Howard Bancorp (HBMD) 10-Q 2019 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2019

OR

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

Commission File Number: 001-35489

HOWARD BANCORP, INC.

(Exact name of registrant as specified in its charter)

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

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

(410) 750-0020

(Registrant’s telephone number, including area code)

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	HBMD	Nasdaq Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No ¨

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

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

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

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

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

The number of outstanding shares of common stock outstanding as of July 31, 2019.

Common Stock, $0.01 par value – 19,081,008 shares

HOWARD BANCORP, INC.

TABLE OF CONTENTS

		Page
PART I	Financial Information	4
Item 1.	Financial Statements	4
	Consolidated Balance Sheets (Unaudited)	4
	Consolidated Statements of Operations (Unaudited)	5
	Consolidated Statements of Comprehensive (Loss) Income (Unaudited)	6
	Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)	6
	Consolidated Statements of Cash Flows (Unaudited)	7
	Notes to Consolidated Financial Statements (Unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	35
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	52
Item 4.	Controls and Procedures	52
PART II	Other Information	53
Item 1.	Legal Proceedings	53
Item 1A.	Risk Factors	53
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	53
Item 3.	Defaults Upon Senior Securities	53
Item 4.	Mine Safety Disclosures	53
Item 5.	Other Information	53
Item 6.	Exhibits	53
Signatures		54

2

FORWARD-LOOKING STATEMENTS

This report contains “forward-looking statements,” as that phrase is defined in the Private Securities Litigation Reform Act of 1995, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may,” “should” and words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. These forward-looking statements include, but are not limited to statements of our goals, intentions and expectations, particularly with respect to our business plan and strategies, including opening of additional branches, expansion into new markets, potential acquisitions, increasing capital, market share, loan, investments and asset growth, revenue and profit growth and expanding client relationships. Actual results could differ materially from those anticipated in such forward-looking statements. Factors that might cause such differences include, but are not limited to:

· deterioration in general economic conditions, either nationally or in our market area, or a return to recessionary conditions;

· competition among depository and other financial institutions;

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

· adverse changes in the securities markets;

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

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

· our ability to successfully integrate acquired entities, if any;

· our ability to fully realize the expected benefits and other impacts of our acquisition of First Mariner Bank;

· changes in consumer spending, borrowing and savings habits;

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

· changes in our organization, compensation and benefit plans;

· loss of key personnel;

· the impact of recent branch closures and the opening of new branches on expenses;

· our ability to maintain the asset quality of our investment portfolios and the anticipated recovery and collection of unrealized losses on securities available for sale;

· our ability to continue our expected focus on commercial customers as well as continuing to originate residential real estate loans and both maintaining our residential mortgage loan portfolio and continuing to sell loans into the secondary market;

· the impact of the Tax Cuts and Jobs Act (the “TCJA”) of 2017;

· changes in our expected occupancy and equipment expenses;

· changes to our allowance for credit losses, and the adequacy thereof;

· our ability to maintain adequate liquidity levels and future sources of liquidity;

· our ability to retain a large portion of maturing certificates of deposit;

· the impact on us of recent changes to accounting standards;

· the impact of future cash requirements relating to commitments to extend credit;

· the impact of interest rate changes on our net interest income; and

· the effects of other factors, including those discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 and the other documents filed by the Company with the SEC from time to time.

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. You should not put undue reliance on any forward-looking statements. These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not undertake any obligation to update any forward-looking statements after the date of this report.

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

3

PART I

Item 1. Financial Statements

Howard Bancorp, Inc. and Subsidiary

Consolidated Balance Sheets

	Unaudited
	June 30,			December 31,
(in thousands, except share data)	2019			2018
ASSETS
Cash and due from banks	$	124,868		$	100,976
Federal funds sold		193			522
Total cash and cash equivalents		125,061			101,498
Securities available for sale, at fair value		151,685			223,858
Securities held to maturity, at amortized cost		9,750			9,250
Nonmarketable equity securities		11,220			11,786
Loans held for sale, at fair value		37,680			21,261
Loans and leases, net of unearned income		1,701,020			1,649,751
Allowance for credit losses		(9,120	)		(9,873	)
Net loans and leases		1,691,900			1,639,878
Bank premises and equipment, net		42,876			45,137
Goodwill		65,949			70,697
Core deposit intangible		9,932			11,482
Bank owned life insurance		75,060			74,153
Other real estate owned		4,702			4,392
Deferred tax assets, net		37,803			35,285
Interest receivable and other assets		32,016			17,837
Total assets	$	2,295,634		$	2,266,514
LIABILITIES
Noninterest-bearing deposits	$	422,117		$	429,200
Interest-bearing deposits		1,295,099			1,256,606
Total deposits		1,717,216			1,685,806
Short-term borrowings		220,669			134,576
Long-term borrowings		28,142			142,077
Accrued expenses and other liabilities		26,080			9,372
Total liabilities		1,992,107			1,971,831
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock - par value of $0.01 authorized 20,000,000 shares; issued and outstanding 19,063,080 shares at June 30, 2019 and 19,039,347 at December 31, 2018		191			190
Capital surplus		276,218			275,843
Retained earnings		24,621			18,277
Accumulated other comprehensive income		2,497			373
Total stockholders’ equity		303,527			294,683
Total liabilities and stockholders’ equity	$	2,295,634		$	2,266,514

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

4

Consolidated Statements of Operations

	Unaudited
	For the six months ended						For the three months ended
	June 30,						June 30,
(in thousands, except share data)	2019			2018			2019			2018
INTEREST INCOME
Interest and fees on loans and leases	$	41,697		$	33,366		$	21,131		$	19,788
Interest and dividends on securities		3,596			1,684			1,740			1,116
Other interest income		636			475			274			261
Total interest income		45,929			35,525			23,145			21,165
INTEREST EXPENSE
Deposits		7,568			3,079			4,004			1,729
Short-term borrowings		1,335			1,407			754			717
Long-term borrowings		2,198			1,011			1,033			839
Total interest expense		11,101			5,497			5,791			3,285
NET INTEREST INCOME		34,828			30,028		��	17,354			17,880
Provision for credit losses		2,835			2,545			1,110			1,425
Net interest income after provision for credit losses		31,993			27,483			16,244			16,455
NONINTEREST INCOME
Service charges on deposit accounts		1,311			916			684			590
Realized and unrealized gains on mortgage banking activity		3,793			3,439			2,308			1,623
Gain (loss) on the sale of securities		658			(139	)		658			-
Loss on the disposal of bank premises & equipment		(83	)		-			(83	)		-
Income from bank owned life insurance		907			705			460			420
Loan fee income		2,038			3,925			995			2,059
Other operating income		1,752			1,475			819			925
Total noninterest income		10,376			10,321			5,841			5,617
NONINTEREST EXPENSE
Compensation and benefits		16,306			17,480			8,272			9,911
Occupancy and equipment		6,754			4,167			5,183			2,617
Amortization of core deposit intangible		1,551			1,222			767			863
Marketing and business development		941			2,109			484			1,104
Professional fees		1,503			1,023			718			717
Data processing fees		2,525			1,648			1,147			1,047
Merger and restructuring expense		-			15,673			-			5,698
FDIC assessment		568			414			281			261
Other real estate owned		131			19			104			(3	)
Loan production expense		1,220			2,252			700			1,309
Other operating expense		2,812			2,285			1,798			1,616
Total noninterest expense		34,311			48,292			19,454			25,140
INCOME (LOSS) BEFORE INCOME TAXES		8,058			(10,488	)		2,631			(3,068	)
Income tax expense (benefit)		1,714			(2,535	)		543			(791	)
NET INCOME (LOSS)	$	6,344		$	(7,953	)	$	2,088		$	(2,277	)
NET INCOME (LOSS) PER COMMON SHARE
Basic	$	0.33		$	(0.50	)	$	0.11		$	(0.12	)
Diluted	$	0.33		$	(0.50	)	$	0.11		$	(0.12	)

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

5

Consolidated Statements of Comprehensive (Loss) Income

	Unaudited
	Six months ended						Three months ended
	June 30,						June 30,
(in thousands)	2019			2018			2019			2018
Net Income (Loss)	$	6,344		$	(7,953	)	$	2,088		$	(2,277	)
Other comprehensive income (loss)
Investments available-for-sale:
Reclassification adjustment for (gain) loss		(658	)		139			(658	)		-
Related income tax		180			(38	)		180			-
Unrealized holding gains (losses)		3,590			(288	)		1,790			18
Related income tax (expense) benefit		(988	)		71			(492	)		(69	)
Comprehensive income (loss)	$	8,468		$	(8,069	)	$	2,908		$	(2,328	)

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

Consolidated Statements of Changes in Stockholders’ EquityUnaudited

										Accumulated
										other
	Number of		Common		Capital		Retained			comprehensive
(dollars in thousands, except share data)	shares		stock		surplus		earnings			income (loss)			Total
Six months ended
Balances at January 1, 2018		9,820,592	$	98	$	110,387	$	22,105		$	(337	)	$	132,253
Net loss		-		-		-		(7,953	)		-			(7,953	)
Net unrealized loss on securities		-		-		-		-			(116	)		(116	)
Acquisition of First Mariner Bank		9,143,222		92		164,486		-			-			164,578
Director stock awards		4,800		-		101		-			-			101
Exercise of options		3,284		-		35		-			-			35
Stock-based compensation		37,062		-		572		-			-			572
Balances at June 30, 2018		19,008,960	$	190	$	275,581	$	14,152		$	(453	)	$	289,470
Balances at January 1, 2019		19,039,347	$	190	$	275,843	$	18,277		$	373		$	294,683
Net income		-		-		-		6,344			-			6,344
Net unrealized gain on securities		-		-		-		-			2,124			2,124
Director stock awards		4,802		-		62		-			-			62
Exercise of options		12,149		1		104		-			-			105
Employee stock purchase plan		6,782		-		97		-			-			97
Stock-based compensation		-		-		112		-			-			112
Balances at June 30, 2019		19,063,080	$	191	$	276,218	$	24,621		$	2,497		$	303,527

										Accumulated
										other
	Number of		Common		Capital		Retained			comprehensive
(dollars in thousands, except share data)	shares		stock		surplus		earnings			income (loss)			Total
Three months ended
Balances at March 31, 2018		18,991,026	$	190	$	275,489	$	16,429		$	(401	)	$	291,707
Net loss		-		-		-		(2,277	)		-			(2,277	)
Net unrealized loss on securities		-		-		-		-			(52	)		(52	)
Acquisition of First Mariner Bank		-		-		-		-			-			-
Director stock awards		-		-		-		-			-			-
Exercise of options		1,604		-		17		-			-			17
Stock-based compensation		16,330		-		75		-			-			75
Balances at June 30, 2018		19,008,960	$	190	$	275,581	$	14,152		$	(453	)	$	289,470
Balances at March 31, 2019		19,059,485	$	191	$	276,128	$	22,533		$	1,677		$	300,529
Net income		-		-		-		2,088			-			2,088
Net unrealized gain on securities		-		-		-		-			820			820
Director stock awards		-		-		-		-			-			-
Exercise of options		3,595		-		28		-			-			28
Employee stock purchase plan		-		-		-		-			-			-
Stock-based compensation		-		-		62		-			-			62
Balances at June 30, 2019		19,063,080	$	191	$	276,218	$	24,621		$	2,497		$	303,527

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

6

Consolidated Statements of Cash Flows

	Unaudited
	Six months ended
	June 30
(in thousands)	2019			2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	6,344		$	(7,953	)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Provision for credit losses		2,835			2,545
Deferred income tax		1,422			1,852
Provision for other real estate owned		65			-
Depreciation and amortization		1,209			1,200
Stock-based compensation		112			572
Net (accretion) amortization of investment securities		(51	)		25
Net accretion of discount on purchased loans		(925	)		(628	)
(Gain) loss on sales of securities		(658	)		139
Loss on the sale of property		83			-
Net amortization of intangible asset		1,551			1,222
Loans originated for sale		(259,868	)		(337,290	)
Proceeds from sale of loans originated for sale		247,241			355,115
Realized and unrealized gains on mortgage banking activity		(3,793	)		(3,439	)
Gain on sales of other real estate owned, net		-			(45	)
Cash surrender value of BOLI		(907	)		(705	)
(Increase) decrease in interest receivable		(214	)		431
Increase in interest payable		31			340
Decrease in other assets		3,008			2,470
Increase (decrease) in other liabilities		928			(355	)
Net cash (used in) provided by operating activities		(1,587	)		15,496
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investment securities available-for-sale		(6,002	)		(44,535	)
Purchases of investment securities held-to-maturity		(500	)		-
Proceeds from sale/maturities of investment securities available-for-sale		81,159			112,039
Net increase in loans and leases outstanding		(54,308	)		(10,662	)
Proceeds from the sale of other real estate owned		-			954
Purchase of premises and equipment		(422	)		(1,773	)
Proceeds from the sale of premises and equipment		1,392			-
Cash acquired in acquisition		-			29,285
Net cash provided by investing activities		21,319			85,308
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits		31,410			(4,699	)
Net increase (decrease) in short-term borrowings		86,093			(126,293	)
Net (decrease) increase in long term debt		(113,935	)		109,041
Net proceeds from issuance of common stock, net of cost		263			136
Net cash provided by (used in) financing activities		3,831			(21,815	)
Net increase in cash and cash equivalents		23,563			78,989
Cash and cash equivalents at beginning of period		101,498			28,972
Cash and cash equivalents at end of period	$	125,061		$	107,961
SUPPLEMENTAL INFORMATION
Cash payments for interest	$	11,070		$	4,881
Cash payments for income taxes		-			-
Transferred from loans to other real estate owned		375			174
Cash payments for operating leases		785			1,710
Assets acquired in business combination (net of cash received)		-			970,709
Liabilities assumed in business combination		-			897,569
Lease liabilities arising from obtaining right of use assets (see Note 8)		15,183			-

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

7

Notes to Consolidated Financial Statements(unaudited)

Note 1: Summary of Significant Accounting Policies

Nature of Operations

On December 15, 2005, Howard Bancorp, Inc. (“Bancorp”) acquired all of the stock and became the holding company of Howard Bank (the “Bank”) pursuant to the Plan of Reorganization approved by the stockholders of the Bank and by federal and state regulatory agencies. Each share of the Bank’s common stock was converted into two shares of Bancorp common stock effected by the filing of Articles of Exchange on that date, and the stockholders of the Bank became the stockholders of Bancorp. The Bank has seven subsidiaries, six of which are intended to hold foreclosed real estate (three of which are inactive) and the other owns and manages real estate that is used as a branch location and has office and retail space. The accompanying consolidated financial statements of Bancorp and its wholly owned subsidiary, the Bank (collectively, the “Company”), have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

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

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

On December 6, 2018, the Company entered into Subordinated Note Purchase Agreements with certain institutional accredited investors (the “Purchasers”) pursuant to which the Company sold and issued $25,000,000 in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due December 6, 2028 (the “Notes”). The Notes were issued by the Company to the Purchasers at a price equal to 100% of their face amount in a private offering in reliance on the exemptions from registration available under Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”), and the provisions of Regulation D thereunder. The Company intends to use the net proceeds from this offering for general corporate purposes, to provide for continued growth and to supplement its regulatory capital ratios.

On March 1, 2018, Bancorp completed its previously announced merger (the “First Mariner merger”) with First Mariner Bank, a Maryland chartered trust company (“First Mariner”), pursuant to the Agreement and Plan of Reorganization dated as August 14, 2017, and as amended by Amendment No. 1 on November 8, 2017, by and among Bancorp, the Bank and First Mariner (as amended, the “First Mariner Merger Agreement”). At the effective time of the First Mariner merger, First Mariner merged with and into the Bank, with the Bank continuing as the surviving bank of the First Mariner merger and a wholly owned subsidiary of the Company. At the effective time of the First Mariner merger, each outstanding share of First Mariner common stock and First Mariner Series A Non-Voting Non-Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the right to receive 1.6624 shares of Bancorp common stock, provided that cash was paid in lieu of any fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,222 shares of our common stock, which was valued at approximately $164.6 million based on Bancorp’s closing stock price of $18.00 on February 28, 2018.

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

Principles of Consolidation

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

Use of Estimates

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

8

Allowance for Credit Losses

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

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

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

· changes in lending policies, procedures, practices or personnel;

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

· changes and migration of classified assets;

· changes in exposure to subordinate collateral lien positions;

· levels and composition of existing guarantees on loans by the Small Business Administration or other agencies;

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

· changes and trends in levels of loan payment delinquencies; and

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

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

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

Goodwill, Other Intangible Assets and Long-Lived Assets

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

9

Management has determined that Bancorp has one reporting unit, and based upon the annual impairment analysis, it was determined that there was not an impairment of the carrying value of either the goodwill, core deposit intangible or other long-lived assets for 2018. The Company is not aware of any issues that have arisen since our last impairment analysis performed in the fourth quarter of 2018.

Income Taxes

The Company uses the asset/liability method of accounting for income taxes. Under the asset/liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse.

As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. In addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or the entire deferred tax asset will not be realized.

The Company does not have uncertain tax positions that are deemed material, and did not recognize any adjustments for unrecognized tax benefits. The Company’s policy is to recognize interest and penalties on income taxes in other noninterest expenses. The Company remains subject to examination by federal and state taxing authorities for income tax returns for the years ending after December 31, 2015.

Share-Based Compensation

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

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

Reclassifications

Certain items in prior financial statements have been reclassified to conform to the current presentation. These reclassifications did not affect previously reported net income or total stockholders’ equity.

New Accounting Pronouncements

The Financial Accounting Standards Board (“FASB”) has issued Accounting Standards Update (“ASU”) 2018-16,Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (“SOFR”) Overnight Index Swap (“OIS”) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes.This ASU permits use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes. Alternative Reference Rates Committee has proposed that the SOFR is the rate that represents best practice as the alternative to derivatives currently indexed to London Inter-Bank Offered Rate (“LIBOR”). The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments should be adopted on a prospective basis for qualifying new or re-designated hedging relationships entered into on or after the date of adoption. The Company has non-designated hedge contracts that are indexed to LIBOR and is monitoring this activity and evaluating the related risks as they relate to derivatives.

The FASB has issued ASU 2018-13,Fair Value Measurement (Topic 820): Disclosure Framework— Changes to the Disclosure Requirements for Fair Value Measurement.This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reason for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019; early adoption is permitted. Entities are also allowed to elect early adoption of the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. Since ASU 2018-13 only revises disclosure requirements, it will not have a material impact on the Company’s Consolidated Financial Statements.

10

The FASB has issued ASU 2017-04,Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.  The amendments in this Update simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. Impairment charges should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this Update are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company will evaluate the guidance in this update but does not expect it to have a significant impact on the Company’s financial position or result of operations.

The FASB has issued ASU 2016-13,Financial Instruments—Credit Losses (Topic 326). The main objective of this update is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the guidance in this update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The guidance in this update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company has engaged a third party vendor and is currently gathering historical data and reviewing the methodologies and assumptions utilized to determine the impact of this update on the Company’s Consolidated Financial Statements.

Note 2: Business Combinations

First Mariner Acquisition

On March 1, 2018, Howard Bancorp completed its previously announced merger with First Mariner into the Bank, pursuant to the First Mariner Merger Agreement. At the effective time of the First Mariner merger, First Mariner merged with and into the Bank, with the Bank continuing as the surviving bank of the First Mariner merger. At the effective time of the First Mariner merger, pursuant to the terms of the First Mariner Merger Agreement, each outstanding share of First Mariner common stock and First Mariner Series A Non-Voting Non-Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the right to receive 1.6624 shares of Howard Bancorp common stock, provided that cash was paid in lieu of any fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,222 shares of our common stock, which was valued at approximately $164.6 million based on Howard Bancorp’s closing stock price of $18.00 on February 28, 2018.

The Company has accounted for the First Mariner merger under the acquisition method of accounting in accordance with FASB ASC Topic 805, “Business Combinations,” whereby the acquired assets and assumed liabilities were recorded by Howard Bancorp at their estimated fair values as of their acquisition date.

Management made significant estimates and exercised significant judgment in accounting for the acquisition of First Mariner. Management judgmentally assigned risk ratings to loans based on appraisals and estimated collateral values, expected cash flows, prepayment speeds and estimated loss factors to measure fair values for loans. Deposits and borrowings were valued based upon interest rates, original and remaining terms and maturities, as well as current rates for similar funds in the same markets. Premises and equipment was valued based on recent appraised values. Management used quoted or current market prices to determine the fair value of investment securities.

11

The following table provides the purchase price as of the date of the First Mariner merger (the “acquisition date”), the identifiable assets acquired and liabilities assumed at their estimated fair values, and the resulting goodwill of $65.3 million recorded from the acquisition:

(in thousands)

Purchase Price Consideration
Cash consideration	$	9,245
Purchase price assigned to shares exchanged for stock		164,578
Total purchase price for First Mariner acquisition	$	173,823
Assets acquired at fair value:
Cash and cash equivalents	$	38,889
Interest bearing deposits with banks		3,920
Investment securities available for sale		130,302
Loans held for sale		28,189
Loans		664,338
Accrued interest receivable		3,023
Other assets		124,797
Core deposit intangible		12,588
Total fair value of assets acquired	$	1,006,046
Liabilities assumed at fair value:
Deposits		706,435
Borrowings		185,020
Accrued expenses and other liabilities		6,114
Total fair value of liabilities assumed	$	897,569
Net assets acquired at fair value:			$	108,477
Transaction consideration paid to First Mariner				173,823
Amount of goodwill recorded from First Mariner Acquisition			$	65,346

The goodwill resulting from the First Mariner merger at June 30, 2019 of $65.3 million is lower than the $70.1 million reflected at December 31, 2018 due to a change in the acquired value of the net deferred tax asset included in other assets above. At the acquisition date, wording of the TCJA appeared to indicate that appreciation in the cash value of acquired BOLI would not be consider exempt from taxation.  However, industry groups and congress had urged the IRS to issue regulations to clarify how this section of the TCJA would be applied.  In the first quarter of 2019, the IRS issued new proposed guidance which clarified the new law and made it more likely than not that the appreciated value of the BOLI acquired by the Company would be tax exempt.

Pro Forma Condensed Combined Financial Information:

The following table presents unaudited pro forma information as if the First Mariner Merger had been completed on January 1, 2018. The pro forma information does not necessarily reflect the results of operations that would have occurred had the First Mariner Merger occurred at the beginning of 2018. Supplemental pro forma earnings were adjusted to exclude merger related costs. The expected future amortizations of the various fair value adjustments were included beginning of the period. Cost savings are not reflected in the unaudited pro forma amounts for the periods presented. The pro forma financial information does not include the impact of possible business model changes, nor does it consider any potential impacts of current market conditions on revenues, expense efficiencies, or other factors.

	Six months ended		Three months ended
	June 30, 2018		June 30, 2018
Net interest income after provision	$	32,953	$	17,064
Noninterest income		12,351		5,617
Noninterest expense		41,304		20,190
Net income		2,899		1,805
Net income per share	$	0.15	$	0.10

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Note 3: Investment Securities

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

As part of the Bank’s overall interest rate position strategies, the Bank sold $35.4 million of held for sale investment securities in the second quarter of 2019 recording a gain on the sale of $658 thousand. In 2018 the Bank sold $33.0 million of pre-acquisition investment securities and recorded a loss on the sale of $139 thousand. Because of the composition and remaining duration of the securities portfolio acquired in the First Mariner merger, management deemed it prudent for interest rate risk management purposes to liquidate the majority of the acquired portfolio. Thus, in the first quarter of 2018, the Bank sold nearly $69.37 million of First Mariner securities, with no gains or losses incurred upon the liquidation, as the sales were executed within days of the merger.

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

(in thousands)	June 30, 2019								December 31, 2018
			Gross		Gross						Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated		Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value		Cost		Gains		Losses		Fair Value
Available for sale
U.S. Government Agencies	$	60,684	$	1,089	$	4	$	61,769	$	130,088	$	428	$	119	$	130,397
Mortgage-backed		84,542		2,407		22		86,927		90,242		364		146		90,460
Other investments		3,010		-		21		2,989		3,011		-		10		3,001
	$	148,236	$	3,496	$	47	$	151,685	$	223,341	$	792	$	275	$	223,858
Held to maturity Corporate debentures	$	9,750	$	165	$	-	$	9,915	$	9,250	$	45	$	42	$	9,253

Gross unrealized losses and fair value by investment category and length of time the individual securities have been in a continuous unrealized loss position at June 30, 2019 and December 31, 2018 are presented below:

June 30, 2019
(in thousands)	Less than 12 months				12 months or more				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
Available for sale
U.S. Government Agencies	$	1,001	$	-	$	1,995	$	4	$	2,996	$	4
Mortgage-backed		-		-		2,149		22		2,149		22
Other investments		2,989		21		-		-		2,989		21
	$	3,990	$	21	$	4,144	$	26	$	8,134	$	47
Held to maturity Corporate debentures	$	-	$	-	$	-	$	-	$	-	$	-

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December 31, 2018
(in thousands)	Less than 12 months				12 months or more				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
Available for sale
U.S. Government Agencies	$	3,049	$	3	$	13,887	$	116	$	16,936	$	119
Mortgage-backed		26,197		54		2,107		92		28,304		146
Other investments		3,001		10		-		-		3,001		10
	$	32,247	$	67	$	15,994	$	208	$	48,241	$	275
Held to maturity Corporate debentures	$	2,458	$	42	$	-	$	-	$	2,458	$	42

The unrealized losses that existed were a result of market changes in interest rates since the original purchase. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include the (1) duration and magnitude of the decline in value, (2) financial condition of the issuer or issuers and (3) structure of the security. The portfolio contained 7 securities with unrealized losses and 31 securities with unrealized losses at June 30, 2019 and December 31, 2018, respectively.

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

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

(in thousands)	June 30, 2019				December 31, 2018
	Amortized		Estimated Fair		Amortized		Estimated Fair
	Cost		Value		Cost		Value
Amounts maturing:
One year or less	$	1,999	$	1,995	$	38,936	$	38,892
After one through five years		53,691		54,692		88,175		88,513
After five through ten years		22,347		22,794		19,873		19,921
After ten years		79,949		82,119		85,607		85,785
	$	157,986	$	161,600	$	232,591	$	233,111

At June 30, 2019 and December 31, 2018, $13.4 million and $42.3 million in fair value of securities, respectively, were pledged as collateral for both repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts. No single issuer of securities, except for government agency and mortgage backed securities, had outstanding balances that exceeded ten percent of stockholders’ equity at June 30, 2019.

Note 4: Loans and Leases

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

The loan portfolio segment balances at June 30, 2019 and December 31, 2018 are presented in the following table:

14

	June 30, 2019					December 31, 2018
(in thousands)	Total		% of Total			Total		% of Total
Real estate
Construction and land	$	115,753		6.8	%	$	123,671		7.5	%
Residential - first lien		411,213		24.2			383,044		23.2
Residential - junior lien		80,303		4.7			89,645		5.4
Total residential real estate		491,516		28.8			472,689		28.6
Commercial - owner occupied		232,771		13.7			234,102		14.2
Commercial - non-owner occupied		442,449		26.0			427,747		25.9
Total commercial real estate		675,220		39.7			661,849		40.1
Total real estate loans		1,282,489		75.3			1,258,209		76.2
Commercial loans and leases		367,856		21.6			336,876		20.5
Consumer		50,675		3.0			54,666		3.3
Total loans	$	1,701,020		100.0	%	$	1,649,751		100.0	%

Net loan origination fees, which are included in the amounts above, totaled $975 thousand and $307 thousand at June 30, 2019 and December 31, 2018, respectively.

Acquired Impaired Loans

The following table documents changes in the accretable discount on acquired impaired loans at:

	For the six months ended						For the three months ended
	June 30,						June 30,
(in thousands)	2019			2018			2019			2018
Balance at beginning of period	$	877		$	-		$	835		$	1,052
Impaired loans acquired		-			1,055			-			-
Accretion of fair value discounts		(110	)		(34	)		(68	)		(31	)
Balance at end of period	$	767		$	1,021		$	767		$	1,021

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

	Contractually
	Required
	Payments		Carrying
(in thousands)	Receivable		Amount
At June 30, 2019	$	12,246	$	9,816
At December 31, 2018		15,463		11,446
At June 30, 2018		17,116		12,611

Note 5: Credit Quality Assessment

Allowance for Credit Losses

The following tables provide information on the activity in the allowance for credit losses by the respective loan portfolio segment for the periods ended June 30, 2019 and June 30, 2018:

15

	June 30, 2019
										Commercial			Commercial			Commercial
	Construction			Residential			Residential			owner			non-owner			loans			Consumer
(in thousands)	and land			first lien			junior lien			occupied			occupied			and leases			loans			Total
Allowance for credit losses:
Six months ended:
Beginning balance	$	741		$	1,170		$	292		$	735		$	4,057		$	2,644		$	234		$	9,873
Charge-offs		(282	)		(362	)		(471	)		(44	)		(2,026	)		(525	)		(18	)		(3,728	)
Recoveries		-			-			104			-			3			32			1			140
Provision for credit losses		669			982			512			202			765			(456	)		161			2,835
Ending balance	$	1,128		$	1,790		$	437		$	893		$	2,799		$	1,695		$	378		$	9,120
Three months ended:
Beginning balance	$	1,220		$	1,372		$	390		$	817		$	3,188		$	1,543		$	224		$	8,754
Charge-offs		(62	)		(238	)		(221	)		(44	)		-			(298	)		(11	)		(874	)
Recoveries		-			-			99			-			1			30			-			130
Provision for credit losses		(30	)		656			169			120			(390	)		420			165			1,110
Ending balance	$	1,128		$	1,790		$	437		$	893		$	2,799		$	1,695		$	378		$	9,120

	June 30, 2018
										Commercial			Commercial			Commercial
	Construction			Residential			Residential			owner			non-owner			loans			Consumer
(in thousands)	and land			first lien			junior lien			occupied			occupied			and leases			loans			Total
Allowance for credit losses:
Six months ended:
Beginning balance	$	735		$	668		$	177		$	617		$	1,410		$	2,529		$	23		$	6,159
Charge-offs		(202	)		(102	)		(149	)		(1	)		(746	)		(912	)		(49	)		(2,161	)
Recoveries		-			1			-			-			2			68			5			76
Provision for credit losses		128			113			185			110			957			982			70			2,545
Ending balance	$	661		$	680		$	213		$	726		$	1,623		$	2,667		$	49		$	6,619
Three months ended:
Beginning balance	$	563		$	736		$	186		$	698		$	1,470		$	2,472		$	23		$	6,148
Charge-offs		-			(3	)		(60	)		-			(212	)		(644	)		(45	)		(964	)
Recoveries		-			2			-			-			-			7			1			10
Provision for credit losses		98			(55	)		87			28			365			832			70			1,425
Ending balance	$	661		$	680		$	213		$	726		$	1,623		$	2,667		$	49		$	6,619

The following tables provide additional information on the allowance for credit losses at June 30, 2019 and December 31, 2018:

	June 30, 2019
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Allowance allocated to:
individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
collectively evaluated for impairment	$	1,128	$	1,790	$	437	$	893	$	2,799	$	1,695	$	378	$	9,120
Loans:
Ending balance	$	115,753	$	411,213	$	80,303	$	232,771	$	442,449	$	367,856	$	50,675	$	1,701,020
individually evaluated for impairment	$	933	$	12,530	$	914	$	225	$	2,608	$	1,862	$	287	$	19,359
collectively evaluated for impairment	$	114,820	$	398,683	$	79,389	$	232,546	$	439,841	$	365,994	$	50,388	$	1,681,661

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	December 31, 2018
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Allowance allocated to:
individually evaluated for impairment	$	-	$	-	$	-	$	-	$	2,195	$	200	$	-	$	2,395
collectively evaluated for impairment	$	741	$	1,170	$	292	$	735	$	1,862	$	2,444	$	234		7,478
Loans:
Ending balance	$	123,671	$	383,044	$	89,645	$	234,102	$	427,747	$	336,876	$	54,666	$	1,649,751
individually evaluated for impairment	$	1,449	$	13,259	$	1,137	$	1,268	$	5,018	$	2,455	$	174		24,760
collectively evaluated for impairment	$	122,222	$	369,785	$	88,508	$	232,834	$	422,729	$	334,421	$	54,492	$	1,624,991

Acquired loans from the First Mariner merger in 2018 were evaluated for impairment subsequent to the merger. No allowance was required on these loans due to the assigned credit marks on these loans.

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

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

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

	June 30, 2019
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Credit quality indicators:
Not classified	$	114,945	$	399,658	$	79,389	$	232,546	$	439,764	$	366,049	$	50,388	$	1,682,739
Special mention		-		-		-		-		-		-		-		-
Substandard		808		11,555		914		225		2,685		1,807		287		18,281
Doubtful		-		-		-		-		-		-		-		-
Total	$	115,753	$	411,213	$	80,303	$	232,771	$	442,449	$	367,856	$	50,675	$	1,701,020

	December 31, 2018
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Credit quality indicators:
Not classified	$	122,270	$	370,766	$	88,507	$	228,408	$	422,591	$	334,152	$	54,492	$	1,621,186
Special mention		78		-		-		3,877		-		-		-		3,955
Substandard		1,323		12,278		1,138		1,817		5,156		2,724		174		24,610
Doubtful		-		-		-		-		-		-		-		-
Total	$	123,671	$	383,044	$	89,645	$	234,102	$	427,747	$	336,876	$	54,666	$	1,649,751

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

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

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

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

An aged analysis of past due loans is as follows:

	June 30, 2019
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Analysis of past due loans:
Accruing loans current	$	114,945	$	396,863	$	78,091	$	232,539	$	439,289	$	365,687	$	50,035	$	1,677,449
Accruing loans past due:
30-59 days past due		-		-		836		7		204		361		14		1,422
60-89 days past due		-		1,355		378		-		-		-		339		2,072
Greater than 90 days past due		-		1,440		84		-		348		-		-		1,872
Total past due		-		2,795		1,298		7		552		361		353		5,366
Non-accrual loans1		808		11,555		914		225		2,608		1,808		287		18,205
Total loans	$	115,753	$	411,213	$	80,303	$	232,771	$	442,449	$	367,856	$	50,675	$	1,701,020

	December 31, 2018
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	and land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Analysis of past due loans:
Accruing loans current	$	121,831	$	361,522	$	86,884	$	232,834	$	422,297	$	334,058	$	54,483	$	1,613,909
Accruing loans past due:
30-59 days past due		-		6,433		937		-		432		94		9		7,905
60-89 days past due		166		2,241		687		-		-		307		-		3,401
Greater than 90 days past due		351		570		-		-		-		-		-		921
Total past due		517		9,244		1,624		-		432		401		9		12,227
Non-accrual loans1		1,323		12,278		1,137		1,268		5,018		2,417		174		23,615
Total loans	$	123,671	$	383,044	$	89,645	$	234,102	$	427,747	$	336,876	$	54,666	$	1,649,751

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

Total loans either in non-accrual status or in excess of 90 days delinquent totaled $20.1 million or 1.2% of total loans outstanding at June 30, 2019, which represents a decrease from $24.5 million, or 1.5%, at December 31, 2018.

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The following tables reflect impaired loans at June 30, 2019 and December 31, 2018:

	June 30, 2019
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	& land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Impaired loans:
Recorded investment1	$	933	$	12,530	$	914	$	225	$	2,608	$	1,862	$	287	$	19,359
With an allowance recorded		-		-		-		-		-		-		-		-
With no related allowance recorded		933		12,530		914		225		2,608		1,862		287		19,359
Related allowance		-		-		-		-		-		-		-		-
Unpaid principal		1,322		13,818		1,135		246		4,363		3,097		302		24,283
Six months ended:
Average balance of impaired loans		1,459		15,171		1,385		247		4,480		3,536		313		26,591
Interest income recognized		-		138		33		8		13		14		5		211
Three months ended:
Average balance of impaired loans		1,454		15,154		1,370		247		4,457		3,525		313		26,520
Interest income recognized		-		86		26		8		6		10		4		140

	December 31, 2018
							Commercial		Commercial		Commercial
	Construction		Residential		Residential		owner		non-owner		loans		Consumer
(in thousands)	& land		first lien		junior lien		occupied		occupied		and leases		loans		Total
Impaired loans:
Recorded investment1	$	1,449	$	13,259	$	1,137	$	1,268	$	5,018	$	2,455	$	174	$	24,760
With an allowance recorded		-		-		-		-		2,816		200		-		3,016
With no related allowance recorded		1,449		13,259		1,137		1,268		2,202		2,255		174		21,744
Related allowance		-		-		-		-		2,195		200		-		2,395
Unpaid principal		1,873		14,425		1,456		1,569		5,295		4,868		185		29,671
Average balance of impaired loans		1,873		15,446		1,448		1,569		5,340		5,556		185		31,417
Interest income recognized		-		474		51		16		5		125		5		676

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

Included in the total impaired loans above were non-accrual loans of $18.2 million and $23.6 million at June 30, 2019 and December 31, 2018, respectively. Interest income that would have been recorded if non-accrual loans had been current and in accordance with their original terms was $534 thousand and $1.0 million for the six months ended June 30, 2019 and 2018, respectively.

Loans may have their terms restructured (e.g., interest rates, loan maturity date, payment and amortization period, etc.) in circumstances that provide payment relief to a borrower experiencing financial difficulty. Such restructured loans are considered trouble debt restructured loans (“TDRs”) that may either be impaired loans that may either be in accruing status or non-accruing status.  Non-accruing TDRs may return to accruing status provided there is a sufficient period of payment performance in accordance with the restructure terms.  Loans may be removed from the restructured category in the year subsequent to the restructuring if: a) the restructuring agreement specifies an interest rate equal to or greater than the rate that the creditor was willing to accept at the time of restructuring for a new loan with comparable risk; and b) the loan is not impaired based on the terms specified by the restructuring agreement.    

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TDRs at June 30, 2019 and December 31, 2018 are as follows:

	June 30, 2019
	Number		Non-Accrual		Number		Accrual		Total
(dollars in thousands)	of Loans		Status		of Loans		Status		TDRs
Construction and land		-	$	-		1	$	125	$	125
Residential real estate - first lien		2		285		2		975		1,260
Commercial - non-owner occupied		1		800		-		-		800
Commercial loans and leases		1		514		-		-		514
		4	$	1,599		3	$	1,100	$	2,699

	December 31, 2018
	Number		Non-Accrual		Number		Accrual		Total
(dollars in thousands)	of Loans		Status		of Loans		Status		TDRs
Construction and land		-	$	-		1	$	125	$	125
Residential real estate - first lien		2		291		2		982		1,273
Commercial - non-owner occupied		2		2,815		-		-		2,815
Commercial loans and leases		1		514		-		-		514
		5	$	3,620		3	$	1,107	$	4,727

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

	June 30, 2019
			Not Performing		Performing
	Related		to Modified		to Modified		Total
(in thousands)	Allowance		Terms		Terms		TDRs
Construction and land
Extension or other modification	$	-	$	-	$	125	$	125
Residential real estate - first lien
Extension or other modification		-		285		975		1,260
Commercial RE - non-owner occupied
Rate modification		-		800		-		800
Commercial loans
Forbearance		-		514		-		514
Total troubled debt restructured loans	$	-	$	1,599	$	1,100	$	2,699

	December 31, 2018
			Not Performing		Performing
	Related		to Modified		to Modified		Total
(in thousands)	Allowance		Terms		Terms		TDRs
Construction and land
Extension or other modification	$	-	$	-	$	125	$	125
Residential real estate - first lien
Extension or other modification		-		291		982		1,273
Commercial RE - non-owner occupied
Rate modification		2,195		2,815		-		2,815
Commercial loans
Forbearance		-		514		-		514
Total troubled debt restructured loans	$	2,195	$	3,620	$	1,107	$	4,727

There were no new loans restructured during the six months ended June 30, 2019. There was one new loan restructured during the six months ended June 30, 2018. In the second quarter of 2018 the Bank extended the terms of a residential real estate loan that was non-performing.

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Performing TDRs were in compliance with their modified terms and there are no further commitments associated with these loans. During the six months ended June 30, 2019 there were no TDRs that defaulted within the twelve month period after their modification dates.

Management routinely evaluates other real estate owned (“OREO”) based upon periodic appraisals. For the six months ended June 30, 2019 there was one residential first mortgage totaling $375 thousand transferred from loans to OREO and for the same period in 2018 there was one residential first mortgage totaling $174 thousand transferred from loans to OREO. In the second quarter 2019 the Bank recorded a $65 thousand valuation allowance on one property because the current appraised value, less estimated cost to sell, was lower than the recorded carrying value of the OREO. In the first half of 2018 there were no such valuation allowances. The Company did not sell any properties held in OREO in the first half of 2019. The Company sold one commercial property in Sussex County Delaware during the second quarter of 2018 with a carrying value was $593 thousand. The Company recorded a $45 thousand gain from the sale of this property. At June 30, 2019 there were seven loans secured by residential first liens totaling $4.5 million in the process of foreclosure.

Note 6: Derivatives and Hedging Activities

Non-designated Hedges of Interest Rate Risk

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

As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of June 30, 2019 and December 31, 2018, the interest rate swaps had an aggregate notional amount of approximately $5.9 million and $6.2 million, respectively, the fair value of the interest swap derivatives are recorded in other assets and other liabilities. All changes in fair value are recorded through earnings as noninterest income. For the six months ended June 30, 2019, the Company recorded a net loss of $6 thousand related to the change in fair value of these interest rate swap derivatives.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheet as of June 30, 2019 and December 31, 2018.

				June 30, 2019
	Balance Sheet	Notional		Estimated Fair Value
(dollars in thousands)	Location	Amount		Gain		Loss
Not designated hedges of interest rate risk:
Customer related interest rate contracts:
Matched interest rate swaps with borrowers	Other assets and other liabilities	$	2,958	$	222	$	-
Matched interest rate swaps with counterparty	Other assets and other liabilities	$	2,958	$	-	$	234

				December 31, 2018
	Balance Sheet	Notional		Estimated Fair Value
(dollars in thousands)	Location	Amount		Gain		Loss
Not designated hedges of interest rate risk:
Customer related interest rate contracts:
Matched interest rate swaps with borrowers	Other assets and other liabilities	$	3,061	$	100	$	-
Matched interest rate swaps with counterparty	Other assets and other liabilities	$	3,061	$	-	$	106

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Note 7: Goodwill and Other Intangible Assets

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

At December 31, 2018 the Company had $70.7 million in goodwill compared to $65.9 million at June 30, 2019. Based upon updated information the goodwill was adjusted downward in the first quarter of 2019 by $4.7 million to reflect revised valuations as detailed in Note 2.

The table below shows goodwill balances at June 30, 2019 and December 31, 2018.

	June 30,		December 31,
(in thousands)	2019		2018
Goodwill
Banking	$	65,949	$	70,697

Core deposit intangible consists of premiums paid for the acquisition of core deposits and are amortized based upon the estimated economic benefits received. The gross carrying amount and accumulated amortization of other intangible assets are as follows:

	June 30, 2019						Weighted
	Gross				Net		Average
	Carrying		Accumulated		Carrying		Remaining Life
(in thousands)	Amount		Amortization		Amount		(Years)
Amortizing intangible assets:
Core deposit intangible	$	16,135	$	6,203	$	9,932		4.2

	December 31, 2018						Weighted
	Gross				Net		Average
	Carrying		Accumulated		Carrying		Remaining Life
(in thousands)	Amount		Amortization		Amount		(Years)
Amortizing intangible assets:
Core deposit intangible	$	16,135	$	4,653	$	11,482		4.7

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

(in thousands)
2019	$	1,463
2020		2,674
2021		2,326
2022		1,915
2023		1,298
Thereafter		256
Total amortizing intangible assets	$	9,932

Note 8: Leases

On January 1, 2019, the Company adopted the requirements of ASU 2016-02, Leases (Topic 842). The objective of this ASU, along with several related ASUs issued subsequently, is to increase transparency and comparability between organizations that enter into lease agreements. The most significant change is the requirement to recognize right of use (“ROU”) assets and lease liabilities for leases classified as operating leases. The standard requires disclosures to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. As part of the transition to the new standard, the Company was required to measure and recognize leases that existed at January 1, 2019, and the Company elected a modified retrospective approach. For leases existing at the effective date, the Company elected the package of three transition practical expedients and therefore did not reassess whether an arrangement is or contains a lease, did not reassess lease classification, and did not reassess what qualifies as an initial direct cost.

22

The adoption of Topic 842 resulted in the initial recognition of operating ROU assets and related lease liabilities of $18.0 million on January 1, 2109, which were recorded in other assets and other liabilities, respectively. As of the adoption date, there were no lease incentives that would have impacted the ROU asset balance.

In the second quarter of 2019, with the execution of our branch optimization initiative, under which we announced the closing of three additional branch locations and the consolidation of two other existing branch locations we incurred $3.6 million in expenses, primarily related to the early termination of existing lease arrangements for the closing locations. All of the costs associated with this initiative were recognized in the second quarter of 2019 and the locations are expected to close in September of 2019. The early termination of these leases reduced the initial $18.0 million in ROU assets recorded on January 1, 2019 to $14.8 million at June 30, 2019.

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

Operating leases included the following at:

(in thousands)	June 30, 2019
Operating Leases
Operating leases ROU	$	14,837
Operating lease liabilities	$	15,183

The components of lease expense were as follows:

	Six months ended June 30,						Three months ended June 30,
(in thousands)	2019			2018			2019			2018
Operating lease cost	$	1,080		$	1,960		$	530		$	1,228
Sublease income		(293	)		(251	)		(108	)		(113	)
Amortization of ROU assets		82			-			82			-
	$	869		$	1,709		$	504		$	1,115

Lease liability maturities are as follows:

(in thousands)
2019	$	876
2020		1,636
2021		1,546
2022		1,404
2023		1,257
Thereafter		12,396
Total future lease payments	$	19,115
Discount of cash flows		(3,932	)
Present value on net future lease payments	$	15,183
Weighted average remaining term in years		7.14
Weighted average discount rate		3.02	%

Note 9: Deposits

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

(dollars in thousands)	June 30, 2019					December 31, 2018
			% of					% of
	Amount		Total			Amount		Total
Noninterest-bearing demand	$	422,117		24	%	$	429,200		26	%
Interest-bearing checking		184,060		11			227,322		13
Money market accounts		357,833		21			356,130		21
Savings		137,346		8			134,893		8
Certificates of deposit $250 and over		78,619		5			82,511		5
Certificates of deposit under $250		537,241		31			455,750		27
Total deposits	$	1,717,216		100	%	$	1,685,806		100	%

23

Note 10: Stock Options and Stock Awards

The Company’s equity incentive plan provides for awards of nonqualified and incentive stock options as well as vested and non-vested common stock awards. As of June 30, 2019, 575,314 shares are reserved for issuance pursuant to future grants under our stock incentive plan. Employee stock options can be granted with exercise prices at the fair market value (as defined within the plan) of the stock at the date of grant and with terms of up to ten years. Except as otherwise permitted in the plan, upon termination of employment for reasons other than retirement, permanent disability or death, the option exercise period is reduced or the options are canceled.

Stock awards may also be granted to non-employee members of the Company’s Board of Directors (the “Board”) as compensation for attendance and participation at meetings of the Board and meetings of the various committees of the Board. For the six months ended June 30, 2019 and 2018, Bancorp issued 4,802 and 4,800 shares of common stock, respectively, to directors as compensation for their service.

Stock Options

The fair value of the Company’s stock options granted as compensation is estimated on the measurement date, which, for the Company, is the date of grant. The fair value of stock options is calculated using the Black-Scholes option-pricing model under which the Company estimates expected market price volatility and expected term of the options based on historical data and other factors. There were 25,000 stock options granted during the six months ended June 30, 2019, while no stock options were granted for the year ended December 31, 2018.

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

	June 30, 2019					December 31, 2018
				Weighted					Weighted
				Average					Average
				Exercise					Exercise
	Shares			Price		Shares			Price
Balance at January 1,		15,268		$	8.76		30,991		$	9.69
Granted		25,000			14.54		-			-
Exercised		(12,149	)		8.59		(9,123	)		10.63
Forfeited		(1,850	)		10.10		(6,600	)		10.52
Balance at period end		26,269		$	14.25		15,268		$	8.76
Exercisable at period end		1,269		$	8.50		15,268		$	8.76
Weighted average fair value of options granted during the year				$	5.83				$	-

The cash received from the exercise of stock options during the six months ended June 30, 2019 was $105 thousand, while $35 thousand was received during the six months ended June 30, 2018. The intrinsic value of a stock option is the amount that the market value of the underlying stock exceeds the exercise price of the option. Based upon a fair market value of $15.17 at June 30, 2019, the options outstanding had an aggregate intrinsic value of $24 thousand. At December 31, 2018, based upon fair market value of $14.30, the outstanding options outstanding had an aggregate intrinsic value of $85 thousand.

Restricted Stock Units

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

24

The Company granted 18,500 RSUs during the first half of 2019, subject to a three-year vesting schedule. The Company granted 20,732 RSUs during 2018, which immediately vested upon grant.

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

	June 30, 2019				December 31, 2018
			Weighted					Weighted
			Average					Average
			Grant Date					Grant Date
	Shares		Fair Value		Shares			Fair Value
Balance at January 1,		9,731	$	17.29		52,155		$	15.09
Granted		18,500		14.54		20,732			19.90
Vested		-		-		(54,542	)		16.63
Forfeited		-		-		(8,614	)		14.41
Balance at period end		28,231	$	15.49		9,731		$	17.29

At June 30, 2019, based on RSUs outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested RSUs was $292 thousand. Based upon the contractual terms, this expense is expected to be recognized as follows:

(in thousands)
2019	$	75
2020		120
2021		90
2022		7
	$	292

Stock-Based Compensation Expense

Stock-based compensation is recognized as compensation cost in the statement of operations based on their fair values on the measurement date, which, for the Company, is the date of the grant. The amount that the Company recognized in stock-based compensation expense related to the issuance of restricted stock and RSUs and for director compensation paid in stock is presented in the following table:

	Six months ended				Three months ended
	June 30				June 30
(in thousands)	2019		2018		2019		2018
Stock-based compensation expense
Related to the issuance of restricted stock and RSUs	$	112	$	572	$	62	$	75
Director compensation paid in stock	$	62	$	101	$	-	$	-

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Note 11: Benefit Plans

Profit Sharing Plan

The Company sponsors a defined contribution retirement plan through a Section 401(k) profit sharing plan. Employees may contribute up to 15% of their pretax compensation. Participants are eligible for matching Company contributions up to 4% of eligible compensation dependent on the level of voluntary contributions. Company matching contributions totaled $540 thousand and $587 thousand, respectively, for the six months ended June 30, 2019 and 2018. The Company’s matching contributions vest immediately.

Supplemental Executive Retirement Plan (“SERP”)

In 2014, the Bank created a SERP for the Chief Executive Officer. This plan was amended in 2016. Under the defined benefit SERP, Mary Ann Scully will receive $150,000 each year for 15 years after attainment of the Normal Retirement Age (as defined in the SERP). Ms. Scully will earn vesting on a graduated schedule in which she will become fully vested on August 25, 2019, which has been established for purposes of the SERP as her retirement date. Expense related to this SERP totaled $105 thousand and $139 thousand for the six month periods ending June 30, 2019 and 2018, respectively.

Employee Stock Purchase Plan

The 2017 Employee Stock Purchase Plan (the “Plan”) provides eligible employees of the Company and certain of its subsidiaries with opportunities to purchase shares of the Company’s common stock at a discounted price, with the Company contributing up to a fifteen percent discount per offering period. An aggregate of 250,000 shares of the Company’s common stock was approved for issuance under the Plan. The Plan is intended to qualify as an “employee stock purchase plan” as defined in Section 423 of the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder, and shall be interpreted consistent therewith. The first offering period under the Plan commenced on October 1, 2018 and ended on December 31, 2018, and the 2018 expense related to the Plan totaled $11 thousand. The current offering period began on January 1, 2019 ending on June 30, 2019, and the expense related to the Company’s contribution to the Plan totaled $19 thousand for the six months ended June 30, 2019.

Note 12: Income (Loss) per Common Share

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

	Six months ended					Three months ended
	June 30,					June 30,
(dollars in thousands, except per share data)	2019		2018			2019		2018
Net income	$	6,344	$	(7,953	)	$	2,088	$	(2,277	)
Preferred stock dividends		-		-			-		-
Net income (loss) available to common stockholders (numerator)	$	6,344	$	(7,953	)	$	2,088	$	(2,277	)
BASIC
Basic average common shares outstanding (denominator)		19,056,953		16,058,092			19,061,164		19,002,851
Basic income (loss) per common share	$	0.33	$	(0.50	)	$	0.11	$	(0.12	)
DILUTED
Average common shares outstanding		19,056,953		16,058,092			19,061,164		19,002,851
Dilutive effect of common stock equivalents		14,367		-			6,460		-
Diluted average common shares outstanding (denominator)		19,071,320		16,058,092			19,067,624		19,002,851
Diluted income (loss) per common share	$	0.33	$	(0.50	)	$	0.11	$	(0.12	)
Common stock equivalents outstanding that are anti-dilutive and thus excluded from calculation of diluted number of shares presented above		25,000		25,326			25,000		27,245

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Note 13: Risk-Based Capital

Bancorp and the Bank are subject to various regulatory capital requirements administered by the federal bank regulatory 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 Bancorp and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Bancorp’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

In July 2013, Federal Deposit Insurance Corporation (the “FDIC”) and the other federal bank regulatory agencies issued a final rule that revised their leverage and 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 (“Basel III”) and certain provisions of the Dodd-Frank Act. The final rule, which became effective on January 1, 2015, applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $1 billion or more and top-tier savings and loan holding companies. The final rule created a new common equity Tier 1 (“CET1”) minimum capital requirement (4.5% of risk-weighted assets), increased the minimum Tier 1 capital ratio (from 4% to 6% of risk-weighted assets), imposed a minimum leverage ratio of 4.0%, and changed the risk-weight of certain assets to better reflect credit risk and other risk exposures. These include, among other things, a 150% risk weight for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in non-accrual status, and a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital unless the Company elects to opt-out from this treatment. The Company has elected to permanently opt out of this treatment in the Company’s capital calculations, as permitted by the final rule.

Additionally, subject to a transition schedule, the rule limits Bancorp’s and the Bank’s ability to make capital distributions, engage in share repurchases and pay certain discretionary bonus payments if the they do not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.

In addition, under revised prompt corrective action requirements, in order to be considered “well-capitalized,” Bancorp and the Bank must have a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 ratio of 6.5% or greater, a leverage capital ratio of 5.0% or greater, and not be subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.

There are three main categories of capital under the regulatory capital guidelines. Common equity tier 1 capital consists of paid-in common stock, retained earnings and certain common equity Tier 1 minority interests. Various items, including certain amounts of goodwill, intangible assets, deferred tax assets, must be deducted from common equity Tier 1 before capital ratios are calculated. Tier 1 capital (which, together with common equity tier 1 capital, makes up Tier 1 capital) generally consists of perpetual preferred stock and, in certain circumstances and subject to certain limitations, minority investments in certain subsidiaries, less goodwill and other non-qualifying intangible assets, and certain other deductions. Tier 2 capital consists of perpetual preferred stock that is not otherwise eligible to be included as Tier 1 capital, hybrid capital instruments, term subordinated debt and intermediate-term preferred stock and, subject to limitations, general allowances for credit losses. At least half of total capital must consist of Tier 1 capital. Accumulated other comprehensive income (positive or negative) must be reflected in regulatory capital. Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of several risk weights is applied to the different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the counterparty. For example, claims guaranteed by the U.S. government or one of its agencies are risk-weighted at 0%. Off-balance sheet items, such as loan commitments, are also applied a risk weight after calculating balance sheet equivalent amounts. One of four credit conversion factors (0%, 20%, 50% and 100%) is assigned to loan commitments based on the likelihood of the off-balance sheet item becoming an asset. For example, certain loan commitments are converted at 50% and then risk-weighted at 100%. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Management believes that, as of June 30, 2019 and December 31, 2018, Bancorp and the Bank met all capital adequacy requirements to which they are subject.

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The following table reflects Bancorp’s and the Bank’s capital at June 30, 2019 and December 31, 2018:

											To be well
											capitalized under
											the FDICIA
						For capital					prompt corrective
	Actual					adequacy purposes					action provisions
(dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of June 30, 2019:
Total capital (to risk-weighted assets)
Howard Bank	$	225,871		12.37	%	$	146,133		8.00	%	$	182,666		10.00	%
Howard Bancorp	$	231,176		12.55	%	$	147,415		8.00	%		N/A
Common equity tier 1 capital
(to risk-weighted assets)
Howard Bank	$	216,751		11.87	%	$	82,200		4.50	%	$	118,733		6.50	%
Howard Bancorp	$	193,914		10.52	%	$	82,921		4.50	%		N/A
Tier 1 capital (to risk-weighted assets)
Howard Bank	$	216,751		11.87	%	$	109,599		6.00	%	$	146,133		8.00	%
Howard Bancorp	$	193,914		10.52	%	$	110,561		6.00	%		N/A
Tier 1 capital (to average assets)
(Leverage ratio)
Howard Bank	$	216,751		10.14	%	$	85,502		4.00	%	$	106,878		5.00	%
Howard Bancorp	$	193,914		9.06	%	$	85,586		4.00	%		N/A
As of December 31, 2018:
Total capital (to risk-weighted assets)
Howard Bank	$	212,099		11.80	%	$	143,810		8.00	%	$	179,762		10.00	%
Howard Bancorp	$	218,425		12.14	%	$	143,889		8.00	%		N/A
Common equity tier 1 capital
(to risk-weighted assets)
Howard Bank	$	202,226		11.25	%	$	80,893		4.50	%	$	116,846		6.50	%
Howard Bancorp	$	179,935		10.00	%	$	80,938		4.50	%		N/A
Tier 1 capital (to risk-weighted assets)
Howard Bank	$	202,226		11.25	%	$	107,857		6.00	%	$	143,810		8.00	%
Howard Bancorp	$	179,935		10.00	%	$	107,917		6.00	%		N/A
Tier 1 capital (to average assets)
(Leverage ratio)
Howard Bank	$	202,226		9.84	%	$	82,212		4.00	%	$	102,765		5.00	%
Howard Bancorp	$	179,935		8.77	%	$	82,046		4.00	%		N/A

Note 14: Fair Value

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

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

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

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

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

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

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

Recurring Fair Value Measurements

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

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

Interest rate lock commitments are recorded at fair value determined as the amount that would be required to settle each of these derivatives at the balance sheet date. In the normal course of business, the Company enters into contractual interest rate lock commitments to extend credit to borrowers with fixed expiration dates. The commitment becomes effective when the borrowers lock in a specified interest rate within the time frames established by the mortgage division. All borrowers are evaluated for credit worthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time interest rate is locked by the borrower and the sale date of the loan to an investor. To mitigate this interest rate risk inherent in providing rate lock commitments to borrowers, the Company enters into best effort forward sales contracts to sell loans to investors. The forward sales contracts lock in an interest rate price for the sale of loans similar to the specific rate lock commitment. Rate lock commitments to the borrowers through to the date the loan closes are undesignated derivatives and accordingly, are marked to fair value in earnings. These valuations fall into a Level 3 of the fair value hierarchy. The rate lock commitments are deemed as Level 3 inputs because the Company applies an estimated pull-through rate, which is deemed an unobservable measure. The pull-through rate utilized is based upon historic pull-through rates that ranged from 70 percent to 80 percent.

For loans held for investment that were originally intended to be sold and previously included as loans held for sale, fair value is determined by discounting estimated cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

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The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis at June 30, 2019 and December 31, 2018.

June 30, 2019			Quoted Price in		Significant
			Active Markets		Other		Significant
	Carrying		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(in thousands)	(Fair Value)		(Level 1)		(Level 2)		(Level 3)
Assets
Available for sale securities:
U.S. Government agencies	$	61,769	$	-	$	61,769	$	-
Mortgage-backed securities		86,927		-		86,927		-
Other investments		2,989		-		2,989		-
Loans held for sale		37,680		-		37,680		-
Loans held for investment		1,343		-		1,343		-
Rate lock commitments		466		-		-		466
Interest rate swap assets		222		-		222		-
Liabilities
Interest rate swap liabilities		234		-		234		-

December 31, 2018			Quoted Price in		Significant
			Active Markets		Other		Significant
	Carrying		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(in thousands)	(Fair Value)		(Level 1)		(Level 2)		(Level 3)
Assets
Available for sale securities:
U.S. Government agencies	$	130,397	$	-	$	130,397	$	-
Mortgage-backed securities		90,460		-		90,460		-
Other investments		3,001		-		3,001		-
Loans held for sale		21,261		-		21,261		-
Loans held for investment		1,303		-		1,303		-
Rate lock commitments		126		-		-		126
Interest rate swap assets		100		-		100		-
Liabilities
Interest rate swap liabilities		106		-		106		-

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

	June 30,		December 31,
	2019		2018
Balance, beginning of period	$	126	$	530
Privately held equity investment		-		(72	)
Net gains (losses) included in realized and unrealized gains on mortgage banking activity in noninterest income		340		(332	)
Balance, end of period	$	466	$	126

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Assets under fair value option:

June 30, 2019		Carrying		Aggregate
	��	Fair Value		Unpaid
(in thousands)		Amount		Principal		Difference
Loans held for sale		$	37,680	$	36,710	$	970
Loans held for investment			1,343		1,312		31

December 31, 2018	Carrying		Aggregate
	Fair Value		Unpaid
(in thousands)	Amount		Principal		Difference
Loans held for sale	$	21,261	$	20,785	$	476
Loans held for investment		1,303		1,342		(39	)

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

Non-recurring Fair Value Measurements

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

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

Other real estate owned acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at fair value, less selling costs. Any write-downs to fair value at the time of transfer to OREO are charged to noninterest expense subsequent to foreclosure. Values are derived from appraisals of underlying collateral and discounted cash flow analysis. There was a $65 thousand valuation loss recognized during the six months ended June 30, 2019, and no valuation losses were recognized during the six months ended June 30, 2018. OREO is classified within Level 3 of the hierarchy.

The following table sets forth the Company’s financial assets and liabilities that were accounted for or disclosed at fair value on a nonrecurring basis at the periods presented. OREO is carried at fair value less anticipated costs to sell. Impaired loans are measured using the fair value of collateral, if applicable.

June 30, 2019			Quoted Price in		Significant
			Active Markets		Other		Significant
	Carrying		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(in thousands)	(Fair Value)		(Level 1)		(Level 2)		(Level 3)
Other real estate owned	$	4,702	$	-	$	-	$	4,702
Impaired loans:
Construction and land		933		-		-		933
Residential - first lien		12,530		-		-		12,530
Residential - junior lien		914		-		-		914
Commercial - owner occupied		225		-		-		225
Commercial - non-owner occupied		2,608		-		-		2,608
Commercial loans and leases		1,862		-		-		1,862
Consumer		287		-		-		287

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December 31, 2018			Quoted Price in		Significant
			Active Markets		Other		Significant
	Carrying		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(in thousands)	(Fair Value)		(Level 1)		(Level 2)		(Level 3)
Other real estate owned	$	4,392	$	-	$	-	$	4,392
Impaired loans:
Construction and land		1,449		-		-		1,449
Residential - first lien		13,259		-		-		13,259
Residential - junior lien		1,137		-		-		1,137
Commercial - owner occupied		1,268		-		-		1,268
Commercial - non-owner occupied		2,823		-		-		2,823
Commercial loans and leases		2,255		-		-		2,255
Consumer		174		-		-		174

OREO consisted of an outstanding balance at June 30, 2019 of $7.0 million, less valuation allowance of $2.3 million, and at December 31, 2018 of $6.6 million, less valuation allowance of $2.2 million. There was no related allowance on impaired loans at June 30, 2019; however, there was an allowance of $2.4 million on impaired loans at December 31, 2018.

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

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

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

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

	June 30, 2019
					Quoted Price in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Available for sale securities	$	151,685	$	151,685	$	-	$	151,685	$	-
Held to maturity securities		9,750		9,915		-		-		9,915
Nonmarketable equity securities		11,220		11,220		-		11,220		-
Loans held for sale		37,680		37,680		-		37,680		-
Loans held for investment		1,343		1,343		-		1,343		-
Rate lock commitments		466		466		-		-		466
Loans and leases1		1,690,557		1,687,688		-		-		1,687,688
Interest rate swap		222		222		-		222		-
Financial Liabilities
Deposits		1,717,216		1,716,079		-		1,716,079		-
Short-term borrowings		220,669		220,669		-		220,669		-
Long-term borrowings		28,142		28,043		-		28,043		-
Interest rate swap		234		234		-		234		-

	December 31, 2018
					Quoted Price in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Available for sale securities	$	223,858	$	223,858	$	-	$	223,858	$	-
Held to maturity securities		9,250		9,253		-		-		9,253
Nonmarketable equity securities		11,786		11,786		-		11,786		-
Loans held for sale		21,261		21,261		-		21,261		-
Loans held for investment		1,303		1,303		-		1,303		-
Rate lock commitments		126		126		-		-		126
Loans and leases1		1,638,575		1,613,506		-		-		1,613,506
Interest rate swap		100		100		-		100		-
Financial Liabilities
Deposits		1,685,806		1,681,295		-		1,681,295		-
Short-term borrowings		134,576		134,576		-		134,576		-
Long-term borrowings		142,077		142,296		-		142,296		-
Interest rate swap		106		106		-		106		-

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

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Note 15: Revenue Recognition

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees, monthly service fees, check orders, and other deposit account related fees. The Banks’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Banks’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

Other Operating Income

Other operating income is primarily comprised of debit and credit card income, ATM fees, merchant services income, revenue streams such as safety deposit box rental fees, and other miscellaneous service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Banks’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Bank’s cardholder uses a non-Bank ATM or a non-Bank cardholder uses a Bank ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Bank determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Bank’s performance obligation for fees, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.

The following presents noninterest income, segregated by revenue streams in scope and out of scope of Topic 606, for the six and three months ended June 30, 2019 and 2018.

	Unaudited
	Six months ended				Three months ended
	June 30,				June 30,
(in thousands)	2019		2018		2019		2018
NONINTEREST INCOME
Service charges on deposit accounts	$	413	$	247	$	239	$	152
Fees and other services charges		1,314		1,094		685		689
Other		39		39		15		20
Noninterest income in scope of Topic 606		1,766		1,380		939		861
Noninterest income out of scope of Topic 606		8,610		8,941		4,902		4,756
Total noninterest income	$	10,376	$	10,321	$	5,841	$	5,617

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Bank’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals. Consideration is often received immediately or shortly after the Bank satisfies its performance obligation and revenue is recognized. The Bank does not typically enter into long term revenue contracts with customers, and therefore, does not experience significant contract balances. As of June 30, 2019 and December 31, 2018, the Bank did not have any significant contract balances.

Contract Acquisition Costs

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Bank did not capitalize any contract acquisition cost.

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

This section is intended to help our stockholders and potential investors understand our financial performance through a discussion of the factors affecting our consolidated financial condition at June 30, 2019 and December 31, 2018 and our consolidated results of operations for the periods ended June 30, 2019 and 2018. This section should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements.

Overview

Howard Bancorp, Inc. is the holding company for Howard Bank. Howard Bank was formed in 2004. Howard Bank’s business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. Typically, commercial real estate and business loans involve a higher degree of risk and carry a higher yield than one-to four-family residential loans. Although we plan to continue to focus on commercial customers, we intend to continue our origination of one- to four-family residential mortgage loans, maintaining our portfolio of mortgage lending and also selling select loans into the secondary markets.

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

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

On December 6, 2018, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which the Company sold and issued $25,000,000 in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due December 6, 2028. The Notes were issued by the Company to the Purchasers at a price equal to 100% of their face amount in reliance on the exemptions from registration available under Section 4(a)(2) of the Securities Act and the provisions of Regulation D thereunder. The Company intends to use the net proceeds for general corporate purposes, to provide for continued growth and to supplement its regulatory capital ratios.

On March 1, 2018, we acquired First Mariner through the completion of our previously announced merger pursuant to the First Mariner Merger Agreement. At the effective time of the First Mariner merger, First Mariner merged with and into the Bank, with the Bank continuing as the surviving bank of the First Mariner merger and a wholly owned subsidiary of the Company. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,222 shares of our common stock, which was valued at approximately $164.6 million.

Financial highlights during the six months ended June 30, 2019 are as follows:

· Assets - $2.3 billion, primarily from:

· Investment securities - $172.7 million

· Loans held for investment - $1.7 billion

· Liabilities - $2.0 billion, primarily from:

· Deposits - $1.7 billion

· Borrowings - $248.8 million

· Stockholders equity - $303.5 million

· Net Income increased $14.3 million for the six month period ended June 30, 2019 compared to the same period in 2018. A net loss of $8.0 million for the first half of 2018 was driven by merger related expenses of $15.7 million, while there were no such merger related expenses during the first six months of 2019. However, the first six month period of 2019 included additional expenses related to our branch optimization initiative under which a total of $3.6 million in expenses were recorded in increased occupancy expense for the closing of branch locations. The $6.3 million in net income recorded for the first six month period of 2019 generated basic and diluted earnings per share of $0.33 compared to a loss of $0.50 per common share for the six month period ended June 30, 2018.

35

Critical Accounting Policies

Our accounting and financial reporting policies conform to GAAP and general practice within the banking industry. Accordingly, preparation of the financial statements requires management to exercise significant judgment or discretion or make significant assumptions and estimates based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. In reviewing and understanding financial information for us, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements. The accounting policies we view as critical are those relating to the allowance for credit losses, goodwill and other intangible assets, acquisition accounting, income taxes and share based compensation. Significant accounting policies are discussed in detail in “Notes to Consolidated Financial Statements - Note 1: Summary of Significant Account Policies” in our Annual Report on Form 10-K for the year ended December 31, 2018. There have been no material changes to the significant accounting policies as described in the Annual Report. Disclosures regarding the effects of new accounting pronouncements are included in Note 1 of this report.

Balance Sheet Analysis and Comparison of Financial Condition

A comparison between the June 30, 2019 and December 31, 2018 balance sheets is presented below.

General

Total assets increased $29.1 million, or 1.3%, to $2.296 billion at June 30, 2019 as compared to $2.267 billion at December 31, 2018. This asset growth consisted primarily of increases in our loan portfolio of $51.3 million and cash and cash equivalents of $23.6 million, offset by a $72.2 million decrease in investment securities. Total deposits increased $31.4 million or 1.9%, while total borrowings decreased $27.8 million, when comparing balances at June 30, 2019 to balances at December 31, 2018.

Investment Securities

Available for sale

Available for sale securities are reported at fair value. We currently hold U.S. agency securities, mortgage backed securities and corporate investments in our securities portfolio, which are categorized as available for sale. We use our securities portfolio to provide the required collateral for funding via commercial customer overnight securities sold under agreement to repurchase (“repurchase agreements”) as well as to provide sufficient liquidity to fund our loans and provide funds for withdrawals of deposits.

Held to maturity

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

Nonmarketable equity

At June 30, 2019 and December 31, 2018, we held an investment in stock of the Federal Home Loan Bank (“FHLB”) of $11.2 million and $11.8 million, respectively. This investment is required for continued FHLB membership and is based partially upon the amount of borrowings outstanding from the FHLB. This FHLB stock is carried at cost.

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

	June 30, 2019				December 31, 2018
	Amortized		Estimated		Amortized		Estimated
(in thousands)	Cost		Fair Value		Cost		Fair Value
Available for sale
U.S. Government Agencies	$	60,684	$	61,769	$	130,088	$	130,397
Mortgage-backed		84,542		86,927		90,242		90,460
Other investments		3,010		2,989		3,011		3,001
	$	148,236	$	151,685	$	223,341	$	223,858
Held to maturity
Corporate debentures	$	9,750	$	9,915	$	9,250	$	9,253

36

We had available for sale securities of $151.7 million and $223.9 million at June 30, 2019 and December 31, 2018, respectively, which were recorded at fair value. This represents a decrease of $72.2 million or 32.2% at June 30, 2019 from the prior year end primarily as a result of us selling $36.1 million in securities during the second quarter of 2019 recording a gain of $658 thousand on the sale. We intentionally decreased the size of our available for sale portfolio given the increased rate of growth in our loan portfolio and also because of the minimal spread given the yields on new investments compared to the incremental cost of funds. In 2018, all acquired First Mariner investment securities were classified as available for sale, and were acquired at their fair values. For interest rate sensitivity reasons, we elected to immediately liquidate a portion of acquired securities portfolio upon the closing of the First Mariner merger and because we sold these securities acquired within days of the closing of the transaction, we did not record any gain or loss on the sale. In 2018, we sold approximately $69.7 million of the acquired securities and retained nearly $51.0 million in our portfolio. Additionally in 2018, the Bank took the opportunity to reposition a portion of its pre-acquisition portfolio through the sale of primarily shorter duration agency debenture bonds with maturities over one year.  In the first quarter of 2018, the Bank sold $33.0 million of securities at a loss of $139 thousand.

We had securities held to maturity of $9.7 million and $9.3 million at June 30, 2019 and December 31, 2018, consisting of corporate debentures recorded at amortized cost.

With respect to our portfolio of securities available for sale, the portfolio contained 7 securities with unrealized losses of $47 thousand and 31 securities with unrealized losses of $275 thousand at June 30, 2019 and December 31, 2018, respectively. Changes in the fair value of these securities resulted primarily from interest rate fluctuations. We do not intend to sell these securities nor is it more likely than not that we would be required to sell these securities before their anticipated recovery, and we believe the collection of the investment and related interest is probable. Based on this analysis, we do not consider any of the unrealized losses to be other than temporary impairment losses. There were no held to maturity securities in a loss position at June 30, 2019, while three securities were in a loss position at December 31, 2018.

Loan and Lease Portfolio

Total loans and leases increased $51.3 million, or 3.1%, to $1.7 billion at June 30, 2019 from $1.6 million at December 31, 2018. Organic growth was primarily from increases in commercial loans and leases of $31.0 million, residential first lien loans of $28.2 million and commercial real estate loans of $13.4 million from December 31, 2018 as we continue to focus on the needs of small to mid-size businesses in our market area. This growth was offset by decreases on construction and land loans of $7.7 million and consumer loans of $4.0 million from December 31, 2018.

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

	June 30, 2019					December 31, 2018
(in thousands)	Total		% of Total			Total		% of Total
Real estate
Construction and land	$	115,753		6.8	%	$	123,671		7.5	%
Residential - first lien		411,213		24.2			383,044		23.2
Residential - junior lien		80,303		4.7			89,645		5.4
Total residential real estate		491,516		28.8			472,689		28.6
Commercial - owner occupied		232,771		13.7			234,102		14.2
Commercial - non-owner occupied		442,449		26.0			427,747		25.9
Total commercial real estate		675,220		39.7			661,849		40.1
Total real estate loans		1,282,489		75.3			1,258,209		76.2
Commercial loans and leases		367,856		21.6			336,876		20.5
Consumer		50,675		3.0			54,666		3.3
Total loans	$	1,701,020		100.0	%	$	1,649,751		100.0	%

Loan Held for Sale

We sell the majority of residential mortgage loans originated by the Bank. Loans held for sale increased $16.4 million to $37.7 million at June 30, 2019 from $21.3 million at December 31, 2018. The volume of mortgage loans originated for sale into the secondary market continues to be strong, with $259.9 million in loans originated in the first half of 2019 compared to $337.3 million for the same period of 2018. The 2018 levels were influenced by our consumer direct unit of our mortgage division that was closed in the second quarter of 2018, and as we previously announced, we expected this decline in levels of mortgage originations.

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Leases

As a result of the Company adopting requirements of Accounting Standards Update (“ASU”) 2016-02,Leases(Topic 842), we recognized $14.8 million in right-of-use assets and $15.18 million lease liabilities for operating leases. These amounts are reflected in other assets and other liabilities on our Consolidated Balance Sheet at June 30, 2019, and primarily account for the net changes in both other assets and liabilities from the amounts reported at December 31, 2018.

Deposits

Deposits increased from $1.686 billion at December 31, 2018 to $1.717 billion at June 30, 2019, an increase of $31.4 million or 1.9%. The primary increase in deposits was the $77.6 million increase in certificates of deposit and to a lesser extent an increase in money market accounts of $1.7 million and savings accounts of $2.4 million. This growth was offset by a $43.3 million decrease in interest-bearing checking and $7.1 million decrease in noninterest-bearing checking. The composition of our deposits shifted during the second quarter of 2019 as transaction deposits of $606 million at June 30, 2019 declined by $50.3 million or 7.7% as our largest deposit relationship, reduced their balances by $61.6 million during the second quarter to fund new opportunities and investments. The decline in the transaction deposits necessitated an increase in our higher cost deposit sources, primarily certificates of deposit.

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

	June 30, 2019					December 31, 2018
			% of					% of
(dollars in thousands)	Amount		Total			Amount		Total
Noninterest-bearing demand	$	422,117		24	%	$	429,200		26	%
Interest-bearing checking		184,060		11			227,322		13
Money market accounts		357,833		21			356,130		21
Savings		137,346		8			134,893		8
Certificates of deposit $250 and over		78,619		5			82,511		5
Certificates of deposit under $250		537,241		31			455,750		27
Total deposits	$	1,717,216		100	%	$	1,685,806		100	%

Borrowings

Customer deposits remain the primary source we utilize to meet funding needs, but we supplement this with short-term and long-term borrowings. Borrowings consist of overnight unsecured master notes, repurchase agreements, FHLB advances and subordinated debentures. Repurchase agreements consist of overnight electronic sweep products that move customer excess funds from noninterest-bearing deposit accounts to an interest-bearing repurchase agreement, which is classified as a borrowing. Master notes similarly sweep funds from the Bank’s customer accounts to the Company but do not require pledged collateral. Repurchase agreements sweep funds within the Bank and are secured primarily by pledges of U.S. Government Agency securities, based upon their fair value, as collateral for 100% of the principal and accrued interest of its repurchase agreements.

Subordinated Debt

On December 6, 2018, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which the Company sold and issued $25,000,000 in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due December 6, 2028. The Notes were issued by the Company to the Purchasers at a price equal to 100% of their face amount in reliance on the exemptions from registration available under Section 4(a)(2) of the Securities Act and the provisions of Regulation D thereunder. The Company used the net proceeds of this offering for general corporate purposes, to provide for continued growth and to supplement its regulatory capital ratios.

The Notes have been structured to qualify initially as Tier 2 capital for regulatory capital purposes. The Notes will initially bear interest at a rate of 6.00% per annum from and including December 6, 2018, to but excluding December 6, 2023, with interest during this period payable semi-annually in arrears. From and including December 6, 2023, to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month LIBOR, plus 302 basis points, with interest during this period payable quarterly in arrears. The Notes are redeemable by the Company at its option, in whole or in part, on or after December 6, 2023.

Patapsco Statutory Trust I, a Connecticut statutory business trust and an unconsolidated wholly-owned subsidiary of Howard Bancorp (the “Trust”), issued $5 million of capital trust pass-through securities to investors. The interest rate currently adjusts on a quarterly basis at the rate of the three month LIBOR plus 1.48%. The Trust purchased $5,155,000 of junior subordinated deferrable interest debentures from Patapsco Bancorp. The debentures are the sole asset of the Trust. Patapsco Bancorp also fully and unconditionally guaranteed the obligations of the Trust under the capital securities, which guarantee became an obligation of Howard Bancorp upon our acquisition of Patapsco Bancorp. The capital securities are redeemable by the Company at par. The capital securities must be redeemed upon final maturity of the subordinated debentures on December 31, 2035.

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Our borrowings totaled $248.8 million at June 30, 2019 compared to $276.7 million at December 31, 2018, reflecting a decrease of $27.8 million. Short-term borrowings at June 30, 2019 consisted of repurchase agreements and master notes of $4.7 million, and nine short-term FHLB advances totaling $216.0 million. Long-term borrowings totaled $28.1 million at June 30, 2019, consisting only of subordinated debt, compared to long term borrowings of $142.1 million at December 31, 2018. In the second quarter 2019 we repaid $85 million of long-term FHLB borrowings, recording a pre-payment penalty of $651 thousand in our other operating expenses. The early repayment of these advances was primarily for asset/liability management purposes and a result of the current rate environment.

Stockholders’ Equity

Total stockholders’ equity increased $8.8 million, or approximately 3.0%, from $294.7 million at December 31, 2018 to $303.5 million at June 30, 2019. The increase in stockholders’ equity is primarily the result of the retention of the earnings for the first half of 2019 as well as market interest rate changes which increased the level of unrealized gains in our investment portfolio.

Total stockholders’ equity at June 30, 2019 represents a capital to asset ratio of 13.2%, compared to 13.0% at December 31, 2018. Book value per share was $15.92 at June 30, 2019 and $15.48 at December 31, 2018. Leverage ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio were 9.06%, 10.52% and 12.55%, respectively at June 30, 2019.

Average Balance and Yields

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

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	Six months ended June 30,
	2019								2018
	Average			Income		Yield			Average			Income		Yield
(dollars in thousands)	Balance			/ Expense		/ Rate			Balance			/ Expense		/ Rate
Earning assets
Loans and leases:1
Commercial loans and leases	$	337,331		$	8,703		5.20	%	$	290,828		$	7,094		4.92	%
Commercial real estate		657,035			16,517		5.07			572,846			13,448		4.73
Construction and land		121,358			3,507		5.83			97,780			2,571		5.30
Residential real estate		486,882			11,170		4.63			395,712			8,410		4.29
Consumer		52,424			1,288		4.95			31,442			860		5.52
Total loans and leases		1,655,030			41,185		5.02			1,388,608			32,383		4.70
Loans held for sale		23,530			512		4.38			50,857			983		3.90
Other earning assets2		65,031			636		1.97			66,322			475		1.44
Securities:3
U.S. Treasury		-			-					1,494			6		0.83
U.S Gov agencies		104,233			1,431		2.77			58,239			487		1.69
Mortgage-backed		88,764			1,426		3.24			37,775			555		2.96
Corporate debentures		9,264			286		6.22			9,250			285		6.22
Other investments		13,436			453		6.79			16,886			351		4.19
Total securities		215,697			3,596		3.36			123,644			1,684		2.75
Total earning assets		1,959,288			45,929		4.73			1,629,431			35,525		4.40
Cash and due from banks		14,248								14,914
Bank premises and equipment, net		44,791								41,058
Other assets		223,198								149,283
Less: allowance for credit losses		(9,470	)							(5,093	)
Total assets	$	2,232,055							$	1,829,593
Interest-bearing liabilities
Deposits:
Interest-bearing demand accounts	$	216,305			542		0.51	%	$	123,915		$	141		0.23	%
Money market		355,429			1,282		0.73			344,685			934		0.55
Savings		138,703			124		0.18			117,947			86		0.15
Time deposits		547,256			5,620		2.07			378,235			1,918		1.02
Total interest-bearing deposits		1,257,693			7,568		1.21			964,782			3,079		0.65
Short-term borrowings		112,785			1,335		2.39			181,105			1,407		1.57
Long-term borrowings		124,022			2,198		3.57			71,359			1,011		2.86
Total interest-bearing funds		1,494,500			11,101		1.50			1,217,246			5,497		0.91
Noninterest-bearing deposits		416,647								366,958
Other liabilities and accrued expenses		20,336								7,106
Total liabilities		1,931,483								1,591,310
Shareholders' equity		300,572								238,283
Total liabilities & shareholders' equity	$	2,232,055							$	1,829,593
Net interest rate spread4				$	34,828		3.23	%				$	30,028		3.49	%
Effect of noninterest-bearing funds							0.36								0.23
Net interest margin on earning assets5							3.58	%							3.72	%

1) Loan fee income is included in the interest income calculation, and non-accrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(2) Includes Federal funds sold.

(3) Available for sale securities are presented at fair value, held to maturity securities are presented at amortized cost.

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

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

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	Three months ended June 30,
	2019								2018
	Average			Income		Yield			Average			Income		Yield
(dollars in thousands)	Balance			/ Expense		/ Rate			Balance			/ Expense		/ Rate
Earning assets
Loans and leases:1
Commercial loans and leases	$	345,180		$	4,478		5.20	%	$	340,677		$	4,295		5.06	%
Commercial real estate		664,079			8,407		5.08			642,032			7,685		4.80
Construction and land		116,057			1,686		5.83			109,109			1,517		5.58
Residential real estate		493,003			5,598		4.55			469,093			5,096		4.36
Consumer		51,174			641		5.02			43,774			620		5.68
Total loans and leases		1,669,493			20,810		5.00			1,604,685			19,213		4.80
Loans held for sale		30,432			321		4.23			58,011			575		3.98
Other earning assets2		62,629			274		1.76			70,739			261		1.48
Securities:3
U.S. Treasury		-			-					1,494			3		0.83
U.S Gov agencies		97,128			669		2.76			55,194			281		2.04
Mortgage-backed		87,954			699		3.19			49,166			386		3.15
Corporate debentures		9,277			143		6.18			9,250			142		6.18
Other investments		13,595			229		6.75			19,702			304		6.18
Total securities		207,954			1,740		3.36			134,806			1,116		3.32
Total earning assets		1,970,508			23,145		4.71			1,868,241			21,165		4.54
Cash and due from banks		13,853								17,703
Bank premises and equipment, net		44,567								51,419
Other assets		226,852								200,966
Less: allowance for credit losses		(8,980	)							(6,179	)
Total assets	$	2,246,800							$	2,132,150
Interest-bearing liabilities
Deposits:
Interest-bearing demand accounts	$	207,159			248		0.48	%	$	146,549		$	79		0.22	%
Money market		354,808			670		0.76			386,228			579		0.60
Savings		139,673			66		0.19			147,525			53		0.14
Time deposits		566,284			3,020		2.14			423,841			1,018		0.96
Total interest-bearing deposits		1,267,924			4,004		1.27			1,104,143			1,729		0.63
Short-term borrowings		125,292			754		2.41			167,245			717		1.72
Long-term borrowings		110,474			1,033		3.75			121,299			839		2.77
Total interest-bearing funds		1,503,690			5,791		1.54			1,392,687			3,285		0.95
Noninterest-bearing deposits		414,502								443,222
Other liabilities and accrued expenses		25,009								7,030
Total liabilities		1,943,201								1,842,939
Shareholders' equity		303,599								289,211
Total liabilities & shareholders' equity	$	2,246,800							$	2,132,150
Net interest rate spread4				$	17,354		3.17	%				$	17,880		3.59	%
Effect of noninterest-bearing funds							0.37								0.24
Net interest margin on earning assets5							3.53	%							3.83	%

1) Loan fee income is included in the interest income calculation, and non-accrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(2) Includes Federal funds sold.

(3) Available for sale securities are presented at fair value, held to maturity securities are presented at amortized cost.

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

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

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Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total of the changes set forth in the rate and volume columns are presented in the total column.

	Six months ended June 30,									Three months ended June 30,
	2019 vs. 2018									2019 vs. 2018
	Due to variances in									Due to variances in
(in thousands)	Total			Rates			Volumes1			Total			Rates			Volumes1
Interest earned on:
Loans and leases:
Commercial loans and leases	$	1,609		$	408		$	1,201		$	183		$	122		$	61
Commercial real estate		3,069			964			2,105			722			445			277
Construction and land		936			256			680			169			67			102
Residential real estate		2,760			660			2,100			502			227			275
Consumer		428			(88	)		516			21			(72	)		93
Loans held for sale		(471	)		122			(593	)		(254	)		36			(290	)
Securities		1,912			375			1,537			624			12			612
Other earning assets		161			175			(14	)		13			49			(36	)
Total interest income		10,404			2,872			7,532			1,980			886			1,094
Interest paid on:
Savings deposits		38			18			20			13			18			(5	)
Interest bearing checking		401			169			232			169			95			74
Money market accounts		348			303			45			91			151			(60	)
Time deposits		3,702			1,971			1,731			2,002			1,246			756
Short-term borrowings		(72	)		734			(806	)		37			289			(252	)
Long-term borrowings		1,187			253			934			194			297			(103	)
Total interest expense		5,604			3,448			2,156			2,507			2,097			410
Net interest earned	$	4,800		$	(576	)	$	5,376		$	(527	)	$	(1,211	)	$	684

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

Comparison of Results of Operations

A comparison between the six months ended June 30, 2019 and June 30, 2018 is presented below.

General

Because of the timing of the First Mariner merger closing on March 1, 2018, the first half operating results of 2018 included only four months’ worth of combined revenues and operating expenses. Additionally the first six months of 2018 results included $15.7 million in expenses relating to the closing of the First Mariner merger while 2019 did not have any merger related expenses.

Net income increased $14.3 million to a net income of $6.3 million for the six months ended June 30, 2019 compared to net loss of $8.0 million for the six months ended June 30, 2018. The net loss of $8.0 million for the first half of 2018 was driven by merger related expenses of $15.7 million, while there were no such merger related expenses during the first six months of 2019. However, the first six month period of 2019 included additional expenses related to our branch optimization initiative under which a total of $3.6 million in expenses were recorded in increased occupancy expense for the closing of branch locations. Earnings per common share for the first six months of 2019 were $0.33 compared to a loss per common share $0.50 for the same period of 2018.

Interest Income

Interest income increased $10.4 million, or 29.3%, to $45.9 million for the six months ended June 30, 2019 compared to $35.5 million for the same period in 2018. Interest income and fees on portfolio loans increased $8.8 million for the first half of 2019 compared to the same period in 2018, as average portfolio loans increased by $266.4 million, while the yield on the portfolio loans increased by 32 basis points when comparing the two periods. The increase in loan yields was market driven and was experienced in nearly every category of loans. Other factors that affected the increase of interest income were increases in interest income from investment securities of $1.9 million on an average balances increase of $92.1 million and an increase in the yields on these securities of 61 basis points when comparing the two periods.

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Interest Expense

Interest expense increased $5.6 million to $11.1 million for the six months ended June 30, 2019, compared to $5.5 million for the same period in 2018. Interest expense on deposits increased by $4.5 million as a result of an average balance increase of $292.9 million in our interest-bearing deposits for the first half of 2019 compared to the first half of 2018 as well as an increase in the average rate paid on interest-bearing deposits, which increased 56 basis points. Our interest expense on borrowings increased $1.1 million for the first half of 2019 compared to the first half of 2018. While the average balance of borrowings decreased $15.9 million when comparing the first half of 2019 to the same period in 2018, the average rate paid on such borrowings increased 86 basis points during the same period, due to both the higher market rates as well as the issuance of the subordinated debt in December 2018.

Net Interest Income

Net interest income is our largest source of operating revenue. Net interest income is affected by various factors including changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities and maturities. Net interest income is determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. As a result of the changes to interest income and interest expense described above, net interest income increased $4.8 million, or 16.0%, during the six months ended June 30, 2019 compared to the six months ended June 30, 2018.

Provision for Credit Losses

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

Based on management’s evaluation of the above factors, we had a provision for credit losses of $2.8 million for the six months ended June 30, 2019 compared to $2.5 million for the same period in 2018. The 2019 provision was primarily driven by higher loan growth in the second quarter of 2019 along with charging off loans in 2019 that previously had specific reserves held against them. The 2019 charge offs increased our cumulative historic loss experience, which increased the levels of allowance needed during 2019.

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

Noninterest Income

Total noninterest income remained relatively unchanged, totaling $10.4 million for the six months ended June 30, 2019 compared to $10.3 million for the same period in 2018. The change in noninterest income was driven by reductions in mortgage banking revenues, down $2.1 million in the first half of 2019 compared to the same period 2018. This decline was a result of the intended de-emphasis of mortgage banking announced at the time of the acquisition of First Mariner as well as the discontinuation of the national leads-based Consumer Direct mortgage unit in April 2018. Partially offsetting this decline, was a gain on the sale of securities of $658 thousand which was part of an overall interest rate positioning strategy. Additionally, 2019 benefitted from the receipt of a $300 thousand prepayment penalty on one large loan that paid off early which occurred in the first quarter. Service charges on deposit accounts, for the first half of 2019, which consist of account activity fees such as overdraft fees and other traditional banking fees, increased $395 thousand and other operating income, which consists mainly of non-depository account fees such as wire, merchant card and ATM services increased $277 thousand when comparing the six month periods.

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Noninterest Expenses

Noninterest expenses decreased $14.0 million to $34.3 million for the six months ended June 30, 2019 from $48.3 million for the six months ended June 30, 2018. The greatest impact on the noninterest expense decrease was $15.7 million in merger related expenses associated with the First Mariner merger in the first half of 2018 with no merger related expenses reflected in the same period of 2019. Excluding the merger related expenses for 2018, noninterest expenses would have had an increase of $1.7 million when comparing the 2019 versus 2018 six month operating periods. However the second quarter of 2019 noninterest expense included approximately $3.6 million in occupancy expenses related to the costs of our reduction in branch locations as a part of our branch optimization initiatives and $651 thousand of other operating expense related to the early prepayment of several higher rate FHLB advances. Compensation and benefits decreased $1.2 million, primary as a result of efficiencies recognized from joint merger employee expenses. Occupancy and equipment expenses increased $2.6 million period over period, however excluding the $3.6 million in branch expenses noted above, occupancy expenses decreased by $1 million for the first half of 2019 compared to the same period in 2018 due to a reduction in office and branch locations during 2018. In aggregate, all other noninterest expenses categories have remained relatively unchanged when comparing the six month periods.

Income Tax Expense

For the first half of 2019, we had income tax expense of $1.7 million compared to a net tax benefit of $2.5 million at June 30, 2018 because of the pretax loss resulting from the First Mariner merger expenses. The first six months of 2019 benefited from a reduction of $300 thousand in tax expense during the first quarter, resulting from recent IRS regulations concerning the tax exemption of BOLI acquired in an acquisition. Prior to the first quarter of 2019, the income earned since the merger date, March 1, 2018, from acquired BOLI was not treated as tax exempt, however with the new IRS regulation, the income on the acquired BOLI is now exempt from income tax, and the $300 thousand cumulative adjustment reduced our tax expense in the first quarter of 2019. The effective tax rate is influenced by the sources of non-taxable income, such as the income from our BOLI program, and also by certain non-deductible expense items. Certain merger and acquisition costs are deemed not deductible for income tax purposes, which impacts the effective tax rate. As a result of these effects, our effective tax rate decreased to 21.3% for the first six months of 2019 from 24.2% for the first half of 2018.

A comparison between the three months ended June 30, 2019 and June 30, 2018 is presented below.

General

Net income increased $4.4 million to a net income of $2.1 million for the three months ended June 30, 2019 compared to net loss of $2.3 million for the three months ended June 30, 2018. As stated above, the driver of the 2019 increase compared to 2018 was the $5.7 million in merger related expenses recorded in the second quarter of 2018.

Interest Income

Interest income increased $2.0 million to $23.1 million for the three months ended June 30, 2019 compared to $21.2 million for the same period in 2018. Interest income and fees on portfolio loans increased $1.6 million for the second quarter compared to the same period in 2018, as average portfolio loans increased $64.8 million. The remaining quarter over quarter increase in interest income resulted from increases in interest on our securities portfolio of $624 thousand primarily as a result of volume and a 4 basis point increase in yields.

Interest Expense

Interest expense increased $2.5 million to $5.8 million for the three months ended June 30, 2019, compared to $3.3 million for the same period in 2018. Interest expense on deposits increased $2.3 million as a result of an increase in the average balance of $163.8 million for the second quarter of 2019 compared to the same period in 2018. In addition, our interest expense on borrowings increased $231 thousand for the second quarter of 2019 compared to the second quarter of 2018 primarily as a result of 167 basis point increase in interest rates given current market conditions and the afore mentioned subordinated debt issuance.

Net Interest Income

As a result of the changes in our interest income and interest expense as discussed above, our net interest income decreased $526 thousand during the three months ended June 30, 2019 compared to the three months ended June 30, 2018.

Provision for Credit Losses

Based on management’s evaluation of all of the relevant loan loss methodology factors, we had a provision for credit losses of $1.1 million for the three months ended June 30, 2019 compared to $1.4 million for the same period in 2018, a decrease of $315 thousand. This decrease was primarily a result of charging off loans in the second quarter of 2018 that previously had specific reserves applied against them, and the charge offs increased our cumulative historic loss experience, which increased the necessary levels of the allowance.

Noninterest Income

Noninterest income was $5.8 million for the three months ended June 30, 2019 compared to $5.6 million for the three months ended June 30, 2018, a $224 thousand or 4.0% increase. Noninterest income from realized and unrealized gains on mortgage banking revenues increased approximately $685 thousand. Although 2019 mortgage origination levels were lower for the first half of 2019 compared to 2018, the 2019 monthly origination levels were relatively stable, while immediately after the merger, combined origination levels decreased in 2018, which negatively impacted fair value revenues for the first six months of 2018. With the lower levels of mortgage originations for 2019 compared to 2018, we experienced a decline in loan related fees of nearly $1.1 million for the first half of 2019 compared to the same period in 2018. Also impacting noninterest income for the second quarter of 2019 was a gain on the sale of securities of $658 thousand which was part of an overall interest rate positioning.

Noninterest Expenses

Noninterest expenses decreased $5.7 million during the three months ended June 30, 2019 compared to the three months ended June 30, 2018. The greatest impact on the noninterest expense decrease was $5.7 million in merger related expenses associated with the First Mariner acquisition in the second quarter of 2018 with no merger related expenses reflected in the same period of 2019. Excluding the 2018 merger expenses, the noninterest expenses for 2019 were relatively unchanged from 2018. However when comparing the three month periods for 2019 to 2018, compensation expenses decreased $1.6 million, marketing related expenses decreased by $620 thousand and loan related expenses decreased $609 thousand. These expense reductions were offset by a $2.6 million increase in occupancy expense, which includes $3.6 million recorded in the second quarter of 2019 toward the reduction in branch locations. Excluding this $3.6 million, occupancy expenses would have decreased by $1.0 million for the second quarter of 2019 compared to the same period in 2018. Other operating expenses reflects $651 thousand of expense related to the early prepayment of a few higher rate FHLB advances.

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Income Tax Expense

Income tax expense for the three months ended June 30, 2019 was $543 thousand. Because of the pre-tax loss in the second quarter 2018 we had an income tax benefit of $791 thousand, resulting in a change in tax expense of $1.3 million when comparing the two quarters.

Nonperforming and Problem Assets

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

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

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

(in thousands)	June 30, 2019			December 31, 2018
Non-accrual loans:
Real estate loans:
Construction and land	$	808		$	1,323
Residential - first lien		11,555			12,278
Residential - junior lien		914			1,137
Commercial		2,833			6,286
Commercial and leases		1,808			2,417
Consumer		287			174
Total non-accrual loans		18,205			23,615
Accruing troubled debt restructured loans:
Real estate loans:
Construction and land		125			125
Residential - first lien		975			982
Total accruing troubled debt restructured loans		1,100			1,107
Total non-performing loans		19,305			24,722
Other real estate owned:
Land		1,707			1,772
Residential - first lien		1,437			1,062
Commercial		1,558			1,558
Total other real estate owned		4,702			4,392
Total non-performing assets	$	24,007		$	29,114
Ratios:
Non-performing loans to total gross loans		1.13	%		1.50
Non-performing assets to total assets		1.05	%		1.28
Loans past due 90 days still accruing:
Real estate loans:
Construction and land	$	-		$	351
Residential - first lien		1,440			570
Residential - junior lien		84			-
Commercial		348			-
	$	1,872		$	921

Included in non-accrual loans at June 30, 2019 are four troubled debt restructured loans (“TDRs”) totaling $1.6 million that were not performing in accordance with their modified terms, and the accrual of interest has ceased. Further, there were three TDRs totaling $1.1 million performing subject to their modified terms at June 30, 2019. There were no additional loans restructured during the first half of 2019.

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

Nonperforming assets amounted to $24.0 million, or 1.05% of total assets, at June 30, 2019 compared to $29.1 million, or 1.28% of total assets, at December 31, 2018. Total nonperforming assets decreased $5.1 million during the first half of 2019 primarily as a result of charging-off of several of the loans included in nonperforming assets at December 31, 2018.

The composition of our nonperforming assets at June 30, 2019 is further described below:

Non-Accrual Loans:

· Two construction and land loans.

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· 45 residential first lien loans, five with a combined fair value of $4.0 million in the process of foreclosure.

· 19 residential junior lien loans, two with a combined fair value of $73 thousand in the process of foreclosure.

· Two commercial owner occupied loans.

· 8 commercial non-owner occupied loans, representing six separate relationships.

· 12 commercial loans, two with a Small Business Administration (“SBA”) guarantee

· Three consumer loans.

Accruing Troubled Debt Restructured Loans:

· One construction and land loan

· Two residential real estate loans

Other Real Estate Owned:

· Several parcels of unimproved land.

· Several lots of non-residential property.

· Two commercial real estate properties.

· Six residential 1-4 family properties.

There was one new property transferred into OREO with a carrying value of $375 thousand in the first half of 2019. Costs relating to OREO recorded in noninterest expenses were $66 thousand and $63 thousand for the six months ended June 30, 2019 and 2018, respectively and $39 thousand and $41 thousand for the three months ended June 30, 2019 and 2018, respectively. There was a $65 thousand valuation allowance recorded in the second quarter of 2019 as the current appraised value, less estimated cost to sell, was not sufficient to cover the recorded OREO amount, there was no valuation allowance recorded in the first half of 2018. We did not sell any OREO properties in 2019, and we sold one property in the first half of 2018 with a carrying amount of $593 thousand, recording a net loss on the sale of $45 thousand.

Allowance for Credit Losses

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

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

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

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

A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired when, based on current information and events, it is probable that Howard Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. The impairment of a loan may be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, Howard Bank’s impairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis.

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

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

· changes in lending policies, procedures, practices or personnel;

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

· changes and migration of classified assets;

· changes in exposure to subordinate collateral lien positions;

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

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

· changes and trends in levels of loan payment delinquencies; and

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

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

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

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

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

At June 30, 2019 and December 31, 2018, nonperforming loans amounted to $19.3 million and $24.7 million, respectively. There were no loans requiring specific reserves in 2019. The amount of impaired loans requiring specific reserves totaled $3.0 million at December 31, 2018, with the reduction primarily driven by charging off loans that previously had specific reserves held against them, which increased the levels of allowance needed. The amount of impaired loans without a specific valuation allowance totaled $19.3 million and $21.7 million, respectively, at such dates.

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

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

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

(in thousands)	June 30, 2019			December 31, 2018
Balance at beginning of year	$	9,873		$	6,159
Charge-offs:
Real estate
Construction and land loans		(282	)		(202	)
Residential first lien loans		(362	)		(142	)
Residential junior lien loans		(471	)		(195	)
Commercial owner occupied loans		(44	)		(28	)
Commercial non-owner occupied loans		(2,026	)		(797	)
Commercial loans and leases		(525	)		(1,092	)
Consumer loans		(18	)		(63	)
		(3,728	)		(2,519	)
Recoveries:
Real estate
Construction and land loans		-			-
Residential first lien loans		-			8
Residential junior lien loans		104			10
Commercial owner occupied loans		-			-
Commercial non-owner occupied loans		3			32
Commercial loans and leases		32			88
Consumer loans		1			4
		140			142
Net charge-offs		(3,588	)		(2,377	)
Provision for credit losses		2,835			6,091
Balance at end of period	$	9,120		$	9,873
Net charge-offs to average loans and leases		0.22	%		0.16	%

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Allocation of Allowance for Credit Losses

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

	June 30, 2019					December 31, 2018
(dollars in thousands)	Amount		Percent1			Amount		Percent1
Real estate
Construction and land loans	$	1,128		6.8	%	$	741		7.5	%
Residential first lien loans		1,790		24.2			1,170		23.2
Residential junior lien loans		437		4.7			292		5.4
Commercial owner occupied loans		893		13.7			735		14.2
Commercial non-owner occupied loans		2,799		26.0			4,057		25.9
Commercial loans and leases		1,695		21.7			2,644		20.5
Consumer loans		378		3.0			234		3.3
Total	$	9,120		100.0	%	$	9,873		100.0	%

1) Represents the percent of loans in each category to total loans, not the composition of the allowance for credit losses.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, and the sale of securities available for sale. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Committee (“ALCO”) is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2019 and December 31, 2018.

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

· Expected loan demand;

· Expected deposit flows and borrowing maturities;

· Yields available on interest-earning deposits and securities; and

· The objectives of our asset/liability management program.

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

Our most liquid assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At June 30, 2019 and December 31, 2018, cash and cash equivalents totaled $125.1 million and $101.5 million, respectively.

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

At June 30, 2019 and December 31, 2018, we had $297.2 million and $387.3 million, respectively, in loan commitments outstanding, including commitments issued to originate loans of $115.0 million and $104.5 million at June 30, 2019 and December 31, 2018, respectively, and $282.1 million and $282.8 million in unused lines of credit to borrowers at June 30, 2019 and December 31, 2018, respectively. In addition to commitments to originate loans and unused lines of credit we had $15.7 million and $16.7 million in letters of credit at June 30, 2019 and December 31, 2018, respectively. Certificates of deposit of $437.7 million or 71% of our CD’s are scheduled to mature during the remainder of 2019. If we do not retain these deposits, we may be required to seek other sources of funds, including loan and securities sales, and FHLB advances. Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on the certificates of deposit. We believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of our certificates of deposit with maturities of one year or less as of June 30, 2019.

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Our primary investing activity is originating loans.During the six months ended June 30, 2019 and 2018, cash used to fund net loan growth was $54.3 million and $10.7 million, respectively. During the first half of 2019 we purchased $6.5 million of securities while receiving $45.7 million as a result of securities maturing or being called and $35.4 million from the sale of securities. For the same period in 2018 we purchased $44.5 million of new securities while receiving $112.0 million as a result of securities sales and maturing securities.

Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced a net increase in deposits of $31.4 million during the six months ended June 30, 2019. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.

Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB that provide an additional source of funds. FHLB advances were $216.0 million at June 30, 2019 compared to $232.0 million at December 31, 2018. At June 30, 2019, we had the ability to borrow up to a total of $424.9 million based upon our credit availability at the FHLB, subject to collateral requirements.

The Company and the Bank are subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2019 and December 31, 2018, we exceeded all regulatory capital requirements. We are considered “well capitalized” under regulatory guidelines.

Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements

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

Outstanding loan commitments and lines of credit at June 30, 2019 and December 31, 2018 are as follows:

(in thousands)	June 30, 2019		December 31, 2018
Unfunded loan commitments	$	115,020	$	104,466
Unused lines of credit		282,146		282,822
Letters of credit		15,655		16,661

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

The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in consolidated balance sheets at June 30, 2019 or December 31, 2018 as a liability for credit loss related to these commitments.

Impact of Inflation and Changing Prices

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

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Liquidity and Funding

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

The additional information called for by this item is incorporated herein by reference to the “Liquidity and Capital Resources” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Quarterly Report on Form 10-Q.

Interest Rate Risk

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

In determining the appropriate level of interest rate risk, the Company considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The Company uses a number of tools to measure interest rate risk including a model to simulate the impact of changes in interest rates on our net interest income, monitoring the sensitivity of the net present value of the balance sheet and monitoring the difference or gap between maturing or rate-sensitive assets and liabilities over various time periods.

Management believes that short term interest rate risk is best measured by simulation modeling. This analysis calculates expected net interest income based upon historical trends, spreads to market rates, historical market relationships, prepayment behavior and current and expected product offerings using base market rates and using a rising and a falling interest rate scenario. For example, if rates were to rise 1.00% or 2.00% over the next 12 months, net interest income might increase. Conversely, if rates were to decline over the next 12 months, net interest income might decline.

These estimates are highly assumption-dependent, and may change regularly as the Company’s asset/liability structure and business evolves from one period to the next, results will vary as different interest rate scenarios are used and are measured relative to a base net interest income scenario that may change.

For the rising and falling interest rate scenarios, the base market interest rate forecast are shocked both down 100 and 200 basis points and up 100, 200, 300, and 400 basis points. At June 30, 2019, our net interest income exposure related to these hypothetical changes in market interest rates was within the current guidelines established in our governing policies.

Item 4. Controls and Procedures

As required by SEC rules, the Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of June 30, 2019. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

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There were no material changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended June 30, 2019, that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

PART II - Other Information

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There have been no material changes in the risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC on March 15, 2019.

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

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None

Item 6. Exhibits

3.1	Articles of Incorporation of Howard Bancorp, Inc., incorporated by reference to Exhibit 3.1 of the Company’s Form S-1 filed November 28, 2011
3.2	Articles of Amendment to Articles of Incorporation of Howard Bancorp, Inc., incorporated by reference to Exhibit 3.2 of the Company's Form S-1 filed November 28, 2011
3.3	Amended and Restated Articles Supplementary of Senior Non-Cumulative Perpetual Preferred Stock, Series AA, incorporated by reference to Exhibit 3.3 of the Company's Form S-1 filed November 28, 2011
3.4	Articles of Amendment to Articles of Incorporation of Howard Bancorp, Inc., incorporated by reference to Exhibit 3.3 of the Company's Form 8-K filed January 24, 2017
3.5	Amended and Restated Bylaws of Howard Bancorp, Inc., incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed May 22, 2019
31(a)	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - filed herewith
31(b)	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - filed herewith
32	Certifications pursuant to 18 U.S.C. Section 1350, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith
101	Extensible Business Reporting Language (“XBRL”) – filed herewith
101.INS	XBRL Instance File
101.SCH	XBRL Schema File
101.CAL	XBRL Calculation File
101.DEF	XBRL Definition File
101.LAB	XBRL Label File
101.PRE	XBRL Presentation File

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Signatures

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

	HOWARD BANCORP, INC.
	(Registrant)
August 9, 2019	/s/ Mary Ann Scully
Date	MARY ANN SCULLY
	Chief Executive Officer
August 9, 2019	/s/ George C. Coffman
Date	GEORGE C. COFFMAN
	Executive Vice President and Chief Financial Officer

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