Note 3 - Loans Receivable and Allowance for Loan Losses

Loans receivable are summarized as follows:


	March 31, 2020		December 31, 2019
	(dollars in thousands)
Residential mortgage	$	260,981	$	269,654
Commercial		43,490		43,127
Commercial real estate		220,654		229,257
Construction, land acquisition, and development		99,861		92,822
Home equity/2nds		12,199		12,031
Consumer		1,474		1,541
Total loans receivable		638,659		648,432
Unearned loan fees		(2,709)		(2,747)
Loans receivable	$	635,950	$	645,685

Certain loans in the amount of $151.8 million have been pledged under a blanket floating lien to the Federal Home Loan Bank of Atlanta (“FHLB”) as collateral against advances at March 31, 2020.

At March 31, 2020, the Bank was servicing $25.5 million in loans for the Federal National Mortgage Association (“FNMA”) and $12.6 million in loans for the Federal Home Loan Mortgage Corporation (“FHLMC”). At December 31, 2019, the Bank was servicing $25.9 million in loans for FNMA and $13.0 million in loans for FHLMC.

Credit Quality

An Allowance 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. Management has an established methodology to determine the adequacy of the Allowance that assesses the risks and losses inherent in the loan portfolio. The methodology takes 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 requires the use of estimates and assumptions. Actual results could differ significantly from those estimates. While management uses all available information to estimate losses on loans, future additions to the Allowance may be necessary based on changes in economic conditions and our actual loss experience. In addition, various regulatory agencies periodically review the Allowance as an integral part of their examination process. Such agencies may require us to recognize additions to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as of March 31, 2020 and December 31, 2019.

For purposes of determining the Allowance, we have segmented our loan portfolio by product type. Our portfolio loan segments are residential mortgage, commercial, commercial real estate, construction, land acquisition, and development (“ADC”), Home equity/2nds, and consumer. We have looked at all segments and have determined that no additional subcategorization is warranted based upon our consideration of risk. Our portfolio classes are the same as our portfolio segments.

Inherent Credit Risks

The inherent credit risks within the loan portfolio vary depending upon the loan class as follows:

Residential mortgage - secured by one to four family dwelling units. The loans generally have limited risk as they are secured by first mortgages on the unit, which are generally the primary residence of the borrower, and are generally at a loan-to-value ratio (“LTV”) of 80% or less.

Commercial - underwritten in accordance with our policies and include evaluating historical and projected profitability and cash flow to determine the borrower’s ability to repay the obligation as agreed. Commercial loans are made primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral supporting the loan. Accordingly, the repayment of a commercial loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. These loans are viewed primarily as cash flow dependent and, secondarily, as loans secured by real-estate and/or other assets. Repayment of these loans is generally dependent upon the principal business conducted on the property securing the loan. Line of credit loans may be adversely affected by conditions in the real estate markets or the economy in general. Management monitors and evaluates line of credit loans based on collateral and risk-rating criteria.

U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) - We are participating in the PPP and began origination of such loans that are expected to be 100% guaranteed by the SBA early in the second quarter of 2020. This loan program should be able to assist our commercial customers in remaining operational during this time of uncertainty surrounding the COVID-19 pandemic.

Commercial real estate - subject to the underwriting standards and processes similar to commercial, in addition to those underwriting standards for real estate loans. These loans are viewed primarily as loans secured by real estate and secondarily as cash flow dependent. As repayment of these loans is generally dependent upon the successful operation of the property securing the loan, we look closely at the cash flows generated by the property securing the loan, although the primary underwriting criteria for these loan types is the sufficient value of the underlying collateral. Commercial real estate loans may be adversely affected by conditions in the real estate markets or the economy in general. Management monitors and evaluates commercial real estate loans based on collateral and risk-rating criteria. The Bank also utilizes third-party experts to provide environmental and market valuations. The nature of commercial real estate loans makes them more difficult to monitor and evaluate.

ADC - underwritten in accordance with our underwriting policies which include a financial analysis of the developers, property owners, construction cost estimates, and independent appraisal valuations. These loans will rely on the value associated with the project upon completion. These cost and valuation estimates may be inaccurate. Construction loans generally involve the disbursement of substantial funds over a short period of time with repayment substantially dependent upon the success of the completed project rather than the ability of the borrower or guarantor to repay principal and interest. Additionally, land is underwritten according to our policies which include independent appraisal valuations as well as the estimated value associated with the land upon completion of development. These cost and valuation estimates may be inaccurate.

The sources of repayment of these loans is typically permanent financing expected to be obtained upon completion or sales of developed property. These loans are closely monitored by onsite inspections and are considered to be of a higher risk than other real estate loans due to their ultimate repayment being sensitive to general economic conditions, availability of long-term financing, interest rate sensitivity, and governmental regulation of real property.

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.

Home equity/2nds - subject to the underwriting standards and processes similar to residential mortgages and secured by one to four family dwelling units. Home equity/2nds loans have greater risk than residential mortgages as a result of the Bank generally being in a second lien position.

Consumer - consist of loans to individuals through the Bank’s retail network and typically unsecured or secured by personal property. Consumer loans have a greater credit risk than residential loans because of the lower value of the underlying collateral, if any.

COVID-19

The COVID-19 pandemic has created additional risk for all loan segments due to the economic downturn, both nationally and locally. Many business have been temporarily shut down and many people are unemployed during the national and local “stay at home” orders in place in many areas. During this time of economic uncertainty, borrowers could face an extended period of unemployment and may not be able to meet their loan obligations. Additionally, real estate collateral values could significantly decline and full repayment of loans could be in doubt. We have adjusted some of our economic qualitative factors that affect our Allowance calculation to reflect our best estimate of these risks. Management will continue to evaluate the adequacy of the Allowance as more economic data becomes available and as changes within our portfolio are known. The effects of the pandemic may require us to fund additional increases in the Allowance in future periods.

Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to U.S. GAAP in certain circumstances. In addition, OCC Bulletin 2020-35 provides more limited circumstances in which a loan modification is not subject to classification as a TDR.

CARES Act Section 4013 and OCC Bulletin 2020-35 forbearance agreements are available to both qualified commercial and consumer loan borrowers. Due to the widespread impact of COVID-19 and the State of Maryland “Stay At Home” Order, we expect that some loan borrowers will seek loan forbearance or loan modification agreements in the second quarter of 2020.

The following tables present, by portfolio segment, the changes in the Allowance and the recorded investment in loans:


	Three Months Ended March 31, 2020
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	2,264	$	1,421	$	984	$	2,286	$	134	$	—	$	49	$	7,138
Charge-offs		—		—		—		—		—		(15)		—		(15)
Recoveries		3		5		32		—		2		3		—		45
Net recoveries (charge-offs)		3		5		32		—		2		(12)		—		30
Provision for loan losses		217		139		24		329		15		12		14		750
Ending Balance	$	2,484	$	1,565	$	1,040	$	2,615	$	151	$	—	$	63	$	7,918

Ending balance - individually evaluated for impairment	$	742	$	—	$	62	$	29	$	—	$	—	$	—	$	833
Ending balance - collectively evaluated for impairment		1,742		1,565		978		2,586		151		—		63		7,085
	$	2,484	$	1,565	$	1,040	$	2,615	$	151	$	—	$	63	$	7,918

Ending loan balance -individually evaluated for impairment	$	14,385	$	—	$	1,208	$	428	$	548	$	68			$	16,637
Ending loan balance -collectively evaluated for impairment		246,596		43,490		219,446		99,433		11,651		1,406				622,022
	$	260,981	$	43,490	$	220,654	$	99,861	$	12,199	$	1,474			$	638,659


	December 31, 2019
	Residential				Commercial					Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Ending balance - individually evaluated for impairment	$	752	$	—	$	64	$	32	$	2	$	—	$	—	$	850
Ending balance - collectively evaluated for impairment		1,512		1,421		920		2,254		132		—		49		6,288
	$	2,264	$	1,421	$	984	$	2,286	$	134	$	—	$	49	$	7,138

Ending loan balance - individually evaluated for impairment	$	11,517	$	—	$	1,221	$	880	$	563	$	69			$	14,250
Ending loan balance - collectively evaluated for impairment		258,137		43,127		228,036		91,942		11,468		1,472				634,182
	$	269,654	$	43,127	$	229,257	$	92,822	$	12,031	$	1,541			$	648,432


	Three Months Ended March 31, 2019
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	2,224	$	2,736	$	457	$	2,239	$	222	$	1	$	165	$	8,044
Charge-offs		—		—		—		—		—		—		—		—
Recoveries		5		—		34		—		2		—		—		41
Net recoveries		5		—		34		—		2		—		—		41
Provision for (reversal of) loan losses		343		(996)		221		340		18		—		74		—
Ending Balance	$	2,572	$	1,740	$	712	$	2,579	$	242	$	1	$	239	$	8,085

Ending balance - individually evaluated for impairment	$	905	$	—	$	91	$	32	$	2	$	—	$	—	$	1,030
Ending balance - collectively evaluated for impairment		1,667		1,740		621		2,547		240		1		239		7,055
	$	2,572	$	1,740	$	712	$	2,579	$	242	$	1	$	239	$	8,085

Ending loan balance - individually evaluated for impairment	$	12,259	$	—	$	1,934	$	1,106	$	859	$	74			$	16,232
Ending loan balance - collectively evaluated for impairment		258,720		44,725		236,684		107,827		11,855		1,072				660,883
	$	270,979	$	44,725	$	238,618	$	108,933	$	12,714	$	1,146			$	677,115

The following tables present the credit quality breakdown of our loan portfolio by class:


	March 31, 2020
			Special
	Pass		Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	260,609	$	—	$	372	$	260,981
Commercial		42,290		1,200		—		43,490
Commercial real estate		217,509		2,331		814		220,654
ADC		99,563		—		298		99,861
Home equity/2nds		11,807		392		—		12,199
Consumer		1,474		—		—		1,474
	$	633,252	$	3,923	$	1,484	$	638,659


	December 31, 2019
			Special
	Pass		Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	265,510	$	—	$	4,144	$	269,654
Commercial		41,927		1,200		—		43,127
Commercial real estate		225,363		2,835		1,059		229,257
ADC		92,304		—		518		92,822
Home equity/2nds		11,490		402		139		12,031
Consumer		1,541		—		—		1,541
	$	638,135	$	4,437	$	5,860	$	648,432

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans:


	March 31, 2020
	Past Due
	30-59		60-89		90+								Non-
	Days		Days		Days		Total		Current		Total		Accrual
	(dollars in thousands)
Residential mortgage	$	2,176	$	85	$	5,016	$	7,277	$	253,704	$	260,981	$	6,696
Commercial		—		—		—		—		43,490		43,490		—
Commercial real estate		299		—		126		425		220,229		220,654		234
ADC		652		—		—		652		99,209		99,861		173
Home equity/2nds		—		—		133		133		12,066		12,199		143
Consumer		161		—		—		161		1,313		1,474		—
	$	3,288	$	85	$	5,275	$	8,648	$	630,011	$	638,659	$	7,246


	December 31, 2019
	Past Due
	30-59		60-89		90+								Non-
	Days		Days		Days		Total		Current		Total		Accrual
	(dollars in thousands)
Residential mortgage	$	3,183	$	81	$	2,200	$	5,464	$	264,190	$	269,654	$	3,766
Commercial		—		—		—		—		43,127		43,127		—
Commercial real estate		—		—		126		126		229,131		229,257		237
ADC		—		89		—		89		92,733		92,822		89
Home equity/2nds		—		—		139		139		11,892		12,031		150
Consumer		—		15		—		15		1,526		1,541		—
	$	3,183	$	185	$	2,465	$	5,833	$	642,599	$	648,432	$	4,242

We did not have any loans greater than 90 days past due and still accruing as of March 31, 2020 or December 31, 2019.

The interest which would have been recorded on the above nonaccrual loans if those loans had been performing in accordance with their contractual terms was approximately $467,000 and $412,000 for the three months ended March 31, 2020 and 2019, respectively. The actual interest income recorded on those loans was approximately $60,000 and $22,000 for the three months ended March 31, 2020 and 2019, respectively.

The following tables summarize impaired loans:


	March 31, 2020						December 31, 2019
	Unpaid						Unpaid
	Principal		Recorded		Related		Principal		Recorded		Related
	Balance		Investment		Allowance		Balance		Investment		Allowance
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	10,086	$	9,825	$	—	$	7,258	$	7,035	$	—
Commercial		—		—		—		—		—		—
Commercial real estate		905		661		—		908		668		—
ADC		328		324		—		752		752		—
Home equity/2nds		956		548		—		996		553		—
Consumer		66		66		—		69		69		—
With a related Allowance:
Residential mortgage		4,682		4,560		742		4,604		4,482		752
Commercial		—		—		—		—		—		—
Commercial real estate		547		547		62		553		553		64
ADC		104		104		29		128		128		32
Home equity/2nds		—		—		—		12		10		2
Consumer		2		2		—		—		—		—
Totals:
Residential mortgage		14,768		14,385		742		11,862		11,517		752
Commercial		—		—		—		—		—		—
Commercial real estate		1,452		1,208		62		1,461		1,221		64
ADC		432		428		29		880		880		32
Home equity/2nds		956		548		—		1,008		563		2
Consumer		68		68		—		69		69		—


	Three Months Ended March 31,
	2020				2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	9,648	$	89	$	6,668	$	69
Commercial		—		—		—		—
Commercial real estate		664		15		1,204		17
ADC		235		5		1,058		7
Home equity/2nds		553		6		853		13
Consumer		82		1		35		1
With a related Allowance:
Residential mortgage		4,571		57		5,751		81
Commercial		—		—		215		—
Commercial real estate		549		8		758		8
ADC		104		1		134		2
Home equity/2nds		—		—		12		—
Consumer		2		1		40		—
Totals:
Residential mortgage		14,219		146		12,419		150
Commercial		—		—		215		—
Commercial real estate		1,213		23		1,962		25
ADC		339		6		1,192		9
Home equity/2nds		553		6		865		13
Consumer		84		2		75		1

There were $674,000 and $1.4 million in consumer mortgage properties included in real estate acquired through foreclosure at March 31, 2020 and December 31, 2019, respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction totaled $5.1 million as of March 31, 2020 and $2.3 million as of December 31, 2019.

TDRs

See discussion above in this Note regarding the CARES Act relating to loan modifications during the COVID-19 pandemic.

Our portfolio of TDRs was accounted for under the following methods:


	March 31, 2020
							Total	Total
	Number of	Accrual		Number of	Nonaccrual		Number of	Balance of
	Modifications	Status		Modifications	Status		Modifications	Modifications
	(dollars in thousands)
Residential mortgage	31	$	7,615	1	$	85	32	$	7,700
Commercial real estate	2		974	—		—	2		974
ADC	1		129	—		—	1		129
Consumer	2		68	—		—	2		68
	36	$	8,786	1	$	85	37	$	8,871


	December 31, 2019
							Total	Total
	Number of	Accrual		Number of	Nonaccrual		Number of	Balance of
	Modifications	Status		Modifications	Status		Modifications	Modifications
	(dollars in thousands)
Residential mortgage	31	$	7,675	1	$	85	32	$	7,760
Commercial real estate	2		984	—		—	2		984
ADC	1		130	—		—	1		130
Consumer	2		69	—		—	2		69
	36	$	8,858	1	$	85	37	$	8,943

There were no TDRs that defaulted during the three months ended March 31, 2020 or 2019 which were modified during the previous 12 month period.

We did not modify any loans that would qualify as TDRs during the three months ended March 31, 2020 or 2019.