The accounting and reporting policies of Severn Bancorp, Inc. and subsidiaries (the “Company”) conform to accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) and prevailing practices within the financial services industry for interim financial information and Rule ~~8-01~~8‑01 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete financial statements and prevailing practices within the banking industry. In the opinion of management, all adjustments (comprising only of those of a normal recurring nature) necessary for a fair presentation of the results of operations for the interim periods presented have been made. The results of operations for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, ~~2017~~2019 or any other interim or future period. Events occurring after the date of the financial statements up to~~November 14, 2017~~, the date the financial statements were available to be issued were considered in the preparation of the consolidated financial statements.

These statements should be read in conjunction with the financial statements and accompanying notes included in the Company’s ~~2016~~2018 Annual Report on Form ~~10-K~~10‑K as filed with the Securities and Exchange Commission (“SEC”).

The unaudited consolidated financial statements include the accounts of Severn Bancorp, Inc., and its wholly-owned subsidiaries, Mid-Maryland Title Company, Inc., SBI Mortgage Company, and ~~SBI Mortgage Company’s subsidiary, Crownsville Development Corporation, and its subsidiary, Crownsville Holdings I, LLC, and~~ Severn Savings Bank, FSB (the “Bank”), ~~and~~along with the Bank’s subsidiaries, Louis Hyatt, Inc., Homeowners Title and Escrow Corporation, Severn Financial Services Corporation, SSB Realty Holdings, LLC, SSB Realty Holdings II, LLC, and HS West, LLC. Also included are the accounts of SBI Mortgage Company’s subsidiary, Crownsville Development Corporation, and its subsidiary, Crownsville Holdings I, LLC. All intercompany accounts and transactions have been eliminated in the accompanying consolidated financial statements.

~~Acquisition~~

On September 1, 2017, we acquired Mid-Maryland Title Company, Inc. (the “Title Company”) by issuing stock in a business combination. We issued 108,084 shares in the transaction valued at $775,000. We recorded $759,000 in goodwill in the transaction. The acquisition continues our growth strategy and focus on being a full-service provider and complements the mortgage services, commercial banking services, and commercial real estate services we provide. The acquisition of the Title Company has not had a material effect on the Company’s financial condition or results of operations.

The 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 ~~that~~ affect the reported amounts of assets and liabilities ~~and disclosure of contingent assets and liabilities as of~~at the date of the financial statements and ~~affect~~ the reported amounts of ~~revenues earned~~income and expenses ~~incurred~~ during the ~~reporting period. Actual results could differ from~~periods presented. The accounting policies we view as critical are those ~~estimates. Estimates that could change significantly relate~~relating to the ~~provision for loan losses and the related~~ allowance for loan losses (“Allowance”), ~~determination of impaired loans and~~ the ~~related measurement of impairment,~~ valuation of ~~investment~~ securities, the valuation of real estate acquired through foreclosure, and the valuation of share-based compensation, the assessment that a liability should be recognized with respect to any matters under litigation, and the calculation of current and deferred income taxes and the realizability of net deferred tax ~~assets.~~

We consider all highly liquid securities with original maturities of three months or less to be cash equivalents. For reporting purposes, assets grouped in the Consolidated Statements of ~~reporting cash flows, cash and cash equivalents include cash~~Financial Condition under the captions “Cash and due from ~~banks, federal~~banks” and “Federal funds sold and ~~interest-earning~~interest-bearing deposits ~~with banks.~~

Certain reclassifications have been made to amounts previously reported to conform to current period presentation.

In ~~March~~February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) ~~No. 2016-09,~~ ~~Stock Compensation: Improvements to Employee Share-Based Payment Accounting~~2016‑02, , the purpose of which is to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liability, and classification on the statement of cash flows. ASU No. 2016-09 is effective for interim and annual reporting periods beginning after December 15, 2016. Early application is permitted. The adoption of the guidance did not have a material effect on the Company’s financial position, results of operation, or cash flows. We have elected to account for stock option forfeitures when they occur.

~~In May 2014, FASB issued ASU No. 2014-09,~~ ~~Revenue from Contracts with Customers,~~ ~~as amended by ASU 2015-14,~~ ~~Revenue from Contracts with Customers: Deferral of the Effective Date,~~ ~~ASU 2016-08, Revenue from Contracts with Customers: Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net),~~ ~~ASU 2016-10, Revenue from Contracts with Customers, Identifying Performance Obligations and Licensing,~~ ~~ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients,~~ ~~ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue form Contracts with Customers,~~ that provides accounting guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to customers. The guidance also provides for a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate. This standard may affect an entity’s financial statements, business processes and internal control over financial reporting. The standard is effective for interim and annual periods beginning after December 15, 2017. The standard must be adopted using either a full retrospective approach for all periods presented in the period of adoption or a modified retrospective approach. The following revenue streams were identified to be within the scope of ASU No. 2014-09: real estate commissions, real estate management fees, and deposit service charges. For all affected revenue streams, we are currently planning to use a modified retrospective approach to uncompleted contracts at the date of adoption. Periods prior to the date of adoption are not retrospectively revised, but a cumulative effect of adoption is recognized for the impact of the ASU on uncompleted contracts at the date of adoption. We are still evaluating the impact of guidance in this update, including method of implementation, and related changes to disclosures that may be required.

~~In January 2016, FASB issued ASU No. 2016-01,~~ ~~Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities~~, which requires entities to measure equity investments at fair value and recognize changes on fair value in net income. The guidance also provides a new measurement alternative for equity investments that do not have readily determinable fair values and don’t qualify for the net asset value practical expedient. Entities will have to record changes in instrument–specific credit risk for financial liabilities measured under the fair value option in other comprehensive income, except for certain financial liabilities of consolidated collateralized financing entities. Entities will also have to reassess the realizability of a deferred tax asset related to an available-for-sale (“AFS”) debt security in combination with their other deferred tax assets. For public entities, the guidance in this ASU is effective for the first interim or annual period beginning after December 15, 2017. Early adoption by public entities is permitted as of the beginning of the year of adoption for selected amendments by a cumulative effect adjustment to the balance sheet. The adoption of this standard is not expected to have a material impact on the Company’s financial position, results of operations, or cash flows.

~~In February 2016, FASB issued ASU 2016-02,~~ Leases, which requires a lessee to recognize the assets and liabilities that arise from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease payments and a ~~“right-of-use”~~right-of-use (“ROU”) asset. The accounting applied by the lessor is relatively unchanged. The ASU also requires expanded qualitative and quantitative disclosures. For public business entities, the guidance iswas effective for interim and annual reporting periods beginning after December 15, 2018 and mandates a modified retrospective transition for all entities. ~~Early application is permitted.~~ We ~~have determined that~~adopted this standard using the option to apply the transition provisions of the new standard at the adoption date instead of the earliest period presented as provided in ASU ~~No.~~2018-11. Additionally, we elected to apply all practical expedients as provided in ASU 2016-02, ~~may~~with the exception of the hindsight practical expedient which was not elected. As a result of the adoption of this standard, effective January 1, 2019, we recognized both an ROU asset and a lease liability of $2.7 million to be recorded in ~~an increase in~~other assets ~~to recognize~~and other liabilities, respectively, on the balance sheet. The lease liability represents the present value of the future payments on five leased properties and six leased pieces of equipment within the Company’s footprint, while the ROU asset reflects the lease ~~obligations, with~~liability adjusted for deferred rent balances of the respective properties as of the adoption date of January 1, 2019. The Company expects its regulatory capital ratios to remain above the thresholds necessary to be classified as a ~~corresponding increase in liabilities, however, we do~~“well capitalized” institution.

In March 2017, FASB issued ASU No. 2017‑08, Receivables - Nonrefundable Fees and Other costs, which provides guidance that called for the shortening of the amortization period for certain callable debt securities held at a premium. The standard was effective for interim and annual reporting periods beginning after December 15, 2018. The adoption of ASC No. 2017‑08 did not ~~expect this to~~ have a material impact on our financial position, results of operations, or cash flows.

In February 2018, FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects From Accumulated Other Comprehensive Income, which allowed a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The ASU is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The adoption of ASU No. 2018-02 did not have a material impact on its financial position, results of operations, or cash flows.

Pronouncements Issued

In June 2016, FASB issued ASU No. ~~2016-13,~~ 2016‑13, Financial Instruments – Credit Losses, which sets forth a current expected credit loss (“CECL”) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. In July 2019, the FASB issued a proposal to delay the implementation for smaller reporting companies such as us until January 2023; however, that proposal is not final as of the filing of this Quarterly Report on Form 10-Q.

We have contracted with a third party vendor to assist in the transition to CECL. The Bank has purchased the third party vendor’s CECL software and has separately contracted with their advisory services group to help with the installation and transition. As the Bank has been using other software of this specific vendor, they have access to the Bank’s historical data. The third party vendor has been analyzing the Bank’s data, and the Bank has been updating the data to provide the information necessary for CECL calculations. The third party vendor has also begun determining which economic factors are most directly responsible for losses. They have started to recommend pools to be used for CECL calculations, and appropriate methods (as proscribed by CECL) to calculate the reserve for the various pools. As the third party vendor has many financial institution clients, they will be able to provide peer group data to the extent the Bank’s data is not sufficient to make the many determinations required under CECL. The current plan is to be running the CECL and the incurred loss model in parallel during the fourth quarter of 2019 and be in position to completely transition to CECL by the required date.

~~In August 2016, FASB issued ASU No. 2016-15,~~ ~~Classification of Certain Cash Receipts and Cash Payments,~~ which provides guidance regarding the presentation of certain cash receipts and cash payments in the statement of cash flows, addressing eight specific cash flow classification issues, in order to reduce existing diversity in practice. The standard is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted. We do not expect the adoption of ASC No. 2016-15 to have a material impact on our financial position, results of operations, or cash flows.

~~In March 2017, FASB issued ASU No. 2017-08,~~ ~~Receivables - Nonrefundable Fees and Other costs,~~ which provides guidance that calls for the shortening of the amortization period for certain callable debt securities held at a premium. The standard is effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. We do not expect the adoption of ASC No. 2017-08 to have a material impact on our financial position, results of operations, or cash flows.

The amortized cost and ~~estimated~~ fair values of our ~~AFS~~available-for-sale (“AFS”) securities portfolio were as ~~follows as of September 30, 2017:~~follows:


	June 30, 2019
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses		Fair Value
	(dollars in thousands)
U.S. Treasury securities	$	1,997	$	—	$	2	$	1,995
U.S. government agency notes		9,051		—		15		9,036
	$	11,048	$	—	$	17	$	11,031


	December 31, 2018
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses		Fair Value
	(dollars in thousands)
U.S. Treasury securities	$	1,992	$	—	$	11	$	1,981
U.S. government agency notes		10,086		—		89		9,997
	$	12,078	$	—	$	100	$	11,978

Amortized
Cost

Unrealized
Gains

Unrealized
Losses

Estimated
Fair Value

(dollars in thousands)
U.S. government agency notes $ 3,135 $ - $ 6 $ 3,129

~~We did not hold any AFS securities as of December 31, 2016.~~

The amortized cost and ~~estimated~~ fair values of our held-to-maturity (“HTM”) securities portfolio were as follows:


	June 30, 2019
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
	(dollars in thousands)
U.S. Treasury securities	$	1,992	$	23	$	—	$	2,015
U.S. government agency notes		8,989		103		24		9,068
Mortgage-backed securities		22,581		83		39		22,625
	$	33,562	$	209	$	63	$	33,708


	December 31, 2018
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
	(dollars in thousands)
U.S. Treasury securities	$	1,991	$	17	$	—	$	2,008
U.S. government agency notes		11,992		45		92		11,945
Mortgage-backed securities		24,929		6		676		24,259
	$	38,912	$	68	$	768	$	38,212

9

September 30, 2017

Amortized
Cost

Unrealized
Gains

Unrealized
Losses

Estimated
Fair Value

(dollars in thousands)
U.S. Treasury securities $ 7,996 $ 106 $ - $ 8,102
U.S. government agency notes 19,008 137 43 19,102
Mortgage-backed securities 31,760 97 102 31,755
$ 58,764 $ 340 $ 145 $ 58,959

December 31, 2016

Amortized
Cost

Unrealized
Gains

Unrealized
Losses

Estimated
Fair Value

(dollars in thousands)
U.S. Treasury securities $ 12,998 $ 167 $ - $ 13,165
U.S. government agency notes 20,027 133 54 20,106
Mortgage-backed securities 29,732 52 228 29,556
$ 62,757 $ 352 $ 282 $ 62,827

~~Three~~

Table of Contents

Gross unrealized losses and fair value by length of time that the individual AFS securities ~~were~~have been in an unrealized loss position ~~as of September 30, 2017 for less than twelve months, with~~at the ~~largest single unrealized loss~~dates indicated are presented in ~~any one security amounting to~~ ~~$3,000.~~the following tables:


	June 30, 2019
	Less than 12 months					12 months or more					Total
	# of	Fair		Unrealized		# of	Fair		Unrealized		# of	Fair		Unrealized
	Securities	Value		Losses		Securities	Value		Losses		Securities	Value		Losses
	(dollars in thousands)
U.S. Treasury securities	—	$	—	$	—	2	$	1,995	$	2	2	$	1,995	$	2
U.S. government agency notes	—		—		—	7		9,036		15	7		9,036		15
	—	$	—	$	—	9	$	11,031	$	17	9	$	11,031	$	17


	December 31, 2018
	Less than 12 months					12 months or more					Total
	# of	Fair		Unrealized		# of	Fair		Unrealized		# of	Fair		Unrealized
	Securities	Value		Losses		Securities	Value		Losses		Securities	Value		Losses
	(dollars in thousands)
U.S. Treasury securities	1	$	990	$	5	1	$	991	$	6	2	$	1,981	$	11
U.S. government agency notes	—		—		—	8		9,997		89	8		9,997		89
	1	$	990	$	5	9	$	10,988	$	95	10	$	11,978	$	100

Gross unrealized losses and fair value by length of time that the individual HTM securities have been in an unrealized loss position at the dates indicated are presented in the following tables:


	June 30, 2019
	Less than 12 months					12 months or more					Total
	# of	Fair		Unrealized		# of	Fair		Unrealized		# of	Fair		Unrealized
	Securities	Value		Losses		Securities	Value		Losses		Securities	Value		Losses
	(dollars in thousands)
U.S. government agency notes	—	$	—	$	—	7	$	6,989	$	24	7	$	6,989	$	24
Mortgage-backed securities	—		—		—	6		7,643		39	6		7,643		39
	—	$	—	$	—	13	$	14,632	$	63	13	$	14,632	$	63


	December 31, 2018
	Less than 12 months					12 months or more					Total
	# of	Fair		Unrealized		# of	Fair		Unrealized		# of	Fair		Unrealized
	Securities	Value		Losses		Securities	Value		Losses		Securities	Value		Losses
	(dollars in thousands)
U.S. government agency notes	—	$	—	$	—	10	$	9,927	$	92	10		9,927		92
Mortgage-backed securities	—		—		—	18		24,011		676	18		24,011		676
	—	$	—	$	—	28	$	33,938	$	768	28	$	33,938	$	768

September 30, 2017
Less than 12 months 12 months or more Total

Estimated
Fair Value

Unrealized
Losses

Estimated
Fair Value

Unrealized
Losses

Estimated
Fair Value

Unrealized
Losses

(dollars in thousands)
U.S. government agency notes $ 4,000 $ 2 $ 7,005 $ 41 $ 11,005 $ 43
Mortgage-backed securities 11,687 39 7,501 63 19,188 102
$ 15,687 $ 41 $ 14,506 $ 104 $ 30,193 $ 145

December 31, 2016
Less than 12 months 12 months or more Total

Estimated
Fair Value

Unrealized
Losses

Estimated
Fair Value

Unrealized
Losses

Estimated
Fair Value

Unrealized
Losses

(dollars in thousands)
U.S. government agency notes $ 5,002 $ 54 $ - $ - $ 5,002 $ 54
Mortgage-backed securities 23,457 228 - - 23,457 228
$ 28,459 $ 282 $ - $ - $ 28,459 $ 282

In ~~the HTM securities portfolio, 21 securities were in a loss position as of September 30, 2017, with the largest single unrealized loss in any one security amounting to $29,000.~~

8

~~Table of Contents~~

All of the securities that are currently in a gross unrealized loss position are so due to declines in fair values resulting from changes in interest rates or increased liquidity spreads since the time they were purchased. We have the intent and ability to hold these debt securities to maturity (including the AFS securities) and do not intend to sell, nor do we believe it will be more likely than not that we will be required to sell, any impaired securities prior to a recovery of amortized cost. We expect these securities will be repaid in full, with no losses realized. As such, management considers any impairment to be temporary.

10

Table of Contents

Contractual maturities of debt securities at ~~September~~June 30, ~~2017~~2019 are shown below. Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.


	AFS Securities				HTM Securities
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(dollars in thousands)
Due in one year or less	$	10,033	$	10,019	$	7,004	$	6,993
Due after one through five years		1,015		1,012		3,977		4,090
Mortgage-backed securities		—		—		22,581		22,625
	$	11,048	$	11,031	$	33,562	$	33,708

AFS Securities HTM Securities

Amortized
Cost

Estimated
Fair Value

Amortized
Cost

Estimated
Fair Value

(dollars in thousands)
Due in one year or less $ - $ - $ 10,009 $ 10,014
Due after one through five years 3,135 3,129 15,030 15,112
Due after five years through ten years - - 1,965 2,078
Mortgage-backed securities - - 31,760 31,755
$ 3,135 $ 3,129 $ 58,764 $ 58,959

~~During both the three and nine months ended September 30, 2017, we recognized gross gains and losses on the sale of securities of $4,000 and $2,000, respectively.~~

We did not sell any securities during ~~2016.~~

the three and six months ended June 30, 2019 or 2018.

There were no securities pledged as collateral as of ~~September~~June 30, ~~2017~~2019 or December 31, ~~2016.~~

2018.

Note 3 - Loans Receivable and Allowance for Loan Losses

Loans receivable are summarized as follows:


	June 30, 2019		December 31, 2018
	(dollars in thousands)
Residential mortgage	$	276,013	$	276,389
Commercial		45,347		35,884
Commercial real estate		238,699		244,088
Construction, land acquisition, and development		108,182		114,540
Home equity/2nds		12,581		13,386
Consumer		1,621		1,087
Total loans receivable		682,443		685,374
Unearned loan fees		(2,870)		(3,025)
Loans receivable	$	679,573	$	682,349

September 30, 2017 December 31, 2016
(dollars in thousands)
Residential mortgage $ 292,068 $ 260,603
Commercial 37,485 46,468
Commercial real estate 223,167 195,710
Construction, land acquisition, and development 84,164 90,102
Home equity/2nds 15,861 19,129
Consumer 1,118 1,210
Total loans receivable 653,863 613,222
Unearned loan fees (2,899 ) (2,944 )
Net loans receivable $ 650,964 $ 610,278

Certain loans in the amount of ~~$210.4~~$165.6 million have been pledged under a blanket floating lien to the Federal Home Loan Bank of Atlanta (“FHLB”) as collateral against ~~advances.~~

advances at June 30, 2019.

At June 30, 2019, the Bank was servicing $27.5 million in loans for the Federal National Mortgage Association (“FNMA”) and $14.0 million in loans for the Federal Home Loan Mortgage Corporation (“FHLMC”). At December 31, 2018, the Bank was servicing $29.4 million in loans for FNMA and $15.1 million in loans for FHLMC.

Credit Quality

An Allowance is provided through charges to income in an amount that management believes will be adequate to absorb losses on existing loans that may become uncollectible based on evaluations of the collectability of loans and prior loan loss experience. Management has an established methodology to determine the adequacy of the Allowance that assesses the risks and losses inherent in the loan portfolio. The methodology takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers’ ability to pay. Determining the amount of the Allowance requires the use of estimates and assumptions. Actual results could differ significantly from those estimates. While management uses all available information to estimate losses on loans, future additions to the Allowance may be necessary based on changes in economic ~~conditions.~~conditions and our actual loss experience. In addition, various regulatory agencies periodically review the Allowance as an integral part of their examination process. Such agencies may require us to recognize additions to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as of ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~2018.

11

Table of Contents

At December 31, 2018, due to a re-evaluation of our qualitative factors, we changed our estimates of the Allowance relative to historical loss experience within specific loan portfolio segments in order to better align our qualitative factors with historical losses experienced over a longer period of time, relative to those specific loan segments. The result of this change in estimate did not result in a material increase in the Allowance compared to the year ended December 31, 2017, however there were material changes to the Allowance between loan segments. Due to the change in accounting estimate, Allowance allocated to commercial loans and ADC loans increased approximately $2.2 million and $1.1 million, respectively, while the Allowance allocated to residential mortgage loans and commercial real estate loans decreased approximately $600,000 and $2.7 million, respectively, as of December 31, 2018. This change in accounting estimate had no impact on earnings or diluted earnings per share.

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

9

~~Table of Contents~~

Inherent Credit Risks

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

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

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

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

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

12

Table of a higher risk than other real estate loans due to their ultimate repayment being sensitive to general economic conditions, availability of long-term financing, interest rate sensitivity, and governmental regulation of real property.Contents

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

If the Bank is forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that the Bank will be able to recover all of the unpaid balance of the loan as well as related foreclosure and holding costs. In addition, the Bank may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time.

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

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

~~Risk Ratings~~

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

10

~~Table of Contents~~

The accrual of interest on loans is discontinued at the time the loan is 90 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed in nonaccrual status or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed in nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, generally after nine months of consecutive current payments and completion of an updated analysis of the borrower’s ability to service the loan.

Loans that experience insignificant payment delays and payment shortfalls may not be placed in nonaccrual status or classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

~~Allowance Methodology~~

The Allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. The general component relates to loans that are classified as doubtful, substandard, or special mention that are not considered impaired, as well as loans that are not classified.

~~A loan is considered impaired if it meets any of the following three criteria:~~

·

~~Loans that are 90 days or more in arrears (nonaccrual loans);~~

·

~~Loans where, based on current information and events, it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement; or~~

·

~~Loans that are modified and qualify as troubled debt restructured loans (“TDR” or “TDRs”).~~

~~If a loan is considered to be impaired, it is then determined to be either cash flow or collateral dependent for purposes of Allowance determination.~~

~~With respect to all loan segments, we do not charge off a loan, or a portion of a loan, until one of the following conditions have been met:~~

·

~~The loan has been foreclosed. At the time of foreclosure, a charge off is recorded for the difference between the recorded amount of the loan and the fair value of the underlying collateral.~~

·

An agreement to accept less than the recorded balance of the loan has been made with the borrower. Once an agreement has been finalized, a charge-off is recorded for the difference between the recorded amount of the loan and the agreed upon proceeds amount.

·

The loan is considered to be a collateral dependent impaired loan when its collateral valuation is less than the recorded balance. The loan is written down for accounting purposes by the amount of the difference between the recorded balance and collateral value.

~~Specific Allowance Component~~

Impaired loans secured by real estate - when a secured real estate loan becomes impaired, a decision is made as to whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the LTV ratio based on the original appraisal, and the condition of the property. Appraised values are discounted, if appropriate, to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

Impaired loans secured by collateral other than real estate - for loans secured by nonreal estate collateral, such as accounts receivable, inventory, and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging, or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

11

~~Table of Contents~~

For such loans that are classified as impaired, an Allowance is established when the current fair value of the underlying collateral less its estimated disposal costs is lower than the carrying value of the loan. For loans that are not solely collateral dependent, an Allowance is established when the present value of the expected future cash flows of the impaired loan is lower than the carrying value of the loan.

~~General Allowance Component~~

The general component of the Allowance is based on historical loss experience adjusted for qualitative factors. Loans are pooled by portfolio class and an historical loss percentage, based upon a four-year net charge-off history, is applied to each class. The result of that calculation for each loan class is then applied to the current loan portfolio balances to determine the required general component of the Allowance per loan class. We then apply additional loss multipliers to the different classes of loans to reflect various qualitative factors. These qualitative factors include, but are not limited to:

·

~~Levels and trends in delinquencies and nonaccruals;~~

·

~~Inherent risk in the loan portfolio;~~

·

~~Trends in volume and terms of the loan;~~

·

~~Effects of any change in lending policies and procedures;~~

·

~~Experience, ability, and depth of management;~~

·

~~National and local economic trends and conditions;~~

·

~~Effect of any changes in concentration of credit; and~~

·

~~Industry conditions.~~

12

~~Table of Contents~~

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


	Three Months Ended June 30, 2019
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	2,572	$	1,740	$	712	$	2,579	$	242	$	1	$	239	$	8,085
Charge-offs		(20)		—		—		—		—		(12)		—		(32)
Recoveries		3		—		33		—		4		—		—		40
Net (charge-offs) recoveries		(17)		—		33		—		4		(12)		—		8
Provision for (reversal of) loan losses		11		(174)		47		104		(23)		11		24		—
Ending Balance	$	2,566	$	1,566	$	792	$	2,683	$	223	$	—	$	263	$	8,093


	Three Months Ended June 30, 2018
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	3,301	$	514	$	2,995	$	1,060	$	297	$	2	$	—	$	8,169
Charge-offs		(37)		—		—		—		—		—		—		(37)
Recoveries		1		—		122		—		2		—		—		125
Net (charge-offs) recoveries		(36)		—		122		—		2		—		—		88
(Reversal of) provision for loan losses		(303)		(100)		(526)		1,000		(70)		(1)		—		—
Ending Balance	$	2,962	$	414	$	2,591	$	2,060	$	229	$	1	$	—	$	8,257

13

Three Months Ended September 30, 2017

Residential
Mortgage
Commercial
Commercial
Real Estate
ADC
Home Equity/
2nds
Consumer Total
(dollars in thousands)
Beginning Balance $ 3,403 $ 389 $ 2,571 $ 984 $ 367 $ 4 $ 7,718
Charge-offs - - - - - - -
Recoveries 156 - 40 - 22 - 218
Net recoveries 156 - 40 - 22 - 218
(Reversal of) provision for loan losses (137 ) 53 (44 ) 158 (28 ) (2 ) -
Ending Balance $ 3,422 $ 442 $ 2,567 $ 1,142 $ 361 $ 2 $ 7,936

Nine Months Ended September 30, 2017
(dollars in thousands)
Beginning Balance $ 3,833 $ 478 $ 2,535 $ 1,390 $ 728 $ 5 $ 8,969
Charge-offs (707 ) - - - (98 ) - (805 )
Recoveries 295 - 100 - 27 - 422
Net (charge-offs) recoveries (412 ) - 100 - (71 ) - (383 )
Provision for (reversal of) loan losses 1 (36 ) (68 ) (248 ) (296 ) (3 ) (650 )
Ending Balance $ 3,422 $ 442 $ 2,567 $ 1,142 $ 361 $ 2 $ 7,936

Ending balance - individually evaluated for impairment $ 1,544 $ - $ 186 $ 50 $ - $ 2 $ 1,782
Ending balance - collectively evaluated for impairment 1,878 442 2,381 1,092 361 - 6,154
$ 3,422 $ 442 $ 2,567 $ 1,142 $ 361 $ 2 $ 7,936

Ending loan balance - individually evaluated for impairment $ 20,379 $ - $ 3,419 $ 1,003 $ - $ 87 $ 24,888
Ending loan balance - collectively evaluated for impairment 268,790 37,485 219,748 83,161 15,861 1,031 626,076
$ 289,169 $ 37,485 $ 223,167 $ 84,164 $ 15,861 $ 1,118 $ 650,964

December 31, 2016

Residential
Mortgage
Commercial
Commercial
Real Estate
ADC
Home Equity/
2nds
Consumer Total
(dollars in thousands)
Ending Allowance balance - individually evaluated for impairment $ 1,703 $ 15 $ 196 $ 53 $ 402 $ 4 $ 2,373
Ending Allowance balance - collectively evaluated for impairment 2,130 463 2,339 1,337 326 1 6,596
$ 3,833 $ 478 $ 2,535 $ 1,390 $ 728 $ 5 $ 8,969

Ending loan balance - individually evaluated for impairment $ 20,403 $ 148 $ 5,656 $ 858 $ 3,137 $ 96 $ 30,298
Ending loan balance - collectively evaluated for impairment 237,256 46,320 190,054 89,244 15,992 1,114 579,980
$ 257,659 $ 46,468 $ 195,710 $ 90,102 $ 19,129 $ 1,210 $ 610,278

13

Table of Contents


	Six Months Ended June 30, 2019
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	2,224	$	2,736	$	457	$	2,239	$	222	$	1	$	165	$	8,044
Charge-offs		(20)		—		—		—		—		(12)		—		(32)
Recoveries		8		—		67		—		6		—		—		81
Net (charge-offs) recoveries		(12)		—		67		—		6		(12)		—		49
Provision for (reversal of) loan losses		354		(1,170)		268		444		(5)		11		98		—
Ending Balance	$	2,566	$	1,566	$	792	$	2,683	$	223	$	—	$	263	$	8,093

Ending balance - individually evaluated for impairment	$	889	$	—	$	67	$	32	$	24	$	—	$	—	$	1,012
Ending balance - collectively evaluated for impairment		1,677		1,566		725		2,651		199		—		263		7,081
	$	2,566	$	1,566	$	792	$	2,683	$	223	$	—	$	263	$	8,093

Ending loan balance -individually evaluated for impairment	$	13,205	$	—	$	1,889	$	1,119	$	859	$	72			$	17,144
Ending loan balance -collectively evaluated for impairment		261,269		45,347		235,479		107,063		11,722		1,549				662,429
	$	274,474	$	45,347	$	237,368	$	108,182	$	12,581	$	1,621			$	679,573

Three Months Ended September 30, 2016

Residential
Mortgage
Commercial
Commercial
Real Estate
ADC
Home Equity/
2nds
Consumer Total
(dollars in thousands)
Beginning Balance $ 3,892 $ 752 $ 2,577 $ 983 $ 593 $ 7 $ 8,804
Charge-offs - - - (72 ) - - (72 )
Recoveries 137 10 4 - 2 50 203
Net recoveries (charge-offs) 137 10 4 (72 ) 2 50 131
(Reversal of) provision for loan losses (161 ) (63 ) (189 ) 289 226 (52 ) 50
Ending Balance $ 3,868 $ 699 $ 2,392 $ 1,200 $ 821 $ 5 $ 8,985

Nine Months Ended September 30, 2016
(dollars in thousands)
Beginning Balance $ 4,188 $ 291 $ 2,792 $ 956 $ 528 $ 3 $ 8,758
Charge-offs (151 ) (17 ) (178 ) (72 ) (28 ) - (446 )
Recoveries 322 43 4 100 4 50 523
Net recoveries (charge-offs) 171 26 (174 ) 28 (24 ) 50 77
(Reversal of) provision for loan losses (491 ) 382 (226 ) 216 317 (48 ) 150
Ending Balance $ 3,868 $ 699 $ 2,392 $ 1,200 $ 821 $ 5 $ 8,985

Ending balance - individually evaluated for impairment $ 1,583 $ 15 $ 200 $ 55 $ 402 $ 4 $ 2,259
Ending balance - collectively evaluated for impairment 2,285 684 2,192 1,145 419 1 6,726
$ 3,868 $ 699 $ 2,392 $ 1,200 $ 821 $ 5 $ 8,985

Ending loan balance - individually evaluated for impairment $ 22,521 $ 495 $ 5,696 $ 1,446 $ 3,519 $ 100 $ 33,777
Ending loan balance - collectively evaluated for impairment 246,375 41,864 193,219 79,894 16,220 1,109 578,681
$ 268,896 $ 42,359 $ 198,915 $ 81,340 $ 19,739 $ 1,209 $ 612,458

14

Table of Contents


	December 31, 2018
	Residential				Commercial					Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Ending balance - individually evaluated for impairment	$	927	$	430	$	142	$	32	$	2	$	—	$	—	$	1,533
Ending balance - collectively evaluated for impairment		1,297		2,306		315		2,207		220		1		165		6,511
	$	2,224	$	2,736	$	457	$	2,239	$	222	$	1	$	165	$	8,044

Ending loan balance - individually evaluated for impairment	$	12,579	$	430	$	1,992	$	1,278	$	871	$	76			$	17,226
Ending loan balance - collectively evaluated for impairment		262,180		35,454		240,701		113,262		12,515		1,011				665,123
	$	274,759	$	35,884	$	242,693	$	114,540	$	13,386	$	1,087			$	682,349

15

Table of Contents


	Six Months Ended June 30, 2018
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	3,099	$	527	$	2,805	$	1,236	$	386	$	2	$	—	$	8,055
Charge-offs		(360)		—		—		(13)		—		—		—		(373)
Recoveries		222		—		333		—		20		—		—		575
Net (charge-offs) recoveries		(138)		—		333		(13)		20		—		—		202
Provision for (reversal of) loan losses		1		(113)		(547)		837		(177)		(1)		—		—
Ending Balance	$	2,962	$	414	$	2,591	$	2,060	$	229	$	1	$	—	$	8,257

Ending balance - individually evaluated for impairment	$	1,295	$	—	$	153	$	1,002	$	2	$	1	$	—	$	2,453
Ending balance - collectively evaluated for impairment		1,667		414		2,438		1,058		227		—		—		5,804
	$	2,962	$	414	$	2,591	$	2,060	$	229	$	1	$	—	$	8,257

Ending loan balance - individually evaluated for impairment	$	15,926	$	300	$	2,003	$	3,046	$	1,461	$	80			$	22,816
Ending loan balance - collectively evaluated for impairment		273,503		42,318		230,835		104,518		11,976		946				664,096
	$	289,429	$	42,618	$	232,838	$	107,564	$	13,437	$	1,026			$	686,912

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


	June 30, 2019
			Special
	Pass		Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	270,573	$	—	$	3,901	$	274,474
Commercial		44,139		1,208		—		45,347
Commercial real estate		232,597		3,088		1,683		237,368
ADC		107,351		—		831		108,182
Home equity/2nds		11,990		418		173		12,581
Consumer		1,621		—		—		1,621
	$	668,271	$	4,714	$	6,588	$	679,573

16

September 30, 2017
Pass
Special
Mention
Substandard Total
(dollars in thousands)
Residential mortgage $ 281,954 $ 1,397 $ 5,818 $ 289,169
Commercial 37,299 50 136 37,485
Commercial real estate 216,373 4,668 2,126 223,167
ADC 82,958 - 1,206 84,164
Home equity/2nds 14,531 471 859 15,861
Consumer 1,118 - - 1,118
$ 634,233 $ 6,586 $ 10,145 $ 650,964

14

Table of Contents


	December 31, 2018
			Special
	Pass		Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	270,727	$	827	$	3,205	$	274,759
Commercial		35,435		19		430		35,884
Commercial real estate		237,387		3,523		1,783		242,693
ADC		113,072		—		1,468		114,540
Home equity/2nds		12,536		434		416		13,386
Consumer		1,087		—		—		1,087
	$	670,244	$	4,803	$	7,302	$	682,349

December 31, 2016
Pass
Special
Mention
Substandard Total
(dollars in thousands)
Residential mortgage $ 248,819 $ 4,316 $ 4,524 $ 257,659
Commercial 46,011 204 253 46,468
Commercial real estate 184,820 7,420 3,470 195,710
ADC 89,324 - 778 90,102
Home equity/2nds 16,056 472 2,601 19,129
Consumer 1,210 - - 1,210
$ 586,240 $ 12,412 $ 11,626 $ 610,278

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


	June 30, 2019
	30-59		60-89		90+
	Days		Days		Days		Total						Non-
	Past Due		Past Due		Past Due		Past Due		Current		Total		Accrual
	(dollars in thousands)
Residential mortgage	$	531	$	—	$	2,148	$	2,679	$	271,795	$	274,474	$	3,288
Commercial		—		—		—		—		45,347		45,347		—
Commercial real estate		—		—		452		452		236,916		237,368		779
ADC		—		—		388		388		107,794		108,182		388
Home equity/2nds		—		—		173		173		12,408		12,581		429
Consumer		16		—		3		19		1,602		1,621		3
	$	547	$	—	$	3,164	$	3,711	$	675,862	$	679,573	$	4,887


	December 31, 2018
	30-59		60-89		90+
	Days		Days		Days		Total						Non-
	Past Due		Past Due		Past Due		Past Due		Current		Total		Accrual
	(dollars in thousands)
Residential mortgage	$	1,060	$	—	$	1,794	$	2,854	$	271,905	$	274,759	$	2,580
Commercial		—		—		430		430		35,454		35,884		430
Commercial real estate		137		—		660		797		241,896		242,693		660
ADC		255		—		387		642		113,898		114,540		558
Home equity/2nds		96		—		428		524		12,862		13,386		428
Consumer		13		—		—		13		1,074		1,087		—
	$	1,561	$	—	$	3,699	$	5,260	$	677,089	$	682,349	$	4,656

September 30, 2017

30-59
Days
Past Due

60-89
Days
Past Due

90+
Days
Past Due

Total
Past Due
Current Total
Non-
Accrual

   (dollars in thousands)
Residential mortgage $ 1,173 $ 1,216 $ 2,364 $ 4,753 $ 284,416 $ 289,169 $ 4,531
Commercial - - - - 37,485 37,485 84
Commercial real estate - 478 - 478 222,689 223,167 160
ADC - - 239 239 83,925 84,164 318
Home equity/2nds - - 458 458 15,403 15,861 1,284
Consumer - - - - 1,118 1,118 -
   $ 1,173 $ 1,694 $ 3,061 $ 5,928 $ 645,036 $ 650,964 $ 6,377

December 31, 2016

30-59
Days
Past Due

60-89
Days
Past Due

90+
Days
Past Due

Total
Past Due
Current Total
Non-
Accrual

(dollars in thousands)
Residential mortgage $ 1,472 $ 2,074 $ 964 $ 4,510 $ 253,149 $ 257,659 $ 3,580
Commercial - - - - 46,468 46,468 151
Commercial real estate - 171 515 686 195,024 195,710 2,938
ADC 106 - 6 112 89,990 90,102 269
Home equity/2nds 34 - 2,174 2,208 16,921 19,129 2,914
Consumer 4 - - 4 1,206 1,210 -
$ 1,616 $ 2,245 $ 3,659 $ 7,520 $ 602,758 $ 610,278 $ 9,852

We dodid not have any loans greater than 90 days past due and still accruing ~~loans~~ as of ~~September~~June 30, ~~2017~~2019 or December 31, ~~2016.~~

2018.

The interest which would have been recorded on the above nonaccrual loans if those loans had been performing in accordance with their contractual terms was approximately ~~$1.2~~$382,000 and $1.1 million ~~and $338,000~~ for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016,~~2018, respectively. The actual interest income recorded on those loans was approximately ~~$403,000~~$82,000 and ~~$130,000~~$208,000 for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016,~~2018, respectively.

17

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Table of Contents

The following tables summarize impaired loans:


	June 30, 2019						December 31, 2018
	Unpaid						Unpaid
	Principal		Recorded		Related		Principal		Recorded		Related
	Balance		Investment		Allowance		Balance		Investment		Allowance
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	7,740	$	7,513	$	—	$	7,054	$	6,808	$	—
Commercial		—		—		—		—		—		—
Commercial real estate		1,365		1,325		—		1,244		1,206		—
ADC		988		987		—		1,142		1,143		—
Home equity/2nds		1,308		825		—		1,290		859		—
Consumer		69		68		—		76		76		—
With a related Allowance:
Residential mortgage		5,812		5,692		889		5,888		5,771		927
Commercial		—		—		—		476		430		430
Commercial real estate		564		564		67		795		786		142
ADC		132		132		32		135		135		32
Home equity/2nds		35		34		24		13		12		2
Consumer		4		4		—		—		—		—
Totals:
Residential mortgage		13,552		13,205		889		12,942		12,579		927
Commercial		—		—		—		476		430		430
Commercial real estate		1,929		1,889		67		2,039		1,992		142
ADC		1,120		1,119		32		1,277		1,278		32
Home equity/2nds		1,343		859		24		1,303		871		2
Consumer		73		72		—		76		76		—

18

September 30, 2017 December 31, 2016

Unpaid
Principal
Balance

Recorded
Investment

Related
Allowance

Unpaid
Principal
Balance

Recorded
Investment

Related
Allowance

With no related Allowance: (dollars in thousands)
Residential mortgage $ 12,856 $ 11,306 $ - $ 9,854 $ 9,338 $ -
Commercial - - - - - -
Commercial real estate 1,576 1,527 - 3,900 3,698 -
ADC 636 636 - 441 441 -
Home equity/2nds - - - 2,139 1,529 -
Consumer - - - - - -
With a related Allowance:
Residential mortgage 9,306 9,073 1,544 11,176 11,065 1,703
Commercial - - - 148 148 15
Commercial real estate 1,892 1,892 186 1,958 1,958 196
ADC 402 367 50 417 417 53
Home equity/2nds - - - 1,608 1,608 402
Consumer 87 87 2 96 96 4
Totals:
Residential mortgage 22,162 20,379 1,544 21,030 20,403 1,703
Commercial - - - 148 148 15
Commercial real estate 3,468 3,419 186 5,858 5,656 196
ADC 1,038 1,003 50 858 858 53
Home equity/2nds - - - 3,747 3,137 402
Consumer 87 87 2 96 96 4

Three Months Ended September 30, Nine Months Ended September 30,
2017 2016 2017 2016

Average
Recorded
Investment

Interest
Income
Recognized

Average
Recorded
Investment

Interest
Income
Recognized

Average
Recorded
Investment

Interest
Income
Recognized

Average
Recorded
Investment

Interest
Income
Recognized

With no related Allowance: (dollars in thousands)
Residential mortgage $ 10,423 $ 138 $ 12,734 $ 132 $ 9,696 $ 353 $ 13,774 $ 417
Commercial - - 274 2 - - 150 3
Commercial real estate 1,531 22 3,730 57 2,652 69 4,655 134
ADC 637 9 1,031 9 487 21 1,431 36
Home equity/2nds 918 15 1,911 18 679 40 1,991 59
Consumer - - - - - - 23 -
With a related Allowance:
Residential mortgage 8,910 116 9,831 106 9,231 286 10,684 356
Commercial - - 149 2 37 - 182 7
Commercial real estate 1,896 23 1,977 25 1,919 73 2,040 77
ADC 369 6 426 6 385 16 513 20
Home equity/2nds 180 - 1,078 6 715 - 370 7
Consumer 88 1 102 1 91 2 73 2
Totals:
Residential mortgage 19,333 254 22,565 238 18,927 639 24,458 773
Commercial - - 423 4 37 - 332 10
Commercial real estate 3,427 45 5,707 82 4,571 142 6,695 211
ADC 1,006 15 1,457 15 872 37 1,944 56
Home equity/2nds 1,098 15 2,989 24 1,394 40 2,361 66
Consumer 88 1 102 1 91 2 96 2

~~Residential~~

Table of Contents


	Three Months Ended June 30,								Six Months Ended June 30,
	2019				2018				2019				2018
	Average		Interest		Average		Interest		Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized		Investment		Recognized
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	7,197	$	81	$	7,867	$	88	$	6,950	$	160	$	9,824	$	174
Commercial		—		—		457		13		—		—		78		20
Commercial real estate		1,327		17		1,326		14		1,245		37		1,350		30
ADC		977		7		397		4		1,034		15		555		9
Home equity/2nds		834		17		1,285		12		844		30		483		20
Consumer		224		1		—		—		46		2		—		—
With a related Allowance:
Residential mortgage		5,706		80		7,439		75		5,731		160		7,184		152
Commercial		—		—		—		—		143		—		—		—
Commercial real estate		567		11		751		8		694		20		1,276		14
ADC		132		2		344		6		134		4		1,117		11
Home equity/2nds		34		—		13		—		19		1		4		—
Consumer		4		—		80		1		28		—		82		—
Totals:
Residential mortgage		12,903		161		15,306		163		12,681		320		17,008		326
Commercial		—		—		457		13		143		—		78		20
Commercial real estate		1,894		28		2,077		22		1,939		57		2,626		44
ADC		1,109		9		741		10		1,168		19		1,672		20
Home equity/2nds		868		17		1,298		12		863		31		487		20
Consumer		228		1		80		1		74		2		82		—

There were $1.3 million and $1.4 million in consumer mortgage properties included in real estate acquired through foreclosure at June 30, 2019 and December 31, 2018, respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction totaled ~~$3.1~~$2.3 million as of ~~September~~June 30, ~~2017. Residential mortgage loans in real estate acquired through foreclosure amounted to $287,000~~2019 and ~~$393,000 at September 30, 2017 and~~$1.9 million as of December 31, ~~2016, respectively.~~

~~TDRs~~

~~In situations where, for economic~~2018.

Troubled Debt Restructure Loans (“TDR” or legal reasons related to a borrower’s financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR. Such concessions could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. At the time that a loan is modified, management evaluates any possible impairment based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole remaining source of repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. Any impairment amount is then set up as a specific reserve in the Allowance.

16

~~Table of Contents~~

~~The following table presents loans that were modified during the nine months ended September 30:~~

2017 2016

Number of
Modifications

Recorded
Investment
Prior to
Modification

Recorded
Investment
After
Modification

Number of
Modifications

Recorded
Investment
Prior to
Modification

Recorded
Investment
After
Modification

(dollars in thousands)
Residential Mortgage 3 $ 624 $ 624
- $ - $ - 3 $ 624 $ 624

~~We did not modify any loans during the three months ended September 30, 2017 or 2016.~~

~~Interest on our~~“TDRs”)

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


	June 30, 2019
							Total	Total
	Number of	Accrual		Number of	Nonaccrual		Number of	Balance of
	Modifications	Status		Modifications	Status		Modifications	Modifications
	(dollars in thousands)
Residential mortgage	35	$	9,332	3	$	422	38	$	9,754
Commercial real estate	2		1,000	—		—	2		1,000
ADC	1		132	—		—	1		132
Consumer	3		73	—		—	3		73
	41	$	10,537	3	$	422	44	$	10,959

19

September 30, 2017

Number of
Modifications

Accrual
Status

Number of
Modifications

Nonaccrual
Status

Total
Number of
Modifications

Total
Balance of
Modifications

(dollars in thousands)
Residential mortgage 43 $ 13,086 4 $ 2,285 47 $ 15,371
Commercial real estate 3 1,875 1 84 4 1,959
ADC 1 138 1 6 2 144
Home equity/2nds 1 230 - - 1 230
Consumer 4 87 - - 4 87
52 $ 15,416 6 $ 2,375 58 $ 17,791

December 31, 2016

Number of
Modifications

Accrual
Status

Number of
Modifications

Nonaccrual
Status

Total
Number of
Modifications

Total
Balance of
Modifications

(dollars in thousands)
Residential mortgage 48 $ 15,886 4 $ 2,137 52 $ 18,023
Commercial real estate 3 1,914 2 249 5 2,163
ADC 2 170 1 6 3 176
Consumer 5 96 - - 5 96
58 $ 18,066 7 $ 2,392 65 $ 20,458

~~During the three and nine months ended September 30, 2017 and 2016, there~~

Table of Contents


	December 31, 2018
							Total	Total
	Number of	Accrual		Number of	Nonaccrual		Number of	Balance of
	Modifications	Status		Modifications	Status		Modifications	Modifications
	(dollars in thousands)
Residential mortgage	36	$	9,469	3	$	446	39	$	9,915
Commercial real estate	2		1,019	—		—	2		1,019
ADC	1		134	—		—	1		134
Consumer	3		76	—		—	3		76
	42	$	10,698	3	$	446	45	$	11,144

There were no TDRs that ~~subsequently~~ defaulted during the three and six months ended June 30, 2019 or 2018 which were modified during the previous 12 month ~~period ended September 30, 2017 and 2016.~~

~~Off-Balance Sheet Instruments~~

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statements of financial condition. The contract amounts of these instruments express the extent of involvement we have in each class of financial instruments.

Our exposure to credit loss from nonperformance by the other party to the above mentioned financial instruments is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Unless otherwise noted, we require collateral or other security to support financial instruments with off-balancesheet credit risk.

17

~~Table of Contents~~

~~The following table shows the contract amounts for our off-balance sheet instruments:~~

September 30,
2017

December 31,
2016

(dollars in thousands)
Standby letters of credit $ 3,854 $ 4,022
Home equity lines of credit 12,425 7,736
Unadvanced construction commitments 72,045 15,728
Mortgage loan commitments - 574
Lines of credit 13,092 34,125
Loans sold and serviced with limited repurchase provisions 19,979 70,773

Standby letters of credit are conditional commitments issued by the Bank guaranteeing performance by a customer to various municipalities. These guarantees are issued primarily to support performance arrangements and are limited to real estate transactions. The majority of these standby letters of credit expire within twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit as deemed necessary. Management believes, except for certain standby letters of credit, that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The current amount of the liability as of September 30, 2017 and December 31, 2016 for guarantees under standby letters of credit issued was $79,000 and $94,000, respectively.

Home equity lines of credit are loan commitments to individuals as long as there is no violation of any condition established in the contract. Commitments under home equity lines expire ten years after the date the loan closes and are secured by real estate. We evaluate each customer’s credit worthiness on a case-by-case basis.

~~Unadvanced construction commitments are loan commitments made to borrowers for both residential and commercial projects that are either in process or are expected to begin construction shortly.~~

Mortgage loan commitments not reflected in the accompanying statements of financial condition at December 31, 2016 included two loans at a fixed interest rate of 4.25% totaling $574,000. There were no such commitments at September 30, 2017.

Lines of credit are loan commitments to individuals and companies as long as there is no violation of any condition established in the contract. Lines of credit have a fixed expiration date. The Bank evaluates each customer’s credit worthiness on a case-by-case basis.

The Bank has entered into several agreements to sell mortgage loans to third parties. These agreements contain limited provisions that require the Bank to repurchase a loan if the loan becomes delinquent within a period ranging generally from 120 to 180 days after the sale date depending on the investor’s agreement. The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. We established a reserve for potential repurchases for these loans, which amounted to $59,000 at September 30, 2017 and $48,000 at December 31, 2016. period.

We did not ~~repurchase~~modify any loans during the ~~nine~~three and six months ended ~~September~~June 30, ~~2017~~2019 or ~~2016.~~

2018.

Note 4 - Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on our financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

In July ~~2015,~~2013, federal bank regulatory agencies issued final results to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and ~~include~~included transition provisions which implement certain portions of the rules through January 1, 2019. Under the final rules, the effects of certain accumulated other comprehensive income items are not excluded, however, banking organizations like us that are not considered “advanced approaches” banking organizations may make a one-time permanent election to continue to exclude these items. With the submission of the Call Report for the first quarter of 2015, we made this election in order to avoid significant variations in the level of capital that can be caused by interest rate fluctuations on the fair value of the Bank’s AFS securities portfolio.

18

~~Table of Contents~~

The Basel III rules also establish a “capital conservation buffer” of 2.5% above the ~~new~~ regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The new capital conservation buffer requirements began to phase in effective January 2016 at 0.625% of risk-weighted assets and increase by that amount each year until fully implemented in January 2019 (1.25% at September 30, 2017). An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses to executive officers if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

As a result of the Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies are required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes. The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement. The federal banking agencies must set the minimum capital for the new Community Bank Leverage Ratio at not less than 8% and not more than 10%. A financial institution can elect to be subject to this new definition. The federal banking agencies have proposed the Community Bank Leverage Ratio be set at 9%. However, until the federal banking agencies finalize the proposed rule, the Basel III rules remain in effect.

20

Table of Contents

As of the date of the last regulatory exam, the Bank was considered “well capitalized” and as of ~~September~~June 30, ~~2017,~~2019, the Bank continued to meet the requirements to be considered “well capitalized” based on applicable U.S. regulatory capital ratio requirements.

The Bank’s regulatory capital amounts and ratios were as follows:


					Minimum				Minimum				To be Well
					Requirements				Requirements				Capitalized Under
					for Capital Adequacy				with Capital				Prompt Corrective
	Actual				Purposes				Conservation Buffer				Action Provision
	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
June 30, 2019	(dollars in thousands)
Common Equity Tier 1 Capital (to risk-weighted assets)	$	118,722	18.0	%	$	29,725	4.5	%	$	46,238	7.0	%	$	42,936	6.5	%
Total capital (to risk-weighted assets)		126,919	19.2	%		52,844	8.0	%		69,358	10.5	%		66,055	10.0	%
Tier 1 capital (to risk-weighted assets)		118,722	18.0	%		39,633	6.0	%		56,147	8.5	%		52,844	8.0	%
Tier 1 capital (to average quarterly assets)		118,722	13.1	%		36,246	4.0	%		58,900	6.5	%		45,307	5.0	%

December 31, 2018
Common Equity Tier 1 Capital (to risk-weighted assets)	$	114,749	17.4	%	$	29,651	4.5	%	$	42,006	6.4	%	$	42,830	6.5	%
Total capital (to risk-weighted assets)		122,889	18.7	%		52,713	8.0	%		65,068	9.9	%		65,892	10.0	%
Tier 1 capital (to risk-weighted assets)		114,749	17.4	%		39,535	6.0	%		51,890	7.9	%		52,713	8.0	%
Tier 1 capital (to average quarterly assets)		114,749	13.5	%		33,932	4.0	%		49,838	5.9	%		42,415	5.0	%

Actual
Minimum
Requirements
for Capital Adequacy
Purposes

Minimum
Requirements
with Capital
Conservation Buffer

To be Well
Capitalized Under
Prompt Corrective
Action Provision

Amount Ratio Amount Ratio Amount Ratio Amount Ratio
September 30, 2017 (dollars in thousands)
Common Equity Tier 1 Capital (to risk-weighted assets) $ 104,318 16.8 % $ 27,907 4.5 % $ 35,658 5.8 % $ 40,309 6.5 %

Total capital (to risk-weighted assets) 112,086 18.1 % 49,612 8.0 % 57,363 9.3 % 62,015 10.0 %

Tier 1 capital (to risk-weighted assets) 104,318 16.8 % 37,209 6.0 % 44,961 7.3 % 49,612 8.0 %

Tier 1 capital (to average quarterly assets) 104,318 13.3 % 31,313 4.0 % 41,099 5.3 % 39,142 5.0 %

December 31, 2016
Common Equity Tier 1 Capital (to risk-weighted assets) $ 98,970 16.5 % $ 26,983 4.5 % $ 30,730 5.1 % $ 38,975 6.5 %

Total capital (to risk-weighted assets) 106,517 17.8 % 47,969 8.0 % 51,717 8.6 % 59,962 10.0 %

Tier 1 capital (to risk-weighted assets) 98,970 16.5 % 35,977 6.0 % 39,725 6.6 % 47,969 8.0 %

Tier 1 capital (to average quarterly assets) 98,970 12.9 % 30,634 4.0 % 35,420 4.6 % 38,292 5.0 %

Note 5 - Earnings Per Share

Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding for each period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options, warrants, and convertible preferred stock, and are determined using the treasury stock method.

Not included in the diluted earnings per share calculation ~~for 2017 and 2016~~ because they were anti-dilutive were ~~20,000~~22,000 and ~~126,600~~24,000 shares ~~respectively,~~ of common stock issuable upon exercise of outstanding stock options for the three and six months ended June 30, 2018, respectively, as well as an additional 437,500 shares of common stock that was issuable upon conversion of the Company’s Series A Preferred ~~Stock, and, in 2016, 556,976~~Stock. There were no anti-dilutive shares for the three or six months ended June 30, 2019.

On April 2, 2018, the Company exercised its option to convert all 437,500 outstanding shares of Series A Preferred Stock into shares of the Company’s common stock. The conversion ratio was one share of Series A Preferred Stock for one share of common stock. As of April 2, 2018, the Series A Preferred Stock was no longer deemed outstanding and all rights with respect to such stock ~~issuable upon the exercise~~ceased and terminated.

21

Table of ~~a warrant were also anti-dilutive and excluded from the calculation.~~Contents

Information relating to the calculations of our income per common share is summarized as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
	(dollars in thousands, except for per share data)
Weighted-average shares outstanding - basic		12,775,123		12,684,711		12,774,191		12,463,132
Dilution		87,168		96,326		85,789		95,937
Weighted-average share outstanding - diluted		12,862,291		12,781,037		12,859,980		12,559,069

Net income available to common stockholders	$	2,176	$	1,918	$	4,785	$	3,733
Net income per share - basic	$	0.17	$	0.15	$	0.37	$	0.30
Net income per share - diluted	$	0.17	$	0.15	$	0.37	$	0.30

Three Months Ended September 30, Nine Months Ended September 30,
2017 2016 2017 2016
(dollars in thousands, except for per share data)
Weighted-average shares outstanding - basic 12,172,586 12,104,379 12,140,689 11,324,660
Dilution 150,986 79,360 107,525 51,193
Weighted-average share outstanding - diluted 12,323,572 12,183,739 12,248,214 11,375,853

Net income available to common stockholders $ 1,121 $ 539 $ 2,753 $ 12,864

Net income per share - basic $ 0.09 $ 0.04 $ 0.23 $ 1.14
Net income per share - diluted $ 0.09 $ 0.04 $ 0.22 $ 1.13

19

~~Table of Contents~~

Note 6 - Stock-Based Compensation

We ~~maintain~~have maintained a stock-based compensation plan for directors, officers, and other key employees of the Company. The aggregate number of shares of common stock that ~~may~~could be issued with respect to the awards granted under the plan iswas 500,000 plus any shares forfeited under the Company’s old stock-based compensation plan. Under the terms of the stock-based compensation plan, the Company ~~has~~had the ability to grant various stock compensation incentives, including stock options, stock appreciation rights, and restricted stock. The stock-based compensation iswas granted under terms and conditions determined by the Compensation Committee of the Board of Directors. Under the stock-based compensation plan, stock options generally ~~have~~had a maximum term of ten years, and ~~are~~were granted with an exercise price at least equal to the fair market value of the common stock on the date the options ~~are~~were granted. Generally, options granted to directors, officers, and employees of the Company ~~vest~~vested over a five-year period, although the Compensation Committee ~~has~~had the authority to provide for different vesting schedules.

The ability to grant new options from this plan expired in March of 2018. A new plan, with the same provisions and number of shares available for grant as the old plan was approved at the stockholders’ meeting in May of 2019. No shares have been granted from this plan as of June 30, 2019.

We account for stock-based compensation in accordance with FASB ~~Accounting Standards Codification~~ASC Topic 718, Compensation – Stock Compensation, whichrequires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense in the statement of operations at fair value. Additionally, we are required to recognize the expense of employee services received in share-based payment transactions and measure the expense based on the grant date fair value of the award. The expense is recognized over the period during which an employee is required to provide service in exchange for the ~~award.~~ award. Stock-based compensation expense included in the consolidated statements of operations for the three months ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018 totaled ~~$44,000~~$34,000 and ~~$48,000,~~$57,000, respectively. Stock-based compensation expense included in the consolidated statements of operations for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018 totaled ~~$146,000~~$77,000 and ~~$143,000,~~$113,000, respectively.

22

~~The weighted average fair value~~

Table of the options issued during the three and nine months ended September 30, 2017 was $2.56. There were no options granted during the three or nine months ended September 30, 2016. The fair value of the options was calculated using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions for the three and nine months ended September 30, 2017:Contents

~~Dividend yield~~		~~0.00~~	%
~~Expected volatility~~		~~36.02~~	%
~~Risk-free interest rate~~		~~1.76~~	%
~~Expected lives~~	~~5.5 years~~

Information regarding our stock-based compensation plan is as follows as of and for the ~~nine~~six months ended ~~September~~June 30:


	2019						2018
				Weighted-						Weighted-
		Weighted-		Average	Aggregate			Weighted-		Average	Aggregate
		Average		Remaining	Intrinsic			Average		Remaining	Intrinsic
	Number	Exercise		Contractual	Value		Number	Exercise		Contractual	Value
	of Shares	Price		Term (in years)	(in thousands)		of Shares	Price		Term (in years)	(in thousands)
Outstanding at beginning of period	349,023	$	6.32				434,025	$	5.87
Granted	—		—				6,500		7.41
Exercised	(15,561)		5.25				(24,002)		4.00
Forfeited	(38,500)		6.41				(1,750)		5.26
Outstanding at end of period	294,962	$	6.37	3.0	$	684	414,773	$	6.01	6.0	$	1,096
Exercisable at end of period	179,200	$	5.95	2.3	$	492	209,998	$	5.18	5.9	$	730

The cash received from the exercise of stock options amounted to $41,000 for the three months ended June 30, 2018 and $81,000 and $97,000 for the six months ended June 30, 2019 and 2018, respectively.

The stock-based compensation expense amounts and fair values of options at the time of the grants were derived using the Black-Scholes option-pricing model. The following weighted average assumptions were used to value options granted for the six months ended June 30, 2018. There were no options granted in 2019.


Expected life		5.5 years
Risk-free interest rate		2.67	%
Expected volatility		32.20	%
Expected dividend yield		—
Weighted average per share fair value of options granted	$	2.57

2017 2016

Number
of Shares

Weighted-
Average
Exercise
Price

Weighted-
Average
Remaining
Contractual
Term (in years)

Aggregate
Intrinsic
Value
(in thousands)

Number
of Shares

Weighted-
Average
Exercise
Price

Weighted-
Average
Remaining
Contractual
Term (in years)

Aggregate
Intrinsic
Value
(in thousands)

Outstanding at beginning of period 339,500 $ 5.31 339,800 $ 4.83
Granted 20,000 7.10 - -
Exercised (5,025 ) 3.37 - -
Forfeited (16,000 ) 4.59 (54,500 ) 5.07
Outstanding at end of period 338,475 5.48 7.2 $ 526 285,300 4.79 8.2 $ 491
Exercisable at end of period 173,702 4.78 6.5 $ 398 136,125 4.37 7.0 $ 292

As of ~~September~~June 30, ~~2017,~~2019, there was ~~$520,000~~$353,000 of total unrecognized stock-based compensation expense related to nonvested stock options, which is expected to be recognized over the next 5951 months.

Note 7 - Commitments and Contingencies

Off-Balance Sheet Instruments

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statements of financial condition. The contract amounts of these instruments express the extent of involvement we have in each class of financial instruments.

Our exposure to credit loss from nonperformance by the other party to the above mentioned financial instruments is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Unless otherwise noted, we require collateral or other security to support financial instruments with off-balance sheet credit risk.

23

20

Table of Contents

~~Note 7 - Other Comprehensive Income~~


	June 30,		December 31,
	2019		2018
	(dollars in thousands)
Standby letters of credit	$	3,398	$	3,321
Home equity lines of credit		17,364		17,015
Unadvanced construction commitments		77,251		75,326
Mortgage loan commitments		829		1,649
Lines of credit		21,321		20,990
Loans sold and serviced with limited repurchase provisions		43,839		49,623

Standby letters of credit are conditional commitments issued by the Bank guaranteeing performance by a customer to various municipalities. These guarantees are issued primarily to support performance arrangements and are limited to real estate transactions. The ~~following table presents~~majority of these standby letters of credit expire within twelve months, with automatic one year renewals. The Bank has the ~~changes~~option to stop any automatic renewal. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit as deemed necessary. Management believes, except for certain standby letters of credit, that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The current amount of the liability as of June 30, 2019 and December 31, 2018 for guarantees under standby letters of credit issued was $36,000 and $42,000, respectively.

Home equity lines of credit are loan commitments to individuals as long as there is no violation of any condition established in the ~~components~~contract. Commitments under home equity lines expire ten years after the date the loan closes and are secured by real estate. We evaluate each customer’s credit worthiness on a case-by-case basis.

Unadvanced construction commitments are loan commitments made to borrowers for both residential and commercial projects that are either in process or are expected to begin construction shortly.

Residential mortgage loan commitments at June 30, 2019 consisted of ~~accumulated other comprehensive loss~~three loans totaling $829,000. Such commitments at December 31, 2018 consisted of three loans totaling $1.6 million.

Lines of credit are loan commitments to individuals and companies as long as there is no violation of any condition established in the contract. Lines of credit have a fixed expiration date. The Bank evaluates each customer’s credit worthiness on a case-by-case basis.

The Bank has entered into several agreements to sell mortgage loans to third parties. These agreements contain limited provisions that require the Bank to repurchase a loan if the loan becomes delinquent within a period ranging generally from 120 to 180 days after the sale date depending on the investor agreement. The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. We established a reserve for potential repurchases for these loans, which amounted to $106,000 at June 30, 2019 and $91,000 at December 31, 2018. We did not repurchase any loans during the six months ended June 30, 2019 or 2018.

Other Contingencies

The Company provides banking services to customers who do business in the medical-use cannabis industry. While the growing, processing, and sales of medical-use cannabis is legal in the state of Maryland, the business currently violates Federal law. The Company may be deemed to be aiding and abetting illegal activities through the services that it provides to these customers. The strict enforcement of Federal laws regarding medical-use cannabis would likely result in the Company’s inability to continue to provide banking services to these customers and the Company could have legal action taken against it by the Federal government, including imprisonment and fines. There is an uncertainty of the potential impact to the Company’s consolidated financial statements if the Federal government takes actions against the Company. As of June 30, 2019, the Company has not accrued an amount for the potential impact of any such actions.

24

Table of Contents

Following is a summary of the level of business activities with our medical-use cannabis customers:

• Deposit and loan balances at June 30, 2019 were approximately $27.1 million, or 4.0% of total deposits, and $15.0 million, or 2.2% of total loans, respectively. Deposit and loan balances at December 31, 2018 were approximately $17.0 million, or 2.2% of total deposits, and $14.1 million, or 2.1% of total loans, respectively.

•Interest and noninterest income for the three months ended June 30, 2019 were approximately $233,000 and $491,000, respectively. Interest and noninterest income for the three months ended June 30, 2018 were approximately $134,000 and $315,000, respectively.

•Interest and noninterest income for the six months ended June 30, 2019 were approximately $428,000 and $941,000, respectively. Interest and noninterest income for the six months ended June 30, 2018 were approximately $310,000 and $545,000, respectively.

•The volume of deposits in the accounts of medical-use cannabis customers for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017:~~

Three Months Nine Months
(dollars in thousands)
Balance at beginning of period $ 6 $ -
Other comprehensive loss before reclassification (9 ) (3 )
Amounts reclassified from accumulated other comprehensive loss (1 ) (1 )
Net other comprehensive loss during period (10 ) (4 )
Balance at end of period $ (4 ) $ (4 )

~~We did not have any accumulated other comprehensive income or loss~~2019 was approximately $56.6 million and $106.1 million, respectively. The volume of deposits in the accounts of medical-use cannabis customers for the three ~~or nine~~and six months ended ~~September~~June 30, ~~2016.~~

2018 was approximately $11.4 million and $29.3 million, respectively.

Note 8 - Fair Value of Financial Instruments

A fair value hierarchy that prioritizes the inputs to valuation methods is used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair market hierarchy are as follows:

~~Level 1:~~

~~Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets, or liabilities.~~

~~Level 2:~~

~~Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.~~

~~Level 3:~~

~~Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).~~

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).

An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

We record transfers between levels at the end of the reporting period in which the change in significant inputs occurs.

25

Table of Contents

Assets Measured on a Recurring Basis

The following ~~tables present~~table presents fair value measurements for assets that are measured at fair value on a recurring basis as of and for the ~~nine~~six months ended ~~September~~June 30, ~~2017:~~2019:


					Significant
					Other		Significant		Total Changes
			Quoted		Observable		Unobservable		In Fair Values
	Carrying		Prices		Inputs		Inputs		Included In
	Value		(Level 1)		(Level 2)		(Level 3)		Period Income
Assets:	(dollars in thousands)
AFS Securities - U.S. Treasury notes	$	1,995	$	1,995	$	—	$	—	$	—
AFS Securities - U.S. government agency notes		9,036		—		9,036		—		—
Loans held for sale ("LHFS")		17,987		—		17,987		—		278
Mortgage servicing rights ("MSRs")		343		—		—		343		(94)
Interest-rate lock commitments ("IRLCs")		345		—		—		345		245
Best efforts forward contracts		39		—		39		—		39

Liabilities:
Mandatory forward contracts		36		—		36		—		(20)

Carrying
Value

Quoted
Prices
(Level 1)

Significant
Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Total Changes
In Fair Values
Included In
Period Income

(dollars in thousands)
AFS Securities - U.S. government agency notes $ 3,129 $ - $ 3,129 $ - $ -
Loans held for sale (“LHFS”) 4,871 - 4,871 - 139
Mortgage servicing rights (“MSRs”) 473 - - 473 (84 )
Interest-rate lock commitments (“IRLCs”) 42 - 42 - (120 )
Mandatory forward contracts 7 - 7 - (146 )
Best efforts forward contracts 6 - 6 - 6

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~~Table of Contents~~

The following ~~tables present~~table presents fair value measurements for assets and liabilities that are measured at fair value on a recurring basis as of and for the year ended December 31, ~~2016:~~2018:


					Significant
					Other		Significant		Total Changes
			Quoted		Observable		Unobservable		In Fair Values
	Carrying		Prices		Inputs		Inputs		Included In
	Value		(Level 1)		(Level 2)		(Level 3)		Period Income
Assets:	(dollars in thousands)
AFS Securities - U.S. Treasury notes	$	1,981	$	1,981	$	—	$	—	$	—
AFS Securities - U.S. government agency notes		9,997		—		9,997		—		—
LHFS		9,686		—		9,686		—		192
MSRs		437		—		—		437		(40)
IRLCs		100		—		—		100		78

Liabilities:
Mandatory forward contracts		16		—		16		—		(30)
Best efforts forward contracts		—		—		—		—		(3)

Carrying
Value

Quoted
Prices
(Level 1)

Significant
Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Total Changes
In Fair Values
Included In
Period Income

(dollars in thousands)
MSRs $ 557 $ - $ - $ 557 $ 66
IRLCs 162 - 162 - (21 )
Mandatory forward contracts 153 - 153 - 42

The following table provides additional quantitative information about assets measured at fair value on a recurring basis and for which we have utilized Level 3 inputs to determine fair value:


	Fair Value		Valuation	Unobservable	Range
	Estimate		Technique	Input	(Weighted-Average)
June 30, 2019:	(dollars in thousands)
MSRs	$	343	Market Approach	Weighted average prepayment speed	12.90	%
IRLCs		345	Market Approach	Range of pull through rate	70% - 95	%
				Average pull through rate	83	%

December 31, 2018:
MSRs	$	437	Market Approach	Weighted average prepayment speed	9.80	%
IRLCs		100	Market Approach	Range of pull through rate	70% - 95	%
				Average pull through rate	84	%

26

Fair Value
Estimate

Valuation
Technique

Unobservable
Input

Range
(Weighted-Average)

(dollars in thousands)
September 30, 2017:
MSRs $ 473 Market Approach Weighted average prepayment speed 3.95 %

December 31, 2016:
MSRs $ 557 Market Approach Weighted average prepayment speed 3.95 %

Table of Contents

The following table shows the activity in the MSRs:



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
	(dollars in thousands)
Beginning balance	$	400	$	499	$	437	$	477
Valuation adjustment		(57)		2		(94)		24
Ending balance	$	343	$	501	$	343	$	501

The following table shows the activity in the IRLCs:


	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
	(dollars in thousands)
Beginning balance	$	335	$	184	$	100	$	22
Valuation adjustment		10		(16)		245		146
Ending balance	$	345	$	168	$	345	$	168

AFS Securities

The estimated fair values of AFS debt securities are obtained from a nationally-recognized pricing service. This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing to prepare valuations. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond’s terms and conditions, among other things, and are based on market data obtained from sources independent from the Bank. U.S Treasury Securities are considered Level 1 and all of our other securities are considered Level 2. The Level 2 investments in the Bank’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets. The Bank has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in the Bank’s portfolio are not exchange-traded, and such nonexchange-traded fixed income securities are typically priced by correlation to observed market data.

LHFS

~~At September 30, 2017,~~

LHFS ~~were~~are carried at fair value, which is determined based on outstanding investor commitments or, in the absence of such commitments, on current investor yield requirements or third party pricing models. ~~At December 31, 2016, LHFS were carried at the lower-of-cost or market value (“LCM”) utilizing the same method.~~

MSRs

The fair value of MSRs is determined using a valuation model administered by a third party that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service (including delinquency and foreclosure costs), escrow account earnings, contractual servicing fee income, and other ancillary income such as late fees. Management reviews all significant assumptions on a monthly basis. Mortgage loan prepayment speed, a key assumption in the model, is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate used to determine the present value of estimated future net servicing income, another key assumption in the model, is an estimate of the required rate of return investors in the market would require for an asset with similar risk. Both assumptions can, and generally will, change as market conditions and interest rates change.

27

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Table of Contents

IRLCs

We utilize a third party specialist model to estimate the fair value of our IRLCs, which are valued based upon mandatory pricing quotes from correspondent lenders less estimated costs to process and settle the loan. Fair value is adjusted for the estimated probability of the loan closing with the borrower.

Forward Contracts

To avoid interest rate risk, we enter into best efforts forward sales commitments with investors at the time we make an IRLC to a borrower. Once a loan has been closed and funded, the best efforts commitments convert to mandatory forward sales commitments. The mandatory commitments are derivatives, and the bank measures and reports them at fair value. Fair value is based on the gain or loss that would occur if we were to pair-off the transaction with the investor at the measurement date. This is a level 2 input. We have elected to measure and report best efforts commitments at fair value using a valuation methodology similar to that used for our mandatory commitments.

Assets Measured on a Nonrecurring Basis

We may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of ~~LCM~~lower-of-cost-or-market value (“LCM”) accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis, the following tables provide the level of valuation assumptions used to determine each adjustment and the carrying value of assets:


	June 30, 2019
					Significant
					Other		Significant
			Quoted		Observable		Unobservable
	Carrying		Prices		Inputs		Inputs		Range of	Weighted
	Value		(Level 1)		(Level 2)		(Level 3)		Discount (1)	Average
	(dollars in thousands)
Impaired loans	$	5,538	$	—	$	—	$	5,538	0% - 15%	7	%
Real estate acquired through foreclosure		625		—		—		625	0% - 16%	16	%

(1)

Discount based on current market conditions and estimated selling costs

December 31, 2018

Significant

Other

Significant

Quoted

Observable

Unobservable

Carrying

Prices

Inputs

Range of

Weighted

Value

(Level 1)

(Level 2)

(Level 3)

Discount (1)

Average

(dollars in thousands)

Impaired loans

$

5,678

$

—

$

—

$

5,678

0% - 16%

6.7

%

September 30, 2017

Carrying
Value

Quoted
Prices
(Level 1)

Significant
Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Range of
Discount

Weighted
Average

(dollars in thousands)
Impaired loans $ 1,597 $ - $ - $ 1,597 0% - 33 % 25.5 %
Real estate acquired through foreclosure 691 - - 691 0% - 26 % 20.9 %

(1)

Discount based on current market conditions and estimated selling costs

December 31, 2016

Carrying
Value

Quoted
Prices
(Level 1)

Significant
Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Range of
Discount

Weighted
Average

(dollars in thousands)
Impaired loans $ 2,136 $ - $ - $ 2,136 0% - 2 % 2.0 %
Real estate acquired through foreclosure 767 - - 767 0% - 10 % 10.0 %

Impaired Loans

Impaired loans are those for which we have measured impairment based on the present value of expected future cash flows or on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. If it is determined that the repayment of the loan will be provided solely by the underlying collateral, and there are no other available and reliable sources of repayment, the loan is considered collateral dependent. Impaired loans that are considered collateral dependent are carried at ~~the~~ LCM. Collateral may be in the form of real estate or business assets including equipment, inventory, and/or accounts receivable. The use of independent appraisals and management’s best judgment are significant inputs in arriving at the fair value measure of the underlying collateral and impaired loans are therefore classified within level 3 of the fair value hierarchy.

28

Table of Contents

For such loans that are classified as impaired, an Allowance is established when the present value of the expected future cash flows of the impaired loan is lower than the carrying value of that loan. For such impaired loans that are classified as collateral dependent, an Allowance is established when the current market value of the underlying collateral less its estimated disposal costs has not been finalized, but management determines that it is likely that the value is lower than the carrying value of that loan. Once the net collateral value has been determined, a charge-off is taken for the difference between the net collateral value and the carrying value of the loan.

23

~~Table of Contents~~

Real Estate Acquired Through Foreclosure

We record foreclosed real estate assets at the fair value less estimated selling costs on their acquisition dates and at the lower of such initial amount or estimated fair value less estimated selling costs thereafter. We generally obtain certified external appraisals of real estate acquired through foreclosure and estimate fair value using those appraisals. Other valuation sources may be used, including broker price opinions, letters of intent, and executed sale agreements.

Fair Value of All Financial Instruments

The carrying value and ~~estimated~~ fair value of all financial instruments are summarized in the following tables. The descriptions of the fair value calculations for AFS securities, LHFS, MSRs, IRLCs, best efforts forward contracts, mandatory forward contracts, impaired loans, and real estate acquired through foreclosure are included in the discussions above.tables:


	June 30, 2019
	Carrying		Fair Value
	Value		Level 1		Level 2		Level 3		Total
Assets:	(dollars in thousands)
Cash and cash equivalents	$	77,337	$	77,337	$	—	$	—	$	77,337
Certificates of deposit held for investment		7,540		7,540		—		—		7,540
AFS securities		11,031		1,995		9,036		—		11,031
HTM securities		33,562		2,015		31,693		—		33,708
LHFS		17,987		—		17,987		—		17,987
Loans receivable, net		671,480		—		—		679,488		679,488
Restricted stock investments		2,857		—		2,857		—		2,857
Accrued interest receivable		2,605		—		2,605		—		2,605
ROU asset		2,494		—		2,494		—		2,494
MSRs		343		—		—		343		343
IRLCs		345		—		—		345		345
Best effort forward contracts		39		—		39		—		39
Liabilities:
Deposits		685,416		—		683,846		—		683,846
Accrued interest payable		350		—		350		—		350
Borrowings		48,500		—		44,886		—		44,886
Subordinated debentures		20,619		—		—		20,619		20,619
Lease liability		2,528		—		2,528		—		2,528
Mandatory forward contracts		36		—		36		—		36

29

September 30, 2017
Carrying Fair Value
Value Level 1 Level 2 Level 3 Total
Assets: (dollars in thousands)
Cash and cash equivalents $ 41,635 $ 41,635 $ - $ - $ 41,635
AFS securities 3,129 - 3,129 - 3,129
HTM securities 58,764 8,102 50,857 - 58,959
LHFS 4,871 - 4,871 - 4,871
Loans receivable 643,028 - - 653,381 653,381
Restricted stock investments 4,699 - 4,699 - 4,699
Accrued interest receivable 2,503 - 2,503 - 2,503
MSRs 473 - - 473 473
IRLCs 42 - 42 - 42
Mandatory forward contracts 7 - 7 - 7
Best effort forward contracts 6 - 6 - 6
Liabilities:
Deposits 593,492 - 586,594 - 586,594
Borrowings 93,450 - 87,909 - 87,909
Subordinated debentures 20,619 - - 20,619 20,619
Accrued interest payable 478 - 478 - 478

December 31, 2016
Carrying Fair Value
Value Level 1 Level 2 Level 3 Total
Assets: (dollars in thousands)
Cash and cash equivalents $ 67,114 $ 67,114 $ - $ - $ 67,114
HTM securities 62,757 13,165 49,662 - 62,827
LHFS 10,307 - 10,313 - 10,313
Loans receivable 601,309 - - 602,953 602,953
Restricted stock investments 5,103 - 5,103 - 5,103
Accrued interest receivable 2,249 - 2,249 - 2,249
MSRs 557 - - 557 557
IRLCs 162 - 162 - 162
Mandatory forward contracts 153 - 153 - 153
Liabilities:
Deposits 571,946 - 572,556 - 572,556
Borrowings 103,500 - 97,961 - 97,961
Subordinated debentures 20,619 - - 20,619 20,619
Accrued interest payable 538 - 538 - 538

24

Table of Contents


	December 31, 2018
	Carrying		Fair Value
	Value		Level 1		Level 2		Level 3		Total
Assets:	(dollars in thousands)
Cash and cash equivalents	$	188,340	$	188,340	$	—	$	—	$	188,340
Certificates of deposit held for investment		8,780		8,780		—		—		8,780
AFS securities		11,978		1,981		9,997		—		11,978
HTM securities		38,912		2,008		36,204		—		38,212
LHFS		9,686		—		9,686		—		9,686
Loans receivable, net		674,305		—		—		670,512		670,512
Restricted stock investments		3,766		—		3,766		—		3,766
Accrued interest receivable		2,848		—		2,848		—		2,848
MSRs		437		—		—		437		437
IRLCs		100		—		—		100		100
Liabilities:
Deposits		779,506		—		778,313		—		778,313
Accrued interest payable		419		—		419		—		419
Borrowings		73,500		—		69,210		—		69,210
Subordinated debentures		20,619		—		—		20,619		20,619
Mandatory forward contracts		16		—		16		—		16

At ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018 the Bank had loan funding commitments of ~~$97.6~~$116.8 million and ~~$58.2~~$115.0 million, respectively, and standby letters of credit outstanding of ~~$3.9~~$3.4 million and ~~$4.0~~$3.3 million, respectively. The fair value of these commitments is nominal.

~~Cash and Cash Equivalents~~

~~The carrying amount reported in the consolidated statements of financial condition for cash and cash equivalents approximate those assets’ fair values.~~

~~HTM securities~~

The Company utilizes a third party source to determine the fair value of its securities. The methodology consists of pricing models based on asset class and includes available trade, bid, other market information, broker quotes, proprietary models, various databases, and trading desk quotes. U.S Treasury Securities are considered Level 1 and all of our other securities are considered Level 2.

~~Loans Receivable~~

The fair values of loans receivable were estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. These rates were used for each aggregated category of loans.

~~Restricted Stock Investments~~

~~The carrying value of restricted stock investments is a reasonable estimate of fair value as these investments do not have a readily available market.~~

~~Deposits~~

The fair values disclosed for demand deposit accounts, savings accounts, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

~~Borrowings~~

~~Long-term and short-term borrowings were segmented into categories with similar financial characteristics. Carrying values were discounted using a cash flow approach based on market rates.~~

~~Subordinated debentures~~

Current economic conditions have rendered the market for this liability inactive. As such, the Company is unable to determine a good estimate of fair value. Since the rate paid on the debentures held is lower than what would be required to secure an interest in the same debt at year end and we are unable to obtain a current fair value, the Company has disclosed that the carrying value approximates the fair value.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about financial instruments. These estimates do not reflect any premium or discount that could result from a one-time sale of our total holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect estimates. The above information should not be interpreted as an estimate of the fair value of the Company since a fair value calculation is only provided for a limited portion of our assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between our disclosures and those of other companies may not be meaningful.

There were no transfers between any of Levels 1, 2 and 3 for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 or ~~2016~~2018 or for the year ended December 31, ~~2016.~~2018.

Note 9 - Leases

A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, we adopted ASU No. 2016-02 “Leases” (“Topic 842”) and all subsequent ASUs that modified Topic 842. For us, Topic 842 primarily affected the accounting treatment for operating lease agreements in which we are the lessee.

Substantially all of the leases in which we are the lessee are comprised of real estate property for branches, ATM locations, office equipment, and office space with terms extending through 2035. All of our leases are classified as operating leases, and therefore, were previously not recognized on the our consolidated statements of financial condition. With the adoption of Topic 842, operating lease agreements are required to be recognized on the consolidated statements of financial condition as an ROU asset and a corresponding lease liability.

30

25

Table of Contents

~~Item 2.~~

~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

The following table represents the consolidated statements of financial condition classification of our ROU assets and lease liabilities, included in other assets and other liabilities, respectively. We elected not to include short-term leases (i.e., leases with initial terms of twelve months or less) on the consolidated statements of financial condition.


	June 30, 2019
	(dollars in thousands)
Lease ROU assets	$	2,494
Lease liabilities		2,528

The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. Our lease agreements often include one or more options to renew at our discretion. If at lease inception, we consider the exercising of a renewal option to be reasonably certain we will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, we utilize our incremental borrowing rate at lease inception over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used. The weighted-average remaining lease term was 11.8 years and the weighted-average discount rate was 3.25% as of June 30, 2019.

The following table represents lease costs and other lease information. As we elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as common area maintenance and utilities. Variable lease cost also includes payments for ATM location leases in which payments are based on a percentage of ATM transactions (i.e., ATM surcharge fees), rather than a fixed amount.


	Three Months Ended		Six Months Ended
	June 30, 2019		June 30, 2019
	(dollars in thousands)
Operating lease costs	$	106	$	213
Variable lease cost		—		—
Total lease cost		106		213

Cash paid on operating lease liabilities amounted to $79,000 and $159,000 for the three and six months ended June 30, 2019 and 2018, respectively.

Future minimum payments for finance leases and operating leases with initial or remaining terms of one year or more were as follows:


	June 30, 2019
Lease payments due:	(dollars in thousands)
June 30, 2020	$	351
June 30, 2021		315
June 30, 2022		293
June 30, 2023		269
June 30, 2024		223
Thereafter		1,682
Total future minimum lease payments		3,133
Amounts representing interest		(605)
Present value of net future minimum lease payments		2,528

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

When used in this report, the terms “the Company,” “we,” “us,” and “our” refer to Severn Bancorp and, unless the context requires otherwise, its consolidated subsidiaries. The following discussion should be read and reviewed in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in Severn Bancorp’s Annual Report on Form ~~10-K~~10‑K as of and for the year ended December 31, ~~2016.~~2018.

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The Company

The Company is a savings and loan holding company chartered as a corporation in the state of Maryland in 1990. It conducts business primarily through three subsidiaries, Severn Savings Bank, FSB (the “Bank”), Mid-Maryland Title Company, Inc. (the “Title Company”), and SBI Mortgage Company (“SBI”). SBI holds mortgages that do not meet the underwriting criteria of the Bank, and is the parent company of Crownsville Development Corporation (“Crownsville”), which is doing business as Annapolis Equity Group and acquires real estate for syndication and investment purposes. The Title Company is a real estate settlement company that handles commercial and residential real estate settlements in Maryland. The Bank’s principal subsidiary, Louis Hyatt, Inc. (“Hyatt Commercial”), conducts business as Hyatt Commercial, a commercial real estate brokerage and property management company. ~~The Bank has five~~We maintain six branches in Anne Arundel County, Maryland ~~which~~at June 30, 2019 and are opening a seventh branch in Crofton, Maryland in the third quarter of 2019. The branches offer a full range of deposit products and we originate mortgages in ~~its~~the Bank’s primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware, and Virginia. As of ~~September~~June 30, ~~2017,~~2019, we had ~~132~~167 full-time equivalent employees.

Overview

The Company provides a wide range of personal and commercial banking services. Personal services include mortgage lending and various other lending services as well as deposit products such as personal Internet banking and online bill pay, checking accounts, individual retirement accounts, money market accounts, and savings and time deposit accounts. Commercial services include commercial secured and unsecured lending services as well as business Internet banking, corporate cash management services, and deposit services. The Company also provides ATMs, credit cards, debit cards, safe deposit boxes, and telephone banking, among other products and services.

We have experienced ~~a slightly~~an improved level of profitability for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, primarily due to an improvement in net interest income as well as improved profitability of our mortgage-banking operations. We recognized increased deposit service charges as a result of fees from medical-use cannabis deposit accounts. Noninterest expenses increased for the ~~payoff of high costing Federal Home Loan Bank of Atlanta (“FHLB”) advances~~three and ~~reversals of the provision for loan losses. Management believes that, while conditions continue~~six months ended June 30, 2019 due to ~~improve~~as severance payments to former employees, increased consulting fees, and ~~real estate values~~investments in ~~the Company’s market area continue~~staff and systems to ~~stabilize, certain detrimental factors still exist in the market. The interest rate spread between our cost of funds~~enhance production and what we earn on loans has grown somewhat from 2016 levels due primarily to the aforementioned payoff of FHLB advances and a change in the mix from higher costing time deposits to lower costing transaction accounts. During the second quarter of 2016, we reversed the valuation allowance maintained on the net deferred tax asset, which resulted in an $11.2 million tax benefit. With the reversal of the valuation allowance, we are now recording a provision for income taxes.

efficiency.

The Company expects to experience similar market conditions during the remainder of ~~2017, as the national and local economies continue to improve and as the employment environment in our market improves.~~2019, provided interest rates do not increase or decrease rapidly. If interest rates ~~increase,~~change rapidly, demand for loans may ~~decrease~~fluctuate and our interest rate spread could ~~decrease.~~change significantly. We will continue to manage loan and deposit pricing against the risks of rising costs of our deposits and borrowings. Interest rates are outside of our control, so we must attempt to balance the pricing and duration of the loan portfolio against the risks of rising costs of our deposits and borrowings. The continued success and attraction of Anne Arundel County, Maryland, and vicinity, will also be important to our ability to originate and grow ~~mortgage~~ loans and deposits, as will our continued focus on maintaining a low overhead. If ~~the~~ volatility in the market and the economy ~~continues or worsens,~~occurs, our business, financial condition, results of operations, access to funds, and the price of our stock could be materially and adversely impacted.

~~Acquisition~~

~~On September 1, 2017, we acquired the Title Company by issuing stock in a business combination. We issued 108,084 shares~~

Critical Accounting Policies

Our accounting and financial reporting policies conform to accounting principles generally accepted in the ~~transaction valued at $775,000. We recorded $759,000 in goodwill in~~United States of America (“U.S.”) (“GAAP”) and general practice within the ~~transaction. The acquisition continues our growth strategy and focus on being a full-service provider and complements the mortgage services, commercial~~ banking ~~services, and commercial real estate services we provide. The acquisition~~industry. Accordingly, preparation of the ~~Title Company has not had~~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 ~~effect~~impact on the ~~Company’s financial condition~~carrying value of certain assets or ~~results~~on income. These estimates and assumptions affect the reported amounts of ~~operations.~~

~~Critical Accounting Policies~~

~~Our significant accounting policies are set forth in Note 1~~assets and liabilities at the date of the ~~audited consolidated~~ financial statements ~~for~~and the ~~year ended December 31, 2016 which were included in our Annual Report on Form 10-K. Of these significant~~reported amounts of income and expenses during the periods presented. The accounting policies we ~~consider our policies regarding~~view as critical are those relating to the ~~valuation of investment securities, the Allowance~~allowance for loan losses (“Allowance”), the valuation of securities, the valuation of real estate acquired through foreclosure, and the valuation of the net deferred tax asset to be our most critical accounting policies, due to the fact that these policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried in the consolidated financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. When applying accounting policies in such areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets and liabilities. Below is a discussion of our critical accounting policies.

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~~Table of Contents~~

~~Securities~~

We designate securities into one of three categories at the time of purchase. Debt securities that we have the intent and ability to hold to maturity are classified as held to maturity (“HTM”) and recorded at amortized cost. Debt and equity securities are classified as trading if bought and held principally for the purpose of sale in the near term. Trading securities are reported at estimated fair value, with unrealized gains and losses included in earnings. Debt securities not classified as HTM and debt and equity securities not classified as trading securities are considered available for sale (“AFS”) and are reported at estimated fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity, net of tax effects, in accumulated other comprehensive loss.

AFS and HTM securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near-term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security.

The initial indications of other-than-temporary impairment (“OTTI”) for both debt and equity securities are a decline in the market value below the amount recorded for a security and the severity and duration of the decline. In determining whether an impairment is other than temporary, we consider the length of time and the extent to which the market value has been below cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions of its industry, our intent to sell the security, and if it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. We also consider the cause of the price decline (general level of interest rates and industry- and issuer-specific factors), the issuer’s financial condition, near-term prospects and current ability to make future payments in a timely manner, the issuer’s ability to service debt, and any change in agencies’ ratings at evaluation date from acquisition date and any likely imminent action. Once a decline in value is determined to be other than temporary, the security is segmented into credit- and noncredit-related components. Any impairment adjustment due to identified credit-related components is recorded as an adjustment to current period earnings, while noncredit-related fair value adjustments are recorded through accumulated other comprehensive loss. In situations where we intend to sell or it is more likely than not that we will be required to sell the security, the entire OTTI loss is recognized in earnings.

~~Allowance for Loan Losses~~

The Allowance is maintained at an amount that management believes will be adequate to absorb losses on existing loans that may become uncollectible, based on evaluations of the collectability of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers’ ability to pay. Determining the amount of the Allowance requires the use of estimates and assumptions. Actual results could differ significantly from those estimates.

Future additions or reductions in the Allowance may be necessary based on changes in economic conditions, particularly in Anne Arundel County and the State of Maryland. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s Allowance. Such agencies may require the Bank to recognize additions to the Allowance based on their judgments about information available to them at the time of their examination.

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

For such loans that are classified as impaired, an Allowance is established when the current fair value of the underlying collateral less its estimated disposal costs has not been finalized, but management determines that it is likely that the value is lower than the carrying value of that loan. Once the fair collateral value has been determined, a charge off is taken for the difference between the fair value and the carrying value of the loan. For loans that are not solely collateral dependent, an Allowance is established when the present value of the expected future cash flows of the impaired loan is lower than the carrying value of that loan.

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~~Table of Contents~~

The general component relates to loans that are classified as doubtful, substandard, or special mention that are not considered impaired, as well as nonclassified loans. The general reserve is based on historical loss experience adjusted for qualitative factors. These qualitative factors include, but are not limited to:

·

~~Levels and trends in delinquencies and nonaccruals;~~

·

~~Inherent risk in the loan portfolio;~~

·

~~Trends in volume and terms of the loan;~~

·

~~Effects of any change in lending policies and procedures;~~

·

~~Experience, ability, and depth of management;~~

·

~~National and local economic trends and conditions;~~

·

~~Effect of any changes in concentration of credit; and~~

·

~~Industry conditions.~~

~~A loan is considered impaired if it meets any of the following three criteria:~~

·

~~Loans that are 90 days or more in arrears (nonaccrual loans);~~

·

~~Loans where, based on current information and events, it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement; or~~

·

~~Loans that are modified and qualify as troubled debt restructured loans (“TDR” or “TDRs”).~~

Loans that experience insignificant payment delays and payment shortfalls may not be classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

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

~~Real Estate Acquired Through Foreclosure~~

Real estate acquired through or in the process of foreclosure is recorded at fair value less estimated disposal costs. Management periodically evaluates the recoverability of the carrying value of the real estate acquired through foreclosure using estimates as described under “~~Allowance for Loan Losses~~” above. In the event of a subsequent change in fair value, the carrying amount is adjusted to the lesser of the new fair value, less disposal costs, or the carrying value recorded at acquisition. The amount of the change is charged or credited to noninterest expense. Expenses on real estate acquired through foreclosure incurred prior to the disposition of the property, such as maintenance, insurance and taxes, and physical security, are charged to expense. Material expenses that improve the property to its best use are capitalized to the property. If a foreclosed property is sold for more or less than the carrying value, a gain or loss is recognized upon the sale of the property.

~~Deferred Income Taxes~~

Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities based on enacted tax rates expected to be in effect when such amounts are realized or settled. Deferred tax assets are recognized only to the extent that it is more likely than not that such amount will be realized based on consideration of available evidence.

~~The effect on~~ deferred tax assets and ~~liabilities~~liabilities. Significant accounting policies are discussed in detail in “Notes to Consolidated Financial Statements - Note 1 - Summary of ~~a change~~Significant Account Policies” in ~~tax rates is recognized in income~~our Annual Report on Form 10-K as of and for the year ended December 31, 2018. There have been no material changes to the significant accounting policies as described in the ~~period that includes~~Annual Report other than those mentioned in Note 1 to the ~~enactment date. To~~financial statements in this Quarterly Report on Form 10-Q. Disclosures regarding the extent that current available evidence about the future raises doubt about the likelihood of a deferred tax asset being realized, a valuation allowance is established. We recognizes a tax position as a benefit only if it “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination presumed to occur. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The judgment about the level of future taxable income is inherently subjective and is reviewed on a continual basis as regulatory and business factors change.effects

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Table of Contents

of new accounting pronouncements are included in Note 1 to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Results of Operations

Net Income

Three ~~months ended September~~Months Ended June 30

Net income ~~increased by $204,000, or 19.3%,~~amounted to ~~$1.3~~$2.2 million and $1.9 million for the three months ended ~~September~~June 30, ~~2017, compared to $1.1 million for the three months ended September 30, 2016.~~2019 and 2018, respectively. Basic and diluted income per share were ~~$0.09~~$0.17 for the three months ended ~~September~~June 30, ~~2017~~2019, compared to ~~$0.04~~ basic and diluted income per share of $0.15for the three months ended ~~September~~June 30, ~~2016.~~2018. The increase in net income reflected improved net interest income ~~decreased~~and noninterest ~~expenses, and a reduced loan loss provision,~~income, partially offset by ~~decreased~~increased noninterest ~~income.~~

~~Nine months ended September~~expense and income tax provision.

Six Months Ended June 30

Net income ~~decreased by $11.3 million,~~increased $982,000, or ~~78.1%~~25.8%, to ~~$3.2~~$4.8 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, compared to ~~$14.4~~$3.8 million for the ~~nine~~six months ended ~~September~~June 30, ~~2016.~~2018. Basic and diluted income per share were ~~$0.23 and $0.22, respectively,~~$0.37, for the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, compared to ~~$1.14 (basic)~~basic and ~~$1.13 (diluted)~~diluted income per share of $0.30 for the ~~nine~~six months ended ~~September~~June 30, 2016. During 2016, we recorded a one-time reversal of the valuation allowance held against the net deferred tax asset in the amount of $11.2 million. Income before taxes amounted to $5.3 million for the nine months ended September 30, 2017, compared to $3.6 million for the nine months ended September 30, 2016.2018. The increase in ~~pre-tax~~net income reflected improved net interest income ~~a reversal of loan loss provision,~~ and ~~decreased~~ noninterest ~~expense,~~income, partially offset by ~~decreased~~increased noninterest ~~income.~~

expense and income tax provision.

Net Interest Income

Three ~~months ended September~~Months Ended June 30

Net interest income ~~which is interest earned net of interest expense,~~ increased by ~~$614,000,~~$918,000, or ~~10.7%~~13.3%, to $6.3 million for the three months ended September 30, 2017, compared to $5.7 million for the three months ended September 30, 2016. Our net interest margin increased from 3.19% for the third quarter of 2016 to 3.38% for the third quarter of 2017. Our net interest spread increased from 3.04% for the third quarter of 2016 to 3.16% for the third quarter of 2017.

~~Interest Income~~

~~Interest income increased by $397,000, or 5.1%, to $8.2 million for the three months ended September 30, 2017, compared~~ to $7.8 million for the three months ended ~~September~~June 30, ~~2016.~~2019, compared to $6.9 million for the same period of 2018. Our net interest margin decreased slightly from 3.57% for the three months ended June 30, 2018 to 3.55% for the three months ended June 30, 2019. Our net interest spread decreased from 3.29% for the three months ended June 30, 2018 to 3.20% for the three months ended June 30, 2019.

Six Months Ended June 30

Net interest income increased by $2.0 million, or 14.5%, to $15.9 million for the six months ended June 30, 2019, compared to $13.9 million for the six months ended June 30, 2018. Our net interest margin decreased slightly from 3.62% for the six months ended June 30, 2018 to 3.60% for the six months ended June 30, 2019. Our net interest spread decreased from 3.37% for the six months ended June 30, 2018 to 3.27% for the six months ended June 30, 2019.

Interest Income

Three Months Ended June 30

Interest income increased by $1.2 million, or 13.6%, to $10.2 million for the three months ended June 30, 2019, compared to $9.0 million for the three months ended June 30, 2018, primarily due to increases in interest income on loans due to an increased average yield and an increase in interest income on other interest-earning assets due to increased average volume and yield. Average interest-earning assets increased from ~~$713.4~~$777.8 millionfor the ~~third quarter of 2016~~three months ended June 30, 2018 to ~~$743.9~~$885.5 million for the ~~third quarter~~three months ended June 30, 2019, due primarily to growth in average other interest-earning assets of ~~2017.~~$113.2 million, most of which consisted of interest-earning deposits in banks, and an increase in the average yield on loans. The increase in interest-bearing deposits in banks was the result of increased deposits from our medical-use cannabis customers. The average yield on other interest-earning assets increased from 1.53% for the three months ended June 30, 2018 to 1.95% for the same period of 2019. Average loans outstanding increased ~~by $12.1~~$5.6 million ~~due~~from $673.7 million for the three months ended June 30, 2018 to ~~increased originations.~~$679.3 million for the three months ended June 30, 2019. The average yield on loans held for investment increased from ~~4.80%~~5.03% for the three months ended ~~September~~June 30, ~~2016~~2018 to ~~4.92%~~5.42% for the three months ended ~~September~~

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Table of Contents

June 30, ~~2017~~2019 as a result of the increased interest rate environment. Average held-to-maturity (“HTM”) securities decreased by $14.3 million due to securities maturities and repayments from mortgage-backed securities.

Six Months Ended June 30

Interest income increased by $2.9 million, or 16.2%, to $20.8 million for the six months ended June 30, 2019, compared to $17.9 million for the six months ended June 30, 2018, primarily due to increases in interest income on loans and other interest-earning assets. Average interest-earning assets increased from $775.9 million for the six months ended June 30, 2018 to $892.0 million for the six months ended June 30, 2019 due primarily to growth in average other interest-earning assets of $120.5 million, most of which consisted of interest-earning deposits in banks, and an increase in the average yield on loans. The increase in interest-bearing deposits in banks was the result of increased deposits from our medical-use cannabis customers. The average yield on other interest-earning assets increased from 1.54% for the six months ended June 30, 2018 to 2.32% for the same period of 2019. Average loans outstanding increased $7.7 million from $671.2 million for the six months ended June 30, 2018 to $678.8 million for the six months ended June 30, 2019. The average yield on loans held for investment increased from 5.04% for the six months ended June 30, 2018 to 5.44% for the six months ended June 30, 2019 as a ~~slightly~~result of the increased interest rate environment. Average HTM securities decreased by ~~$11.6~~$14.6 million due to ~~security~~securities maturities and repayments from mortgage-backed securities.

Interest Expense

Three Months Ended June 30

Interest expense increased by $305,000, or 14.7%, to $2.4 million for the three months ended June 30, 2019, compared to $2.1 million for the three months ended June 30, 2018 as a result of a $624,000 increase in interest expense on deposits, partially offset by a $319,000 decrease in interest expense on borrowings. The ~~proceeds were used~~increase in deposit interest expense was primarily due to ~~fund~~an increase in the ~~purchase~~average rate paid on interest-bearing deposits, driven by the rising interest rate environment as well as increased effects of ~~AFS securities and, along~~competition with other ~~available funds,~~financial institutions. These factors increased the ~~purchase of~~average rate paid on deposits from 1.02% for the three months ended June 30, 2018 to 1.29% for the three months ended June 30, 2019. The average rate paid on certificates of deposit increased from ~~other banks, which contributed~~1.76% for the three months ended June 30, 2018 to 2.12% for the ~~increase in~~same period of 2019. Additionally, the average ~~other interest-earning assets.~~

~~Interest Expense~~

~~Interest expense decreased by $217,000, or 10.2%,~~rate paid on checking and savings accounts increased from 0.42% for the three months ended June 30, 2018 to ~~$1.9~~0.84% for the three months ended June 30, 2019. The average balance of checking and savings accounts increased significantly from $277.3 million for the three months ended ~~September~~June 30, ~~2017, compared~~2018 to ~~$2.1~~$385.1 million for the three months ended ~~September~~June 30, ~~2016.~~2019, primarily due to increases in our medical-use cannabis related accounts. The average balance of certificates of deposit decreased from $223.8 million for the three months ended June 30, 2018 to $206.0 million for the same period of 2019 due to runoff from maturing certificates of deposit. Average borrowings decreased $39.4 million due to payoffs of Federal Home Loan Bank of Atlanta (“FHLB”) advances.

Six Months Ended June 30

Interest expense increased by $870,000, or 21.9%, to $4.8 million for the six months ended June 30, 2019, compared to $4.0 million for the six months ended June 30, 2018 as a result of a $1.4 million increase in interest expense on deposits, partially offset by a $490,000 decrease in interest expense on borrowings. The increase in deposit interest expense was primarily due to ~~a decrease~~an increase in the average rate paid on ~~transaction accounts~~interest-bearing deposits, driven by the rising interest rate environment as well as increased effects of competition with other financial institutions. These factors increased the average rate paid on deposits from ~~0.23%~~0.95% for the ~~third quarter of 2016~~six months ended June 30, 2018 to ~~0.12%~~1.25% for the ~~third quarter~~six months ended June 30, 2019. The average rate paid on certificates of ~~2017, due~~deposit increased from 1.61% for the six months ended June 30, 2018 to ~~a change in~~2.07% for the ~~mix~~same period of 2019. Additionally, the average rate paid on checking and savings accounts increased from ~~higher costing time deposits~~0.44% for the six months ended June 30, 2018 to ~~lower costing transaction accounts. Additionally,~~0.82% for the six months ended June 30, 2019. The average ~~interest-bearing liabilities decreased by $19.0 million to $615.3~~balance of checking and savings accounts increased significantly from $286.3 million for the ~~three~~six months ended ~~September~~June 30, ~~2017 compared~~2018 to ~~$634.3~~$398.2 million for the six months ended June 30, 2019, primarily due to increases in our medical-use cannabis related accounts. The average balance of certificates of deposit decreased from $223.2 million for the six months ended June 30, 2018 to $208.6 million for the same period of ~~2016.~~2019 due to runoff from maturing certificates of deposit. Average borrowings decreased $37.0 million due to payoffs of FHLB advances.

34

~~Nine months ended September 30~~

Net interest income increased by $1.4 million, or 8.7%, to $17.9 million for the nine months ended September 30, 2017, compared to $16.5 million for the nine months ended September 30, 2016. Our net interest margin increased from 3.07% for the nine months ended September 30, 2016 to 3.25% for the nine months ended September 30, 2017. Our net interest spread increased from 2.94% for the nine months ended September 30, 2016 to 3.04% for the nine months ended September 30, 2017.

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Table of Contents

~~Interest Income~~

Interest income increased by $704,000, or 3.1%, to $23.7 million for the nine months ended September 30, 2017, compared to $23.0 million for the comparable period of 2016. Average interest-earning assets increased from $718.0 million for the nine months ended September 30, 2016 to $738.4 million for the nine months ended September 30, 2017. Average loans outstanding increased by $6.7 million due to increased originations. The average yield on loans increased from 4.74% for the nine months ended September 30, 2016 to 4.81% for the nine months ended September 30, 2017. Average HTM securities decreased by $9.5 million due to security maturities and repayments from mortgage-backed securities. As mentioned above, the purchase of AFS securities and certificates of deposit from other banks contributed to the increase in average other interest-earning assets.

~~Interest Expense~~

Interest expense decreased by $727,000, or 11.2%, to $5.8 million for the nine months ended September 30, 2017, compared to $6.5 million for the comparable period of 2016. The decrease was primarily due to the decreased average rate of our borrowings. Average borrowings decreased $18.0 million and the average rate paid on borrowings decreased from 3.47% for the nine months ended September 30, 2016 to 3.26% for the nine months ended September 30, 2017. Additionally, average interest-bearing liabilities decreased by $30.7 million to $614.7 million for the nine months ended September 30, 2017 compared to $645.4 million for the same period of 2016.

The following ~~table sets~~tables set forth, for the periods indicated, information regarding the average balances of interest-earning assets and interest-bearing liabilities and the resulting yields on average interest-earning assets and average rates paid on average interest-bearing liabilities. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.


																		Three Months Ended June 30,
		Three Months Ended September 30,																2019						2018
		2017								2016								Average				Yield/		Average				Yield/
		Average Balance (1)			Interest (2)		Yield/ Rate (4)			Average Balance (1)			Interest (2)		Yield/ Rate (4)			Balance		Interest (2)		Rate (4)		Balance		Interest (2)		Rate (4)
ASSETS		(dollars in thousands)																(dollars in thousands)
Loans		$	621,177		$	7,702		4.92	%	$	609,096		$	7,346		4.80	%
Loans held for sale (“LHFS”)			3,117			40		5.09	%		10,384			133		5.10	%
AFS securities			5,853			26		1.76	%		-			-		-
HTM securities			62,249			304		1.94	%		73,872			280		1.51	%
Loans (1)																		$	679,334	$	9,176	5.42	%	$	673,700	$	8,444	5.03	%
Loans held for sale ("LHFS")																			10,184		50	1.97	%		5,172		72	5.58	%
Available-for-sale ("AFS") securities																			11,553		50	1.74	%		11,794		52	1.77	%
Held-to-maturity ("HTM") securities																			36,410		191	2.10	%		50,675		255	2.02	%
Other interest-earning assets (3)			46,825			106		0.90	%		14,134			16		0.45	%		144,974		705	1.95	%		31,730		121	1.53	%
Restricted stock investments, at cost			4,676			61		5.18	%		5,885			67		4.53	%		3,077		52	6.80	%		4,763		57	4.80	%
Total interest-earning assets			743,897			8,239		4.39	%		713,371			7,842		4.37	%		885,532		10,224	4.63	%		777,834		9,001	4.64	%
Allowance			(8,383	)							(8,808	)							(8,082)						(8,184)
Cash and other noninterest-earning assets			56,589								71,805								42,753						43,474
Total assets		$	792,103			8,239				$	776,368			7,842				$	920,203		10,224			$	813,124		9,001

LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Checking and savings		$	287,299			89		0.12	%	$	271,003			154		0.23	%	$	385,084		807	0.84	%	$	277,269		292	0.42	%
Certificates of deposit			214,282			922		1.71	%		221,778			865		1.55	%		206,022		1,091	2.12	%		223,822		982	1.76	%
Total interest-bearing deposits			501,581			1,011		0.80	%		492,781			1,019		0.82	%		591,106		1,898	1.29	%		501,091		1,274	1.02	%
Borrowings			113,719			897		3.13	%		141,537			1,106		3.11	%		75,887		481	2.54	%		115,279		800	2.78	%
Total interest-bearing liabilities			615,300			1,908		1.23	%		634,318			2,125		1.33	%		666,993		2,379	1.43	%		616,370		2,074	1.35	%
Noninterest-bearing deposits			86,437								39,685
Noninterest-bearing deposit accounts																			146,832						99,714
Other noninterest-bearing liabilities			2,665								4,530								4,382						2,365
Stockholders’ equity			87,701								97,835
Total liabilities and stockholders’ equity		$	792,103			1,908				$	776,368			2,125
Stockholders' equity																			101,996						94,675
Total liabilities and stockholders' equity																		$	920,203		2,379			$	813,124		2,074
Net interest income/net interest spread	Net interest income/net interest spread				$	6,331		3.16	%				$	5,717		3.04	%			$	7,845	3.20	%			$	6,927	3.29	%
Net interest margin								3.38	%							3.19	%					3.55	%					3.57	%

(1)Nonaccrual loans are included in average loans.

(2)There are no tax equivalency adjustments.

(3)Other interest-earning assets include interest-earning deposits, federal funds sold, and certificates of deposit held for investment.

(4)Annualized.

~~(1)~~

~~Nonaccrual loans are included in average loans.~~

~~(2)~~

~~There are no tax equivalency adjustments.~~

~~(3)~~

~~Other interest-earning assets include interest-earning deposits and federal funds sold~~

35

~~(4)~~

~~Annualized~~

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Nine Months Ended September 30,
2017 2016

Average
Balance (1)

Interest (2)

Yield/
Rate (4)

Average
Balance (1)

Interest (2)

Yield/
Rate (4)

ASSETS (dollars in thousands)
Loans $ 613,833 $ 22,105 4.81 % $ 607,113 $ 21,561 4.74 %
LHFS 3,690 162 5.87 % 7,570 286 5.05 %
AFS securities 4,984 71 1.90 % - - -
HTM securities 61,705 856 1.85 % 71,253 890 1.67 %
Other interest-earning assets (3) 49,353 317 0.86 % 26,479 50 0.25 %
Restricted stock investments, at cost 4,791 181 5.05 % 5,573 201 4.82 %
Total interest-earning assets 738,356 23,692 4.29 % 717,988 22,988 4.28 %
Allowance (8,687 ) (8,857 )
Cash and other noninterest-earning assets 61,758 69,151
Total assets $ 791,427 23,692 $ 778,282 22,988

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing deposits:
Checking and savings $ 282,649 618 0.29 % $ 290,518 481 0.22 %
Certificates of deposit 215,499 2,306 1.43 % 220,337 2,521 1.53 %
Total interest-bearing deposits 498,148 2,924 0.78 % 510,855 3,002 0.78 %
Borrowings 116,539 2,844 3.26 % 134,546 3,493 3.47 %
Total interest-bearing liabilities 614,687 5,768 1.25 % 645,401 6,495 1.34 %
Noninterest-bearing deposits 85,928 36,725
Other noninterest-bearing liabilities 2,624 4,559
Stockholders’ equity 88,188 91,597
Total liabilities and stockholders’ equity $ 791,427 5,768 $ 778,282 6,495
Net interest income/net interest spread $ 17,924 3.04 % $ 16,493 2.94 %
Net interest margin 3.25 % 3.07 %

	Six Months Ended June 30,
	2019						2018
	Average				Yield/		Average				Yield/
	Balance		Interest (2)		Rate (4)		Balance		Interest (2)		Rate (4)
ASSETS	(dollars in thousands)
Loans (1)	$	678,846	$	18,327	5.44	%	$	671,157	$	16,779	5.04	%
LHFS		8,378		66	1.59	%		4,297		108	5.07	%
AFS securities		11,805		102	1.74	%		11,696		103	1.78	%
HTM securities		37,016		398	2.17	%		51,630		524	2.05	%
Other interest-earning assets (3)		152,756		1,758	2.32	%		32,291		247	1.54	%
Restricted stock investments, at cost		3,189		116	7.34	%		4,805		117	4.91	%
Total interest-earning assets		891,990		20,767	4.69	%		775,876		17,878	4.65	%
Allowance		(8,075)						(8,163)
Cash and other noninterest-earning assets		42,305						43,355
Total assets	$	926,220		20,767			$	811,068		17,878

LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Checking and savings	$	398,214		1,624	0.82	%	$	286,313		624	0.44	%
Certificates of deposit		208,561		2,143	2.07	%		223,165		1,783	1.61	%
Total interest-bearing deposits		606,775		3,767	1.25	%		509,478		2,407	0.95	%
Borrowings		79,309		1,070	2.72	%		116,316		1,560	2.70	%
Total interest-bearing liabilities		686,084		4,837	1.42	%		625,794		3,967	1.28	%
Noninterest-bearing deposits		134,845						98,277
Other noninterest-bearing liabilities		3,750						2,234
Stockholders' equity		101,541						84,763
Total liabilities and stockholders' equity	$	926,220		4,837			$	811,068		3,967
Net interest income/net interest spread			$	15,930	3.27	%			$	13,911	3.37	%
Net interest margin					3.60	%					3.62	%

~~(1)~~

~~Nonaccrual loans are included in average loans.~~

~~(2)~~

~~There are no tax equivalency adjustments.~~

~~(3)~~

~~Other interest-earning assets include interest-earning deposits and federal funds sold~~

~~(4)~~

~~Annualized~~

(1)Nonaccrual loans are included in average loans.

(2)There are no tax equivalency adjustments.

(3)Other interest-earning assets include interest-earning deposits, federal funds sold, and certificates of deposit held for investment.

(4)Annualized.

The “Rate/Volume Analysis” below indicates the changes in our net interest income as a result of changes in volume and rates. We maintain an asset and liability management policy designed to provide a proper balance between rate-sensitive assets and rate-sensitive liabilities to attempt to optimize interest margins while providing adequate liquidity for our

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anticipated needs. Changes in interest income and interest expense that result from variances in both volume and rates have been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each.


	Three Months Ended June 30, 2019 vs. 2018						Six Months Ended June 30, 2019 vs. 2018
	Due to Variances in						Due to Variances in
	Rate		Volume		Total		Rate		Volume		Total
Interest earned on:	(dollars in thousands)
Loans	$	661	$	71	$	732	$	1,354	$	194	$	1,548
LHFS		(233)		211		(22)		(191)		149		(42)
AFS securities		(1)		(1)		(2)		(3)		2		(1)
HTM Securities		75		(139)		(64)		84		(210)		(126)
Other interest-earning assets		42		542		584		180		1,331		1,511
Restricted stock investments, at cost		85		(90)		(5)		94		(95)		(1)
Total interest income		629		594		1,223		1,518		1,371		2,889

Interest paid on:
Interest-bearing deposits:
Checking and savings		369		146		515		690		310		1,000
Certificates of deposit		531		(422)		109		676		(316)		360
Total interest-bearing deposits		900		(276)		624		1,366		(6)		1,360
Borrowings		(65)		(254)		(319)		30		(520)		(490)
Total interest expense		835		(530)		305		1,396		(526)		870
Net interest income	$	(206)	$	1,124	$	918	$	122	$	1,897	$	2,019

Three Months Ended September 30, 2017 vs. 2016 Nine Months Ended September 30, 2017 vs. 2016
Due to Variances in Due to Variances in
Rate Volume Total Rate Volume Total
Interest earned on: (dollars in thousands)
Loans $ 169 $ 187 $ 356 $ 312 $ 232 $ 544
LHFS - (93 ) (93 ) 65 (189 ) (124 )
AFS securities - 26 26 - 71 71
HTM Securities 240 (216 ) 24 109 (143 ) (34 )
Other interest-earning assets 28 62 90 196 71 267
Restricted stock investments, at cost 39 (45 ) (6 ) 14 (34 ) (20 )
Total interest income 476 (79 ) 397 696 8 704

Interest paid on:
Interest-bearing deposits:
Checking and savings (123 ) 58 (65 ) 158 (21 ) 137
Certificates of deposit 217 (160 ) 57 (160 ) (55 ) (215 )
Total interest-bearing deposits 94 (102 ) (8 ) (2 ) (76 ) (78 )
Borrowings 53 (262 ) (209 ) (199 ) (450 ) (649 )
Total interest expense 147 (364 ) (217 ) (201 ) (526 ) (727 )
Net interest income $ 329 $ 285 $ 614 $ 897 $ 534 $ 1,431

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Provision for Loan Losses

Our loan portfolio is subject to varying degrees of credit risk and an Allowance is maintained to absorb losses inherent in our loan portfolio. Credit risk includes, but is not limited to, the potential for borrower default and the failure of collateral to be worth what we determined it was worth at the time of the granting of the loan. We monitor loan delinquencies at least monthly. All loans that are delinquent and all loans within the various categories of our portfolio as a group are evaluated. Management, with the advice and recommendation of the Company’s Board of Directors, estimates an Allowance to be set aside for loan losses. Included in determining the calculation are such factors as historical losses for each loan portfolio, current market value of the loan’s underlying collateral, inherent risk contained within the portfolio after considering the state of the general economy, economic trends, consideration of particular risks inherent in different kinds of lending and consideration of known information that may affect loan collectability. ~~As a result of our Allowance analysis,~~

We did not record provision for loan losses during the ~~nine~~three or six months ended ~~September~~June 30, ~~2017, we determined that a provision reversal of $650,000 was appropriate.~~

2019 or 2018.

See additional information about the provision for loan losses under “Credit Risk Management and the Allowance” later in this Item.

Noninterest Income

Three ~~months ended September~~Months Ended June 30

Total noninterest income ~~decreased~~increased by ~~$497,000,~~$547,000, or ~~26.2%~~26.5%, to ~~$1.4~~$2.6 million for the three months ended ~~September~~June 30, ~~2017,~~2019, compared to ~~$1.9~~$2.1 million for the three months ended June 30, 2018, with the majority of the increase from mortgage-banking revenue and deposit service charges. Mortgage-banking revenue increased $452,000, or 71.2%, due to the increased volume of loans originated from $25.0 million in the three months ended June 30, 2018 to $69.4 million in the three months ended June 30, 2019. Deposit service charges increased $201,000 due primarily to on-boarding and monthly fees associated with medical-use cannabis customer accounts. The Title Company generated $262,000 in revenue during the three months ended June 30, 2019 compared to $293,000 for the three months ended ~~September~~June 30, ~~2016, primarily due~~2018.

Six Months Ended June 30

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Total noninterest income increased by $1.0 million, or 26.3%, to ~~decreased mortgage-banking revenue.~~$4.9 million for the six months ended June 30, 2019, compared to $3.9 million for the six months ended June 30, 2018, with increases in most noninterest income categories. Mortgage-banking revenue ~~decreased $708,000,~~increased $577,000, or ~~67.9%~~46.9%, due to ~~a decreased~~the increased volume of loans originated ~~through our Internet mortgage platform (“E-Home Finance”)~~from $40.8 million in the ~~third quarter of 2017 compared~~six months ended June 30, 2018 to $88.9 million in the third quarter of 2016. In 2017, the decision was made to move away from the E-Home Finance purchased lead model and instead focus on internally generated leads. We have experienced a temporary reduction in volume during this transition.six months ended June 30, 2019. Deposit service charges increased ~~$158,000~~$415,000 due primarily to ~~onboarding~~on-boarding and monthly fees received on a new deposit product during the three months ended September 30, 2017. Other noninterest income includes $48,000 in revenue generated by the Title Company after the acquisition on September 1, 2017.

~~Nine months ended September 30~~

Total noninterest income decreased by $1.8 million, or 32.6%, to $3.8 million for the nine months ended September 30, 2017, compared to $5.6 million for the comparable period in 2016, primarily due to decreased real estate commissions and mortgage-banking revenue.associated with medical-use cannabis customer accounts. Real estate commissions ~~by Hyatt Commercial decreased by $287,000,~~increased $115,000, or ~~23.0%,~~15.4% due to ~~$959,000 for~~an increase in the ~~nine~~volume of properties sold during the six months ended ~~September~~June 30, ~~2017, compared to $1.2 million for the same period of 2016. The decrease was due to a decreased volume of commercial sales in the nine months ended September 30, 2017~~2019 compared to the same period of 2018. The Title Company generated $479,000 in ~~2016. Mortgage-banking~~ revenue ~~decreased $1.5~~during the six months ended June 30, 2019 compared to $435,000 for the six months ended June 30, 2018 due to an increase in loan closings and related title work.

Noninterest Expense

Three Months Ended June 30

Total noninterest expense increased $1.2 million, or ~~57.3%~~18.3%, to ~~$1.2~~$7.5 million for the nine months ended September 30, 2017, compared to $2.7 million for the comparable period of 2016. This decrease in activity was the result of a decrease in the volume of loans originated through E-Home Finance in the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 due to the transition from the E-Home Finance purchased lead model to internally generated leads. Deposit service charges increased $160,000 due primarily to onboarding fees received on a new deposit product during the nine months ended September 30, 2017. Other noninterest income includes $48,000 in revenue generated by the Title Company after the acquisition on September 1, 2017.

~~Noninterest Expense~~

~~Three months ended September 30~~

~~Total noninterest expenses decreased $609,000, or 9.9%, to $5.5 million~~ for the three months ended ~~September~~June 30, ~~2017,~~2019, compared to ~~$6.1~~$6.4 million for the three months ended June 30, 2018, primarily due to increases in compensation and related expenses, professional fees, data processing fees, and licensing and software expenses. Compensation and related expenses increased by $489,000, or 11.1%, to $4.9 million for the three months ended ~~September~~June 30, ~~2016,~~2019, compared to $4.4 million for the three months ended June 30, 2018. This increase was primarily due to ~~decreases~~annual salary increases, additional hirings, severance payments to former employees, and increased commission expense that corresponds with our increased loan origination and mortgage-banking volumes. Professional fees increased $338,000 due to increased consulting costs. Data processing fees and licensing and software expense increased $99,000 and $136,000, respectively, due to additional efficiency and security enhancements to our core and related systems, as well as the implementation of a new customer relationship management (“CRM”) system.

Six Months Ended June 30

Total noninterest expense increased $1.8 million, or 14.1%, to $14.3 million for the six months ended June 30, 2019, compared to $12.5 million for the six months ended June 30, 2018, primarily due to increases in compensation and related expenses, ~~Federal Deposit Insurance Corporation (“FDIC”) assessments, mortgage leads purchased,~~professional fees, data processing fees, licensing and ~~professional fees.~~software expenses, and increased write-downs on real estate acquired through foreclosure. Compensation and related expenses ~~decreased~~increased by ~~$640,000,~~$736,000, or ~~16.3%~~8.5%, to ~~$3.3~~$9.4 million for the six months ended June 30, 2019, compared to $8.7 million for the six months ended June 30, 2018. This increase was primarily due to the aforementioned annual salary increases, additional hirings, severance payments, and commission expense. Professional fees increased $369,000 due to increased consulting costs. Data processing fees and licensing and software expense increased $177,000 and $197,000, respectively, due to the aforementioned efficiency and security system enhancements and the new CRM system. We experienced write-downs and costs related to real estate acquired through foreclosure of $149,000 during the six months ended June 30, 2019 compared to $14,000 during the same period of 2018. The majority of the increase from 2018 to 2019 was due to the write down of two properties.

Income Tax Provision

Three Months Ended June 30

We recorded a $771,000 tax provision on net income before income taxes of $2.9 million for the three months ended ~~September~~June 30, ~~2017,~~2019, compared to ~~$3.9~~an income tax provision of $724,000 on net income before income taxes of $2.6 million for the three months ended ~~September~~June 30, ~~2016.~~2018. The increase in the tax provision was primarily due to the increase in net income before income taxes.

Six Months Ended June 30

We recorded a $1.8 million tax provision on net income before income taxes of $6.5 million for the six months ended June 30, 2019, compared to an income tax provision of $1.5 million on net income before income taxes of $5.3 million for

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the six months ended June 30, 2018. The increase in the tax provision was primarily due to the increase in net income before income taxes.

The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017, which lowered the corporate federal tax rate from 35% to 21% effective January 1, 2018. Among other things, the Tax Act has significantly lowered our effective tax rate. Our effective tax rate was reduced to 26.2% for the three months ended June 30, 2019 compared to 27.4% for the three months ended June 30, 2018 and 26.9% for the six months ended June 30, 2019 compared to 27.9% for the six months ended June 30, 2018. Our effective tax rate is affected by temporary and permanent book to tax differences arising during the periods.

Financial Condition

Total assets decreased $112.1 million to $862.1 million at June 30, 2019, compared to $974.2 million at December 31, 2018. This decrease was primarily due to ~~staff reductions. Our FDIC insurance premiums~~a $111.0 million, or 58.9%, decrease in cash and cash equivalents, to $77.3 million at June 30, 2019 from $188.3 million at December 31, 2018. Additionally, we experienced a decrease in loans of $2.8 million, or 0.4%, to $679.6 million at June 30, 2019 from $682.3 million at December 31, 2018. Total deposits decreased during the third quarter of 2017 as a result of the termination of the formal agreements with the Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve Board (“FRB”) in 2016. Professional fees$94.1 million, or 12.1%, to $685.4 million at June 30, 2019 compared to $779.5 million at December 31, 2018. Total borrowings decreased by ~~$65,000,~~$25.0 million or ~~34.4%~~34.0%, to ~~$124,000 for the three months ended September~~$48.5 million at June 30, ~~2017,~~2019 compared to ~~$189,000 for the three months ended September 30, 2016, primarily due to decreased fees incurred for consulting. Mortgage leads purchased decreased $157,000~~$73.5 million at December 31, 2018 due to the transition away from the E-Home Finance purchased lead model. Partially offsetting the decreases in noninterest expense, on-line charges increased $120,000, credit reports and appraisal fees increased $55,000, and we recorded increased write-downs and incurred increased costs on real estate acquired through foreclosure during the three months ended September 30, 2017 compared to the same period in 2016.

~~Nine months ended September 30~~

Total noninterest expenses decreased $1.3 million, or 7.0%, to $17.0 million for the nine months ended September 30, 2017, compared to $18.3 million for the nine months ended September 30, 2016, with decreases in the majoritypaydown of expense categories. Compensation and related expenses decreased by $499,000, or 4.4%, to $10.7 million for the nine months ended September 30, 2017, compared to $11.2 million for the nine months ended September 30, 2016 due to staff reductions. During the nine months ended September 30, 2017, we reversed an over accrual of FDIC assessment expense due to a lower 2017 rate assessment that arose from the termination of the OCC and FRB agreements in 2016. Professional fees decreased by $151,000, or 28.6%, to $377,000 for the nine months ended September 30, 2017, compared to $528,000 for the same period of 2016, primarily due to a decrease in fees incurred for consulting. Mortgage leads purchased decreased $325,000 due to the transition away from the E-Home Finance purchased lead model.

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~~Income Tax Provision~~

We recorded $950,000 and $2.2 million in income tax provisions during the three and nine months ended September 30, 2017, respectively, compared to a tax provision of $378,000 for the three months ended September 30, 2016 and a $10.8 million income tax benefit for the nine months ended September 30, 2016. We fully released our net deferred tax asset valuation allowanceFHLB advances in the first half of ~~2016.~~

~~Financial Condition~~

~~Total assets~~2019. Stockholders’ equity increased ~~$13.8~~$4.2 million to ~~$801.3~~$102.7 million at ~~September~~June 30, ~~2017,~~2019 compared to ~~$787.5~~$98.5 million at December 31, ~~2016. LHFS decreased $5.4 million, or 52.7%, to $4.9 million at September 30, 2017, compared to $10.3 million at December 31, 2016. This decrease was~~2018, primarily due to ~~a lower volume of loan originations, and~~the increase in retained earnings, partially offset by dividends to a lesser extent, the timing of loans pending sale. Loans increased $40.7 million, or 6.7%, to $651.0 million at September 30, 2017 from $610.3 million at December 31, 2016 due to increased residential mortgage and commercial real estate originations during 2017. Total deposits increased $21.5 million, or 3.8%, to $593.5 million at September 30, 2017 compared to $571.9 million at December 31, 2016. Total borrowings decreased by $10.1 million, or 9.7%, to $93.5 million at September 30, 2017 compared to $103.5 million at December 31, 2016. The borrowings held at December 31, 2016 began to mature in February of 2017. To facilitate the funding of the loan growth and the repayment of FHLB advances, cash and cash equivalents decreased by $25.5 million, or 38.0%, to $41.6 million at September 30, 2017, compared to $67.1 million at December 31, 2016.

stockholders.

Securities

We utilize the securities portfolio as part of our overall asset/liability management practices to enhance interest revenue while providing necessary liquidity for the funding of loan growth or deposit withdrawals. We continually monitor the credit risk associated with investments and diversify the risk in the securities portfolios. We held ~~$3.1~~$11.0 million and $12.0 million in securities classified as AFS as of ~~September~~June 30, ~~2017.~~2019 and December 31, 2018, respectively. We held ~~$58.8~~$33.6 million and ~~$62.8~~$38.9 million, respectively, in securities classified as HTM as of ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~

2018.

Changes in current market conditions, such as interest rates and the economic uncertainties in the mortgage, housing, and banking industries impact the securities market. Quarterly, we review each security in our portfolio to determine the nature of any decline in value and evaluate if any impairment should be classified as ~~OTTI.~~other-than-temporary impairment (“OTTI”). For the three and ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, we determined that no OTTI charges were required.

All of the AFS and HTM securities that are temporarily impaired as of ~~September~~June 30, ~~2017~~2019 are so due to declines in fair values resulting from changes in interest rates or decreased credit/liquidity spreads compared to the time they were purchased. We have the intent to hold these securities to maturity (including those designated as AFS) and it is more likely than not that we will not be required to sell the securities before recovery of value. As such, management considers the impairments to be temporary.

Our ~~AFS securities portfolio consists of United States of America (“U.S.”) government agency notes in the amount of $3.1 million at September 30, 2017, all of which were purchased in 2017.~~

~~Our HTM~~ securities portfolio composition is as follows:


	AFS				HTM
	June 30, 2019		December 31, 2018		June 30, 2019		December 31, 2018
	(dollars in thousands)
U.S. Treasury securities	$	1,995	$	1,981	$	1,992	$	1,991
U.S. government agency notes		9,036		9,997		8,989		11,992
Mortgage-backed securities		—		—		22,581		24,929
	$	11,031	$	11,978	$	33,562	$	38,912

39

September 30, 2017 December 31, 2016
(dollars in thousands)
U.S. Treasury securities $ 7,996 $ 12,998
U.S. government agency notes 19,008 20,027
Mortgage-backed securities 31,760 29,732
$ 58,764 $ 62,757

~~LHFS~~

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LHFS

We originate residential mortgage loans for sale on the secondary market. ~~At September 30, 2017, such~~Such LHFS, which are carried at fair value, amounted to ~~$4.9~~$18.0 million at June 30, 2019 and $9.7 million at December 31, 2018, the majority of which are subject to purchase commitments from investors. ~~The~~ LHFS ~~balance at December 31, 2016 was $10.3 million and was recorded at lower-of-cost or market value (“LCM”).~~ ~~LHFS decreased~~increased by ~~$5.4~~$8.3 million, or ~~52.7%~~85.7%, compared to December 31, ~~2016. This decrease was~~2018, primarily due to ~~a lower origination volume~~increased originations and to the timing of loans pending sale on the secondary market.

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Loans

Our loan portfolio is expected to produce higher yields than investment securities and other interest-earning assets; the absolute volume and mix of loans and the volume and mix of loans as a percentage of total interest-earning assets is an important determinant of our net interest margin.

The following table sets forth the composition of our loan portfolio:


	June 30, 2019				December 31, 2018
			Percent				Percent
	Amount		of Total		Amount		of Total
	(dollars in thousands)
Residential Mortgage	$	274,474	40.4	%	$	274,759	40.3	%
Commercial		45,347	6.7	%		35,884	5.2	%
Commercial real estate		237,368	34.9	%		242,693	35.6	%
Land acquisition, development, and construction ("ADC")		108,182	15.9	%		114,540	16.8	%
Home equity/2nds		12,581	1.9	%		13,386	2.0	%
Consumer		1,621	0.2	%		1,087	0.1	%
	$	679,573	100.0	%	$	682,349	100.0	%

September 30, 2017 December 31, 2016
Amount
Percent
of Total
Amount
Percent
of Total

(dollars in thousands)
Residential Mortgage $ 289,169 44.4 % $ 257,659 42.2 %
Commercial 37,485 5.8 % 46,468 7.6 %
Commercial real estate 223,167 34.3 % 195,710 32.1 %
Construction, land acquisition, and development (“ADC”) 84,164 12.9 % 90,102 14.8 %
Home equity/2nds 15,861 2.4 % 19,129 3.1 %
Consumer 1,118 0.2 % 1,210 0.2 %
$ 650,964 100.0 % $ 610,278 100.0 %

Loans ~~increased~~decreased by ~~$40.7~~$2.8 million, or ~~6.7%~~0.4%, to ~~$651.0~~$679.6 million at ~~September~~June 30, ~~2017,~~2019, compared to ~~$610.3~~$682.3 million at December 31, ~~2016.~~2018. This ~~increase~~decrease was due to ~~increased~~decreased demand and originations, as well as increased payoffs of ~~residential mortgages and~~ commercial real estate, ADC and home equity/2nds loans.

We did experience an increase in commercial loan demand during the six months ended June 30, 2019.

Credit Risk Management and the Allowance

Credit risk is the risk of loss arising from the inability of a borrower to meet his or her obligations and entails both general risks, which are inherent in the process of lending, and risks specific to individual borrowers. Our credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry, or collateral type.

We manage credit risk by evaluating the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies and evaluation processes are designed to minimize our risk, management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions.

Management has an established methodology to determine the adequacy of the Allowance that assesses the risks and losses inherent in the loan portfolio. Our Allowance methodology employs management’s assessment as to the level of future losses on existing loans based on our internal review of the loan portfolio, including an analysis of the borrowers’ current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers and/or lines of business. In determining our ability to collect certain loans, we also consider the fair value of any underlying collateral. In addition, we evaluate credit risk concentrations, including trends in large dollar exposures to related borrowers, industry and geographic concentrations, and economic and environmental factors. Our risk management practices are designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may inherently exist within the loan portfolio. The assessment aspects involved in analyzing the quality of individual

40

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loans and assessing collateral values can also contribute to undetected, but probable, losses. For more detailed information about our Allowance methodology and risk rating system, see Note 3 to the Consolidated Financial Statements.

34

~~Table of Contents~~

The following table summarizes the activity in our Allowance by portfolio segment:


	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
	(dollars in thousands)
Allowance, beginning of year	$	8,085		$	8,169		$	8,044		$	8,055
Charge-offs:
Residential mortgage		(20)			(37)			(20)			(360)
Commercial		—			—			—			—
Commercial real estate		—			—			—			—
ADC		—			—			—			(13)
Home equity/2nds		—			—			—			—
Consumer		(12)			—			(12)			—
Total charge-offs		(32)			(37)			(32)			(373)
Recoveries:
Residential mortgage		3			1			8			222
Commercial		—			—			—			—
Commercial real estate		33			122			67			333
ADC		—			—			—			—
Home equity/2nds		4			2			6			20
Consumer		—			—			—			—
Total recoveries		40			125			81			575
Net recoveries		8			88			49			202
Provision for loan losses		—			—			—			—
Allowance, end of period	$	8,093		$	8,257		$	8,093		$	8,257
Loans:
Period-end balance	$	679,573		$	686,912		$	679,573		$	686,912
Average balance during period		679,334			673,700			678,846			671,157
Allowance as a percentage of
period-end loan balance		1.19	%		1.20	%		1.19	%		1.20	%
Percent of average loans (annualized):
Provision for loan losses		—	%		—	%		—	%		—	%
Net recoveries		—	%		0.05	%		0.01	%		0.06	%

Three Months Ended September 30, Nine Months Ended September 30,
2017 2016 2017 2016
(dollars in thousands)
Allowance, beginning of period $ 7,718 $ 8,804 $ 8,969 $ 8,758
Charge-offs:
Residential mortgage - - (707 ) (151 )
Commercial - - - (17 )
Commercial real estate - - - (178 )
ADC - (72 ) - (72 )
Home equity/2nds - - (98 ) (28 )
Consumer - - - -
Total charge-offs - (72 ) (805 ) (446 )
Recoveries:
Residential mortgage 156 137 295 322
Commercial - 10 - 43
Commercial real estate 40 4 100 4
ADC - - - 100
Home equity/2nds 22 2 27 4
Consumer - 50 - 50
Total recoveries 218 203 422 523
Net recoveries (charge offs) 218 131 (383 ) 77
Provision for (reversal of) loan losses - 50 (650 ) 150
Allowance, end of period $ 7,936 $ 8,985 $ 7,936 $ 8,985
Loans:
Period-end balance $ 650,964 $ 612,458 $ 650,964 $ 612,458
Average balance during period 621,177 609,096 613,833 607,113
Allowance as a percentage of period-end loan balance 1.22 % 1.47 % 1.22 % 1.47 %
Percent of average loans (annualized):
Provision for (reversal of) loan losses - 0.03 % (0.14 )% 0.03 %
Net recoveries (charge offs) 0.14 % 0.09 % (0.08 )% 0.02 %

The following table summarizes our allocation of the Allowance by loan segment:


	June 30, 2019						December 31, 2018
					Percent						Percent
					of Loans						of Loans
			Percent		to Total				Percent		to Total
	Amount		of Total		Loans		Amount		of Total		Loans
	(dollars in thousands)
Residential mortgage	$	2,566	31.7	%	40.4	%	$	2,224	27.6	%	40.3	%
Commercial		1,566	19.4	%	6.7	%		2,736	34.0	%	5.2	%
Commercial real estate		792	9.8	%	34.9	%		457	5.7	%	35.6	%
ADC		2,683	33.1	%	15.9	%		2,239	27.8	%	16.8	%
Home equity/2nds		223	2.8	%	1.9	%		222	2.8	%	2.0	%
Consumer		—	—	%	0.2	%		1	—	%	0.1	%
Unallocated		263	3.2	%	—	%		165	2.1	%	—	%
Total	$	8,093	100.0	%	100.0	%	$	8,044	100.0	%	100.0	%

September 30, 2017 December 31, 2016
Amount
Percent
of Total

Percent
of Loans
to Total
Loans
Amount
Percent
of Total

Percent
of Loans
to Total
Loans

(dollars in thousands)
Residential mortgage $ 3,422 43.1 % 44.4 % $ 3,833 42.7 % 42.2 %
Commercial 442 5.6 % 5.8 % 478 5.3 % 7.6 %
Commercial real estate 2,567 32.3 % 34.3 % 2,535 28.3 % 32.1 %
ADC 1,142 14.4 % 12.9 % 1,390 15.5 % 14.8 %
Home equity/2nds 361 4.6 % 2.4 % 728 8.1 % 3.1 %
Consumer 2 - 0.2 % 5 0.1 % 0.2 %
Total $ 7,936 100.0 % 100.0 % $ 8,969 100.0 % 100.0 %

Based upon management’s evaluation, provisions are made to maintain the Allowance as a best estimate of inherent losses within the portfolio. The Allowance totaled ~~$7.9~~$8.1 million at ~~September~~June 30, ~~2017~~2019 and ~~$9.0~~$8.0 million at December 31, ~~2016.~~2018. Any

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changes in the Allowance from period to period reflect management’s ongoing application of its methodologies to establish the Allowance, which, for the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, resulted in ~~decreased~~increased allocated Allowances for ~~most~~residential mortgage, commercial real estate, and ADC loans. The Allowance for commercial loans decreased due to a large favorable resolution to a credit with an allocated reserve in previous periods of $430,000 and due to a high charge-off year rolling out of our lookback period.

At December 31, 2018, due to a re-evaluation of our qualitative factors, we changed our estimates of the Allowance relative to historical loss experience within specific loan portfolio segments in order to better align our qualitative factors with historical losses experienced over a longer period of time, relative to those specific loan segments. The result of this change in estimate did not result in a material increase in the Allowance compared to the year ended December 31, 2017, however there were material changes to the Allowance between loan segments. Due to the change in accounting estimate, the Allowance allocated to commercial loans and ADC loans increased approximately $2.2 million and $1.1 million, respectively, while the Allowance ~~for~~allocated to residential mortgage loans and commercial real estate ~~increased over the~~loans decreased approximately $600,000 and $2.7 million, respectively, as of December 31, ~~2016 level. The changes~~2018. This change in ~~the Allowances for the respective loan segments were a function of the changes in the corresponding loan balances and asset quality.~~

accounting estimate had no impact on earnings or diluted earnings per share.

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~~Table of Contents~~

As a result of our Allowance analysis, ~~and overall improved asset quality,~~ we ~~released $650,000 from the Allowance during the nine months ended September 30, 2017. We~~ did not record aany provision ~~nor did we release any Allowance~~ during the three and six months ended ~~September~~June 30, ~~2017. We recorded $50,000 and $150,000, respectively, in provision for losses for the three and nine months ended September 30, 2016.~~2019 or 2018. We recorded net recoveries of ~~$218,000~~$8,000 and $49,000, respectively, during the three and six months ended June 30, 2019 and net ~~charge-offs $383,000,~~recoveries of $88,000 and $202,000, respectively, during the three and ~~nine~~six months ended ~~September~~June 30, ~~2017 compared to~~2018. During the three and six months ended June 30, 2019, annualized net recoveries ~~of $131,000 and $77,000, respectively, during the three months and nine months ended September 30, 2016. During the nine months ended September 30, 2017, annualized net (charge-offs) recoveries~~ as ~~compared to~~a percentage of average loans outstanding amounted to ~~(0.08)%~~0.00% and 0.01%, respectively, compared to ~~0.02%~~0.05% and 0.06%, during the ~~first nine~~three and six months ~~of 2016.~~ended June 30, 2018, respectively. The Allowance as a percentage of outstanding loans ~~decreased from 1.47%~~was 1.19% as of June 30, 2019 compared to 1.18% as of December 31, ~~2016 to 1.22% as of September 30, 2017, reflecting the improvement in our overall asset quality.~~

2018.

Although management uses available information to establish the appropriate level of the Allowance, future additions or reductions to the Allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions, and other factors. As a result, our Allowance may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our Allowance and related methodology. Such agencies may require us to recognize adjustments to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as of ~~September~~June 30, ~~2017~~2019 and is sufficient to address the credit losses inherent in the current loan portfolio.

Nonperforming Assets (“NPAs”)

Given the volatility of the real estate market, it is very important for us to have current ~~appraisals~~valuations on our NPAs. Generally, we obtain appraisals or alternative valuations on NPAs annually. In addition, as part of our asset monitoring activities, we maintain a Loss Mitigation Committee that meets monthly. During these Loss Mitigation Committee meetings, all NPAs and loan delinquencies are reviewed. We also produce an NPA report which is distributed monthly to senior management and is also discussed and reviewed at the Loss Mitigation Committee meetings. This report contains all relevant data on the NPAs, including the latest appraised value (or alternative valuation vehicle) and valuation date. Accordingly, these reports identify which assets will require an updated ~~appraisal.~~valuation. As a result, we have not experienced any internal delays in identifying which loans/credits require ~~appraisals.~~updated valuations. With respect to the ordering process of ~~the~~ appraisals, we have not experienced any delays in turnaround time nor has this been an issue over the past three years. Furthermore, we have not had any delays in turnaround time or variances thereof in our specific loan operating markets.

NPAs, expressed as a percentage of total assets, totaled ~~0.93%~~0.73% at ~~September~~June 30, ~~2017~~2019 and ~~1.37%~~0.64% at December 31, ~~2016.~~2018. The ratio of the Allowance to nonperforming loans was ~~124.4%~~165.6% at ~~September~~June 30, ~~2017~~2019 and ~~91.0%~~172.8% at December 31, ~~2016. The increase in this ratio from December 31, 2016 to September 30, 2017 was a reflection~~2018.

42

Table of ~~the decrease in nonperforming loans, as well as an increase in total assets.~~Contents

The distribution of our NPAs is illustrated in the following table. We did not have any loans greater than 90 days past due and still accruing at ~~September~~June 30, ~~2017 and~~2019 or December 31, ~~2016.~~2018.



	June 30, 2019		December 31, 2018
Nonaccrual Loans:	(dollars in thousands)
Residential mortgage	$	3,288	$	2,580
Commercial		—		430
Commercial real estate		779		660
ADC		388		558
Home equity/2nds		429		428
Consumer		3		��
		4,887		4,656
Real Estate Acquired Through Foreclosure:
Residential mortgage		1,259		1,366
ADC		171		171
		1,430		1,537
Total Nonperforming Assets	$	6,317	$	6,193

September 30, 2017 December 31, 2016
Nonaccrual Loans: (dollars in thousands)
Residential mortgage $ 4,531 $ 3,580
Commercial 84 151
Commercial real estate 160 2,938
ADC 318 269
Home equity/2nds 1,284 2,914
Consumer - -
6,377 9,852

Real Estate Acquired Through Foreclosure:
Residential mortgage 287 393
Commercial - -
Commercial real estate 601 341
ADC 216 239
Home equity/2nds - -
Consumer - -
1,104 973
Total Nonperforming Assets $ 7,481 $ 10,825

Nonaccrual loans ~~amounted to $6.4~~totaled $4.9 million, or ~~1.0%~~0.72% of total loans, at ~~September~~June 30, ~~2017~~2019 and ~~$9.9~~$4.7 million, or ~~1.6%~~0.68% of total loans at December 31, ~~2016. We added~~2018. Significant activity in nonaccrual loans during the six months ended June 30, 2019 included the addition of seven loans in the amount of ~~$2.6~~$1.3 million to nonaccrual ~~status during 2017. Of~~loans, the ~~balance~~transfer of ~~nonaccrual loans at December 31, 2016, $2.6 million were returned to accrual status, $422,000 were charged off, $515,000 were transferred~~one loan to real estate acquired through foreclosure of $171,000, and ~~$1.7 million were paid off.~~

36

~~Table~~payoffs of ~~Contents~~

$830,000 in nonaccrual loans that existed at December 31, 2018.

Real estate acquired through foreclosure ~~increased $131,000~~decreased $107,000 to $1.4 million at June 30, 2019 compared to December 31, ~~2016. The increase in commercial real estate was primarily from~~2018 due to one ~~foreclosure in the amount of $515,000.~~

property addition, partially offset by write downs on properties existing at December 31, 2018.

The activity in our real estate acquired through foreclosure was as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
	(dollars in thousands)
Balance at beginning of period	$	1,601	$	237	$	1,537	$	403
Real estate acquired in satisfaction of loans		—		—		171		—
Write-downs and losses on real estate acquired through foreclosure		(64)		—		(171)		(44)
Proceeds from sales of real estate acquired through foreclosure		(107)		—		(107)		(64)
Other		—		58		—		—
Balance at end of period	$	1,430	$	295	$	1,430	$	295

Three Months Ended September 30, Nine Months Ended September 30,
2017 2016 2017 2016
(dollars in thousands)
Balance at beginning of period $ 1,015 $ 1,112 $ 973 $ 1,744
Real estate acquired in satisfaction of loans 188 293 703 1,370
Write-downs and losses (99 ) (62 ) (139 ) (149 )
Proceeds from sales - - (433 ) (1,622 )
Balance at end of period $ 1,104 $ 1,343 $ 1,104 $ 1,343

~~TDRs~~

Troubled Debt Restructures (“TDRs”)

In situations where, for economic or legal reasons related to a borrower’s financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR.

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Table of Contents

The composition of our TDRs is illustrated in the following table:


	June 30, 2019		December 31, 2018
Residential mortgage:	(dollars in thousands)
Nonaccrual	$	422	$	446
<90 days past due/current		9,332		9,469
Commercial real estate:
Nonaccrual		—		—
<90 days past due/current		1,000		1,019
ADC:
Nonaccrual		—		—
<90 days past due/current		132		134
Consumer:
Nonaccrual		—		—
<90 days past due/current		73		76
Totals:
Nonaccrual		422		446
<90 days past due/current		10,537		10,698
	$	10,959	$	11,144

September 30, 2017 December 31, 2016
Residential mortgage: (dollars in thousands)
Nonaccrual $ 2,285 $ 2,137
<90 days past due/current 13,086 15,886
Commercial real estate:
Nonaccrual 84 249
<90 days past due/current 1,875 1,914
ADC:
Nonaccrual 6 6
<90 days past due/current 138 170
Home equity/2nds:
Nonaccrual - -
<90 days past due/current 230 -
Consumer
Nonaccrual - -
<90 days past due/current 87 96
Totals
Nonaccrual 2,375 2,392
<90 days past due/current 15,416 18,066
$ 17,791 $ 20,458

See additional information on TDRs in Note 3 to the Consolidated Financial ~~Statements.~~

Statements herein.

Deposits

Deposits ~~were $593.5~~totaled $685.4 million at ~~September~~June 30, ~~2017~~2019 and ~~$571.9~~$779.5 million at December 31, ~~2016. During~~2018. The $94.1 million decrease was primarily the ~~nine months ended September 30, 2017, we obtained significant new noninterest-bearing~~result of short-term medical-use cannabis related funds that account holders relocated to investment opportunities outside of the Bank. Management was aware of the short-term nature of certain medical-use cannabis related deposits and ~~interest-bearing checking accounts through a campaign designed~~offset those funds by maintaining short-term liquidity to ~~attract deposits in certain local emerging markets. The decrease in certificates of~~meet any deposit ~~(“CDs”) was due to the payoff of regularly maturing CDs.~~

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~~Table of Contents~~

outflows.

The deposit breakdown is as follows:


	June 30, 2019				December 31, 2018
			Percent				Percent
	Balance		of Total		Balance		of Total
	(dollars in thousands)
NOW	$	124,035	18.1	%	$	106,508	13.7	%
Money market		132,476	19.3	%		203,351	26.1	%
Savings		69,097	10.1	%		75,692	9.7	%
Certificates of deposit		226,451	33.0	%		247,351	31.7	%
Total interest-bearing deposits		552,059	80.5	%		632,902	81.2	%
Noninterest-bearing deposits		133,357	19.5	%		146,604	18.8	%
Total deposits	$	685,416	100.0	%	$	779,506	100.0	%

September 30, 2017 December 31, 2016
Balance
Percent
of Total
Balance
Percent
of Total

(dollars in thousands)
Checking and savings $ 261,581 44.1 % $ 239,985 41.9 %
Certificates of deposit 260,396 43.9 % 273,816 47.9 %
Total interest-bearing deposits 521,977 88.0 % 513,801 89.8 %
Noninterest-bearing deposits 71,515 12.0 % 58,145 10.2 %
Total deposits $ 593,492 100.0 % $ 571,946 100.0 %

Borrowings

Our borrowings consist of advances from the FHLB and a term loan from a commercial bank.

The FHLB advances are available under a specific collateral pledge and security agreement, which requires that we maintain collateral for all of our borrowings equal to 30% of total assets. Our advances from the FHLB may be in the form of short-term or long-term obligations. Short-term advances have maturities for one year or less and may contain prepayment penalties. Long-term borrowings through the FHLB have original maturities up to 15 years and generally contain prepayment penalties.

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Table of Contents

At ~~September~~June 30, ~~2017,~~2019, our total credit line with the FHLB was ~~$231.7~~$264.4 million. The Bank, from time to time, utilizes the line of credit when interest rates are more favorable than obtaining deposits from the public. Our outstanding FHLB advance balance at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016~~2018 was ~~$90.0~~$45.0 million and ~~$100.0~~$70.0 million, respectively.

On September 30, 2016, we entered into a loan agreement with a commercial bank whereby we borrowed ~~$3,500,000~~$3.5 million for a term of 8 years. The unsecured note bears interest at a fixed rate of 4.25% for the first 36 months then, at the option of the Company, converts to either (1) floating rate of the Wall Street Journal Prime plus 50 basis points or (2) fixed rate at two hundred seventy five (275) basis points over the five year amortizing FHLB rate for the remaining five years. Repayment terms are monthly interest only payments for the first 36 months, then quarterly principal payments of $175,000 plus interest. The loan is subject to a prepayment penalty of 1% of the principal amount prepaid during the first 36 months. If we elect the 5 year fixed rate of 275 basis points over the FHLB rate (“FHLB Rate Period”), the loan will be subject to a prepayment penalty of 2% during the first and second years of the FHLB Rate Period and 1% of the principal repaid during the third, fourth, and fifth years of the FHLB Rate Period. We may make additional principal payments from internally generated funds of up to $875,000 per year during any fixed rate period without penalty. There is no prepayment penalty during any floating rate period.

The following table sets forth information concerning the interest rates and maturity dates of the advances from the FHLB as of ~~September~~June 30, ~~2017:~~2019:


Principal
Amount (in thousands)		Rate	Maturity
$	10,000	1.59%	2019
	25,000	1.75% to 1.92%	2020
	10,000	2.19%	2022
$	45,000

Principal
Amount (in thousands)
Rate Maturity
$ 24,950 1.21% to 4.05% 2017
15,000 2.58% to 3.43% 2018
35,000 1.55% to 4.00% 2019
15,000 1.75% 2020
$ 89,950

Subordinated Debentures

As of both ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the Company had outstanding $20.6 million in principal amount of Junior Subordinated Debt Securities, due in 2035 (the “2035 Debentures”). The 2035 Debentures were issued pursuant to an Indenture dated as of December 17, 2004 (the “2035 Indenture”) between the Company and Wells Fargo Bank, National Association as Trustee. The 2035 Debentures pay interest quarterly at a floating rate of interest of ~~3-month~~3‑month LIBOR plus 200 basis points, and mature on January 7, 2035. Payments of principal, interest, premium and other amounts under the 2035 Debentures are subordinated and junior in right of payment to the prior payment in full of all senior indebtedness of the Company, as defined in the 2035 Indenture. The 2035 Debentures became redeemable, in whole or in part, by the Company on January 7, 2010.

38

~~Table of Contents~~

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

Under the terms of the 2035 ~~Debenture,~~Debentures, we are permitted to defer the payment of interest on the 2035 Debentures for up to 20 consecutive quarterly periods, provided that no event of default has occurred and is continuing. As of December 31, 2015, we had deferred the payment of fifteen quarters of interest and the cumulative amount of interest in arrears not paid, including interest on unpaid interest, was $1,863,000. During the third quarter of 2016, we paid all of the deferred interest and as of SeptemberJune 30, ~~2017,~~2019, we were current on all interest due on the 2035 ~~Debenture.~~Debentures.

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Table of Contents

Capital Resources

Total stockholders’ equity increased ~~$4.1~~$4.2 million to ~~$92.0~~$102.7 million at ~~September~~June 30, ~~2017~~2019 compared to ~~$87.9~~$98.5 million as of December 31, ~~2016.~~2018. The increase was principally the result of ~~2017~~2019 net income ~~and stock issuance related~~ to date, partially offset by dividends paid during the ~~purchase of the Title Company.~~

six months ended June 30, 2019.

Series A Preferred Stock

On November 15, 2008, the Company completed a private placement offering consisting of a total of 70 units, at an offering price of $100,000 per unit, for gross proceeds of ~~$7,000,000.~~$7.0 million. Each unit ~~consists~~consisted of 6,250 shares of the Company’s Series A 8.0% Non-Cumulative Convertible Preferred Stock. ~~Dividends will not be paid on our~~On March 13, 2018, the Company notified holders of its Series A preferred stock that the Company had exercised its option to convert each of the 437,500 outstanding shares of Series A preferred stock for one share of common ~~stock in any quarter until the dividend on~~stock. The Company converted the Series A ~~Preferred Stock has been paid for such quarter; however, there is no requirement~~preferred stock on April 2, 2018. As of that ~~our Board of Directors declare any dividends on~~date, the Series A ~~Preferred Stock~~preferred stock was no longer deemed outstanding, and ~~any unpaid dividends are not cumulative.~~

~~Series B Preferred Stock~~

On November 21, 2008, we entered into an agreement with the United States Department of the Treasury (“Treasury”), pursuant to which we issued and sold (i) shares of our Series B Fixed Rate Cumulative Perpetual Preferred Stock (“Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 556,976 shares of the Company’s common stock, par value $0.01 per share. As of December 31, 2016, the Company had redeemed all ~~outstanding shares of the Preferred Stock. At September 30, 2017 the Treasury continues to hold the Warrant.~~

The Warrant has a 10-year term and is immediately exercisable at an exercise price of $6.30 per share of Common Stock. The exercise price and number of shares subject to the Warrant are both subject to anti-dilution adjustments. Pursuant to the Purchase Agreement, Treasury has agreed not to exercise voting powerrights with respect to ~~any shares of Common Stock issued upon exercise of the Warrant. The warrant expires November 11, 2018.~~

such stock have ceased and terminated.

Capital Adequacy

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. As of ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the Bank exceeded all capital adequacy requirements to which it is subject and meets the qualifications to be considered “well capitalized.” See details of our capital ratios in Note 4 of the Consolidated Financial Statements.

Liquidity

Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers, to fund the operations of our mortgage-banking business, as well as to meet current and planned expenditures. These cash requirements are met on a daily basis through the inflow of deposit funds, the maintenance of short-term overnight investments, maturities and calls in our securities portfolio, and available lines of credit with the FHLB, which requires pledged collateral. Fluctuations in deposit and short-term borrowing balances may be influenced by the interest rates paid, general consumer confidence, and the overall economic environment. There can be no assurances that deposit withdrawals and loan fundings will not exceed all available sources of liquidity on a short-term basis. Such a situation would have an adverse effect on our ability to originate new loans and maintain reasonable loan and deposit interest rates, which would negatively impact earnings.

39

~~Table of Contents~~

Our principal sources of liquidity are loan repayments, maturing investments, deposits, borrowed funds, and proceeds from loans sold on the secondary market. The levels of such sources are dependent on the Bank’s operating, financing, and investing activities at any given time. We consider core deposits stable funding sources and include all deposits, except time deposits of $100,000 or more. The Bank’s experience has been that a substantial portion of certificates of deposit renew at time of maturity and remain on deposit with the Bank. Additionally, loan payments, maturities, deposit growth, and earnings contribute to our flow of funds.

In addition to our ability to generate deposits, we have external sources of funds, which may be drawn upon when desired. The primary source of external liquidity is an available line of credit with the FHLB. The Bank’s total credit availability under the FHLB’s credit availability program was ~~$231.7~~$264.4 million at ~~September~~June 30, ~~2017,~~2019, of which ~~$90.0~~$45.0 million was outstanding.

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit (collectively “commitments”), which totaled ~~$101.4~~$116.8 million at ~~September~~June 30, ~~2017.~~2019. Historically, many of the commitments

46

Table of Contents

expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. ~~As of September 30, 2017, we had $72.0 million in unadvanced construction commitments, which we~~We expect to fund these commitments from the sources of liquidity described above. These amounts do not include undisbursed lines of credit, home equity lines of credit, and standby letters of credit, in the aggregate amount of $29.2 million at September 30, 2017, which we anticipate we will be able to fund, if required, from these liquidity sources in the regular course of business.

Customer withdrawals are also a principal use of liquidity, but are generally mitigated by growth in customer funding sources, such as deposits and short-term borrowings.

In addition to the foregoing, the payment of dividends is a use of cash, but is not expected to have a material effect on liquidity. As of ~~September~~June 30, ~~2017,~~2019, we had no material commitments for capital expenditures.

Our ability to acquire deposits or borrow could be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. At ~~September~~June 30, ~~2017,~~2019, management considered the Company’s liquidity level to be sufficient for the purposes of meeting our cash flow requirements. We are not aware of any undisclosed known trends, demands, commitments, or uncertainties that are reasonably likely to result in material changes in our liquidity.

We anticipate that our primary sources of liquidity over the next twelve months will be from loan repayments, maturing investments, deposit growth, and borrowed funds. We believe that these sources of liquidity will be sufficient for us to meet our liquidity needs over the next twelve months.

Off-Balance Sheet Arrangements and Derivatives

We enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, and letters of credit. In addition, we have certain operating lease obligations.

Credit Commitments

Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. We are not aware of any accounting loss we would incur by funding our commitments.

See detailed information on credit commitments above under “Liquidity.”

Derivatives

We maintain and account for derivatives, in the form of interest-rate lock commitments (“IRLCs”) ,and mandatory ~~forward contracts, and best effort~~ forward contracts, in accordance with the Financial Accounting Standards Board guidance on accounting for derivative instruments and hedging activities. We recognize gains and losses on IRLCs, mandatory forward contracts, and best effort forward contracts on the loan pipeline through mortgage-banking revenue in the Consolidated Statements of Operations.

40

~~Table of Contents~~

IRLCs on mortgage loans that we intend to sell in the secondary market are considered derivatives. We are exposed to price risk from the time a mortgage loan closes until the time the loan is sold. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 14 days to 60 days. For these IRLCs, we attempt to protect the Bank from changes in interest rates through the use of best efforts and mandatory forward contracts.

47

Table of Contents

Information pertaining to the carrying amounts of our derivative financial instruments follows:



	June 30, 2019				December 31, 2018
	Notional		Estimated		Notional		Estimated
	Amount		Fair Value		Amount		Fair Value
	(dollars in thousands)
Asset - IRLCs	$	17,811	$	345	$	3,710	$	100
Asset - best effort forward contracts		17,811		39		3,710		—
Liability - mandatory forward contracts		17,536		36		9,363		16

September 30, 2017 December 31, 2016

Notional
Amount

Estimated
Fair Value

Notional
Amount

Estimated
Fair Value

(dollars in thousands)
Asset - IRLCs $ 2,329 $ 42 $ 9,725 $ 162
Asset - Mandatory forward contracts 4,731 7 10,302 153
Asset - Best effort forward contracts 2,329 6 - -

Inflation

The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with ~~accounting principles generally accepted in the U.S.~~GAAP and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. As a financial institution, virtually all of our assets and liabilities are monetary in nature and interest rates have a more significant impact on our performance than the effects of general levels of inflation. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect our results of operations unless mitigated by a corresponding increase in our revenues. However, we believe that the impact of inflation on our operations was not material ~~in 2017 or 2016.~~

~~Item 3.~~

~~Quantitative and Qualitative Disclosures About Market Risk~~

for the three and six months ended June 30, 2019 and 2018.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The principal objective of the Company’s interest rate risk management is to evaluate the interest rate risk included in balance sheet accounts, determine the level of risks appropriate given our business strategy, operating environment, capital and liquidity requirements, and performance objectives, and manage the risk consistent with our interest rate risk management policy. Through this management, we seek to reduce the vulnerability of our operations to changes in interest rates. The Board of Directors of the Company is responsible for reviewing our asset/liability policy and interest rate risk position. The Board of Directors reviews the interest rate risk position on a quarterly basis and, in connection with this review, evaluates the Company’s business activities and strategies, the effect of those strategies on the Company’s net interest margin and the effect that changes in interest rates will have on the loan portfolio. While continuous movement of interest rates is certain, the extent and timing of these movements is not always predictable. Any movement in interest rates has an effect on our profitability. We face the risk that rising interest rates could cause the cost ofinterest-bearing liabilities, such as deposits and borrowings, to rise faster than the yield on interest-earning assets, such as loans and investments. Our interest rate spread and interest rate margin also may be negatively impacted in a declining interest rate environment even though we generally borrow at short-term interest rates and lend at longer-term interest rates. This is because loans and other interest-earning assets may be prepaid and replaced with lower yielding assets before the supporting interest-bearing liabilities reprice downward. Our interest rate margin may also be negatively impacted in a flat or inverse-yield curve environment. Mortgage origination activity tends to increase when interest rates trend lower and decrease when interest rates rise.

Our primary strategy to control interest rate risk is to strive to balance our loan origination activities with the interest rate market. We attempt to maintain a substantial portion of our loan portfolio in short-term loans such as construction loans. This has proven to be an effective hedge against rapid increases in interest rates as the construction loan portfolio reprices rapidly.

The matching of maturity or repricing of interest-earning assets and interest-bearing liabilities may be analyzed by examining the extent to which these assets and liabilities are interest rate sensitive and by monitoring the Bank’s interest rate sensitivity gap. An interest-earning asset or interest-bearing liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. The difference between rate sensitive assets and rate sensitive liabilities represents the Bank’s interest sensitivity gap. At ~~September~~June 30, ~~2017,~~2019, we had a one-year cumulative negative gap of ~~approximately $159.2~~$61.1 million.

48

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Exposure to interest rate risk is actively monitored by management. The objective is to maintain a consistent level of profitability within acceptable risk tolerances across a broad range of potential interest rate environments. We use the PROFITstar® model to monitor our exposure to interest rate risk, which calculates changes in the economic value of equity (“EVE”).

The following table represents our EVE as of ~~September~~June 30, ~~2017:~~2019:


Change in Rates		Amount		$ Change		% Change
		(dollars in thousands)
+400	bp	$	132,344	$	(728)	(0.55)	%
+300	bp		133,692		620	0.47	%
+200	bp		136,263		3,191	2.40	%
+100	bp		136,817		3,745	2.81	%
0	bp		133,072
(100)	bp		120,430		(12,642)	(9.50)	%
(200)	bp		98,275		(34,797)	(26.15)	%

Change in Rates Amount $ Change % Change
(dollars in thousands)
+400 bp $ 160,130 $ (16,836 ) -9.51 %
+300 bp 166,030 (10,936 ) -6.18 %
+200 bp 170,894 (6,072 ) -3.43 %
+100 bp 174,580 (2,386 ) -1.35 %
0 bp 176,966
-100 bp 176,569 (397 ) -0.22 %
-200 bp 169,398 (7,568 ) -4.28 %

The preceding income simulation analysis does not represent a forecast of actual results and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, which are subject to change, including: the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. Also, as market conditions vary, prepayment/refinancing levels, the varying impact of interest rate changes on caps and floors embedded in adjustable-rate loans, early withdrawal of deposits, changes in product preferences, and other internal/external variables will likely deviate from those assumed.

~~Item 4.~~

~~Controls and Procedures~~

~~The Company’s management,~~

Item 4. Controls and Procedures

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the ~~supervision~~Securities and ~~with~~Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized, and reported within the ~~participation of~~time periods specified in the ~~Company’s~~Securities and Exchange Commission’s (“SEC”) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer (“CEO”) and the Interim Chief Financial Officer ~~evaluated,~~(“Interim CFO”), as appropriate, to allow timely decisions regarding required disclosure.

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the ~~last day~~SEC. As of June 30, 2019, the ~~period covered by this report,~~Company’s management, including the Company’s CEO and Interim CFO, have evaluated the effectiveness ~~of the design and operation~~ of the Company’s disclosure controls and procedures as defined in ~~Rule~~Rules 13a-15 and 15d-15(e) under the ~~Securities~~ Exchange ~~Act~~Act. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of ~~1934.~~achieving the desired control objectives. In addition, the design of disclosure controls and procedures must necessarily reflect the fact that there are resource constraints and that management is required to apply its judgement in evaluating the benefits of possible controls and procedures relative to their costs. Based on ~~that~~this evaluation, the ~~Chief Executive Officer~~Company's CEO and ~~Chief Financial Officer~~Interim CFO concluded that, as of the ~~Company’s~~end of the period covered by this quarterly report, the Company's disclosure controls and procedures were ~~effective. There were~~not effective because of the material weakness described below.

A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's quarterly financial statements will not be prevented or detected on a timely basis. The identification of the material weaknesses did not impact any of our consolidated financial statements for any prior annual or interim periods, other than as described in our Annual Report on Form 10-K as of and for the year ended December 31, 2018. Accordingly, management believes that the financial

49

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statements included in this Quarterly Report on Form 10-Q present fairly in all material respects the Company's financial condition, results of operations and cash flows for the periods presented.

The Company has identified a material weakness in its internal control over financial reporting, specifically related to both management’s review controls and risk rating controls over the Company’s Allowance. The material weakness in internal control over financial reporting resulted from a lack of sufficient management review controls over the development and monitoring of qualitative factors used in calculating the general component of the Allowance, a lack of sufficient management review controls over the relevant inputs and assumptions used to measure the fair value of impaired loans, lack of controls to identify the completeness of TDRs, and review over the completeness of changes to loans’ risk ratings that are required to be modified within the Company’s loan accounting system.

Management has been actively engaged in developing remediation plans to address the above control deficiencies. The Company has enhanced its management review controls over the development and monitoring of qualitative factors and other relevant assumptions used in calculating the general component of the Allowance. The Company has also enhanced its current review process over impaired loans to ensure a timely review is being performed at an appropriate level of precision as it pertains to the relevant inputs and assumptions to measure the fair value of impaired loans, including appraisal review controls. The Company has also implemented a process to ensure the completeness and accuracy of the population to provide assurance that all required loans are properly evaluated for TDR classification. Finally, the Company has enhanced controls over the review of the completeness of changes to loans’ risk ratings that are required to be modified within the Company’s loan accounting system.

The Company had also previously identified a material weakness in its internal control over financial reporting, specifically related to its reconciliation controls relating to LHFS. The material weakness in internal control over financial reporting resulted from a 2018 material reclassification entry identified during the audit. The impact of this reclassification was corrected on the consolidated statement of financial condition as of December 31, 2018.

Management has since incorporated stronger internal controls over the LHFS, including strengthening the reconciliation process to ensure accuracy of LHFS, including the reflection of all loan sales.

Although the Company’s remediation efforts are well underway and are expected to be fully completed in the near future, the Company’s material weakness will not be considered remediated until new internal controls are operational for a period of time and are tested, and management concludes that these controls are operating effectively.

Other than the remediation described above, there has been no ~~changes~~change in the Company’s internal ~~controls~~control over financial reporting ~~(as defined in Rule 13a-15 under the Securities Act of 1934)~~ during the ~~three months~~quarter ended ~~September~~June 30, ~~2017~~2019 that ~~have~~has materially affected, or ~~are~~is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

~~Item 1.~~

~~Legal Proceedings~~

Item 1. Legal Proceedings

In the normal course of business, we are party to litigation arising from the banking, financial, and other activities we conduct. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising from these matters will have a material effect on the Company’s financial condition, operating results, or liquidity as of ~~September~~June 30, ~~2017.~~

2019.

~~Item 1A.~~

~~Risk Factors~~

Item 1A. Risk Factors

The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Annual Report on Form ~~10-K~~10‑K of Severn Bancorp as of and for the year ended December 31, ~~2016.~~2018. There ~~has~~have been no material ~~change~~changes in our risk factors since the filing of our December 31, ~~2016~~2018 Annual Report on Form ~~10-K.~~10‑K.

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Table of Contents

~~Item 2.~~

~~Unregistered Sales of Equity Securities and Use of Proceeds~~

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

None.

~~Item 3.~~

~~Defaults Upon Senior Securities~~

Item 3. Defaults Upon Senior Securities

None.

~~Item 4.~~

~~Mine Safety Disclosures~~

Item 4. Mine Safety Disclosures

Not applicable.

42

~~Table of Contents~~

~~Item 5.~~

~~Other Information~~

Item 5. Other Information

None.

Item 6. Exhibits

~~Item 6.~~

~~Exhibits~~

Exhibit No.		Description
31.1
~~31.1~~		Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2		Certification of Interim Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

32		Certification of Chief Executive Officer and Interim Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101		The following financial statements from the Severn Bancorp, Inc. Quarterly Report on Form ~~10-Q~~10‑Q as of ~~September~~June 30, ~~2017~~2019 and for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of ~~Accumulated~~ Comprehensive Income; (iv) the Consolidated Statements of Changes in Stockholders’ Equity; (v) the Consolidated Statements of Cash Flows; and (vi) the Notes to Consolidated Financial Statements.

43

~~Table of Contents~~

EXHIBIT INDEX

Exhibit No.		Description

31.1		Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2		Certification of Interim Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

32		Certification of Chief Executive Officer and Interim Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101		The following financial statements from the Severn Bancorp, Inc. Quarterly Report on Form ~~10-Q~~10‑Q as of ~~September~~June 30, ~~2017~~2019 and for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of ~~Accumulated~~ Comprehensive Income; (iv) the Consolidated Statements of Changes in Stockholders’ Equity; (v) the Consolidated Statements of Cash Flows; and (vi) the Notes to Consolidated Financial Statements.

51

44

Table of Contents

SIGNATURES~~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.


	SEVERN BANCORP, INC.

~~November 14, 2017~~ August 9, 2019	/s/ Alan J. Hyatt
	Alan J. Hyatt, Chairman of the Board, President and Chief Executive Officer
	(Principal Executive Officer)

~~November 14, 2017~~ August 9, 2019	/s/ ~~Paul B. Susie~~	Marc S. Winkler
	~~Paul B. Susie,~~
	~~Executive Vice President,~~ Marc S. Winkler, Interim Chief Financial Officer
	(Principal Financial and Accounting Officer)

52

45

~~Maryland~~		~~52-1726127~~
Maryland	52‑1726127
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification no.)


Large accelerated filer ☐		Accelerated filer ☐☑

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

Emerging growth company ☐


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

	Nine Months Ended September 30, 2017 (unaudited)
	Number of Shares of Preferred Stock		Number of Shares of Common Stock		Preferred Stock		Common Stock		Additional Paid-In Capital		Retained Earnings			Accumulated Comprehensive Loss			Total Stockholders’ Equity
Balance at January 1, 2017		437,500		12,123,179	$	4	$	121	$	63,960	$	23,845		$	-		$	87,930
Net income		-		-		-		-		-		3,166			-			3,166
Stock-based compensation		-		-		-		-		146		-			-			146
Stock issued in acquisition		-		108,084		-		1		774		-			-			775
Stock issued, net of expense		-		14,162		-		-		207		-			-			207
Dividend declared on Series A preferred stock		-		-		-		-		-		(210	)		-			(210	)
Amortization of discount on Series B preferred stock		-		-		-		-		203		(203	)		-			-
Other comprehensive loss		-		-		-		-		-		-			(4	)		(4	)
Balance at September 30, 2017		437,500		12,245,425	$	4	$	122	$	65,290	$	26,598		$	(4	)	$	92,010

	Nine Months Ended September 30, 2016 (unaudited)
	Number of Shares of Preferred Stock			Number of Shares of Common Stock		Preferred Stock		Common Stock		Additional Paid-In Capital			Retained Earnings			Accumulated Comprehensive Income		Total Stockholders’ Equity
Balance at January 1, 2016		460,893			10,088,879	$	4	$	101	$	76,335		$	10,016		$	-	$	86,456
Net income		-			-		-		-		-			14,437			-		14,437
Stock-based compensation		-			-		-		-		143			-			-		143
Stock issued, net of expense		-			2,015,500		-		20		10,490			-			-		10,510
Stock redemption on Series B preferred stock		(23,393	)		-		-		-		(23,393	)		-			-		(23,393	)
Dividend declared on Series A preferred stock		-			-		-		-		-			(140	)		-		(140	)
Dividend declared on Series B preferred stock		-			-		-		-		-			(1,230	)		-		(1,230	)
Amortization of discount on Series B preferred stock		-			-		-		-		203			(203	)		-		-
Balance at September 30, 2016		437,500			12,104,379	$	4	$	121	$	63,778		$	22,880		$	-	$	86,783


		Page
PART I – FINANCIAL INFORMATION		~~Page~~

Item 1.	Financial Statements

	Consolidated Statements of Financial Condition as of ~~September~~June 30, ~~2017 (unaudited)~~2019 and December 31, ~~2016~~2018 (unaudited)	1

	Consolidated Statements of Operations for the Three and ~~Nine~~Six Months Ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018 (unaudited)	2

	Consolidated Statements of Comprehensive Income for the Three and ~~Nine~~Six Months Ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018 (unaudited)	3

	Consolidated Statements of Changes in Stockholders’ Equity for the ~~Nine~~Three and Six Months Ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018 (unaudited)	4

	Consolidated Statements of Cash Flows for the ~~Nine~~Six Months Ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018 (unaudited)	5 6

	Notes to Consolidated Financial Statements (unaudited)	6 7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26 31

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41 48

Item 4.	Controls and Procedures	42 49


PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	42 50

Item 1A.	Risk Factors	42 50

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42 51

Item 3.	Defaults Upon Senior Securities	42 51

Item 4.	Mine Safety Disclosures	42 51

Item 5.	Other Information	43 51

Item 6.	Exhibits	~~Exhibits~~	4351

EXHIBIT INDEX		44 51

SIGNATURES		45 52

	September 30, 2017			December 31, 2016
ASSETS	(unaudited)
Cash and due from banks	$	1,654		$	39,396
Federal funds sold and interest-bearing deposits in other banks		39,981			27,718
Cash and cash equivalents		41,635			67,114
Securities available for sale, at fair value		3,129			-
Securities held to maturity (fair value of $58,959 at September 30, 2017 and $62,827 at December 31, 2016)		58,764			62,757
Loans held for sale, at fair value at September 30, 2017		4,871			10,307
Loans receivable		650,964			610,278
Allowance for loan losses		(7,936	)		(8,969	)
Loans, net		643,028			601,309
Real estate acquired through foreclosure		1,104			973
Restricted stock investments		4,699			5,103
Premises and equipment, net		23,398			24,030
Accrued interest receivable		2,503			2,249
Bank owned life insurance		5,023			-
Deferred income taxes		8,002			10,081
Other assets		5,174			3,562
Total assets	$	801,330		$	787,485

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest bearing	$	71,515		$	58,145
Interest-bearing		521,977			513,801
Total deposits		593,492			571,946
Short-term borrowings		4,950			-
Long-term borrowings		88,500			103,500
Subordinated debentures		20,619			20,619
Accrued expenses and other liabilities		1,759			3,490
Total liabilities		709,320			699,555

Stockholders’ Equity:
Preferred stock, $0.01 par value, 1,000,000 shares authorized:
Preferred stock series “A,” 437,500 shares issued and outstanding and $3,500 liquidation preference at both September 30, 2017 and December 31, 2016		4			4
Common stock, $0.01 par value, 20,000,000 shares authorized; 12,245,425 and 12,123,179 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively		122			121
Additional paid-in capital		65,290			63,960
Retained earnings		26,598			23,845
Accumulated other comprehensive loss		(4	)		-
Total stockholders’ equity		92,010			87,930
Total liabilities and stockholders’ equity	$	801,330		$	787,485

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Interest income:	(unaudited)
Loans	$	7,742		$	7,479		$	22,267		$	21,847
Securities		330			280			927			890
Other earning assets		167			83			498			251
Total interest income		8,239			7,842			23,692			22,988
Interest expense:
Deposits		1,011			1,019			2,924			3,002
Borrowings and subordinated debentures		897			1,106			2,844			3,493
Total interest expense		1,908			2,125			5,768			6,495
Net interest income		6,331			5,717			17,924			16,493
Provision for (reversal of) loan losses		-			50			(650	)		150
Net interest income after provision for (reversal of) loan losses		6,331			5,667			18,574			16,343
Noninterest income:
Mortgage-banking revenue		334			1,042			1,150			2,693
Real estate commissions		311			455			959			1,246
Real estate management fees		197			214			513			564
Credit report and appraisal fees		137			99			390			304
Deposit service charges		190			32			265			105
Other noninterest income		230			54			485			667
Total noninterest income		1,399			1,896			3,762			5,579
Noninterest expense:
Compensation and related expenses		3,288			3,928			10,719			11,218
Occupancy		354			333			1,015			942
Legal fees		41			81			104			217
Write-downs, losses, and costs of real estate acquired through foreclsoure, net		126			41			166			184
Federal Deposit Insurance Corpation insurance premiums		69			126			133			296
Professional fees		124			189			377			528
Advertising		198			158			649			510
Online charges		237			117			661			617
Credit report and appraisal fees		203			148			478			480
Licensing and software		152			115			326			345
Mortgage leads purchased		48			205			234			559
Other		681			689			2,158			2,405
Total noninterest expense		5,521			6,130			17,020			18,301
Income before income tax provision (benefit)		2,209			1,433			5,316			3,621
Income tax provision (benefit)		950			378			2,150			(10,816	)
Net income		1,259			1,055			3,166			14,437
Amortization of discount on preferred stock		(68	)		(68	)		(203	)		(203	)
Dividends on preferred stock		(70	)		(448	)		(210	)		(1,370	)
Net income available to common stockholders	$	1,121		$	539		$	2,753		$	12,864
Net income per common share - basic	$	0.09		$	0.04		$	0.23		$	1.14
Net income per common share - diluted	$	0.09		$	0.04		$	0.22		$	1.13

	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
	(dollars in thousands)
U.S. government agency notes	$	3,135	$	-	$	6	$	3,129

	September 30, 2017
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
	(dollars in thousands)
U.S. Treasury securities	$	7,996	$	106	$	-	$	8,102
U.S. government agency notes		19,008		137		43		19,102
Mortgage-backed securities		31,760		97		102		31,755
	$	58,764	$	340	$	145	$	58,959

	December 31, 2016
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
	(dollars in thousands)
U.S. Treasury securities	$	12,998	$	167	$	-	$	13,165
U.S. government agency notes		20,027		133		54		20,106
Mortgage-backed securities		29,732		52		228		29,556
	$	62,757	$	352	$	282	$	62,827

	Three Months Ended September 30, 2017
	Residential Mortgage			Commercial		Commercial Real Estate			ADC		Home Equity/ 2nds			Consumer			Total
	(dollars in thousands)
Beginning Balance	$	3,403		$	389	$	2,571		$	984	$	367		$	4		$	7,718
Charge-offs		-			-		-			-		-			-			-
Recoveries		156			-		40			-		22			-			218
Net recoveries		156			-		40			-		22			-			218
(Reversal of) provision for loan losses		(137	)		53		(44	)		158		(28	)		(2	)		-
Ending Balance	$	3,422		$	442	$	2,567		$	1,142	$	361		$	2		$	7,936

	Nine Months Ended September 30, 2017
	(dollars in thousands)
Beginning Balance	$	3,833		$	478		$	2,535		$	1,390		$	728		$	5		$	8,969
Charge-offs		(707	)		-			-			-			(98	)		-			(805	)
Recoveries		295			-			100			-			27			-			422
Net (charge-offs) recoveries		(412	)		-			100			-			(71	)		-			(383	)
Provision for (reversal of) loan losses		1			(36	)		(68	)		(248	)		(296	)		(3	)		(650	)
Ending Balance	$	3,422		$	442		$	2,567		$	1,142		$	361		$	2		$	7,936

Ending balance - individually evaluated for impairment	$	1,544		$	-		$	186		$	50		$	-		$	2		$	1,782
Ending balance - collectively evaluated for impairment		1,878			442			2,381			1,092			361			-			6,154
	$	3,422		$	442		$	2,567		$	1,142		$	361		$	2		$	7,936

Ending loan balance - individually evaluated for impairment	$	20,379		$	-		$	3,419		$	1,003		$	-		$	87		$	24,888
Ending loan balance - collectively evaluated for impairment		268,790			37,485			219,748			83,161			15,861			1,031			626,076
	$	289,169		$	37,485		$	223,167		$	84,164		$	15,861		$	1,118		$	650,964

	Three Months Ended September 30, 2016
	Residential Mortgage			Commercial			Commercial Real Estate			ADC			Home Equity/ 2nds		Consumer			Total
	(dollars in thousands)
Beginning Balance	$	3,892		$	752		$	2,577		$	983		$	593	$	7		$	8,804
Charge-offs		-			-			-			(72	)		-		-			(72	)
Recoveries		137			10			4			-			2		50			203
Net recoveries (charge-offs)		137			10			4			(72	)		2		50			131
(Reversal of) provision for loan losses		(161	)		(63	)		(189	)		289			226		(52	)		50
Ending Balance	$	3,868		$	699		$	2,392		$	1,200		$	821	$	5		$	8,985

	Nine Months Ended September 30, 2016
	(dollars in thousands)
Beginning Balance	$	4,188		$	291		$	2,792		$	956		$	528		$	3		$	8,758
Charge-offs		(151	)		(17	)		(178	)		(72	)		(28	)		-			(446	)
Recoveries		322			43			4			100			4			50			523
Net recoveries (charge-offs)		171			26			(174	)		28			(24	)		50			77
(Reversal of) provision for loan losses		(491	)		382			(226	)		216			317			(48	)		150
Ending Balance	$	3,868		$	699		$	2,392		$	1,200		$	821		$	5		$	8,985

Ending balance - individually evaluated for impairment	$	1,583		$	15		$	200		$	55		$	402		$	4		$	2,259
Ending balance - collectively evaluated for impairment		2,285			684			2,192			1,145			419			1			6,726
	$	3,868		$	699		$	2,392		$	1,200		$	821		$	5		$	8,985

Ending loan balance - individually evaluated for impairment	$	22,521		$	495		$	5,696		$	1,446		$	3,519		$	100		$	33,777
Ending loan balance - collectively evaluated for impairment		246,375			41,864			193,219			79,894			16,220			1,109			578,681
	$	268,896		$	42,359		$	198,915		$	81,340		$	19,739		$	1,209		$	612,458

	September 30, 2017
	Pass		Special Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	281,954	$	1,397	$	5,818	$	289,169
Commercial		37,299		50		136		37,485
Commercial real estate		216,373		4,668		2,126		223,167
ADC		82,958		-		1,206		84,164
Home equity/2nds		14,531		471		859		15,861
Consumer		1,118		-		-		1,118
	$	634,233	$	6,586	$	10,145	$	650,964

	September 30, 2017
	30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Total Past Due		Current		Total		Non- Accrual
	(dollars in thousands)
Residential mortgage	$	1,173	$	1,216	$	2,364	$	4,753	$	284,416	$	289,169	$	4,531
Commercial		-		-		-		-		37,485		37,485		84
Commercial real estate		-		478		-		478		222,689		223,167		160
ADC		-		-		239		239		83,925		84,164		318
Home equity/2nds		-		-		458		458		15,403		15,861		1,284
Consumer		-		-		-		-		1,118		1,118		-
	$	1,173	$	1,694	$	3,061	$	5,928	$	645,036	$	650,964	$	6,377

	September 30, 2017						December 31, 2016
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Unpaid Principal Balance		Recorded Investment		Related Allowance
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	12,856	$	11,306	$	-	$	9,854	$	9,338	$	-
Commercial		-		-		-		-		-		-
Commercial real estate		1,576		1,527		-		3,900		3,698		-
ADC		636		636		-		441		441		-
Home equity/2nds		-		-		-		2,139		1,529		-
Consumer		-		-		-		-		-		-
With a related Allowance:
Residential mortgage		9,306		9,073		1,544		11,176		11,065		1,703
Commercial		-		-		-		148		148		15
Commercial real estate		1,892		1,892		186		1,958		1,958		196
ADC		402		367		50		417		417		53
Home equity/2nds		-		-		-		1,608		1,608		402
Consumer		87		87		2		96		96		4
Totals:
Residential mortgage		22,162		20,379		1,544		21,030		20,403		1,703
Commercial		-		-		-		148		148		15
Commercial real estate		3,468		3,419		186		5,858		5,656		196
ADC		1,038		1,003		50		858		858		53
Home equity/2nds		-		-		-		3,747		3,137		402
Consumer		87		87		2		96		96		4

	2017						2016
	Number of Modifications		Recorded Investment Prior to Modification		Recorded Investment After Modification		Number of Modifications		Recorded Investment Prior to Modification		Recorded Investment After Modification
	(dollars in thousands)
Residential Mortgage								3	$	624	$	624
		-	$	-	$	-		3	$	624	$	624

	September 30, 2017
	Number of Modifications		Accrual Status		Number of Modifications		Nonaccrual Status		Total Number of Modifications		Total Balance of Modifications
	(dollars in thousands)
Residential mortgage		43	$	13,086		4	$	2,285		47	$	15,371
Commercial real estate		3		1,875		1		84		4		1,959
ADC		1		138		1		6		2		144
Home equity/2nds		1		230		-		-		1		230
Consumer		4		87		-		-		4		87
		52	$	15,416		6	$	2,375		58	$	17,791

	Actual					Minimum Requirements for Capital Adequacy Purposes					Minimum Requirements with Capital Conservation Buffer					To be Well Capitalized Under Prompt Corrective Action Provision
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2017	(dollars in thousands)
Common Equity Tier 1 Capital (to risk-weighted assets)	$	104,318		16.8	%	$	27,907		4.5	%	$	35,658		5.8	%	$	40,309		6.5	%

Total capital (to risk-weighted assets)		112,086		18.1	%		49,612		8.0	%		57,363		9.3	%		62,015		10.0	%

Tier 1 capital (to risk-weighted assets)		104,318		16.8	%		37,209		6.0	%		44,961		7.3	%		49,612		8.0	%

Tier 1 capital (to average quarterly assets)		104,318		13.3	%		31,313		4.0	%		41,099		5.3	%		39,142		5.0	%

December 31, 2016
Common Equity Tier 1 Capital (to risk-weighted assets)	$	98,970		16.5	%	$	26,983		4.5	%	$	30,730		5.1	%	$	38,975		6.5	%

Total capital (to risk-weighted assets)		106,517		17.8	%		47,969		8.0	%		51,717		8.6	%		59,962		10.0	%

Tier 1 capital (to risk-weighted assets)		98,970		16.5	%		35,977		6.0	%		39,725		6.6	%		47,969		8.0	%

Tier 1 capital (to average quarterly assets)		98,970		12.9	%		30,634		4.0	%		35,420		4.6	%		38,292		5.0	%

	2017									2016
	Number of Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)		Number of Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding at beginning of period		339,500		$	5.31						339,800		$	4.83
Granted		20,000			7.10						-			-
Exercised		(5,025	)		3.37						-			-
Forfeited		(16,000	)		4.59						(54,500	)		5.07
Outstanding at end of period		338,475			5.48		7.2	$	526		285,300			4.79		8.2	$	491
Exercisable at end of period		173,702			4.78		6.5	$	398		136,125			4.37		7.0	$	292

	Three Months			Nine Months
	(dollars in thousands)
Balance at beginning of period	$	6		$	-
Other comprehensive loss before reclassification		(9	)		(3	)
Amounts reclassified from accumulated other comprehensive loss		(1	)		(1	)
Net other comprehensive loss during period		(10	)		(4	)
Balance at end of period	$	(4	)	$	(4	)

	Carrying Value		Quoted Prices (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Changes In Fair Values Included In Period Income
	(dollars in thousands)
AFS Securities - U.S. government agency notes	$	3,129	$	-	$	3,129	$	-	$	-
Loans held for sale (“LHFS”)		4,871		-		4,871		-		139
Mortgage servicing rights (“MSRs”)		473		-		-		473		(84	)
Interest-rate lock commitments (“IRLCs”)		42		-		42		-		(120	)
Mandatory forward contracts		7		-		7		-		(146	)
Best efforts forward contracts		6		-		6		-		6

	Fair Value Estimate		Valuation Technique	Unobservable Input	Range (Weighted-Average)
	(dollars in thousands)
September 30, 2017:
MSRs	$	473	Market Approach	Weighted average prepayment speed		3.95	%

December 31, 2016:
MSRs	$	557	Market Approach	Weighted average prepayment speed		3.95	%

	Three Months Ended September 30, 2017 vs. 2016									Nine Months Ended September 30, 2017 vs. 2016
	Due to Variances in									Due to Variances in
	Rate			Volume			Total			Rate			Volume			Total
Interest earned on:	(dollars in thousands)
Loans	$	169		$	187		$	356		$	312		$	232		$	544
LHFS		-			(93	)		(93	)		65			(189	)		(124	)
AFS securities		-			26			26			-			71			71
HTM Securities		240			(216	)		24			109			(143	)		(34	)
Other interest-earning assets		28			62			90			196			71			267
Restricted stock investments, at cost		39			(45	)		(6	)		14			(34	)		(20	)
Total interest income		476			(79	)		397			696			8			704

Interest paid on:
Interest-bearing deposits:
Checking and savings		(123	)		58			(65	)		158			(21	)		137
Certificates of deposit		217			(160	)		57			(160	)		(55	)		(215	)
Total interest-bearing deposits		94			(102	)		(8	)		(2	)		(76	)		(78	)
Borrowings		53			(262	)		(209	)		(199	)		(450	)		(649	)
Total interest expense		147			(364	)		(217	)		(201	)		(526	)		(727	)
Net interest income	$	329		$	285		$	614		$	897		$	534		$	1,431

Principal Amount (in thousands)		Rate	Maturity
$	24,950	1.21% to 4.05%	2017
	15,000	2.58% to 3.43%	2018
	35,000	1.55% to 4.00%	2019
	15,000	1.75%	2020
$	89,950

	September 30, 2017				December 31, 2016
	Notional Amount		Estimated Fair Value		Notional Amount		Estimated Fair Value
	(dollars in thousands)
Asset - IRLCs	$	2,329	$	42	$	9,725	$	162
Asset - Mandatory forward contracts		4,731		7		10,302		153
Asset - Best effort forward contracts		2,329		6		-		-