Howard Bancorp Inc - FORM 10-Q

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EX-31.B - EXHIBIT 31(B) - Howard Bancorp Inc	v385183_ex31b.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2014

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

Commission File Number: 001-35489

HOWARD BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland	20-3735949
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

6011 University Blvd. Suite 370, Ellicott City, MD	21043
(Address of principal executive offices)	(Zip Code)

(410) 750-0020

(Registrant’s telephone number, including area code)

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 x No ¨

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

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

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨	Small reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The number of outstanding shares of common stock outstanding as of July 31, 2014.

Common Stock, $0.01 par value – 4,104,224 shares

HOWARD BANCORP, INC.

TABLE OF CONTENTS

		Page
PART I	Financial Information	4
Item 1.	Financial Statements	4
	Consolidated Balance Sheet (Unaudited)	4
	Consolidated Statements of Operations (Unaudited)	5
	Consolidated Statements of Comprehensive Income (Unaudited)	6
	Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)	6
	Consolidated Statements of Cash Flows (Unaudited)	7
	Notes to Consolidated Financial Statements (Unaudited)	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24

Item 3.	Quantitative and Qualitative Disclosure about Market Risk	39

Item 4.	Controls and Procedures	39

PART II	Other Information	39
Item 1.	Legal Proceeding	39

Item 1A.	Risk Factors	39

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39

Item 3.	Defaults upon Senior Securities	39

Item 4.	Mine Safety Disclosures	39

Item 5.	Other Information	39

Item 6.	Exhibits	39

Signature		41

As used in this report, “Bancorp” refers to Howard Bancorp, Inc., references to the “Company,” “we,” “us,” and “ours” refer to Howard Bancorp, Inc. and its subsidiaries, collectively, and references to the “Bank” refer to Howard Bank.

This report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may,” “should” and words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.

These forward-looking statements include, but are not limited to:

statements of our goals, intentions and expectations, particularly our business plans and strategies, increasing originations of residential mortgage loans, increasing our portfolio of mortgage lending and selling loans into the secondary market;

the impact of [a] new accounting pronouncement[s];

statements regarding our intentions in our investment portfolio and the status of unrealized losses in such portfolios;

statements with respect to our allowance for credit losses, and the adequacy thereof;

statements with respect to anticipated losses on nonperforming loans;

future cash requirements relating to commitments to extend credit, and that we do not anticipate any material losses in connection therewith;

our ability to retain maturing certificates of deposits;

our statement with respect to adequate liquidity; and

the impact on us of pending legal proceedings.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not undertake any obligation to update any forward-looking statements after the date of this report.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

general economic conditions, either nationally or in our market area, that are worse than expected;

competition among depository and other financial institutions;

inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

adverse changes in the securities markets;

changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

our ability to enter new markets successfully and capitalize on growth opportunities, and to otherwise implement our growth strategy;

our ability to successfully integrate acquired entities, if any

changes in consumer spending, borrowing and savings habits;

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission (“SEC”) and the Public Company Accounting Oversight Board;

changes in our organization, compensation and benefit plans

loss of key personnel; and

other risk discussed in this report, in our annual report on Form 10-K for the year ended December 31, 2013, as filed with the SEC, and in other reports we may file.

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. You should not put undue reliance on any forward-looking statements.

PART I

Item 1. Financial Statements

Howard Bancorp, Inc. and Subsidiary

Consolidated Balance Sheets

	Unaudited
	June 30,			December 31,
(in thousands)	2014			2013
ASSETS
Cash and due from banks	$	21,151		$	23,282
Federal funds sold		5,420			12,454
Total cash and cash equivalents		26,571			35,736
Securities available-for-sale, at fair value		16,130			28,688
Nonmarketable equity securities		2,565			2,282
Loans held for sale, at fair value		28,851			3,298
Loans and leases, net of unearned income		433,336			403,875
Allowance for credit losses		(3,053	)		(2,506	)
Net loans and leases		430,283			401,369
Bank premises and equipment, net		11,521			10,842
Core deposit intangible		302			342
Bank owned life insurance		11,468			11,282
Other real estate owned		2,377			2,377
Deferred income taxes		1,302			1,125
Interest receivable and other assets		2,165			2,577
Total assets	$	533,535		$	499,918
LIABILITIES
Noninterest-bearing deposits	$	97,540		$	89,759
Interest-bearing deposits		324,795			299,190
Total deposits		422,335			388,949
Short-term borrowings		36,616			45,658
Long-term borrowings		23,500			16,000
Accrued expenses and other liabilities		1,455			687
Total liabilities		483,906			451,294
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred stock—par value $0.01 (liquidation preference of $1,000 per share) authorized 5,000,000; shares issued and outstanding 12,562 series AA at June 30, 2014 and December 31, 2013, net of issuance cost		12,562			12,562
Common stock - par value of $0.01 authorized 10,000,000 shares; issued and outstanding 4,090,402 shares at June 30, 2014 and 4,095,650 December 31, 2013		41			41
Capital surplus		37,672			37,607
Accumulated deficit		(652	)		(1,590	)
Accumulated other comprehensive income		6			4
Total shareholders’ equity		49,629			48,624
Total liabilities and shareholders’equity	$	533,535		$	499,918

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Operations

	Unaudited
	For the six months ended					For the three months ended
	June 30,					June 30,
(in thousands)	2014		2013			2014		2013
INTEREST INCOME
Interest and fees on loans	$	10,262	$	8,085		$	5,363	$	4,129
Interest and dividends on securities		57		41			27		19
Other interest income		21		23			7		12
Total interest income		10,340		8,149			5,397		4,160

INTEREST EXPENSE
Deposits		926		786			485		398
Short-term borrowings		56		57			25		27
Long-term borrowings		101		40			58		19
Total interest expense		1,083		883			568		444

NET INTEREST INCOME		9,257		7,266			4,829		3,716
Provision for credit losses		501		526			325		165
Net interest income after provision for credit losses		8,756		6,740			4,504		3,551

NONINTEREST INCOME
Service charges on deposit accounts		307		168			153		82
Realized and unrealized gains on mortgage banking activity		1,476		160			1,326		52
Loss on the sale of other real estate owned		-		(37	)		-		-
Income from bank owned life insurance		186		137			94		71
Other operating income		713		214			486		110
Total noninterest income		2,682		642			2,059		315

NONINTEREST EXPENSE
Compensation and benefits		5,667		3,355			2,907		1,763
Occupancy and equipment		1,056		747			586		359
Amortization of core deposit intangible		41		-			21		-
Marketing and business development		720		311			459		178
Professional fees		571		389			341		243
Data processing fees		314		239			170		123
FDIC Assessment		201		155			119		78
Other operating expense		1,272		605			746		305
Total noninterest expense		9,842		5,801			5,349		3,049

INCOME BEFORE INCOME TAXES		1,596		1,581			1,214		817
Income tax expense		593		584			477		303
NET INCOME		1,003		997		$	737	$	514
Preferred stock dividends		63		102			32		33
Net income available to common shareholders	$	940	$	895		$	705	$	481
NET INCOME PER COMMON SHARE
Basic	$	0.23	$	0.22		$	0.17	$	0.12
Diluted	$	0.23	$	0.22		$	0.17	$	0.12

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Comprehensive Income

	For the six months ended
	June 30,
(in thousands)	2014		2013
(Unaudited)
Net Income	$	1,003	$	997
Other comprehensive income
Investments available-for-sale:
Unrealized holding losses		2		(20	)
Related income tax benefit		-		8
Comprehensive income	$	1,005	$	985

	For the three months ended
	June 30,
(in thousands)	2014			2013
(Unaudited)
Net Income	$	737		$	514
Other comprehensive income
Investments available-for-sale:
Unrealized holding losses		(2	)		(8	)
Related income tax benefit		1			3
Comprehensive income	$	736		$	509

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Changes in Shareholders’ Equity

														Accumulated
														other
	Preferred		Number of			Common		Capital			Accumulated			comprehensive
(dollars in thousands, except per share data)	stock		shares			stock		Surplus			deficit			gain/loss			Total
(Unaudited)
Balances at January 1, 2013	$	12,562		4,040,471		$	40	$	37,484		$	(3,386	)	$	21		$	46,721
Net income		-		-			-		-			997			-			997
Net unrealized loss on securities		-		-			-		-			-			(12	)		(12	)
Dividends paid on preferred stock		-		-			-		-			(102	)		-			(102	)
Issuance of common stock:
Stock awards		-		-			-		29			-			-			29
Balances at June 30, 2013	$	12,562		4,040,471		$	40	$	37,513		$	(2,491	)	$	9		$	47,633

Balances at January 1, 2014	$	12,562		4,095,650		$	41	$	37,607		$	(1,592	)	$	4		$	48,622
Net income		-		-			-		-			1,003			-			1,003
Net unrealized gains on securities		-		-			-		-			-			2			2
Dividends paid on preferred stock		-		-			-		-			(63	)		-			(63	)
Forfeited restricted shares		-		(6,668	)		-		(34	)		-			-			(34	)
Stock based compensation		-		-			-		86			-			-			86
Issuance of common stock:
Stock awards		-		1,420			-		13			-			-			13
Balances at June 30, 2014	$	12,562		4,090,402		$	41	$	37,672		$	(652	)	$	6		$	49,629

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Cash Flows

	Unaudited
	Six months ended
	June 30,
(in thousands)	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,003		$	997
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Provision for credit losses		501			526
Deferred income taxes (benefit)		(177	)		(74	)
Depreciation		351			292
Stock-based compensation		99			29
Forfeited restricted shares		(34	)		-
Net accretion of investment securities		1			14
Net amortization of intangible asset		41			-
Loans originated for sale		(103,644	)		(8,115	)
Proceeds from sales of loans		79,568			8,265
Realized and unrealized gains on mortgage banking activity		(1,476	)		(160	)
Loss on sales of other real estate owned, net		-			37
Cash surrender value of BOLI		(186	)		(137	)
Decrease in interest receivable		(32	)		(45	)
Increase in interest payable		21			13
Decrease (increase) in other assets		158			(314	)
Increase (decrease) in other liabilities		746			(412	)
Net cash (used in) provided by operating activities		(23,060	)		916

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investment securities available-for-sale		(6,000	)		(18,997	)
Proceeds from maturities of investment securities available-for-sale		18,557			30,603
Net increase in loans and leases outstanding		(29,556	)		(29,764	)
Purchase of bank owned life insurance		-			(8,000	)
Proceeds from the sale of other real estate owned		-			141
Purchase of premises and equipment		(1,028	)		(57	)
Net cash used in investing activities		(18,027	)		(26,074	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in noninterest-bearing deposits		7,780			(12,752	)
Net increase in interest-bearing deposits		25,745			23,437
Net decrease in short-term borrowings		(9,040	)		(7,979	)
Proceeds from issuance of long-term debt		9,500			14,000
Repayment of long-term debt		(2,000	)		(4,000	)
Cash dividends on preferred stock		(63	)		(102	)
Net cash provided by financing activities		31,922			12,604

Net decrease in cash and cash equivalents		(9,165	)		(12,554	)
Cash and cash equivalents at beginning of period		35,736			36,361
Cash and cash equivalents at end of period	$	26,571		$	23,807

SUPPLEMENTAL INFORMATION
Cash payments for interest	$	1,061		$	870
Cash payments for income taxes		-			425

The accompanying notes are an integral part of these consolidated financial statements.

Notes to Consolidated Financial Statements (unaudited)

Note 1: Summary of Significant Accounting Policies

Nature of Operations

On December 15, 2005, Howard Bancorp, Inc. (“Bancorp”) acquired all of the stock and became the holding company of Howard Bank (the “Bank”) pursuant to the Plan of Reorganization approved by the shareholders of the Bank and by federal and state regulatory agencies. Each share of Bank common stock was converted into two shares of Bancorp common stock effected by the filing of Articles of Exchange on that date, and the shareholders of the Bank became the shareholders of Bancorp. The Bank has four subsidiaries, three of which hold foreclosed real estate and the other owns and manages real estate that is used as a branch location and has office and retail space. The accompanying consolidated financial statements of Bancorp and its wholly-owned subsidiary bank (collectively the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These consolidated financial statements included herein are unaudited; however in the opinion of management, present a fair representation of the Company’s financial condition, results of operations, and cash flows for the periods presented. The Company believes that the disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2013 have been derived from audited financial statements. Other than the application of the fair value option to loans held for sale there have been no significant changes to the Company’s accounting policies as disclosed in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2013. The results of operations for the three and six months ended June 30, 2014 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period.

Bancorp was incorporated in April of 2005 under the laws of the State of Maryland and is a bank holding company registered under the Bank Holding Company Act of 1956. Bancorp is a single bank holding company with one subsidiary, Howard Bank, which operates as a state trust company with commercial banking powers regulated by the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”).

The Company is a diversified financial services company providing commercial banking, mortgage banking and consumer finance through banking branches, the internet and other distribution channels to businesses, business owners, professionals and other consumers located primarily in the Greater Baltimore Metropolitan Area.

The following is a description of the Company’s significant accounting policies.

Principles of Consolidation

The consolidated financial statements include the accounts of Bancorp, its subsidiary bank and the bank’s subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications may have been made to the prior year’s consolidated financial statements to conform to current period presentation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for credit losses, other-than-temporary impairment of investment securities, determination of fair value for financial instruments, deferred income taxes and share-based compensation.

Loans Held for Sale

During the quarter ended June 30, 2014 the Company elected to apply the fair value option under Financial Account Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 825-10 “Recognition and Measurement of Financial Assets and Financial Liabilities” to loans held for sale. As such, Mortgage loans originated and intended for sale into the secondary market are carried at fair value. Fair value is determined based on outstanding investor commitments, and in the absence of such commitments, on current investor yield requirements or third party pricing models. This election was made in order to better align the timing and recognition of the revenues generated, with the related costs associated with mortgage loans originated with the intent to sell at the measurement date. Prior to this election, loans were originated and recorded at cost as of the measurement date, and related gains or losses were not recorded until the loan was sold. The effect of implementing the fair value for mortgage loans held for sale accelerated mortgage related revenues by $836 thousand as of June 30, 2014.

The Company sells its mortgage loans to third party investor’s service released. Upon sale and delivery, loans are legally isolated from the Company and the Company has no ability to restrict or constrain the ability of third party investors to pledge or exchange the mortgage loans. The Company does not have the entitlement or ability to repurchase the mortgage loans or unilaterally cause third party investors to put the mortgage loans back to the Company. Unrealized and realized gains on loan sales are determined using the specific identification method and are recognized through mortgage banking activity in the Consolidated Statement of Operations.

Segment Information

The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Bank to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.

New Accounting Pronouncements

ASU No. 2014-4, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force). The guidance clarifies when an “in substance repossession or foreclosure” occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, such that all or a portion of the loan should be derecognized and the real estate property recognized. ASU 2014-04 states that a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendments of ASU 2014-04 also require interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The amendments of ASU 2014-04 are effective for interim and annual periods beginning after December 15, 2014, and may be applied using either a modified retrospective transition method or a prospective transition method as described in ASU 2014-04. The Company will evaluate this amendment but does not believe they will have an impact on its financial position or results of operations

ASU No. 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The amendments in this update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting and for repurchase financing arrangements; require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The amendments in this update require two new disclosures certain transactions. First to disclose information about certain transactions accounted for as a sale in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets through an agreement with the same counterparty. Secondly to disclose information about repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The amendments of ASU 2014-11 are effective for interim and annual periods beginning after December 15, 2014. The Company will evaluate this amendment but does not believe they will have an impact on its financial position or results of operations

ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards should be applied. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. The amendments of ASU 2014-12 are effective for interim and annual periods beginning after December 15, 2014.

Note 2: Investments Securities

The amortized cost and estimated fair values of investments available for sale are as follows:

(in thousands)	June 30, 2014								December 31, 2013
			Gross		Gross						Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated		Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value		Cost		Gains		Losses		Fair Value
U.S. Government agencies	$	15,998	$	1	$	-	$	15,999	$	28,522	$	1	$	2	$	28,521
Mortgage-backed		123		8		-		131		157		10		-		167
	$	16,121	$	9	$	-	$	16,130	$	28,679	$	11	$	2	$	28,688

There have not been any individual securities with an unrealized loss position for a period greater than one year as of either June 30, 2014 or December 31, 2013. Gross unrealized losses and fair value by investment category and length of time the individual securities have been in a continuous unrealized loss position at December 31, 2013 are presented below:

December 31, 2013
(in thousands)	Less than 12 months				12 months or more				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
U.S. Government agencies	$	15,994	$	2	$	-	$	-	$	15,994	$	2
Mortgage-backed		-		-		-		-		-		-
	$	15,994	$	2	$	-	$	-	$	15,994	$	2

As of June 30, 2014, there were no gross unrealized losses.

The unrealized losses that existed were a result of market changes in interest rates since the original purchase. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) structure of the security.

An impairment loss is recognized in earnings if any of the following are true: (1) the Company intends to sell the debt security; (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the Company does not expect to recover the entire amortized cost basis of the security. In situations where the Company intends to sell or when it is more likely than not that the Company will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as a component of other comprehensive income, net of deferred tax.

The amortized cost and estimated fair values of investments available for sale by contractual maturity are shown below:

(in thousands)	June 30, 2014				December 31, 2013
	Amortized		Estimated Fair		Amortized		Estimated Fair
	Cost		Value		Cost		Value
Amounts maturing:
One year or less	$	15,998	$	15,999	$	28,522	$	28,521
After one through five years		31		33		51		54
After five through ten years		92		98		106		113
After ten years		-		-		-		-
	$	16,121	$	16,130	$	28,679	$	28,688

There were no sales of investment securities during the six months ended June 30, 2014 or in 2013. At June 30, 2014 and December 31, 2013, $11.8 million and $20.7 million fair value of securities, respectively, were pledged as collateral for repurchase agreements. The outstanding balance of no single issuer, except for U. S. Government and U. S. Government agency securities, exceeded ten percent of shareholders’ equity at either June 30, 2014 or December 31, 2013.

Note 3: Loans and Leases

The Company makes loans to customers primarily in the Greater Baltimore Maryland metropolitan area, and surrounding communities. A substantial portion of the Company’s loan portfolio consists of loans to businesses secured by real estate and/or other business assets.

The loan portfolio segment balances at June 30, 2014 and December 31, 2013 are presented in the following table:

	June 30,					December 31,
(in thousands)	2014		% of Total			2013		% of Total
Real estate
Construction and land	$	62,349		14.4	%	$	50,884		12.6	%
Residential - first lien		52,794		12.2			39,249		9.7
Residential - junior lien		9,362		2.2			8,266		2.0
Total residential real estate		62,156		14.3			47,515		11.7
Commercial - owner occupied		88,374		20.4			90,333		22.4
Commercial - non-owner occupied		111,101		25.6			113,559		28.1
Total commercial real estate		199,475		46.0			203,892		50.5
Total real estate loans		323,980		74.8			302,291		74.8
Commercial loans and leases		108,291		25.0			100,410		24.9
Consumer		1,065		0.2			1,174		0.3
Total loans	$	433,336		100.0	%	$	403,875		100.0	%

There were $28.9 million and $3.3 million in loans held for sale at June 30, 2014 and at December 31, 2013, respectively.

Note 4: Credit Quality Assessment

Allowance for Credit Losses

The following table provides information on the activity in the allowance for credit losses by the respective loan portfolio segment for the three months and six months ended June 30, 2014 and June 30, 2013:

	June 30, 2014
									Commercial		Commercial			Commercial
	Construction		Residential			Residential			owner		non-owner			loans		Consumer
(in thousands)	and land		first lien			junior lien			occupied		occupied			and leases		loans			Total
Allowance for credit losses:
Six months ended
Beginning balance	$	122	$	200		$	34		$	131	$	541		$	1,464	$	14		$	2,506
Charge-offs		-		-			-			-		-			-		-			-
Recoveries		-		-			-			-		4			42		-			46
Provision for credit losses		37		(4	)		(17	)		7		116			365		(3	)		501
Ending balance	$	159	$	196		$	17		$	138	$	661		$	1,871	$	11		$	3,053

Three months ended
Beginning balance	$	143	$	187		$	16		$	137	$	686		$	1,518	$	13		$	2,700
Charge-offs		-		-			-			-		-			-		-			-
Recoveries		-		-			-			-		-			28		-			28
Provision for credit losses		16		9			1			1		(25	)		325		(2	)		325
Ending balance	$	159	$	196		$	17		$	138	$	661		$	1,871	$	11		$	3,053

Ending balance:
individually evaluated for impairment		-		4			-			-		123			188		-			315
collectively evaluated for impairment		159		192			17			138		538			1,683		11			2,738

Loans:
Ending balance		62,349		52,794			9,362			88,374		111,101			108,291		1,065			433,336
Ending balance:
individually evaluated for impairment		-		319			-			-		2,965			1,798		-			5,082
collectively evaluated for impairment		62,349		52,475			9,362			88,374		108,136			106,493		1,065			428,254

	June 30, 2013
									Commercial		Commercial			Commercial
	Construction			Residential			Residential		owner		non-owner			loans			Consumer
(in thousands)	and land			first lien			junior lien		occupied		occupied			and leases			loans			Total
Allowance for credit losses:
Six months ended
Beginning balance	$	127		$	204		$	22	$	650	$	505		$	1,227		$	29		$	2,764
Charge-offs		-			(183	)		-		-		-			(202	)		-			(385	)
Recoveries		-			-			-		-		30			16			-			46
Provision for credit losses		(5	)		112			-		13		(33	)		441			(2	)		526
Ending balance	$	122		$	133		$	22	$	663	$	502		$	1,482		$	27		$	2,951

Three months ended
Beginning balance	$	138		$	131		$	22	$	650	$	468		$	1,542		$	29		$	2,980
Charge-offs		-						-		-		-			(202	)		-			(202	)
Recoveries		-			-			-		-					8			-			8
Provision for credit losses		(16	)		2			-		13		34			134			(2	)		165
Ending balance	$	122		$	133		$	22	$	663	$	502		$	1,482		$	27		$	2,951

Ending balance:
individually evaluated for impairment		-			-			-		-		148			444			-			592
collectively evaluated for impairment		122			133			22		663		354			1,038			27			2,359
Loans:
Ending balance		42,210			31,870			7,786		76,406		96,637			95,542			1,192			351,643
Ending balance:
individually evaluated for impairment		-			-			-		-		3,104			3,454			-			6,558
collectively evaluated for impairment		42,210			31,870			7,786		76,406		93,533			92,088			1,192			345,085

When potential losses are identified, a specific provision and/or charge-off may be taken, based on the then current likelihood of repayment, that is at least in the amount of the collateral deficiency, and any potential collection costs, as determined by the independent third party appraisal.

All loans that are considered impaired are subject to the completion of an impairment analysis. This analysis highlights any potential collateral deficiencies. A specific amount of impairment is established based on the Company’s calculation of the probable loss inherent in the individual loan. The actual occurrence and severity of losses involving impaired credits can differ substantially from estimates.

Credit risk profile by portfolio segment based upon internally assigned risk assignments are presented below:

	June 30, 2014
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Credit quality indicators:
Not classified	$	62,349	$	52,475	$	9,362	$	88,374	$	108,136	$	106,299	$	1,065	$	428,060
Special mention		-		-		-		-		-		-		-		-
Substandard		-		319		-		-		2,965		1,992		-		5,276
Doubtful		-		-		-		-		-		-		-		-
Total	$	62,349	$	52,794	$	9,362	$	88,374	$	111,101	$	108,291	$	1,065	$	433,336

	December 31, 2013
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Credit quality indicators:
Not classified	$	50,884	$	38,918	$	8,266	$	90,333	$	113,301	$	97,817	$	1,174	$	400,693
Special mention		-		-		-		-		-		-		-		-
Substandard		-		331		-		-		258		2,593		-		3,182
Doubtful		-		-		-		-		-		-		-		-
Total	$	50,884	$	39,249	$	8,266	$	90,333	$	113,559	$	100,410	$	1,174	$	403,875

Special mention - A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Substandard - Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans classified doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.

Loans classified special mention, substandard, doubtful or loss are reviewed at least quarterly to determine their appropriate classification. All commercial loan relationships are reviewed annually. Non-classified residential mortgage loans and consumer loans are not evaluated unless a specific event occurs to raise the awareness of a possible credit deterioration.

An aged analysis of past due loans are as follows:

	June 30, 2014
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Analysis of past due loans:
Accruing loans current	$	62,349	$	52,155	$	9,362	$	88,374	$	110,686	$	107,084	$	1,064	$	431,074
Accruing loans past due:
31-59 days past due		-		-		-		-		-		-		1		1
60-89 days past due				-		-		-				-		-		-
Greater than 90 days past due		-		320		-		-		159		-		-		479
Total past due		-		320		-		-		159		-		1		480

Non-accrual loans		-		319		-		-		256		1,207		-		1,782

Total loans	$	62,349	$	52,794	$	9,362	$	88,374	$	111,101	$	108,291	$	1,065	$	433,336

	December 31, 2013
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Analysis of past due loans:
Accruing loans current	$	50,884	$	38,025	$	8,266	$	90,333	$	113,142	$	97,127	$	1,174	$	398,951
Accruing loans past due:
31-59 days past due		-		570		-		-		-		150		-		720
60-89 days past due		-		323		-		-		-		244		-		567
Greater than 90 days past due		-		-		-		-		159		296		-		455
Total past due		-		893		-		-		159		690		-		1,742

Non-accrual loans		-		331		-		-		258		2,593		-		3,182

Total loans	$	50,884	$	39,249	$	8,266	$	90,333	$	113,559	$	100,410	$	1,174	$	403,875

Total loans either in non-accrual status or in excess of ninety days delinquent totaled $2.3 million or .52% of total loans outstanding as of June 30, 2014, which represents a decrease from $3.6 million as of December 31, 2013.

The impaired loans at June 30, 2014 and December 31, 2013 are as follows:

	June 30, 2014
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	& land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Impaired loans:
Recorded investment	$	-	$	319	$	-	$	-	$	2,965	$	1,798	$	-	$	5,082
With an allowance recorded		-		319		-		-		256		560		-		1,135
With no related allowance recorded		-		-		-		-		2,709		1,238		-		3,947

Related allowance		-		4		-		-		123		188		-		315

Unpaid principal		-		319		-		-		2,965		1,799		-		5,083

Six months ended June 30, 2014
Average balance of impaired loans		-		329		-		-		2,981		2,207		-		5,517
Interest income recognized		-		9		-		-		100		82		-		191
Three months ended June 30, 2014
Average balance of impaired loans		-		329		-		-		2,977		2,165		-		5,471
Interest income recognized		-		4		-		-		83		36		-		123

	December 31, 2013
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	& land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Impaired loans:
Recorded investment	$	-	$	331	$	-	$	-	$	2,984	$	2,975	$	-	$	6,290
With an allowance recorded		-		331		-		-		258		677		-		1,266
With no related allowance recorded		-		-		-		-		2,726		2,298		-		5,024

Related allowance		-		4		-		-		31		224		-		259

Unpaid principal		-		331		-		-		2,984		2,978		-		6,293

Average balance of impaired loans		-		333		-		-		2,994		3,706		-		7,033
Interest income recognized		-		15		-		-		208		120		-		343

Nonaccrual loans included in impaired loans totaled $1.8 million and $3.2 million at June 30, 2014 and December 31, 2013, respectively. Interest income that would have been recorded if nonaccrual loans had been current and in accordance with their original terms was $82 thousand for the first six months of 2014.

Management routinely evaluates other real estate owned (“OREO”) based upon periodic appraisals. For the six months ended June 30, 2014 and 2013 there were no additional valuation allowances recorded as the current appraised value was sufficient to cover the recorded OREO amount. There were no new loans transferred from loans to OREO for either six months ended June 30 presented.

For the first half of 2014, the Company sold no properties held as OREO and for the first half of 2013 sold one property totaling $178 thousand.

The trouble debt restructured loans (“TDRs”) at June 30, 2014 and December 31, 2013 are as follows:

June 30, 2014

Number

Non-Accrual

Number

Accrual

Total

(dollars in thousands)

of Loans

Status

of Loans

Status

TDRs

Commercial loans

794

230

1,024

December 31, 2013

Number

Non-Accrual

Number

Accrual

Total

(dollars in thousands)

of Loans

Status

of Loans

Status

TDRs

Commercial loans

861

A summary of TDR modifications outstanding and performance under modified terms are as follows:

	June 30, 2014
	Not Performing		Performing
	to Modified		to Modified		Total
(in thousands)	Terms		Terms		TDRs
Commercial loans
Interest only payments	$	-	$	-	$	-
Rate modification		-		-		-
Forberance		794		-		794
Extension or other modification		-		230		230
Total commercial	$	794	$	230	$	1,024

	December 31, 2013
	Not Performing		Performing
	to Modified		to Modified		Total
(in thousands)	Terms		Terms		TDRs
Commercial loans
Interest only payments	$	-	$	-	$	-
Rate modification		-		-		-
Forberance		861		-		861
Extension or other modification		-		-		-
Total commercial	$	861	$	-	$	861

There was one new loan restructured in the first six months of 2014.

Note 5: Intangibles

The gross carrying amount and accumulated amortization of intangible assets are as follows:

June 30, 2014

Weighted

Gross

Net

Average

Carrying

Accumulated

Carrying

Remaining Life

(in thousands)

Amount

Amortization

Amount

(Years)

Amortizing intangible assets:

Core deposit intangible

376

302

8.51

Estimated future amortizing expense for amortizing intangibles within the years ending December 31, are as follows:

(in thousands)
2014	$	33
2015		57
2016		46
2017		36
2018		29
Thereafter		101
Total amortizing intangible assets	$	302

Note 6: Deposits

The following table details the composition of deposits and the related percentage mix of total deposits, respectively:

(dollars in thousands)	June 30, 2014					December 31, 2013
			% of					% of
	Amount		Total			Amount		Total
Noninterest-bearing demand	$	97,540		23	%	$	89,759		23	%
Interest-bearing checking		32,027		7			31,443		8
Money market accounts		112,872		27			96,365		25
Savings		12,169		3			12,496		3
Certificates of deposit $100,000 and over		120,746		29			110,516		29
Certificates of deposit under $100,000		46,981		11			48,370		12
Total deposits	$	422,335		100	%	$	388,949		100	%

Note 7: Stock Options, Awards and Warrants

The Company initially raised $4,775,000 of capital by selling to its founders investment units consisting of one share of common stock and a fully detachable warrant equal to .25 shares of common stock per unit. The warrants were issued in recognition of the financial and organizational risk undertaken by the purchasers in the organizational offering. The warrants are immediately exercisable and will expire ten (10) years from the date of issuance, which will be in August 2014. As of June 30, 2014 there have been no exercises of these warrants and the Company has outstanding warrants to purchase 119,376 shares at the price of $10.00 per share. Based upon a fair market value of $9.62 at June 30, 2014 the warrants outstanding had no aggregate intrinsic value.

The Company’s equity incentive plan provides for awards of nonqualified and incentive stock options as well as vested and non-vested common stock awards. Employee stock options can be granted with exercise prices at the fair market value (as defined within the plan) of the stock at the date of grant and with terms of up to ten years. Except as otherwise permitted in the plan, upon termination of employment for reasons other than retirement, permanent disability or death, the option exercise period is reduced or the options are canceled.

Stock awards may also be granted to non-employee members of the Board of Directors as compensation for attendance and participation at meetings of the Board of Directors and meetings of the various committees of the Board. For the six months ended June 30, 2014 directors earned 2,719 shares of stock as compensation for their service.

Stock Options

The following table summarizes the Company’s stock option activity and related information for the period ended:

	June 30, 2014					December 31, 2013
				Weighted					Weighted
				Average					Average
				Exercise					Exercise
	Shares			Price		Shares			Price
Balance at January 1, 2014		387,101		$	11.19		395,351		$	11.16
Granted		-			-		-			-
Exercised		-			-		-			-
Forfeited		(5,000	)		10.10		(8,250	)		9.90
Balance at June 30, 2014		382,101		$	11.21		387,101		$	11.19
Exercisable at June 30, 2014		382,101		$	11.21		387,101		$	11.19
Weighted average fair value of options granted during the year				$	-				$	-

The intrinsic value of a stock option is the amount that the market value of the underlying stock exceeds the exercise price of the option. Based upon a fair market value of $9.62 at June 30, 2014 the options outstanding had an aggregate intrinsic value of $37 thousand. There have not been any stock options exercised during 2014.

Restricted Stock

In the second quarter of 2013, 50,000 shares of restricted stock were granted, with 30,000 of the shares subject to a three year vesting schedule with one third of the shares vesting each year on the grant date anniversary. The remaining 20,000 awarded shares also are subject to a three year vesting schedule, however they only vest if certain annual performance measures are satisfactorily achieved.

A summary of the activity for the Company’s restricted stock for the period indicated is presented in the following table:

	June 30, 2014					December 31, 2013
				Weighted				Weighted
				Average				Average
				Grant Date				Grant Date
	Shares			Fair Value		Shares		Fair Value
Balance at January 1, 2014		50,000		$	6.89		-	$	-
Granted		-			-		50,000		6.89
Vested		(10,002	)		6.91		-		-
Forfeited		(6,668	)		6.85		-		-
Balance at June 30, 2014		33,330		$	6.89		50,000	$	6.89

Of the 20,000 shares of restricted stock that were issued during 2013 with vesting subject to meeting certain performance measures, those measures were not achieved, and thus 6,668 shares were forfeited during the first half of 2014. At June 30, 2014, based on restricted stock awards outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested restricted stock awards was $201 thousand. This expense is expected to be recognized through 2016.

Restricted Stock Units

Restricted stock units are similar to restricted stock, except the recipient does not receive the stock immediately, but instead receives it according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time. Each restricted stock unit that vests entitles the recipient to receive one share of common stock on a specified issuance date. The recipient does not have any stockholder rights, including voting, dividend or liquidation rights, with respect to the shares underlying awarded restricted stock units until the recipient becomes the record holder of those shares.

In the second quarter of 2014, 42,000 restricted stock units were granted, with 17,000 of the units subject to a three year vesting schedule with one third of the units vesting each year on the grant date anniversary. The remaining 25,000 awarded units also are subject to a three year vesting schedule, however they only vest if certain annual performance measures are satisfactorily achieved.

A summary of the activity for the Company’s restricted stock units for the period indicated is presented in the following table:

	June 30, 2014
			Weighted
			Average
			Grant Date
	Shares		Fair Value
Balance at January 1, 2014		-	$	-
Granted		42,000		11.30
Vested		-		-
Forfeited		-		-
Balance at June 30, 2014		42,000	$	11.30

At June 30, 2014, based on restricted stock unit awards outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested restricted stock unit awards was $435 thousand. This expense is expected to be recognized through 2017.

Note 8: Profit Sharing Plan

The Company sponsors a defined contribution retirement plan through a Section 401(k) profit sharing plan. Employees may contribute up to 15% of their pretax compensation. Participants are eligible for matching Company contributions up to 4% of eligible compensation dependent on the level of voluntary contributions. Company matching contributions totaled $119 thousand for the six months ended June 30, 2014 and $66 thousand for the six months ended June 30, 2013. The Company’s matching contributions vest immediately. The increase in the matching contributions for the Company was due to a large increase in the number of participants in the plan. With the growth in overall staff over the last year, the number of participants in the plan has increased from 51 participants at June 30, 2013 to 91 participants at June 30, 2014.

Note 9: Income per Common Share

The table below shows the presentation of basic and diluted income per common share for the periods ended:

	Six months ended						Three months ended
	June 30,						June 30,
(dollars in thousands, except per share data)	2014			2013			2014			2013
Net income	$	1,003		$	997		$	737		$	514
Preferred dividends		(63	)		(102	)		(32	)		(33	)
Net income available to common shareholders (numerator)	$	940		$	895		$	705		$	481
BASIC
Basic average common shares outstanding (denominator)		4,051,388			4,016,162			4,056,174			3,992,120
Basic income per common share	$	0.23		$	0.22		$	0.17		$	0.12
DILUTED
Average common shares outstanding		4,051,388			4,016,162			4,056,174			3,992,120
Diluted effect of common stock equivalents		57,500			33,284			66,722			57,327
Diluted average common shares outstanding (denominator)		4,108,888			4,049,446			4,122,896			4,049,447
Diluted income per common share	$	0.23		$	0.22		$	0.17		$	0.12

Common stock equivalents outstanding that are anti-dilutive and thus excluded from calculation of diluted number of shares presented above		474,971			512,927			474,971			512,927

Note 10: Risk-Based Capital

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) required that the federal regulatory agencies adopt regulations defining five capital tiers for banks: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Quantitative measures, established by the regulators to ensure capital adequacy, require that the Bank and Bancorp maintain minimum ratios (set forth below) of capital to risk-weighted assets. Under the guidelines, capital is compared to the relative risk related to the balance sheet. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Management believes that, as of June 30, 2014 and December 31, 2013 the Bank met all capital adequacy requirements to which it is subject.

											To be well
											capitalized under
											the FDICIA
						For capital					prompt corrective
	Actual					adequacy purposes					action provisions
(dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of June 30, 2014:
Total capital (to risk-weighted assets)
Howard Bank	$	51,607		11.29	%	$	36,561		8.00	%	$	45,702		10.00	%
Howard Bancorp	$	52,254		11.33	%	$	36,885		8.00	%		N/A
Tier 1 capital (to risk-weighted assets)
Howard Bank	$	48,554		10.62	%	$	18,281		4.00	%	$	27,421		6.00	%
Howard Bancorp	$	49,201		10.67	%	$	18,443		4.00	%		N/A
Tier 1 capital (to average assets)
(Leverage ratio)
Howard Bank	$	48,554		9.53	%	$	20,390		4.00	%	$	25,487		5.00	%
Howard Bancorp	$	49,201		9.65	%	$	20,389		4.00	%		N/A
As of December 31, 2013:
Total capital (to risk-weighted assets)
Howard Bank	$	49,902		11.85	%	$	33,684		8.00	%	$	42,105		10.00	%
Howard Bancorp	$	50,700		12.05	%	$	33,668		8.00	%		N/A
Tier 1 capital (to risk-weighted assets)
Howard Bank	$	47,396		11.26	%	$	16,842		4.00	%	$	25,263		6.00	%
Howard Bancorp	$	48,195		11.45	%	$	16,834		4.00	%		N/A
Tier 1 capital (to average assets)
(Leverage ratio)
Howard Bank	$	47,396		9.77	%	$	19,406		4.00	%	$	24,257		5.00	%
Howard Bancorp	$	48,195		9.93	%	$	19,414		4.00	%		N/A

The Bank is currently prohibited from paying dividends without the prior approval of the Commissioner.

Note 11: Preferred Stock

On September 22, 2011, we entered into a Securities Purchase Agreement with the Secretary of the Treasury, pursuant to which Bancorp issued and sold to the Treasury 12,562 shares of our Senior Non-Cumulative Perpetual Preferred Stock, Series AA, having a liquidation preference of $1,000 per share, for aggregate proceeds of $12,562,000. The issuance was pursuant to the Treasury’s Small Business Lending Fund (SBLF) program, a $30 billion fund established under the Small Business Jobs Act of 2010, which encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion. The Series AA Preferred Stock holders are entitled to receive non-cumulative dividends payable quarterly on each January 1, April 1, July 1 and October 1, beginning October 1, 2011. The dividend rate, which is calculated on the aggregate Liquidation Amount, was initially set at 5% per annum based upon the current level of “Qualified Small Business Lending” (“QSBL”) by the Bank and is currently set at 1%. The dividend rate for each dividend period may vary and is set based upon the percentage change in qualified lending between each dividend period and the baseline QSBL level established at the time the Agreement was entered into. Such dividend rate may vary from 1% per annum to 5% per annum for the second through tenth dividend periods and from 1% per annum to 7% per annum for the eleventh through the eighteenth dividend periods and though March 22, 2016 with respect to the nineteenth dividend period. If the Series AA Preferred Stock remains outstanding for more than four-and-one-half years, the dividend rate will be fixed at 9%. Prior to that time, in general, the dividend rate decreases as the level of the Bank’s QSBL increases. Such dividends are not cumulative, but Bancorp may only declare and pay dividends on its common stock (or any other equity securities junior to the Series AA Preferred Stock) if it has declared and paid dividends for the current dividend period on the Series AA Preferred Stock, and will be subject to other restrictions on its ability to repurchase or redeem other securities. In addition, if (i) we have not timely declared and paid dividends on the Series AA Preferred Stock for six dividend periods or more, whether or not consecutive, the Treasury (or any successor holder of Series AA Preferred Stock) may designate a representative to attend all meetings of Bancorp’s Board of Directors in a nonvoting observer capacity and Bancorp must give such representative copies of all notices, minutes, consents and other materials that Bancorp provide to its directors in connection with such meetings.

We may redeem the shares of Series AA Preferred Stock, in whole or in part, at any time at a redemption price equal to the sum of the Liquidation Amount per share and the per-share amount of any unpaid dividends for the then-current period, subject to any required prior approval by our primary federal banking regulator.

Note 12: Fair Value

FASB ASC Topic 820 “Fair Value Measurements” defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale and loans held for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:

Level 1: Valuations for assets and liabilities traded in active exchange markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

A financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within Level 1 or Level 2 of the fair value hierarchy. As required by FASB ASC Topic 820, the Company does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high-yield corporate bonds, less liquid mortgage products, less liquid equities, state, municipal and provincial obligations, and certain physical commodities. Such instruments are generally classified within Level 2 of the fair value hierarchy.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management's best estimate is used.

Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans and is classified at a Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisal by qualified licensed appraisers hired by the Company. The value of business equipment, inventory and accounts receivable collateral is based on the net book value on the business' financial statements and, if necessary, discounted based on management's review and analysis. Appraised and reported values may be discounted based on management's historical knowledge, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the client and client's business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

The following table sets forth the Company's financial assets and liabilities that were accounted for or disclosed at fair value on a recurring basis as of June 30, 2014 and December 31, 2013.

June 30, 2014

Quoted Price in

Significant

Active Markets

Other

Significant

Carrying

for Identical

Observable

Unobservable

Value

Assets

Inputs

(in thousands)

(Fair Value)

(Level 1)

(Level 2)

(Level 3)

Investment securities:

U.S. Goverment agencies

15,999

Mortgage-backed securities

131

Loans held for sale

28,851

December 31, 2013

Quoted Price in

Significant

Active Markets

Other

Significant

Carrying

for Identical

Observable

Unobservable

Value

Assets

Inputs

(in thousands)

(Fair Value)

(Level 1)

(Level 2)

(Level 3)

Investment securities:

U.S. Goverment agencies

28,521

Mortgage-backed securities

167

The following table sets forth the Company's financial assets and liabilities that were accounted for or disclosed at fair value on a nonrecurring basis at June 30, 2014 and December 31, 2013.

June 30, 2014			Quoted Price in		Significant
			Active Markets		Other		Significant
	Carrying		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(in thousands)	(Fair Value)		(Level 1)		(Level 2)		(Level 3)
Other real estate owned	$	2,377	$	-	$	-	$	2,377
Impaired loans:
Construction and land		-		-		-		-
Residential - first lien		315		-		-		315
Residential - junior lien		-		-		-		-
Commercial - owner occupied		-		-		-		-
Commercial - non-owner occupied		2,842		-		-		2,842
Commercial loans and leases		1,610		-		-		1,610
Consumer		-		-		-		-

December 31, 2013			Quoted Price in		Significant
			Active Markets		Other		Significant
	Carrying		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(in thousands)	(Fair Value)		(Level 1)		(Level 2)		(Level 3)
Other real estate owned	$	2,377	$	-	$	-	$	2,377
Impaired loans:
Construction and land		-		-		-		-
Residential - first lien		327		-		-		327
Residential - junior lien		-		-		-		-
Commercial - owner occupied		-		-		-		-
Commercial - non-owner occupied		2,953		-		-		2,953
Commercial loans and leases		2,754		-		-		2,754
Consumer		-		-		-		-

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are based on quoted market prices where available or calculated using present value techniques. Since quoted market prices are not available on many of our financial instruments, estimates may be based on the present value of estimated future cash flows and estimated discount rates. These financial assets and liabilities have not been recorded at fair value.

The following methods and assumptions were used to estimate the fair value of financial instruments where it is practical to estimate fair value:

Cash and cash equivalents: The fair value of cash and cash equivalents is estimated to approximate the carrying amounts.

Securities available-for-sale: Based on quoted market prices. If quoted market price is not available fair value is estimated using quoted market prices for similar securities. See Note 2 for additional information.

Nonmarketable equity securities: Because these securities are not marketable, the carrying amount approximates the fair value.

Loans held for sale: Loans held for sale are carried at fair value. Based on outstanding investor commitments or, in absent of such commitments, based on current investor yield requirements on third party models.

Loans: For variable rate loans the carrying amount approximates the fair value. For fixed rate loans the fair value is calculated by discounting estimated cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The estimated cash flows do not anticipate prepayments.

Deposits: The carrying amount of non-maturity deposits such as demand deposits, money market and saving deposits approximates the fair value. The fair value of deposits with predetermined maturity dates such as certificate of deposits is estimated by discounting the future cash flows using current rates of similar deposits with similar remaining maturities.

Short-term borrowing: Variable rate repurchase agreements carrying amounts approximate the fair values at the reporting date.

Long-term borrowing: Because the borrowing is a variable rate instrument, the carrying amount approximates the fair value.

Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented for loans would be indicative of the value negotiated in an actual sale.

	June 30, 2014
					Quoted Price in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Cash and cash equivalents	$	26,571	$	26,571	$	-	$	26,571	$	-
Investment securities		16,130		16,130		-		16,130		-
Nonmarketable equity securities		2,565		2,565		-		2,565		-
Loans held for sale		28,851		28,851		-		28,851		-
Loans and leases		433,336		434,133		-		-		434,133
Financial Liabilities
Deposits		422,335		421,524		-		-		421,524
Short-term borrowings		36,616		36,616		-		36,616		-
Long-term borrowings		23,500		23,492		-		23,492		-

	December 31, 2013
					Quoted Price in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Cash and cash equivalents	$	35,736	$	35,736	$	-	$	35,736	$	-
Investment securities		28,688		28,688		-		28,688		-
Nonmarketable equity securities		2,282		2,282		-		2,282		-
Loans held for sale		3,298		3,298		-		3,298		-
Loans and leases		401,369		401,652		-		-		401,652
Financial Liabilities
Deposits		388,949		389,220		-		-		389,220
Short-term borrowings		45,658		45,658		-		45,658		-
Long-term borrowings		16,000		16,008		-		16,008		-

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section is intended to help readers understand our financial performance through a discussion of the factors affecting our consolidated financial condition. This section should be read in conjunction with the consolidated financial statements and accompanying notes.

Overview

Bancorp is the holding company for the Bank. The Bank is a trust company chartered under Subtitle 2 of Title 3 of the Financial Institutions Article of the Annotated Code of Maryland. The Bank was formed in March 2004 and commenced banking operations on August 9, 2004. The Bank does not exercise trust powers, and our regulatory structure is the same as a Maryland-chartered commercial bank. As such, our business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. Typically, commercial real estate and business loans involve a higher degree of risk and carry a higher yield than one-to four-family residential loans. Although we plan to continue to focus on commercial customers, we intend to increase our originations of one- to four-family residential mortgage loans going forward, increasing our portfolio of mortgage lending and also selling select loans into the secondary markets.

We are headquartered in Ellicott City, Maryland and we consider our primary market area to be The Greater Baltimore Metropolitan Area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services to small to medium sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are primarily funded by core deposits of customers in our market.

Our core business strategy is to deliver superior customer service that is supported by an extremely high level of banking sophistication. Our specialized community banking focus on both local markets and small business related market segments is combined with a broad array of products, new technology and seasoned banking professionals which positions the Bank differently than most competitors. Our experienced executives establish a relationship with each client and bring value to all phases of a client’s business and personal banking needs. We call it Hands-On Service.

Our results of operations depend mainly on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios and the interest expense we pay on deposits and borrowings. Results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest expense consists primarily of compensation and employee benefits, as well as office occupancy, business development, deposit insurance and general administrative and data processing expenses. Our operations are significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially affect our financial condition and results of operations.

Total assets increased by over $33.6 million or 6.7% when comparing June 30, 2014 assets of $533.5 million to the $499.9 million at December 31, 2013. Total loans outstanding of $433.3 million at the end of June 2014, showed an increase of $29.5 million or 7.3% compared to total loans of $403.9 million on December 31, 2013. Total deposits grew by $33.4 million or 8.6% when comparing June 30, 2014 to December 31, 2013.

Net income was $1.0 million during the first half of both 2014 and 2013, and $.7 million and $.5 million, respectively, during the three months ended June 30, 2014 and 2013. Net interest income for the six months ended June 30, 2014 was $9.3 million versus $7.3 million for the first six months of 2013, an increase of approximately $2.0 million or 27.4%. Total noninterest income was $0.6 million for the first half of 2013, compared to $2.7 million for the same period in 2014. The first half 2014 noninterest income was primarily impacted by increased mortgage banking activities of $1.3 million. Total noninterest expenses increased by $4.0 million from $5.8 million for the six months ended June 30, 2013 to $9.8 million for the same period in 2014. Most of the increase in expenses was due to additional compensation costs as we continued to expand our staff.

During the first half of 2014, we have spent considerable financial and nonfinancial resources in putting together a highly professional team of mortgage bankers. To accommodate the mortgage banking initiative, we have leased additional office space in Annapolis, Maryland, and opened mortgage offices in Columbia, Maryland and in Timonium, Maryland. Over the twelve months from June 30, 2013 to June 30, 2014, we added three new branch locations in Towson, Maryland, Bel Air, Maryland, and Aberdeen, Maryland, in addition to opening a regional office in Towson. This dramatic increase of both customer service offices and the related staff additions geographically extends our market presence and our brand, and provides a platform for continued growth in size and revenues.

In the second quarter of 2014, the Bank executed an agreement to acquire approximately $17 million in additional loans and nearly $21 million in deposits via the purchase of a branch in the Havre de Grace area of Harford County, Maryland from NBRS Financial Bank, subject to regulatory approval.

Critical Accounting Policies

Our accounting and financial reporting policies conform to GAAP and general practice within the banking industry. Accordingly, the financial statements require management to exercise significant judgment or discretion or make significant assumptions based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. In reviewing and understanding financial information for us, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements. We consider the allowance for credit losses to be our most significant accounting policy, which is further described in the notes to the financial statements.

The allowance for credit losses is established through a provision for credit losses charged against income. Loans are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent losses in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on impacted loans, value of collateral, estimated losses on our loan portfolios as well as consideration of general loss experience. Based on our estimate of the level of allowance for credit losses required, we record a provision for credit losses to maintain the allowance for credit losses at an appropriate level.

We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with respect to the allowance for credit losses. In addition, our regulatory agencies, as an integral part of their examination processes, periodically review our allowance for credit losses. Such agencies may require that we recognize additions to the allowance for credit losses based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for credit losses may be required that would adversely impact earnings in future periods.

We account for income taxes under the asset/liability method. We recognize deferred tax assets for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred tax assets could change in the near term.

We follow the provisions of ASC Topic 718 "Compensation," which requires the expense recognition over a service period for the fair value of share based compensation awards, such as stock options, restricted stock, and performance based shares. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates which directly impact estimated fair value. The accounting standard also allows for the use of alternative option pricing models which may impact fair value as determined. Our practice is to utilize reasonable and supportable assumptions which are reviewed with the appropriate Board committee.

Balance Sheet Analysis and Comparison of Financial Condition

A comparison between June 30, 2014 and December 31, 2013 balance sheets is presented below.

Assets

Total assets increased $33.6 million, or 6.7%, to $533.5 million at June 30, 2014 compared to $499.9 million at December 31, 2013. This asset growth was primarily due to $29.5 million growth in total loans, partially offset by decreases of $9.2 million in cash and cash equivalents and $12.6 million in investment securities. In addition, total assets were impacted by the increase in loans held for sale, which are directly attributable to the Bank’s newly created mortgage banking division. The asset growth was funded primarily from increases in customer deposits, which increased from $388.9 million at December 31, 2013 to $422.3 million at June 30, 2014, an increase of $33.4 million or 8.9%.

Securities Available for Sale

We currently hold both U.S. agency securities and mortgage backed securities in our securities portfolio, all of which are categorized as available for sale. Our securities portfolio is used to provide the required collateral for funding via commercial customer repurchase agreements as well as to provide sufficient liquidity to fund our loans and provide funds for withdrawals of deposited funds. At June 30, 2014 and December 31, 2013 we held an investment in stock of the Federal Home Loan Bank of Atlanta (“FHLB”) of $2.6 million and $2.3 million, respectively. This investment is required for continued FHLB membership, and is based partially upon the amount of borrowings outstanding from the FHLB. These investments are carried at cost. We have never held stock in Fannie Mae or Freddie Mac.

The following tables set forth the composition of our investment securities portfolio at the dates indicated.

(in thousands)	June 30, 2014				December 31, 2013
	Amortized		Estimated		Amortized		Estimated
	Cost		Fair Value		Cost		Fair Value

U.S. Government agencies	$	15,998	$	15,999	$	28,522	$	28,521
Mortgage-backed		123		131		157		167
	$	16,121	$	16,130	$	28,679	$	28,688

We had securities available for sale of $16.1 million and $28.7 million at June 30, 2014 and December 31, 2013, respectively, which were recorded at fair value. This represents a decrease of $12.6 million, or 43.8%, from the prior year end. The decrease in our securities portfolio resulted from scheduled maturities, and we used the funds received to partially fund the growth in loans and loans held for sale, while maintaining an appropriate amount of securities to collateralize our repurchase agreements at June 30, 2014. We did not record any gains or losses on the sales or calls of securities or mortgage backed securities in either period presented.

With respect to our total portfolio of securities available for sale, we held no securities that had unrealized losses at June 30, 2014, and at December 31, 2013 held certain securities that had unrealized losses of less than $1 thousand. The minimal changes in the fair value of these securities resulted primarily from interest rate fluctuations.

Loan and Lease Portfolio

Total loans and leases increased by $29.5 million or 7.3%, to $433.3 million at June 30, 2014 from $403.9 million at December 31, 2013. At June 30, 2014, total loans were 81.2% of total assets, up from 80.8% of total assets at December 31, 2013. As the economy in our market area has started to improve so has demand for certain types of credit, especially commercial real estate, commercial and construction loans. In addition, with the expansion of our mortgage banking activities, our portfolio of residential mortgages also reflected growth during the six month period.

The following table sets forth the composition of our loan portfolio at the dates indicated. We had loans held for sale of $28.9 million at June 30, 2014, and $3.3 million at December 31, 2013.

	June 30,					December 31,
(in thousands)	2014		% of Total			2013		% of Total
Real estate
Construction and land	$	62,349		14.4	%	$	50,884		12.6	%
Residential - first lien		52,794		12.2			39,249		9.7
Residential - junior lien		9,362		2.2			8,266		2.0
Total residential real estate		62,156		14.3			47,515		11.7
Commercial - owner occupied		88,374		20.4			90,333		22.4
Commercial - non-owner occupied		111,101		25.6			113,559		28.1
Total commercial real estate		199,475		46.0			203,892		50.5
Total real estate loans		323,980		74.8			302,291		74.8
Commercial loans and leases		108,291		25.0			100,410		24.9
Consumer		1,065		0.2			1,174		0.3
Total loans	$	433,336		100.0	%	$	403,875		100.0	%

Deposits

Our deposits increased from $388.9 million at December 31, 2013 to $422.3 million at June 30, 2014, an increase of $33.4 million or 8.9%. The increase resulted primarily from increases of $16.5 million or 17.1% in money market accounts, $8.8 million or 5.6% in other certificates of deposit and $7.8 million or 8.7% in non-interest bearing accounts from December 31, 2013 to March 31, 2014. Every category of deposit experienced growth from the December 2013 levels, with the exception of savings that had a slight decline.

The following tables set forth the distribution of total deposits, by account type, at the dates indicated

(dollars in thousands)	June 30, 2014					December 31, 2013
			% of					% of
	Amount		Total			Amount		Total
Noninterest-bearing demand	$	97,540		23	%	$	89,759		23	%
Interest-bearing checking		32,027		7			31,443		8
Money market accounts		112,872		27			96,365		25
Savings		12,169		3			12,496		3
Certificates of deposit $100,000 and over		120,746		29			110,516		29
Certificates of deposit under $100,000		46,981		11			48,370		12
Total deposits	$	422,335		100	%	$	388,949		100	%

Borrowings

Customer deposits remain the primary source utilized to meet funding needs. Borrowings consist of overnight unsecured master notes, overnight securities sold under agreement to repurchase (“repurchase agreements”) and FHLB advances. Our borrowings totaled $60.1 million at June 30, 2014 and $61.7 million at December 31, 2013. Short-term borrowings totaled $36.6 million at June 30, 2014 and $45.7 million at December 31, 2013. We had nine long-term FHLB advances outstanding totaling $23.5 million at June 30, 2014 compared to six FHLB advances outstanding totaling $16 million at December 31, 2013.

Shareholders’ Equity

Total shareholders’ equity increased by $1.0 million, or 2.1%, from $48.6 million at December 31, 2013 to $49.6 million at June 30, 2014. The increase in shareholders’ equity is primarily the result of the retention of the earnings for the first half of 2014.

Total shareholders’ equity at June 30, 2014 represents a capital to asset ratio of 9.3%, while the total shareholders’ equity at December 31, 2013 represents a capital to asset ratio of 9.7%. Even though capital levels increased, the overall growth in asset levels resulted in a decline in the capital to asset ratio.

Average Balance and Yields

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, and have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

	For the six months ended June 30,
	2014								2013
	Average			Income		Yield			Average			Income		Yield
(dollars in thousands)	Balance			/ Expense		/ Rate			Balance			/ Expense		/ Rate
Earning assets
Loans and leases: ¹
Commercial loans and leases	$	98,433		$	2,448		5.02	%	$	87,807		$	2,105		4.83	%
Commercial real estate		202,984			4,888		4.86			162,697			4,040		5.01
Construction and land		55,146			1,462		5.34			39,692			1,050		5.34
Residential real estate		54,487			1,170		4.33			38,029			835		4.43
Consumer		1,017			29		5.80			1,226			31		5.08
Total loans and leases		412,067			9,997		4.89			329,450			8,062		4.93
Loans held for sale		15,245			265		3.51			1,390			24		3.48
Federal funds sold		20,908			21		0.20			21,231			23		0.22
Securities: ²
U.S Gov agencies		21,086			11		0.11			15,724			18		0.22
Mortgage-backed		150			3		4.54			294			7		4.58
Other investments		2,386			43		3.60			1,555			16		2.13
Total securities		23,622			57		0.49			17,573			41		0.47
Total earning assets		471,842			10,340		4.42			369,645			8,149		4.45
Cash and due from banks		5,311								4,702
Bank premises and equipment, net		11,251								9,460
Other assets		17,528								14,155
Less: allowance for credit losses		(2,696	)							(2,886	)
Total assets	$	503,236							$	395,076
Interest-bearing liabilities
Deposits:
Interest-bearing demand accounts	$	31,857		$	40		0.25	%	$	25,054		$	35		0.28	%
Money market		102,021			210		0.42			74,613			174		0.47
Savings		12,659			15		0.24			11,991			25		0.41
Time deposits $100,000 and over		70,543			412		1.18			55,438			332		1.21
Other time deposits		87,952			249		0.57			58,557			220		0.76
Total interest-bearing deposits		305,032			926		0.61			225,653			786		0.70
Short-term borrowings		36,602			56		0.31			22,501			57		0.51
Long-term borrowings		18,972			101		1.08			13,017			40		0.63
Total interest-bearing funds		360,606			1,083		0.61			261,171			883		0.68
Noninterest-bearing deposits		92,870								85,736
Other liabilities and accrued expenses		780								923
Total liabilities		454,256								347,830
Shareholders' equity		48,980								47,246
Total liabilities & shareholders' equity	$	503,236							$	395,076
Net interest rate spread ³				$	9,257		3.81	%				$	7,266		3.76	%
Effect of noninterest-bearing funds							0.14								0.20
Net interest margin on earning assets⁴							3.96	%							3.96	%

(1)

Loan fee income is included in the interest income calculation, and nonaccrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(2)

Available for sale securities and loans held for sale are presented at fair value.

(3)

Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4)

Net interest margin represents net interest income divided by average total interest-earning assets.

	For the three months ended June 30,
	2014								2013
	Average			Income		Yield			Average			Income		Yield
(dollars in thousands)	Balance			/ Expense		/ Rate			Balance			/ Expense		/ Rate
Earning assets
Loans and leases: ¹
Commercial loans and leases	$	100,173		$	1,274		5.10	%	$	90,683		$	1,063		4.70	%
Commercial real estate		202,813			2,463		4.87			165,843			2,059		4.98
Construction and land		58,240			786		5.42			41,687			563		5.41
Residential real estate		58,638			630		4.31			38,123			419		4.41
Consumer		1,058			15		5.84			1,220			15		5.06
Total loans and leases		420,922			5,168		4.92			337,556			4,119		4.89
Loans held for sale		22,733			195		3.44			903			10		4.44
Federal funds sold		15,857			7		0.18			21,231			12		0.23
Securities: ²
U.S. Gov agencies		16,477			5		0.12			12,218			7		0.21
Mortgage-backed		141			2		4.51			271			3		4.47
Other investments		2,517			20		3.26			1,623			9		2.24
Total securities		19,135			27		0.56			14,112			19		0.53
Total earning assets		478,647			5,397		4.52			373,802			4,160		4.46
Cash and due from banks		5,503								4,832
Bank premises and equipment, net		11,438								9,406
Other assets		17,368								14,201
Less: allowance for credit losses		(2,804	)							(2,955	)
Total assets	$	510,152							$	399,286
Interest-bearing liabilities
Deposits:
Interest-bearing demand accounts	$	32,277		$	20		0.25	%	$	26,012		$	18		0.28	%
Money market		104,289			116		0.45			75,389			88		0.47
Savings		12,569			7		0.21			12,322			13		0.41
Time deposits $100,000 and over		72,055			220		1.22			54,560			169		1.24
Other time deposits		89,859			122		0.54			61,974			110		0.71
Total interest-bearing deposits		311,049			485		0.63			230,257			398		0.69
Short-term borrowings		34,068			25		0.29			21,407			27		0.51
Long-term borrowing		21,522			58		1.08			13,934			19		0.55
Total interest-bearing funds		366,639			568		0.62			265,598			444		0.67
Noninterest-bearing deposits		93,625								85,417
Other liabilities and accrued expenses		740								867
Total liabilities		461,004								351,882
Shareholders' equity		49,148								47,404
Total liabilities & shareholders' equity	$	510,152							$	399,286
Net interest rate spread ³				$	4,829		3.90	%				$	3,716		3.79	%
Effect of noninterest-bearing funds							0.15								0.19
Net interest margin on earning assets⁴							4.05	%							3.99	%

(1)

Loan fee income is included in the interest income calculation, and nonaccrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(2)

Available for sale securities and loans held for sale are presented at fair value.

(3)

Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4)

Net interest margin represents net interest income divided by average total interest-earning assets.

Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column is further broken down to show the impact of changes in either rates or volumes. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.

	For the six months ended June 30,									For the three months ended June 30,
	2014 vs. 2013									2014 vs. 2013
	Due to variances in									Due to variances in
(in thousands)	Total			Rates			Volumes ¹			Total			Rates			Volumes ¹
Interest earned on:
Loans and leases:
Commercial loans and leases	$	343		$	159		$	184		$	211		$	361		$	(150	)
Commercial real estate		848			(246	)		1,094			404			(181	)		585
Construction and land		412			4			408			223			0			223
Residential real estate		335			(38	)		373			211			(39	)		250
Consumer		(2	)		9			(11	)		0			10			(10	)
Loans held for sale		241			0			241			185			(9	)		194
Taxable securities		16			4			12			8			5			3
Federal funds sold		(2	)		(4	)		2			(5	)		(12	)		7
Total interest income		2,191			(112	)		2,303			1,237			135			1,102

Interest paid on:
Savings deposits		(10	)		(22	)		12			(6	)		(25	)		19
Checking plus interest deposits		5			(7	)		12			2			(7	)		9
Money market accounts		36			(40	)		76			28			(16	)		44
Time deposit $100,000 and over		80			(16	)		96			51			(11	)		62
Other time deposits		29			(110	)		139			12			(104	)		116
Short-term borrowings		(1	)		(45	)		44			(2	)		(46	)		44
Long-term borrowing		61			59			2			39			74			(35	)
Total interest expense		200			(181	)		381			124			(135	)		259
Net interest earned	$	1,991		$	69		$	1,922		$	1,113		$	270		$	843

(1) Change attributed to mix (rate and volume) are included in volume variance

Comparison of Results of Operations

A comparison between the six months ended June 30, 2014 and June 30, 2013 is presented below.

General

Net income available to common shareholders increased $45 thousand, or 5.0%, to $940 thousand for the six months ended June 30, 2014 compared to $895 thousand for the six months ended June 30, 2013. This increase was primarily due to an increase in total revenues of $4.0 million or 51.0%, led by growth in net interest income and higher noninterest income from our mortgage banking activities, offset by an increase in noninterest expenses of $4.0 million or 69.7% given our recent investments in geographic expansion and the commencement of our mortgage operations.

Interest Income

Interest income increased $2.2 million, or 26.9%, to $10.3 million for the six months ended June 30, 2014 compared to $8.1 million for the same period in 2013. The increase was due to a $2.2 million or 26.9% increase in interest income on loans and leases, and included $265 thousand in interest on mortgage loans held for sale. The increase in interest income on loans was due to a nearly $83 million or 25.1% increase in the average balance of the loan portfolio during the six months ended June 30, 2014 compared to the six months ended June 30, 2013. In addition to the growth in our portfolio of loans, an increase of $13.9 million in the average balance of loans held for sale drove a $241 thousand increase in interest income on loans held for sale. Interest income from our securities portfolio increased $16 thousand or 39.0% primarily as a result of a 34.4% increase in their average balances.

Interest Expense

Interest expense increased by $200 thousand, or 22.6%, to $1.1 million for the six months ended June 30, 2014, compared to $0.9 million for the same period in 2013. Even though we were able to grow average interest bearing sources of funds by $79.4 million or 35.2% for the first half of 2014 compared to the first half of 2013, total interest expense only rose 17.8% as the average rates paid on deposits decreased from .70% to .61% when comparing the two periods, primarily as a result of a continuing shift in the composition of our deposits towards lower cost deposit products including noninterest-bearing deposits, the average balance of which grew $7.1 million when comparing the six months ended June 30, 2014 to the same period of the prior year. In addition to the growth of deposits, the average balance of borrowings increased 55.2% which also increased overall interest expense.

Net Interest Income

Net interest income is our largest source of operating revenue. Net interest income is affected by various factors including changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities and maturities. Net interest income is determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income increased $2.0 million, or 27.4%, during the six months ended June 30, 2014 compared to the six months ended June 30, 2013. As noted above, the increase in net interest income was primarily due to an increase in interest income of $2.2 million, reduced by an increase of $200 thousand in interest expense.

Provision for Credit Losses

We establish a provision for credit losses, which is a charge to earnings, in order to maintain the allowance for credit losses at a level we consider adequate to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for credit losses, management considers past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of nonperforming loans. The amount of the allowance is based on estimates and actual losses may vary from such estimates as more information becomes available or economic conditions change. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as circumstances change as more information becomes available. The allowance for credit losses is assessed on a quarterly basis and provisions are made for credit losses as required in order to maintain the allowance.

Based on management’s evaluation of the above factors, we had a provision for credit losses of $501 thousand for the six months ended June 30, 2014 compared to $526 thousand for the same period in 2013, a decrease of $25 thousand. The provision for 2014 reflects additional general provisions that are required given our continued growth in the size of the loan portfolio, as well as any specific provisions required on loans that are individually evaluated and deemed to be impaired.

Management analyzes the allowance for credit losses as described in the section entitled “Allowance for Credit Losses.” The provision that is recorded is sufficient, in management’s judgment, to bring the allowance for credit losses to a level that reflects the losses inherent in our loan portfolio relative to loan mix, economic conditions and historical loss experience. Management believes, to the best of its knowledge, that all known losses as of the balance sheet dates have been recorded. However, although management uses the best information available to make determinations with respect to the provisions for credit losses, additional provisions for credit losses may be required to be established in the future should economic or other conditions change substantially. In addition, as an integral part of their examination process, the Commissioner and the Federal Deposit Insurance Corporation (“FDIC”) will periodically review the allowance for credit losses. The Commissioner and the FDIC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.

Noninterest Income

Noninterest income was $2.7 million for the six months ended June 30, 2014 compared to $0.6 million for the six months ended June 30, 2013, a $2.0 million increase. The largest increase was generated from mortgage banking activities. Realized and unrealized gains from these activities increased from $0.1 million in the first half of 2013 to 1.5 million in the first half of 2014, and included the effect of implementing the fair value method for mortgage loans held for sale which accelerated mortgage related revenues by $836 thousand. Fees generated from mortgage banking, included in other operating income, increased 100% for the first half of 2014 compared to the comparable prior year period, representing $376 thousand in revenues. Additionally, the approximately $3.0 million expansion of our BOLI program in generated an increase of $49 thousand in income from bank owned life insurance, to $186 thousand during the first six months of 2014 compared to $137 thousand during the first half of 2013. Service charges on deposit accounts, which consists of account activity fees and other traditional banking fees, increased 82.5% to $307 thousand for the six months ended June 30, 2014 from $168 thousand for the same period in 2013 due mostly to an increase in overdraft-related fees. Other operating income, besides fees generated from mortgage banking activities, consists mainly of certain loan fees and non-depository account fees. Noninterest income benefited in the first half of 2014 from loan fees of $31 thousand associated with letters of credit from two credit relationships. These fees for customer related services such as wire, merchant card and ATM increased $26 thousand during the six months ended June 30, 2014 compared to the same period of 2013 due to increases in these transactions.

Noninterest Expenses

Noninterest expenses increased $4.0 million or 69.7%, to $9.8 million for the six months ended June 30, 2014 from $5.8 million for the six months ended June 30, 2013. This increase reflects the large investments in staff and infrastructure made during the first half of 2014 to build the mortgage banking platform, which is also evident in the additional revenues that were generated, from continuing branch expansion efforts, and increased marketing related to our business development initiatives. Compensation and employee benefits increased $2.3 million or 68.9% in the first six months of 2014 compared to the same period in 2013. Full time equivalent employees at June 30, 2014 increased nearly 50% from June 30, 2013 as the Bank has built its mortgage banking team, added branch and other sales staff, and also expanded support and compliance areas of the Bank. The increase in occupancy and equipment costs of $309 thousand or 41.3% reflects our adding three new branch locations, a regional office, and two additional mortgage offices since June 30, 2013. Our newly established mortgage banking group had an impact on nearly all areas of our noninterest expenses relating to both start-up and ongoing operating costs when comparing the six months ended June 30, 2014 to the six months ended June 30, 2013. Marketing and business development expenses increased a total of $409 thousand, of which $223 thousand pertained to mortgage sales activities. Professional fees consists of legal, consulting and outside service providers, increased $182 thousand in total, $40 thousand relating to start-up mortgage banking legal matters, and the reminder due to ongoing banking related growth initiatives. Other operating expensed consists of loan related expenses (including credit reports, appraisals and collection costs), and a variety of general expenses such as phone and data lines, supplies and postage and courier services. Of the total $669 thousand increase in other operating expenses, $362 thousand corresponded to the development of the mortgage banking infrastructure and a 150% increase in loan related cost associated with the additional volume in processing mortgages requests.

Net Income Available to Common Shareholders

Net income available to common shareholders during the six months ended June 30, 2014 increased $45 thousand or 5.0% to $940 thousand compared to $895 thousand during the six months ended June 30, 2013. This reflects our ongoing growth initiatives that included expanding regional markets into Baltimore and Harford counties, and commencing our mortgage banking platform, which depressed earnings for the first quarter, versus the additional revenues that were generated in the second quarter as our mortgage banking operation continues to transition from the building stage into the full operating phase. Preferred stock dividends were lower during the 2014 period because of a reduction in the dividend rate paid on our SBLF Preferred Stock given the growth in applicable loan categories in accordance with the terms of the program.

A comparison between the three months ended June 30, 2014 and June 30, 2013 is presented below.

General

Net income available to common shareholders increased $224 thousand, or 46.5%, to $705 thousand for the three months ended June 30, 2014 compared to $481 thousand for the three months ended June 30, 2013. This resulted in earnings per share increasing to $.17 for the second quarter 2014 compared to $.12 in the same period of 2013.

Interest Income

Interest income increased $1.2 million, or 29.8%, to $5.4 million for the three months ended June 30, 2014 compared to $4.2 million for the same period 2013. The increase was primarily due to a $1.2 million, or 30.0%, increase in interest income on loans. The increase in interest income on loans was due to a $83.3 million or 24.7% increase in the average balance of the loan portfolio compared to the three months ended June 30, 2013, slightly enhanced by a 3 basis point increase in the average yield. In addition to the portfolio loans, the $21.8 million increase in the average balance of loans held for sale quarter over quarter contributed to the increase in interest and fees on loans. In addition, interest and dividends on securities increased during the first quarter of 2014 compared to the same period last year as a result of a $5.0 million increase in the average balance of investment securities quarter over quarter. Partially offsetting these increases was a decline in interest income on federal funds sold, which decreased $5 thousand over the same period in 2013 as a result of a five basis point decrease in the average yield and a $5.3 million decrease in the average balance of federal funds sold quarter over quarter.

Interest Expense

Interest expense increased $124 thousand, or 27.8%, to $568 thousand for the three months ended June 30, 2014, compared to $444 thousand for the same period 2013, primarily as a result of increases in the average balance of both interest-bearing deposits and borrowing of $80.8 million and $20.2 million, respectively. The average rate paid on interest-bearing deposits decreased to 0.63% during the three months ended June 30, 2014 from 0.69% during the same period of 2013, partially offsetting the impact of the increase in the average balances

Net Interest Income

Net interest income increased $1.1 million, or 29.9%, during the three months ended June 30, 2014 compared to the three months ended June 30, 2013. As noted above, the increase in net interest income was due to an increase of $1.2 million in interest income coupled with only a $0.1 million increase in interest expense during the three month period.

Provision for Credit Losses

Based on management’s evaluation, we had a provision for credit losses of $325 thousand for the three months ended June 30, 2014 compared to $165 thousand for the same period in 2013, an increase of $160 thousand. The provision for the second quarter of 2014 was primarily due to additional general provisions that were required given the continued growth in the size of our loan portfolio.

Noninterest Income

Noninterest income was $2.1 million for the three months ended June 30, 2014 compared to $0.3 million for the three months ended June 30, 2013, a $1.7 million or 553.4% increase. This increase was primarily due to the $1.3 million of income generated from the mortgage banking activities during the second quarter of 2014.

Noninterest Expenses

Noninterest expenses increased by $2.3 million or 75.5%, during the three months ended June 30, 2014 compared to the three months ended June 30, 2013. As discussed above with respect to the six month period ended June 30, 2014, expanding regional markets and our mortgage banking platform were the greatest factors impacting the increase in noninterest expenses. Compensation and employee benefits increased $1.1 million or 64.9% quarter over quarter. Occupancy and equipment expenses increased $227 thousand or 63.2%, as a result of our increased locations as mentioned above. Additionally, as previously stated our mortgage banking initiative has had an impact on all other areas of noninterest expenses. Marketing and business development increased $280 thousand; professional cost increased $99 thousand; data process increased $48 thousand. Other noninterest expense increased nearly 100% to $1.9 million for the three months ended June 30, 2014 compared to $0.9 million for the same period of 2013.

Nonperforming and Problem Assets

Management performs reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a timely manner. When in the best interests of the Bank and the customer, we will do a troubled debt restructure with respect to a particular loan. When not possible, we are aggressively moving loans through the legal and foreclosure process within applicable legal constraints.

Loans are generally placed on non-accrual status when payment of principal or interest is 90 days or more past due and the value of the collateral securing the loan, if any, is less than the outstanding balance of the loan. Loans are also placed on non-accrual status if management has serious doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are placed on non-accrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received. The loan may be returned to accrual status if the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time and ultimate collectability of the total contractual principal and interest is no longer in doubt.

The table below sets forth the amounts and categories of our nonperforming assets, which consist of nonaccrual loans, troubled debt restructurings and OREO (which includes real estate acquired through, or in lieu of, foreclosure), at the dates indicated.

(in thousands)	June 30, 2014			December 31, 2013
Non-accrual loans:
Real estate loans:
Residential - First Lien	$	319		$	331
Commercial		256			258
Commercial and leases		1,207			2,593
Total non-accrual loans		1,782			3,182
Troubled debt restructure loans:
Accruing troubled debt restructure loans		230			-
Total non-performing loans		2,012			3,182
Other real estate owned:
Land		595			595
Commercial		1,782			1,782
Total other real estate owned		2,377			2,377
Total non-performing assets	$	4,389		$	5,559
Ratios:
Non-performing loans to total gross loans		0.46	%		0.79	%
Non-performing assets to total assets		0.82	%		1.11	%

Included in total non-accrual loans at June 30, 2014are six trouble debt restructured loans totaling $0.8 million that were not performing in accordance with the modified terms, and the accrual of interest has ceased. There was one commercial real estate credit totaling $159 thousand and one residential mortgage totaling $320 thousand that was 90 days or more past due and still accruing interest at June 30, 2014. At December 31, 2013 there one commercial real estate credit totaling $159 thousand and one commercial credit totaling $296 thousand 90 days or more past due and still accruing interest.

Under GAAP, we are required to account for certain loan modifications or restructurings as “troubled debt restructurings.” In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if Howard Bank, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession, such as a reduction in the effective interest rate, to the borrower that we would not otherwise consider. However, all debt restructurings or loan modifications for a borrower do not necessarily always constitute troubled debt restructurings.

Nonperforming assets amounted to $4.4 million, or 0.82% of total assets, at June 30, 2014 compared to $5.6 million or 1.11% of total assets at December 31, 2013. Total nonperforming assets have decreased by $1.2 million during 2014, with OREO remaining unchanged as there were no new properties added, no current properties sold and no additional valuation adjustments required on current assets. The decrease in non-accrual loans was impacted by the reductions in the balances of several non-accrual loans as principal payments were received from the borrowers and also as funds were received from the Small Business Administration (the “SBA”) for claims made under their guarantees.

The composition of our nonperforming loans at June 30, 2014 is further described below:

Six commercial loans to a local business totaling $0.80 million. Most of these loans have an SBA guarantee, and reserves have been taken to reflect the amount expected to be received once claims are submitted to the SBA.

Eleven small commercial loans totaling approximately $0.26 million to borrowers that are in various stages of collection. Each relationship is independently evaluated, and no losses are anticipated.

One commercial real estate loan for $0.27 million, which is guaranteed by a local business and is also secured by the assets of the business. A specific reserve has been established and based upon current valuations, no further losses are anticipated.

Two commercial loans to one customer totaling $0.13 million, both of which carries an SBA guarantee. A settlement offer has been negotiated, and no further losses are anticipated.

One residential mortgage for $0.32 million. A specific reserve has been established and based upon current valuations, no further losses are anticipated.

Allowance for Credit Losses

We provide for credit losses based upon the consistent application of our documented allowance for credit loss methodology. All credit losses are charged to the allowance for credit losses and all recoveries are credited to it. Additions to the allowance for credit losses are provided by charges to income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio and make provisions for credit losses in order to maintain the allowance for credit losses in accordance with GAAP. The allowance for credit losses consists primarily of two components:

Specific allowances are established for loans classified as substandard or doubtful. For loans classified as impaired, the allowance is established when the net realizable value (collateral value less costs to sell) of the impaired loan is lower than the carrying amount of the loan. The amount of impairment provided for as a specific allowance is represented by the deficiency, if any, between the underlying collateral value and the carrying value of the loan. Impaired loans for which the estimated fair value of the loan, or the loan’s observable market price or the fair value of the underlying collateral, if the loan is collateral dependent, exceeds the carrying value of the loan are not considered in establishing specific allowances for credit losses; and

General allowances established for credit losses on a portfolio basis for loans that do not meet the definition of impaired loans. The portfolio is grouped into similar risk characteristics, primarily loan type and regulatory classification. We apply an estimated loss rate to each loan group. The loss rates applied are based upon our loss experience adjusted, as appropriate, for the qualitative factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions.

The allowance for credit losses is maintained at a level to provide for losses that are probable and can be reasonably estimated. Management’s periodic evaluation of the adequacy of the allowance is based on Howard Bank’s past credit loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.

A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired when, based on current information and events, it is probable that Howard Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. 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 the 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 impairment of a loan may be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, Howard Bank’s impairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis.

Our loan policies state that after all collection efforts have been exhausted, and the loan is deemed to be a loss, then the remaining loan balance will be charged to the established allowance for credit losses. All loans are evaluated for loss potential once it has been determined by the Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan is deemed not to be well secured, the loan should be moved to nonaccrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined a charge-off against the allowance for credit losses for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.

The adjustments to historical loss experience are based on our evaluation of several qualitative factors, including:

changes in lending policies, procedures, practices or personnel;

changes in the level and composition of construction portfolio and related risks;

changes and migration of classified assets;

changes in exposure to subordinate collateral lien positions;

levels and composition of existing guarantees on loans by SBA or other agencies;

changes in national, state and local economic trends and business conditions;

changes and trends in levels of loan payment delinquencies; and

any other factors that managements considers relevant to the quality or performance of the loan portfolio.

We evaluate the allowance for credit losses based upon the combined total of the specific and general components. Generally when the loan portfolio increases, absent other factors, the allowance for credit loss methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally when the loan portfolio decreases, absent other factors, the allowance for credit loss methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease.

Commercial and commercial real estate loans generally have greater credit risks compared to the one- to four-family residential mortgage loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Actual credit losses may be significantly more than the allowance for credit losses we have established, which could have a material negative effect on our financial results.

Generally, we underwrite commercial loans based on cash flow and business history and receive personal guarantees from the borrowers where appropriate. We generally underwrite commercial real estate loans and residential real estate loans at a loan-to-value ratio of 85% or less at origination. Accordingly, in the event that a loan becomes past due and, randomly with respect to performing loans, we will conduct visual inspections of collateral properties and/or review publicly available information, such as online databases, to ascertain property values. We will also obtain formal appraisals on a regular basis even if we are not considering liquidation of the property to repay a loan. It is our practice to obtain updated appraisals if there is a material change in market conditions or if we become aware of new or additional facts that indicate a potential material reduction in the value of any individual property collateral.

For impaired loans, we utilize the appraised value in determining the appropriate specific allowance for credit losses attributable to a loan. In addition, changes in the appraised value of multiple properties securing our loans may result in an increase or decrease in our general allowance for credit losses as an adjustment to our historical loss experience due to qualitative and environmental factors, as described above.

At June 30, 2014 and December 31, 2013, impaired loans amounted to $5.1 million and $6.3 million, respectively. The amount of impaired loans requiring specific reserves totaled $1.1 million and $1.3 million, respectively. The amount of impaired loans with no specific valuation allowance totaled $4.0 million and $5.0 million, respectively.

Nonperforming loans are evaluated and valued at the time the loan is identified as impaired on a case by case basis, at the lower of cost or market value. Market value is measured based on the value of the collateral securing the loan. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by us. Appraised values may be discounted based on management’s historical experience, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. The difference between the appraised value and the principal balance of the loan will determine the specific allowance valuation required for the loan, if any. Nonperforming loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

We evaluate the loan portfolio on at least a quarterly basis, more frequently if conditions warrant, and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Commissioner and the FDIC will periodically review the allowance for credit losses. The Commissioner and the FDIC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.

The following table sets forth activity in our allowance for credit losses for the indicated periods:

	Six months ended June 30,					Three months ended June 30,
(in thousands)	2014		2013			2014		2013
Balance at beginning of year	$	2,506	$	2,764		$	2,700	$	2,980
Charge-offs:
Real estate
Residential first lien loans		-		(183	)		-		-
Commercial loans and leases		-		(202	)		-		(202	)
		-		(385	)		-		(202	)
Recoveries:
Real estate
Commercial non-owner occupied loans		4		30			-		-
Commercial loans and leases		42		16			28		8
		46		46			28		8

Net recoveries (charge-offs)		46		(339	)		28		(194	)

Provision for credit losses		501		526			325		165

Balance at end of period	$	3,053	$	2,951		$	3,053	$	2,951

Allocation of Allowance for Credit Losses

The following tables set forth the allowance for credit losses allocated by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance for credit losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

	June 30, 2014					December 31, 2013
(dollars in thousands)	Amount		Percent¹			Amount		Percent¹
Real estate
Construction and land loans	$	159		14.4	%	$	122		12.6	%
Residential first lien loans		196		12.2			200		9.7
Residential junior lien loans		17		2.2			34		2.0
Commercial owner occupied loans		138		20.4			131		22.4
Commercial non-owner occupied loans		661		25.6			541		28.1
Commercial loans and leases		1,871		25.0			1,464		24.9
Consumer loans		11		0.2			14		0.3
Total	$	3,053		100.0	%	$	2,506		100.0	%

(1) Represents the percent of loans in each category to total loans

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, principal repayments and the sale of securities available for sale. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset Liability Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2014 and December 31, 2013. We regularly monitor and adjust our investments in liquid assets based upon our assessment of:

Expected loan demand;

	2)	Expected mortgage origination activities;
	3)	Expected deposit flows and borrowing maturities;

Yields available on interest-earning deposits and securities; and

The objectives of our asset/liability management program.

Excess liquid assets are invested generally in interest-earning deposits and short-term securities.

Our most liquid assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At June 30, 2014 and December 31, 2013, cash and cash equivalents totaled $26.6 million and $35.7 million, respectively.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our statements of cash flows included in our financial statements.

At June 30, 2014 and December 31, 2013, we had $105.1 million and $75.8 million, respectively, in loan commitments outstanding, including commitments issued to originate loans of $59.4 million and $34.5 million at June 30, 2014 and December 31, 2013, respectively, and $45.6 million and $41.3 million in unused lines of credit to borrowers at June 30, 2014 and December 31, 2013, respectively. A large portion of the increase in the commitments to originate loans was derived from commitments for residential mortgage loans, now that our mortgage banking group is fully operational. In addition to commitments to originate loans and unused lines of credit we had $10.5 million and $9.8 million in letters of credit at June 30, 2014 and December 31, 2013, respectively. Certificates of deposit due within one year of June 30, 2014 totaled $103.1 million, or 24.4% of total deposits. Should these deposits not remain with us, we may be required to seek other sources of funds, including loan and securities sales, and FHLB advances. Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on the certificates of deposit. We believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of our certificates of deposit with maturities of one year or less.

Our primary investing activity is originating loans. During the six months ended June 30, 2014 cash was utilized to increase our portfolio of loans by $29.6 million and our loans held for sale portfolio by $25.6 million. For the six month period ended June 30, 2013, these amounts were $29.8 million and $0.01 million, respectively. During the first half of 2014 we purchased $6.0 million in additional securities and we received $18.6 million from security maturities; by comparison during the six months ended June 30, 2013 we purchase $19.0 million in additional securities while receiving $30.6 million from security maturities. Total cash used to fund our activities totaled $9.1 million and $12.6 million for the six months ended June 30, 2014 and 2013, respectively.

Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced a net increase in deposits of $33.5 million during the six months ended June 30, 2014. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.

Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB, which provide an additional source of funds. FHLB advances were $47 million at June 30, 2014 compared to $40 million at December 31, 2013. At June 30, 2014, we had the ability to borrow up to a total of $101.5 million based upon our credit availability at the FHLB, subject to collateral requirements.

The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2014 and December 31, 2013, the Bank exceeded all regulatory capital requirements. The Bank is considered “well capitalized” under regulatory guidelines.

Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements

We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These financial instruments are limited to commitments to originate loans and involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses which would have a material effect on us.

Outstanding loan commitments and lines of credit at June 30, 2014 and December 31, 2013 are as follows:

(in thousands)	June 30, 2014		December 31, 2013

Unfunded loan commitments	$	59,419	$	34,464
Unused lines of credit		45,634		41,326
Letters of credit		10,531		9,676

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally have interest rates at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that all customers will draw upon their lines of credit in full at any one time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer’s credit-worthiness on a case-by-case basis. Because we conservatively underwrite these facilities at inception, we have not had to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit.

The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in the statement of financial condition at June 30, 2014 or December 31, 2013 as a liability for credit loss related to these commitments.

Impact of Inflation and Changing Prices

Our financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable

Item 4. Controls and Procedures

As of the end of the period covered by this quarterly report on Form 10-Q Bancorp’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of Bancorp’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, Bancorp’s Chief Executive Officer and Chief Financial Officer concluded that Bancorp’s disclosure controls and procedures are effective as of June 30, 2014. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by Bancorp in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

In addition, there were no changes in Bancorp’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended June 30, 2014, that have materially affected, or are reasonably likely to materially affect Bancorp’s internal control over financial reporting.

PART II - Other Information

Item 1. Legal Proceedings

From time to time, we may be involved in litigation relating to claims arising out of our normal course of business. As of the date of this report, we are not aware of any material pending litigation matters.

Item 1A. Risk Factors

There have been no material changes in the risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 27, 2014.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Our registration statement on Form S-1, File Number 333-178204, with respect to our initial public offering of our common stock, was declared effective by the SEC on May 14, 2012. We sold a total of 1,396,364 shares of common stock in our initial public offering for aggregate gross proceeds of $10.2 million.

After expenses, we raised net proceeds of approximately $9.0 million in the public offering. During the third quarter of 2014 we provided $8.5 million of the proceeds to the Bank to increase its capital levels in order to support the Bank’s continued growth.

Item 3. Defaults upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None

Item 6. Exhibits

10.26	Branch Purchase and Assumption Agreement between NBRS Financial Bank and Howard Bank dated April 24, 2014 (incorporated by reference to Exhibit 10.26 of Bancorp’s Current Report on Form 8-K filed with the SEC on April 29, 2014)

31(a)	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - filed herewith

31(b)	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - filed herewith

32	Certifications pursuant to 18 U.S.C. Section 1350, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith

101	Extensible Business Reporting Language (“XBRL”) – filed herewith

	101.INS	XBRL Instance File

	101.SCH	XBRL Schema File

	101.CAL	XBRL Calculation File

	101.DEF	XBRL Definition File

	101.LAB	XBRL Label File

	101.PRE	XBRL Presentation File

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		HOWARD BANCORP, INC.
		(Registrant)

August 12, 2014		/s/ Mary Ann Scully
Date		MARY ANN SCULLY
		PRESIDENT AND CEO

August 12, 2014		/s/ George C. Coffman
Date		GEORGE C. COFFMAN
		EVP AND CFO

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