Bay Bancorp 10Q 2014 Q3 Quarterly report

United States Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2014

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

For the transition period from _____to _____

Commission file number 0-23090

BAY BANCORP, INC.

(Exact name of registrant as specified in its charter)


MARYLAND		52-1660951
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

2328 West Joppa Road, Suite 325, Lutherville, Maryland 21093

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code (410) 494-2580

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

Title of Each Class:Name of Each Exchange on Which Registered:

Common Stock, par value $1.00 per share 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 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 ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, 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 and post such files). Yes ☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (See definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act). (check one): Large accelerated filer ☐Accelerated filer ☐ Non-accelerated filer ☐Smaller reporting company ☑

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: At November 14, 2014, the number of shares outstanding of the registrant’s common stock was 11,030,773.

BAY BANCORP, INC.

TABLE OF CONTENTS



PART I.	FINANCIAL INFORMATION	PAGE

Item 1.	Financial Statements
	Consolidated Balance Sheets at September 30, 2014 (unaudited) and December 31, 2013	3
	Consolidated Statements of Income (Loss) for the Three Months and Nine Months Ended September 30, 2014 and 2013 (unaudited)	4
	Consolidated Statements of Comprehensive Income (Loss) for the Three Months and Nine Months Ended September 30, 2014 and 2013 (unaudited)	5
	Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2014 and 2013 (unaudited)	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (unaudited) (unaudited)	7
	Notes to Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	55
Item 4.	Controls and Procedures	55

PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	56
Item 1A.	Risk Factors	56
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 3.	Defaults Upon Senior Securities	56
Item 4.	Mine Safety Disclosures	56
Item 5.	Other Information	56
Item 6.	Exhibits	56

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS



	September 30,
	2014		December 31,
	(unaudited)			2013

ASSETS

Cash and due from banks	$	7,318,090	$	7,126,720
Interest bearing deposits with banks and federal funds sold		9,654,840		16,146,340
Total Cash and Cash Equivalents		16,972,930		23,273,060

Time deposits with banks		284,849		-
Investment securities available for sale, at fair value		34,428,746		36,586,669
Investment securities held to maturity, at amortized cost		1,334,462		-
Restricted equity securities, at cost		1,367,995		1,009,695
Loans held for sale		6,317,277		12,836,234

Loans, net of deferred fees and costs		394,080,772		320,680,332
Less: Allowance for loan losses		(1,129,250)		(851,000)
Loans, net		392,951,522		319,829,332

Real estate acquired through foreclosure		1,642,524		1,290,120
Premises and equipment, net		5,589,176		5,998,532
Bank owned life insurance		5,453,093		5,356,575
Core deposit intangible		3,732,826		3,993,679
Deferred tax assets, net		5,258,484		6,564,121
Accrued interest receivable		1,277,781		1,186,748
Prepaid expenses		1,058,985		922,426
Accrued taxes receivable		1,253,060		-
Defined benefit pension asset		540,058		-
Other assets		55,780		242,112
Total Assets	$	479,519,548	$	419,089,303

LIABILITIES

Noninterest-bearing deposits	$	92,902,861	$	90,077,139
Interest-bearing deposits		305,693,481		270,916,332
Total Deposits		398,596,342		360,993,471

Short-term borrowings		12,000,000		-
Defined benefit pension liability		-		42,492
Accrued expenses and other liabilities		3,724,242		3,499,072
Total Liabilities		414,320,584		364,535,035

STOCKHOLDERS’ EQUITY
Common stock - par $1.00 per share, authorized 20,000,000 shares, issued and outstanding 11,014,517 and 9,379,753 shares as of September 30, 2014 and December 31, 2013, respectively.		11,014,517		9,379,753
Additional paid-in capital		43,143,903		36,357,001
Retained earnings		9,488,743		7,703,597
Accumulated other comprehensive income		1,551,801		1,113,917
Total Stockholders' Equity		65,198,964		54,554,268
Total Liabilities and Stockholders' Equity	$	479,519,548	$	419,089,303

See accompanying notes to unaudited consolidated financial statements

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(unaudited)



	Three Months Ended September 30,				Nine Months Ended September 30,
		2014		2013		2014		2013

Interest income:
Interest and fees on loans	$	5,537,260	$	5,679,302	$	16,457,477	$	12,410,826
Interest on loans held for sale		64,265		349,561		196,274		590,714
Interest and dividends on securities		213,862		154,267		706,315		321,486
Interest on deposits with banks and federal funds sold		7,217		20,730		39,245		58,526
Total Interest Income		5,822,604		6,203,860		17,399,311		13,381,552

Interest expense:
Interest on deposits		286,368		397,159		896,596		898,763
Interest on short-term borrowings		12,706		-		12,706		1,692
Total Interest Expense		299,074		397,159		909,302		900,455
Net Interest Income		5,523,530		5,806,701		16,490,009		12,481,097

Provision for loan losses		220,373		350,365		580,217		533,621
Net interest income after provision for loan losses		5,303,157		5,456,336		15,909,792		11,947,476

Noninterest income:
Electronic banking fees		674,701		708,300		1,991,048		1,359,477
Mortgage banking fees and gains		259,740		529,570		767,803		1,556,385
Net (loss) gain on sale of real estate acquired through foreclosure		(1,503)		40,998		27,422		89,342
Brokerage commissions		-		199,392		-		316,884
Service charges on deposit accounts		99,451		100,476		303,396		191,690
Bargain purchase gain		-		-		510,844		2,860,199
Other income		95,003		184,311		3,031,629		397,418
Total Noninterest Income		1,127,392		1,763,047		6,632,142		6,771,395

Noninterest Expenses:
Salary and employee benefits		3,244,553		3,461,109		9,769,014		7,644,886
Occupancy expenses		722,573		716,482		2,256,683		1,458,086
Furniture and equipment expenses		280,320		239,704		875,274		526,551
Legal, accounting and other professional fees		356,226		344,867		1,088,451		961,948
Data processing and item processing services		371,572		394,021		863,909		832,636
FDIC insurance costs		84,882		82,246		287,568		194,572
Advertising and marketing related expenses		105,546		78,277		290,511		220,254
Foreclosed property expenses		113,903		104,170		504,295		273,084
Loan collection costs		152,196		143,021		305,099		303,253
Core deposit intangible amortization		245,674		336,273		738,416		517,203
Merger and acquisition related expenses		637,272		143,709		877,560		1,998,646
Other expenses		1,656,932		674,990		2,710,244		1,228,680
Total Noninterest Expenses		7,971,649		6,718,869		20,567,024		16,159,799
(Loss) income before income taxes		(1,541,100)		500,514		1,974,910		2,559,072

Income tax (benefit) expense		(599,585)		(422,279)		189,764		235,811
Net (loss) income	$	(941,515)	$	922,793	$	1,785,146	$	2,323,261

Basic net (loss) income per common share	$	(0.09)	$	0.11	$	0.18	$	0.29

Diluted net (loss) income per common share	$	(0.09)	$	0.11	$	0.18	$	0.29

See accompanying notes to unaudited consolidated financial statements

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited)



	Three Months Ended September 30,				Nine Months Ended September 30,
		2014		2013		2014		2013

Net (loss) income	$	(941,515)	$	922,793	$	1,785,146	$	2,323,261

Other comprehensive income (loss) items:
		-
Unrealized (loss) gain on investment securities available for sale		(170,591)		166,613		479,882		(414,903)
Income tax benefit (expense) relating to item above		67,320		(65,729)		(189,330)		163,672
Net effect on other comprehensive income (loss)		(103,271)		100,884		290,552		(251,231)

Unrealized gain on defined benefit pension plan		243,303		-		243,303		-
Income tax expense relating to item above		(95,971)		-		(95,971)		-
Net effect on other comprehensive income (loss)		147,332		-		147,332		-

Other comprehensive income (loss)		44,061		100,884		437,884		(251,231)
Comprehensive (loss) income	$	(897,454)	$	1,023,677	$	2,223,030	$	2,072,030

See accompanying notes to unaudited consolidated financial statements

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2014 and 2013 (unaudited)



								Accumulated
				Additional				Other
		Common		Paid-in		Retained		Comprehensive
		Stock		Capital		Earnings		Income		Total
Balance December 31, 2013	$	9,379,753	$	36,357,001	$	7,703,597	$	1,113,917	$	54,554,268

Net income		-		-		1,785,146		-		1,785,146
Other comprehensive income		-		-		-		437,884		437,884
Stock-based compensation		212,000		1,209,666		-		-		1,421,666
Issuance of common stock		1,422,764		5,577,236		-		-		7,000,000
Balance September 30, 2014	$	11,014,517	$	43,143,903	$	9,488,743	$	1,551,801	$	65,198,964


								Accumulated
				Additional				Other
		Common		Paid-in		Retained		Comprehensive
		Stock		Capital		Earnings		Income (loss)		Total

Balance December 31, 2012 (1)	$	5,831,963	$	21,269,898	$	4,462,463	$	260,092	$	31,824,416

Net income		-		-		2,323,261		-		2,323,261
Other comprehensive loss		-		-		-		(251,231)		(251,231)
Issuance of common stock		2,039,958		8,960,042		-		-		11,000,000
Carrollton Bancorp shares retained at the date of Merger		1,483,457		5,800,313		-		-		7,283,770
Stock-based compensation		-		242,022		-		-		242,022
Issuance of common stock under stock option plan		8,887		31,103		-		-		39,990
Balance September 30, 2013 (1)	$	9,364,265	$	36,303,378	$	6,785,724	$	8,861	$	52,462,228

(1)

As restated for the effect of the Merger (as defined in Note 1), with each share of Jefferson Bancorp, Inc. common stock, $0.01 par, converted into 2.2217 shares of Bay Bancorp, Inc. common stock, $1.00 par.

See accompanying notes to unaudited consolidated financial statements

BAY BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Nine months end September 30,
		2014		2013

Cash flows from operating activities:
Net income	$	1,785,146	$	2,323,261
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization of premises and equipment		678,888		457,776
Stock-based compensation		1,421,666		242,022
Amortization of investment premiums and discounts, net		191,749		257,654
Accretion of net discounts on loans		(4,045,706)		(2,869,803)
Amortization of core deposit intangibles		738,416		517,203
Amortization of deposit premiums		(856,059)		(653,036)
Provision for loan losses		580,217		533,621
Increase in cash surrender value of bank owned life insurance		(96,518)		(59,985)
Bargain purchase gain		(510,844)		(2,860,199)
Loss on sale of premise and equipment		4,431		-
Write down of real estate acquired through foreclosure		318,031		94,500
Net gain on sale of real estate acquired through foreclosure		(27,422)		(89,342)
Net decrease in loans held for sale		5,417,257		185,237
Deferred income taxes		1,020,336		-
Net decrease (increase) in accrued interest receivable		256,739		(901,234)
Net increase in accrued taxes receivable		(1,253,060)		(411,586)
Net increase in defined benefit pension plan		(339,247)		(29,340)
Net decrease in prepaid expenses and other assets		49,773		3,881,866
Net increase (decrease) in accrued expenses and other liabilities		221,904		(995,993)
Net cash provided by (used in) operating activities		5,555,697		(377,378)

Cash flows from investing activities:
Acquisition, net of cash acquired		24,623,173		27,152,544
Net decrease in time deposits with banks		1,261,869		-
Purchases of investment securities available for sale		-		(6,056,846)
Redemptions and maturities of investment securities available for sale		2,649,404		3,608,699
Proceeds from sale of securities available for sale		-		2,622,462
Purchases of investment securities held to maturity		(1,340,499)		-
Redemption of restricted equity securities		895,300		34,800
Net decrease in loans		13,187,086		6,497,486
Proceeds from sale of real estate acquired through foreclosure		515,919		1,615,393
Purchases of premises and equipment		(312,713)		(309,794)
Proceeds from sale of premises and equipment		38,750		1,124,850
Net cash provided by investing activities		41,518,289		36,289,594

Cash flows from financing activities:
Net decrease in deposits		(72,374,116)		(37,443,691)
Net increase (decrease) in short-term borrowings		12,000,000		(170,000)
Proceeds from issuance of common stock		7,000,000		11,000,000
Issuance of common stock on stock option exercise		-		39,990
Net cash used in financing activities		(53,374,116)		(26,573,701)

Net (decrease) increase in cash and cash equivalents		(6,300,130)		9,338,515
Cash and cash equivalents at beginning of period		23,273,060		19,684,829
Cash and cash equivalents at end of period	$	16,972,930	$	29,023,344


Supplemental Disclosures of Cash Flow information:
Interest paid on deposits and borrowings	$	1,771,208	$	1,790,049
Income taxes paid		833,943		319,530

Non Cash activities:
Transfer of loans to real estate acquired through foreclosure	$	1,158,932	$	751,148
Transfer of loans held for sale to loan portfolio		1,101,700		-

See accompanying notes to unaudited consolidated financial statements

NOTES TO CONSOLIDATED (UNAUDITED) FINANCIAL STATEMENTS

NOTE 1 – ORGANIZATIONAL

Nature of Business

Bay Bancorp, Inc. is a savings and loan holding company. Through its subsidiary, Bay Bank, FSB, (the “Bank”), a federal savings bank (an “FSB”), Bay Bancorp, Inc. serves the community with a network of 11 branches strategically located throughout the Baltimore Metropolitan Statistical Area, particularly Baltimore City and the Maryland counties of Baltimore, Anne Arundel, Howard, and Harford. The Bank serves local consumers, small and medium size businesses, professionals and other valued customers by offering a broad suite of financial products and services, including on-line and mobile banking, commercial banking, cash management, mortgage lending and retail banking. The Bank funds a variety of loan types including commercial and residential real estate loans, commercial term loans and lines of credit, consumer loans and letters of credit. The Bank’s subsidiary, Bay Financial Services, Inc., provides investment advisory and brokerage services.

As used in these notes, the term “the Company” refers to Bay Bancorp, Inc. and, unless the context clearly requires otherwise, its consolidated subsidiaries.

Background

On April 19, 2013, Bay Bancorp, Inc. acquired all the outstanding common stock of Jefferson Bancorp, Inc. (“Jefferson”) in a merger (the “Merger”) that was accounted for as a reverse acquisition and recapitalization in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). For accounting and financial reporting purposes, Jefferson is deemed to have acquired Bay Bancorp, Inc. in the Merger even though Bay Bancorp, Inc. was the legal successor in the Merger, and the historical financial statements of Jefferson became the Company’s historical financial statements. Consequently, the assets and liabilities and the operations that are reflected in the historical consolidated financial statements prior to the Merger are those of Jefferson, and the historical consolidated financial statements after the Merger include the assets and liabilities of Jefferson and Bay Bancorp, Inc., historical operations of Jefferson and operations of the combined corporation after April l9, 2013. See Note 3 for further information regarding the Merger. When discussing periods prior to April 19, 2013, the term “the Company” as used in these notes refers to Jefferson and its consolidated subsidiaries.

Until November 1, 2013, Bay Bancorp, Inc. operated under the name Carrollton Bancorp. Effective November 1, 2013, the Company’s corporate name was changed to Bay Bancorp, Inc.

In April 2014, the Bank announced its exit from the Individual Retirement Account (“IRA”) product line. At that time, as a result of the announcement, the Bank stopped offering IRAs to new customers and resigned as custodian for its existing IRAs. IRA deposit balances of $24 million or 6% of total deposits were either transferred to new IRA custodians or disbursed to customers by May 23, 2014. The IRA exit increased second quarter other income $2.4 million, resulting from the recognition of the remaining interest rate mark-to-market adjustment on IRA deposits, that was recorded in connection with the Bank Merger (defined in Note 3).

On May 15, 2014, Bay Bancorp, Inc. entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Financial Services Partners Fund I, LLC (“FSPF”), and several directors and executive officers of the Company (collectively, the “Investors”). Pursuant to the Purchase Agreement, the Company agreed to sell an aggregate of 1,422,764 shares (the “Shares”) of the Company’s common stock, par value $1.00 per share (the “Common Stock”), to the Investors at a purchase price of $4.92 per Share, which was the closing bid price of a share of Common Stock on May 14, 2014 as reported on The NASDAQ Capital Market (the “Transaction”). The closing of the Transaction occurred on May 15, 2014, and the Company received aggregate gross proceeds of $7,000,000 from the Transaction. The Company contributed these proceeds to the Bank, to bolster its regulatory capital and provide funds for future acquisitions and general working capital purposes.

On May 30, 2014, the Bank acquired certain assets and assumed substantially all deposits and certain other liabilities of Slavie Federal Savings Bank (“Slavie”), which was closed on May 30, 2014 by the Office of the Comptroller of the Currency (the “Slavie Acquisition”). The Slavie Acquisition was completed in accordance with the terms of the Purchase and Assumption Agreement All Deposits, with the Federal Deposit Insurance Corporation (the”FDIC”). The Bank did not acquire any of Slavie’s other real estate owned. Additionally, the Bank did not at closing commit to purchase any owned or leased bank premises of Slavie; however, the Bank was granted an option to elect following closing to purchase any or all of the banking premises owned by Slavie, or, in the case of leased banking premises, to assume the lease. The Bank terminated the lease for Slavie’s Bel Air location in October 2014 and extended its current lease at the Overlea branch. See Note 3 for further information regarding the Slavie Acquisition.

NOTE 2 – BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Bay Bancorp, Inc., the Bank and the Bank’s consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The investment in subsidiary is recorded on Bay’s books on the basis of its equity in the net assets.

In management’s opinion, the accompanying unaudited consolidated financial statements, which have been prepared in conformity with U.S. GAAP for interim period reporting, reflect all adjustments necessary for a fair presentation of the financial positions at September 30, 2014 and December 31, 2013, the results of operations for the three and nine months ended September 30, 2014 and 2013, and the statements of cash flows for the nine months ended September 30, 2014. The results of the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014 or any future interim period. The unaudited consolidated financial statements and accompanying notes should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in the Company’s Annual Report on 10-K for the year ended December 31, 2013.

Reclassifications

Certain prior period amounts have been reclassified and restated to conform to current period presentation. The bargain purchase gain for the three and six months ended June 30, 2014 related to the Slavie Acquisition was retroactively restated downward for measurement period adjustments of $186,682 (pretax) recorded for the three months ended September 30, 2014. These adjustments decreased the previously reported net income for the three and six months ended June 30, 2014 by $110,329.

Certain prior year amounts have been reclassified and restated to conform to current period presentation. The bargain purchase gain for the three months and nine months ended September 30, 2013 related to the Merger was retroactively restated for measurement period adjustments of $338,598 and $2,157,102, respectively, recorded during 2013. These adjustments increased the previously reported net income and total equity for the three months ended September 30, 2013 by $338,598 and decreased the previously reported net income and total equity for the nine months ended September 30, 2013 by $2,157,102.

Use of Estimates

The preparation of financial statements 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 materially from those estimates.

Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses (the “allowance”); the fair value of financial instruments, such as loans, investment securities, and derivatives; measurement and assessment of intangible assets and other purchase accounting related adjustments; benefit plan obligations and expenses; the valuation of deferred tax assets; real estate acquired through foreclosure; net assets acquired in the Merger and Slavie Acquisition; and the estimate of expected cash flows for loans acquired with deteriorated credit quality.

Recent Accounting Pronouncements and Developments

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-04, Receivables-Troubled Debt Restructuring by Creditors (Subtopic 310-40), clarifying that when an in-substance repossession or foreclosure occurs, a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the guidance requires interim and annual disclosure of the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. The amended guidance is not expected to have a significant impact on the Company’s financial statement disclosures.

NOTE 3 – BUSINESS COMBINATIONS

The Company has accounted for the Slavie Acquisition under the acquisition method of accounting in accordance with FASB Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations,” whereby the acquired net assets and assumed liabilities were recorded by the Company at their estimated fair values as of their acquisition dates. Fair value estimates were based on management’s assessment of the best information available as of the acquisition dates.

As of September 30, 2014, the Company recorded adjustments to the fair values of certain acquired assets and assumed liabilities as previously reported at June 30, 2014. These adjustments resulted in a $186,682 (pretax) reduction in the bargain purchase gain for the nine months ended September 30, 2014. The bargain purchase gain for the three and six months ended June 30, 2014 was also retroactively restated downward for these measurement period adjustments. The previously recorded bargain purchase gain as of June 30, 2014 was based upon a preliminary settlement with the FDIC and initial fair value estimates for loans, intangibles, and deposits developed by management. Subsequently, a final settlement with the FDIC and a third party valuation of loans, intangibles, and deposits was performed, the results of which are reflected in the updated pretax bargain purchase gain of $510,844 for the nine months ended September 30, 2014. The accounting for acquired loans has not been completed pending finalization of the third party valuation report, which may result in future adjustments to the bargain purchase gain.

In accordance with the framework established by FASB ASC Topic 820, “Fair Value Measurements and Disclosure,” the Company used a fair value hierarchy to prioritize the information used to develop assumptions to calculate estimates in determining fair values. These fair value hierarchies are discussed in Note 14.

Slavie Acquisition

The following table presents the allocation of the consideration received to the acquired assets and assumed liabilities in the Slavie Acquisition as of the acquisition date. The allocation results in an after-tax bargain purchase gain of $309,316.



Assets acquired at fair value:

	Cash and Cash Equivalents		$ 30,341,150
	Time deposits with banks		1,546,718
	Investment securities available for sale, at fair value		197,311
	Restricted equity securities, at cost		1,253,600
	Loans, net of deferred fees and costs		82,901,019
	Accrued interest receivable		347,772
	Core deposit intangible		477,563
		Total assets acquired	$ 117,065,133

Liabilities assumed at fair value:
	Deposits		$ 110,833,046
	Accrued expenses and other liabilities		3,266
		Total liabilities assumed	$ 110,836,312

Net assets acquired at fair value:				$ 6,228,821

Transaction cash consideration paid				(5,717,977)

Total estimated bargain purchase gain, before tax				510,844
Tax expense				(201,528)
Total estimated bargain purchase gain, after tax				$ 309,316

In many cases, determining the fair value of the acquired assets and assumed liabilities requires the Company to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of these determinations related to the valuation of acquired loans.

The following is a summary of the loans acquired in the Slavie Acquisition:


		Purchased Credit Impaired Loans		Purchased Non-Impaired Loans		Total Purchased Loans
Contractually required principal and interest at acquisition	$	26,970,809	$	68,701,805	$	95,672,614
Contractual cash flows not expected to be collected		(4,807,542)		-		(4,807,542)
Expected cash flows at acquisition		22,163,267		68,701,805		90,865,072
Interest component of expected cash flows		(2,938,191)		(5,025,862)		(7,964,053)
Basis in purchased loans at acquisition - estimated fair value	$	19,225,076	$	63,675,943	$	82,901,019

Pro Forma Condensed Combined Financial Information

The following pro forma financial information combines the historical results of the Company and pre-acquisition Slavie. The pro forma financial information does not include the potential impacts of possible business model changes, current market conditions, revenue enhancements, expense efficiencies, or other factors. The pro forma results exclude the impact of the bargain purchase gain of $510,844 and Slavie Acquisition related expenses of $758,791 for the nine months ended September 30, 2014. While adjustments were made for the estimated impact of certain fair value adjustments, the following results are not indicative of what would have occurred had the acquisition taken place on the indicated dates.

If the Slavie Acquisition had been completed on January 1, 2014, total revenue, net of interest expense, would have been approximately $6.7 million and $31.3 million, respectively, for the three and nine month periods ended September 30, 2014. Net (loss) income would have been approximately ($0.3) million and $1.7 million, respectively, for the same periods. Basic and diluted (loss) earnings per share would have been ($0.03) for the three months ended September 30, 2014 and $0.17 for the nine months ended September 30, 2014.

If the Slavie Acquisition had been completed on January 1, 2013, total revenue, net of interest expense, would have been approximately $8.8 million and $23.3 million, respectively, for the three and nine month periods ended September 30, 2013. Net (loss) income would have been approximately ($1.3) million and $0.1 million, respectively, for the same periods. Basic and diluted (loss) earnings per share would have been ($0.14) for the three months ended September 30, 2013 and $0.02 for the nine months ended September 30, 2013.

The Merger

On April 19, 2013, Bay Bancorp, Inc. (then known as Carrollton Bancorp) completed its previously announced Merger with Jefferson. Pursuant to the terms and conditions of the Agreement and Plan of Merger, dated as of April 8, 2012 (as amended, the “Merger Agreement”), by and among Jefferson, Bay Bancorp, Inc., and FSPF, Jefferson merged with and into Bay Bancorp, Inc., with Bay Bancorp, Inc. continuing as the surviving corporation. In addition, Bay Bancorp’s bank subsidiary, Carrollton Bank, merged with and into the Bank, which was then a subsidiary of Jefferson with the Bank continuing as the surviving bank (the “Bank Merger”). Prior to the Bank Merger, Carrollton Bank had five subsidiaries: Bay Financial Services, Inc. f/k/a Carrollton Financial Services, Inc. (“BFS”); Carrollton Community Development Corporation (“CCDC”); Mulberry Street, LLC (“MSLLC”); 13 Beaver Run LLC (“BRLLC”); and Mulberry Street A LLC (“MSALLC” and, together with BFS, CCDC, MSLLC and BRLLC, the “Carrollton Subsidiaries”). Carrollton Bank’s interests in the Carrollton Subsidiaries were transferred to the Bank, as a result of the Bank Merger.

Prior to the completion of the Merger, on April 18, 2013, FSPF invested $11,000,000 in Jefferson in exchange for 2,039,958 shares of common stock of Jefferson at a per share price of $5.39 (as restated for the Merger).

Upon closing of the Merger, each outstanding share of Jefferson's common stock was converted into the right to receive 2.2217 shares of Bay Bancorp's Inc. common stock. As a result of the Merger, Bay Bancorp, Inc. issued approximately 7.9 million shares of its common stock to Jefferson's stockholders in the aggregate. Pursuant to the terms and conditions of the Merger Agreement, the holders of Bay Bancorp, Inc. common stock immediately prior to the Merger elected to tender approximately 42% of the shares outstanding in conjunction with the Merger for cash at a value of $6.20 per share (the “Cash Election”). As a result of the Merger and after giving effect to the cash election, FSPF owned approximately 84% of the outstanding shares of Bay Bancorp, Inc.’s common stock, and the stockholders of Bay Bancorp, Inc. immediately prior to the Merger owned approximately 16% of the outstanding shares of Bay Bancorp, Inc.’s common stock.

Since the number of shares of Bay Bancorp, Inc.’s common stock issued to Jefferson’s stockholders in connection with the Merger exceeded 50% of the number of issued and outstanding shares of Bay Bancorp, Inc.’s common stock immediately after the Merger, the Merger is treated as a reverse acquisition of assets and a recapitalization for accounting purposes. As a result, Jefferson is deemed to have acquired Bay Bancorp, Inc. for accounting and financial reporting purposes and the historical financial statements of Jefferson have become the Company’s historical financial statements pursuant to U.S. GAAP. Results of operations of the acquired business are included in the consolidated income statement since April 19, 2013, the effective date of the Merger.

The Merger is accounted for using the acquisition method of accounting, and accordingly, the assets acquired and liabilities assumed were recognized at fair value on the date the transaction was completed. There was no goodwill recorded as a result of the Merger; however, a non-taxable bargain purchase gain of $2,860,199 for the year ended December 31, 2013 was recognized and included as a separate line item within noninterest income on the consolidated statements of income. The bargain purchase gain represented the excess of the fair value of net assets acquired over consideration paid. The consideration paid represented a substantial discount to the book value of pre-Merger Bay Bancorp, Inc.’s net assets at the acquisition date. The net impact of the fair value adjustments resulted in a $5,282,481 reduction in pre-Merger net assets of Bay Bancorp, Inc. The more significant fair value adjustments were the net discount on loans of $7,927,608 and the core deposit intangible of $4,611,362 which is being amortized over an estimated useful life of approximately nine years.

The purchase price and the amounts of acquired identifiable assets and liabilities assumed as of the acquisition date were as follows:



						April 19, 2013
Purchase price:

	Shares of Company common stock outstanding as of stockholder vote			2,579,388
	Less: Shares tendered for cash			1,095,931
	Shares of Company common stock retained by current stockholders			1,483,457

	Shares of Company common stock retained by current stockholders			1,483,457
	x Market price per share as of April 19, 2013		$	4.91
	Purchase price based on value of shares retained				$	7,283,770

	Shares tendered for cash			1,095,931
	x Price per share as agreed to in the Definitive Agreement		$	6.20
	Purchase price based on value of shares tendered for cash					6,794,777

		Total purchase price			$	14,078,547


Identifiable assets:
	Cash and cash equivalents					33,947,321
	Investment securities available for sale and restricted equity securities					23,191,025
	Loans held for sale					29,444,871
	Loans					224,946,116
	Core deposit intangible					4,611,362
	Premises and equipment					7,086,582
	Bank owned life insurance					5,263,255
	Real estate acquired through foreclosure					908,718
	Deferred tax asset					6,394,833
	Other assets					4,976,174
		Total identifiable assets			$	340,770,257

Identifiable liabilities:
	Deposits					318,269,096
	Short-term borrowings					170,000
	Defined benefit pension plan					2,266,626
	Lease liability					683,009
	Other liabilities					2,442,780
		Total identifiable liabilities			$	323,831,511

Bargain purchase gain resulting from the Merger					$	2,860,199

The following is a summary of the loans acquired in the Merger:


		Purchased Credit Impaired Loans		Purchased Non-Impaired Loans		Total Purchased Loans
Contractually required principal and interest at acquisition	$	44,734,226	$	193,685,946	$	238,420,172
Contractual cash flows not expected to be collected		(7,912,505)		-		(7,912,505)
Expected cash flows at acquisition		36,821,721		193,685,946		230,507,667
Interest component of expected cash flows		(2,788,895)		(2,772,656)		(5,561,551)
Basis in purchased loans at acquisition - estimated fair value	$	34,032,826	$	190,913,290	$	224,946,116

The fair value of checking, savings and money market deposit accounts acquired was assumed to be the carrying value as these accounts have no stated maturity and are payable on demand. Certificate of deposit accounts were valued as the present value of the certificates’ expected contractual payments discounted at market rates for similar certificates.

In connection with the Slavie Acquisition and the Merger, the Company incurred acquisition and merger related expenses. These expenses were primarily related to professional services, system conversions and integration of operations, termination of existing contractual arrangements to purchase various services, initial marketing and promotion expenses designed to introduce the Bank to the former Carrollton Bank and Slavie Bank customers, and other costs of completing the transaction.

Merger and Acquisition Related Expenses

A summary of the Slavie Acquisition and Merger related expenses included in the consolidated statements of income as follows:



		Three Months Ended September 30,		Nine Months Ended September 30,
Slavie Acquisition:		2014		2014
Professional Fees	$	84,511	$	109,872
Data processing		489,712		557,393
Advertising and marketing expenses		33,689		40,427
Net occupancy and equipment costs		11,994		17,935
All other		17,366		33,164
Total acquisition related expenses	$	637,272	$	758,791



		Three Months Ended September 30,				Nine Months Ended September 30,
Carrollton Merger:		2014		2013		2014		2013
Salaries and employee benefits	$	-	$	72,936	$	-	$	132,583
Professional Fees		-		14,516		96,847		411,942
Data processing		-		11,963		21,922		1,183,579
Advertising and marketing expenses		-		19,438		-		159,374
Net occupancy and equipment costs		-		16,226		-		56,969
All other		-		8,630		-		54,199
Total merger related expenses		-		143,709		118,769		1,998,646
Total merger and acquisition related expenses	$	637,272	$	143,709	$	877,560	$	1,998,646

NOTE 4 – INVESTMENT SECURITIES

Investment securities are accounted for according to their purpose and holding period. Trading securities are those that are bought and held principally for the purpose of selling them in the near term. The Company held no trading securities as of September 30, 2014 and December 31, 2013. Available-for-sale investment securities, comprised of debt and mortgage-backed securities, are those that may be sold before maturity due to changes in the Company's interest rate risk profile or funding needs, and are reported at fair value with unrealized gains and losses, net of taxes, reported as a component of other comprehensive income. Held-to-maturity investment securities, comprised of debt and mortgage-backed securities, are those that management has the positive intent and ability to hold to maturity and are reported at amortized cost.

Realized gains and losses are recorded in noninterest income and are determined on a trade date basis using the specific identification method. Interest and dividends on investment securities are recognized in interest income on an accrual basis. Premiums and discounts are amortized or accreted into interest income using the interest method over the expected lives of the individual securities.

At September 30, 2014 and December 31, 2013, the amortized cost and estimated fair value of the Company’s investment securities portfolio are summarized as follows:


		Amortized		Gross Unrealized				Estimated
Available for Sale		cost		Gains		Losses		Fair Value
September 30, 2014

U.S. government agency	$	7,567,229	$	156,448	$	-	$	7,723,677
Residential mortgage-backed securities		21,455,909		313,283		(284,234)		21,484,958
State and municipal		5,162,368		24,005		(580)		5,185,793
Total debt securities		34,185,506		493,736		(284,814)		34,394,428
Equity securities		78,753		-		(44,435)		34,318
Totals	$	34,264,259	$	493,736	$	(329,249)	$	34,428,746

		Amortized		Gross Unrealized				Estimated
Held-to-Maturity		cost		Gains		Losses		Fair Value
September 30, 2014

Residential mortgage-backed securities	$	1,334,462	$	-	$	(10,644)	$	1,323,818
Total debt securities		1,334,462		-		(10,644)		1,323,818
Totals	$	1,334,462	$	-	$	(10,644)	$	1,323,818

		Amortized		Gross Unrealized				Estimated
Available for Sale		cost		Gains		Losses		Fair Value
December 31, 2013

U.S. government agency	$	7,592,138	$	3,694	$	(69,917)	$	7,525,915
Residential mortgage-backed securities		23,965,230		273,885		(438,112)		23,801,003
State and municipal		5,265,944		-		(76,058)		5,189,886
Total debt securities		36,823,312		277,579		(584,087)		36,516,804
Equity securities		78,752		-		(8,887)		69,865
Totals	$	36,902,064	$	277,579	$	(592,974)	$	36,586,669

At December 31, 2013, the Bank had no held-to-maturity securities.

As of September 30, 2014, securities with unrealized losses segregated by length of impairment were as follows:



		Less than 12 months				12 months or longer				Total
Available for Sale		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
September 30, 2014		Value		Losses		Value		Losses		Value		Losses
U.S. government agency	$	-	$	-	$	-	$	-	$	-	$	-
Residential mortgage-backed securities		3,707,352		(11,033)		6,960,917		(273,201)		10,668,269		(284,234)
State and municipals		767,575		(580)		-		-		767,575		(580)
Total debt securities		4,474,927		(11,613)		6,960,917		(273,201)		11,435,844		(284,814)
Equity securities		48,878		(44,435)		-		-		48,878		(44,435)
Totals	$	4,523,805	$	(56,048)	$	6,960,917	$	(273,201)	$	11,484,722	$	(329,249)



		Less than 12 months				12 months or longer				Total
Held-to-Maturity		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
September 30, 2014		Value		Losses		Value		Losses		Value		Losses
Residential mortgage-backed securities	$	1,323,818	$	(10,644)	$	-	$	-	$	1,323,818	$	(10,644)
Total debt securities		1,323,818		(10,644)		-		-		1,323,818		(10,644)
Totals	$	1,323,818	$	(10,644)	$	-	$	-	$	1,323,818	$	(10,644)

As of December 31, 2013, securities with unrealized losses segregated by length of impairment were as follows:


		Less than 12 months				12 months or longer				Total
Available for Sale		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2013		Value		Losses		Value		Losses		Value		Losses
U.S. government agency	$	7,215,837	$	(69,917)	$	-	$	-	$	7,215,837	$	(69,917)
Residential mortgage-backed securities		15,637,539		(438,112)		-		-		15,637,539		(438,112)
State and municipals		5,189,886		(76,058)		-		-		5,189,886		(76,058)
Total debt securities		28,043,262		(584,087)		-		-		28,043,262		(584,087)
Equity securities		69,865		(8,887)		-		-		69,865		(8,887)
Totals	$	28,113,127	$	(592,974)	$	-	$	-	$	28,113,127	$	(592,974)

Unrealized losses in the Company’s portfolio of available for sale securities were $284,814 and $584,087 in aggregate at September 30, 2014 and December 31, 2013, respectively, and were related to 15 and 24 securities, respectively. Unrealized losses on the Company’s held-to-maturity security were $10,644 at September 30, 2014 was related to 1 security. The Company had no held-to-maturity securities at December 31, 2013. These unrealized losses were caused by increases in market interest rates, spread volatility, or other factors that management deems to be temporary. Since management believes that it is more likely than not that the Company will not be required to sell these securities prior to maturity or a full recovery of the amortized cost, the Company does not consider these securities to be other-than-temporarily impaired.

Accumulated other comprehensive income (loss) related to available for sale securities was $99,581 and ($190,971) at September 30, 2014 and December 31, 2013, respectively.

The outstanding balance of no single issuer, except for U.S. Agency securities, exceeded ten percent of stockholders’ equity at September 30, 2014 or December 31, 2013.

No investment securities held by the Company as of September 30, 2014 or December 31, 2013 were subject to a write-down due to credit related other-than-temporary impairment.

Contractual maturities of debt securities at September 30, 2014 are shown below. Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.




	Available for Sale				Held-to-Maturity
		Amortized		Fair		Amortized		Fair
		Cost		Value		Cost		Value
Within one year	$	490,031	$	490,000	$	-	$	-
Over one to five years		3,026,600		3,046,163		-		-
Over five to ten years		9,212,966		9,373,307		-		-
Over ten years		-		-		-		-
Residential mortgage-backed securities		21,455,909		21,484,958		1,334,462		1,323,818
Totals	$	34,185,506	$	34,394,428	$	1,334,462	$	1,323,818

The Company’s residential mortgage-backed securities portfolio is presented as a separate line within the maturity table, since borrowers have the right to prepay obligations without prepayment penalties.

During the nine months ended September 30, 2013, the Company sold its entire portfolio of collateralized debt obligations. These securities, which were acquired as a result of the Merger, were backed by trust preferred securities issued by banks, thrifts, and insurance companies. Sale proceeds of $2,622,462 represented the fair value of these securities at the date of the Merger therefore there is neither a gain nor a loss from the sale included in the results of operations for the nine months ended September 30, 2013.

At September 30, 2014, securities with an amortized cost of $20,302,897 (fair value of $20,439,528) were pledged as collateral for potential borrowings from the Federal Home Loan Bank of Atlanta (the “FHLB”) and the Federal Reserve Bank. At December 31, 2013, securities with an amortized cost of $19,721,274 (fair value of $19,535,096) were pledged as collateral for potential borrowings from the FHLB of Atlanta and the Federal Reserve Bank.

NOTE 5 – LOANS AND ALLOWANCE FOR LOAN LOSSES

The fundamental lending business of the Company is based on understanding, measuring, and controlling the credit risk inherent in the loan portfolio. The Company's loan portfolio is subject to varying degrees of credit risk. These risks entail both general risks, which are inherent in the lending process, and risks specific to individual borrowers. The Company's credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry or collateral type. The loan portfolio segment balances are presented in the following table:



		September 30,		December 31,
		2014		2013
Commercial & Industrial	$	35,464,650	$	34,278,539
Commercial Real Estate		163,746,908		157,450,876
Residential Real Estate		135,200,446		73,323,554
Home Equity Line of Credit		37,255,646		33,257,822
Land		4,007,984		1,716,747
Construction		17,373,092		19,343,013
Consumer & Other		1,032,046		1,309,781
Total Loans		394,080,772		320,680,332
Less: Allowance for Loan Losses		(1,129,250)		(851,000)
Net Loans	$	392,951,522	$	319,829,332

At September 30, 2014 and December 31, 2013, loans not considered to have deteriorated credit quality at acquisition had a total remaining unamortized discount of $5,119,014 and $3,386,065, respectively.

Portfolio Segments:

The Company currently manages its credit products and the respective exposure to loan losses by the following specific portfolio segments, which are levels at which the Company develops and documents its systematic methodology to determine the allowance for loan losses. The Company considers each loan type to be a portfolio segment having unique risk characteristics.

Commercial & Industrial

Commercial & Industrial (“C&I”) loans are made to provide funds for equipment and general corporate needs. Repayment of these loans primarily uses the funds obtained from the operation of the borrower's business. C&I loans also include lines of credit that are utilized to finance a borrower's short-term credit needs and/or to finance a percentage of eligible receivables or inventory. Of primary concern in C&I lending is the borrower's creditworthiness and ability to successfully generate sufficient cash flow from their business to service the debt.

Commercial Real Estate

Commercial Real Estate loans are bifurcated into Investor and Owner Occupied types (classes). Commercial Real Estate - Investor loans consist of loans secured by non-owner occupied properties and involve investment properties for warehouse, retail, apartment, and office space with a history of occupancy and cash flow. This commercial real estate class includes mortgage loans to the developers and owners of commercial real estate where the borrower intends to operate or sell the property at a profit and use the income stream or proceeds from the sale(s) to repay the loan. Commercial Real Estate - Owner Occupied loans consist of commercial mortgage loans secured by owner occupied properties and involves a variety of property types to conduct the borrower's operations. The primary source of repayment for this type of loan is the cash flow from the business and is based upon the borrower's financial health and the ability of the borrower and the business to repay. At September 30, 2014 and December 31, 2013, Commercial Real Estate – Investor loans had a total balance of $105,270,324 and $110,352,299, respectively. At September 30, 2014 and December 31, 2013, Commercial Real Estate – Owner Occupied loans had a total balance of $58,476,584 and $47,098,577, respectively.

Residential Real Estate

Residential Real Estate loans are bifurcated into Investor and Owner Occupied types (classes). Residential Real Estate - Investor loans consist of loans secured by non-owner occupied residential properties and usually carry higher credit risk than Residential Real Estate – Owner Occupied loans due to their reliance on stable rental income and due to lower incentive for the borrower to avoid foreclosure. Payments on loans secured by rental properties often depend on the successful operation and management of the properties and the payment of rent by tenants. At September 30, 2014 and December 31, 2013, Residential Real Estate – Investor loans had a total balance of $49,813,521 and $26,670,715, respectively. At September 30, 2014 and December 31, 2013, Residential Real Estate – Owner Occupied loans had a total balance of $85,386,925 and $46,652,839, respectively.

Home Equity Line of Credit

Home Equity Lines of Credit (“HELOCs”) are a form of revolving credit in which a borrower's primary residence serves as collateral. Borrowers use HELOCs primarily for education, home improvements, and other significant personal expenditures. The borrower will be approved for a specific credit limit set at a percentage of the home's appraised value less the balance owed on the existing first mortgage. Major risks in HELOC lending include the borrower's ability to service the existing first mortgage plus proposed HELOC, the Company's ability to pursue collection in a second lien position upon default, and overall risks in fluctuation in the value of the underlying collateral property.

Land

Land loans are secured by underlying properties that usually consist of tracts of undeveloped land that do not produce income. These loans carry the risk that there will be inadequate demand to ensure the sale of the property within an acceptable time. As a result, land loans carry the risk that the builder will have to pay the property taxes and other carrying costs of the property until an end buyer is found.

Construction

Construction loans, which include land development loans, are generally considered to involve a higher degree of credit risk than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property's value at completion of construction and estimated costs of construction, as well as the property’s ability to attract and retain tenants. Loan funds are disbursed periodically as pre-specified stages of completion are attained based upon site inspections. If the Company is forced to foreclose on a building before or at completion due to a default, it may be unable to recover all of the unpaid balance of and accrued interest on the loan as well as related foreclosure and holding costs.

Consumer & Other

Consumer & Other loans include installment loans, personal lines of credit, and automobile loans. Payment on these loans often depends on the borrower's creditworthiness and ability to generate sufficient cash flow to service the debt.

Allowance for Loan Losses

To control and monitor credit risk, management has an internal credit process in place to determine whether credit standards are maintained along with in-house loan administration accompanied by oversight and review procedures. The primary purpose of loan underwriting is the evaluation of specific lending risks that involves the analysis of the borrower's ability to service the debt as well as the assessment of the underlying collateral. Oversight and review procedures include the monitoring of the portfolio credit quality, early identification of potential problem credits and the management of the problem credits. As part of the oversight and review process, the Company maintains an allowance for loan losses to absorb estimated and probable losses inherent in the loan portfolio.

For purposes of calculating the allowance, the Company segregates its loan portfolio into segments based primarily on the type of supporting collateral. The Commercial Real Estate and Residential Real Estate segments, which both exclude any collateral property currently under construction, are further disaggregated into Owner Occupied and Investor classes for each. Further, all segments are also segregated as either purchased credit impaired loans, purchased loans not deemed impaired, troubled debt restructurings, or new originations.

The analysis for determining the allowance is consistent with guidance set forth in U.S. GAAP and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. Pursuant to Bank policy, the allowance is evaluated quarterly by management and is based upon management's review of the collectability of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers' ability to repay, estimated value of any underlying collateral and prevailing economic conditions. The allowance consists of specific and general reserves. The specific reserves relate to loans classified as impaired primarily including nonaccrual loans, troubled debt restructurings, and purchased credit impaired loans where cash flows have deteriorated from those forecasted as of the acquisition date. The reserve for these loans is established when the discounted cash flows, collateral value, or observable market price, whichever is appropriate, of the impaired loan is lower than the carrying value. For impaired loans, any measured impairment is charged-off against the loan and allowance for those loans that are collateral dependent in the applicable reporting period.

The general reserve covers loans that are not classified as impaired and primarily includes purchased loans not deemed impaired and new loan originations. The general reserve requirement is based on historical loss experience and several qualitative factors derived from economic and market conditions that have been determined to have an effect on the probability and magnitude of a loss. Since the Bank does not have its own sufficient loss experience, management also references the historical net charge-off experience of peer groups to determine a reasonable range of reserve values, which is permissible per Bank policy. The peer groups consist of competing Maryland-based financial institutions with established ranges in total asset size. Management will continue to evaluate the appropriateness of the peer group data used with each quarterly allowance analysis until such time that the Bank has sufficient loss experience to provide a foundation for the general reserve requirement. The qualitative analysis incorporates global environmental factors in the following trends: national and local economic metrics; portfolio risk ratings and composition; and concentrations in credit.

The following table provides information on the activity in the allowance for loan losses by the respective loan portfolio segment for the three and nine months ended September 30, 2014:



Three Months Ended September 30:
		Commercial		Commercial		Residential		Home Equity						Consumer
		& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	179,364	$	507,243	$	116,918	$	141,864	$	7,035	$	139,055	$	8,167	$	1,099,646
Charge-offs		-		(79,633)		(125,827)		(15,508)		-		-		-		(220,968)
Recoveries(1)		30,000		-		-		-		-		-		199		30,199
Provision		(28,265)		87,379		140,104		18,283		92		2,963		(183)		220,373
Ending balance	$	181,099	$	514,989	$	131,195	$	144,639	$	7,127	$	142,018	$	8,183	$	1,129,250



Nine Months Ended September 30:
		Commercial		Commercial		Residential		Home Equity						Consumer
		& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	167,400	$	324,080	$	80,239	$	129,203	$	6,918	$	135,416	$	7,744	$	851,000
Charge-offs		-		(216,589)		(163,304)		(79,492)		-		-		-		(459,385)
Recoveries(1)		30,000		101,614		5,542		9,844		-		-		10,418		157,418
Provision		(16,301)		305,884		208,718		85,084		209		6,602		(9,979)		580,217
Ending balance	$	181,099	$	514,989	$	131,195	$	144,639	$	7,127	$	142,018	$	8,183	$	1,129,250

The following table presents loans and the related allowance for loan losses, by loan portfolio segment, at September 30, 2014:



		Commercial		Commercial		Residential		Home Equity						Consumer
		& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-

Ending balance: collectively evaluated for impairment		181,099		514,989		131,195		144,639		7,127		142,018		8,183		1,129,250
Totals	$	181,099	$	514,989	$	131,195	$	144,639	$	7,127	$	142,018	$	8,183	$	1,129,250

Loans:
Ending balance: individually evaluated for impairment(2)	$	966,910	$	2,332,399	$	4,543,405	$	273,298	$	-	$	-	$	-	$	8,116,012

Ending balance: collectively evaluated for impairment		32,162,347		136,605,506		119,632,767		36,238,707		491,246		15,500,613		1,032,046		341,663,232

Ending balance: loans acquired with deteriorated credit quality(3)		2,335,393		24,809,003		11,024,274		743,641		3,516,738		1,872,479		-		44,301,528
Totals	$	35,464,650	$	163,746,908	$	135,200,446	$	37,255,646	$	4,007,984	$	17,373,092	$	1,032,046	$	394,080,772

(1)

Excludes cash payments received on loans acquired with deteriorated credit quality with a carrying value of $0.

(2)

Includes loans acquired with deteriorated credit quality of $1,995,000 that have current period charge-offs.

(3)

Consists of loans acquired with deteriorated credit quality that do not have current period charge-offs or specific reserves.

The following table provides information on the activity in the allowance for loan losses by the respective loan portfolio segment for the three and nine months ended September 30, 2013:



Three Months Ended September 30:
		Commercial		Commercial		Residential		Home Equity						Consumer
		& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	135,869	$	170,117	$	210,691	$	93,646	$	6,865	$	114,886	$	6,363	$	738,437
Charge-offs		(41,260)		(85,805)		(297,998)		-		-		-		(1,000)		(426,063)
Recoveries(1)		-		-		3,702		1,007		23,026		-		-		27,735
Provision		54,999		160,279		129,297		17,779		(23,168)		9,217		1,962		350,365
Ending balance	$	149,608	$	244,591	$	45,692	$	112,432	$	6,723	$	124,103	$	7,325	$	690,474



Nine Months Ended September 30:
		Commercial		Commercial		Residential		Home Equity						Consumer
		& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Beginning balance	$	121,759	$	131,350	$	199,306	$	81,955	$	6,400	$	109,335	$	5,837	$	655,942
Charge-offs		(41,260)		(85,805)		(441,421)		-		-		-		(1,000)		(569,486)
Recoveries(1)		-		-		33,793		13,578		23,026		-		-		70,397
Provision		69,109		199,046		254,014		16,899		(22,703)		14,768		2,488		533,621
Ending balance	$	149,608	$	244,591	$	45,692	$	112,432	$	6,723	$	124,103	$	7,325	$	690,474

The following table presents loans and the related allowance for loan losses, by loan portfolio segment, at December 31, 2013:



		Commercial		Commercial		Residential		Home Equity						Consumer
		& Industrial		Real Estate		Real Estate		Line of Credit		Land		Construction		& Other		Total
Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-


Ending balance: collectively evaluated for impairment		167,400		324,080		80,239		129,203		6,918		135,416		7,744		851,000
Totals	$	167,400	$	324,080	$	80,239	$	129,203	$	6,918	$	135,416	$	7,744	$	851,000

Loans:
Ending balance: individually evaluated for impairment(2)	$	730,881	$	1,354,962	$	3,544,741	$	325,866	$	-	$	104,926	$	-	$	6,061,376

Ending balance: collectively evaluated for impairment		31,315,355		132,236,685		66,467,228		32,418,288		355,190		17,894,718		1,309,781		281,997,245

Ending balance: loans acquired with deteriorated credit quality(3)		2,232,303		23,859,229		3,311,585		513,668		1,361,557		1,343,369		-		32,621,711
Totals	$	34,278,539	$	157,450,876	$	73,323,554	$	33,257,822	$	1,716,747	$	19,343,013	$	1,309,781	$	320,680,332

(1)

Excludes cash payments received on loans acquired with deteriorated credit quality with a carrying value of $0.

(2)

Includes loans acquired with deteriorated credit quality of $501,143 that have current period charge-offs

(3)

Consists of loans acquired with deteriorated credit quality that do not have current period charge-offs or specific reserves.

The following table presents information with respect to impaired loans, which include loans acquired with deteriorated credit quality that have current period charge-offs, as of September 30, 2014 and for the three and nine months ended September 30, 2014:


		At September 30, 2014						For the Three Months Ended September 30, 2014					For the Nine Months Ended September 30, 2014
				Unpaid				Average		Interest			Average		Interest
		Recorded		Principal		Related		Recorded		Income			Recorded		Income
		Investment		Balance		Allowance		Investment		Recognized(1)			Investment		Recognized(1)
With no related allowance recorded:
Commercial & Industrial	$	966,910	$	1,173,278	$	-	$	978,206	$	22,430		$	1,007,154	$	68,283
Commercial Real Estate - Investor		2,163,056		2,928,609		-		2,220,341		3,491			2,225,646		62,185
Commercial Real Estate - Owner Occupied		169,344		169,344		-		412,316		-			432,665		-
Residential Real Estate - Investor		620,877		702,587		-		627,948		-			640,483		-
Residential Real Estate - Owner Occupied		3,922,527		4,541,673		-		3,990,028		55,659			4,048,332		164,913
Home Equity Line of Credit		273,298		316,317		-		276,336		-			277,928		-
Land		-		-		-		-		-			-		-
Construction		-		-		-		-		-			-		-
Consumer & Other		-		19,434		-		-		-			-		-

With an allowance recorded:
Commercial & Industrial		-		-		-		-		-			-		-
Commercial Real Estate - Investor		-		-		-		-		-			-		-
Commercial Real Estate - Owner Occupied		-		-		-		-		-			-		-
Residential Real Estate - Investor		-		-		-		-		-			-		-
Residential Real Estate - Owner Occupied		-		-		-		-		-			-		-
Home Equity Line of Credit		-		-		-		-		-			-		-
Land		-		-		-		-		-			-		-
Construction		-		-		-		-		-			-		-
Consumer & Other		-		-		-		-		-			-		-
Total:		8,116,012		9,851,242		-		8,505,175		81,580			8,632,208		295,381

Commercial & Industrial	$	966,910	$	1,173,278	$	-	$	978,206	$	22,430		$	1,007,154	$	68,283
Commercial Real Estate		2,332,399		3,097,953		-		2,632,657		3,491	-		2,658,311		62,185
Residential Real Estate		4,543,405		5,244,260		-		4,617,976		55,659			4,688,815		164,913
Home Equity Line of Credit		273,298		316,317		-		276,336		-			277,928		-
Land		-		-		-		-		-			-		-
Construction		-		-		-		-		-			-		-
Consumer & Other		-		19,434		-		-		-			-		-
	$	8,116,012	$	9,851,242	$	-	$	8,505,175	$	81,580		$	8,632,208	$	295,381

(1)

Consists primarily of interest income recognized on troubled debt restructurings subsequent to acquisition.

The following table presents information with respect to impaired loans, which include loans acquired with deteriorated credit quality that have current period charge-offs, as of December 31, 2013 and for the three and nine months ended September 30, 2013:


		At December 31, 2013						For the Three Months Ended September 30, 2013				For the Nine Months Ended September 30, 2013
				Unpaid				Average		Interest		Average		Interest
		Recorded		Principal		Related		Recorded		Income		Recorded		Income
		Investment		Balance		Allowance		Investment		Recognized(1)		Investment		Recognized(1)
With no related allowance recorded:
Commercial & Industrial	$	730,881	$	875,797	$	-	$	852,617	$	26,027	$	890,013	$	78,837
Commercial Real Estate - Investor		659,002		1,147,133		-		133,265		627		133,781		1,886
Commercial Real Estate - Owner Occupied		695,960		689,644		-		-		-		-		-
Residential Real Estate - Investor		680,662		770,812		-		314,848		-		315,308		-
Residential Real Estate - Owner Occupied		2,864,079		3,698,438		-		2,449,322		37,003		2,453,341		122,265
Home Equity Line of Credit		325,866		370,361		-		422,760		645		423,089		1,866
Land		-		-		-		-		-		-		-
Construction		104,926		845,451		-		100,930		25,246		92,730		71,755
Consumer & Other		-		20,491		-		-		265		-		1,057

With an allowance recorded:
Commercial & Industrial		-		-		-		-		-		-		-
Commercial Real Estate - Investor		-		-		-		-		-		-		-
Commercial Real Estate - Owner Occupied		-		-		-		-		-		-		-
Residential Real Estate - Investor		-		-		-		194,753		3,191		200,426		9,744
Residential Real Estate - Owner Occupied		-		-		-		-		-		-		-
Home Equity Line of Credit		-		-		-		-		-		-		-
Land		-		-		-		-		-		-		-
Construction		-		-		-		-		-		-		-
Consumer & Other		-		-		-		-		-		-		-
Total:		6,061,376		8,418,127		-		4,468,495		93,004		4,508,688		287,410

Commercial & Industrial	$	730,881	$	875,797	$	-	$	852,617	$	26,027	$	890,013	$	78,837
Commercial Real Estate		1,354,962		1,836,777		-		133,265		627		133,781		1,886
Residential Real Estate		3,544,741		4,469,250		-		2,958,923		40,194		2,696,075		132,009
Home Equity Line of Credit		325,866		370,361		-		422,760		645		429,089		1,866
Land		-		-		-		-		-		-		-
Construction		104,926		845,451		-		100,930		25,246		92,730		71,755
Consumer & Other		-		20,491		-		-		265		-		1,057
	$	6,061,376	$	8,418,127	$	-	$	4,468,495	$	93,004	$	4,241,688	$	287,410

(1)

Consists primarily of accretion income on loans acquired from Bay National Bank with deteriorated credit quality that were reclassified as troubled debt restructurings subsequent to acquisition.

In addition to monitoring the performance status of the loan portfolio, the Company utilizes a risk rating scale (1-8) to evaluate loan asset quality for all loans. Loans that are rated 1-4 are classified as pass credits. Loans rated a 5 (Watch) are pass credits, but are loans that have been identified that warrant additional attention and monitoring. Loans that are risk rated 5 or higher are placed on the Company's monthly watch list. For the pass rated loans, management believes there is a low risk of loss related to these loans and, as necessary, credit may be strengthened through improved borrower performance and/or additional collateral. Loans rated a 6 (Special Mention) or higher are considered criticized loans and represent an increased level of credit risk and are placed into these three categories:

6 (Special Mention) - Borrowers exhibit potential credit weaknesses or downward trends that may weaken the credit position if uncorrected. The borrowers are considered marginally acceptable without potential for loss of principal or interest.

7 (Substandard) - Borrowers have well defined weaknesses or characteristics that present the possibility that the Company will sustain some loss if the deficiencies are not corrected.

8 (Doubtful) - Borrowers classified as doubtful have the same weaknesses found in substandard borrowers; however, these weaknesses indicate that the collection of debt in full (principal and interest), based on current conditions, is highly questionable and improbable.

In the normal course of loan portfolio management, relationship managers are responsible for continuous assessment of credit risk arising from the individual borrowers within their portfolio and assigning appropriate risk ratings. Credit Administration is responsible for ensuring the integrity and operation of the risk rating system and maintenance of the watch list. The Officer's Loan Committee meets monthly to discuss and monitor problem credits and internal risk rating downgrades that result in updates to the watch list.

The following table provides information with respect to the Company's credit quality indicators by class of the loan portfolio as of September 30, 2014:



		Risk Rating
		Pass		Special Mention		Substandard		Doubtful		Total
Commercial & Industrial	$	32,023,851	$	1,585,772	$	1,855,027	$	-	$	35,464,650
Commercial Real Estate - Investor		91,247,191		6,187,634		7,835,499		-		105,270,324
Commercial Real Estate - Owner Occupied		44,410,438		3,397,710		10,668,436		-		58,476,584
Residential Real Estate - Investor		38,952,333		2,044,031		8,817,157		-		49,813,521
Residential Real Estate - Owner Occupied		80,672,199		79,364		4,635,362		-		85,386,925
Home Equity Line of Credit		36,589,130		-		666,516		-		37,255,646
Land		1,886,396		-		2,121,588		-		4,007,984
Construction		16,551,800		83,063		738,229		-		17,373,092
Consumer & Other		1,032,046		-		-		-		1,032,046
Total	$	343,365,384	$	13,377,574	$	37,337,814	$	-	$	394,080,772

The following table provides information with respect to the Company's credit quality indicators by class of the loan portfolio as of December 31, 2013:



		Risk Rating
		Pass		Special Mention		Substandard		Doubtful		Total
Commercial & Industrial	$	33,136,370	$	713,909	$	428,260	$	-	$	34,278,539
Commercial Real Estate - Investor		99,120,824		4,265,276		6,966,199		-		110,352,299
Commercial Real Estate - Owner Occupied		37,768,562		3,883,453		5,446,562		-		47,098,577
Residential Real Estate - Investor		25,795,419		242,381		632,915		-		26,670,715
Residential Real Estate - Owner Occupied		42,223,599		77,473		4,351,767		-		46,652,839
Home Equity Line of Credit		32,418,803		391,993		447,026		-		33,257,822
Land		1,716,747		-		-		-		1,716,747
Construction		18,847,368		88,044		407,601		-		19,343,013
Consumer & Other		1,309,781		-		-		-		1,309,781
Total	$	292,337,473	$	9,662,529	$	18,680,330	$	-	$	320,680,332

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of September 30, 2014. Purchased credit impaired (“PCI”) loans are excluded from this aging and nonaccrual loans schedule.



		Accrual Loans
		30-59		60-89		90 or More
		Days		Days		Days		Total				Nonaccrual		Total
		Past Due		Past Due		Past Due		Past Due		Current		Loans		Loans
Commercial & Industrial	$	-	$	-	$	-	$	-	$	32,796,429	$	332,828	$	33,129,257
Commercial Real Estate - Investor		411,395		-		-		411,395		87,340,661		2,472,374		90,224,430
Commercial Real Estate - Owner Occupied		-		-		-		-		47,044,131		169,344		47,213,475
Residential Real Estate - Investor		142,524		100,219		-		242,743		39,475,920		808,174		40,526,837
Residential Real Estate - Owner Occupied		571,229		116,074		-		687,303		79,590,144		2,876,887		83,154,334
Home Equity Line of Credit		276,419		24,897		-		301,316		35,903,959		306,730		36,512,005
Land		-		-		-		-		491,246		-		491,246
Construction		-		-		-		-		15,500,614		-		15,500,614
Consumer & Other		1,535		4,789		-		6,324		1,024,822		900		1,032,046
Total	$	1,403,102	$	245,979	$	-	$	1,649,081	$	339,167,926	$	6,967,237	$	347,784,244

PCI loans														46,296,528
Total Loans													$	394,080,772

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2013. PCI loans are excluded from this aging and nonaccrual loans schedule.



		Accrual Loans
		30-59		60-89		90 or More
		Days		Days		Days		Total				Nonaccrual		Total
		Past Due		Past Due		Past Due		Past Due		Current		Loans		Loans
Commercial & Industrial	$	60,653	$	-	$	-	$	60,653	$	31,842,702	$	142,881	$	32,046,236
Commercial Real Estate - Investor		-		-		-		-		93,983,453		100,459		94,083,912
Commercial Real Estate - Owner Occupied		175,341		-		-		175,341		38,135,290		695,960		39,006,591
Residential Real Estate - Investor		-		226,996		-		226,996		24,892,038		472,100		25,591,134
Residential Real Estate - Owner Occupied		1,049,769		117,372		-		1,167,141		41,151,500		2,102,194		44,420,835
Home Equity Line of Credit		319,767		-		-		319,767		32,128,982		295,406		32,744,155
Land		-		-		-		-		355,191		-		355,191
Construction		104,926		-		-		104,926		17,894,719		-		17,999,645
Consumer & Other		508		-		-		508		1,309,271		-		1,309,779
Total	$	1,710,964	$	344,368	$	-	$	2,055,332	$	281,693,146	$	3,809,000	$	287,557,478

PCI loans														33,122,854
Total Loans													$	320,680,332

Troubled Debt Restructurings

The restructuring of a loan constitutes a troubled debt restructuring, or TDR, if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider in the normal course of business. A concession may include an extension of repayment terms which would not normally be granted, a reduction of interest rate or the forgiveness of principal and/or accrued interest. If the debtor is experiencing financial difficulty and the creditor has granted a concession, the Company will make the necessary disclosures related to the TDR. In certain cases, a modification may be made in an effort to retain a customer who is not experiencing financial difficulty. This type of modification is not considered to be a TDR. Once a loan has been modified and is considered a TDR, it is reported as an impaired loan. All TDRs are evaluated individually for impairment on a quarterly basis as part of the allowance for credit losses calculation. A specific allowance for TDR loans is established when the discounted cash flows, collateral value or observable market price, whichever is appropriate, of the TDR is lower than the carrying value. If a loan deemed a TDR has performed for at least six months at the level prescribed by the modification, it is not considered to be non-performing; however, it will generally continue to be reported as impaired, but may be returned to accrual status. A TDR is deemed in default on its modified terms once a contractual payment is 30 or more days past due.

The following table presents a breakdown of loans that Company modified during the nine months ended September 30, 2014 and 2013:




	Nine Months Ended September 30, 2014					Nine Months Ended September 30, 2013
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial & Industrial	1	$	85,397	$	85,397	1	$	160,885	$	160,885
Commercial Real Estate - Investor	-		-		-	-		-		-
Commercial Real Estate - Owner Occupied	-		-		-	-		-		-
Residential Real Estate - Investor	-		-		-	-		-		-
Residential Real Estate - Owner Occupied	1		397,806		397,806	1		683,763		683,763
Home Equity Line of Credit	-		-		-	1		68,685		68,685
Land	-		-		-	-		-		-
Construction	-		-		-	-		-		-
Consumer & Other	-		-		-	-		-		-
Totals	2	$	483,203	$	483,203	3	$	913,333	$	913,333

For the nine months ended September 30, 2014, there were two loans modified as TDRs. The restructuring of a C&I loan included an extension of loan maturity date at an interest rate lower than the current rate for new debt with similar risk. The restructuring of Residential Real Estate - Owner Occupied loan included an extension of the interest only period for an additional twelve months to allow more manageable debt servicing by the borrower. As of September 30, 2014, both TDRs were accruing loans.

For the nine months ended September 30, 2013, the restructuring of a HELOC resulted in interest rate concessions and changes in payment terms and monthly principal and interest payments to interest only, to allow more manageable debt service by the borrower. As of September 30, 2013 this HELOC TDR was on nonaccrual status. The restructuring of the C&I loan included an extension of the loan maturity date at an interest rate lower than the current rate with new debt with similar risk. This loan subsequently paid off in November 2013. The modification of the Residential Real Estate – Owner Occupied loan included an extension of loan maturity date and reduced payments per executed forbearance agreement. This loan subsequently transferred to real estate acquired through foreclosure in April 2014 at its carrying value of $495,000.

None of the loans modified as a TDR during the previous twelve months were in default of their modified terms at September 30, 2014. At September 30, 2014 and December 31, 2013, the Bank had $2,140,452 and $2,582,468, respectively, in loans identified as TDRs of which $405,718 and $948,488, respectively, were on nonaccrual status.

NOTE 6 – ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A TRANSFER

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchased credit-impaired loans are initially measured at fair value, which considers estimated future loan losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses related to these loans was not carried over and recorded at the acquisition date. The Company monitors actual loan cash flows to determine any improvement or deterioration from those forecasted as of the acquisition date.

The following table reflects the carrying amount of purchased credit impaired loans, which are included in the loan categories in Note 5 – Loans and Allowances for Loan Losses:



		September 30, 2014		December 31, 2013
Commercial & Industrial	$	2,335,393	$	2,232,303
Commercial Real Estate		26,309,003		24,360,372
Residential Real Estate		11,519,274		3,311,585
Home Equity Line of Credit		743,641		513,668
Land		3,516,738		1,361,557
Construction		1,872,479		1,343,369
Total Loans	$	46,296,528	$	33,122,854

The contractual amount outstanding for these loans totaled $57,341,147 and $41,571,473 as of September 30, 2014 and December 31, 2013, respectively.

The following table reflects activity in the accretable yield for these loans for the three and nine months ended September 30, 2014 and 2013:



		Three months ended				Nine months ended
		September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Balance at beginning of period	$	1,069,436	$	2,948,968	$	1,991,662	$	1,049,653
Acquired through Carrolton Merger		-		-		-		2,788,895
Acquired through Slavie Acquisition		-		-		1,058,535		-
Reclassification from nonaccretable difference		1,206,447		486,191		2,198,677		865,701
Accretion into interest income		(1,118,362)		(943,216)		(4,088,244)		(2,172,043)
Disposals		-		(5,211)		(3,109)		(45,474)
Balance at end of period	$	1,157,521	$	2,486,732	$	1,157,521	$	2,486,732

The following table reflects activity in the allowance for these loans for the three and nine months ended September 30, 2014 and 2013:



		Three months ended				Nine months ended
		September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Balance at beginning of period	$	132,724	$	-	$	-	$	213,882
Reclassification to TDR		-		-		-		(213,882)
Charge-offs		(116,999)		(25,655)		(116,999)		(29,655)
Recoveries		-		25,050		(4,040)		41,763
Provision for loan losses		(15,725)		605		121,039		(12,108)
Balance at end of period	$	-	$	-	$	-	$	-

NOTE 7 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE

The following table reflects activity in real estate acquired through foreclosure for the three and nine months ended September 30, 2014 and 2013:



		Three months ended September 30,				Nine months ended September 30,
		2014		2013		2014		2013
Balance at beginning of period	$	1,520,609	$	1,474,119	$	1,290,120	$	1,151,256
Acquired through Merger		-		-		-		908,718
New transfers from loans		185,667		242,796		1,158,932		751,148
Sales		(19,800)		(470,544)		(488,497)		(1,526,051)
Write-downs		(43,952)		(55,800)		(318,031)		(94,500)
Balance at end of period	$	1,642,524	$	1,190,571	$	1,642,524	$	1,190,571

NOTE 8 – CORE DEPOSIT INTANGIBLE ASSETS

The Company's core deposit intangible assets at September 30, 2014 consist primarily of assets recorded as a result of the Merger and the Slavie Acquisition, with a combined remaining weighted average life of approximately 7.2 years. The following table presents the changes in the net book value of core deposit intangible assets for the nine months ended September 30, 2014 and 2013:



		2014		2013
Balance at beginning of period	$	3,993,679	$	173,815
Additions from the Carrollton Merger		-		4,611,362
Additions from the Slavie Acquisition		477,563		-
Amortization expense		(738,416)		(517,203)
Balance, September 30	$	3,732,826	$	4,267,974

The following table presents the gross carrying amount, accumulated amortization, and net carrying amount of core deposit intangible assets as of September 30, 2014 and December 31, 2013:



		September 30, 2014		December 31, 2013
Gross carrying amount	$	5,578,211	$	5,100,648
Accumulated amortization		(1,845,385)		(1,106,969)
Net carrying amount	$	3,732,826	$	3,993,679

The following table sets forth the future amortization expense for the Company’s core deposit intangible assets at September 30, 2014:


Periods ending December 31:		Amount
2014	$	254,545
2015		854,098
2016		649,939
2017		490,847
2018		402,243
Subsequent years		1,081,154
Total	$	3,732,826

NOTE 9 – SHORT-TERM BORROWINGS

Borrowings at September 30, 2014 consisted of the following:


Federal Home Loan Bank Advances		September 30, 2014
Due October, 2014, Fixed Rate 0.16%	$	8,000,000
Due December 2014, Daily Rate 0.355%		4,000,000
Total	$	12,000,000

Interest expense on FHLB advances for the three months ended September 30, 2014 and 2013 was $12,706 and $0, respectively. Interest expense on FHLB advances for the nine months ended September 30, 2014 and 2013 was $12,706 and $1,692, respectively.

Fixed-rate advances had a weighted-average interest rate of 0.33% for the three and nine months ended September 30, 2014, respectively.

The Company had no long-term borrowings at December 31, 2013.

NOTE 10 – STOCK-BASED COMPENSATION

The Jefferson Bancorp, Inc. 2010 Stock Option Plan (the “Jefferson Plan”) was adopted by the Jefferson Board of Directors in September 2010 and approved by Jefferson’s stockholders in April 2011. The Jefferson Plan provides for the granting of incentive stock options intended to comply with the requirements of Section 422 of the Internal Revenue Code and non-qualified stock options (collectively “Awards”). Awards were available for grant to officers, employees and non-employee directors, independent consultants and contractors of Jefferson and its affiliates, including the Bank.

The Jefferson Plan authorized the issuance of up to 260,000 shares of common stock and had a term of ten years. In general, options granted under the Jefferson Plan have an exercise price equal to 100% of the fair market value of the common stock at the date of the grant and have a ten year term. Options relating to a total of 218,000 shares of common stock were outstanding at the date of the Merger. As a result of the Merger, the Jefferson Plan is now administered by Bay Bancorp, Inc.’s Board of Directors.

The Carrollton Bancorp 2007 Equity Plan (the “Equity Plan” and, together with the Jefferson Plan, the “Plans”) was approved at the 2007 annual meeting of stockholders of Bay Bancorp, Inc. Under the Equity Plan, 500,000 shares of common stock were reserved for issuance. Options relating to a total of 52,060 shares of common stock were outstanding as of the date of the Merger. All grants after the date of the Merger were made under the Equity Plan.

At the effective time of the Merger, options covering 8,000 shares of Jefferson’s common stock had been exercised and options to purchase 208,000 shares of Jefferson’s common stock were outstanding. Each option that was outstanding at the effective time of the Merger was assumed by Bay Bancorp, Inc. and, pursuant to the adjustment provisions of the Jefferson Plan, was converted into an option to purchase that number of shares of Bay Bancorp, Inc.’s common stock equal to the product of the shares of Jefferson common stock subject to the option and 2.2217, which was the exchange ratio in the Merger, rounded down to the nearest whole share. Also pursuant to the adjustment provisions of the Jefferson Plan, the total number of shares authorized under the Plan, less the shares that had been issued upon the exercise of options prior to the Merger, was adjusted to reflect the change in the common stock subject to the Jefferson Plan, from that of Jefferson to that of Bay Bancorp, Inc., and to reflect the exchange ratio in the Merger.

On July 29, 2014, the Board of Directors of Bay Bancorp, Inc. granted options to purchase 77,000 shares of its common stock to certain officers and a consultant. The options were granted under the Jefferson Plan and as a result, the adjusted Jefferson Plan authorized a total of 559,868 shares of Bay Bancorp, Inc.’s common stock, with 539,110 shares subject to outstanding assumed options and 20,758 shares remaining for future grant.

The following weighted average assumptions were used for options granted during the nine months ended September 30, 2014:


			2014
	Dividend yield		0.0%
	Expected life		6.0 years
	Expected volatility		0.0%
	Risk-free interest rate		0.00%

The dividend yield is based on estimated future dividend yields. The expected term of share options granted is generally derived from historical experience. Expected volatilities are generally based on historical volatilities. The risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The following tables summarize changes in the Company's stock options outstanding for the nine months ended September 30, 2014:



	Stock Options Outstanding		Weighted Average Exercise Price	Stock Options Exercisable	Weighted Average Remaining Contractual Life
Outstanding, December 31, 2013	608,905	$	5.23	377,255	6.3 years
Granted	187,000		4.97	-
Vested	-		4.86	108,998
Exercised	-		-	-
Cancelled	(12,890)		15.70	(12,890)
Outstanding, September 30, 2014	783,015	$	5.00	473,363	6.6 years

Stock-based compensation expense is recognized on a straight-line basis over the vesting period of the stock options and is recorded in noninterest expense. For the nine months ended September 30, 2014 and 2013, stock-based compensation expense applicable to the Plans was $350,507 and $222,022, respectively. Unrecognized stock-based compensation expense attributable to non-vested options was $324,081 at September 30, 2014. This amount is expected to be recognized over a remaining weighted average period of approximately 2.4 years.

Restricted Stock Awards

On June 26, 2013, the Company’s Board of Directors revised its director compensation policy to provide for an annual grant to each non-employee director of an award of shares of restricted common stock having a fair market value of $10,000 that will vest one year after the date of the grant. At September 30, 2014, there were a total of 16,256 non-vested restricted shares outstanding. Total stock-based compensation expense attributable to the shares of restricted common stock was $22,494 and $64,159 for the three and nine months end September 30, 2014, respectively. The total unrecognized compensation expense attributable to the shares of restricted common stock was $53,317 at September 30, 2014.

Stock Awards

On July 29, 2014 the Board of Directors of Bay Bancorp, Inc. granted 212,000 shares of the Company’s common stock to certain directors and officers. The stock awards were granted under the Carrollton Bancorp 2007 Equity Plan and the shares had no restrictions at the date of issue.

NOTE 11 – DEFINED BENEFIT PENSION PLAN

The Carrollton Bank Retirement Income Plan (the “Pension Plan”) was acquired through the Merger. The Pension Plan provides defined benefits based on years of service and final average salary. Effective December 31, 2004, all benefit accruals for existing employees were frozen and no new employees were eligible for benefits under the Pension Plan.

The components of net periodic pension benefit for the nine month period ended September 30, 2014 are as follows:



		2014
Service cost	$	45,554
Interest cost		332,029
Expected return on plan assets		(448,769)
Amortization of net loss/(gain)		(59,121)
Net periodic pension benefit	$	(130,307)

Accumulated other comprehensive income related to the Pension Plan was $1,452,220 and $1,304,888 at September 30, 2014 and December 31, 2013, respectively.

401(k) Plan

The Company has a 401(k) profit sharing plan covering substantially all full-time employees. At this time, the Company has elected not to match employee contributions as defined under this plan. Therefore, the expense associated with this plan during the nine months ended September 30, 2014 and 2013 was $0.

NOTE 12 – INCOME TAXES

The differences between the statutory federal income tax rate of 34% and the effective tax rate for the Company are reconciled as follows:



	Three Months Ended September 30,		Nine Months Ended September 30,
	2014	2013	2014	2013
Income tax expense at federal statutory rate	34.0%	34.0%	34.0%	34.0%
Increase (decrease) resulting from:
Amended returns refund claims for pre-acquisition tax periods	-	-	-24.4%	0.0%
Reversal of valuation allowance attributable to future built-in losses	-	-	-8.0%	0.0%
Non-taxable bargain purchase gain	-	-147.9%	-	-34.3%
Bank owned life insurance	-0.2%	-3.8%	-1.5%	-1.2%
Tax exempt income	-	-0.8%	-0.7%	-0.4%
State income taxes, net of federal income tax benefit	5.5%	15.7%	6.1%	5.4%
Incentive stock options	0.1%	8.8%	3.0%	2.9%
Nondeductible merger-related expenses	-	6.9%	-	2.2%
Other nondeductible expenses	-0.5%	2.7%	1.1%	0.6%
Effective income tax rate	38.9%	-84.4%	9.6%	9.2%

The actual effective tax rate of 9.6% for the nine months ended September 30, 2014 includes the second quarter $482,000 refunds claimed (which were received in October 2014) on the filing of amended income tax returns for the former Carrollton Bank as well as the impact of the $157,000 partial reversal in the first quarter of 2014 of a valuation allowance attributable to estimated future built-in losses that were recorded in 2013.

The actual effective tax rates of -84.4% and 9.2% for the three and nine months ended September 30, 2013, respectively, included a non-taxable bargain purchase gain of $2.9 million that resulted from the Merger, which was a tax-free reorganization for income tax purposes.

The bargain purchase gain recognized in 2014 is the result of the Slavie Acquisition from the FDIC in a taxable transaction. Therefore, there is no impact from the transaction on the effective tax rate. The estimated annual effective tax rate excluding the amended return claims and the partial reversal of the valuation allowance for the reporting periods ended September 30, 2014 was 42.0%.

The estimated annual effective tax rate excluding the impact of the restated non-taxable bargain purchase gain for the reporting periods ended September 30, 2013 was 43.5%. The estimated annual effective tax rates, excluding the above mentioned discrete items, for the reporting periods ended September 30, 2014 and September 30, 2013 were impacted by the level of permanent differences (relative to total income), including state income taxes, non-taxable income, and nondeductible expenses, resulting in an effective rate higher than the statutory rates for the interim reporting periods.

In conjunction with the Merger, the Company incurred an ownership change within the meaning of Section 382 of the Internal Revenue Code. As a result, applicable federal and state tax laws place an annual limitation of approximately $351,000 on the amount of certain losses that may be used, including built-in losses that existed at the date of the ownership change. During 2013, the Company recognized built-in losses of approximately $6.9 million; a tax benefit was not recorded for a portion of these losses due to the application of the Section 382 annual limitation. During 2014, the Company expects to recognize additional built-in losses of approximately $0.6 million. A tax benefit of approximately $2.6 million for the carryover of excess recognized built-in losses has been recorded for the approximately $6.5 million of recognized built-in losses that the Company expects to utilize in future periods. These loss carryforwards expire in 2034. The Company also anticipates additional future recognized built-in losses of approximately $0.2 million. The Company is exploring various tax planning strategies to further utilize the built-in losses for which a benefit has not been recorded. If the Company were able to increase the realizable built-in losses, the Company may realize a tax benefit in future periods for the built-in losses not previously recognized.

Additionally, the Company had federal net operating loss carry forwards of approximately $0.6 million as of the date of the ownership change which expire in 2034. These losses are subject to the Section 382 limitations noted above. A tax benefit was not recorded for these losses due to the application of the Section 382 annual limitation.

The $157,000 valuation allowance recorded in 2013 for estimated recognized 2014 built-in losses that the Company did not expect to utilize in future periods was reversed during the three months ended March 31, 2014. This reversal was supported by lower than expected recognized built-in losses in 2014 through the one year anniversary of the merger. The Company now expects to utilize all 2014 and future years’ recognized built-in losses.

At September 30, 2014, the Company had state net operating loss carry forwards of approximately $1.1 million, which begin to expire in 2031. Pre-Merger Bay Bancorp, Inc. also recorded book impairment losses on certain equity securities, which would generate capital losses for tax purposes if the securities were sold at their current assessed fair market value. A valuation allowance has been established against the corresponding deferred tax assets associated with these losses, as the benefit is not more likely than not to be realized.

Realization of deferred tax assets is dependent upon the generation of sufficient future taxable income during the periods in which existing deferred tax assets are expected to become deductible for income tax purposes. Management has determined that the Company is more likely than not to realize existing net deferred tax assets as of September 30, 2014, with the exception of the items noted above.

NOTE 13- NET INCOME PER COMMON SHARE

Basic earnings per common share is derived by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period and does not included the effect of any potentially dilutive common stock equivalents. Diluted earnings per share is derived by dividing net income available to common stockholders by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding common stock equivalents. There is no dilutive effect on earnings per share during loss period.

The calculation of net income per common share for the nine months ended September 30, 2014 and 2013 are as follows:


		Three Months Ended September 30,			Nine Months Ended September 30
		2014		2013		2014		2013
Basic earnings per share:
Net income	$	(941,515)	$	922,793	$	1,785,146	$	2,323,261
Weighted average shares outstanding (1)		10,966,251		9,363,643		10,162,200		7,971,845
Basic net (loss) income per share	$	(0.09)	$	0.11	$	0.18	$	0.29

Diluted earnings per share:
Net income	$	(941,515)	$	922,793	$	1,785,146	$	2,323,261
Weighted average shares outstanding (1)		10,966,251		9,363,643		10,162,200		7,971,845
Dilutive potential shares		32,987		20,760		37,004		9,906
Total diluted average shares outstanding		10,999,238		9,384,403		10,199,204		7,981,751
Total diluted (loss) net income per share	$	(0.09)	$	0.11	$	0.18	$	0.29

Anti-dilutive shares		290,835		181,806		272,639		296,995

(1)

Pre-Merger Jefferson common shares adjusted for the effect of the conversion to Bay Bancorp, Inc. common shares.

NOTE 14 - COMMITMENTS AND CONTINGENT LIABILITIES

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments include loan commitments, unused lines of credit and standby letters of credit. The Company uses these financial instruments to meet the financing needs of its customers. Financial instruments 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 which would have a material effect on the accompanying consolidated financial statements.

Outstanding loan commitments and lines and letters of credit were as follows:



		September 30, 2014		December 31, 2013

Loan commitments	$	5,467,601	$	6,224,298
Unused lines of credit		67,745,447		58,479,498
Standby letters of credit		1,921,131		2,254,568

Loan commitments and unused lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments. The collateral requirement is based on management's credit evaluation of the counter party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

In the ordinary course of business, the Company has various outstanding contingent liabilities that are not reflected in the accompanying consolidated financial statements. In the opinion of management, after consulting with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the financial condition of the Company.

NOTE 15 – FAIR VALUE

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

The Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured 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 fair value.

Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets and liabilities.

Level 2 - Valuation is based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets and liabilities; quoted prices in 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 asset or liability.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Assets Recorded at Fair Value on a Recurring Basis

The following methods and assumptions were used by the Company to measure certain assets recorded at fair value on a recurring basis in the consolidated financial statements:

Investment Securities Available for Sale

The fair value of investment securities available for sale is the market value based on quoted market prices, when available (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar assets or, due to the limited market activity of the instrument, externally developed models that use significant observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3). It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities and market information from third party sources. In the absence of current market activity, securities may be evaluated either by reference to similarly situated bonds or based on the liquidation value or restructuring value of the underlying assets. There were no transfers between Level 1 and Level 2 and no change in valuation techniques used to measure fair value of securities available for sale for the period ended September 30, 2014.

The tables below present the recorded amount of assets measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013:



		Carrying Value (Fair Value)		Quoted Prices (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)
September 30, 2014
U.S. government agency	$	7,723,677	$	-	$	7,723,677	$	-
Residential mortgage-backed securities		21,484,958		-		21,484,958		-
State and municipal		5,185,793		-		5,185,793		-
Equity securities		34,318		34,318		-		-
	$	34,428,746	$	34,318	$	34,394,428	$	-



		Carrying Value (Fair Value)		Quoted Prices (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)

December 31, 2013
U.S. government agency	$	7,525,915	$	-	$	7,525,915	$	-
Residential mortgage-backed securities		23,801,003		-		23,801,003		-
State and municipal		5,189,886		-		5,189,886		-
Equity securities		69,865		69,865		-		-
	$	36,586,669	$	69,865	$	36,516,804	$	-

Assets Recorded at Fair Value on a Nonrecurring Basis

On a nonrecurring basis, the Company may be required to measure certain assets at fair value in accordance with generally accepted accounting principles. These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets due to impairment.

The following methods and assumptions were used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:

Loans held for sale

Loans held for sale are recorded at the lower of cost or estimated market value on an aggregate basis. Market value is determined based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale. As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the nine months ended September 30, 2014 and the year ended December 31, 2013.

Impaired Loans

Loans for which it is probable that payment of principal and interest will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310, using the present value of expected cash flows, the loan’s observable market price, or the fair value of collateral (less selling costs) if the loan is collateral dependent. A specific allowance for loan loss is then established or a partial charge-off is recorded if the loan is collateral dependent and the loan is classified at a Level 3 in the fair value hierarchy. Appraised collateral 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 borrower’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those applied in prior periods.

Real Estate Acquired Through Foreclosure

Real estate acquired through foreclosure (“REO”) is adjusted to fair value upon transfer of the loan to REO and is classified at a Level 3 in the fair value hierarchy. Subsequently, the REO is carried at the lower of carrying value or fair value. The estimated fair value for REO included in Level 3 is determined by independent market based appraisals and other available market information, less costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of REO deteriorates subsequent to the period of transfer, the REO is also classified at a Level 3 in the fair value hierarchy. Valuation techniques are consistent with those techniques applied in prior periods.

The tables below present the recorded assets measured at fair value on a nonrecurring basis as of September 30, 2014 and December 31, 2013:



September 30, 2014:		Carrying Value (Fair Value)		Quoted Prices (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)
Impaired loans	$	2,677,002	$	-	$	-	$	2,677,002
Real estate acquired through foreclosure		1,234,064		-		-		1,234,064
	$	3,911,066	$	-	$	-	$	3,911,066



December 31, 2013:		Carrying Value (Fair Value)		Quoted Prices (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Other Unobservable Inputs (Level 3)
Impaired loans	$	875,357	$	-	$	-	$	875,357
Real estate acquired through foreclosure		960,006		-		-		960,006
	$	1,835,363	$	-	$	-	$	1,835,363

Fair Value of Financial Instruments

The Company discloses fair value information about financial instruments, for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheets. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by a quoted market price, if one exists.

Quoted market prices, where available, are shown as estimates of fair market values. Because no quoted market prices are available for a significant part of the Company's financial instruments, the fair values of such instruments have been derived based on the amount and timing of estimated future cash flows and using market discount rates.

Present value techniques used in estimating the fair value of many of the Company's financial instruments are significantly affected by the assumptions used. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate cash settlement of the instrument. Additionally, the accompanying estimates of fair values are only representative of the fair values of the individual financial assets and liabilities and should not be considered an indication of the fair value of the Company.

The following disclosure of estimated fair values of the Company's financial instruments at September 30, 2014 and December 31, 2013 is made in accordance with the requirements of ASC Topic 820:





			September 30, 2014				December 31, 2013
	Level in Fair Value Hierarchy		Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value

Financial assets:
Cash and cash equivalents	Level 1	$	16,972,930	$	16,972,930	$	23,273,060	$	23,273,060
Time deposits with banks	Level 2		284,849		284,849		-		-
Investment securities available for sale (debt)	Level 2		34,394,428		34,394,428		36,516,804		36,516,804
Investment securities available for sale (equity)	Level 1		34,318		34,318		69,865		69,865
Investment securities held to maturity (debt)	Level 2		1,334,462		1,323,818		-		-
Restricted equity securities	Level 2		1,367,995		1,367,995		1,009,695		1,009,695
Loans held for sale	Level 2		6,317,277		6,317,277		12,836,234		12,836,234
Loans, net of allowance	Level 3		392,951,522		398,652,382		319,829,332		327,390,640
Accrued interest receivable	Level 2		1,277,781		1,277,781		1,186,748		1,186,748

Financial liabilities:
Deposits	Level 3		398,596,342		399,125,345		360,993,471		361,208,309
Short-term borrowings	Level 2		-		-		-		-
Accrued interest payable	Level 2		32,795		32,795		38,642		38,642

The following methods and assumptions were used to estimate the fair value of each category of financial instruments for which it is practicable to estimate that value:

Cash and due from banks, federal funds sold and overnight investments. The carrying amount approximated the fair value.

Time deposits with banks. The carrying amount of time deposits with banks approximated fair value.

Investment securities (available for sale). The fair value of debt securities is based upon quoted prices for similar assets or externally developed models that use significant observable inputs. The fair value of equity securities is based on quoted market prices.

Investment securities (held to maturity). The fair value of debt securities is based upon quoted prices for similar assets or externally developed models that use significant observable inputs.

Restricted equity securities. Since these stocks are restricted as to marketability, the carrying value approximated fair value.

Loans held for sale. The carrying amount approximated the fair value.

Loans. The fair value of loans was estimated by computing the discounted value of estimated cash flows, adjusted for probable credit losses, for pools of loans having similar characteristics. The discount rate was based upon the current market rate for a similar loan. Nonperforming loans had an assumed interest rate of 0%.

Accrued interest receivable and payable. The carrying amount approximated the fair value of accrued interest, considering the short-term nature of the instrument and its expected collection.

Deposit liabilities. The fair value of demand, money market savings and regular savings deposits, which have no stated maturity, were considered equal to their carrying amount, representing the amount payable on demand. The fair value of time deposits was based upon the discounted value of contractual cash flows at current rates for deposits of similar remaining maturity.

Short-term borrowings. The carrying amount of fixed rate FHLB advances approximated fair value due to the short-term nature of the instrument. The carrying amount of variable rate FHLB advances approximated the fair value.

Off-balance sheet instruments. The Company charges fees for commitments to extend credit. Interest rates on loans, for which these commitments are extended, are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.

NOTE 16 – REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. The minimum levels of Tier 1 and Total capital to risk-weighted assets are 4% and 8%, respectively, under the current regulations.

In addition, the OCC requires that FSBs, like the Bank, maintain a minimum level of Tier 1 capital to average total assets excluding intangibles. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered adequately capitalized is 4%, but an individual institution could be required to maintain a higher level. In connection with the Merger, the Bank entered into an Operating Agreement with the OCC (the “Operating Agreement”) pursuant to which the Bank agreed, among other things, to maintain a leverage ratio of 10% for the term of the Operating Agreement. The Operating Agreement will remain in effect until it is terminated by the OCC or the Bank ceases to be an FSB, either due to a merger or otherwise.

Until the adoption of the Basel III Capital Rules, the Company is not subject to its specific capital requirements. The Basel III Capital Rules generally will subject the Company to the same capital requirements that apply to other depository institution holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and a leverage ratio of Tier 1 capital (as defined) to average tangible assets (as defined). At September 30, 2014 and December 31, 2013, the Bank had regulatory capital in excess of that required under each requirement and was classified as “well capitalized”.

Actual capital amounts and ratios for the Bank are presented in the following tables (dollars in thousands):



										To Be Well
										Capitalized Under
						To Be Considered				Prompt Corrective
		Actual				Adequately Capitalized				Action Provisions
As of September 30, 2014:		Amount	Ratio			Amount	Ratio			Amount	Ratio

Total Risk-Based Capital Ratio	$	60,376	16.14	%	$	29,922	8.00	%	$	37,402	10.00	%

Tier I Risk-Based Capital Ratio	$	59,247	15.84	%	$	14,961	4.00	%	$	22,441	6.00	%

Leverage Ratio	$	59,247	12.51	%	$	18,943	4.00	%	$	23,679	5.00	%

As of December 31, 2013:

Total Risk-Based Capital Ratio	$	47,815	14.68	%	$	26,049	8.00	%	$	32,562	10.00	%

Tier I Risk-Based Capital Ratio	$	46,964	14.42	%	$	13,025	4.00	%	$	19,537	6.00	%

Leverage Ratio	$	46,964	11.41	%	$	16,461	4.00	%	$	20,577	5.00	%

Banking regulations also limit the amount of dividends that may be paid without prior approval by an FSB's regulatory agencies. In addition to these regulations, the Bank agreed in the Operating Agreement that it would not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including the minimum capital requirements. Due to these restrictions and the Bank’s desire to preserve capital to fund its growth, the Company currently does not anticipate paying a dividend for the foreseeable future. In addition to these regulatory restrictions, it should be noted that the declaration of dividends is at the discretion of the Company’s Board of Directors and will depend, in part, on the Company’s earnings and future capital needs. Accordingly, there can be no assurance that dividends will be declared in any future period.

The Bank is required to maintain reserves against certain deposit liabilities which was satisfied with vault cash and balances on deposit with the Federal Reserve Bank of Richmond during the reserve maintenance periods that included September 30, 2014 and December 31, 2013.

Under current Federal Reserve regulations, the Bank is limited in the amount it may lend to the parent company and its nonbank subsidiaries. Loans to a single affiliate may not exceed 10%, and loans to all affiliates may not exceed 20% of the Bank’s capital stock, surplus, and undivided profits, plus the allowance for loan and lease losses. Loans from the Bank to nonbank affiliates, including the parent company, are also required to be collateralized according to regulatory guidelines. At September 30, 2014, there were no loans from the Bank to any nonbank affiliate, including the parent company.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As used in this Quarterly Report, the term “the Company” refers to Bay Bancorp, Inc. and, unless the context clearly requires otherwise, the terms “we,” “us,” and “our,” refer to Bay Bancorp, Inc. and its consolidated subsidiaries.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Statements that include the use of terminology such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “estimates,” and similar expressions also identify forward-looking statements. The statements in this report with respect to, among other things, our plans and strategies; objectives and intentions and the anticipated results thereof; the impact of the recent merger; the impact of regulations on our business; our potential exposure to various types of market risks, such as interest rate risk and credit risk; anticipated funding of commitments to extend credit and unused lines of credit; potential losses from off-balance sheet arrangements, taking advantage of opportunities emerging as the business environment improves and leads to increased loan demand in the future; the recovery of fair value of available for sale securities; the allowance for loan losses; liquidity sources and the impact of the outcome of pending legal proceedings are forward-looking. These forward-looking statements are based on our current intentions, beliefs, and expectations.

These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Actual results may differ materially from these forward-looking statements because of, among other things:

unexpected changes or further deterioration in the housing market or in general economic conditions in our market area, or a slowing economic recovery;

unexpected changes in market interest rates or monetary policy;

the impact of new governmental regulations that might require changes in our business model;

changes in laws, regulations, policies and guidelines impacting our ability to collect on outstanding loans or otherwise negatively impacting its business;

higher than anticipated loan losses or the insufficiency of the allowance for credit losses;

changes in consumer confidence, spending and savings habits relative to the services we provide;

continued relationships with major customers;

competition from other financial institutions in originating or refinancing loans, attracting deposits, and providing various financial services that may affect our profitability;

the ability to continue to grow our business organically and through acquisition and successful integration of bank entities while controlling our costs;

changes in competitive, governmental, regulatory, accounting, technological and other factors that may affect us specifically or the banking industry generally, including as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”); and

our inability to successfully integrate assets, liabilities and operations of institutions that we acquire.

Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-Q. We undertake no obligation to update or revise the information contained in this report whether as a result of new information, future events or circumstances, or otherwise. Past results of operations may not be indicative of future results.

GENERAL

Bay Bancorp, Inc., a Maryland corporation organized in 1990, is a savings and loan holding company headquartered in Lutherville, Maryland. Until November 1, 2013, the Company operated under the name Carrollton Bancorp. Effective November 1, 2013, the Company’s name was changed to Bay Bancorp, Inc.

On May 30, 2014, Bay Bank, FSB (the“Bank”) entered into a Purchase and Assumption Agreement (the “Slavie Agreement”) with Federal Deposit Insurance Corporation (“FDIC”) pursuant to which it acquired certain assets and assume substantially all deposits and certain other liabilities (the “Slavie Acquisition”), of Slavie Federal Savings Bank (“Slavie”), which was closed on that date by the Office of the Comptroller of the Currency (“OCC”). The OCC appointed the FDIC as the Receiver of the failed institution. The Slavie Agreement did not include a loss share arrangement. The acquired net assets and assumed liabilities were recorded at their estimated fair values as of the acquisition date. Management believes that the Slavie Acquisition presented an opportunity to add earning assets at a discount along with a long-tenured deposit base.

On April 19, 2013, the Company completed its previously announced merger with Jefferson Bancorp, Inc. (“Jefferson”) with the Company as the surviving corporation (the “Merger”). The Merger was accounted for as a reverse acquisition, which means that for accounting and financial reporting purposes, Jefferson is deemed to have acquired the Company in the Merger even though the Company was the legal successor in the Merger, and the historical financial statements of Jefferson have become the Company’s historical financial statements. Consequently, the assets and liabilities and the operations that are reflected in the historical consolidated financial statements prior to the Merger are those of Jefferson, and the historical consolidated financial statements after the Merger include the assets and liabilities of Jefferson and the Company, historical operations of Jefferson and operations of the combined Company after April l9, 2013.

Prior to the Merger, the Company had one bank subsidiary, Carrollton Bank, and Jefferson had one bank subsidiary, the Bank. The Bank commenced operations on July 9, 2010. As part of the Merger, Carrollton Bank merged with and into the Bank, with the Bank as the surviving bank subsidiary of the Company (the “Bank Merger”). The Bank is a federal savings bank (“FSB”) that provides a full range of financial services to individuals, businesses and organizations through its branch and loan origination offices and its automated teller machines. Deposits in the Bank are insured by the FDIC. The Bank has six subsidiaries: Bay Financial Services, Inc. (“BFS”); Carrollton Community Development Corporation (“CCDC”); Flagship Acquisition Trust; and three limited liability company subsidiaries.

We are focused on providing superior financial and customer service to small and medium-sized commercial and retail businesses, owners of these businesses and their employees, to business professionals and to individual consumers located in the central Maryland region, through our network of ten branch locations. We attract deposit customers from the general public and use such funds, together with other borrowed funds, to make loans. Our results of operations are primarily determined by the difference between interest income earned on our interest-earning assets, primarily interest and fee income on loans, and interest paid on our interest-bearing liabilities, including deposits and borrowings.

Our mortgage division is in the business of originating residential mortgage loans and then selling them to investors. The division also originates adjustable rate residential mortgage loans for the Bank’s portfolio. The mortgage banking business is structured to provide a source of fee income largely from the process of originating residential mortgage loans for sale in the secondary market. Mortgage banking products include Federal Housing Administration and Federal Veterans Administration loans, conventional and nonconforming first and second mortgages, and construction and permanent financing. Loans originated by the mortgage division are generally sold into the secondary market but may be considered for retention by us as part of our balance sheet strategy.

BFS provides brokerage services and a variety of financial planning and investment options to customers. Until termination of the agreement on December 31, 2013, these services were provided in partnership with INVEST Financial Corp. (“INVEST”) pursuant to a service agreement and BFS recognized commission income as these services were provided. BFS is pleased to have begun a partnership with Founders Financial Securities, LLC beginning in May of 2014 to provide our customers with customized financial management and investment services solutions. Founders Financial Securities, LLC offers a full suite of planning services some of which include: wealth management; education planning; tax reduction strategies; investment management; retirement planning & 401K; comprehensive financial planning; tax-deferred annuities; life insurance; and long term care insurance. BFS will recognize commission income as these services are provided.

Flagship Acquisition Trust holds other real estate owned that is acquired by the Bank in foreclosure or by deed in lieu of foreclosure. The Bank’s three limited liability company subsidiaries manage and dispose of real estate acquired through foreclosure.

CCDC has been used to promote, develop, and improve the housing and economic conditions of people in Maryland. Efforts have been coordinated with local non-profit organizations to identify opportunities in the community. CCDC worked with a local non-profit ministry whose mission and vision is to eliminate poverty housing in the region by building decent houses for affordable

homeownership throughout the Baltimore metropolitan region. CCDC generates revenue through the origination and holding of loans for the purchase of these homes

AVAILABILITY OF INFORMATION

We make available through the Investor Relations area of our website, at www.baybankmd.com, annual reports on Form 10-K, quarterly reports on Form 10-Q, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In general, we intend that these reports be available as soon as practicable after they are filed with or furnished to the Securities and Exchange Commission (“SEC”). The SEC maintains a website (www.sec.gov) where these filings are also available through the SEC’s EDGAR system. There is no charge for access to these filings through either our site or the SEC’s site.

MARKET AREA

We consider our core markets to be the communities within the Baltimore Metropolitan Statistical Area, particularly Baltimore City and the Maryland counties of Baltimore, Anne Arundel, Howard, Carroll and Harford. Lending activities are broader, including the entire State of Maryland, and, to a limited extent, the surrounding states. All of our revenue is generated within the United States.

COMPETITION

Our principal competitors for deposits are other financial institutions, including other savings institutions, commercial banks, credit unions, and local banks and branches or affiliates of other larger banks located in our primary market area. Competition among these institutions is based primarily on interest rates and other terms offered, service charges imposed on deposit accounts, the quality of services rendered, and the convenience of banking facilities. Additional competition for depositors' funds comes from mutual funds, U.S. Government securities, insurance companies and private issuers of debt obligations and suppliers of other investment alternatives for depositors such as securities firms. Competition from credit unions has intensified in recent years as historical federal limits on membership have been relaxed. Because federal law subsidizes credit unions by giving them a general exemption from federal income taxes, credit unions have a significant cost advantage over banks and savings associations, which are fully subject to federal income taxes. Credit unions may use this advantage to offer rates that are highly competitive with those offered by banks and thrifts.

Current federal law allows the acquisition of banks by bank holding companies nationwide. Further, federal and Maryland law permit interstate banking. Recent legislation has broadened the extent to which financial services companies, such as investment banks and insurance companies, may control commercial banks. As a consequence of these developments, competition in our principal market may increase, and a further consolidation of financial institutions in Maryland may occur.

STRATEGY

We operate on the premise that the consolidation activities in the banking industry have created an opportunity for a well-capitalized community bank to satisfy banking needs that are no longer being adequately met in the local market. Large national and regional banks are catering to larger customers and provide an impersonal experience, and typical community banks, because of their limited capacity, are unable to meet the needs of many small-to-medium-sized businesses. Specifically, as a result of bank mergers in the 1990s, many banks in the Baltimore metropolitan area became local branches of large regional and national banks. Although size gave the larger banks some advantages in competing for business from large corporations, including economies of scale and higher lending limits, we believe that these larger, national banks remain focused on a mass market approach which de-emphasizes personal contact and service. We also believe that the centralization of decision-making power at these large institutions has resulted in a lack of customer service. At many of these institutions, determinations are made at the out-of-state “home office" by individuals who lack personal contact with customers as well as an understanding of the customers' needs and scope of the relationship with the institution. We believe that this trend is ongoing, and continues to be particularly frustrating to owners of small and medium-sized businesses, business professionals and individual consumers who traditionally have been accustomed to dealing directly with a bank executive who had an understanding of their banking needs with the ability to deliver a prompt response.

We attempt to differentiate ourselves from the competition through personalized service, flexibility in meeting the needs of customers, prompt decision making and the availability of senior management to meet with customers and prospective customers.

OVERVIEW

Net income was $1.79 million or $0.18 per diluted share for the nine months ended September 30, 2014, compared to net income of $2.32 million or $0.29 per diluted share for the first nine months of 2013. For the third quarter of 2014, we reported a net loss of $0.94 million or $0.09 per diluted share, compared to net income of $2.64 million or $0.26 per diluted share for the second quarter of 2014 and net income of $0.92 million or $0.11 per diluted share for the third quarter of 2013. The results for the nine months ended September 30, 2014 include a $511,000 bargain purchase gain compared to a $2.86 million bargain purchase gain for the first nine months of 2013.

During the third quarter of 2014, after completing strategic steps in the second quarter of 2014 to reduce core operating expenses and cost of funds, the Bank absorbed $1.1 million of previously announced, one-time stock-based compensation expense, and $0.6 million in expenses related to the Slavie Acquisition and subsequent integration. The Slavie Acquisition supports our plan to add earning assets at a discount, increase scale and improve profitability going forward.

The return on average assets for the three and nine months ended September 30, 2014 was -0.77% and 0.54%, respectively, as compared to 0.80% and 0.93%, respectively, for the same periods of 2013. The return on average equity for the three and nine months ended September 30, 2014 was -5.62% and 3.89%, respectively, as compared to 6.74% and 6.70%, respectively, for the same periods of 2013.

Total assets decreased to $480 million at September 30, 2014 from $487 million at June 30, 2014 and $419 million at December 31, 2013.

Total loans were $394 million at September 30, 2014, a decrease of 0.3% from $395 million at June 30, 2014 and an increase of 23% from $321 million at December 31, 2013.

Total deposits were $399 million at September 30, 2014, a decrease of 5% from $419 million at June 30, 2014 and an increase of 10% from $361 million at December 31, 2013.

Net interest income for the three and nine month periods ended September 30, 2014 totaled $5.5 million and $16.5 million, respectively, compared to $5.8 million and $12.5 million, respectively, for the same periods of 2013. The third quarters were comparable from a leverage basis with variable accretion income credited at a slower pace in third quarter of 2014. Discount recognition will vary due to the timing and nature of resolutions. Third quarter of 2014 recognition trailed the third quarter of 2013 recognition by $0.46 million. Earning asset leverage was a key driver in year-over-year results, as average earning assets increased to $401 million for the nine months ended September 30, 2014, compared to $311 million for the same period of 2013.

Net interest margin for the three and nine months ended September 30, 2014 was 4.80% and 5.50%, respectively, compared to 5.44% and 5.37%, respectively, for the same periods of 2013. The third quarter decrease reflects the variable pace of accretion income. For the first nine months of 2014, favorable credit resolutions and a 14 basis point decrease in the average cost of interest bearing liabilities to 0.42% when compared to the same period of 2013 support the 13 basis point improvement.

Nonperforming assets increased to $20.67 million at September 30, 2014, up from $18.46 million at June 30, 2014 and $9.60 million at December 31, 2013. The increase resulted from the Slavie Acquisition, which added performing credit impaired loans at June 30, 2014, all with purchase discounts which are expected to be sufficient to resolve any credit impairments.

The provision for loan losses in the three and nine months ending September 30, 2014 was $220,000 and $580,000, respectively, compared to $350,000 and $534,000, respectively, for the same periods of 2013. The changes from the 2013 periods were due primarily to charge offs recorded on collateral dependent loans and specific reserves established for loans acquired in the Merger. As a result, the allowance for loan losses was $1.13 million at September 30, 2014, representing 0.29% of total loans, compared to $0.85 million, or 0.27% of total loans, at December 31, 2013. Management expects both the allowance for loan losses and the related provision for loan losses to increase in the future due to the gradual runoff of the discount on the acquired loan portfolio and an increase in new loan originations.

Total Capital increased to $65.2 million at September 30, 2014 from $65.0 million at June 30, 2014 and $54.6 million at December 31, 2013. The book value of Bay Bancorp, Inc. common stock was $5.92 per share at September 30, 2014, compared to $6.01 per share at June 30, 2014 and $5.82 per share at December 31, 2013

Recent Events

On July 29, 2014, the Company’s Board of Directors granted 212,000 shares of the Company’s common stock to certain directors and officers and granted options to purchase 77,000 shares of the Company’s common stock to certain officers and a consultant. The equity awards were granted to recognize the grantees’ efforts in building the Bank since being founded in 2010 by Financial Services Partners Fund I, LLC (“FSPF”). H Bancorp, LLC was formed on June 30, 2014 as the successor entity to FSPE

and the Company’s new top-tier holding company. The liquidation of FSPF was a condition imposed by the Board of Governors of the Federal Reserve System as part of its approval of the Merger. The Company realized an expense of $1.1 million in the third quarter of 2014 as a result of these equity awards. Further details can be found in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 5, 2014.

In the Slavie Acquisition, the Bank acquired assets with a fair value of $117.1 million, including $82.9 million in loans, while assuming liabilities of $110.8 million. The Bank did not acquire any of Slavie’s other real estate owned.

An independent valuation specialist was engaged during the third quarter of 2014 to prepare a fair valuation analysis for the Slavie loan portfolio, core deposit intangible asset, and time deposit portfolio. The valuation resulted in a pre-tax bargain purchase gain of $511,000 compared to an initial estimated pre-tax bargain purchase gain of $697,000 recorded at June 30, 2014. The adjusted valuation was properly recorded as a second quarter 2014 adjustment, resulting in an $113,000 decrease in second quarter after-tax income. Summary valuation as of May 30, 2014 includes an overall loan fair value mark-to-market discount to book value of $7.83 million, a core deposit intangible of $0.48 million and a certificate premium of $0.13 million.

We anticipate a normal level of expenses in the fourth quarter of 2014 related to the Slavie system conversion and other acquisition related costs.

Over the weekend of October 10, 2014, the Bank completed the core system integration of the Slavie/FISERV platform to the Bay Bank/FIS platform. The Finance/General Ledger consolidation was also completed within this integration. Several Slavie employees filled open positions within the Bank and have relocated to their new locations.

The former headquarters branch for Slavie was closed on October 10, 2014. All deposits were transferred to the Bank’s Hickory branch location. We anticipate no additional costs related to the facility.

CRITICAL ACCOUNTING POLICIES

Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany transactions are eliminated in consolidation and certain reclassifications are made when necessary in order to conform the previous year’s financial statements to the current year’s presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Therefore, actual results could differ from these estimates. Our financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets. The most critical accounting policies applied relate to treatment of the allowance for loan losses, accounting for acquired loans, valuation of the securities portfolio, and accounting for income taxes.

Allowance for Loan Losses

The allowance involves a higher degree of judgment and complexity than other significant accounting policies. The allowance is calculated with the objective of maintaining a reserve level believed by us to be sufficient to absorb estimated probable loan losses. Our determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, expected loan commitment usage, the amounts and timing of expected future cash flows on impaired and purchased credit impaired loans, value of collateral, estimated losses on consumer loans and residential mortgages and general amounts for historical loss experience. The process also considers economic conditions and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from our estimates, an additional provision for loan losses may be required that would adversely impact earnings in future periods. See the section of this document titled, “Allowance for Loan Losses and Credit Risk Management.”

Accounting for Acquired Loans

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchased credit impaired loans are initially measured at fair value, which considers estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance related to these loans was not carried over and recorded at the acquisition date. We monitor actual loan cash flows to determine any improvement or deterioration from those forecasted as of the acquisition date. Our acquired loans with specific credit deterioration are accounted for in accordance with Financial Accounting Standards Board Accounting Standards Codification 310-30. Certain acquired loans, those for which specific credit related deterioration subsequent to origination is identified, are recorded at fair value reflecting the present value of the amounts expected to

be collected. Income recognition on purchased credit impaired loans is based on a reasonable expectation about the timing and amount of cash flows to be collected.

Valuation of the Securities Portfolio

Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of an investment. We review other criteria such as magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Investment Securities

Our investment policy authorizes management to invest in traditional securities instruments in order to provide ongoing liquidity, income and a ready source of collateral that can be pledged in order to access other sources of funds. The investment portfolio consists of available for sale and held-to-maturity securities. Available for sale securities are securities that we intend to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors. Held-to-maturity securities are investment securities, comprised of debt and mortgage-backed securities, that management has the positive intent and ability to hold to maturity and are reported at amortized cost.

Accounting for Income Taxes

We use the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates in effect when these differences reverse. 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 all of the deferred tax assets will not be realized. We exercise significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. Realization of deferred tax assets is dependent on generating sufficient taxable income in the future.

RESULTS OF OPERATIONS

Net Interest Income



		Three Months Ended September 30, 2014					Three Months Ended September 30, 2013

		Average Balance		Interest	Yield/Rate		Average Balance		Interest	Yield/Rate

ASSETS
Interest-earning assets:

Interest bearing deposits with banks and federal funds sold	$	15,145,200	$	7,217	0.19%	$	31,173,177	$	20,730	0.26%
Investment securities available for sale		36,385,239		211,289	2.30%		27,953,097		149,767	2.14%
				-
Investment securities held to maturity		496,138		5,158	4.12%		-		-	0.00%

Restricted equity securities		1,205,551		(2,585)	-0.85%		690,700		4,500	2.58%
Total cash and investments		53,232,128		221,079	1.65%		59,816,974		174,997	1.16%

Loans held for sale		6,141,356		64,265	4.19%		36,152,972		349,561	3.87%
Loans, net
Commercial & Industrial		61,379,076		796,794	5.15%		40,861,175		800,352	7.77%
Commercial Real Estate		154,581,582		2,139,654	5.49%		158,063,888		2,660,710	6.68%
Residential Real Estate		124,551,744		1,785,037	5.73%		61,938,709		1,121,242	7.24%
HELOC		39,930,506		491,236	4.92%		41,583,873		519,414	5.00%
Construction		14,030,571		257,260	7.27%		21,462,642		368,474	6.81%
Land		1,774,082		42,186	9.43%		1,723,718		176,465	40.62%
Consumer & Other		1,055,035		25,093	9.44%		2,185,037		32,645	5.93%
Total loans, net (1)		397,302,596		5,537,260	5.53%		327,819,042		5,679,302	6.87%
Total earning assets		456,676,080	$	5,822,604	5.06%		423,788,988	$	6,203,860	5.81%
Cash		3,867,123					7,383,118
Allowance for loan losses		(1,115,411)					(765,831)
Market valuation		271,053					(196,364)
Other assets		25,476,162					27,757,018
Total non-earning assets		28,498,927					34,177,941
Total Assets	$	485,175,007				$	457,966,929

LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing checking and savings	$	86,148,810	$	24,346	0.11%	$	67,150,443	$	19,931	0.12%
Money market		85,103,308		77,138	0.36%		83,028,390		76,174	0.36%
Certificates of deposit		133,898,612		184,884	0.55%		149,947,049		301,054	0.80%
Total interest-bearing deposits		305,150,730		286,368	0.37%		300,125,882		397,159	0.53%
Borrowed funds:
Federal funds purchased		-		-	-		-		-	-
FHLB advances		14,893,759		12,706	0.34%		-		-	-
Total borrowed funds		14,893,759		12,706	0.34%		-		-
Total interest-bearing funds		320,044,489		299,074	0.37%		300,125,882		397,159	0.53%
Noninterest-bearing deposits		95,814,126		-			98,384,826		-
Total cost of funds		415,858,615	$	299,074	0.29%		398,510,708	$	397,159	0.40%
Other liabilities and accrued expenses		2,664,301					5,159,906
Total Liabilities		418,522,916					403,670,614
Stockholders' Equity		66,652,091					54,296,315
Total Liabilities and Stockholders' Equity	$	485,175,007				$	457,966,929
Net interest income and spread (2)			$	5,523,530	4.69%			$	5,806,701	5.28%
Net interest margin (3)					4.80%					5.44%

(1)

Non-accrual loans are included in average loans.

(2)

Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(3)

Net interest margin represents net interest income as a percentage of average interest-earning assets.

The following table sets forth, for the periods indicated, information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities. No tax equivalent yield adjustments were made, as the effect thereof was not material.



		Nine Months Ended September 30, 2014					Nine Months Ended September 30, 2013

		Average Balance		Interest	Yield/Rate		Average Balance		Interest	Yield/Rate

ASSETS
Interest-earning assets:

Interest bearing deposits with banks and federal funds sold	$	32,640,616	$	39,245	0.16%	$	28,702,898	$	58,526	0.27%
Investment securities available for sale		37,545,164		691,087	2.46%		20,313,935		310,900	2.04%
Investment securities held to maturity		167,197		5,158	4.12%		-		-	0.00%
Restricted equity securities		1,263,218		10,070	1.06%		544,539		10,586	2.60%
Total cash and investments		71,616,195		745,560	1.39%		49,561,372		380,012	1.03%

Loans held for sale		6,223,878		196,274	4.20%		21,517,686		590,714	3.66%
Loans, net
Commercial & Industrial		36,271,522		1,949,582	7.19%		30,118,143		1,812,076	8.04%
Commercial Real Estate		156,713,201		7,606,983	6.49%		115,183,781		5,570,534	6.47%
Residential Real Estate		81,086,007		4,349,089	7.15%		47,212,067		2,658,607	7.51%
HELOC		30,978,309		1,512,797	6.51%		28,087,440		1,211,108	5.75%
Construction		14,952,647		833,247	7.45%		15,235,703		826,097	7.25%
Land		1,721,383		132,865	10.32%		1,946,873		263,527	18.10%
Consumer & Other		1,154,154		72,914	8.45%		1,729,460		68,877	5.32%
Total loans, net (1)		322,877,223		16,457,477	6.81%		239,513,467		12,410,826	6.93%
Total earning assets		400,717,296	$	17,399,311	5.81%		310,592,525	$	13,381,552	5.76%
Cash		12,655,169					4,826,887
Allowance for loan losses		(3,169,476)					(787,898)
Market valuation		154,259					248,285
Other assets		35,122,534					18,542,519
Total non-earning assets		44,762,486					22,829,793
Total Assets	$	445,479,782				$	333,422,318

LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing checking and savings	$	69,673,458	$	67,116	0.13%	$	43,217,713	$	45,057	0.14%
Money market		80,721,057		223,247	0.37%		57,905,369		163,236	0.38%
Time deposits		119,384,436		606,233	0.68%		113,701,701		690,470	0.81%
Total interest-bearing deposits		269,778,951		896,596	0.44%		214,824,783		898,763	0.56%
Borrowed funds:
Federal funds purchased		-		-	0.00%		18,315		139	1.01%
FHLB advances		5,019,142		12,706	0.34%		37,363		1,553	5.56%
Total borrowed funds		5,019,142		12,706	0.34%		55,678		1,692	4.06%
Total interest-bearing funds		274,798,093		909,302	0.44%		214,880,461		900,455	0.56%
Noninterest-bearing deposits		93,621,837		-			68,652,131		-
Total cost of funds		368,419,930	$	909,302	0.33%		283,532,592	$	900,455	0.42%
Other liabilities and accrued expenses		1,989,167					3,551,366
Total Liabilities		370,409,097					287,083,958
Stockholders' Equity		75,070,685					46,338,360
Total Liabilities and Stockholders' Equity	$	445,479,782				$	333,422,318
Net interest income and spread (2)			$	16,490,009	5.36%			$	12,481,097	5.20%
Net interest margin (3)					5.50%					5.37%

(1)

Non-accrual loans are included in average loans.

(2)

Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(3)

Net interest margin represents net interest income as a percentage of average interest-earning assets.

Net interest income, the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities, is the most significant component of our earnings. Net interest income is a function of several factors, including the volume and mix of interest-earning assets and funding sources, as well as the relative level of market interest rates. While management’s policies influence some of these factors, external forces, including customer needs and demands, competition, the economic policies of the federal government and the monetary policies of the Federal Reserve also affect net interest income.

Net interest income increased by $4.0 million for the nine months ended September 30, 2014 when compared to the nine months ended September 30, 2013. The increase was supported by $90 million of growth in average interest earning assets added by the Merger and the Slavie Acquisition, a 14 basis point reduction in the average cost of funds, and a 5 basis point increase in the average rates earned on interest earning assets. The net interest margin for the third quarter of 2014 decreased to 4.80% from 5.56% for the second quarter of 2014 and 5.44% for the third quarter of 2013. While the average rates on interest earning assets increased, interest income recognition was assisted by favorable accretions of net discounts on loans of $0.9 million and $4.0 million during the three and nine month periods of 2014, respectively, compared to $1.2 million and $3.2 million, respectively, during the same periods of 2013. As of September 30, 2014, the remaining net loan discounts on the Bank’s loan portfolio, including pre-Merger Bank loans and loans acquired in the Merger and the Slavie acquisition totaled $16.6 million.

Total interest income decreased by $0.4 million, or -6.15%, for the three months ended September 30, 2014, when compared to the same period in 2013. Total interest income increased by $4.0 million, or 30.02%, for the nine months ended September 30, 2014, when compared to the same periods in 2013. Interest income on loans decreased by $0.1 million, or -2.29%, for the three months ended September 30, 2014 and increased by $4.0 million, 32.61%, for the nine months ended September 30, 2014 when compared to same periods of 2013. Interest income on loans held for sale, investment securities and interest-bearing deposits in banks and federal funds sold decreased by an aggregate of $0.2 million and increased by the aggregate of $0.1 million for the three and nine months ended September 30, 2014, respectively, when compared to same periods of 2013. Due primarily to the Merger and the Slavie Acquisition, average interest-earning assets increased by $32.9 million and $90.1 million, respectively, while average interest-bearing liabilities increased $20.1 and $73.7 million during the three and nine months ended September 30, 2014, respectively, when compared to same periods of 2013.

Total interest expense decreased by $0.1 million, or 24.7% for the three months ended September 30, 2014, when compared to same period of 2013. The total cost of interest-bearing liabilities decreased to 0.42% for the nine months ended September 30, 2014, as compared to 0.56% for same period of 2013. Average noninterest-bearing deposits increased by $2.6 million and $25.0 million during the three and nine months ended September 30, 2014, respectively, when compared to the same periods in 2013, again, primarily due to the Merger and the Slavie Acquisition.

Provision for Loan Losses

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management's best estimate, is necessary to absorb probable losses within the existing loan portfolio. On a monthly basis, management reviews all loan portfolios to determine trends and monitor asset quality. For consumer loan portfolios, this review generally consists of reviewing delinquency levels on an aggregate basis with timely follow-up on accounts that become delinquent. In commercial loan portfolios, delinquency information is monitored and periodic reviews of business and property leasing operations are performed on an individual loan basis to determine potential collection and repayment problems. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.

The provision for loan losses in the three and nine months ending September 30, 2014 was $220,000 and $580,000, respectively, compared to $350,000 and $534,000, respectively, for the same periods of 2013. The changes from the 2013 periods were due primarily to charge-offs and specific reserves established for loans acquired in the Bank Merger and loan originations thus far in 2014. As a result, the allowance for loan losses was $1.13 million at September 30, 2014, representing 0.29% of total loans, compared to $1.10 million, or 0.28% of total loans, at June 30, 2014 and $0.85 million, or 0.27% of total loans, at December 31, 2013. Management expects both the allowance for loan losses and the related provision for loan losses to increase in the future due to the gradual runoff of the discount on the acquired loan portfolio and an increase in new loan originations.

Noninterest Income

The following tables reflect the amounts and changes in noninterest income for the three and nine months ended September 30, 2014 and 2013:



		Three Months Ended September 30,				2014 vs 2013
		2014		2013		$ Change	% Change

Electronic banking fees (1)	$	674,701	$	708,300	$	(33,599)	-5%
Mortgage-banking fees and gains (1)		259,740		529,570		(269,830)	-51%
Net (loss) gain on sale of real estate acquired through foreclosure		(1,503)		40,998		(42,501)	-104%
Brokerage commissions (1)		-		199,392		(199,392)	-100%
Service charges on deposit accounts		99,451		100,476		(1,025)	-1%
Other income		95,003		184,311		(89,308)	-48%
Total Noninterest Income	$	1,127,392	$	1,763,047	$	(635,655)	-36%



		Nine Months Ended September 30,				2014 vs 2013
		2014		2013		$ Change	% Change

Electronic banking fees (1)	$	1,991,048	$	1,359,477	$	631,571	46%
Mortgage banking fees and gains (1)		767,803		1,556,385		(788,582)	-51%
Net gain on sale of real estate acquired through foreclosure		27,422		89,342		(61,920)	-69%
Brokerage commissions (1)		-		316,884		(316,884)	-100%
Service charges on deposit accounts		303,396		191,690		111,706	58%
Bargain purchase gain		510,844		2,860,199		(2,349,355)	-82%
Other income		3,031,629		397,418		2,634,211	663%
Total Noninterest Income	$	6,632,142	$	6,771,395	$	(139,253)	-2%

(1)

New business unit acquired in the Merger

Noninterest income for the three months ended September 30, 2014 was $1.13 million compared to $1.76 million for the same period in 2013. This decrease was primarily the result of $0.27 million decrease in mortgage banking fees and gains along with a $0.20 million decline in brokerage commissions. Expectations are for increased income in both areas in upcoming quarters.

Noninterest income for the nine months ended September 30, 2014 was $6.63 million compared to $6.77 million for the same period in 2013. This variance is the result of the 2014 recognition of the remaining interest rate mark-to-market adjustment on IRA deposits of $2.16 million and a 2014 $0.51 million bargain purchase gain associated with the Slavie Acquisition compared to the $2.86 million bargain purchase gain associated with the Merger that was recognized during the first nine months of 2013. Electronic banking fees increased by $0.63 million during the first nine months of 2014, as the Merger added this business unit to the Bank. Mortgage banking fees for the first nine months of 2014 declined by $0.79 million when compared to the same period of 2013, while deposit service charges increased by $0.1 million.

Noninterest Expenses

The following table reflects the amounts and changes in noninterest expense for the three months ended September 30, 2014 and 2013:



		Three Months Ended September 30,				2014 vs 2013
		2014		2013		$ Change	% Change

Salary and employee benefits	$	3,244,553	$	3,461,109	$	(216,556)	-6%
Occupancy expenses		722,573		716,482		6,091	1%
Furniture and equipment expenses		280,320		239,704		40,616	17%
Legal, accounting and other professional fees		356,226		344,867		11,359	3%
Data processing and items processing services		371,572		394,021		(22,449)	-6%
FDIC insurance costs		84,882		82,246		2,636	3%
Advertising and marketing related expenses		105,546		78,277		27,269	35%
Foreclosed property expenses		113,903		104,170		9,733	9%
Loan collection costs		152,196		143,021		9,175	6%
Core deposit intangible amortization		245,674		336,273		(90,599)	-27%
Merger and acquisition related expenses		637,272		143,709		493,563	343%
Other expenses		1,656,932		674,990		981,942	145%
Total Noninterest Expenses	$	7,971,649	$	6,718,869	$	1,252,780	19%

The following table reflects the amounts and changes in noninterest expense for the nine months ended September 30, 2014 and 2013:



		Nine Months Ended September 30,				2014 vs 2013
		2014		2013		$ Change	% Change

Salary and employee benefits	$	9,769,014	$	7,644,886	$	2,124,128	28%
Occupancy expenses		2,256,683		1,458,086		798,597	55%
Furniture and equipment expenses		875,274		526,551		348,723	66%
Legal, accounting and other professional fees		1,088,451		961,948		126,503	13%
Data processing and item processing services		863,909		832,636		31,273	4%
FDIC insurance costs		287,568		194,572		92,996	48%
Advertising and marketing related expenses		290,511		220,254		70,257	32%
Foreclosed property expenses		504,295		273,084		231,211	85%
Loan collection costs		305,099		303,253		1,846	1%
Core deposit intangible amortization		738,416		517,203		221,213	43%
Merger and acquisition related expenses		877,560		1,998,646		(1,121,086)	-56%
Other expenses		2,710,244		1,228,680		1,481,564	121%
Total Noninterest Expenses	$	20,567,024	$	16,159,799	$	4,407,225	27%

Noninterest expense for the three months ended September 30, 2014 was $7.97 million compared to $6.26 million for the prior quarter and $6.72 million for the third quarter of 2013. The primary contributors to the increase when compared to the third quarter of 2013 were increases in Merger-related expenses of $0.49 million and other expenses of $0.98 million.

Noninterest expense for the nine months ended September 30, 2014 was $20.57 million compared to $16.16 million for the same period in 2013, an increase of $4.41 million. The increase relates to the inclusion during the first three quarters of 2014 of a full nine months of ongoing expenses related to the Merger and $0.76 million of expenses from the Slavie Acquisition. Categories impacted by these full nine months of expenses were increases in salaries and employee benefits of $2.12 million, occupancy, furniture and equipment expenses of $1.10 million, foreclosed property expenses of $0.23 million, legal, accounting and other professional fees of $0.13 million and core deposit intangible amortization of $0.22 million. This was offset by a $1.12 million decline in Merger-related expenses. The increase in other expenses relates to the 212,000 shares awarded and immediately vested in July 2014, along with a full nine months of other expenses related to the Merger.

Income Taxes

The actual effective tax rate of 38.9% for the three months ended September 30, 2014 is slightly lower than the federal and state combined statutory rate primarily due to that portion of our investment portfolio that is invested in municipal bonds.

The actual effective tax rate of 9.6% for the nine months ended September 30, 2014 includes the second quarter $482,000 refunds claimed on the filing of amended income tax returns for the former Carrollton Bank as well as the impact of the $157,000 partial reversal in the first quarter of 2014 of a valuation allowance attributable to estimated future built-in losses that were recorded in 2013.

The bargain purchase gain recognized in 2014 is the result of the Slavie Acquisition in a taxable transaction. Therefore, there is no impact from the transaction on the effective tax rate. The estimated annual effective tax rate excluding the amended return claims and the partial reversal of the valuation allowance for the reporting periods ended September 30, 2014 was 42.0%.

FINANCIAL CONDITION

Total assets were $480 million at September 30, 2014, an increase of $60.4 million, or 14%, when compared to December 31, 2013. The increase was due to net increases in loans of $73.4 million, or 23%. The Bank acquired net loans of $82.9 million in the Slavie Acquisition, which was offset by a net loan decline of $9.9 million and a $6.5 million decrease in mortgage loans held for sale. Excluding $7.0 of net principal repayments from the Slavie portfolio in the third quarter of 2014, the Bank achieved increased commercial and residential lending volume, as third quarter new loan originations and draws exceeded loan principal repayments by $6.4 million.

Total deposits were $399 million at September 30, 2014, an increase of $37.6 million, or 10%, when compared to December 31, 2013. The increase was primarily driven from $110.8 million deposits assumed in the Slavie Acquisition, offset by the $24.0 million decrease from the exit of the IRA product line, a net $9.5 million decrease resulting from the three closed Bank branch locations, and deposits acquired in the Slavie Acquisition declining by $42.7 million as part of the Bank’s strategy to reposition the deposit composition in connection with the FDIC receivership. Organic net deposit growth of $3 million completes the activity over the first three quarters of 2014.

Stockholders’ equity was $65.2 million at September 30, 2014, an increase of $10.6 million, or 20% when compared to December 31, 2013. The increase resulted primarily from the $7.0 million received in the Capital Transaction and the retention of corporate earnings.

Investment Securities

Our investment policy authorizes management to invest in traditional securities instruments in order to provide ongoing liquidity, income and a ready source of collateral that can be pledged in order to access other sources of funds. The investment portfolio consists of available-for-sale and held-to-maturity securities. Available-for-sale securities are those securities that we intend to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors. Held-to-maturity securities are securities we have the intent and ability to hold until maturity. These securities are carried at amortized cost.

The investment portfolio consists primarily of U.S. Government agency securities, residential mortgage-backed securities, and state and municipal obligations. The income from state and municipal obligations is exempt from federal income tax. Certain agency securities are exempt from state income taxes. We use the investment portfolio as a source of both liquidity and earnings. Management continues to evaluate investment options that will produce income without assuming significant credit or interest rate risk and to look for opportunities to use liquidity from maturing investments to reduce our use of high cost time deposits and borrowed funds.

Investment securities decreased $0.8 million, or 2.3%, to $35.8 million at September 30, 2014, from $36.6 million at December 31, 2013. This decrease was the result of net principal pay downs, discount accretion and premium amortization totaling $2.8 million and an increase in market value of $0.5 million offset by net purchases and acquisitions of $1.5 million.

Restricted Equity Securities

Restricted equity securities increased $0.4 million or 35.49%, to $1.4 at September 30, 2014, from $1.0 million at December 31, 2013. This increase was the result of additional purchases of FHLB stock required as a result of increased borrowings from the FHLB.

Loans Held for Sale

Loans held for sale were $6.3 million at September 30, 2014 compared to $12.8 million at December 31, 2013. The decrease in loans held for sale was due to loan sales outpacing new originations during the first nine months of 2014. Loans originated for sale to third-party investors generally remain on our balance sheet for an average of 45 days.

Loans

Loans, net of deferred fees and costs, increased by $73.4 million from $320.7 million at December 31, 2013 to $394.1 million at September 30, 2014, primarily due to the Slavie Acquisition.

Loans are placed on nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of all interest and/or principal is in doubt. Placing a loan on nonaccrual status means that we no longer accrue interest on such loan and reverses any interest previously accrued but not collected. Management may grant a waiver from nonaccrual status for a 90-day past-due loan that is both well secured and in the process of collection. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to make payments in accordance with the terms of the loan and remain current.

A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the fair value of the collateral for collateral dependent loans and at the present value of expected future cash flows using the loans’ effective interest rates for loans that are not collateral dependent.

At September 30, 2014, we had 274 impaired loans totaling $52.4 million (including PCI loans of $46.3 million). Of this amount, 59 impaired loans totaling $11.2 million were classified as nonaccrual loans. At September 30, 2014, troubled debt restructurings, or TDRs, included in impaired loans totaled $2.1 million, eight loans of which were included in nonaccrual loans having a total balance of $0.4 million. Borrowers under all other restructured loans are paying in accordance with the terms of the modified loan agreement and have been placed on accrual status after a period of performance with the restructured terms. At September 30, 2014, there were no specific reserves included in the allowance for loan losses for impaired loans.

The following table presents details of our nonperforming loans and nonperforming assets, as these asset quality metrics are evaluated by management, at the dates indicated:




	September 30, 2014		December 31, 2013

Nonaccrual loans excluding PCI loans	$	6,967,237	$	3,809,000
Nonaccrual PCI loans		4,837,477		179,114
TDR loans excluding those in nonaccrual loans or past due 90+ days		1,734,734		1,633,980
Accruing loans past due 90+ days excluding PCI loans		-		-
Accruing PCI loans past due 90+ days		5,487,280		2,692,572

Total nonperforming loans		19,026,728		8,314,666

Real estate acquired through foreclosure		1,642,524		1,290,120

Total nonperforming assets	$	20,669,252	$	9,604,786

The level of nonperforming assets has increased primarily as a result of the Merger and the Slavie Acquisition. Nonperforming assets continue to have a negative impact on earnings as the economy is showing only some improvement. Management has worked diligently to identify borrowers that may be facing difficulties in order to restructure terms where appropriate, secure additional collateral or pursue foreclosure and other secondary sources of repayment. The continued success in reducing nonperforming assets will ultimately be dependent on continued management diligence and improvement in the economy and the real estate market.

Potential problem loans consist of loans that are performing under contract but for which credit problems have caused us to place them on our list of criticized loans. These loans have a risk rating of 6 (Special Mention) or higher, and exclude all nonaccrual

loans and accruing loans past due 90+ days. As of September 30, 2014, these loans totaled $27.6 million and consisted primarily of Commercial Real Estate loans and Residential Real Estate loans which had balances of $16.3 million and $7.9 million, respectively. Difficulties in the economy and the accompanying impact on these borrowers, as well as future events, such as regulatory examination assessments, may result in these loans and others being classified as nonperforming assets in the future.

Allowance for Loan Losses and Credit Risk Management

Management valued the loan portfolio acquired by the Bank as part of the Slavie Acquisition with the assistance of an independent third party appraiser. Based on the Bank’s review of the fair values of the acquired loans as presented in the appraisal report provided during the third quarter and overall assessment of the condition of the acquired loans since acquisition, an updated specific reserve or general reserve analysis was not deemed necessary on this acquired portfolio at September 30, 2014. As such, the methodology and summary results of the allowance analysis described herein relate solely to the legacy pre-Slavie Acquisition Bay Bank loan balances at September 30, 2014.

The allowance for loan losses is established to estimate losses that may occur on loans by recording a provision for loan losses that is charged to earnings in the current period. The allowance is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historic experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Measured impairment and credit losses are charged against the allowance when management believes the loan or a portion of the loan’s balance is not collectable. Subsequent recoveries, if any, are credited to the allowance.

The allowance consists of specific and general reserves. The specific reserve relates to individual loans that are classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement and primarily includes nonaccrual loans, troubled debt restructurings, and purchased credit impaired loans where cash flows have deteriorated from those forecast as of the acquisition date. For those loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price, whichever is appropriate, of the impaired loan is lower than the carrying value of the loan. For collateral-dependent impaired loans, any measured impairment is properly charged-off against the loan and allowance in the applicable reporting period. The specific component may fluctuate from period to period if changes occur in the nature and volume of impaired loans.

The general reserve covers pools of similar loans, including purchased loans that did not have deteriorated credit quality and new loan originations, and is based upon historical loss experience and several qualitative factors. These qualitative factors address various risk characteristics in the Bank’s loan portfolio after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data. Management will continue to evaluate the appropriateness of the peer group data used with each quarterly allowance analysis until such time that the Bank has sufficient loss experience to provide a foundation for the general reserve requirement. The general component may fluctuate from period to period if changes occur in the mix of the Bank’s loan portfolio, economic conditions, or specific industry conditions.

On a quarterly basis, an assessment of the adequacy of the allowance is performed by management using the methodology outlined above and the results are reported to the Board of Directors. The complex evaluations involved in such assessments require significant estimates. Management uses available data to establish the allowance at a prudent level, recognizing that the determination is inherently subjective, and that future adjustments may be necessary, depending upon many items including a change in economic conditions affecting specific borrowers, or in general economic conditions, and new information that becomes available. However, there are no assurances that the allowance will be sufficient to absorb losses on nonperforming loans, or that the allowance will be sufficient to cover losses on nonperforming loans in the future.

The allowance was $1,129,250 at September 30, 2014, compared to $851,000 at December 31, 2013. The allowance as a percentage of total portfolio loans was 0.29% at September 30, 2014 and 0.27% at December 31, 2013.

For non-impaired loans acquired by the Bank from Bay National Bank on July 10, 2010 without evidence of deteriorated credit quality, there was a net unamortized discount of $1.1 million and $1.2 million at September 30, 2014 and December 31, 2013, respectively, which represented 4.5% and 4.2%, respectively, of the related loan balance. For non-impaired acquired legacy Carrollton Bank portfolio loans without evidence of deteriorated credit quality, there was a net unamortized discount of $1.7 million and $1.6 million at September 30, 2014 and December 31, 2013, respectively, which represented 1.3% and 1.1%, respectively, of the related loan balance. As the total combined remaining discount exceeded the indicated total required reserve for these loan pools, no additional reserves were recorded.

During the three and nine months ended September 30, 2014, we recorded net charge-offs of $190,769 and $301,967, respectively, compared to net charge-offs of $398,328 and $499,089, respectively, during the same periods of 2013.

The following table reflects activity in the allowance for loan losses for the periods indicated:


	Three Months Ended September 30,				Nine Months Ended September 30,
		2014		2013		2014		2013
Balance at beginning of year	$	1,099,646	$	738,437	$	851,000	$	655,942
Chargeoffs:
Commercial & Industrial		-		(41,260)		-		(41,260)
Commercial Real Estate		(79,633)		(85,805)		(216,589)		(85,805)
Residential Real Estate		(125,827)		(297,998)		(163,304)		(441,421)
Home Equity Line of Credit		(15,508)		-		(79,492)		-
Land		-		-		-		-
Construction		-		-		-		-
Consumer & Other				(1,000)				(1,000)
Total charge-offs		(220,968)		(426,063)		(459,385)		(569,486)

Recoveries:
Commercial & Industrial		30,000		-		30,000		-
Commercial Real Estate		-		-		101,614		-
Residential Real Estate		-		3,702		5,542		33,793
Home Equity Line of Credit		-		1,007		9,844		13,578
Land		-		23,026		-		23,026
Construction		-		-		-		-
Consumer & Other		199		-		10,418		-
Total recoveries		30,199		27,735		157,418		70,397

Net charge-offs		(190,769)		(398,328)		(301,967)		(499,089)
Provision for loan loss		220,373		350,365		580,217		533,621

Balance at end of period	$	1,129,250	$	690,474	$	1,129,250	$	690,474

Net charge-offs annualized as a percentage of average loans		0.19%		0.49%		0.12%		0.28%

Deposits

The following deposit table presents the composition of deposits at the dates indicated.



	September 30, 2014			December 31, 2013				2014 vs 2013
		Amount	% of Total		Amount	% of Total		$ Change	% Change
Noninterest-bearing deposits	$	92,902,861	23%	$	90,077,139	25%	$	2,825,722	3%

Interest-bearing deposits:
Checking		51,513,763	13%		42,378,939	12%		9,134,824	22%
Savings		37,574,748	9%		27,817,849	8%		9,756,899	35%
Money market		83,871,365	21%		78,356,997	22%		5,514,368	7%
Total interest-bearing checking, savings and money market deposits		172,959,876	43%		148,553,785	42%		24,406,091	16%

Time deposits under $100,000		56,029,038	14%		59,403,534	16%		(3,374,496)	-6%
Time deposits of $100,000 or more		76,704,567	19%		62,959,013	17%		13,745,554	22%
Total time deposits		132,733,605	33%		122,362,547	33%		10,371,058	8%

Total interest bearing deposits		305,693,481	77%		270,916,332	75%		34,777,149	13%

Total Deposits	$	398,596,342	100%	$	360,993,471	100%	$	37,602,871	10%

Total deposits were $399 million at September 30, 2014, an increase of $38 million, or 10%, when compared to December 31, 2013. The increase was primarily driven by $110.8 million in deposits assumed in the Slavie Acquisition, offset by the $24.0 million decrease from the exit of the IRA product line, a net $9.5 million decrease resulting from the three closed Bank branch locations, and deposits acquired in the Slavie Acquisition declining by $43.1 million as part of the Bank’s strategy to reposition the deposit composition. The Bank generated organic net deposit growth of $3 million over the first nine months of 2014. Within the

deposit base, non-interest bearing demand account balances increased $3 million, or 3%; money market balances increased $6 million, or 7%, and time deposit balances increased by $10 million, 8% higher than at year end.

The ratio of noninterest-bearing deposits to total deposits was 23% as of September 30, 2014, 2% lower than at December 31, 2013. Included in our deposit portfolio are brokered deposits through the Promontory Interfinancial Network (the “Network”). Through this deposit matching network, which includes Certificate of Deposit Registry Service (“CDARS“) and Insured Cash Sweep service (“ICS”) deposits, we have the ability to offer our customers access to FDIC-insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through the Network on behalf of a customer, we typically receive matching deposits through the network’s reciprocal deposit program. At September 30, 2014, we had $14.8 million in deposits through the Network compared to $11.6 million at December 31, 2013. We can also choose to place deposits through the Network without receiving matching deposits. At September 30, 2014, we had placed $0.5 million of deposits through the Network for which we received no matching deposits, compared to $3.4 million at December 31, 2013.

Borrowings

Borrowings consisted of short-term FHLB advances totaling $12.0 million at September 30, 2014 and $0 at December 31, 2013. At September 30, 2014, $8.0 million of the borrowings were 30-day advances and the remaining $4.0 million were overnight advances. We had no long-term borrowings at September 30, 2014 and December 31, 2013.

CAPITAL RESOURCES

Ample capital is necessary to sustain growth, provide a measure of protection against unanticipated declines in asset values and safeguard the funds of depositors. Capital also provides a source of funds to meet loan demand and enables us to manage assets and liabilities effectively.

At September 30, 2014, our total stockholders’ equity increased to $65.2 million from $54.6 million at December 31, 2013. The increase resulted primarily from the $7.0 million received in the second quarter of 2014 from the Capital Transaction and the retention of corporate earnings.

In addition, the OCC requires that FSBs, like the Bank, maintain a minimum level of Tier 1 capital to average total assets excluding intangibles. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered adequately capitalized is 4%, but an individual institution could be required to maintain a higher level. In connection with the Merger, the Bank entered into an Operating Agreement with the OCC pursuant to which the Bank agreed, among other things, to maintain a leverage ratio of at least 10% for the term of the Operating Agreement. The Operating Agreement will remain in effect until it is terminated by the OCC or the Bank ceases to be an FSB, either due to a merger or otherwise.

Until the implementation of the Basel III Capital Rules, the Company is not subject to its specific capital requirements. The Basel III Capital Rules generally will subject the Company to the same capital requirements that apply to other depository institution holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and a leverage ratio of Tier 1 capital (as defined) to average tangible assets (as defined). At September 30, 2014 and December 31, 2013, the Bank had regulatory capital in excess of those required under each requirement and was classified as “well capitalized”.

Actual capital amounts and ratios for the Bank are presented in the following table (dollars in thousands):



										To Be Well
										Capitalized Under
						To Be Considered				Prompt Corrective
		Actual				Adequately Capitalized				Action Provisions
As of September 30, 2014:		Amount	Ratio			Amount	Ratio			Amount	Ratio

Total Risk-Based Capital Ratio	$	60,376	16.14	%	$	29,922	8.00	%	$	37,402	10.00	%

Tier I Risk-Based Capital Ratio	$	59,247	15.84	%	$	14,961	4.00	%	$	22,441	6.00	%

Leverage Ratio	$	59,247	12.51	%	$	18,943	4.00	%	$	23,679	5.00	%

As of December 31, 2013:

Total Risk-Based Capital Ratio	$	47,815	14.68	%	$	26,049	8.00	%	$	32,562	10.00	%

Tier I Risk-Based Capital Ratio	$	46,964	14.42	%	$	13,025	4.00	%	$	19,537	6.00	%

Leverage Ratio	$	46,964	11.41	%	$	16,461	4.00	%	$	20,577	5.00	%

The OCC is required to take certain supervisory actions against an undercapitalized FSB, the severity of which depends upon the FSB’s degree of capitalization. Failure to maintain an appropriate level of capital could cause the OCC to take any one or more of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

Banking regulations also limit the amount of dividends that may be paid without prior approval by an FSB's regulatory agency. In addition to these regulations, the Bank agreed in the Operating Agreement that it would not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including the minimum capital requirements. Due to the Bank’s desire to preserve capital to fund its growth, we currently do not anticipate paying a dividend for the foreseeable future. In addition to these regulatory restrictions, it should be noted that the declaration of dividends is at the discretion of our Board of Directors and will depend, in part, on our earnings and future capital needs.

The current capital regime will significantly change when the Basel III Capital Rules are phased in starting on January 1, 2015. These changes are discussed in Item 1 of Part I of the Company’s Annual Return on Form 10-K for the year ended December 31, 2013 under the heading “Capital Requirements” in the “Supervision and Regulation” section.

Management is in the process of reviewing the new rule to determine the impact that it will have on the Company and the Bank.

LIQUIDITY

Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the Company’s customers, as well as to meet current and planned expenditures. Management monitors the liquidity position daily.

Our liquidity is derived primarily from our deposit base, scheduled amortization and prepayments of loans and investment securities, funds provided by operations and capital. Additionally, liquidity is provided through our portfolios of cash and interest-bearing deposits in other banks, federal funds sold, loans held for sale, and securities available for sale. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by the Bank’s competition.

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled $73.2 million at September 30, 2014. Management notes that, historically, a small percentage of unused lines of credit are actually drawn down by customers within a 12-month period.

Our most liquid assets are cash and assets that can be readily converted into cash, including interest-bearing deposits with banks and federal funds sold, and investment securities. As of September 30, 2014, we had $7.3 million in cash and due from banks, $9.7 million in interest-bearing deposits with banks and federal funds sold, and $34.4 million in investment securities available for sale.

The Bank also has external sources of funds through the Federal Reserve Bank (“FRB”) and FHLB, which can be drawn upon when required. The Bank has a line of credit totaling approximately $97.5 million with the FHLB of which $65.5 million was available to be drawn on September 30, 2014 based on outstanding advances and qualifying loans pledged as collateral. In addition, the Bank can pledge securities at the FRB and FHLB and, depending on the type of security, may borrow approximately 50% to 97%, respectively, of the fair market value of the securities. The Bank had $20.3 million of securities pledged at the FHLB, $0.2 million of securities pledged at the FRB, and an additional $15.3 million of unpledged securities. Using all securities as collateral, the Bank could borrow approximately $26.2 million as of September 30, 2014. Additionally, the Bank has unsecured federal funds lines of credit totaling $8.0 million with two institutions and a $4.0 million secured federal funds line of credit with another institution. The secured federal funds line of credit with another institution would require the Bank to transfer securities currently pledged at the FHLB or the FRB or to pledge unpledged securities to this institution before it could borrow against this line. At September 30, 2014, the Bank had $12.0 million of FHLB advances outstanding.

To further aid in managing liquidity, the Bank’s Board of Directors has approved and formed an Asset/Liability Management Committee (“ALCO”) to review and discuss recommendations for the use of available cash and to maintain an investment portfolio. By limiting the maturity of securities and maintaining a conservative investment posture, management can rely on the investment portfolio to help meet any short-term funding needs.

We believe the Bank has adequate cash on hand and available through liquidation of investment securities and available borrowing capacity to meet our liquidity needs. Although we believe sufficient liquidity exists, if economic conditions and consumer confidence deteriorate, this liquidity could be depleted, which would then materially affect our ability to meet operating needs and to raise additional capital.

MARKET RISK AND INTEREST RATE SENSITIVITY

Our primary market risk is interest rate fluctuation. Interest rate risk results primarily from the traditional banking activities in which the Bank engages, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on liabilities. Our interest rate risk represents the level of exposure we have to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates. The ALCO oversees our management of interest rate risk. The objective of the management of interest rate risk is to maximize stockholder value, enhance profitability and increase capital, serve customer and community needs, and protect us from any material financial consequences associated with changes in interest rate risk.

Interest rate risk is that risk to earnings or capital arising from movement of interest rates. It arises from differences between the timing of rate changes and the timing of cash flows (repricing risk); from changing rate relationships across yield curves that affect bank activities (basis risk); from changing rate relationships across the spectrum of maturities (yield curve risk); and from interest rate related options embedded in certain bank products (option risk). Changes in interest rates may also affect a bank’s underlying economic value. The value of a bank’s assets, liabilities, and interest-rate related, off-balance sheet contracts is affected by a change in rates because the present value of future cash flows, and in some cases the cash flows themselves, is changed.

We believe that accepting some level of interest rate risk is necessary in order to achieve realistic profit goals. Management and the Board have chosen an interest rate risk profile that is consistent with our strategic business plan.

The Company’s board of directors has established a comprehensive interest rate risk management policy, which is administered by our ALCO. The policy establishes limits on risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity or “EVE” at risk) resulting from a hypothetical change in U.S. Treasury interest rates. We measure the potential adverse impacts that changing interest rates may have on our short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology we employ. When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model. Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan customers’ ability to service their debts, or the impact of rate changes on demand for loan and deposit products.

We prepare a current base case and eight alternative simulations at least once a quarter and report the analysis to the board of directors. In addition, more frequent forecasts are produced when the direction or degree of change in interest rates are particularly uncertain to evaluate the impact of balance sheet strategies or when other business conditions so dictate.

The statement of condition is subject to quarterly testing for eight alternative interest rate shock possibilities to indicate the inherent interest rate risk. Average interest rates are shocked by +/ - 100, 200, 300, and 400 basis points (“bp”), although we may elect not to use particular scenarios that we determine are impractical in the current rate environment. It is our goal to structure the balance sheet so that net interest-earnings at risk over a twelve-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels.

At September 30, 2014, the simulation analysis reflected an asset sensitive position. Management currently strives to manage higher costing fixed rate funding instruments, while increasing assets that are more fluid in their repricing. An asset sensitive position, theoretically, is favorable in a rising rate environment since more assets than liabilities will reprice in a given time frame as interest rates rise. Similarly, a liability sensitive position, theoretically, is favorable in a declining interest rate environment since more liabilities than assets will reprice in a given time frame as interest rates decline. Management works to maintain a consistent spread between yields on assets and costs of deposits and borrowings, regardless of the direction of interest rates.

OFF-BALANCE SHEET ARRANGEMENTS

We enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, and letters of credit issued by the Bank. Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is a “smaller reporting company” and, as such, disclosure pursuant to this Item 3 is not required.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in Bay Bancorp, Inc. reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the SEC, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in those rules and forms, and that such information is accumulated and communicated to management, including Bay’s principal executive officer (“PEO”) and its principal accounting officer (“PAO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of September 30, 2014 was carried out under the supervision and with the participation of management, including the PEO and the PAO. Based on that evaluation, management, including the PEO and the PAO, has concluded that the Company’s disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the three months ended September 30, 2014, there were no changes in the Company’s internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is involved in various legal actions arising from the normal business activities. In management’s opinion, the outcome of these matters, individually or in the aggregate, will not have a material adverse impact on the results of its operations or financial condition.

ITEM 1A. RISK FACTORS

The risks and uncertainties to which the Company’s financial condition and results of operations are subject were discussed in Bay’s Annual Report on Form 10-K for the year ended December 31, 2013. Management does not believe that any material changes in these risk factors have occurred since they were last disclosed.

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

The exhibits filed or furnished with this quarterly report are listed in the exhibit index that immediately follows the signature hereto, which list is incorporated herein by reference.

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.

BAY BANCORP, INC



Date	November 14, 2014	PRINCIPAL EXECUTIVE OFFICER:

		/s/ Kevin B. Cashen
		Kevin B. Cashen
		President and Chief Executive Officer
		(Principal Executive Officer)

		PRINCIPAL FINANCIAL OFFICER:

Date	November 14, 2014	/s/ Larry D. Pickett
		Larry D. Pickett
		Executive Vice President and Chief Financial Officer
		(Principal Accounting Officer)

EXHIBIT INDEX


Exhibit No.	Description
10.1 31.1	Letter Agreement, dated July 29, 2014, between Bay Bancorp, Inc. and Joseph J. Thomas (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on August 5, 2014).” Rule 13a-14(a) Certification by the Principal Executive Officer (filed herewith)

31.2	Rule 13a-14(a) Certification by the Principal Financial Officer (filed herewith)

32.1	Certification by the Principal Executive Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)

32.2	Certification by the Principal Financial Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)

101	Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith)

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Bad

Bay Bancorp (BYBK) Inactive 10-Q2014 Q3 Quarterly report

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