Loans and Allowance for Credit Losses | Note 4 – Loans and Allowance for Credit Losses The Company makes residential mortgage, commercial and consumer loans to customers primarily in Talbot County, Queen Anne’s County, Kent County, Caroline County and Dorchester County in Maryland and in Kent County, Delaware. The following table provides information about the principal classes of the loan portfolio at March 31, 2017 and December 31, 2016 . (Dollars in thousands) March 31, 2017 December 31, 2016 Construction $ 91,498 $ 84,002 Residential real estate 331,191 325,768 Commercial real estate 388,391 382,681 Commercial 74,189 72,435 Consumer 6,595 6,639 Total loans 891,864 871,525 Allowance for credit losses (8,927) (8,726) Total loans, net $ 882,937 $ 862,799 Loans are stated at their principal amount outstanding net of any purchase premiums, deferred fees and costs. Interest income on loans is accrued at the contractual rate based on the principal amount outstanding. Fees charged and costs capitalized for originating loans are being amortized substantially on the interest method over the term of the loan. A loan is placed on nonaccrual (i.e., interest income is no longer accrued) when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more, unless the loan is well secured and in the process of collection. Any unpaid interest previously accrued on those loans is reversed from income. Interest payments received on nonaccrual loans are applied as a reduction of the loan principal balance unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. A loan is considered impaired if it is probable that the Company will not collect all principal and interest payments according to the loan’s contractual terms. An impaired loan may show deficiencies in the borrower’s overall financial condition, payment history, support available from financial guarantors and/or the fair market value of collateral. The impairment of a loan is measured at the present value of expected future cash flows using the loan’s effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Generally, the Company measures impairment on such loans by reference to the fair value of the collateral. Once the amount of impairment has been determined, the uncollectible portion is charged off. Income on impaired loans is recognized on a cash basis, and payments are first applied against the principal balance outstanding (i.e., placing impaired loans on nonaccrual status). Generally, interest income is not recognized on impaired loans unless the likelihood of further loss is remote. The allowance for credit losses may include specific reserves related to impaired loans. Specific reserves remain until charge offs are made. Impaired loans do not include groups of smaller balance homogenous loans such as residential mortgage and consumer installment loans that are evaluated collectively for impairment. Reserves for probable credit losses related to these loans are based on historical loss ratios and are included in the formula portion of the allowance for credit losses. See additional discussion under the caption “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. A loan is considered a troubled debt restructuring (“TDR”) if a borrower is experiencing financial difficulties and a creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Loans are identified to be restructured when signs of impairment arise such as borrower interest rate reduction request, slowness to pay, or when an inability to repay becomes evident. The terms being offered are evaluated to determine if they are more liberal than those that would be indicated by policy or industry standards for similar, untroubled credits. In those situations where the terms or the interest rates are considered to be more favorable than industry standards or the current underwriting guidelines of the Company’s banking subsidiary, Shore United Bank (the “Bank”), the loan is classified as a TDR. All loans designated as TDRs are considered impaired loans and may be on either accrual or nonaccrual status. In instances where the loan has been placed on nonaccrual status, six consecutive months of timely payments are required prior to returning the loan to accrual status. All loans classified as TDRs which are restructured and accrue interest under revised terms require a full and comprehensive review of the borrower’s financial condition, capacity for repayment, realistic assessment of collateral values, and the assessment of risk entered into any workout agreement. Current financial information on the borrower, guarantor, and underlying collateral is analyzed to determine if it supports the ultimate collection of principal and interest. For commercial loans, the cash flows are analyzed, both for the underlying project and globally. For consumer loans, updated salary, credit history and cash flow information is obtained. Current market conditions are also considered. Following a full analysis, the determination of the appropriate loan structure is made. In the normal course of banking business, risks related to specific loan categories are as follows: Construction loans – Construction loans generally finance the construction of residential real estate for builders and individuals for single family dwellings. In addition, the Bank periodically finances the construction of commercial projects. Credit risk factors include the borrower’s ability to successfully complete the construction on time and within budget, changing market conditions which could affect the value and marketability of projects, changes in the borrower’s ability or willingness to repay the loan and potentially rising interest rates which can impact both the borrower’s ability to repay and the collateral value. Residential real estate – Residential real estate loans are typically made to consumers and are secured by residential real estate. Credit risk arises from the borrower’s continuing financial stability, which can be adversely impacted by job loss, divorce, illness, or personal bankruptcy, among other factors. Also impacting credit risk would be a shortfall in the value of the residential real estate in relation to the outstanding loan balance in the event of a default or subsequent liquidation of the real estate collateral. Commercial real estate – Commercial real estate loans consist of both loans secured by owner occupied properties and non-owner occupied where an established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of occupancy and cash flow. These loans are subject to adverse changes in the local economy and commercial real estate markets. Credit risk associated with owner occupied properties arises from the borrower’s financial stability and the ability of the borrower and the business to repay the loan. Non-owner occupied properties carry the risk of a tenant’s deteriorating credit strength, lease expirations in soft markets and sustained vacancies which can adversely impact cash flow. Commercial – Commercial loans are secured or unsecured loans for business purposes. Loans are typically secured by accounts receivable, inventory, equipment and/or other assets of the business. Credit risk arises from the successful operation of the business which may be affected by competition, rising interest rates, regulatory changes and adverse conditions in the local and regional economy. Consumer – Consumer loans include home equity loans and lines, installment loans and personal lines of credit. Credit risk is similar to residential real estate loans above as it is subject to the borrower’s continuing financial stability and the value of the collateral securing the loan. The following tables include impairment information relating to loans and the allowance for credit losses as of March 31, 2017 and December 31, 2016 . Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total March 31, 2017 Loans individually evaluated for impairment $ 7,883 $ 7,974 $ 5,555 $ - $ 99 $ - $ 21,511 Loans collectively evaluated for impairment 83,615 323,217 382,836 74,189 6,496 - 870,353 Total loans $ 91,498 $ 331,191 $ 388,391 $ 74,189 $ 6,595 $ - $ 891,864 Allowance for credit losses allocated to: Loans individually evaluated for impairment $ 683 $ 282 $ 183 $ - $ - $ - $ 1,148 Loans collectively evaluated for impairment 1,607 1,849 2,729 1,338 256 - 7,779 Total loans $ 2,290 $ 2,131 $ 2,912 $ 1,338 $ 256 $ - $ 8,927 Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total December 31, 2016 Loans individually evaluated for impairment $ 8,007 $ 7,778 $ 6,088 $ - $ 99 $ - $ 21,972 Loans collectively evaluated for impairment 75,995 317,990 376,593 72,435 6,540 - 849,553 Total loans $ 84,002 $ 325,768 $ 382,681 $ 72,435 $ 6,639 $ - $ 871,525 Allowance for credit losses allocated to: Loans individually evaluated for impairment $ 1,639 $ 317 $ 185 $ - $ - $ - $ 2,141 Loans collectively evaluated for impairment 1,148 1,636 2,425 1,145 231 - 6,585 Total loans $ 2,787 $ 1,953 $ 2,610 $ 1,145 $ 231 $ - $ 8,726 The following tables provide information on impaired loans and any related allowance by loan class as of March 31, 2017 and December 31, 2016 . The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken. Recorded Recorded Unpaid investment investment Average Interest principal with no with an Related recorded income (Dollars in thousands) balance allowance allowance allowance investment recognized March 31, 2017 Impaired nonaccrual loans: Construction $ 7,527 $ 76 $ 3,628 $ 666 $ 3,717 $ - Residential real estate 4,491 2,689 1,581 134 4,010 - Commercial real estate 1,213 481 175 99 721 - Commercial - - - - - - Consumer 99 99 - - 99 - Total $ 13,330 $ 3,345 $ 5,384 $ 899 $ 8,547 $ - Impaired accruing TDRs: Construction $ 4,179 $ 3,474 $ 705 $ 17 $ 4,182 $ 30 Residential real estate 3,704 2,665 1,039 148 3,762 43 Commercial real estate 4,899 1,877 3,022 84 4,908 57 Commercial - - - - - - Consumer - - - - - - Total $ 12,782 $ 8,016 $ 4,766 $ 249 $ 12,852 $ 130 Total impaired loans: Construction $ 11,706 $ 3,550 $ 4,333 $ 683 $ 7,899 $ 30 Residential real estate 8,195 5,354 2,620 282 7,772 43 Commercial real estate 6,112 2,358 3,197 183 5,629 57 Commercial - - - - - - Consumer 99 99 - - 99 - Total $ 26,112 $ 11,361 $ 10,150 $ 1,148 $ 21,399 $ 130 Recorded Recorded March 31, 2016 Unpaid investment investment Average Interest principal with no with an Related recorded income (Dollars in thousands) balance allowance allowance allowance investment recognized December 31, 2016 Impaired nonaccrual loans: Construction $ 7,247 $ - $ 3,818 $ 1,621 $ 7,216 $ - Residential real estate 4,013 1,957 1,946 166 2,292 - Commercial real estate 1,801 959 193 117 2,559 - Commercial - - - - 158 - Consumer 99 99 - - 121 - Total $ 13,160 $ 3,015 $ 5,957 $ 1,904 $ 12,346 $ - Impaired accruing TDRs: Construction $ 4,189 $ 3,479 $ 710 $ 18 $ 4,041 $ 25 Residential real estate 3,875 2,829 1,046 151 5,669 55 Commercial real estate 4,936 1,573 3,363 68 5,363 46 Commercial - - - - - - Consumer - - - - - - Total $ 13,000 $ 7,881 $ 5,119 $ 237 $ 15,073 $ 126 Total impaired loans: Construction $ 11,436 $ 3,479 $ 4,528 $ 1,639 $ 11,257 $ 25 Residential real estate 7,888 4,786 2,992 317 7,961 55 Commercial real estate 6,737 2,532 3,556 185 7,922 46 Commercial - - - - 158 - Consumer 99 99 - - 121 - Total $ 26,160 $ 10,896 $ 11,076 $ 2,141 $ 27,419 $ 126 The following tables provide a roll-forward for troubled debt restructurings as of March 31, 2017 and March 31, 2016 . 1/1/2017 3/31/2017 TDR New Disbursements Charge Reclassifications/ TDR Related (Dollars in thousands) Balance TDRs (Payments) offs Transfer In/(Out) Payoffs Balance Allowance For three months ended March 31, 2017 Accruing TDRs Construction $ 4,189 $ - $ (10) $ - $ - $ - $ 4,179 $ 17 Residential real estate 3,875 - (82) (89) - - 3,704 148 Commercial real estate 4,936 - (37) - - - 4,899 84 Commercial - - - - - - - - Consumer - - - - - - - - Total $ 13,000 $ - $ (129) $ (89) $ - $ - $ 12,782 $ 249 Nonaccrual TDRs Construction $ 3,818 $ - $ (190) $ - $ - $ - $ 3,628 $ 666 Residential real estate 1,603 - (22) - - - 1,581 134 Commercial real estate 83 - - - - - 83 - Commercial - - - - - - - - Consumer - - - - - - - - Total $ 5,504 $ - $ (212) $ - $ - $ - $ 5,292 $ 800 Total $ 18,504 $ - $ (341) $ (89) $ - $ - $ 18,074 $ 1,049 1/1/2016 3/31/2016 TDR New Disbursements Charge Reclassifications/ TDR Related (Dollars in thousands) Balance TDRs (Payments) offs Transfer In/(Out) Payoffs Balance Allowance For three months ended March 31, 2016 Accruing TDRs Construction $ 4,069 $ - $ (77) $ - $ - $ - $ 3,992 $ 28 Residential real estate 5,686 - (31) - - - 5,655 112 Commercial real estate 5,740 - (517) (117) - - 5,106 552 Commercial - - - - - - - - Consumer - - - - - - - - Total $ 15,495 $ - $ (625) $ (117) $ - $ - $ 14,753 $ 692 Nonaccrual TDRs Construction $ 4,960 $ 2,570 $ (691) $ (241) $ - $ - $ 6,598 $ 755 Residential real estate 445 - (288) - - - 157 11 Commercial real estate - - - - - - - - Commercial - - - - - - - - Consumer 23 - - - - - 23 - Total $ 5,428 $ 2,570 $ (979) $ (241) $ - $ - $ 6,778 $ 766 Total $ 20,923 $ 2,570 $ (1,604) $ (358) $ - $ - $ 21,531 $ 1,458 The following tables provide information on loans that were modified and considered TDRs during the three months ended March 31, 2017 and March 31, 2016 . Premodification Postmodification outstanding outstanding Number of recorded recorded Related (Dollars in thousands) contracts investment investment allowance TDRs: For three months ended March 31, 2017 Construction - $ - $ - $ - Residential real estate - - - - Commercial real estate 1 760 755 - Commercial - - - - Consumer - - - - Total 1 $ 760 $ 755 $ - For three months ended March 31, 2016 Construction 1 $ 2,570 $ 2,570 $ - Residential real estate - - - - Commercial real estate - - - - Commercial - - - - Consumer - - - - Total 1 $ 2,570 $ 2,570 $ - During the three months ended March 31, 2017, there was one TDR which was modified. The modification to this TDR consisted of a change in maturity date. The following tables provide information on TDRs that defaulted during the three months ended March 31, 2017 and March 31, 2016 . Generally, a loan is considered in default when principal or interest is past due 90 days or more. Number of Recorded Related (Dollars in thousands) contracts investment allowance TDRs that subsequently defaulted: For three months ended March 31, 2017 Construction - $ - $ - Residential real estate 1 89 - Commercial real estate - - - Commercial - - - Consumer - - - Total 1 $ 89 $ - For three months ended March 31, 2016 Construction 1 $ 241 $ - Residential real estate - - - Commercial real estate 1 117 - Commercial - - - Consumer - - - Total 2 $ 358 $ - Management uses risk ratings as part of its monitoring of the credit quality in the Company’s loan portfolio. Loans that are identified as special mention, substandard or doubtful are adversely rated. They are assigned higher risk ratings than favorably rated loans in the calculation of the formula portion of the allowance for credit losses. At March 31, 2017, there were no nonaccrual loans classified as special mention or doubtfu l and $8.7 million of nonaccrual loans were identified as substandard. The comparable amounts at December 31, 2016 were special mention $0 , substandard $9.0 million and doubtful $0 , respectively. The following tables provide information on loan risk ratings as of March 31, 2017 and December 31, 2016 . Special (Dollars in thousands) Pass/Performing Mention Substandard Doubtful Total March 31, 2017 Construction $ 80,284 $ 4,164 $ 7,050 $ - $ 91,498 Residential real estate 317,461 6,496 7,234 - 331,191 Commercial real estate 364,732 15,925 7,734 - 388,391 Commercial 73,304 814 71 - 74,189 Consumer 6,496 - 99 - 6,595 Total $ 842,277 $ 27,399 $ 22,188 $ - $ 891,864 Special (Dollars in thousands) Pass/Performing Mention Substandard Doubtful Total December 31, 2016 Construction $ 72,641 $ 4,195 $ 7,166 $ - $ 84,002 Residential real estate 312,242 6,646 6,880 - 325,768 Commercial real estate 363,461 10,939 8,281 - 382,681 Commercial 71,313 857 265 - 72,435 Consumer 6,540 - 99 - 6,639 Total $ 826,197 $ 22,637 $ 22,691 $ - $ 871,525 The following tables provide information on the aging of the loan portfolio as of March 31, 2017 and December 31, 2016 . Accruing 30-59 days 60-89 days Greater than Total (Dollars in thousands) Current past due past due 90 days past due Nonaccrual Total March 31, 2017 Construction $ 87,683 $ 111 $ - $ - $ 111 $ 3,704 $ 91,498 Residential real estate 324,573 1,062 1,286 - 2,348 4,270 331,191 Commercial real estate 385,788 1,449 390 108 1,947 656 388,391 Commercial 74,088 89 12 - 101 - 74,189 Consumer 6,465 13 8 10 31 99 6,595 Total $ 878,597 $ 2,724 $ 1,696 $ 118 $ 4,538 $ 8,729 $ 891,864 Percent of total loans 98.5 % 0.3 % 0.2 % - % 0.5 % 1.0 % 100.0 % Accruing 30-59 days 60-89 days Greater than Total (Dollars in thousands) Current past due past due 90 days past due Nonaccrual Total December 31, 2016 Construction $ 80,079 $ - $ 105 $ - $ 105 $ 3,818 $ 84,002 Residential real estate 317,992 1,778 2,095 - 3,873 3,903 325,768 Commercial real estate 375,552 3,219 2,758 - 5,977 1,152 382,681 Commercial 72,272 19 134 10 163 - 72,435 Consumer 6,515 13 2 10 25 99 6,639 Total $ 852,410 $ 5,029 $ 5,094 $ 20 $ 10,143 $ 8,972 $ 871,525 Percent of total loans 97.8 % 0.6 % 0.6 % - % 1.2 % 1.0 % 100.0 % Management evaluates the adequacy of the allowance for credit losses at least quarterly and adjusts the provision for credit losses based on this analysis. The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three months ended March 31, 2017 and 2016 . Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes. Management re-evaluated the allowance methodology during the third quarter of 2016, in connection with the consolidation of the two former bank subsidiaries. Prior to consolidation, each bank subsidiary applied a separate allowance methodology based on their respective loan portfolios. The revised methodology incorporates both previous methodologies to align with a consolidated loan portfolio. In addition, beginning in January of 2017 , the allowance methodology was expanded to require the allocation of general reserves to pass/watch loans. This change resulted in an increase in allowance for the first quarter of 2017 when compared to the fourth quarter of 2016 of $1.1 million, which was partially offset by a reduction in specific reserves for a net effect of $250 thousand. Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total For three months ended March 31, 2017 Allowance for credit losses: Beginning Balance $ 2,787 $ 1,953 $ 2,610 $ 1,145 $ 231 $ - $ 8,726 Charge-offs (29) (223) - (65) - - (317) Recoveries 7 11 11 58 4 - 91 Net charge-offs (22) (212) 11 (7) 4 - (226) Provision (475) 390 291 200 21 - 427 Ending Balance $ 2,290 $ 2,131 $ 2,912 $ 1,338 $ 256 $ - $ 8,927 Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total For three months ended March 31, 2016 Allowance for credit losses: Beginning Balance $ 1,646 $ 2,181 $ 2,999 $ 558 $ 156 $ 776 $ 8,316 Charge-offs (241) (16) (238) (67) (8) - (570) Recoveries 6 34 - 65 8 - 113 Net charge-offs (235) 18 (238) (2) - - (457) Provision 342 (185) 496 29 21 (253) 450 Ending Balance $ 1,753 $ 2,014 $ 3,257 $ 585 $ 177 $ 523 $ 8,309 Foreclosure Proceedings Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $410 thousand and $687 thousand as of March 31, 2017 and December 31, 2016 , respectively. At March 31, 2017 and December 31, 2016, there were 3 residential properties held in other real estate owned totaling $92 thousand. Performing TDRs were in compliance with their modified terms and there are no further commitments associated with these loans. |