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EX-31.1 - EXHIBIT 31.1 - Howard Bancorp Inctm2014553d1_ex31-1.htm

 

  

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2020

 

OR

 

¨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.)

 

3301 Boston Street, Baltimore, MD   21224
(Address of principal executive offices)   (Zip Code)

 

(410) 750-0020

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:   Trading Symbol   Name of each exchange on which registered:
Common Stock, par value $0.01 per share   HBMD   The Nasdaq Stock Market LLC

 

 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 every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x    No ¨

 

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

 

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company x Emerging growth company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

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

 

The number of shares of common stock outstanding as of May 8, 2020.

 

Common Stock, $0.01 par value – 18,715,678 shares

 

 

 

 

 

HOWARD BANCORP, INC.

TABLE OF CONTENTS

 

    Page
PART I Financial Information 2
Item 1. Financial Statements  
  Consolidated Balance Sheets (Unaudited) 2
  Consolidated Statements of Operations (Unaudited) 3
  Consolidated Statements of Comprehensive Income (Unaudited) 4
  Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) 4
  Consolidated Statements of Cash Flows (Unaudited) 5
  Notes to Consolidated Financial Statements (Unaudited) 6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 30
     
Item 3. Quantitative and Qualitative Disclosure about Market Risk 50
     
Item 4. Controls and Procedures 51
   
PART II Other Information 52
Item 1. Legal Proceedings 52
     
Item 1A. Risk Factors 52
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 54
     
Item 3. Defaults Upon Senior Securities 54
     
Item 4. Mine Safety Disclosures 54
     
Item 5. Other Information 54
     
Item 6. Exhibits 55
     
Signatures   56

 

 

 

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q (this “report”) contains “forward-looking statements,” as that phrase is defined in the Private Securities Litigation Reform Act of 1995, which can be identified by the use of words such as “estimate,” “project,” “believe,” “goal,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may,” “should,” “could” 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, including the expected impact of exiting our mortgage banking activities, our expectations that many of our unfunded commitments will expire without being drawn, and statements regarding our business plan and strategies. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and may be outside of the Company’s control. Actual events and results may differ materially from those described in such forward-looking statements due to numerous factors, including:

 

·the impact of the recent outbreak of the novel coronavirus, or COVID-19, on our business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the United States economy (including, without limitation, the Coronavirus Aid, Relief and Economic Security Act, or the CARES Act), and the resulting effect of these items on our operations, liquidity and capital position, and on the financial condition of our borrowers and other customers;
·negative economic conditions that adversely affect the economy, real estate values, the job market and other factors nationally and in our market area, in each case that may affect our liquidity and the performance of our loan portfolio;
·any negative perception of our reputation or financial strength;
·competition among depository and other financial institutions;
·changes in U.S. monetary policy, the level and volatility of interest rates, the capital markets and other market conditions that may affect, among other things, our liquidity and the value of our assets and liabilities;
·changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
·the composition of our management team and our ability to attract and retain key personnel;
·our ability to enter new markets successfully and capitalize on growth opportunities, and to otherwise implement our growth strategy;
·material weaknesses in our internal control over financial reporting;
·our ability to successfully integrate acquired entities, if any;
·our inability to replace income lost from exiting our mortgage banking activities with new revenues;
·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 U.S. Securities and Exchange Commission and the Public Company Accounting Oversight Board;
·changes in our organization, compensation and benefit plans;
·negative reactions to our branch closures by our customers, employees and other counterparties;
·execution risk related to the opening of new branches, including increased expenses;
·our ability to maintain the asset quality of our investment portfolios and the anticipated recovery and collection of unrealized losses on securities available for sale;
·impairment of goodwill, other intangible assets or deferred tax assets;
·our ability to continue our expected focus on commercial customers as well as maintaining our residential mortgage loan portfolio;
·changes in our expected occupancy and equipment expenses;
·changes to our allowance for credit losses, and the adequacy thereof;
·our ability to maintain adequate liquidity levels and future sources of liquidity;
·our ability to retain a large portion of maturing certificates of deposit;
·the impact on us of recent changes to accounting standards;
·the impact of future cash requirements relating to commitments to extend credit;
·risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others;
·the risk of changes in technology and customer preferences;
·the impact of any material failure or breach in our infrastructure or the infrastructure of third parties on which we rely as a result of cyber-attacks;
·the impact of interest rate changes on our net interest income;
·the adverse effects of events such as outbreaks of contagious disease, war or terrorist activities, or essential utility outages, including deterioration in the global economy, instability in credit markets and disruptions in our customers’ supply chains and transportation;
·other economic, competitive, governmental, regulatory, technological, and geopolitical factors affecting our operations, pricing, and services; and
·each of the factors and risks under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, Part II, Item 1A, Risk Factors, in this Form 10-Q and in subsequent filings we make with the SEC.

 

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. 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, except as required by law.

 

 1 

 

 

PART I

 

Item 1.Financial Statements

 

Howard Bancorp, Inc. and Subsidiary

 

Consolidated Balance Sheets

 

   Unaudited     
   March 31,   December 31, 
(in thousands, except share data)  2020   2019 
ASSETS          
Cash and due from banks  $15,951   $12,992 
Interest-bearing deposits with banks   179,999    96,985 
Total cash and cash equivalents   195,950    109,977 
Securities available for sale, at fair value   275,252    215,505 
Securities held to maturity, at amortized cost   7,750    7,750 
Nonmarketable equity securities   16,757    14,152 
Loans held for sale, at fair value   3,795    30,710 
Loans and leases, net of unearned income   1,761,419    1,745,513 
Allowance for credit losses   (13,384)   (10,401)
Net loans and leases   1,748,035    1,735,112 
Bank premises and equipment, net   42,543    42,724 
Goodwill   65,949    65,949 
Core deposit intangible   7,770    8,469 
Bank owned life insurance   76,275    75,830 
Other real estate owned   2,322    3,098 
Deferred tax assets, net   33,529    36,010 
Interest receivable and other assets   31,967    29,333 
Total assets  $2,507,894   $2,374,619 
LIABILITIES          
Noninterest-bearing deposits  $483,499   $468,975 
Interest-bearing deposits   1,305,400    1,245,390 
Total deposits   1,788,899    1,714,365 
Customer repurchase agreements and federal funds purchased   5,321    6,127 
FHLB advances   344,000    285,000 
Subordinated debt   28,290    28,241 
Accrued expenses and other liabilities   26,026    26,738 
Total liabilities   2,192,536    2,060,471 
COMMITMENTS AND CONTINGENCIES          
STOCKHOLDERS' EQUITY          
Common stock - par value of $0.01 authorized 20,000,000 shares; issued and outstanding 18,714,844 shares at March 31, 2020 and 19,066,913 at December 31, 2019   187    191 
Capital surplus   269,918    276,156 
Retained earnings   38,501    35,158 
Accumulated other comprehensive income   6,752    2,643 
Total stockholders’ equity   315,358    314,148 
Total liabilities and stockholders’ equity  $2,507,894   $2,374,619 

 

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

 

 2 

 

 

Consolidated Statements of Operations

 

   Unaudited 
   For the three months ended 
   March 31, 
(in thousands, except per share data)  2020   2019 
INTEREST INCOME          
Interest and fees on loans and leases  $20,144   $20,566 
Interest and dividends on securities   1,848    1,856 
Other interest income   234    362 
Total interest income   22,226    22,784 
INTEREST EXPENSE          
Deposits   3,210    3,564 
Customer repurchase agreements and federal funds purchased   4    12 
FHLB advances   1,026    1,254 
Subordinated debt   461    480 
Total interest expense   4,701    5,310 
NET INTEREST INCOME   17,525    17,474 
Provision for credit losses   3,445    1,725 
Net interest income after provision for credit losses   14,080    15,749 
NONINTEREST INCOME          
Service charges on deposit accounts   642    627 
Realized and unrealized gains on mortgage banking activity   1,036    1,485 
Income from bank owned life insurance   445    447 
Loan related fees and service charges   581    1,043 
Other operating income   662    933 
Total noninterest income   3,366    4,535 
NONINTEREST EXPENSE          
Compensation and benefits   8,441    8,034 
Occupancy and equipment   1,033    1,571 
Amortization of core deposit intangible   699    784 
Marketing and business development   450    457 
Professional fees   726    785 
Data processing fees   927    1,378 
FDIC assessment   212    287 
Other real estate owned   78    27 
Loan production expense   468    520 
Other operating expense   1,525    1,014 
Total noninterest expense   14,559    14,857 
INCOME BEFORE INCOME TAXES   2,887    5,427 
Income tax (benefit) expense   (456)   1,171 
NET INCOME  $3,343   $4,256 
NET INCOME PER COMMON SHARE          
Basic  $0.18   $0.22 
Diluted  $0.18   $0.22 

 

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

 

 3 

 

 

Consolidated Statements of Comprehensive Income

 

   Unaudited 
    For the three months ended 
    March 31, 
(in thousands)  2020   2019 
Net Income   $3,343   $4,256 
Other comprehensive income           
Investments available-for-sale:          
Unrealized holding gains    5,669    1,800 
Related income tax expense    (1,560)   (496)
Comprehensive income   $7,452   $5,560 

 

Consolidated Statements of Changes in Stockholders’ Equity

 

                   Accumulated     
                   other     
Unaudited  Number of   Common   Capital   Retained   comprehensive     
(dollars in thousands, except share data)  shares   stock   surplus   earnings   income    Total 
Balances at December 31, 2018   19,039,347   $190   $275,843   $18,277   $373   $294,683 
Net income   -    -    -    4,256    -    4,256 
Other comprehensive gain   -    -    -    -    1,304    1,304 
Director stock awards   4,802    -    62    -    -    62 
Exercise of options   8,554    1    76    -    -    77 
Employee stock purchase plan   6,782    -    97    -    -    97 
Stock-based compensation   -    -    50    -    -    50 
Balances at March 31, 2019   19,059,485   $191   $276,128   $22,533   $1,677   $300,529 
                               
Balances at December 31, 2019   19,066,913   $191   $276,156   $35,158   $2,643   $314,148 
Net income   -    -    -    3,343    -    3,343 
Other comprehensive gain   -    -    -    -    4,109    4,109 
Director stock awards   8,151    -    137    -    -    137 
Employee stock purchase plan   12,581    -    195    -    -    195 
Repurchased shares   (372,801)   (4)   (6,673)   -    -    (6,677)
Stock-based compensation   -    -    103    -    -    103 
Balances at March 31, 2020   18,714,844   $187   $269,918   $38,501   $6,752   $315,358 

 

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

 

 4 

 

 

Consolidated Statements of Cash Flows

 

   Unaudited 
   Three months ended 
   March 31 
(in thousands)  2020   2019 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $3,343   $4,256 
Adjustments to reconcile net income to net cash from operating activities:          
Provision for credit losses   3,445    1,725 
Deferred income tax   921    1,025 
Provision for other real estate owned   21    - 
Depreciation and amortization   558    586 
Stock-based compensation   240    209 
Net accretion of discount on purchased loans   (204)   (464)
Net amortization of intangible asset   699    784 
Loans originated for sale   (79,847)   (84,354)
Proceeds from sale of loans originated for sale   107,798    80,285 
Realized and unrealized gains on mortgage banking activity   (1,036)   (1,485)
Loss on sale of other real estate owned, net   28    - 
Cash surrender value of BOLI   (445)   (447)
Increase in other assets   (3,179)   (243)
Decrease in other liabilities   (2,723)   (1,166)
Other, net   13    (73)
Net cash provided by operating activities   29,632    638 
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchases of investment securities   (64,441)   (5,000)
Proceeds from sales, maturities and calls of investment securities   10,350    38,872 
Net (increase) decrease in loans and leases outstanding   (16,164)   193 
Proceeds from the sales of other real estate owned   727    - 
Purchase of premises and equipment   (377)   (171)
Net cash (used in) provided by investing activities   (69,905)   33,894 
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net increase (decrease) in deposits   74,534    (12,338)
Net decrease in customer repurchase agreements and federal funds purchased   (806)   (6,307)
Net increase (decrease) in FHLB advances   59,000    (20,000)
Proceeds from issuance of common stock, net of cost   195    77 
Repurchase of common stock   (6,677)   - 
Net cash provided by (used in) financing activities   126,246    (38,568)
           
Net increase (decrease) in cash and cash equivalents   85,973    (4,036)
Cash and cash equivalents at beginning of period   109,977    101,498 
Cash and cash equivalents at end of period  $195,950   $97,462 
SUPPLEMENTAL INFORMATION          
Cash payments for interest  $4,230   $5,044 
Cash payments for income taxes   15    - 
Cash payments for operating leases   195    365 
Lease liabilities arising from obtaining right of use assets (see Note 8)   2,011    18,009 
Goodwill reduction for adjustments to acquired net deferred tax assets   -    4,748 

 

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

 

 5 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

Note 1: Summary of Significant Accounting Policies

 

Nature of Operations

 

Howard Bancorp, Inc. (“Bancorp” or the “Company”) was incorporated in April 2005 under the laws of the State of Maryland. On December 15, 2005, Bancorp acquired all of the stock of Howard Bank (the “Bank”) pursuant to the Plan of Reorganization approved by the stockholders of the Bank and by federal and state regulatory agencies. Each share of the Bank’s common stock was converted into two shares of Bancorp common stock effected by the filing of Articles of Exchange on that date, and the stockholders of the Bank became the stockholders of Bancorp. Bancorp is now a bank holding company registered under the Bank Holding Company Act of 1956, with a single bank 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 Bank has nine subsidiaries—six were formed to hold foreclosed real estate (three of which are currently inactive), two own and manage real estate used for corporate purposes, and one holds historic tax credit investments.

 

The Company is a diversified financial services company providing commercial 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.

 

These statements should be read in conjunction with the financial statements and accompanying notes included in the Company's 2019 Annual Report on Form 10-K as filed with the Securities and Exchange Commission ("SEC") on March 16, 2020. There have been no significant changes to the Company's accounting policies as disclosed in the 2019 Annual Report on Form 10-K.

 

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

 

Basis of Presentation

 

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America ("GAAP") and prevailing practices within the financial services industry for financial information.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Bancorp, the Bank and the Bank’s subsidiaries. All significant intercompany accounts and transactions have been eliminated. The parent company only financial statements report investments in the Bank under the equity method.

 

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, goodwill, deferred tax assets, other-than-temporary impairment of investment securities and the fair value of loans held for sale.

 

Allowance for Credit Losses

 

The allowance for credit losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan and lease portfolio and is based on the size and current risk characteristics of the loan and lease portfolio, an assessment of individual problem loans and leases, actual loss experience, current economic events in specific industries and geographic areas including unemployment levels and other pertinent factors including general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogenous loans and leases based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Credit losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.

 

The allowance for credit losses consists of a specific component and a nonspecific component. The components of the allowance for credit losses represent an estimation done pursuant to either the Financial Accounting Standards Board’s (the “FASB”) Accounting Standards Codification (“ASC”) Topic 450 Contingencies or ASC Topic 310 Receivables. The specific component of the allowance for credit losses reflects expected losses resulting from analysis developed through credit allocations for individual loans and leases. The credit allocations are based on a regular analysis of all loans and leases over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The specific component of the allowance for credit losses also includes management’s determination of the amounts necessary given concentrations and changes in portfolio mix and volume.

 

 6 

 

 

The nonspecific portion of the allowance is determined based on management’s assessment of general economic conditions, as well as economic factors in the individual markets in which the Company operates including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. This determination inherently involves a higher risk of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the nonspecific component of the allowance, and it recognizes knowledge of the portfolio may be incomplete. The Bank’s historic loss factors are based upon actual losses incurred by portfolio segment over the preceding 24-month period. In portfolio segments where no actual losses have been incurred within the most recent 24-month period, industry loss data for that portfolio segment, as provided by the Federal Deposit Insurance Corporation (“FDIC”), are utilized. In addition to historic loss factors, the Bank’s methodology for the allowance for credit losses incorporates other risk factors that may be inherent within the portfolio segments. For each portfolio segment, in addition to the historic loss experience, the qualitative factors that are measured and monitored in the overall determination of the allowance include:

 

·changes in lending policies, procedures, and practices;
·changes in international, national, state and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments;
·changes in the nature and volume of the loan portfolio;
·changes in the experience, ability and depth of the lending staff;
·changes in the volume and severity of past due, nonaccrual, and adversely classified loans;
·changes in the quality of our loan review system;
·changes in the value of underlying collateral for collateral-dependent loans;
·the existence of any concentrations of credit, and changes in the level of such concentrations;
·the effect of other external factors such as competition and legal and regulatory requirements; and
· any other factors that management considers relevant to the quality or performance of the loan portfolio.

 

Each of these qualitative risk factors is measured based upon data generated either internally, or in the case of economic conditions utilizing independently provided data on items such as unemployment rates, commercial real estate vacancy rates, or other market data deemed relevant to the business conditions within the markets served.

 

The Company’s loan and lease policies state that after all collection efforts have been exhausted, and the loan or lease is deemed to be a loss, then the remaining loan or lease balance will be charged to the Company’s established allowance for credit losses. All loans and leases 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 or lease is deemed not to be well secured, the loan or lease would be moved to non-accrual 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.

  

Acquired Loans

 

Acquired loans are recorded at fair value at the date of acquisition, and accordingly, no allowance for loan losses is transferred to the acquiring entity under the acquisition method. The fair values of loans with evidence of credit deterioration (acquired credit impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For acquired credit impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the initial investment in the acquired credit impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The acquired credit impaired loan’s contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, but in the form of a loss accrual or a valuation allowance.

 

Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance for credit losses through a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.

 

Goodwill, Other Intangible Assets and Long-Lived Assets

 

Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Long-lived assets are those that provide the Company with a future economic benefit beyond the current year or operating period. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the fair value, less costs to sell. An impairment analysis is performed annually.

 

Management has determined that the Company has one reporting unit, and based upon the annual impairment analysis, it was determined that there was not an impairment of the carrying value of either the goodwill, core deposit intangible or other long-lived assets for 2019.

 

 7 

 

 

Income Taxes

 

The Company uses the asset/liability method of accounting for income taxes. Under the asset/liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. In addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or the entire deferred tax asset will not be realized. The Company does not have uncertain tax positions that are deemed material, and did not recognize any adjustments for unrecognized tax benefits. The Company’s policy is to recognize interest and penalties on income taxes in other noninterest expenses. The Company remains subject to examination by federal and state taxing authorities for income tax returns for the years ending after December 31, 2014.

 

Share-Based Compensation

 

Compensation cost is recognized for stock options and restricted stock issued to directors and employees. Compensation cost is measured as the fair value of these awards on their date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. The market price of the Company’s common stock at the date of grant is used for restricted stock awards, which include restricted stock units. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. When an award is granted to an employee who is retirement eligible, the compensation cost of these awards is recognized over the period up to when the director or employee first becomes eligible to retire.

 

Compensation expense for non-vested common stock awards is based on the fair value of the awards, which is generally the market price of the common stock on the measurement date, which, for the Company, is the date of grant, and is recognized ratably over the service period of the award.

 

Reclassifications

 

Certain reclassifications to prior financial presentation were made to conform to the 2020 presentation. These reclassifications did not affect previously reported net income or total stockholders’ equity.

 

Recent Accounting Pronouncements

 

The FASB has issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (LIBOR), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation.

 

The FASB has issued ASU 2019-10, Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This ASU amends the effective date of the credit loss standard (ASU 2016-13) for smaller reporting companies, as defined by the SEC. The one-time determination of whether an entity is eligible to be a smaller reporting company is based on an entity’s most recent determination as of November 15, 2019, in accordance with SEC regulations. The Company met this definition of smaller reporting company based on its most recent determination as of November 15, 2019. As a result, the effective date of this ASU for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years. In addition, this ASU amended the mandatory effective date for the elimination of Step 2 from the goodwill impairment test (ASU 2017-04 discussed below). As a smaller reporting company, the effective date of the goodwill impairment standard for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years.

 

The FASB has issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.  The amendments in this Update simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. Impairment charges should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. As discussed above, this ASU, as amended by ASU 2019-10, will be effective for the Company on January 1, 2023. The Company will evaluate the guidance in this Update but does not expect it to have a significant impact on the Company’s financial position or results of operations.

 

 8 

 

  

The FASB has issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326). The main objective of this update is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the guidance in this Update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. As discussed above, this ASU, as amended by ASU 2019-10, will be effective for the Company on January 1, 2023. The Company has engaged a third party vendor and is currently gathering historical data and reviewing the methodologies and assumptions utilized to determine the impact of this update on the Company’s Consolidated Financial Statements.

 

COVID-19 Risks and Uncertainties

 

In December 2019, a novel strain of coronavirus (COVID-19) was reported to have surfaced in China, and has since spread to a number of other countries, including the United States. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. The COVID-19 pandemic has severely restricted the level of economic activity in the Company’s markets. In response to the COVID-19 pandemic, the State of Maryland and most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential.

 

While the Company’s business has been designated an essential business, which allows the Bank to continue to serve its customers, the Company serves many customers that have been deemed, or who are employed by businesses that have been deemed, to be non-essential. And many of the Company’s customers that have been categorized to date as essential businesses, or who are employed by businesses that have been categorized as essential businesses, have been adversely affected by the COVID-19 pandemic.

 

The impact of the COVID-19 pandemic is fluid and continues to evolve. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets, and has had an adverse effect on the Company’s business and results of operations. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic has had and is expected to continue to have a an adverse effect on the Company’s business and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and the Company’s customers, employees and vendors.

 

Note 2: Exit of Mortgage Banking Activities

 

On December 18, 2019, the Company entered into an agreement to release certain management members of the mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring all remaining mortgage employees. The Company also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of the mortgage employees, and the sale of the domain name, the LLC paid the Company $750 thousand. Under the agreement, there was a transition period of approximately 45 days, after which the Company agreed to cease originating residential first lien mortgage loans and will exit all mortgage banking activities. Accordingly all of the residential first lien mortgage pipeline were processed by the end of the first quarter of 2020. In order to manage loan run-off within the residential mortgage loan portfolio, the Company plans on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.

 

The following table presents a roll forward of loans held for sale, showing loans originated for sale and loans sold into the secondary market, for the periods March 31, 2020 and, December 31, 2019. In addition, the volume of loans originated for the Company’s loan portfolio as well as a statement of operations for the mortgage banking activities for the same periods. Since the mortgage banking activities were conducted within a division of the Bank, formal financial statements were not prepared. The statement of operations presented below reflects only the direct costs associated with the Company’s mortgage banking activities and is thus representative of the incremental after tax impact of exiting this activity.

 

   Quarter Ended   Year Ended 
(in thousands)  March 31, 2020   December 31, 2019 
Loans held for sale, January 1  $30,710   $21,261 
Loans originated for sale   79,847    573,306 
Loans sold into the secondary market   (106,762)   (563,857)
Loans held for sale, at end of period  $3,795   $30,710 
Loans originated for the Bank's portfolio  $11,378   $114,561 

 

 9 

 

 

   For the three months ended 
   March 31, 
   2020   2019 
Statement of Operations:          
Net interest income  $143   $147 
Realized and unrealized gains on mortgage banking activity   1,036    1,485 
Loan related fees and service charges   389    460 
Total noninterest income   1,425    1,945 
Salaries and benefits   928    1,607 
Occupancy   20    79 
All other operating expenses   490    468 
Total noninterest expense   1,438    2,154 
Pretax contribution    130    (62)
Income tax expense (benefit)   36    (17)
After tax contribution  $94   $(45)

 

Since the Bank’s 91 employees that were engaged in mortgage banking activities were hired by the LLC under the terms of the agreement, no severance costs were recorded. However, in the fourth quarter of 2019, the Company recorded $288 thousand of exit costs associated with change in control and retention agreements. Back office employees remained with the bank for a portion of the first quarter in order to process the pipeline. The LLC is subleasing the office space that was used by these employees; therefore, no exit costs associated with lease terminations were required.

  

Note 3: Investment Securities

 

The Bank holds securities classified as available for sale and held to maturity.

 

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

 

(in thousands)

  March 31, 2020     December 31, 2019  
          Gross     Gross                 Gross     Gross        
    Amortized     Unrealized     Unrealized     Estimated     Amortized     Unrealized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value     Cost     Gains     Losses     Fair Value  
Available for sale U.S. Government                                                                
Agencies   $ 79,916     $ 1,978     $ -     $ 81,894     $ 66,428     $ 963     $ 79     $ 67,312  
Mortgage-backed     180,509       7,315       -       187,824       139,918       2,848       67       142,699  
Other investments     5,510       43       19       5,534       5,510       4       20       5,494  
    $ 265,935     $ 9,336     $ 19     $ 275,252     $ 211,856     $ 3,815     $ 166     $ 215,505  

Held to maturity

                                                               

Corporate debentures

  $ 7,750     $ 117     $ 17     $ 7,850     $ 7,750     $ 147     $ -     $ 7,897  

 

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 March 31, 2020 and December 31, 2019 are presented below:

 

March 31, 2020                        
(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 
Available for sale                              
U.S. Government                              
Agencies  $-   $-   $-   $-   $-   $- 
Mortgage-backed   -    -    -    -    -    - 
Other investments   -    -    2,990    19    2,990    19 
   $-   $-   $2,990   $19   $2,990   $19 
Held to maturity                              
Corporate debentures  $2,483   $17   $-   $-   $2,483   $17 

 

 10 

 

 

December 31, 2019                        
(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 
Available for sale                              
U.S. Government                              
Agencies  $10,689   $79   $-   $-   $10,689   $79 
Mortgage-backed   35,512    60    975    7    36,487    67 
Other investments   -    -    2,990    20    2,990    20 
   $46,201   $139   $3,965   $27   $50,166   $166 
Held to maturity                              
Corporate debentures  $-   $-   $-   $-   $-   $- 

 

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 the (1) duration and magnitude of the decline in value, (2) financial condition of the issuer or issuers and (3) structure of the security. The Company had four securities in the portfolio with unrealized losses at March 31, 2020 compared to 15 at December 31, 2019.

 

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 stockholders’ equity as a component of other comprehensive income, net of deferred tax.

 

The amortized cost and estimated fair values of investment securities by contractual maturity are shown below:

 

(in thousands)  March 31, 2020   December 31, 2019 
   Amortized   Estimated Fair   Amortized   Estimated Fair 
   Cost   Value   Cost   Value 
Amounts maturing:                    
One year or less  $1,498   $1,506   $1,497   $1,500 
After one through five years   49,152    50,633    49,166    50,048 
After five through ten years   38,793    39,752    33,576    33,915 
After ten years   184,242    191,211    135,367    137,939 
   $273,685   $283,102   $219,606   $223,402 

 

At March 31, 2020 and December 31, 2019, $10.9 million and $11.6 million in fair value of securities, respectively, were pledged as collateral for both repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts. No single issuer of securities, except for government agency and mortgage backed securities, had outstanding balances that exceeded ten percent of stockholders’ equity at March 31, 2020.

 

Note 4: Loans and Leases

 

The Company makes loans and leases to customers primarily in the Greater Baltimore 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 March 31, 2020 and December 31, 2019 are presented in the following table:

 

   March 31, 2020   December 31, 2019 
(in thousands)  Total   % of
Total
   Total   % of
Total
 
Real estate                    
Construction and land  $130,980    7.4%  $128,285    7.3%
Residential - first lien   428,788    24.4    437,409    25.1 
Residential - junior lien   71,045    4.0    74,164    4.2 
Total residential real estate   499,833    28.4    511,573    29.3 
Commercial - owner occupied   248,918    14.1    241,795    13.9 
Commercial - non-owner occupied   447,889    25.5    444,052    25.4 
Total commercial real estate   696,807    39.6    685,847    39.3 
Total real estate loans   1,327,620    75.4    1,325,705    75.9 
Commercial loans and leases 1   389,065    22.1    372,872    21.4 
Consumer   44,734    2.5    46,936    2.7 
Total loans and leases  $1,761,419    100.0%  $1,745,513    100.0%

 

1 Includes leases of $5,637 and $6,382 at March 31, 2020 and December 31, 2019, respectively.

 

Net loan origination fees, which are included in the amounts above, totaled $1.3 million at both March 31, 2020 and December 31, 2019.

 

 11 

 

 

Acquired Credit Impaired Loans

 

The following table documents changes in the accretable discount on acquired credit impaired loans at the beginning and end of March 31, 2020 and 2019:

 

   March 31, 
(in thousands)  2020   2019 
Balance at beginning of period  $689   $877 
Impaired loans acquired   -    - 
Accretion of fair value discounts   (16)   (42)
Balance at end of period  $673   $835 

 

The table below presents the outstanding balances and related carrying amounts for all acquired credit impaired loans at the end of the respective periods:

 

   Contractually     
   Required     
   Payments   Carrying 
(in thousands)  Receivable   Amount 
At March 31, 2020  $10,195   $8,111 
At December 31, 2019   10,929    8,706 

 

Note 5: Credit Quality Assessment

 

Allowance for Credit Losses

 

Summary information on the allowance for credit loss activity for the period indicated is presented in the following table:

 

   March 31, 
(in thousands)  2020   2019 
Beginning balance  $10,401   $9,873 
Charge-offs   (583)   (2,854)
Recoveries   121    10 
Net charge-offs   (462)   (2,844)
Provision for credit losses   3,445    1,725 
Ending balance  $13,384   $8,754 

 

The March 31, 2020 allowance reflects the Company’s initial assessment of the impact of COVID-19 on the national and local economies and the impact on various categories of our loan portfolio. Management’s approach to COVID-19 and the evaluation of the allowance considered the following: (1) any change in historical loss rates resulting from COVID-19; (2) any risk rating downgrades related to COVID-19; and (3) any changes to collateral valuations or cash flow assumptions for impaired loans. Based on this review, the Company determined that there were no initial impacts to any of these factors at March 31, 2020.

 

The Company then reviewed our qualitative factors and identified three factors that warranted further evaluation:

 

·Changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments;
·The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
·Changes in the value of underlying collateral for collateral-dependent loans.

 

The Company’s evaluation of changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, considered the abrupt slowdown in commercial economic activity resulting from actions announced by the State of Maryland between the March 5 disclosure of the first confirmed cases of COVID-19 in the state and the March 23 executive order closing all non-essential businesses in the state. In addition, management considered the dramatic rise in the unemployment rate in the Company’s market area. Based on U.S. Department of Labor weekly initial unemployment claims by state, management noted that the average weekly initial unemployment claims for the State of Maryland during the two weeks ending March 28, 2020 were 19 times higher than the average weekly claims for the first eleven weeks of 2020. An increase in this qualitative factor was applied to all loan portfolio categories.

 

 12 

 

 

The Company also evaluated the existence and effect of any concentrations of credit, and changes in the level of such concentrations. Management performed an analysis of the loan portfolio to identify the Company’s exposure to industry segments that management believes may potentially be the most highly impacted by COVID-19. Based on this evaluation, the following table identifies those industry segments within the Company’s loan portfolio that management believes may potentially be most highly impacted by COVID-19. Loan balances and total credit exposures are as of March 31, 2020 while the modification and Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loan balances are as of April 24, 2020.

 

(in millions)

Loan Category

  Loan Balance  

As %

of Total Loans

   Total Exposure (1)  

As %

of Total Exposure

  

Loan

Balance with Modifications

  

As %

of Loan Category

   SBA PPP Loan Balance   As % of Loan Category 
CRE - retail  $109.8    6.2%  $112.0    5.3%  $21.5    19.6%  $-    -%
Hotels   61.5    3.5    67.0    3.2    53.5    87.0    0.9    1.5 
CRE - residential rental   50.3    2.9    51.4    2.4    10.9    21.7    -    - 
Nursing and residential care   39.8    2.3    46.3    2.2    -    -    1.8    4.5 
Retail trade   26.3    1.5    37.3    1.8    1.1    4.2    6.3    24.0 
Restaurants and caterers   26.1    1.5    29.0    1.4    19.5    74.7    8.9    34.1 
Religious and similar organizations   27.6    1.6    28.6    1.4    2.9    10.5    2.7    9.8 
Arts, entertainment, and recreation   16.2    0.9    18.5    0.9    14.5    89.5    1.3    8.0 
Total - selected categories  $357.6    20.3%  $390.1    18.6%  $123.9    34.6%  $21.9    6.1%

 

(1) includes unused lines of credit and unfunded commitments

 

The potentially highly impacted loan exposures noted in the above tables (the “high impacts”) were concentrated in non-owner-occupied commercial real estate (59% of total high impacts), owner-occupied commercial real estate (18% of total high impacts), commercial construction (14% of total high impacts), and commercial loans (9% of total high impacts). An increase in this qualitative factor was applied to these high impact loan portfolio categories.

 

The Company’s evaluation of potential changes in the value of underlying collateral for collateral-dependent loans considered the potential impact of the economic fallout from COVID-19 on commercial property values due to rent relief and possible business failures resulting in vacancies. In addition, the need for office space may diminish in the future as work from home policies have allowed much office-oriented business activity to continue. Excluding the high impact portfolios, management concluded that 53% of the Company’s non-owner-occupied commercial real estate portfolio was not included in the high impact exposure. An increase in this qualitative factor was applied to the Company’s non-owner-occupied commercial real estate portfolio.

 

The following table provides information on the activity in the allowance for credit losses by the respective loan portfolio segment for the three months ended March 31, 2020 and the year ended December 31, 2019:

 

   March 31, 2020 
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Allowance for credit losses:                                        
Beginning balance  $1,256   $2,256   $478   $788   $2,968   $2,103   $552   $10,401 
Charge-offs   -    (33)   -    -    -    (549)   (1)   (583)
Recoveries   -    3    51    -    -    66    1    121 
Provision for credit losses   (64)   (22)   334    466    1,162    1,330    239    3,445 
Ending balance  $1,192   $2,204   $863   $1,254   $4,130   $2,950   $791   $13,384 
                                         
Allowance allocated to:                                        
individually evaluated for impairment  $-   $-   $-   $-   $-   $-   $-   $- 
collectively evaluated for impairment  $1,192   $2,204   $863   $1,254   $4,130   $2,950   $791   $13,384 
Loans and leases:                                        
Ending balance  $130,980   $428,788   $71,045   $248,918   $447,889   $389,065   $44,734   $1,761,419 
individually evaluated for impairment  $478   $12,470   $832   $477   $1,777   $1,092   $102   $17,228 
collectively evaluated for impairment  $130,502   $416,318   $70,213   $248,441   $446,112   $387,973   $44,632   $1,744,191 

 

 13 

 

 

   December 31, 2019 
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Allowance for credit losses:                                        
Beginning balance  $741   $1,170   $292   $735   $4,057   $2,644   $234   $9,873 
Charge-offs   (282)   (518)   (532)   (46)   (2,026)   (622)   (210)   (4,236)
Recoveries   80    -    115    -    17    357    2    571 
Provision for credit losses   717    1,604    603    99    920    (276)   526    4,193 
Ending balance  $1,256   $2,256   $478   $788   $2,968   $2,103   $552   $10,401 
Allowance allocated to:                                        
individually evaluated for impairment  $-   $-   $-   $-   $-   $500   $-   $500 
collectively evaluated for impairment  $1,256   $2,256   $478   $788   $2,968   $1,603   $552    9,901 
Loans and leases:                                        
Ending balance  $128,285   $437,409   $74,164   $241,795   $444,052   $372,872   $46,936   $1,745,513 
individually evaluated for impairment  $481   $13,131   $786   $566   $1,725   $2,360   $127   $19,176 
collectively evaluated for impairment  $127,804   $424,278   $73,378   $241,229   $442,327   $370,512   $46,809   $1,726,337 

 

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.  

 

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 Bank’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:

 

   March 31, 2020   
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Credit quality indicators:                                        
Not classified  $130,502   $416,318   $70,213   $248,441   $446,054   $387,973   $44,632   $1,744,133 
Special mention   -    -    -    -    -    -    -    - 
Substandard   478    12,470    832    477    1,835    1,092    102    17,286 
Doubtful   -    -    -    -    -    -    -    - 
Total  $130,980   $428,788   $71,045   $248,918   $447,889   $389,065   $44,734   $1,761,419 

 

   December 31, 2019     
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Credit quality indicators:                                        
Not classified  $127,804   $425,247   $73,378   $241,229   $442,327   $370,837   $46,809   $1,727,631 
Special mention   -    -    -    -    -    -    -    - 
Substandard   481    12,162    786    566    1,725    2,035    127    17,882 
Doubtful   -    -    -    -    -    -    -    - 
Total  $128,285   $437,409   $74,164   $241,795   $444,052   $372,872   $46,936   $1,745,513 

 

·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 and leases are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans and leases 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 and leases 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.

 

 14 

 

 

Loans and leases classified Special Mention, Substandard, Doubtful or Loss are reviewed at least quarterly to determine their appropriate classification. All commercial loan and lease 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:

 

   March 31, 2020 
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Analysis of past due loans and leases:                                
Accruing loans and leases current  $130,502   $409,466   $68,545   $248,103   $445,290   $387,097   $44,596   $1,733,599 
Accruing loans and leases past due:                                        
30-59 days past due   -    6,844    1,083    -    628    619    28    9,202 
60-89 days past due   -    -    525    -    -    649    7    1,181 
Greater than 90 days past due   -    973    60    338    194    -    1    1,566 
Total past due   -    7,817    1,668    338    822    1,268    36    11,949 
                                         
Non-accrual loans and leases 1   478    11,505    832    477    1,777    700    102    15,871 
                                         
Total loans and leases  $130,980   $428,788   $71,045   $248,918   $447,889   $389,065   $44,734   $1,761,419 

 

   December 31, 2019 
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Analysis of past due loans and leases:                                
Accruing loans and leases current  $127,804   $418,668   $71,634   $241,062   $442,132   $370,877   $46,776   $1,718,953 
Accruing loans and leases past due:                                        
30-59 days past due   -    3,312    748    -    195    35    19    4,309 
60-89 days past due   -    3,220    996    167    -    -    14    4,397 
Greater than 90 days past due   -    47    -    -    -    -    -    47 
Total past due   -    6,579    1,744    167    195    35    33    8,753 
                                         
Non-accrual loans and leases 1   481    12,162    786    566    1,725    1,960    127    17,807 
                                         
Total loans and leases  $128,285   $437,409   $74,164   $241,795   $444,052   $372,872   $46,936   $1,745,513 

  

1 Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do not accrue interest based on the terms of the loan.

 

Total loans either in non-accrual status or in excess of 90 days delinquent totaled $17.4 million or 1.0% of total loans outstanding at March 31, 2020, which represents a decrease from $17.9 million, or 1.0%, at December 31, 2019.

 

The Company had no impaired leases at March 31, 2020 and December 31, 2019. The impaired loans at March 31, 2020 and December 31, 2019 are as follows:

 

   March 31, 2020 
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Impaired loans:                                        
Recorded investment 1  $478   $12,470   $832   $477   $1,777   $1,092   $102   $17,228 
With an allowance recorded   -    -    -    -    -    -    -    - 
With no related allowance recorded   478    12,470    832    477    1,777    1,092    102    17,228 
Related allowance   -    -    -    -    -    -    -    - 
Unpaid principal   663    13,723    1,030    474    2,081    1,646    105    19,722 
Average balance of impaired loans   793    14,999    1,208    478    2,106    2,039    105    21,728 
Interest income recognized   1    138    8    -    3    12    -    162 

 

 15 

 

 

   December 31, 2019 
               Commercial real estate   Commercial         
   Construction   Residential real estate   owner   non-owner   loans   Consumer     
(in thousands)  and land   first lien   junior lien   occupied   occupied   and leases   loans   Total 
Impaired loans:                                        
Recorded investment 1  $481   $13,131   $786   $566   $1,725   $2,360   $127   $19,176 
With an allowance recorded   -    -    -    -    -    554    -    554 
With no related allowance recorded   481    13,131    786    566    1,725    1,806    127    18,622 
Related allowance   -    -    -    -    -    500    -    500 
Unpaid principal   667    14,371    986    583    2,023    3,584    130    22,344 
Average balance of impaired loans   814    15,586    1,338    594    2,105    4,392    141    24,970 
Interest income recognized   5    400    106    30    11    195    1    748 

  

1 Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do not accrue interest based on the terms of the loan.

 

Included in the total impaired loans above were non-accrual loans of $15.9 million and $17.8 million at March 31, 2020 and December 31, 2019, respectively. Interest income that would have been recorded if non-accrual loans had been current and in accordance with their original terms was $133 thousand and $388 thousand for the three months ended March 31, 2020 and 2019, respectively.

 

Loans may have their terms restructured (e.g., interest rates, loan maturity date, payment and amortization period, etc.) in circumstances that provide payment relief to a borrower experiencing financial difficulty. Such restructured loans are considered impaired loans that may either be in accruing status or non-accruing status.  Non-accruing restructured loans may return to accruing status provided there is a sufficient period of payment performance in accordance with the restructure terms.  Loans may be removed from the restructured category in the year subsequent to the restructuring if they have performed based on all of the restructured loan terms.  

 

The Company had no troubled debt restructured (“TDR”) leases at March 31, 2020 and December 31, 2019. The TDR loans at March 31, 2020 and December 31, 2019 are as follows:

 

   March 31, 2020 
   Number   Non-Accrual   Number   Accrual   Total 
(dollars in thousands)  of Loans   Status   of Loans   Status   TDRs 
Construction and land   1   $124    -   $-   $124 
Residential real estate - first lien   2    269    2    965    1,234 
Commercial loans and leases   1    414    2    367    781 
    4   $807    4   $1,332   $2,139 

 

 December 31, 2019 
   Number   Non-Accrual   Number   Accrual   Total 
(dollars in thousands)  of Loans   Status   of Loans   Status   TDRs 
Construction and land   1   $125    -   $-   $125 
Residential real estate - first lien   2    274    2    968    1,242 
Commercial loans and leases   1    414    2    367    781 
    4   $813    4   $1,335   $2,148 

 

 16 

 

 

A summary of TDR modifications outstanding and performing under modified terms is as follows:

 

   March 31, 2020 
       Not Performing   Performing     
   Related   to Modified   to Modified   Total 
(in thousands)  Allowance   Terms   Terms   TDRs 
Construction and land                    
Extension or other modification  $-   $124   $-   $124 
Residential real estate - first lien                    
Extension or other modification   -    269    965    1,234 
Commercial loans                    
Extension or other modification   -    -    367    367 
Forbearance   -    414    -    414 
Total troubled debt restructured loans  $-   $807   $1,332   $2,139 

 

   December 31, 2019 
       Not Performing   Performing     
   Related   to Modified   to Modified   Total 
(in thousands)  Allowance   Terms   Terms   TDRs 
Construction and land                    
Extension or other modification  $-   $125   $-   $125 
Residential real estate - first lien                    
Extension or other modification   -    274    968    1,242 
Commercial loans                    
Extension or other modification   -    -    367    367 
Forbearance   -    414    -    414 
Total troubled debt restructured loans  $-   $813   $1,335   $2,148 

 

On March 22, 2020, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

 

The Company provided COVID-19 related loan modifications to both commercial and retail customers, on a case by case basis, in the form of payment deferrals for periods up to six months. As of March 31, 2020, a total of $101 million of loans (or 5.7% of the loan portfolio) had been modified through payment deferrals.

 

There were no new loans restructured during the three months ended March 31, 2020 and March 31, 2019.

 

Performing TDRs were in compliance with their modified terms and there are no further commitments associated with these loans. During the three months ended March 31, 2020 and 2019 there were no TDRs that subsequently defaulted within twelve months of their modification dates.

 

Management routinely evaluates other real estate owned (“OREO”) based upon periodic appraisals. For the three months ended March 31, 2020 the Bank recorded a $21 thousand valuation allowance on one unimproved parcel of land because the current appraised value (based on a new appraisal), less estimated cost to sell, was lower than the recorded carrying value of the OREO. For the three months ended March 31, 2020 and 2019 there were no new loans transferred from loans to OREO. The Company sold several properties held as OREO during the three months ended March 31, 2020, reducing OREO by $755 thousand and resulting in a loss of $28 thousand. There were no sales of OREO during the three months ended March 31, 2019. At March 31, 2020 there were two loans secured by residential first liens totaling $2.4 million in the process of foreclosure.

 

Note 6: Derivatives and Hedging Activities

 

Non-designated Hedges of Interest Rate Risk

 

The Company maintains interest rate swap contracts with customers that are classified as non-designated hedges and are not speculative in nature. These agreements are designed to convert customer’s variable rate loans with the Company to fixed rate. These interest rate swaps are executed with loan customers to facilitate a respective risk management strategy and allow the customer to pay a fixed rate interest to the Company. These interest rate swaps are simultaneously hedged by executing offsetting interest rate swaps with unrelated market counterparties to minimize the net risk exposure to the Company resulting from the transactions and allow the Company to receive a variable rate interest. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR plus credit spread with payment being calculated on the notional amount. The interest rate swaps are settled with varying maturities.

 

 17 

 

 

As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. The fair value of the interest swap derivatives are recorded in other assets and other liabilities. All changes in fair value are recorded through earnings as noninterest income. For the three months ended March 31, 2020 and March 31, 2019, the Company recorded a net loss of $8 thousand and $2 thousand, respectively related to the change in fair value of these interest rate swap derivatives.

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheet at March 31, 2020 and December 31, 2019:

 

          March 31, 2020 
   Balance Sheet  Notional   Estimated Fair Value 
(dollars in thousands)  Location  Amount   Gain   Loss 
Not designated hedges of interest rate risk:               
Customer related interest rate contracts:                  
Matched interest rate swaps with borrowers  Other assets and               
      other liabilities  $2,800   $415   $- 
Matched interest rate swaps with counterparty  Other assets and               
      other liabilities  $2,800   $-   $419 

 

          December 31, 2019 
   Balance Sheet  Notional   Estimated Fair Value 
(dollars in thousands)  Location  Amount   Gain   Loss 
Not designated hedges of interest rate risk:               
Customer related interest rate contracts:                  
Matched interest rate swaps with borrowers  Other assets and               
      other liabilities  $2,853   $217   $- 
Matched interest rate swaps with counterparty  Other assets and               
      other liabilities  $2,853   $-   $228 

 

Note 7: Goodwill and Other Intangible Assets

 

Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset would more-likely-than-not reduce the fair value below the carrying amount. The Bank has one reporting unit, which is the core banking operation.

 

The table below shows goodwill balances at:

 

(in thousands)  March 31, 2020   December 31, 2019 
Goodwill          
Banking  $65,949   $65,949 

 

Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in either business combinations or other purchases of deposits and are amortized based upon the estimated economic benefits received. The gross carrying amount and accumulated amortization of other intangible assets are as follows:

 

   March 31, 2020   Weighted 
   Gross       Net   Average 
   Carrying   Accumulated   Carrying   Remaining Life 
(in thousands)  Amount   Amortization   Amount   (Years) 
Amortizing intangible assets:                    
Core deposit intangible  $16,135   $8,365   $7,770    3.5 

 

   December 31, 2019   Weighted 
   Gross       Net   Average 
   Carrying   Accumulated   Carrying   Remaining Life 
(in thousands)  Amount   Amortization   Amount   (Years) 
Amortizing intangible assets:                    
Core deposit intangible  $16,135   $7,666   $8,469    3.7 

 

Estimated future amortization expense for amortizing intangibles are as follows:

 

 18 

 

 

(in thousands)    
2020  $1,975 
2021   2,326 
2022   1,915 
2023   1,298 
2024   256 
Total amortizing intangible assets  $7,770 

 

Note 8: Leases

 

The Company has operating leases on land and buildings with remaining lease terms ranging from 2020 to 2030. Many of the leases include renewal options, with renewal terms generally extending up to 10 years.

 

In 2019, with the execution of the Company’s branch optimization initiative, under which the closing of three branch locations and the consolidation of two other existing branch locations was announced, a $3.6 million charge to noninterest expenses, primarily related to the early termination of existing lease arrangements for the closing locations, was recorded in the second quarter of 2019. The closing of the three locations occurred in the third quarter of 2019, and the consolidation of the two branch locations into a single new location occurred in the first quarter of 2020. The early termination of these leases reduced the initial $18.0 million in ROU assets recorded on January 1, 2019 to $14.5 million at December 31, 2019. In the first quarter of 2020, the opening of the new location noted above increased ROU assets by $2.0 million.

 

Operating leases included the following at:

 

(in thousands)  March 31, 2020   December 31, 2019 
Operating Leases          
Operating leases ROU assets  $               15,674   $                     14,092 
Operating lease liabilities  $16,134   $14,507 

 

The components of lease expense were as follows:

 

   March 31, 
(in thousands)  2020   2019 
Operating lease cost  $364   $550 
Sublease income   (168)   (185)
Amortization of ROU assets   45    - 
   $241   $365 

 

 19 

 

 

Lease liability maturities are as follows:

 

(in thousands)    
2020  $1,285 
2021   1,662 
2022   1,520 
2023   1,372 
2024   1,170 
Thereafter   13,033 
Total future lease payments  $20,042 
Discount of cash flows   (3,908)
Present value on net future lease payments  $16,134 
      
Weighted average remaining term in years   6.64 
Weighted average discount rate   2.89%

 

Note 9: Deposits

 

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

 

                 
  March 31, 2020   December 31, 2019 
       % of       % of 
(dollars in thousands)  Amount   Total   Amount   Total 
Noninterest-bearing demand  $483,499    27%  $468,975    27%
Interest-bearing checking   173,739    10    183,447    11 
Money market accounts   356,469    20    360,711    21 

Savings

   134,060    7    130,141    7 
Certificates of deposit $250 and over   66,713    4    77,782    5 
Certificates of deposit under $250   574,419    32    493,309    29 
Total deposits  $1,788,899    100%  $1,714,365    100%

 

Note 10: Stock Options and Stock Awards

 

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. As of March 31, 2020, 456,263 shares are reserved for issuance pursuant to future grants under the Company’s stock incentive plan. 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 and typically vest over a three to five year period. 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 Company’s board of directors (the “Board of Directors” or “Board”) as compensation for attendance and participation at meetings of the Board of Directors and meetings of the various committees of the Board. For the three months ended March 31, 2020 and 2019, the Company issued 8,151 and 4,802 shares of common stock, respectively, to directors as compensation for their service.

 

Stock Options

 

The fair value of the Company’s stock options granted as compensation is estimated on the measurement date, which, for the Company, is the date of grant. The fair value of stock options is calculated using the Black-Scholes option-pricing model under which the Company estimates expected market price volatility and expected term of the options based on historical data and other factors. There were no stock options granted during the three months ended March 31, 2020, while there were 25,000 options granted for the year ended December 31, 2019.

 

 20 

 

 

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

 

                 
   March 31, 2020   December 31, 2019 
       Weighted       Weighted 
       Average       Average 
       Exercise       Exercise 
   Shares   Price   Shares   Price 
Balance at January 1,   25,000   $14.54    15,268   $8.76 
Granted   -    -    25,000    14.54 
Exercised   -    -    (13,418)   8.58 
Forfeited   -    -    (1,850)   10.10 
Balance at period end   25,000   $14.54    25,000   $14.54 
Exercisable at period end   8,337   $-    -   $- 
Weighted average fair value of options                    
granted during the year         N/A         $5.83 

 

No stock options were exercised for the three months ended March 31, 2020. The cash received from the exercise of stock options was $77 thousand for the three months ended March 31, 2019. 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 $10.86 at March 31, 2020, the options outstanding had no aggregate intrinsic value. At March 31, 2019, based upon a fair market value of $14.81, the options outstanding had an aggregate intrinsic value of $77 thousand. At March 31, 2020, based on stock options outstanding at the time, the total unrecognized pre-tax compensation expense related to unvested options was $89 thousand.

 

Restricted Stock Units (“RSU”)

 

RSUs are equity awards where 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 RSU that vests entitles the recipient to receive one share of the Company’s 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 RSUs until the recipient becomes the record holder of those shares. The valuation of the Company’s RSUs is the closing price per share of the Company’s common stock on the date of grant.

 

The Company granted 100,000 RSUs during the first quarter of 2020, subject to a five-year vesting schedule. The Company granted 18,500 RSUs during the first quarter of 2019, subject to a three-year vesting schedule.

 

A summary of the activity for the Company’s RSUs for the periods indicated is presented in the following table:

 

   March 31, 2020   December 31, 2019 
       Weighted       Weighted 
       Average       Average 
       Grant Date       Grant Date 
   Shares   Fair Value   Shares   Fair Value 
Balance at January 1,   11,032   $17.48    9,731   $17.29 
Granted   100,000    18.00    26,500    15.16 
Vested   -         (6,699)   16.13 
Forfeited   -         (18,500)   14.54 
Balance at period end   111,032   $17.95    11,032   $17.48 

 

 21 

 

 

At March 31, 2020, based on RSUs outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested RSUs was $1.9 million. Based upon the contractual terms, this expense is expected to be recognized as follows:

 

(in thousands)    
2020  $314 
2021   404 
2022   397 
2023   360 
2024   360 
2025   30 
   $1,865 

 

Stock-Based Compensation Expense

 

Stock-based compensation expense attributable to stock options and RSUs is based on their fair values on the measurement date, which, for the Company, is the date of the grant. This cost is then recognized in noninterest expense on a straight-line basis over the vesting period of the respective stock options and RSUs. The amount that the Company recognized in stock-based compensation expense related to the issuance of stock options and RSUs as well as director compensation paid in stock is presented in the following table:

 

   Three months ended 
   March 31, 
(in thousands)  2020   2019 
Stock-based compensation expense          
Related to the issuance of  restricted stock and RSUs  $91   $42 
Related to the issuance of stock options   12    8 
Director compensation paid in stock   137    62 
Total stock-based compensation expense  $240   $112 

 

Note 11: Benefit Plans

 

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 $301 thousand and $277 thousand, respectively, for the three months ended March 31, 2020 and 2019. The Company’s matching contributions vest immediately.

 

Supplemental Executive Retirement Plan (“SERP”)

 

In 2014, the Bank created a SERP for the Chief Executive Officer (“CEO”). This plan was amended in 2016. Under the defined benefit SERP, the CEO will receive $150,000 each year for 15 years after attainment of the Normal Retirement Age (as defined in the SERP). The CEO earned vesting on a graduated schedule and she became fully vested on August 25, 2019, which had been established for purposes of the SERP as the commencement date for SERP distributions. Expense related to this SERP totaled $19 thousand and $53 thousand for the three month periods ending March 31, 2020 and 2019, respectively.

 

Employee Stock Purchase Plan

 

The 2017 Employee Stock Purchase Plan (the “Plan”) provides eligible employees of the Company and certain of its subsidiaries with opportunities to purchase shares of the Company’s common stock. An aggregate of 250,000 shares of the Company’s common stock was approved for issuance under the Plan. The Plan is intended to qualify as an “employee stock purchase plan” as defined in Section 423 of the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder, and shall be interpreted consistent therewith. There was no expense related to this plan for the three month periods ended March 31, 2020 or 2019.

 

 22 

 

 

Note 12: Income per Common Share

 

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

 

   Three months ended 
   March 31, 
(dollars in thousands, except per share data)  2020   2019 
Net income available to common stockholders (numerator)  $3,343   $4,256 
BASIC          
Basic average common shares outstanding (denominator)   18,867,087    19,052,694 
Basic income per common share  $0.18   $0.22 
DILUTED          
Average common shares outstanding   18,867,087    19,052,694 
Dilutive effect of common stock equivalents   47,864    14,097 
Diluted average common shares outstanding (denominator)   18,914,951    19,066,791 
Diluted income per common share  $0.18   $0.22 
           
Common stock equivalents outstanding that are          
anti-dilutive and thus excluded from calculation of          
diluted number of shares presented above   -    25,000 

  

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Note 13: Regulatory Capital

 

The following table reflects Bancorp’s and the Bank’s capital at March 31, 2020 and December 31, 2019:

 

                   To be well 
                   capitalized under 
                   the FDICIA 
           For capital   prompt corrective 
   Actual   adequacy purposes (1)   action provisions 
(dollars in thousands)  Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of March 31, 2020:                              
Total capital (to risk-weighted assets)                              
Howard Bank  $245,246    13.06%  $150,208    8.00%  $187,760    10.00%
Howard Bancorp  $247,926    13.16%  $150,670    8.00%   N/A      
Common equity tier 1 capital                              
(to risk-weighted assets)                              
Howard Bank  $231,862    12.35%  $84,492    4.50%  $122,044    6.50%
Howard Bancorp  $206,253    10.95%  $84,752    4.50%   N/A      
Tier 1 capital (to risk-weighted assets)                              
Howard Bank  $231,862    12.35%  $112,656    6.00%  $150,208    8.00%
Howard Bancorp  $206,253    10.95%  $113,003    6.00%   N/A      
Tier 1 capital (to average assets)                              
(Leverage ratio)                              
Howard Bank  $231,862    10.25%  $90,473    4.00%  $113,092    5.00%
Howard Bancorp  $206,253    9.10%  $90,707    4.00%   N/A      
As of December 31, 2019:                              
Total capital (to risk-weighted assets)                              
Howard Bank  $238,384    12.86%  $148,314    8.00%  $185,392    10.00%
Howard Bancorp  $247,761    13.14%  $150,872    8.00%   N/A      
Common equity tier 1 capital                              
(to risk-weighted assets)                              
Howard Bank  $227,983    12.30%  $83,427    4.50%  $120,505    6.50%
Howard Bancorp  $209,119    11.09%  $84,866    4.50%   N/A      
Tier 1 capital (to risk-weighted assets)                              
Howard Bank  $227,983    12.30%  $111,235    6.00%  $148,314    8.00%
Howard Bancorp  $209,119    11.09%  $113,154    6.00%   N/A      
Tier 1 capital (to average assets)                              
(Leverage ratio)                              
Howard Bank  $227,983    10.43%  $87,434    4.00%  $109,293    5.00%
Howard Bancorp  $209,119    9.55%  $87,599    4.00%   N/A      

 

(1) Amounts shown exclude the capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, Bancorp is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the FRB (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to Bancorp, the Company calculates these ratios for its own planning and monitoring purposes.

 

Bancorp and the Bank met all capital adequacy requirements to which they are subject as of March 31, 2020 and December 31, 2019.

 

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Note 14: 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 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.

 

Recurring Fair Value Measurements

 

All classes of investment securities available for sale are recorded at fair value using an industry-wide valuation service and therefore fall into a Level 2 of the fair value hierarchy. The service uses evaluated pricing models that vary based on asset class and include available trade, bid and other market information. Various methodologies include broker quotes, proprietary models, descriptive terms and conditions databases, and quality control programs.

 

Fair value of loans held for sale is based upon outstanding investor commitments or, in the absence of such commitments, based on current investor yield requirements or third party pricing models and are considered Level 2. Gains and losses on loan sales are determined using specific identification method. Changes in fair value are recognized in the Consolidated Statement of Operations as part of realized and unrealized gain on mortgage banking activities.

 

Interest rate lock commitments are recorded at fair value determined as the amount that would be required to settle each of these derivatives at the balance sheet date. In the normal course of business, the Company enters into contractual interest rate lock commitments to extend credit to borrowers with fixed expiration dates. The commitment becomes effective when the borrowers lock in a specified interest rate within the time frames established by the mortgage division. All borrowers are evaluated for credit worthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time interest rate is locked by the borrower and the sale date of the loan to an investor. To mitigate this interest rate risk inherent in providing rate lock commitments to borrowers, the Company enters into best effort forward sales contracts to sell loans to investors. The forward sales contracts lock in an interest rate price for the sale of loans similar to the specific rate lock commitment. Rate lock commitments to the borrowers through the date the loan closes are undesignated derivatives and accordingly, are marked to fair value in earnings. These valuations fall into a Level 3 of the fair value hierarchy. The rate lock commitments are deemed as Level 3 inputs because the Company applies an estimated pull-through rate, which is deemed an unobservable measure.

 

For loans held for investment that were originally intended to be sold and previously included as loans held for sale, fair value is determined 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.

 

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The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis at March 31, 2020 and December 31, 2019.

 

March 31, 2020      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) 
Assets                    
Available for sale securities:                    
U.S. Government agencies  $81,894   $                      -   $81,894   $                 - 
Mortgage-backed securities   187,824    -    187,824    - 
Other investments   5,534    -    5,534    - 
Loans held for sale   3,795    -    3,795    - 
Loans held for investment   958    -    958    - 
Interest rate swap assets   415    -    415    - 
Liabilities                    
Interest rate swap liabilities   419    -    419    - 

 

December 31, 2019      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) 
Assets                    
Available for sale securities:                    
U.S. Government agencies  $67,312   $                 -   $67,312   $               - 
Mortgage-backed securities   142,699    -    142,699    - 
Other investments   5,494    -    5,494    - 
Loans held for sale   30,710    -    30,710    - 
Loans held for investment   997    -    997    - 
Rate lock commitments   60    -    -    60 
Interest rate swap assets   217    -    217    - 
Liabilities                    
Interest rate swap liabilities   228    -    228    - 

 

The following table presents a reconciliation of the assets that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods presented:

 

(in thousands)  March 31, 2020   December 31, 2019 
Balance, beginning of period  $60   $126 
Privately held equity investment   -    - 
Net losses included in realized and unrealized gains on mortgage banking activity in noninterest income   (60)   (66)
Balance, end of period  $-   $60 

 

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Assets under fair value option:

 

March 31, 2020  Carrying   Aggregate     
   Fair Value   Unpaid     
(in thousands)  Amount   Principal   Difference 
Loans held for sale  $3,795   $3,759   $36 
Loans held for investment   958    950    8 

 

December 31, 2019  Carrying   Aggregate     
   Fair Value   Unpaid     
(in thousands)  Amount   Principal   Difference 
Loans held for sale  $30,710   $29,969   $741 
Loans held for investment   997    966    31 

 

The Company elected to measure the loans held for sale and the loans held for investment that were originally intended for sale, but instead were added to the Bank’s portfolio at fair value, to better align reported results with the underlying economic changes in value of the loans on the Company’s balance sheet.

 

Non-recurring Fair Value Measurements

 

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.

 

Other real estate owned acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at fair value, less selling costs. Any write-downs to fair value at the time of transfer to OREO are charged to the allowance for credit losses. Values are derived from appraisals of underlying collateral and discounted cash flow analysis. A valuation loss of $21 thousand was recognized for the three months ended March 31, 2020 and no valuation loss was recorded for the same period on 2019. This charge was for declines in the value of OREO subsequent to foreclosure. OREO is classified within Level 3 of the hierarchy.

 

Net (loss)/gain included in earnings from the changes in fair value of loans held for sale was $(257) thousand and $72 thousand at March 31, 2020 and 2019, respectively. There was a net gains included in earnings from the changes in fair value of loans held for investment of $8 thousand for the first quarter of 2020 and $56 thousand for the first quarter of 2019.

 

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 March 31, 2020 and December 31, 2019:

 

March 31, 2020      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  $2,322   $-   $-   $2,322 
Impaired loans:                    
Construction and land   478    -    -    478 
Residential - first lien   12,470    -    -    12,470 
Residential - junior lien   832    -    -    832 
Commercial - owner occupied   477    -    -    477 
Commercial - non-owner occupied   1,777    -    -    1,777 
Commercial loans and leases   1,092    -    -    1,092 
Consumer   102    -    -    102 
Total impaired loans   17,228    -    -    17,228 

 

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December 31, 2019      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  $3,098   $                -   $-   $3,098 
Impaired loans:                    
Construction and land   481    -               -    481 
Residential - first lien   13,131    -    -    13,131 
Residential - junior lien   786    -    -    786 
Commercial - owner occupied   566    -    -    566 
Commercial - non-owner occupied   1,725    -    -    1,725 
Commercial loans and leases   1,860    -    -    1,860 
Consumer   127    -    -    127 
Total impaired loans   18,676    -    -    18,676 

 

At March 31, 2020, OREO consisted of an outstanding balance of $3.5 million, less a valuation allowance of $1.2 million. At December 31, 2019, OREO consisted of an outstanding balance of $4.6 million, less a valuation allowance of $1.5 million. A specific allocation of the allowance for credit losses attributable to impaired loans at December 31, 2019 was $500 thousand.

 

Various techniques are used to value OREO and impaired loans.  All loans for which the underlying collateral is real estate, either construction, land, commercial, or residential, an independent appraisal is used to identify the value of the collateral.  The approaches within the appraisal report include sales comparison, income, and replacement cost analysis.  The resulting value will be adjusted by a selling cost of 9.5% and the residual value will be used to determine if there is an impairment. Commercial loans and leases and consumer loans utilize a liquidation approach to the impairment analysis.

 

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.

 

The following table presents the estimated fair value of the Company’s financial instruments at the dates indicated:

 

   March 31, 2020 
           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                         
Available for sale securities  $275,252   $275,252   $-   $275,252   $- 
Held to maturity securities   7,750    7,850    -    -    7,850 
Nonmarketable equity securities   16,757    16,757    -    16,757    - 
Loans held for sale   3,795    3,795    -    3,795    - 
Loans held for investment   958    958             -    958    - 
Loans and leases 1   1,747,077    1,755,134    -    -    1,755,134 
Interest rate swap   415    415    -    415    - 
Financial Liabilities                         
Deposits   1,788,899    1,787,004    -    1,787,004    - 
Customer repos and fed funds purchased   5,321    5,321    -    5,321    - 
FHLB advances   344,000    351,560    -    351,560    - 
Subordinated debt   28,290    28,290    -    28,290    - 
Interest rate swap   419    419    -    419    - 

 

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   December 31, 2019 
           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                         
Available for sale securities  $215,505   $215,505   $-   $215,505   $- 
Held to maturity securities   7,750    7,897    -    -    7,897 
Nonmarketable equity securities   14,152    14,152    -    14,152    - 
Loans held for sale   30,710    30,710    -    30,710    - 
Loans held for investment   997    997    -    997    - 
Rate lock commitments   60    60    -    -    60 
Loans and leases 1   1,734,115    1,735,013    -    -    1,735,013 
Interest rate swap   217    217    -    217    - 
Financial Liabilities                         
Deposits   1,714,365    1,713,081    -    1,713,081    - 
Customer repos and fed funds purchased   6,127    6,127    -    6,127    - 
FHLB advances   285,000    288,731    -    288,731    - 
Subordinated debt   28,241    28,241    -    28,241    - 
Interest rate swap   228    228    -    228    - 

 

(1)Carrying amount is net of unearned income and allowance for loan and lease losses. In accordance with the prospective adoption of ASU No. 2016-01, the fair value of loans were measured using an exit price notion at periods presented. 

 

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

 

The following is a discussion of our consolidated financial condition as of March 31, 2020, as compared to December 31, 2019, and our results of operations for the three month periods ended March 31, 2020 and March 31, 2019. This discussion and analysis should be read in conjunction with our unaudited Consolidated Financial Statements and related notes as well as the financial and statistical data appearing elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2019. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate results of operations for any future periods.

 

We have made, and will continue to make, various forward-looking statements with respect to financial, business and economic matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the cautionary note regarding “Forward-Looking Statements” at the beginning of this report.

 

In this report, unless the context suggests otherwise, references to the “Company” refer to Howard Bancorp, Inc. and references to “we,” “us,” and “our” mean the combined business of the Company and the Bank and its wholly-owned subsidiaries.

 

General

 

Howard Bancorp, Inc. is the holding company for Howard Bank. Howard Bank was formed in 2004. Howard Bank’s business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. We are headquartered in Baltimore, Maryland. 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 primarily to small- and 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.

 

Recent Business Developments

 

On December 18, 2019, we entered into an agreement to release certain management members of our mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring our 91 remaining mortgage employees. We also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of our mortgage employees, and the sale of the domain name, the LLC paid us $750 thousand. Under the agreement, there is a transition period of approximately 45 days, after which we agreed to cease originating residential first lien mortgage loans and exit our mortgage banking activities. Accordingly, we completed processing the residential first lien mortgage pipeline by the end of the first quarter of 2020. In order to manage future loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.

 

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While our mortgage banking activities were marginally profitable in two of the last three years and our decision to exit this activity will eliminate that source of income, we believe that the exit of these activities will have a negligible impact on our net income over the next twelve months and will improve our efficiency ratio. Most importantly, we believe that exiting these activities will allow us to focus resources on growing our more profitable and less volatile commercial banking business that represents our core competency. We expect that this renewed focus will more than replace the marginal levels of net income from our mortgage banking activities within the next twelve months. While we estimate that the after tax income from these activities in 2019 was $1.6 million, the operating expenses we attributed to the mortgage banking activities represented only direct costs and did not include shared services expense for staff and support activities such as loan operations, wire transfer operations, human resources, finance, internal audit, and compliance. If we had allocated these shared services expenses to our mortgage banking activities, the financial returns on our mortgage banking activities would have been even less. The exit of our mortgage banking activities is discussed in Note 2 to the Consolidated Financial Statements.

 

Recent Events - COVID-19

 

In December 2019, a novel strain of coronavirus (COVID-19) was reported to have surfaced in China, and has since spread to a number of other countries, including the United States. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. The COVID-19 pandemic has severely restricted the level of economic activity in our markets. In response to the COVID-19 pandemic, the State of Maryland and most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential. Within our local markets, there has been an abrupt slowdown in commercial economic activity resulting from actions announced by the State of Maryland between the March 5 disclosure of the first confirmed cases of COVID-19 in the state and the March 23 executive order closing all non-essential businesses in the state as well as a dramatic rise in the unemployment rate in our market area.

 

While our business has been designated an essential business, which allows us to continue to serve our customers, we serve many customers that have been deemed, or who are employed by businesses that have been deemed, to be non-essential. And many of our customers that have been categorized to date as essential businesses, or who are employed by businesses that have been categorized as essential businesses, have been adversely affected by the COVID-19 pandemic.

 

The impact of the COVID-19 pandemic is fluid and continues to evolve. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets, and has had an adverse effect on our business and results of operations. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic has had and is expected to continue to have an adverse effect on our business and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and our customers, employees and vendors.

 

Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary market and in the United States as a whole.

 

Our COVID-19 Operational Response

 

Our response has continued to evolve since the first confirmed case of COVID-19 was reported in Maryland on March 5. We have implemented the following measures in an effort to ensure the safety of both our customers and employees while continuing to serve our customers during this challenging period:

 

·Twelve of the Bank’s fifteen branches remain accessible to customers – nine through drive thru capabilities and all twelve through pre-scheduled meetings.
   
·Encouraged utilization of our mobile, online, ATM, and other banking channels to limit personal contact.
   
·Implemented a work-from-home policy for substantially all employees other than branch personnel.
   
·Added one week of paid time off to all full-time employees to be used in either 2020 or 2021, to acknowledge long hours devoted to providing extraordinary customer service.
   
·Implemented deep cleaning procedures at all branch locations and other bank facilities.
   
·Changed the annual meeting of stockholders to a virtual meeting.

 

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Lending Operations and Accommodations to Borrowers

 

We immediately understood to challenges that our lending customers were facing, and we proactively reached out to commercial customers. In addition, we provided loan modifications to both commercial and retail customers, on a case by case basis, in the form of payment deferrals for periods up to six months. As of March 31, 2020, a total of $101 million of loans (or 5.7% of the loan portfolio) had been modified through payment deferrals. As of May 8, 2020, this number had grown to $347 million (or 19.7% of the loan portfolio). We expect that requests for payment deferrals will continue during the second quarter. In accordance with interagency guidance issued in March 2020, these short term deferrals are not considered troubled debt restructurings if the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. We have also temporarily ceased making collection calls, are temporarily waiving a higher proportion of late fees assessed for consumer loans, and have paused new foreclosure and repossession actions. We will continue to re-evaluate these temporary actions based on the ongoing COVID-19 pandemic. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time. Future governmental actions may require these and other types of customer-related responses.

 

We have also actively participated in the Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”) established under the Coronavirus Aid, Relief and Economic Security Act (“CARES” Act). During the first phase of this program, which commenced on April 3, we processed 856 applications that resulted in 797 PPP loan approvals totaling $185.0 million. As of May 8, 2020, we have funded $179.5million of the first phase approvals. The processing fees we expect to receive from the SBA for originating the first phase PPP loans are estimated at approximately $5.8 million; these fees will be deferred and amortized as a yield adjustment in interest income over the life of the loans. In addition, we are continuing to support our customers through our participation in the second phase of this program, which commenced on April 27. As of May 8, 2020, we have processed 190 applications that have resulted in 185 PPP loan approvals totaling $14.7 million, with $9.1 million of the second phase approvals funded. We expect to receive an estimated additional $555 thousand in processing fees from the SBA for the second phase approvals through May 8. Over 150 members of our team (60% of the workforce) were involved in this effort.

 

Impact on Our Results of Operation and Financial Condition

 

We are monitoring the impact of the COVID-19 pandemic on our results of operation and financial condition. While we did not yet have a significant impact to our financial condition as of March 31, 2020, in the form of incurred losses or any communications from our borrowers that significant losses were imminent, we nevertheless determined it prudent to increase our allowance for credit losses by $3.0 million in the first quarter of 2020, related to changes in qualitative factors, primarily as a result of the abrupt slowdown in commercial economic activity related to COVID-19, as well as the dramatic rise in the unemployment rate in our market area. Our allowance for credit losses for periods ending after March 31, 2020 may be materially impacted by the COVID-19 pandemic.

 

We will continue to monitor the impact of COVID-19 on our business, operating results, cash flows, and financial condition, including the valuation of goodwill. If the COVID-19 pandemic extends beyond a few more months and the economy continues to deteriorate, we will have to reevaluate the impact on our financial condition and possible impairment of goodwill.

 

Capital and Liquidity

 

As of March 31, 2020, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by credit losses.

 

We believe there could be potential stresses on liquidity management as a result of the COVID-19 pandemic and our participation in the PPP. As customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit or decreases in customer deposits. To manage this risk, we increased our interest-bearing deposits with banks by $83.0 million in the first quarter of 2020. Since we believe there is sufficient liquidity in the market at this time, we plan to reduce these balances during the second quarter of 2020.

 

The Federal Reserve has created the Paycheck Protection Program Lending Facility (“PPPLF”), a lending facility that will allow us to obtain funding specifically for loans that we make under the PPP, which will allow us to retain existing sources of liquidity for our traditional operations. We have been approved by the Federal Reserve Bank of Richmond (“FRB”) to pledge PPP loans as collateral on borrowings from the PPPLF, and we intend to utilize the PPPLF.

 

Financial Highlights

 

Financial highlights during the three months ended March 31, 2020 are as follows:

 

·Our net income was $3.3 million, or $0.18 per diluted common share in the first quarter of 2020; this compares to net income of $4.3 million, or $0.22 per diluted common share in the first quarter of 2019.
·First quarter 2020 results included a provision for credit losses of $3.4 million, a $1.7 million increase from the first quarter of 2019 ($0.07 after tax per share decrease in earnings per common share (“EPS”)).
·First quarter 2020 results also included a one-time $1.2 million tax benefit ($0.06 per share increase in EPS) resulting from a net operating loss carryback provision in the CARES Act.
·Our return on average assets (“ROA”) and return on average equity (“ROE”) were 0.57% and 4.27%, respectively; this compares to 0.78% and 5.80%, respectively in the first quarter of 2019.
·Our net interest margin was 3.34% in the first quarter of 2020, a decrease of 30 basis points from the first quarter of 2019, due primarily to a 50 basis point decrease in the yield on our earning assets, partially offset by a 24 basis point decrease in funding rates.
·Total assets were $2.51 billion at March 31, 2020, up $133 million from year end 2019, with this asset growth attributable to an increased level of on-balance sheet cash liquidity with interest bearing deposits with banks up $83 million and securities available for sale up $60 million.
·Total loans and leases were $1.76 billion at March 31, 2020, up $16 million from year end 2019.
·Total deposits were $1.79 billion at March 31, 2020, up $75 million from year end 2019, with non-customer deposits up $101 million from year end 2019.
·Our FHLB advances increased by $59 million at March 31, 2020 since year end 2019 and, along with non-customer deposit growth, funded asset growth during the quarter.
·We completed our $7.0 million stock repurchase program on February 24, 2020; a total of 372,801 shares were repurchased during the first quarter for $6.7 million.
·We remain “well capitalized” by all regulatory measures.
·Our book value per common share was $16.85 at March 31, 2020, an increase of $0.27 per share from December 31, 2019.
 ·We completed the processing of the remaining residential first lien mortgage pipeline during the quarter. This activity resulted from our agreement to exit our mortgage banking activities as discussed in our Form 10-K for the year ended December 31, 2019.

  

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Critical Accounting Policies

 

Our accounting and financial reporting policies conform to GAAP and general practice within the banking industry. Accordingly, preparation of the financial statements requires management to exercise significant judgment or discretion or make significant assumptions and estimates 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.

 

The accounting policies we view as critical are those relating to the allowance for credit losses, goodwill and other intangible assets, income taxes, share based compensation, accounting for business combinations and loans acquired in business combinations. These critical accounting policies and the significant assumptions and estimates made by management related to them are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2019. Our significant accounting policies are discussed in detail in “Notes to Consolidated Financial Statements - Note 1: Summary of Significant Account Policies” in our Annual Report on Form 10-K for the year ended December 31, 2019. There have been no material changes to the significant accounting policies as described in the Annual Report on Form 10-K for the year ended December 31, 2019. Disclosures regarding the effects of new accounting pronouncements are included in Note 1 of this report.

 

Financial Condition

 

A comparison between March 31, 2020 and December 31, 2019 balance sheets is presented below.

 

General

 

Total assets increased $133.3 million, or 0.6%, to $2.51 billion at March 31, 2020 compared to $2.37 billion at December 31, 2019. Our asset growth consisted primarily of increases in interest-bearing deposits with banks of $83.0 million, securities available for sale of $59.7 million, and loans and leases of $15.9 million. The primary sources of funding asset growth were increases in deposit balances and FHLB borrowings. While total deposits increased by $74.5 million, customer deposits decreased by $32.6 million and non-customer deposits increased by $107.1 million. FHLB advances increased by $59.0 million.

 

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Securities Available for Sale and Held to Maturity

 

Available for sale

 

Our available for sale securities are reported at fair value. At both March 31, 2020 and December 31, 2019, we held U.S. agency debentures, mortgage backed securities, and corporate debentures. This portfolio is used primarily to provide sufficient liquidity to fund our loans and provide funds for withdrawals of deposits. In addition, this portfolio is used as collateral for funding via commercial customer overnight securities sold under agreement to repurchase (“repurchase agreements”) and as a source of earnings. At March 31, 2020 and December 31, 2019, $10.9 million and $11.6 million in fair value of available for sale securities, respectively, were pledged as collateral for both repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts.

 

Held to maturity

 

Held to maturity securities are reported at amortized cost. The only investments that we have classified as held to maturity are certain corporate debentures. These investments are intended to be held until maturity.

 

The following table sets forth the composition of our investment securities portfolio at the dates indicated.

 

  March 31, 2020   December 31, 2019         
   Amortized   Estimated   Amortized   Estimated   $ Change in     
(in thousands)  Cost   Fair Value   Cost   Fair Value   Fair Value   % Change 
Available for sale                              
U.S. Government Agencies  $79,916   $81,894   $66,428   $67,312   $14,582    21.7%
Mortgage-backed   180,509    187,824    139,918    142,699    45,125    31.6 
Other investments   5,510    5,534    5,510    5,494    40    0.7 
   $265,935   $275,252   $211,856   $215,505   $59,747    27.7%
Held to maturity                              
Corporate debentures  $7,750   $7,850   $7,750   $7,897   $(47)   (0.6)%

 

We had available for sale securities of $275.3 million at March 31, 2020, an increase of $59.7 million, or 27.7%, since December 31, 2019. Our portfolio growth, consisting of both mortgage-backed securities and U.S. Government agency securities, was part of our overall earnings and interest rate risk management strategies.

 

Our available for sale securities portfolio contained four securities with unrealized losses of $19 thousand at March 31, 2020, and 16 securities with unrealized losses of $166 thousand at December 31, 2019. Changes in the fair value of these securities resulted primarily from interest rate fluctuations. We do not intend to sell these securities nor is it more likely than not that we would be required to sell these securities before their anticipated recovery, and we believe the collection of the investment and related interest is probable. Based on this analysis, we do not consider any of the unrealized losses to be other than temporary impairment. Note 3 to our Consolidated Financial Statements provides more detail concerning the composition of our portfolio and our process for evaluating the portfolio for other-than-temporary impairment.

  

Loan and Lease Portfolio

 

Total loans and leases increased $15.9 million, or 0.9%, to $1.76 billion at March 31, 2020 from $1.74 billion at December 31, 2019. Commercial real estate loans increased $11.0 million, or 1.6%, and our commercial loan and leases portfolio increased $16.2 million, or 4.3%. The growth in these portfolio categories is consistent with our continued focus on the needs of small to mid-size businesses in our market area. Our residential mortgage portfolio decreased by $11.7 million during the quarter ended March 31, 2020 as a result of a substantially higher level of prepayments due to the lower level of mortgage market rates that led to a strong mortgage refinance quarter. The level of mortgage runoff was partially mitigated by new loan originations, but the wind down of our mortgage banking activities during the quarter resulted in a lower level of new mortgage originations than in prior quarters. In order to manage loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans on a servicing released basis. In that regard, we are currently negotiating investor agreements that may provide a future flow of new mortgage originations.

 

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The following table sets forth the composition of our loan portfolio at the dates indicated.

 

   March 31, 2020   December 31, 2019         
(in thousands)  Total   % of Total   Total   % of Total   $ Change   % Change 
Real estate                              
Construction and land  $130,980    7.4%  $128,285    7.3%  $2,695    2.1%
Residential - first lien   428,788    24.4    437,409    25.1    (8,621)   (2.0)
Residential - junior lien   71,045    4.0    74,164    4.2    (3,119)   (4.2)
Total residential real estate   499,833    28.4    511,573    29.3    (11,740)   (2.3)
Commercial - owner occupied   248,918    14.1    241,795    13.9    7,123    2.9 
Commercial - non-owner occupied   447,889    25.5    444,052    25.4    3,837    0.9 
Total commercial real estate   696,807    39.6    685,847    39.3    10,960    1.6 
Total real estate loans   1,327,620    75.4    1,325,705    75.9    1,915    0.1 
Commercial loans and leases 1   389,065    22.1    372,872    21.4    16,193    4.3 
Consumer   44,734    2.5    46,936    2.7    (2,202)   (4.7)
Total loans and leases  $1,761,419    100.0%  $1,745,513    100.0%  $15,906    0.9%

 

1 Includes leases of $5,637 and $6,382 at March 31, 2020 and December 31, 2019, respectively.

 

Loan Held for Sale

 

We completed the processing of the remaining residential first lien mortgage pipeline during the quarter and substantially all of the loans originated for sale were sold by March 31, 2020. As a result, loans held for sale were $3.8 million at March 31, 2020, down from $30.7 million at December 31, 2019. Our volume of mortgage loan originations for sale in the secondary market was $79.8 million during the quarter while our volume of loans sold was $106.7 million, resulting in a $26.9 million decrease in loans held for sale.

 

Interest-Bearing Deposits with Banks

 

Interest-bearing deposits with banks, primarily with the Federal Reserve Bank of Richmond (“FRB”), were $180.0 million at March 31, 2020, an increase of $83.0 million from the December 31, 2019 balance of $97.0 million. As the threat of market disruption in response to the pandemic appeared during the quarter, combined with concerns of potentially higher than normal commercial line utilization and possible reductions in customer deposits, we grew our on-balance sheet liquidity with higher balances held at the FRB. Since we believe there is sufficient liquidity in the market at this time, we plan to reduce these balances during the second quarter of 2020.

 

Nonmarketable Equity Securities

 

At March 31, 2020 and December 31, 2019, we held an investment in stock of the Federal Home Loan Bank (“FHLB”) of $16.8 million and $14.2 million, respectively. This investment is required for continued FHLB membership and is based partially upon the amount of borrowings outstanding from the FHLB. This FHLB stock is carried at cost.

 

Deposits

 

Total deposits were $1.79 billion at March 31, 2020, a $74.5 million, or 4.4%, increase from $1.71 billion at December 31, 2019. Customer deposits, which excludes brokered deposits and other non-customer deposits, were down $32.6 million, or 2.2%, in the first quarter of 2020. Our transaction accounts (noninterest-bearing demand and interest-bearing checking) increased by $4.8 million and represented 45.6% of our customer deposits. Brokered and other non-customer deposits were $347.1 million at March 31, 2020, a $107.1 million increase since year end 2019. The growth in this deposit funding source supported the increase in our on-balance sheet liquidity as the threat of market disruption in response to the pandemic appeared during the quarter. Since we believe there is sufficient liquidity in the market at this time, we plan to reduce these balances during the second quarter of 2020.

 

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

 

   March 31, 2020   December 31, 2019         
       % of       % of         
(dollars in thousands)  Amount   Total   Amount   Total   $ Change   % Change 
Noninterest-bearing demand  $483,499    27%  $468,975    27%  $14,524    3.1%
Interest-bearing checking   173,739    10    183,447    11    (9,708)   (5.3)
Money market accounts   356,469    20    360,711    21    (4,242)   (1.2)
Savings   134,060    7    130,141    7    3,919    3.0 
Certificates of deposit $250 and over   66,713    4    77,782    5    (11,069)   (14.2)
Certificates of deposit under $250   574,419    32    493,309    29    81,110    16.4 
Total deposits  $1,788,899    100%  $1,714,365    100%  $74,534    4.3%
                               
By deposit source:                              
Customer deposits  $1,441,829    81%  $1,474,393    86%  $(32,564)   (2.2)%
Brokered and other non-customer deposits   347,070    19    239,972    14    107,098    44.6 
Total deposits  $1,788,899    100%  $1,714,365    100%  $74,534    4.3%

  

FHLB Advances

 

Our primary source of non-deposit funding is FHLB advances. We use a variety a term structures in order to manage liquidity and interest rate risk. FHLB advances were $344.0 million at March 31, 2020, an increase of $59.0 million from December 31, 2019. As of March 31, 2020, $205.0 million of FHLB advances have maturities beyond one year.

 

Stockholders’ Equity

 

Total stockholders’ equity was $315.4 million at March 31, 2020, a $1.2 million increase from $314.1 million at December 31, 2019. Our increase in stockholders’ equity was primarily the result of our first quarter net income of $3.3 million as well as an increase in unrealized gains in our securities available for sale portfolio (net of taxes) of $4.1 million as a result of lower market interest rates. On February 24, 2020, we completed our stock repurchase program authorized by the Board of Directors on April 24, 2019. A total of 392,565 shares at an average price paid per share of $17.83, for an aggregate amount of $7.0 million, were repurchased under the program. A total of 372,801 shares were repurchased during the first quarter of 2020 for an aggregate amount of $6.7 million.

 

Total stockholders’ equity at March 31, 2020 represents an equity to assets ratio of 12.6%, compared to 13.2% at December 31, 2019. Our book value per share was $16.85 at March 31, 2020 and $16.48 at December 31, 2019.

 

Results of Operations

 

A comparison between the three months ended March 31, 2020 and March 31, 2019 is presented below.

 

Net income for the first quarter of 2020 was $3.3 million, or $0.18 per diluted common share. This compares to net income for the first quarter of 2019 of $4.3 million, or $0.22 per diluted common share. The $913 thousand, or $0.04 per diluted common share, decrease in net income was primarily the result of an increase in the provision for credit losses of $1.7 million, which, net of taxes, reduced EPS by $0.07. Our first quarter 2020 results also included a one-time $1.2 million tax benefit resulting from a net operating loss carryback provision in the CARES Act; this tax benefit increased our EPS by $0.06 per diluted common share. In addition, we recorded $788 thousand of expenses attributable to the departure of our former chief financial officer (“CFO”) during the quarter.

 

The Federal Reserve’s Federal Open Market Committee’s target for federal funds increased 125 basis points in 2017 and 100 basis points in 2018 to a range of 2.25% to 2.50% for the year ended December 31, 2018. During 2019, the federal funds target rate remained at the 2.25% to 2.50% range until July 2019 when the Federal Reserve began to drop the federal funds target rate. In the last half of 2019, the Federal Reserve dropped the federal funds target rate 75 basis points to the range of 1.50% to 1.75% at December 31, 2019. In March 2020, in response to the COVID19 pandemic, the Federal Reserve then dropped the federal funds target rate 150 basis points to a range of 0.00% to 0.25%.

 

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Net Interest Income

 

Net interest income for the first quarter of 2020 was $17.5 million, an increase of $51 thousand from the first quarter of 2019. Our net interest margin was 3.34% for the first quarter of 2020, a decrease of 30 basis points (“bp”) from the net interest margin of 3.64% in the first quarter of 2019. Average earning assets of $2.11 billion increased by $160.9 million, or 8.3%, while net interest income was essentially flat. The yield on our earning assets was down 50 bp and was partially offset by a 24 bp decrease in the rate on our interest-bearing liabilities. The net accretion of fair value adjustments on acquired loans added 5 bp to our net interest margin in the first quarter of 2020, an 8 bp decrease from 13 bp in the first quarter of 2019. We expect the impact of this net accretion to continue to decrease in future periods.

 

Interest Income

 

Interest income decreased by $558 thousand, or 2.4%, to $22.2 million for the first quarter of 2020 compared to $22.8 million for the first quarter of 2019. Interest income and fees on loans and leases decreased $397 thousand, or 1.9%, while average loans are up 6.9% to $1.75 billion compared to the first quarter of 2019. The average yield on loans of 4.58% is down 46 bp from the first quarter of 2019 yield and was primarily driven by lower interest rates. The net accretion of fair value adjustments on acquired loans added 7 bp to our average yield on loans in the first quarter of 2020, an 8 bp decrease from 15 bp in the first quarter of 2019. The average yield on available for sale securities decreased by 32 bp to 2.76%, as purchases during the quarter were at substantially lower market rates. Reflective of the significant decline on market rates of interest, the average yield on our interest-bearing deposits in banks fell 107 bp to 1.11% in the first quarter of 2020 compared to the same period in 2019.

 

Interest Expense

 

Interest expense decreased by $609 thousand, or 11.5%, to $4.7 million for the first quarter of 2020, compared to $5.3 million for the same period in 2019. The average rate on our interest-bearing liabilities decreased by 24 bp to 1.21% for the first quarter of 2020 compared to the first quarter of 2019. Interest expense on deposits decreased $354 thousand over the first quarter of 2019; we experienced a $37.7 million decrease in average interest-bearing deposits while the average rate on all interest-bearing deposits was down 9 bp. We dropped the interest rates on our interest-bearing deposits in response to the lower prevailing competitive rates in our market starting in late February, with the full impact of those rate actions to be reflected in future periods. In addition, our interest expense on FHLB advances decreased $229 thousand while the average balance increased $125.5 million. The average rate on FHLB advances dropped 131 bp to 1.29% in the first quarter of 2020, compared to the same period in 2019.

 

Average Balances, Yields and Rates

 

The following tables set forth average balances, yields and rates, 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 as well as any amortization and accretion of fair value adjustments.

 

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           Three months ended March 31,         
       2020           2019     
   Average   Income /   Yield /   Average   Income /   Yield / 
(in thousands)  Balance   Expense   Rate   Balance   Expense   Rate 
Earning assets                              
Loans and leases: (1)                              
Commercial loans and leases  $377,198    4,305    4.59%  $329,393   $4,225    5.20%
Commercial real estate   690,930    8,446    4.92    649,913    8,110    5.06 
Construction and land   131,489    1,463    4.47    126,719    1,822    5.83 
Residential real estate   509,034    5,244    4.14    480,694    5,571    4.70 
Consumer   45,664    520    4.58    53,687    647    4.89 
Total loans and leases   1,754,315    19,978    4.58    1,640,406    20,375    5.04 
Securities available for sale: (2)                              
U.S Gov agencies   70,831    492    2.79    111,417    762    2.77 
Mortgage-backed   151,399    978    2.60    89,583    727    3.29 
Corporate debentures   5,523    92    6.73    3,001    62    8.39 
Total available for sale securities   227,752    1,562    2.76    204,001    1,551    3.08 
Securities held to maturity (2)   7,750    112    5.83    9,250    143    6.27 
FHLB Atlanta stock, at cost   15,708    174    4.46    10,276    162    6.39 
Loans held for sale   18,424    166    3.62    16,552    191    4.68 
Interest bearning deposits in banks   84,860    234    1.11    67,459    362    2.18 
Total earning assets   2,108,809    22,226    4.24%   1,947,944    22,784    4.74%
Cash and due from banks   13,610              14,647           
Bank premises and equipment, net   42,689              45,016           
Other assets   215,459              219,480           
Less: allowance for credit losses   (10,719)             (9,965)          
Total assets  $2,369,848             $2,217,122           
Interest-bearing liabilities                              
Deposits:                              
Interest-bearing demand accounts  $183,305    157    0.34%  $225,552   $293    0.53%
Money market   368,779    706    0.77    356,057    613    0.70 
Savings   133,577    45    0.13    137,722    58    0.17 
Time deposits   523,980    2,302    1.77    528,017    2,600    2.00 
Total interest-bearing deposits   1,209,641    3,210    1.07    1,247,348    3,564    1.16 
Borrowings:                              
FHLB advances   320,868    1,025    1.29    195,311    1,254    2.60 
Fed funds and repos   6,665    4    0.27    14,471    13    0.36 
Subordinated debt   28,258    461    6.56    28,077    479    6.92 
Total borrowings   355,791    1,491    1.69    237,859    1,746    2.98 
Total interest-bearing funds   1,565,432    4,701    1.21%   1,485,207    5,310    1.45%
Noninterest-bearing deposits   464,701              418,816           
Other liabilities   24,909              15,586           
Total liabilities   2,055,042              1,919,609           
Stockholders' equity   314,805              297,513           
Total liabilities & equity  $2,369,848             $2,217,122           
Net interest rate spread (3)       $17,525    3.03%       $17,474    3.29%
Effect of noninterest-bearing funds             0.31              0.34 
Net interest margin on earning assets (4)             3.34%             3.64%

 

(1)Loan fee income is included in the interest income calculation, and non-accrual loans are included in the average loan balance; they have been reflected as loans carrying a zero yield.
(2)Available for sale securities are presented at fair value, held to maturity securities are presented at amortized cost.
(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.

 

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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) as well as any impact of number of days and mix. The total of the changes set forth in the rate and volume columns are presented in the total column.

 

   Three months ended March 31, 
   2020 vs. 2019 
   Due to variances in 
(in thousands)  Total   Rates   Volumes 
Interest income on earning assets:               
Loans and leases:               
Commercial loans and leases  $80   $(501)  $581 
Commercial real estate   336    (234)   569 
Construction and land   (359)   (427)   68 
Residential real estate   (327)   (666)   338 
Consumer   (127)   (41)   (86)
Total interest on loans   (397)   (1,868)   1,471 
Securities available for sale:               
U.S Gov agencies   (270)   5    (275)
Mortgage-backed   251    (155)   405 
Corporate debentures   30    (12)   43 
Total interest on available for sale securities   11    (162)   173 
Securities held to maturity   (31)   (10)   (21)
FHLB Atlanta stock, at cost   12    (49)   62 
Loans held for sale   (25)   (44)   18 
Interest bearning deposits in banks   (128)   (179)   51 
Total interest income   (558)   (2,312)   1,754 
Interest expense on interest-bearing liabilities:               
Deposits:               
Interest-bearing demand accounts   (136)   (102)   (34)
Money market   93    64    29 
Savings   (14)   (13)   (1)
Time deposits   (297)   (301)   4 
Total interest on deposits   (354)   (353)   (1)
Borrowings:               
FHLB advances   (228)   (640)   412 
Fed funds and repos   (8)   (3)   (5)
Subordinated debt   (18)   (25)   7 
Total interest on borrowings   (255)   (668)   414 
Total interest expense   (609)   (1,021)   412 
Net interest income  $51   $(1,291)  $1,342 

 

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Provision for Credit Losses

 

We recorded a provision for credit losses of $3.4 million for the first quarter of 2020, compared to a $1.7 million provision for the first quarter of 2019, an increase of $1.7 million. The first quarter 2020 provision, net of net charge-offs of $462 thousand, resulted in an increase in the allowance for credit losses of $3.0 million. The first quarter 2019 provision, net of net charge-offs of $2.8 million, resulted in a decrease in the allowance of $1.1 million. The increase in our allowance for credit losses is more fully discussed below under the sections entitled “Nonperforming and Problem Assets” and “Allowance for Credit Losses” of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Noninterest Income

 

The following table presents the major categories of noninterest income for the three months ended March 31, 2020 and 2019:

 

   Three months ended         
   March 31,         
(in thousands)  2020   2019   Change   % Change 
Service charges on deposit accounts  $642   $627   $15    2.4%
Realized and unrealized gains on mortgage banking activity   1,036    1,485    (449)   (30.2)
Income from bank owned life insurance   445    447    (2)   (0.4)
Loan related fees and service charges   581    1,043    (462)   (44.3)
Other operating income   662    933    (271)   (29.0)
Total noninterest income  $3,366   $4,535   $(1,169)   (25.8)%

  

Noninterest income was $3.4 million for the three months ended March 31, 2020, a decrease of $1.2 million, or 25.8%, compared to $4.5 million for the same period in 2019. Noninterest income attributable to our mortgage banking activities was $1.4 million in the first quarter of 2020, compared to $1.9 million in the first quarter of 2019. We completed the processing of the remaining residential first lien mortgage pipeline during the quarter and the exit of our mortgage banking activities has been substantially completed as of March 31, 2020. As a result, noninterest income from mortgage banking activities is down $520 thousand from the first quarter of 2019. Noninterest income from our mortgage banking activities consisted of realized and unrealized gains on mortgage banking activity as well as a portion of the line item loan related fees and service charges. Noninterest income from our ongoing banking activities, excluding mortgage banking, was $1.9 million, down $649 thousand, or 25.1%, from the first quarter of 2019.

 

Service charges on deposit accounts, which consisted of account activity fees such as nonsufficient funds (”NSF”) and overdraft fees in addition to other traditional banking fees, increased $15 thousand in the first quarter of 2020. While our total service charges were up slightly, NSF and overdraft fees were down $80 thousand from the first quarter of 2019, with a portion of this reduction representing accommodations to COVID-19 impacted customers.

 

Loan related fees and service charges, after deducting the portion attributable to our mortgage banking activities in both quarters, was $192 thousand in the first quarter of 2020, a reduction of $391 thousand from the first quarter of 2019. The first quarter of 2019 included an early loan payoff fee of $308 thousand.

 

Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services, decreased $271 thousand in the first quarter of 2020 compared to the first quarter of 2019. Fee income from merchant card activity declined $110 thousand quarter over quarter, with a portion of the decline in transaction volumes attributable to the COVID-19 related drop in economic activity. Additionally, the first quarter of 2019 included a one-time refund of $100 thousand.

 

Noninterest Expenses

 

The following table presents the major categories of noninterest expense for the three months ended March 31, 2020 and 2019:

 

   Three months ended         
   March 31,         
(in thousands)  2020   2019   Change   % Change 
Compensation and benefits  $8,441   $8,034   $407    5.1%
Occupancy and equipment   1,033    1,571    (538)   (34.2)
Amortization of core deposit intangible   699    784    (85)   (10.8)
Marketing and business development   450    457    (7)   (1.5)
Professional fees   726    785    (59)   (7.5)
Data processing fees   927    1,378    (451)   (32.7)
FDIC assessment   212    287    (75)   (26.1)
Other real estate owned   78    27    51    188.9 
Loan production expense   468    520    (52)   (10.0)
Other operating expense   1,525    1,014    511    50.4 
Total noninterest expense  $14,559   $14,857   $(298)   (2.0)%

 

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Noninterest expenses were $14.6 million for the first quarter of 2020, a decrease of $298 thousand, or 2.0%, compared to $14.9 million for the first quarter of 2019. Noninterest expenses attributable to our mortgage banking activities were $1.4 million in the first quarter of 2020, down $716 thousand from $2.1 million in the first quarter of 2019. Noninterest expenses from our ongoing banking activities, excluding mortgage banking, were $13.1 million, up $418 thousand, or 3.3%, from the first quarter of 2019. Our first quarter 2020 noninterest expenses included $788 thousand of expenses attributable to the departure of our former CFO.

 

Compensation and benefits expense are the largest component of our noninterest expenses, and increased by $407 thousand in the first quarter of 2020, compared to the same period in 2019. Compensation and benefits expense attributable to our mortgage banking activities were $928 thousand in the first quarter of 2020, compared to $1.6 million in the first quarter of 2019. Compensation and benefits from our ongoing banking activities, excluding mortgage banking, were $7.5 million in the first quarter of 2020 compared to $6.4 million in the first quarter of 2019, an increase of $1.1 million. Included in this increase was $698 thousand of expenses attributable to the departure of our former CFO. The compensation cost savings resulting from our branch optimization initiative in 2019 were offset by increased compensation costs as we continued to build our commercial banking team.

 

Occupancy and equipment expense decreased $538 thousand in the first quarter of 2020 compared to the first quarter of 2019. The projected cost savings from our 2019 branch optimization initiative have been realized, as we closed three branch locations in 2019 and consolidated two other existing branch locations into a new smaller branch location during the quarter.

 

Data processing expenses decreased $451 thousand as we realize the benefits from our renegotiated core processing contract. Other operating expenses increased by $511 thousand in the first quarter of 2020. Other operating expenses consist mainly of a variety of general expenses such as telephone and data lines, supplies and postage, courier services, general insurance, director fees, and miscellaneous losses. We reevaluated certain expense accruals during the first quarter of 2020 and recorded $403 thousand of additional expenses within the other operating expense category.

 

Income Tax Expense

 

For the first quarter of 2020, we recorded an income tax benefit of $456 thousand compared to income tax expense of $1.2 million in the first quarter of 2019. The first quarter of 2020 was favorably impacted by certain provisions of the CARES Act that was signed into law on March 27, 2020. The CARES Act permits corporate taxpayers to recover prior period taxes paid by carrying back net operating losses incurred in tax years ending after December 31, 2017, to tax years ending up to five years earlier. As a result, we will be able to carryback the 2018 tax net operating loss of $9.1 million to tax years 2013-2015. The $1.2 million one-time tax benefit represents the difference between the current federal statutory tax rate of 21% and the 34% statutory federal tax rate applicable during the carryback years. Our effective tax rate for the first quarter of 2020 was (15.8)%; excluding the impact of the $1.2 million one-time benefit, the effective tax rate for the first quarter of 2020 would have been 25.0%.

 

Income tax expense for the first quarter of 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for retroactive application to the taxability of income from BOLI contracts that were acquired in certain tax-free merger transactions. As a result of this change, we recognized a $232 thousand net reduction in income tax expense in the first quarter of 2019 pertaining to BOLI income that was earned, and initially treated as subject to income tax, in 2018. Our effective tax rate for the first quarter of 2019 was 21.6%; excluding the impact of this item, the effective tax rate for the first quarter 2019 would have been 25.9%.

 

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Nonperforming and Problem Assets

 

We perform reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a timely manner.

 

Loans are 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 we have serious doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are placed on a non-accrual status, unpaid accrued interest is fully reversed, and subsequent income, if any, 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.

 

Under GAAP we are required to account for certain loan modifications or restructurings as troubled debt restructurings (“TDRs”). In general, the modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant 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 constitute troubled debt restructurings. We believe loan modifications will potentially result in a lower level of loan losses and loan collection costs than if we proceeded immediately through the foreclosure process with these borrowers.

 

On March 22, 2020, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

 

The Company provided COVID-19 related loan modifications to both commercial and retail customers, on a case by case basis, in the form of payment deferrals for periods up to six months. As of March 31, 2020, a total of $101 million of loans (or 5.7% of the loan portfolio) had been modified through payment deferrals.

 

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

 

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(in thousands)  March 31,
2020
   December 31,
2019
 
Non-accrual loans:          
Real estate loans:          
Construction and land  $478   $481 
Residential - first lien   11,505    12,162 
Residential - junior lien   832    786 
Commercial owner occupied   477    566 
Commercial non-owner occupied   1,777    1,725 
Commercial and leases   700    1,960 
Consumer   102    127 
Total non-accrual loans   15,871    17,807 
Accruing troubled debt restructured loans:          
Real estate loans:          
Residential - first lien   965    968 
Commercial and leases   367    367 
Total accruing troubled debt restructured loans   1,332    1,335 
Total non-performing loans   17,203    19,142 
Other real estate owned:          
Land   1,327    1,559 
Residential - first lien   995    1,344 
Commercial non-owner occupied   -    195 
Total other real estate owned   2,322    3,098 
Total non-performing assets  $19,525   $22,240 
Ratios:          
Non-performing loans to total gross loans   0.98%   1.10%
Non-performing assets to total assets   0.78%   0.94%
Loans past due 90 days still accruing:          
Real estate loans:          
Residential - first lien  $973   $47 
Residential - junior lien   60    - 
Commercial owner occupied   338    - 
Commercial non-owner occupied   194    - 
Consumer   1    - 
Total loans past due 90 days and still accruing  $1,566   $47 

 

Nonperforming Loans

 

Included in non-accrual loans at March 31, 2020 are four troubled debt restructured loans (“TDRs”) with a new carrying balance totaling $807 thousand that were not performing in accordance with their modified terms, and the accrual of interest has ceased. In addition, there were four TDRs totaling $1.3 million that were performing in accordance with their modified terms at March 31, 2020. There were no additional troubled loans restructured during the first three months of 2020.

 

Nonperforming loans were $17.2 million, or 0.98% of total loans and leases, at March 31, 2020 and were down $1.9 million from $19.1 million, or 1.10% of total loans and leases, at December 31, 2019. The decrease was the result of $1.3 million in payoffs and $583 thousand of charge-offs in the first quarter. $564 thousand of the first quarter 2020 nonperforming loan charge-offs were attributable to the full charge-off of loans to one borrower where we had recorded a specific allocation of the allowance for credit losses of $500 thousand at December 31, 2019.

 

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The composition of our nonperforming loans at March 31, 2020 is further described below:

 

Non-Accrual Loans:

·Two construction and land loans
·45 residential first lien loans, two with a combined fair value of $2.4 million in the process of foreclosure
·21 residential junior lien loans, one with a fair value of $23 thousand in the process of foreclosure
·Two commercial owner-occupied loans
·Six commercial non-owner-occupied loans
·Four commercial loans
·One consumer loan

 

Accruing Troubled Debt Restructured Loans:

·Two residential real estate loans
·Two commercial loans

 

Nonperforming Assets

 

Our nonperforming assets were $19.5 million, or 0.78% of total assets, at March 31, 2020 compared to $22.2 million, or 0.94% of total assets, at December 31, 2019. Nonperforming assets consist of nonperforming loans and other real estate owned. Nonperforming assets decreased $2.7 million during the first quarter of 2020, with $1.9 million of the decrease attributable to nonperforming loans and $776 thousand attributable to a decrease in other real estate owned.

  

Other Real Estate Owned

 

Real estate we acquire as a result of foreclosure is classified as Other Real Estate Owned (“OREO”). When a property is acquired as a result of foreclosure, it is recorded at fair value less the anticipated cost to sell at the date of foreclosure. If there is a subsequent change in the value of OREO, we record a valuation allowance to adjust the carrying value of the real estate to its current fair value less estimated disposal costs. Costs relating to holding such real estate are expensed in the current period while costs relating to improving such real estate are capitalized up to the property’s net realizable value until a saleable condition is reached. Costs in excess of the property’s net realizable value would be expensed in the current period.

 

Our OREO totaled $2.3 million at March 31, 2020, a $776 thousand decrease from $3.1 million at December 31, 2019. Included in noninterest expenses during the first quarter of 2020 were $21 thousand attributable to net increases in valuation allowances as the current appraised value of OREO properties, less estimated cost to sell, was insufficient to cover the recorded OREO amount. There was no valuation expense for the same period of 2019. In addition, we sold one parcel of land, one commercial real estate property, and one residential real estate property with a combined net carrying balance of $755 thousand; these sales resulted in a $28 thousand net loss on the disposition of OREO during the quarter. There were no additions to OREO during the first quarter of 2020.

 

OREO at March 31, 2020 consisted of:

 

·Several parcels of unimproved land.
·Three residential 1-4 family properties.

  

Allowance for Credit Losses

 

Our allowance for credit losses (the “allowance”) at March 31, 2020 was $13.4 million, up $3.0 million from $10.4 million at December 31, 2019. Net charge-offs for the quarter were $462 thousand while a $3.4 million provision for credit losses was recorded during the quarter. The allowance was 0.76% of total loans and leases at March 31, 2020, an increase of 16 bp from 0.60% of total loans and leases at December 31, 2019.The allowance was also 77.80% of nonperforming loans at March 31, 2020, an increase of 43% from 54.33% of nonperforming loans at December 31, 2019. The $3.0 million increase in our allowance was primarily the result of management’s response to the COVID-19 pandemic and changes in the qualitative factors discussed below.

  

COVID-19 and Our Evaluation of the Allowance

 

The March 31, 2020 allowance reflects management’s initial assessment of the impact of COVID-19 on the national and local economies and the impact on various categories of our loan portfolio. Our approach to COVID-19 and the evaluation of the allowance considered the following: (1) any change in historical loss rates resulting from COVID-19; (2) any risk rating downgrades related to COVID-19; and (3) any changes to collateral valuations or cash flow assumptions for impaired loans. Based on our review, we determined that there were no initial impacts to any of these factors at March 31, 2020.

 

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We then reviewed our qualitative factors and identified three factors that warranted further evaluation:

 

·Changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments;
·The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
·Changes in the value of underlying collateral for collateral-dependent loans.

 

Our evaluation of changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, considered the abrupt slowdown in commercial economic activity resulting from actions announced by the State of Maryland between the March 5 disclosure of the first confirmed cases of COVID-19 in the state and the March 23 executive order closing all non-essential businesses in the state. In addition, we considered the dramatic rise in the unemployment rate in our market area. Based on U.S. Department of Labor weekly initial unemployment claims by state, we noted that the average weekly initial unemployment claims for the State of Maryland during the two weeks ending March 28, 2020 were 19 times higher than the average weekly claims for the first eleven weeks of 2020. An increase in this qualitative factor was applied to all loan portfolio categories.

 

We also evaluated the existence and effect of any concentrations of credit, and changes in the level of such concentrations. We performed an analysis of our loan portfolio to identify our exposure to industry segments that we believe may potentially be the most highly impacted by COVID-19. Based on our evaluation, the following table identifies those industry segments within our loan portfolio that we believe may potentially be most highly impacted by COVID-19. Loan balances and total credit exposures are as of March 31, 2020 while the modification and SBA PPP balances are as of April 24, 2020.

 

(in millions)
Loan Category
  Loan Balance   As % of Total Loans   Total Exposure   As % of Total Exposure   Balance with Modifications   As % of Loan Category   SBA PPP Loan Relief   As % of Loan Category 
CRE - retail  $109.8    6.2%  $112.0    5.3%  $21.5    19.6%  $-    -%
Hotels   61.5    3.5    67.0    3.2    53.5    87.0    0.9    1.5 
CRE - residential rental   50.3    2.9    51.4    2.4    10.9    21.7    -    - 
Nursing and residential care   39.8    2.3    46.3    2.2    -    -    1.8    4.5 
Retail trade   26.3    1.5    37.3    1.8    1.1    4.2    6.3    24.0 
Restaurants and caterers   26.1    1.5    29.0    1.4    19.5    74.7    8.9    34.1 
Religious and similar organizations   27.6    1.6    28.6    1.4    2.9    10.5    2.7    9.8 
Arts, entertainment, and recreation   16.2    0.9    18.5    0.9    14.5    89.5    1.3    8.0 
Total - selected categories  $357.6    20.3%  $390.1    18.6%  $123.9    34.6%  $21.9    6.1%

 

The potentially highly impacted loan exposures noted in the above table (the “high impacts”) were concentrated in non-owner-occupied commercial real estate (59% of total high impacts), owner-occupied commercial real estate (18% of total high impacts), commercial construction (14% of total high impacts), and commercial loans (9% of total high impacts). An increase in this qualitative factor was applied to these high impact loan portfolio categories.

 

Our evaluation of potential changes in the value of underlying collateral for collateral-dependent loans considered the potential impact of the economic fallout from COVID-19 on commercial property values due to rent relief and possible business failures resulting in vacancies. In addition, the need for office space may diminish in the future as work from home policies have allowed much office-oriented business activity to continue. Excluding the high impact portfolios, we concluded that 53% of our non-owner-occupied commercial real estate portfolio was not included in the high impact exposure. An increase in this qualitative factor was applied to our non-owner-occupied commercial real estate portfolio.

  

Credit Risk Management and Allowance Methodology

 

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 that, 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.

 

In accordance with accounting guidance for business combinations, there was no allowance for credit losses brought forward on any acquired loans in our acquisitions. For acquired performing loans, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to originated loans, and if necessary, additional reserves are recognized in the allowance for credit losses.

 

We recorded acquired credit impaired loans in our acquisitions net of purchase accounting adjustments. Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance for credit losses through a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.

 

1)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

 

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2)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. Our periodic evaluation of the adequacy of the allowance is based on 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 we 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. We determine 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, our 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 our 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 non-accrual 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, and practices;
·changes in international, national, state and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments;
·changes in the nature and volume of the loan portfolio;
·changes in the experience, ability and depth of the lending staff;
·changes in the volume and severity of past due, nonaccrual, and adversely classified loans;
·changes in the quality of our loan review system;
·changes in the value of underlying collateral for collateral-dependent loans;
·the existence of any concentrations of credit, and changes in the level of such concentrations;
·the effect of other external factors such as competition and legal and regulatory requirements; and

·any other factors that management 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.

 

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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 or present value of expected cash flows 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.

 

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 periods ended:

 

(in thousands)  March 31,
2020
   December 31,
2019
 
Balance at beginning of year  $10,401   $9,873 
Charge-offs:          
Real estate          
Construction and land loans   -    (282)
Residential first lien loans   (33)   (518)
Residential junior lien loans   -    (532)
Commercial owner occupied loans   -    (46)
Commercial non-owner occupied loans   -    (2,026)
Commercial loans and leases   (549)   (622)
Consumer loans   (1)   (210)
Total charge-offs   (583)   (4,236)
Recoveries:          
Real estate          
Construction and land loans   -    80 
Residential first lien loans   3    - 
Residential junior lien loans   51    115 
Commercial non-owner occupied loans   -    17 
Commercial loans and leases   66    357 
Consumer loans   1    2 
Total recoveries   121    571 
Net charge-offs   (462)   (3,665)
Provision for credit losses   3,445    4,193 
Balance at end of year  $13,384   $10,401 
           
Net charge-offs to average loans and leases(1)   0.10%   0.22%
Provision for credit losses to average loans and leases(1)   0.78   0.25

 

(1) Annualized          

 

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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.

 

   March 31, 2020   December 31, 2019 
(in thousands)  Amount   Percent (1)   Amount   Percent (1) 
Real estate loans:                    
Construction and land loans  $1,192    7.4%  $1,256    7.3%
Residential first lien loans   2,204    24.4    2,256    25.1 
Residential junior lien loans   863    4.0    478    4.2 
Commercial owner occupied loans   1,254    14.1    788    13.9 
Commercial non-owner occupied loans   4,130    25.5    2,968    25.4 
Total real estate loans   9,643    75.4    7,746    75.9 
Commercial loans and leases   2,950    22.1    2,103    21.4 
Consumer loans   791    2.5    552    2.7 
Total  $13,384    100.0%  $10,401    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, 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 (“ALCO”) 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 March 31, 2020 and December 31, 2019.

 

We regularly monitor and adjust our investments in liquid assets based upon our assessment of:

 

·Expected loan demand;
·Expected deposit flows and borrowing maturities;
·Yields available on interest-earning deposits and securities; and
·The objectives of our asset/liability management program.

 

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.

 

Excess liquid assets are invested generally in interest-bearing deposits in banks (primarily the FRB) and short-term investment securities.

 

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The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At March 31, 2020 and December 31, 2019, interest-bearing deposits in banks totaled $180.0 million and $97.0 million, respectively. As the threat of market disruption in response to the COVID-19 pandemic appeared during the quarter, combined with concerns of potentially higher than normal commercial line utilization and possible reductions in customer deposits, we grew our on-balance sheet liquidity with higher balances held at the FRB. Since there is sufficient liquidity in the market at this time, we will be reducing these balances during the second quarter of 2020.

 

Our total commitments to extend credit and available credit lines are discussed in the following section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, including a table presenting our comparative exposure at March 31, 2020 and December 31, 2019.

 

CDs due within one year totaled $563.4 million, or 31.5% of total deposits, and $458.9 million, or $26.8% of total deposits, at March 31, 2020 and December 31, 2019, respectively. If we do not retain these deposits, 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 CDs held in our portfolio. We believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of our CDs with maturities of one year or less as of March 31, 2020.

 

Our primary investing activity is originating loans. During the first quarter of 2020, cash used to fund net loan growth was $16.2 million, while for the first quarter of 2019 loan principal payments exceeded new loans, which provided $193 thousand in cash. During the first quarter of 2020 we purchased $64.4 million of securities while securities maturities, calls, and principal repayments totaled $10.4 million. For the same period in 2019, we purchased $5.0 million of securities while securities maturities, calls, and principal repayments totaled $38.9 million.

 

Financing activities consist primarily of activity in deposit accounts and FHLB advances. For the first quarter of 2020, our deposit growth was $74.5 million compared to a net decrease in deposits of $12.3 million during the first quarter of 2019. 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 increased to $344.0 million at March 31, 2020 compared to $285.0 million at December 31, 2019. At March 31, 2020, we had an available line of credit for $593.6 million at the FHLB, with borrowings limited to a total of $466.4 million based on pledged collateral. This provides us with $122.4 million of borrowing availability at March 31, 2020.

 

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 March 31, 2020 and December 31, 2019, we exceeded all regulatory capital requirements. We are 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 that would have a material effect on us.

 

Total commitments to extend credit and available credit lines at March 31, 2020 and December 31, 2019 are as follows:

 

(in thousands)  March 31,
2020
   December 31,
2019
 
Unfunded loan commitments  $78,746   $77,314 
Unused lines of credit   291,675    309,519 
Letters of credit   15,395    13,853 
Total commitments to extend credit and available credit lines  $385,816   $400,686 

 

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.

 

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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 consolidated balance sheets at March 31, 2020 or December 31, 2019 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

 

Liquidity and Funding

 

The objective of effective liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities/withdrawals, and other cash commitments efficiently under both normal operating conditions as well as under unforeseen and unpredictable circumstances of industry or market stress. To achieve this objective, ALCO establishes and monitors liquidity guidelines requiring sufficient asset based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. We manage liquidity at both the parent and subsidiary levels through active management of the balance sheet.

 

The additional information called for by this item is incorporated herein by reference to the “Liquidity and Capital Resources” section of Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Quarterly Report on Form 10-Q.

 

Interest Rate Risk

 

Interest rate risk, one of the more prominent risks in terms of potential earnings impact, is an inevitable part of being a financial intermediary. It can occur for any one or more of the following reasons: (a) assets and liabilities may mature or reprice at different times (for example, if assets reprice faster than liabilities and interest rates are generally falling, our earnings will initially decline); (b) assets and liabilities may re-price at the same time but by different amounts (when the general level of interest rates is falling, we may choose for customer management, competitive, or other reasons to reduce the rates paid on checking and savings deposit accounts by an amount that is less than the general decline in market interest rates); (c) short-term and long-term market interest rates may change by different amounts (i.e. the shape of the yield curve may impact new loan yields and funding costs differently); or (d) the remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change (for example, mortgage-backed securities held in the securities available for sale portfolio may prepay significantly earlier than anticipated – with an associated reduction in portfolio yield and income – if long-term mortgage rates decline sharply). In addition to the direct impact of interest rate changes on net interest income through these categories, interest rates indirectly impact earnings through their effect on loan demand, credit losses, mortgage origination fees, and other sources of our earnings.

 

In determining the appropriate level of interest rate risk, we consider the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. We believe that short term interest rate risk is best measured by simulation modeling. We prepare a current base case and standard alternative scenarios at least once quarterly and report the analysis both internally to the Asset / Liability Committee and to the Board of Directors. More frequent or alternative scenarios are often prepared at our discretion.

 

The balance sheet is subject to quarterly testing for the standard alternative interest rate shock possibilities to indicate the inherent interest rate risk. Current and forward rates are shocked by +/- 100, +/- 200, +300, and +400 bp. Certain scenarios may be impractical under different economic circumstances. We seek to structure the balance sheet so that net interest income at risk over a twelve month period does not exceed policy guidelines at the various interest rate shock levels.

 

Measures of the net interest income at risk produced by the simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. The measures are typically based upon a relatively brief period, usually one year, and do not provide meaningful insight into the institution’s long-term performance. Our net interest income exposure to these rate shocks at both March 31, 2020 and December 31, 2019 are presented in the following table. Due to relatively low current market interest rates, it was not possible to calculate the down 200 bp scenario because many of the market interest rates would fall below zero in that scenario. In addition, the down 100 bp scenarios assumes no market interest rates fall below zero. All measures were in compliance with our policy limits.

 

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Estimated Change in Net Interest Income                    
Change in interest rates:  + 400 bp   + 300 bp   + 200 bp   + 100 bp   - 100 bp   - 200 bp 
Policy limits   -15%   -12%   -10%   -10%   -10%   -12%
March 31, 2020   1.0%   1.4%   1.5%   1.4%   -1.4%   na 
December 31, 2019   -13.1%   -9.7%   -6.3%   -3.0%   -0.6%   na 

 

Item 4.Controls and Procedures

 

As required by SEC rules, the Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of March 31, 2020. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by the Company 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.

 

There were no material changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2020, that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

 

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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

 

Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as well as cautionary statements contained in this report, including those under the caption “Forward-Looking Statements,” risks and matters described elsewhere in this report and in our other filings with the SEC.

 

We are providing these additional risk factors to supplement the risk factors contained in Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2019.

 

The COVID-19 pandemic has adversely affected our business and results of operations, and the ultimate impacts of the pandemic on our business, financial condition and results of operations will depend on future developments and other factors that are highly uncertain and will be impacted by the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

 

The ongoing COVID-19 global and national health emergency has caused significant disruption in the international and United States economies and financial markets and has had an adverse effect on our business and results of operations. The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability. In response to the COVID-19 pandemic, the State of Maryland and most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential. These restrictions and other consequences of the pandemic have resulted in significant adverse effects for many different types of businesses, including, among others, those in the travel, hospitality and food and beverage industries, and have resulted in a significant number of layoffs and furloughs of employees nationwide and in the markets in which we operate.

 

The ultimate effects of COVID-19 on the broader economy and the markets that we serve are not known nor is the ultimate length of the restrictions described above and any accompanying effects. Moreover, the Federal Reserve has taken action to lower the Federal Funds rate, which may negatively affect our interest income and, therefore, earnings, financial condition and results of operation. Additional impacts of COVID-19 on our business could be widespread and material, and may include, or exacerbate, among other consequences, the following:

 

·employees contracting COVID-19;
·reductions in our operating effectiveness as our employees work from home;
·a work stoppage, forced quarantine, or other interruption of our business;
·unavailability of key personnel necessary to conduct our business activities;
·effects on key employees, including operational management personnel and those charged with preparing, monitoring and evaluating our financial reporting and internal controls;
·sustained closures of our branch lobbies or the offices of our customers;
·declines in demand for loans and other banking services and products;
·declines in the stability of our deposit base, as well as our capital and liquidity position;
·reduced consumer spending due to both job losses and other effects attributable to COVID-19;
·unprecedented volatility in United States financial markets;
·volatile performance of our investment securities portfolio;
·decline in the credit quality of our loan portfolio, owing to the effects of COVID-19 in the markets we serve, leading to a need to increase our allowance for credit losses;
·declines in value of collateral for loans, including real estate collateral;
·declines in the net worth and liquidity of borrowers and loan guarantors, impairing their ability to honor commitments to us;  and
·declines in demand resulting from businesses being deemed to be “non-essential” by governments in the markets we serve, and from “non-essential” and “essential” businesses suffering adverse effects from reduced levels of economic activity in our markets.

 

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These factors, together or in combination with other events or occurrences that may not yet be known or anticipated, may materially and adversely affect our business, financial condition and results of operations.

 

In March 2020, we announced programs to support our customers, employees, and communities during the COVID-19 pandemic. A significant number of our borrowers have enrolled in one of our programs to defer all loan payments for periods of up to six months. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time.

 

The ongoing COVID-19 pandemic has resulted in meaningfully lower stock prices for many companies, as well as the trading prices for many other securities. The further spread of the COVID-19 outbreak, as well as ongoing or new governmental, regulatory and private sector responses to the pandemic, may materially disrupt banking and other economic activity generally and in the areas in which we operate. This could result in further decline in demand for our banking products and services, and could negatively impact, among other things, our liquidity, regulatory capital and our growth strategy. Any one or more of these developments could have a material adverse effect on our business, financial condition and results of operations.

 

We are taking precautions to protect the safety and well-being of our employees and customers. However, no assurance can be given that the steps being taken will be adequate or deemed to be appropriate, nor can we predict the level of disruption which will occur to our employee’s ability to provide customer support and service. If we are unable to recover from a business disruption on a timely basis, our business, financial condition and results of operations could be materially and adversely affected. We may also incur additional costs to remedy damages caused by such disruptions, which could further adversely affect our business, financial condition and results of operations.

 

The extent to which COVID-19 impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the pandemic, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after COVID-19 has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’ global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future.

 

There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. However, the effects could have a material impact on our results of operations and heighten many of our known risks described in “Item 1.A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019.

 

As a participating lender in the SBA Paycheck Protection Program (“PPP”), we are subject to additional risks of litigation from our customers or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.

 

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Stability Act, or CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes us to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. On April 24, 2020, an additional $320 billion of PPP loan funding was authorized. Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. We may be exposed to the risk of litigation, from both customers and non-customers that approached us regarding PPP loans, regarding our process and procedures used in processing applications for the PPP. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.

 

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We also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by us, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by us, the SBA may deny our liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

 

The outbreak of COVID-19, or an outbreak of other highly infectious or contagious diseases, could disrupt banking and other financial activity in the areas in which we operate and could potentially create widespread business continuity issues for us.

      

Our business is dependent upon the willingness and ability of our employees and customers to conduct banking and other financial transactions. We rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Furthermore, the outbreak could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in Maryland where we operate and could create widespread business continuity issues for us. We have already shifted a substantial portion of our workforce to work remotely and have restricted access to our branch lobbies. However, we could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas. We also face heightened cybersecurity, information security and operational risks as a result of work-from-home arrangements.

 

The borrowing needs of our clients may increase, especially during this challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit.

 

A commitment to extend credit is a formal agreement to lend funds to a client as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our clients under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Because of the credit profile of our clients, we typically have a substantial amount of total unfunded credit commitments, which is not reflected on our balance sheet. As of March 31, 2020, we had $386 million in unfunded credit commitments to our clients. Actual borrowing needs of our clients may exceed our expectations, including due to the COVID-19 pandemic, as our clients’ companies may be more dependent on our credit commitments due, among other things, business challenges, a lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from private investment firms. This could adversely affect our credit quality and our liquidity, which could adversely affect our ability to fund operations and meet obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.

 

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

 

Issuer Repurchases of Equity Securities

 

On April 24, 2019, our Board of Directors authorized a stock repurchase program under which we were permitted to repurchase, from time to time, up to $7.0 million of our outstanding common shares. As of February 24, 2020, we had repurchased all remaining shares under the stock repurchase program, resulting in a total of 392,565 shares repurchased at an average price paid per share of $17.83

 

The following table reflects information regarding our share repurchases for the three months ended March 31, 2020:

 

Period 

Total Number

of Shares

Purchased

  

Average Price

Paid per Share

  

Total Number of

Shares Purchased

as Part of Publicly

Announced Plans

or Programs

  

Maximum Dollar

Value of Shares

that May Yet Be

Purchased Under

the Plans or

Programs

 
January 1, 2020 - January 31, 2020   101,301   $17.39    101,301   $4,915,919 
February 1, 2020 - February 29, 2020   271,500    18.11    271,500    - 
March 1, 2020 - March 31, 2020   -    -    -    - 
Total   372,801   $17.91    372,801      

 

Item 3. Defaults Upon Senior Securities

 

None

 

Item 4. Mine Safety Disclosures

 

Not applicable

 

Item 5. Other Information

 

None

 

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Item 6.Exhibits

 

31.1Certification 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
31.2Certification 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
32Certifications pursuant to 18 U.S.C. Section 1350, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith
101Extensible 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

 

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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)  
       
May 11, 2020      /s/ Mary Ann Scully  
Date       Mary Ann Scully  
       Chairman and Chief Executive Officer  
       
May 11, 2020      /s/ Robert L. Carpenter, Jr.  
Date       Robert L. Carpenter, Jr.  
       Chief Financial Officer  

 

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