,387
     
10,066,679
     
10,066,679
 
 
Key Operating Ratios

   
At or For the Year Ended December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
       
Performance Ratios:
                             
Return on average assets
   
1.99
%
   
0.59
%
   
0.37
%
   
(3.00
%)
   
0.42
%
Return on average equity
   
17.08
%
   
5.45
%
   
3.55
%
   
(24.45
%)
   
3.50
%
Net interest margin
   
3.19
%
   
3.18