Loans and Allowance for Credit Losses | Note 5 – 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, Dorchester County, Baltimore County and Howard County in Maryland, Kent County, Delaware and Accomack County, Virginia. The following table provides information about the principal classes of the loan portfolio at September 30, 2018 and December 31, 2017 . (Dollars in thousands) September 30, 2018 December 31, 2017 Construction $ 126,313 $ 125,746 Residential real estate 425,842 399,190 Commercial real estate 513,169 464,887 Commercial 108,823 97,284 Consumer 6,410 6,407 Total loans 1,180,557 1,093,514 Allowance for credit losses (10,328) (9,781) Total loans, net $ 1,170,229 $ 1,083,733 Loans are stated at their principal amount outstanding net of any purchase premiums, deferred fees an d costs. Loans included deferred costs, net of deferred fees, of $725 thousand and discounts on acquired loans of $1.5 million at September 30, 2018. Loans included deferred costs, net of deferred fees, of $609 thousand and discounts on acquired loans of $1.8 million at December 31, 2017. Interest income on loans is accrued at the contractual rate based on the principal amount outstanding. F ees 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 are offered primarily to builders and individuals to finance the construction of 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 properties 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 September 30, 2018 and December 31, 2017 . Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Total September 30, 2018 Loans individually evaluated for impairment $ 3,104 $ 6,931 $ 5,936 $ 324 $ - $ 16,295 Loans collectively evaluated for impairment 123,209 418,911 507,233 108,499 6,410 1,164,262 Total loans $ 126,313 $ 425,842 $ 513,169 $ 108,823 $ 6,410 $ 1,180,557 Allowance for credit losses allocated to: Loans individually evaluated for impairment $ 375 $ 194 $ 32 $ 20 $ - $ 621 Loans collectively evaluated for impairment 2,409 1,947 2,905 2,190 256 9,707 Total allowance $ 2,784 $ 2,141 $ 2,937 $ 2,210 $ 256 $ 10,328 Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Total December 31, 2017 Loans individually evaluated for impairment $ 6,975 $ 6,018 $ 4,967 $ 337 $ - $ 18,297 Loans collectively evaluated for impairment 118,771 393,172 459,920 96,947 6,407 1,075,217 Total loans $ 125,746 $ 399,190 $ 464,887 $ 97,284 $ 6,407 $ 1,093,514 Allowance for credit losses allocated to: Loans individually evaluated for impairment $ 500 $ 239 $ 33 $ 33 $ - $ 805 Loans collectively evaluated for impairment 1,960 2,045 2,561 2,208 202 8,976 Total allowance $ 2,460 $ 2,284 $ 2,594 $ 2,241 $ 202 $ 9,781 The following tables provide information on impaired loans and any related allowance by loan class as of September 30, 2018 and December 31, 2017 . The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken and interest paid on nonaccrual loans that has been applied to principal . September 30, 2018 Recorded Recorded Quarter-to-date Year-to-date Unpaid investment investment average average principal with no with an Related recorded recorded (Dollars in thousands) balance allowance allowance allowance investment investment September 30, 2018 Impaired nonaccrual loans: Construction $ 3,409 $ 284 $ 2,748 $ 356 $ 3,043 $ 3,006 Residential real estate 2,399 2,267 - - 1,710 1,573 Commercial real estate 2,155 1,739 - - 1,742 1,438 Commercial 425 - 324 20 327 338 Consumer - - - - - - Total $ 8,388 $ 4,290 $ 3,072 $ 376 $ 6,822 $ 6,355 Impaired accruing TDRs: Construction $ 72 $ 53 $ 19 $ 19 $ 145 $ 1,138 Residential real estate 4,664 1,635 3,029 194 4,709 4,613 Commercial real estate 4,197 3,485 712 32 4,307 4,499 Commercial - - - - - - Consumer - - - - - - Total $ 8,933 $ 5,173 $ 3,760 $ 245 $ 9,161 $ 10,250 Total impaired loans: Construction $ 3,481 $ 337 $ 2,767 $ 375 $ 3,188 $ 4,144 Residential real estate 7,063 3,902 3,029 194 6,419 6,186 Commercial real estate 6,352 5,224 712 32 6,049 5,937 Commercial 425 - 324 20 327 338 Consumer - - - - - - Total $ 17,321 $ 9,463 $ 6,832 $ 621 $ 15,983 $ 16,605 September 30, 2017 Recorded Recorded Quarter-to-date Year-to-date Unpaid investment investment average average principal with no with an Related recorded recorded (Dollars in thousands) balance allowance allowance allowance investment investment December 31, 2017 Impaired nonaccrual loans: Construction $ 3,100 $ 182 $ 2,821 $ 459 $ 2,890 $ 3,253 Residential real estate 1,620 1,482 - - 2,840 3,573 Commercial real estate 795 149 - - 489 627 Commercial 425 - 337 33 344 153 Consumer - - - - - 55 Total $ 5,940 $ 1,813 $ 3,158 $ 492 $ 6,563 $ 7,661 Impaired accruing TDRs: Construction $ 3,972 $ 3,038 $ 934 $ 41 $ 4,034 $ 4,086 Residential real estate 4,536 2,042 2,494 239 3,691 3,620 Commercial real estate 4,818 4,084 734 33 4,841 4,872 Commercial - - - - - - Consumer - - - - - - Total $ 13,326 $ 9,164 $ 4,162 $ 313 $ 12,566 $ 12,578 Total impaired loans: Construction $ 7,072 $ 3,220 $ 3,755 $ 500 $ 6,924 $ 7,339 Residential real estate 6,156 3,524 2,494 239 6,531 7,193 Commercial real estate 5,613 4,233 734 33 5,330 5,499 Commercial 425 - 337 33 344 153 Consumer - - - - - 55 Total $ 19,266 $ 10,977 $ 7,320 $ 805 $ 19,129 $ 20,239 The following tables provide a roll-forward for troubled debt restructurings as of September 30, 2018 and September 30, 2017 . 1/1/2018 9/30/2018 TDR New Disbursements Charge- Reclassifications/ TDR Related (Dollars in thousands) Balance TDRs (Payments) offs Transfer In/(Out) Payoffs Balance Allowance For nine months ended September 30, 2018 Accruing TDRs Construction $ 3,972 $ - $ (225) $ (379) $ (696) $ (2,600) $ 72 $ 19 Residential real estate 4,536 - (63) - 542 (351) 4,664 194 Commercial real estate 4,818 - (402) - - (219) 4,197 32 Commercial - - - - - - - - Consumer - - - - - - - - Total $ 13,326 $ - $ (690) $ (379) $ (154) $ (3,170) $ 8,933 $ 245 Nonaccrual TDRs Construction $ 2,878 $ - $ (73) $ - $ 83 $ - $ 2,888 $ 356 Residential real estate - - - (80) 80 - - - Commercial real estate 83 - - - (83) - - - Commercial 337 - (13) - - - 324 20 Consumer - - - - - - - - Total $ 3,298 $ - $ (86) $ (80) $ 80 $ - $ 3,212 $ 376 Total $ 16,624 $ - $ (776) $ (459) $ (74) $ (3,170) $ 12,145 $ 621 1/1/2017 9/30/2017 TDR New Disbursements Charge- Reclassifications/ TDR Related (Dollars in thousands) Balance TDRs (Payments) offs Transfer In/(Out) Payoffs Balance Allowance For nine months ended September 30, 2017 Accruing TDRs Construction $ 4,189 $ - $ (22) $ - $ - $ (134) $ 4,033 $ 41 Residential real estate 3,875 - (120) (89) 1,411 (452) 4,625 228 Commercial real estate 4,936 - (101) - - - 4,835 35 Commercial - - - - - - - - Consumer - - - - - - - - Total $ 13,000 $ - $ (243) $ (89) $ 1,411 $ (586) $ 13,493 $ 304 Nonaccrual TDRs Construction $ 3,818 $ - $ (882) $ - $ (108) $ - $ 2,828 $ 548 Residential real estate 1,603 - (66) - (1,411) - 126 23 Commercial real estate 83 - - - - - 83 - Commercial - 345 (4) - - - 341 - Consumer - - - - - - - - Total $ 5,504 $ 345 $ (952) $ - $ (1,519) $ - $ 3,378 $ 571 Total $ 18,504 $ 345 $ (1,195) $ (89) $ (108) $ (586) $ 16,871 $ 875 The following tables provide information on loans that were modified and considered TDRs during the nine months ended September 30, 2018 and September 30, 2017 . Premodification Postmodification outstanding outstanding Number of recorded recorded Related (Dollars in thousands) contracts investment investment allowance TDRs: For nine months ended September 30, 2018 Construction - $ - $ - $ - Residential real estate - - - - Commercial real estate - - - - Commercial - - - - Consumer - - - - Total - $ - $ - $ - For nine months ended September 30, 2017 Construction - $ - $ - $ - Residential real estate - - - - Commercial real estate 1 760 755 - Commercial 1 462 345 - Consumer - - - - Total 2 $ 1,222 $ 1,100 $ - During the nine months ended September 30, 2018, there were no new TDR’s or previously recorded TDR’s which were modified. The following tables provide information on TDRs that defaulted within twelve months of restructuring during the nine months ended September 30, 2018 and September 30, 2017 . Generally, a loan is considered in default when principal or interest is past due 90 days or more, the loan is placed on nonaccrual, the loan is charged off, or there is a transfer to OREO or repossessed assets. Number of Recorded Related (Dollars in thousands) contracts investment allowance TDRs that subsequently defaulted: For nine months ended September 30, 2018 Construction 1 $ 379 $ - Residential real estate 1 154 - Commercial real estate - - - Commercial - - - Consumer - - - Total 2 $ 533 $ - For nine months ended September 30, 2017 Construction - $ - $ - Residential real estate 1 89 - Commercial real estate - - - Commercial - - - Consumer - - - Total 1 $ 89 $ - Management uses risk ratings as part of its monitoring of the credit quality in the Company’s loan portfolio. The Company added pass/watch credits to an existing pool that included loans that are risk rated as special mention and substandard to be collectively evaluated for impairment for both quantitative and qualitative factors at December 31, 2017. The Company believes that attributing additional reserves to this pool of loans better reflects the perceived risk for the total loan portfolio going forward, due to the significant organic loan growth over the past 24 months, the increase in pass/watch rated credits, and increasing balances/concentrations in certain segments of the loan portfolio. Loans that are identified as special mention, substandard or doubtful are adversely rated. These loans and the pass/watch loans are assigned higher qualitative factors than favorably rated loans in the calculation of the formula portion of the allowance for credit losses. At September 30, 2018, there were no nonaccrual loans classified as special mention or doubtfu l and $7.4 million of nonaccrual loans were identified as substandard. Similarly, at December 31, 2017, there were no nonaccrual loans classified as special mention or doubtful and $5.0 million of nonaccrual loans were identified as substandard. The following tables provide information on loan risk ratings as of September 30, 2018 and December 31, 2017 . Special (Dollars in thousands) Pass/Performing Pass/Watch Mention Substandard Doubtful Total September 30, 2018 Construction $ 92,937 $ 30,307 $ - $ 3,069 $ - $ 126,313 Residential real estate 382,280 35,793 3,433 4,336 - 425,842 Commercial real estate 384,759 115,459 5,604 7,347 - 513,169 Commercial 83,245 24,569 645 364 - 108,823 Consumer 5,898 509 - 3 - 6,410 Total $ 949,119 $ 206,637 $ 9,682 $ 15,119 $ - $ 1,180,557 Special (Dollars in thousands) Pass/Performing Pass/Watch Mention Substandard Doubtful Total December 31, 2017 Construction $ 88,836 $ 30,674 $ - $ 6,236 $ - $ 125,746 Residential real estate 355,575 34,973 4,456 4,186 - 399,190 Commercial real estate 342,051 109,041 7,420 6,375 - 464,887 Commercial 72,440 24,102 308 434 - 97,284 Consumer 5,260 1,147 - - - 6,407 Total $ 864,162 $ 199,937 $ 12,184 $ 17,231 $ - $ 1,093,514 The following tables provide information on the aging of the loan portfolio as of September 30, 2018 and December 31, 2017 . Accruing 30-59 days 60-89 days Greater than Total (Dollars in thousands) Current past due past due 90 days past due Nonaccrual Total September 30, 2018 Construction $ 123,262 $ 19 $ - $ - $ 19 $ 3,032 $ 126,313 Residential real estate 421,384 1,707 484 - 2,191 2,267 425,842 Commercial real estate 508,781 723 1,926 - 2,649 1,739 513,169 Commercial 107,632 519 348 - 867 324 108,823 Consumer 6,399 4 4 3 11 - 6,410 Total $ 1,167,458 $ 2,972 $ 2,762 $ 3 $ 5,737 $ 7,362 $ 1,180,557 Percent of total loans 98.9 % 0.3 % 0.2 % - % 0.5 % 0.6 % 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, 2017 Construction $ 122,475 $ 268 $ - $ - $ 268 $ 3,003 $ 125,746 Residential real estate 394,653 1,589 1,045 421 3,055 1,482 399,190 Commercial real estate 460,998 1,061 2,461 218 3,740 149 464,887 Commercial 96,774 173 - - 173 337 97,284 Consumer 6,395 6 6 - 12 - 6,407 Total $ 1,081,295 $ 3,097 $ 3,512 $ 639 $ 7,248 $ 4,971 $ 1,093,514 Percent of total loans 98.8 % 0.3 % 0.3 % 0.1 % 0.7 % 0.5 % 100.0 % The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three and nine months ended September 30, 2018 and September 30, 2017. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes. Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total For three months ended September 30, 2018 Allowance for credit losses: Beginning Balance $ 2,593 $ 2,150 $ 2,845 $ 2,210 $ 323 $ - $ 10,121 Charge-offs - (109) - (137) - - (246) Recoveries 3 5 5 122 11 - 146 Net charge-offs 3 (104) 5 (15) 11 - (100) Provision 188 95 87 15 (78) - 307 Ending Balance $ 2,784 $ 2,141 $ 2,937 $ 2,210 $ 256 $ - $ 10,328 Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total For three months ended September 30, 2017 Allowance for credit losses: Beginning Balance $ 2,349 $ 2,096 $ 2,802 $ 1,652 $ 233 $ - $ 9,132 Charge-offs - (70) (100) (99) (18) - (287) Recoveries 11 11 8 67 8 - 105 Net charge-offs 11 (59) (92) (32) (10) - (182) Provision (119) 6 174 184 100 - 345 Ending Balance $ 2,241 $ 2,043 $ 2,884 $ 1,804 $ 323 $ - $ 9,295 Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total For nine months ended September 30, 2018 Allowance for credit losses: Beginning Balance $ 2,460 $ 2,284 $ 2,594 $ 2,241 $ 202 $ - $ 9,781 Charge-offs (379) (288) - (263) (24) - (954) Recoveries 18 91 23 144 11 - 287 Net charge-offs (361) (197) 23 (119) (13) - (667) Provision 685 54 320 88 67 - 1,214 Ending Balance $ 2,784 $ 2,141 $ 2,937 $ 2,210 $ 256 $ - $ 10,328 Residential Commercial (Dollars in thousands) Construction real estate real estate Commercial Consumer Unallocated Total For nine months ended September 30, 2017 Allowance for credit losses: Beginning Balance $ 2,787 $ 1,953 $ 2,610 $ 1,145 $ 231 $ - $ 8,726 Charge-offs (54) (393) (100) (870) (33) - (1,450) Recoveries 27 32 27 167 20 - 273 Net charge-offs (27) (361) (73) (703) (13) - (1,177) Provision (519) 451 347 1,362 105 - 1,746 Ending Balance $ 2,241 $ 2,043 $ 2,884 $ 1,804 $ 323 $ - $ 9,295 Foreclosure Proceedings Consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure totaled $132 thousand and $530 thousand as of September 30, 2018 and December 31, 2017 , respectively. There was one residential propert y included in the balance of other real estate owned of $77 thousand at September 30, 2018 and no residential properties included in the balance of other real estate owned at December 31, 2017. All accruing TDRs were in compliance with their modified terms . One loan was transferred to nonaccrual as of September 30, 2018. Both performing and non-performing TDRs had no further commitments associated with them as of September 30, 2018 and December 31, 2017. |