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EX-32 - EX-32 - SEVERN BANCORP INCsvbi-20180331xex32.htm
EX-31.2 - EX-31.2 - SEVERN BANCORP INCsvbi-20180331ex312d61e9b.htm
EX-31.1 - EX-31.1 - SEVERN BANCORP INCsvbi-20180331ex311c6f86e.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

(Mark One)

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

For the quarterly period ended March 31, 2018

or

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 0‑49731

SEVERN BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

Maryland

52‑1726127

(State or other jurisdiction of incorporation or organization)

(I.R.S. employer identification no.)

 

 

 

 

200 Westgate Circle, Suite 200
 Annapolis, Maryland

21401

(Address of principal executive offices)

(Zip Code)

 

410‑260‑2000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and formal fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

 

 

 

Large accelerated filer

 

Accelerated filer 

 

 

 

Non- accelerated filer (Do not check if a smaller reporting company)

 

Smaller reporting company

 

 

 

Emerging growth company 

 

 

 

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock, $0.01 par value –12,688,626 shares outstanding as of May 14, 2018

 

 

 


 

SEVERN BANCORP, INC. AND SUBSIDIARIES

Table of Contents

 

 

 

 

Page

PART I – FINANCIAL INFORMATION 

 

 

 

 

Item 1. 

Financial Statements

 

 

 

 

 

Consolidated Statements of Financial Condition as of March 31, 2018 (unaudited) and December 31, 2017

1

 

 

 

 

Consolidated Statements of Operations for the Three Months Ended March 31, 2018 and 2017 (unaudited)

2

 

 

 

 

Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2018 and 2017 (unaudited)

3

 

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2018 and 2017 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017 (unaudited)

5

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

6

 

 

 

Item 2. 

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

29

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

45

 

 

 

Item 4. 

Controls and Procedures

46

 

 

 

 

 

 

PART II – OTHER INFORMATION 

 

 

 

 

Item 1. 

Legal Proceedings

46

 

 

 

Item 1A. 

Risk Factors

46

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

47

 

 

 

Item 3. 

Defaults Upon Senior Securities

47

 

 

 

Item 4. 

Mine Safety Disclosures

47

 

 

 

Item 5. 

Other Information

47

 

 

 

Item 6. 

Exhibits

47

 

 

 

EXHIBIT INDEX 

48

 

 

SIGNATURES 

49

 

 

i


 

Caution Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10‑Q, as well as other periodic reports filed with the Securities and Exchange Commission (“SEC”), and written or oral communications made from time to time by or on behalf of Severn Bancorp and its subsidiaries (the “Company”), may contain statements relating to future events or future results of the Company that are considered “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be identified by the use of words such as “believe,” “expect,” “anticipate,”  “plan,” “estimate,” “intend,” and “potential,” or words of similar meaning, or future or conditional verbs such as “should,” “could,” or “may.”  Forward-looking statements include statements of our goals, intentions and expectations; statements regarding our business plans, prospects, growth, and operating strategies; statements regarding the quality of our loan and investment portfolios; and estimates of our risks and future costs and benefits.

Forward-looking statements reflect our expectation or prediction of future conditions, events, or results based on information currently available. These forward-looking statements are subject to significant risks and uncertainties that may cause actual results to differ materially from those in such statements. These risks and uncertainties include, but are not limited to, the risks identified in Item 1A of the Company’s 2017 Annual Report on Form 10‑K, Item 1A of Part II of this quarterly report on Form 10‑Q, and the following:

·

general business and economic conditions nationally or in the markets that the Company serves could adversely affect, among other things, real estate prices, unemployment levels, and consumer and business confidence, which could lead to decreases in the demand for loans, deposits, and other financial services that we provide and increases in loan delinquencies and defaults;

·

changes or volatility in the capital markets and interest rates may adversely impact the value of securities, loans, deposits, and other financial instruments and the interest rate sensitivity of our balance sheet as well as our liquidity;

·

our liquidity requirements could be adversely affected by changes in our assets and liabilities;

·

our investment securities portfolio is subject to credit risk, market risk, and liquidity risk as well as changes in the estimates we use to value certain of the securities in our portfolio;

·

the effect of legislative or regulatory developments including changes in laws concerning taxes, banking, securities, insurance, and other aspects of the financial services industry;

·

competitive factors among financial services companies, including product and pricing pressures, and our ability to attract, develop, and retain qualified banking professionals;

·

the effect of fiscal and governmental policies of the United States (“U.S.”) federal government;

·

the effect of any mergers, acquisitions, or other transactions to which we or our subsidiaries may from time to time be a party;

·

costs and potential disruption or interruption of operations due to cyber-security incidents;

·

the effect of any change in federal government enforcement of federal laws affecting the medical-use cannabis industry;

·

the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards Board, the SEC, the Public Company Accounting Oversight Board, and other regulatory agencies; and

·

geopolitical conditions, including acts or threats of terrorism, actions taken by the U.S. or other governments in response to acts or threats of terrorism, and/or military conflicts, which could impact business and economic conditions in the U.S. and abroad.

Forward-looking statements speak only as of the date of this report. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date of this report or to reflect the occurrence of unanticipated events except as required by federal securities laws.

 

ii


 

PART I – FINANCIAL INFORMATION

Item 1.Financial Statements

Severn Bancorp, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 

    

December 31, 

 

    

2018

    

2017

ASSETS

 

(unaudited)

 

  

 

Cash and due from banks

 

$

2,291

 

$

2,382

Federal funds sold and interest-bearing deposits in other banks

 

 

16,016

 

 

19,471

Cash and cash equivalents

 

 

18,307

 

 

21,853

Certificates of deposit held for investment

 

 

8,780

 

 

8,780

Securities available for sale, at fair value

 

 

12,011

 

 

10,119

Securities held to maturity (fair value of $49,026 and $54,004 at March 31, 2018 and December 31, 2017, respectively)

 

 

49,911

 

 

54,303

Loans held for sale, at fair value

 

 

5,803

 

 

4,530

Loans receivable

 

 

669,912

 

 

668,151

Allowance for loan losses

 

 

(8,169)

 

 

(8,055)

Loans, net

 

 

661,743

 

 

660,096

Real estate acquired through foreclosure

 

 

237

 

 

403

Restricted stock investments

 

 

4,844

 

 

4,489

Premises and equipment, net

 

 

23,121

 

 

23,139

Accrued interest receivable

 

 

2,454

 

 

2,640

Deferred income taxes

 

 

4,565

 

 

5,302

Bank owned life insurance

 

 

5,104

 

 

5,064

Goodwill

 

 

1,104

 

 

1,099

Other assets

 

 

3,101

 

 

2,970

Total assets

 

$

801,085

 

$

804,787

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

  

 

 

  

Liabilities:

 

 

  

 

 

  

Deposits:

 

 

  

 

 

  

Noninterest bearing

 

$

73,670

 

$

72,833

Interest-bearing

 

 

516,246

 

 

529,395

Total deposits

 

 

589,916

 

 

602,228

Short-term borrowings

 

 

8,000

 

 

 —

Long-term borrowings

 

 

88,500

 

 

88,500

Subordinated debentures

 

 

20,619

 

 

20,619

Accrued expenses and other liabilities

 

 

1,633

 

 

2,340

Total liabilities

 

 

708,668

 

 

713,687

 

 

 

 

 

 

 

Stockholders' Equity:

 

 

  

 

 

  

Preferred stock, $0.01 par value, 1,000,000 shares authorized:

 

 

  

 

 

  

Preferred stock series ''A,'' 437,500 shares issued and outstanding and $3,500 liquidation preference at both March 31, 2018 and December 31, 2017

 

 

 4

 

 

 4

Common stock, $0.01 par value, 20,000,000 shares authorized; 12,247,626 and 12,233,424 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively

 

 

122

 

 

122

Additional paid-in capital

 

 

65,060

 

 

65,137

Retained earnings

 

 

27,320

 

 

25,872

Accumulated other comprehensive loss

 

 

(89)

 

 

(35)

Total stockholders' equity

 

 

92,417

 

 

91,100

Total liabilities and stockholders' equity

 

$

801,085

 

$

804,787

 

See accompanying notes to consolidated financial statements

1


 

Severn Bancorp, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

 

    

2018

    

2017

    

Interest income:

 

(unaudited)

Loans

 

$

8,371

 

$

7,131

 

Securities

 

 

320

 

 

269

 

Other earning assets

 

 

186

 

 

157

 

Total interest income

 

 

8,877

 

 

7,557

 

Interest expense:

 

 

  

 

 

  

 

Deposits

 

 

1,133

 

 

975

 

Long-term borrowings and subordinated debentures

 

 

760

 

 

996

 

Total interest expense

 

 

1,893

 

 

1,971

 

Net interest income

 

 

6,984

 

 

5,586

 

Reversal of provision for loan losses

 

 

 —

 

 

(275)

 

Net interest income after reversal of provision for loan losses

 

 

6,984

 

 

5,861

 

Noninterest income:

 

 

  

 

 

  

 

Mortgage-banking revenue

 

 

595

 

 

535

 

Real estate commissions

 

 

385

 

 

380

 

Real estate management fees

 

 

183

 

 

194

 

Credit report and appraisal fees

 

 

76

 

 

70

 

Deposit service charges

 

 

295

 

 

34

 

Title company revenue

 

 

142

 

 

 —

 

Other noninterest income

 

 

193

 

 

145

 

Total noninterest income

 

 

1,869

 

 

1,358

 

Noninterest expense:

 

 

  

 

 

  

 

Compensation and related expenses

 

 

4,278

 

 

3,757

 

Occupancy

 

 

344

 

 

336

 

Legal fees

 

 

11

 

 

28

 

Write-downs, losses, and costs of real estate acquired through foreclosure, net

 

 

32

 

 

33

 

Federal Deposit Insurance Corporation insurance premiums

 

 

55

 

 

(2)

 

Professional fees

 

 

109

 

 

135

 

Advertising

 

 

233

 

 

206

 

Data processing

 

 

264

 

 

196

 

Credit report and appraisal fees

 

 

70

 

 

103

 

Licensing and software

 

 

121

 

 

75

 

Mortgage leads purchased

 

 

 —

 

 

95

 

Other noninterest expense

 

 

706

 

 

713

 

Total noninterest expense

 

 

6,223

 

 

5,675

 

Net income before income tax provision

 

 

2,630

 

 

1,544

 

Income tax provision

 

 

745

 

 

619

 

Net income

 

 

1,885

 

 

925

 

Dividends on preferred stock

 

 

(70)

 

 

(70)

 

Net income available to common stockholders

 

$

1,815

 

$

855

 

Net income per common share - basic

 

$

0.15

 

$

0.07

 

Net income per common share - diluted

 

$

0.15

 

$

0.07

 

 

See accompanying notes to consolidated financial statements

2


 

Severn Bancorp, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

    

 

    

2018

    

2017

    

 

 

(unaudited)

Net income

 

$

1,885

 

$

925

 

Other comprehensive loss items:

 

 

  

 

 

  

 

Unrealized holding losses on available-for-sale securities arising during the period (net of tax benefit of $19 and $9 in 2018 and 2017)

 

 

(54)

 

 

(15)

 

Total other comprehensive loss

 

 

(54)

 

 

(15)

 

Total comprehensive income

 

$

1,831

 

$

910

 

 

See accompanying notes to consolidated financial statements

 

 

 

3


 

Severn Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(dollars in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2018

 

    

Number of

    

Number of

    

 

    

 

    

 

    

 

    

Accumulated

    

 

 

 

Shares of

 

Shares of

 

 

 

 

 

Additional

 

 

 

Other

 

Total

 

 

Preferred

 

Common

 

Preferred

 

Common

 

Paid-In

 

Retained

 

Comprehensive

 

Stockholders'

 

 

Stock

 

Stock

 

Stock

 

Stock

 

Capital

 

 Earnings 

 

Loss

 

Equity

 

 

(unaudited)

Balance at January 1, 2018

 

437,500

 

12,233,424

 

$

 4

 

$

122

 

$

65,137

 

$

25,872

 

$

(35)

 

$

91,100

Net income

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1,885

 

 

 —

 

 

1,885

Stock-based compensation

 

 —

 

 —

 

 

 —

 

 

 —

 

 

56

 

 

 —

 

 

 —

 

 

56

Dividend declared on Series A preferred stock

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(70)

 

 

 —

 

 

(70)

Dividends paid on common stock at $0.03 per share

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(367)

 

 

 —

 

 

(367)

Exercise of stock options

 

 —

 

14,202

 

 

 —

 

 

 —

 

 

56

 

 

 —

 

 

 —

 

 

56

Other

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(189)

 

 

 —

 

 

 —

 

 

(189)

Other comprehensive loss

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(54)

 

 

(54)

Balance at March 31, 2018

 

437,500

 

12,247,626

 

$

 4

 

$

122

 

$

65,060

 

$

27,320

 

$

(89)

 

$

92,417

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2017

 

    

Number of

    

Number of

    

 

    

 

    

 

    

 

    

Accumulated

    

 

 

 

Shares of

 

Shares of

 

 

 

 

 

Additional

 

 

 

Other

 

Total

 

 

Preferred

 

Common

 

Preferred

 

Common

 

Paid-In

 

Retained

 

Comprehensive

 

Stockholders'

 

 

Stock

 

Stock

 

Stock

 

Stock

 

Capital

 

 Earnings 

 

Loss

 

Equity

 

 

(unaudited)

Balance at January 1, 2017

 

437,500

 

12,123,179

 

$

 4

 

$

121

 

$

64,471

 

$

23,334

 

$

 —

 

$

87,930

Net income

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

925

 

 

 —

 

 

925

Stock-based compensation

 

 —

 

 —

 

 

 —

 

 

 —

 

 

53

 

 

 —

 

 

 —

 

 

53

Dividend declared on Series A preferred stock

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(70)

 

 

 —

 

 

(70)

Exercise of stock options

 

 —

 

5,025

 

 

 —

 

 

 —

 

 

17

 

 

 —

 

 

 —

 

 

17

Other comprehensive loss

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(15)

 

 

(15)

Balance at March 31, 2017

 

437,500

 

12,128,204

 

$

 4

 

$

121

 

$

64,541

 

$

24,189

 

$

(15)

 

$

88,840

 

See accompanying notes to consolidated financial statements

 

 

 

4


 

Severn Bancorp, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, except per share data)

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

    

2018

    

2017

Cash flows from operating activities:

 

(unaudited)

Net income

 

$

1,885

 

$

925

Adjustments to reconcile net income to net cash from operating activities:

 

 

 

 

 

  

Depreciation and amortization

 

 

307

 

 

298

Amortization of deferred loan fees

 

 

(409)

 

 

(264)

Net amortization of premiums and discounts

 

 

57

 

 

(76)

Reversal of provision for loan losses

 

 

 —

 

 

(275)

Write-downs and losses on real estate acquired through foreclosure, net of gains

 

 

44

 

 

40

Gain on sale of mortgage loans

 

 

(595)

 

 

(535)

Proceeds from sale of mortgage loans held for sale

 

 

15,195

 

 

10,757

Originations of loans held for sale

 

 

(15,873)

 

 

(2,670)

Stock-based compensation

 

 

56

 

 

53

Increase in cash surrender value of bank-owned life insurance

 

 

(40)

 

 

 —

Deferred income taxes

 

 

757

 

 

619

Decrease (increase)  in accrued interest receivable

 

 

186

 

 

(13)

(Increase) decrease in other assets

 

 

(328)

 

 

447

Decrease in accrued expenses and other liabilities

 

 

(707)

 

 

(1,541)

Net cash provided by operating activities

 

 

535

 

 

7,765

Cash flows from investing activities:

 

 

  

 

 

  

Loan principal (disbursements), net of repayments

 

 

(1,238)

 

 

(76)

Redemption of restricted stock investments

 

 

(355)

 

 

402

Purchases of premises and equipment, net

 

 

(288)

 

 

(60)

Activity in securities held to maturity:

 

 

 

 

 

  

Maturities/calls/repayments

 

 

4,356

 

 

3,542

Activity in available-for-sale securities:

 

 

  

 

 

  

Purchases

 

 

(2,000)

 

 

(7,176)

Maturities/calls/repayments

 

 

15

 

 

 8

Proceeds from sales of real estate acquired through foreclosure

 

 

122

 

 

205

Net cash provided by (used in) investing activities

 

 

612

 

 

(3,155)

Cash flows from financing activities:

 

 

  

 

 

  

Net (decrease) increase in deposits

 

 

(12,312)

 

 

21,816

Net increase in short-term borrowings

 

 

8,000

 

 

 —

Additional long-term borrowings

 

 

5,000

 

 

 —

Repayments of long-term borrowings

 

 

(5,000)

 

 

(10,000)

Common stock dividends

 

 

(367)

 

 

 —

Preferred stock dividends

 

 

(70)

 

 

 —

Proceeds from common stock issuance

 

 

56

 

 

17

Net cash (used in) provided by financing activities

 

 

(4,693)

 

 

11,833

(Decrease) increase in cash and cash equivalents

 

 

(3,546)

 

 

16,443

Cash and cash equivalents at beginning of period

 

 

21,853

 

 

67,014

Cash and cash equivalents at end of period

 

$

18,307

 

$

83,457

Supplemental Information:

 

 

  

 

 

  

Interest paid on deposits and borrowed funds

 

$

1,872

 

$

2,002

Income taxes paid

 

 

12

 

 

52

Real estate acquired in satisfaction of loans

 

 

 —

 

 

515

 

See accompanying notes to consolidated financial statements

 

 

5


 

Severn Bancorp, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of and for the three months ended March 31, 2018 and 2017 is unaudited)

Note 1 -  Summary of Significant Accounting Policies

Basis of Presentation

The accounting and reporting policies of Severn Bancorp, Inc. and subsidiaries (the “Company”) conform to accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) and prevailing practices within the financial services industry for interim financial information and Rule 8‑01 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete financial statements and prevailing practices within the banking industry. In the opinion of management, all adjustments (comprising only of those of a normal recurring nature) necessary for a fair presentation of the results of operations for the interim periods presented have been made. The results of operations for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2018 or any other interim or future period. Events occurring after the date of the financial statements up to the date the financial statements were available to be issued, were considered in the preparation of the consolidated financial statements.

These statements should be read in conjunction with the financial statements and accompanying notes included in the Company’s 2017 Annual Report on Form 10‑K as filed with the Securities and Exchange Commission (“SEC”).

Principles of Consolidation

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

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

Cash Flows

We consider all highly liquid securities with original maturities of three months or less to be cash equivalents.  For reporting purposes, assets grouped in the Consolidated Statements of Financial Condition under the captions “Cash and due from banks” and “Federal funds sold and interest-bearing deposits in other banks” are considered cash or cash equivalents.  For financial statement purposes, these assets are carried at cost.  Federal funds sold and interest-bearing deposits in other banks generally have overnight maturities and are in excess of amounts that would be recoverable under Federal Deposit Insurance Corporation (“FDIC”) insurance.

Reclassifications

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

6


 

Revenue Recognition

 

Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

 

The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our mortgage-banking and mortgage servicing activities. Our revenue-generating activities that are within the scope of ASC 606, which are presented in our income statements as components of noninterest income, are service charges on deposit accounts, real estate commissions, and real estate management fees.

 

Service Charges on Deposit Accounts

 

Service charges on deposit accounts represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied.

 

Real Estate Commissions

 

Real Estate Commissions represent commissions received on properties sold. Revenue is recognized when our performance obligation is completed, which is generally the time the property is sold and payment has been received. 

 

Real Estate Management Fees

 

Real Estate Management Fees represent monthly fees received on property maintenance and management.  We perform daily services for these fees and bill for those services on a monthly basis.  We have determined that each day of the performance of the services represents a distinct service.  The overall service of property management each day is substantially the same and has the same pattern of transfer (daily) over the term of the contract.  Further, each distinct day of service represents a performance obligation that would be satisfied over time (over the length of the contract, not at a point in time) and has the same measure of progress (elapsed time).  Management has therefore determined that property management services are a single performance obligation composed of a series of distinct services. In performing the daily management activities, the customer is simultaneously receiving and consuming the benefits provided by our performance of the contract.  Revenue is earned evenly and daily over the life of the contract.  For purposes of expedience, we record the fees when monthly invoices are processed.  Each month contains 1/12 of the contract revenue.

 

Recent Accounting Pronouncements

Pronouncements Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014‑09, Revenue from Contracts with Customers, as amended by ASU 2015‑14, Revenue from Contracts with Customers:  Deferral of the Effective Date, ASU 2016‑08, Revenue from Contracts with Customers:  Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net), ASU 2016‑10, Revenue from Contracts with Customers, Identifying Performance Obligations and Licensing, ASU 2016‑12, Revenue from Contracts with Customers:  Narrow-Scope Improvements and Practical Expedients, ASU 2016‑20, Technical Corrections and Improvements to Topic 606, Revenue form Contracts with Customers, that provides accounting guidance for all revenue arising from contracts with

7


 

customers and affects all entities that enter into contracts to provide goods or services to customers. The guidance also provides for a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate. We adopted the pronouncement on January 1, 2018. Our accounting policies and revenue recognition principles did not change materially as the principles of ASC 606 are largely consistent with the previous revenue recognition practices.  See additional information on revenue recognition above.

 

In January 2016, FASB issued ASU No. 2016‑01, Financial Instruments – Overall:  Recognition and Measurement of Financial Assets and Financial Liabilities, which requires entities to measure equity investments at fair value and recognize changes on fair value in net income. The guidance also provides a new measurement alternative for equity investments that do not have readily determinable fair values and don’t qualify for the net asset value practical expedient. The standard requires entities to record changes in instrument–specific credit risk for financial liabilities measured under the fair value option in other comprehensive income, except for certain financial liabilities of consolidated collateralized financing entities. Entities also have to reassess the realizability of a deferred tax asset related to an available-for-sale (“AFS”) debt security in combination with their other deferred tax assets. The adoption of this standard did not have a material impact on the Company’s financial position, results of operations, or cash flows.

In August 2016, FASB issued ASU No. 2016‑15, Classification of Certain Cash Receipts and Cash Payments, which provides guidance regarding the presentation of certain cash receipts and cash payments in the statement of cash flows, addressing eight specific cash flow classification issues, in order to reduce existing diversity in practice. The adoption of ASC No. 2016‑15 did not have a material impact on our financial position, results of operations, or cash flows.

Pronouncements Issued

In February 2016, FASB issued ASU 2016‑02, Leases, which requires a lessee to recognize the assets and liabilities that arise from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease payments and a “right-of-use” asset. The accounting applied by the lessor is relatively unchanged. The ASU also requires expanded qualitative and quantitative disclosures. For public business entities, the guidance is effective for interim and annual reporting periods beginning after December 15, 2018 and mandates a modified retrospective transition for all entities. Early application is permitted. We have determined that the provisions of ASU No. 2016‑02 may result in an increase in assets to recognize the present value of the lease obligations, with a corresponding increase in liabilities, however, we do not expect this to have a material impact on our financial position, results of operations, or cash flows.

In June 2016, FASB issued ASU No. 2016‑13, Financial Instruments – Credit Losses, which sets forth a current expected credit loss (“CECL”) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. While we are currently in the process of evaluating the impact of the amended guidance on our Consolidated Financial Statements, we currently expect the Allowance to increase upon adoption given that the Allowance will be required to cover the full remaining expected life of the portfolio upon adoption, rather than the incurred loss model under current U.S. GAAP. The extent of this increase is still being evaluated and will depend on economic conditions and the composition of our loan and lease portfolio at the time of adoption.

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

In February 2018, FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects From Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The ASU is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.  Early adoption is permitted.  The

8


 

Company does not expect the adoption of ASU No. 2018-02 to have a material impact on its financial position, results of operations, or cash flows.

 

Note 2 – Correction of an Immaterial Prior Year Error

In 2016, we redeemed the Series B preferred stock sold in 2008 to the U.S. Department of the Treasury (the “TARP Shares”). At the time of the redemption, the remaining unamortized discount of $511,000 should have been fully amortized into additional paid-in capital and retained earnings and reflected as a reduction to net income available to common stockholders. This treatment was not reflected in the consolidated financial statements included in the March 31, 2017 Quarterly Report on Form 10‑Q. We determined that this amount was not material to the 2017 consolidated financial statements. Our March 31, 2017 consolidated financial statements within these consolidated financial statements have been adjusted to reflect the proper recognition of the remaining discount at the time of the redemption as a $68,000 adjustment to net income available to common stockholders, revising the originally reported amount from $787,000 to $855,000. The adjustment had no impact on total assets at March 31, 2017 or December 31, 2017 and no impact on net income for the three months ended March 31, 2017.

Note 3 - Securities

The amortized cost and fair values of our AFS securities portfolio were as follows as of March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

March 31, 2018

 

 

Amortized

 

Unrealized

    

Unrealized

    

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

 

(dollars in thousands)

U.S. Treasury securities

 

$

1,985

 

$

 —

 

$

10

 

$

1,975

U.S. government agency notes

 

 

10,149

 

 

 —

 

 

113

 

 

10,036

 

 

$

12,134

 

$

 —

 

$

123

 

$

12,011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

December 31, 2017

 

 

Amortized

    

Unrealized

    

Unrealized

    

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

 

(dollars in thousands)

U.S. government agency notes

 

$

10,169

 

$

 —

 

$

50

 

$

10,119

 

 

$

10,169

 

$

 —

 

$

50

 

$

10,119

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

Amortized

    

Unrealized

    

Unrealized

    

Fair

 

 

Cost

 

Gains

 

Losses

 

Value

 

 

(dollars in thousands)

U.S. Treasury securities

 

$

4,993

 

$

40

 

$

 8

 

$

5,025

U.S. government agency notes

 

 

15,999

 

 

40

 

 

143

 

 

15,896

Mortgage-backed securities

 

 

28,919

 

 

11

 

 

825

 

 

28,105

 

 

$

49,911

 

$

91

 

$

976

 

$

49,026

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

Amortized

    

Unrealized

    

Unrealized

    

Fair

 

 

Cost

 

Gains

 

Losses

 

Value

 

 

(dollars in thousands)

U.S. Treasury securities

 

$

4,994

 

$

68

 

$

 6

 

$

5,056

U.S. government agency notes

 

 

19,004

 

 

81

 

 

99

 

 

18,986

Mortgage-backed securities

 

 

30,305

 

 

27

 

 

370

 

 

29,962

 

 

$

54,303

 

$

176

 

$

475

 

$

54,004

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

Less than 12 months

 

12 months or more

 

Total

 

    

Fair

    

Unrealized

    

Fair

    

Unrealized

    

Fair

    

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

 

(dollars in thousands)

U.S. Treasury securities

 

$

1,975

 

$

10

 

$

 —

 

$

 —

 

$

1,975

 

$

10

U.S. government agency notes

 

 

9,021

 

 

103

 

 

1,015

 

 

10

 

 

10,036

 

 

113

 

 

$

10,996

 

$

113

 

$

1,015

 

$

10

 

$

12,011

 

$

123

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

Less than 12 months

 

12 months or more

 

Total

 

    

Fair

    

Unrealized

    

Fair

    

Unrealized

    

Fair

    

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

 

(dollars in thousands)

U.S. government agency notes

 

$

10,119

 

$

50

 

$

 —

 

$

 —

 

$

10,119

 

$

50

 

 

$

10,119

 

$

50

 

$

 —

 

$

 —

 

$

10,119

 

$

50

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

Less than 12 months

 

12 months or more

 

Total

 

    

Fair

    

Unrealized

    

Fair

    

Unrealized

    

Fair

    

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

 

(dollars in thousands)

U.S. Treasury securities

 

$

1,992

 

$

 8

 

$

 —

 

$

 —

 

$

1,992

 

$

 8

U.S. government agency notes

 

 

8,953

 

 

41

 

 

4,935

 

 

102

 

 

13,888

 

 

143

Mortgage-backed securities

 

 

21,284

 

 

568

 

 

6,557

 

 

257

 

 

27,841

 

 

825

 

 

$

32,229

 

$

617

 

$

11,492

 

$

359

 

$

43,721

 

$

976

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

Less than 12 months

 

12 months or more

 

Total

 

    

Fair

    

Unrealized

    

Fair

    

Unrealized

    

Fair

    

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

 

(dollars in thousands)

U.S. Treasury securities

 

$

1,993

 

$

 6

 

$

 —

 

$

 —

 

$

1,993

 

$

 6

U.S. government agency notes

 

 

6,977

 

 

23

 

 

6,964

 

 

76

 

 

13,941

 

 

99

Mortgage-backed securities

 

 

20,993

 

 

217

 

 

7,046

 

 

153

 

 

28,039

 

 

370

 

 

$

29,963

 

$

246

 

$

14,010

 

$

229

 

$

43,973

 

$

475

 

In the AFS securities portfolio, 10 securities were in a loss position as of March 31, 2018, with the largest single unrealized loss in any one security amounting to $24,000. In the HTM securities portfolio, 34 securities were in a loss position as of March 31, 2018, with the largest single unrealized loss in any one security amounting to $114,000.

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

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Contractual maturities of debt securities at March 31, 2018 are shown below. Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AFS Securities

 

HTM Securities

 

    

Amortized

    

Fair

    

Amortized

    

Fair

 

 

Cost

 

Value

 

Cost

 

Value

 

 

(dollars in thousands)

Due in one year or less

 

$

1,025

 

$

1,015

 

$

9,006

 

$

8,980

Due after one through five years

 

 

11,109

 

 

10,996

 

 

10,978

 

 

10,909

Due after five years through ten years

 

 

 —

 

 

 —

 

 

1,008

 

 

1,032

Mortgage-backed securities

 

 

 —

 

 

 —

 

 

28,919

 

 

28,105

 

 

$

12,134

 

$

12,011

 

$

49,911

 

$

49,026

 

We did not sell any securities during the three months ended March 31, 2018 or 2017.

There were no securities pledged as collateral as of March 31, 2018 or December 31, 2017.

Note 4 -  Loans Receivable and Allowance for Loan Losses

Loans receivable are summarized as follows:

 

 

 

 

 

 

 

 

    

March 31, 2018

    

December 31, 2017

 

 

(dollars in thousands)

Residential mortgage

 

$

288,061

 

$

287,656

Commercial

 

 

39,015

 

 

37,356

Commercial real estate

 

 

230,336

 

 

236,302

Construction, land acquisition, and development

 

 

100,635

 

 

93,060

Home equity/2nds

 

 

13,853

 

 

15,703

Consumer

 

 

1,050

 

 

1,084

Total loans receivable

 

 

672,950

 

 

671,161

Unearned loan fees

 

 

(3,038)

 

 

(3,010)

Loans receivable

 

$

669,912

 

$

668,151

 

Certain loans in the amount of $190.8 million have been pledged under a blanket floating lien to the Federal Home Loan Bank of Atlanta (“FHLB”) as collateral against advances.

At March 31, 2018, the Bank was servicing $32.7 million in loans for the Federal National Mortgage Association and $15.6 million in loans for the Federal Home Loan Mortgage Corporation.

Credit Quality

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

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

Inherent Credit Risks

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

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

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

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

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

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

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

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

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

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2018

 

    

Residential

    

 

    

Commercial

    

 

    

Home Equity/

    

 

    

 

 

 

Mortgage

 

Commercial

 

Real Estate

 

ADC

 

2nds

 

Consumer

 

Total

 

 

(dollars in thousands)

Beginning Balance

 

$

3,099

 

$

527

 

$

2,805

 

$

1,236

 

$

386

 

$

 2

 

$

8,055

Charge-offs

 

 

(323)

 

 

 —

 

 

 —

 

 

(13)

 

 

 —

 

 

 —

 

 

(336)

Recoveries

 

 

221

 

 

 —

 

 

211

 

 

 —

 

 

18

 

 

 —

 

 

450

Net (charge-offs) recoveries

 

 

(102)

 

 

 —

 

 

211

 

 

(13)

 

 

18

 

 

 —

 

 

114

Provision for (reversal of) loan losses

 

 

304

 

 

(13)

 

 

(21)

 

 

(163)

 

 

(107)

 

 

 —

 

 

 —

Ending Balance

 

$

3,301

 

$

514

 

$

2,995

 

$

1,060

 

$

297

 

$

 2

 

$

8,169

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance - individually evaluated for impairment

 

$

1,285

 

$

 —

 

$

318

 

$

47

 

$

 2

 

$

 1

 

$

1,653

Ending balance - collectively evaluated for impairment

 

 

2,016

 

 

514

 

 

2,677

 

 

1,013

 

 

295

 

 

 1

 

 

6,516

 

 

$

3,301

 

$

514

 

$

2,995

 

$

1,060

 

$

297

 

$

 2

 

$

8,169

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending loan balance -individually evaluated for impairment

 

$

17,439

 

$

296

 

$

2,820

 

$

981

 

$

1,260

 

$

82

 

$

22,878

Ending loan balance -collectively evaluated for impairment

 

 

267,584

 

 

38,719

 

 

227,516

 

 

99,654

 

 

12,593

 

 

968

 

 

647,034

 

 

$

285,023

 

$

39,015

 

$

230,336

 

$

100,635

 

$

13,853

 

$

1,050

 

$

669,912

 

 

 

 

 

13


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

Residential

    

 

    

Commercial

    

 

    

 

Home Equity/

    

 

    

 

 

 

Mortgage

 

Commercial

 

Real Estate

 

ADC

 

2nds

 

Consumer

 

Total

 

 

(dollars in thousands)

Ending balance - individually evaluated for impairment

 

$

1,181

 

$

 —

 

$

182

 

$

48

 

$

 —

 

$

 2

 

$

1,413

Ending balance - collectively evaluated for impairment

 

 

1,918

 

 

527

 

 

2,623

 

 

1,188

 

 

386

 

 

 —

 

 

6,642

 

 

$

3,099

 

$

527

 

$

2,805

 

$

1,236

 

$

386

 

$

 2

 

$

8,055

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending loan balance - individually evaluated for impairment

 

$

18,219

 

$

 —

 

$

2,917

 

$

991

 

$

 —

 

$

84

 

$

22,211

Ending loan balance - collectively evaluated for impairment

 

 

266,427

 

 

37,356

 

 

233,385

 

 

92,069

 

 

15,703

 

 

1,000

 

 

645,940

 

 

$

284,646

 

$

37,356

 

$

236,302

 

$

93,060

 

$

15,703

 

$

1,084

 

$

668,151

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2017

 

    

Residential

    

 

    

Commercial

    

 

    

Home Equity/

    

 

 

    

 

 

 

 

 

Mortgage

 

Commercial

 

Real Estate

 

ADC

 

2nds

 

Consumer

 

Total

 

 

 

(dollars in thousands)

Beginning Balance

    

$

3,833

    

$

478

    

$

2,535

    

$

1,390

    

$

728

 

$

 5

 

$

8,969

 

Charge-offs

 

 

(499)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(499)

 

Recoveries

 

 

107

 

 

27

 

 

 —

 

 

 —

 

 

 3

 

 

 —

 

 

137

 

Net (charge-offs) recoveries

 

 

(392)

 

 

27

 

 

 —

 

 

 —

 

 

 3

 

 

 —

 

 

(362)

 

Provision for (reversal of) loan losses

 

 

348

 

 

(32)

 

 

(20)

 

 

(293)

 

 

(278)

 

 

 —

 

 

(275)

 

Ending Balance

 

$

3,789

 

$

473

 

$

2,515

 

$

1,097

 

$

453

 

$

 5

 

$

8,332

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance - individually evaluated for impairment

 

$

1,757

 

$

 —

 

$

191

 

$

52

 

$

81

 

$

 3

 

$

2,084

 

Ending balance - collectively evaluated for impairment

 

 

2,032

 

 

473

 

 

2,324

 

 

1,045

 

 

372

 

 

 2

 

 

6,248

 

 

 

$

3,789

 

$

473

 

$

2,515

 

$

1,097

 

$

453

 

$

 5

 

$

8,332

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending loan balance - individually evaluated for impairment

 

$

19,008

 

$

 —

 

$

3,130

 

$

818

 

$

2,438

 

$

92

 

$

25,486

 

Ending loan balance - collectively evaluated for impairment

 

 

231,891

 

 

48,554

 

 

187,831

 

 

98,897

 

 

15,584

 

 

1,498

 

 

584,255

 

 

 

$

250,899

 

$

48,554

 

$

190,961

 

$

99,715

 

$

18,022

 

$

1,590

 

$

609,741

 

 

14


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

 

    

 Special

    

 

    

 

 

 

 Pass 

 

 Mention 

 

Substandard

 

Total

 

 

(dollars in thousands)

Residential mortgage

 

$

278,721

 

$

1,367

 

$

4,935

 

$

285,023

Commercial

 

 

38,981

 

 

34

 

 

 —

 

 

39,015

Commercial real estate

 

 

224,274

 

 

4,185

 

 

1,877

 

 

230,336

ADC

 

 

99,455

 

 

 —

 

 

1,180

 

 

100,635

Home equity/2nds

 

 

12,542

 

 

457

 

 

854

 

 

13,853

Consumer

 

 

1,050

 

 

 —

 

 

 —

 

 

1,050

 

 

$

655,023

 

$

6,043

 

$

8,846

 

$

669,912

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

 

    

Special

    

 

    

 

 

 

Pass

 

Mention

 

Substandard

 

Total

 

 

(dollars in thousands)

Residential mortgage

 

$

277,867

 

$

1,563

 

$

5,216

 

$

284,646

Commercial

 

 

37,312

 

 

44

 

 

 —

 

 

37,356

Commercial real estate

 

 

228,746

 

 

4,615

 

 

2,941

 

 

236,302

ADC

 

 

91,868

 

 

 —

 

 

1,192

 

 

93,060

Home equity/2nds

 

 

14,384

 

 

465

 

 

854

 

 

15,703

Consumer

 

 

1,084

 

 

 —

 

 

 —

 

 

1,084

 

 

$

651,261

 

$

6,687

 

$

10,203

 

$

668,151

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

30-59

    

60-89

    

90+

    

 

    

 

    

 

    

 

 

 

Days

 

Days

 

Days

 

Total

 

 

 

 

 

Non-

 

 

Past Due

 

Past Due

 

Past Due

 

Past Due

 

Current

 

Total

 

Accrual

 

 

(dollars in thousands)

Residential mortgage

 

$

99

 

$

95

 

$

2,652

 

$

2,846

 

$

282,177

 

$

285,023

 

$

3,619

Commercial

 

 

 —

 

 

16

 

 

225

 

 

241

 

 

38,774

 

 

39,015

 

 

296

Commercial real estate

 

 

 —

 

 

 —

 

 

216

 

 

216

 

 

230,120

 

 

230,336

 

 

216

ADC

 

 

 —

 

 

 —

 

 

239

 

 

239

 

 

100,396

 

 

100,635

 

 

310

Home equity/2nds

 

 

76

 

 

 —

 

 

1,136

 

 

1,212

 

 

12,641

 

 

13,853

 

 

1,260

Consumer

 

 

36

 

 

 —

 

 

 —

 

 

36

 

 

1,014

 

 

1,050

 

 

 —

 

 

$

211

 

$

111

 

$

4,468

 

$

4,790

 

$

665,122

 

$

669,912

 

$

5,701

 

15


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

30-59

    

60-89

    

90+

    

 

    

 

    

 

    

    

 

 

Days

 

Days

 

Days

 

Total

 

 

 

 

 

Non-

 

 

Past Due

 

Past Due

 

Past Due

 

Past Due

 

Current

 

Total

 

Accrual

 

 

(dollars in thousands)

Residential mortgage

 

$

1,006

 

$

 —

 

$

 —

 

$

1,006

 

$

283,640

 

$

284,646

 

$

3,891

Commercial

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

37,356

 

 

37,356

 

 

78

Commercial real estate

 

 

948

 

 

 —

 

 

 —

 

 

948

 

 

235,354

 

 

236,302

 

 

159

ADC

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

93,060

 

 

93,060

 

 

314

Home equity/2nds

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

15,703

 

 

15,703

 

 

1,268

Consumer

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1,084

 

 

1,084

 

 

 —

 

 

$

1,954

 

$

 —

 

$

 —

 

$

1,954

 

$

666,197

 

$

668,151

 

$

5,710

 

We did not have any loans greater than 90 days past due and still accruing as of March 31, 2018 or December 31, 2017.

The interest which would have been recorded on the above nonaccrual loans if those loans had been performing in accordance with their contractual terms was approximately $462,000 and $172,000 for the three months ended March 31, 2018 and 2017, respectively. The actual interest income recorded on those loans was approximately $34,000 and $71,000 for the three months ended March 31, 2018 and 2017, respectively.

The following tables summarize impaired loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

December 31, 2017

 

    

Unpaid

    

 

    

 

    

Unpaid

    

 

    

 

 

 

Principal

 

Recorded

 

Related

 

Principal

 

Recorded

 

Related

 

 

Balance

 

Investment

 

Allowance

 

Balance

 

Investment

 

Allowance

With no related Allowance:

 

(dollars in thousands)

Residential mortgage

 

$

11,610

 

$

9,958

 

$

 —

 

$

12,929

 

$

11,572

 

$

 —

Commercial

 

 

349

 

 

296

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Commercial real estate

 

 

1,262

 

 

1,148

 

 

 —

 

 

1,562

 

 

1,507

 

 

 —

ADC

 

 

633

 

 

633

 

 

 —

 

 

636

 

 

636

 

 

 —

Home equity/2nds

 

 

1,684

 

 

1,247

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Consumer

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

With a related Allowance:

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential mortgage

 

 

7,596

 

 

7,481

 

 

1,285

 

 

6,761

 

 

6,647

 

 

1,181

Commercial

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Commercial real estate

 

 

1,566

 

 

1,672

 

 

318

 

 

1,410

 

 

1,410

 

 

182

ADC

 

 

387

 

 

348

 

 

47

 

 

392

 

 

355

 

 

48

Home equity/2nds

 

 

14

 

 

13

 

 

 2

 

 

 —

 

 

 —

 

 

 —

Consumer

 

 

82

 

 

82

 

 

 1

 

 

84

 

 

84

 

 

 2

Totals:

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential mortgage

 

 

19,206

 

 

17,439

 

 

1,285

 

 

19,690

 

 

18,219

 

 

1,181

Commercial

 

 

349

 

 

296

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Commercial real estate

 

 

2,828

 

 

2,820

 

 

318

 

 

2,972

 

 

2,917

 

 

182

ADC

 

 

1,020

 

 

981

 

 

47

 

 

1,028

 

 

991

 

 

48

Home equity/2nds

 

 

1,698

 

 

1,260

 

 

 2

 

 

 —

 

 

 —

 

 

 —

Consumer

 

 

82

 

 

82

 

 

 1

 

 

84

 

 

84

 

 

 2

 

16


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

 

2018

 

2017

 

    

Average

    

Interest

    

Average

    

Interest

 

 

Recorded

 

Income

 

Recorded

 

Income

 

 

Investment

 

Recognized

 

Investment

 

Recognized

With no related Allowance:

 

(dollars in thousands)

Residential mortgage

 

$

10,765

 

$

110

 

$

10,592

 

$

117

Commercial

 

 

148

 

 

13

 

 

87

 

 

 8

Commercial real estate

 

 

1,328

 

 

10

 

 

2,494

 

 

39

ADC

 

 

634

 

 

 8

 

 

438

 

 

 6

Home equity/2nds

 

 

623

 

 

 4

 

 

1,615

 

 

15

Consumer

 

 

 —

 

 

 —

 

 

 —

 

 

 —

With a related Allowance:

 

 

  

 

 

  

 

 

  

 

 

  

Residential mortgage

 

 

7,064

 

 

58

 

 

8,839

 

 

97

Commercial

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Commercial real estate

 

 

1,541

 

 

19

 

 

1,925

 

 

24

ADC

 

 

351

 

 

 4

 

 

383

 

 

 5

Home equity/2nds

 

 

 7

 

 

 —

 

 

1,338

 

 

48

Consumer

 

 

83

 

 

 1

 

 

93

 

 

 1

Totals:

 

 

  

 

 

  

 

 

  

 

 

  

Residential mortgage

 

 

17,829

 

 

168

 

 

19,431

 

 

214

Commercial

 

 

148

 

 

13

 

 

87

 

 

 8

Commercial real estate

 

 

2,869

 

 

29

 

 

4,419

 

 

63

ADC

 

 

985

 

 

12

 

 

821

 

 

11

Home equity/2nds

 

 

630

 

 

 4

 

 

2,953

 

 

63

Consumer

 

 

83

 

 

 1

 

 

93

 

 

 1

 

Residential mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction totaled $4.0 million as of March 31, 2018.

Troubled Debt Restructure Loans (“TDR” or “TDRs”)

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

 

    

 

    

 

    

 

    

Total

    

Total

 

 

Number of

 

Accrual

 

Number of

 

Nonaccrual

 

Number of

 

Balance of

 

 

Modifications

 

Status

 

Modifications

 

Status

 

Modifications

 

Modifications

 

 

(dollars in thousands)

Residential mortgage

 

40

 

$

10,692

 

 4

 

$

811

 

44

 

$

11,503

Commercial real estate

 

 3

 

 

1,848

 

 —

 

 

 —

 

 3

 

 

1,848

ADC

 

 1

 

 

136

 

 —

 

 

 —

 

 1

 

 

136

Consumer

 

 3

 

 

82

 

 —

 

 

 —

 

 3

 

 

82

 

 

47

 

$

12,758

 

 4

 

$

811

 

51

 

$

13,569

 

17


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

 

    

 

    

 

    

 

    

Total

    

Total

 

 

Number of

 

Accrual

 

Number of

 

Nonaccrual

 

Number of

 

Balance of

 

 

Modifications

 

Status

 

Modifications

 

Status

 

Modifications

 

Modifications

 

 

(dollars in thousands)

Residential mortgage

 

42

 

$

11,631

 

 2

 

$

736

 

44

 

$

12,367

Commercial real estate

 

 3

 

 

1,862

 

 1

 

 

78

 

 4

 

 

1,940

ADC

 

 1

 

 

137

 

 1

 

 

 6

 

 2

 

 

143

Consumer

 

 4

 

 

84

 

 —

 

 

 —

 

 4

 

 

84

 

 

50

 

$

13,714

 

 4

 

$

820

 

54

 

$

14,534

 

There were no TDRs that defaulted during the three month periods ended March 31, 2018 or 2017 which were modified during the previous 12 month period.

We did not modify any loans during the three months ended March 31, 2018 or 2017.

Note 5 -  Regulatory Matters

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

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

The Basel III rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The new capital conservation buffer requirements began to phase in effective January 2016 at 0.625% of risk-weighted assets and increase by that amount each year until fully implemented in January 2019. In 2018 the capital conservation buffer is 1.875%. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses to executive officers if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

As of the date of the last regulatory exam, the Bank was considered “well capitalized” and as of March 31, 2018, the Bank continued to meet the requirements to be considered “well capitalized” based on applicable U.S. regulatory capital ratio requirements.

18


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minimum

 

Minimum

 

To be Well

 

 

 

 

 

 

 

Requirements

 

Requirements

 

Capitalized Under

 

 

 

 

 

 

 

for Capital Adequacy

 

with Capital

 

Prompt Corrective

 

 

 

Actual

 

 

 

Purposes

 

Conservation Buffer

 

Action Provision

 

 

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

 

 

 

(dollars in thousands)

 

March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Equity Tier 1 Capital (to risk-weighted assets)

 

$

107,618

 

16.8

%  

$

28,750

 

4.5

%  

$

40,729

 

6.4

%  

$

41,527

 

6.5

%

Total capital (to risk-weighted assets)

 

 

115,614

 

18.1

%

 

51,111

 

8.0

%

 

63,090

 

9.9

%

 

63,888

 

10.0

%

Tier 1 capital (to risk-weighted assets)

 

 

107,618

 

16.8

%  

 

38,333

 

6.0

%  

 

50,312

 

7.9

%  

 

51,111

 

8.0

%

Tier 1 capital (to average quarterly assets)

 

 

107,618

 

13.5

%  

 

31,835

 

4.0

%  

 

46,757

 

5.9

%  

 

39,793

 

5.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Equity Tier 1 Capital (to risk-weighted assets)

 

$

105,721

 

16.5

%  

$

28,904

 

4.5

%  

$

36,933

 

5.8

%  

$

41,750

 

6.5

%

Total capital (to risk-weighted assets)

 

 

113,758

 

17.7

%

 

51,385

 

8.0

%

 

59,414

 

9.3

%

 

64,231

 

10.0

%

Tier 1 capital (to risk-weighted assets)

 

 

105,721

 

16.5

%  

 

38,539

 

6.0

%  

 

46,567

 

7.3

%  

 

51,385

 

8.0

%

Tier 1 capital (to average quarterly assets)

 

 

105,721

 

13.5

%  

 

31,440

 

4.0

%  

 

41,264

 

5.3

%  

 

39,300

 

5.0

%

 

 

Note 6 -  Earnings Per Share

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

Not included in the diluted earnings per share calculation for 2018 and 2017 because they were anti-dilutive, were 22,000 and 20,000 shares, respectively, of common stock issuable upon exercise of outstanding stock options and 437,500 shares of common stock issuable upon conversion of the Company’s Series A Preferred Stock.

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

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

 

    

2018

    

2017

    

 

 

(dollars in thousands, except for per share data)

 

Weighted-average shares outstanding - basic

 

 

12,241,554

 

 

12,125,553

 

Dilution

 

 

93,083

 

 

85,027

 

Weighted-average share outstanding - diluted

 

 

12,334,637

 

 

12,210,580

 

 

 

 

 

 

 

 

 

Net income available to common stockholders

 

$

1,815

 

$

855

 

Net income per share - basic

 

$

0.15

 

$

0.07

 

Net income per share - diluted

 

$

0.15

 

$

0.07

 

 

 

19


 

Note 7 - Stock-Based Compensation

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

We account for stock-based compensation in accordance with FASB ASC Topic 718, Compensation – Stock Compensation, which requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense in the statement of operations at fair value. Additionally, we are required to recognize the expense of employee services received in share-based payment transactions and measure the expense based on the grant date fair value of the award. The expense is recognized over the period during which an employee is required to provide service in exchange for the award. Stock-based compensation expense included in the consolidated statements of operations for the three months ended March 31, 2018 and 2017 totaled $56,000 and $53,000, respectively. 

Information regarding our stock-based compensation plan is as follows as of and for the three  months ended March 31:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

2017

 

    

 

    

 

    

Weighted-

    

 

    

 

    

 

    

Weighted-

    

 

 

 

 

 

Weighted-

 

Average

 

Aggregate

 

 

 

Weighted-

 

Average

 

Aggregate

 

 

 

 

Average

 

Remaining

 

Intrinsic

 

 

 

Average

 

Remaining

 

Intrinsic

 

 

Number

 

Exercise

 

Contractual

 

Value

 

Number

 

Exercise

 

Contractual

 

Value

 

 

of Shares

 

Price

 

Term (in years)

 

(in thousands)

 

of Shares

 

Price

 

Term (in years)

 

(in thousands)

Outstanding at beginning of period

 

434,275

 

$

5.87

 

  

 

 

  

 

339,500

 

$

5.31

 

  

 

 

  

Granted

 

6,500

 

 

7.41

 

  

 

 

  

 

 —

 

 

 —

 

  

 

 

  

Exercised

 

(14,202)

 

 

3.95

 

  

 

 

  

 

(5,025)

 

 

3.37

 

  

 

 

  

Forfeited

 

(250)

 

 

7.10

 

  

 

 

  

 

 —

 

 

 —

 

  

 

 

  

Outstanding at end of period

 

426,323

 

$

5.96

 

6.2

 

$

549

 

334,475

 

$

5.34

 

7.7

 

$

627

Exercisable at end of period

 

200,028

 

$

5.03

 

6.1

 

$

453

 

151,249

 

$

4.61

 

6.8

 

$

397

 

The fair values of options at the time of the grants were derived using the Black-Scholes option-pricing model.  The followings weighted average assumptions were used to value options granted for the three months ended March 31, 2018:

 

 

 

 

 

 

    

2018

    

Expected life

 

 

5.5 years

 

Risk-free interest rate

 

 

2.67

%  

Expected volatility

 

 

32.20

%  

Expected dividend yield

 

 

 —

 

Weighted average per share fair value of options granted

 

$

2.57

 

 

As of March 31,2018, there was $662,000 of total unrecognized stock-based compensation expense related to nonvested stock options, which is expected to be recognized over the next 60 months.

20


 

Note 8 - Commitments and Contingencies

Off-Balance Sheet Instruments

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

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

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

    

2018

    

2017

 

 

(dollars in thousands)

Standby letters of credit

 

$

3,434

 

$

3,480

Home equity lines of credit

 

 

14,221

 

 

13,321

Unadvanced construction commitments

 

 

50,021

 

 

74,720

Mortgage loan commitments

 

 

3,148

 

 

595

Lines of credit

 

 

16,796

 

 

16,612

Loans sold and serviced with limited repurchase provisions

 

 

24,592

 

 

21,409

 

Standby letters of credit are conditional commitments issued by the Bank guaranteeing performance by a customer to various municipalities. These guarantees are issued primarily to support performance arrangements and are limited to real estate transactions. The majority of these standby letters of credit expire within twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit as deemed necessary. Management believes, except for certain standby letters of credit, that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The current amount of the liability as of March 31, 2018 and December 31, 2017 for guarantees under standby letters of credit issued was $44,000 and $42,000, respectively.

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

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

Mortgage loan commitments not reflected in the accompanying statements of financial condition at March 31, 2018 included three loans totaling $3.1 million. Such commitments at December 31, 2017 consisted of two loans totaling $595,000.

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

The Bank has entered into several agreements to sell mortgage loans to third parties. These agreements contain limited provisions that require the Bank to repurchase a loan if the loan becomes delinquent within a period ranging generally from 120 to 180 days after the sale date depending on the investor’s agreement. The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. We established a reserve for

21


 

potential repurchases for these loans, which amounted to $67,000 at March 31, 2018 and $63,000 at December 31, 2017. We did not repurchase any loans during the three months ended March 31, 2018 or 2017.

Other Contingencies

The Company provides banking services to customers who do business in the medical-use cannabis industry. While the growing, processing, and sales of medical-use cannabis is legal in the state of Maryland, the business currently violates Federal law. The Company may be deemed to be aiding and abetting illegal activities through the services that it provides to these customers. The strict enforcement of Federal laws regarding medical-use cannabis would likely result in the Company’s inability to continue to provide banking services to these customers and the Company could have legal action taken against it by the Federal government, including imprisonment and fines. There is an uncertainty of the potential impact to the Company’s consolidated financial statements if the Federal government takes actions against the Company. As of March 31, 2018, the Company has not accrued an amount for the potential impact of any such actions.

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

•  Deposit and loan balances at March 31, 2018 were approximately $16.5 million, 2.8% of total deposits, and $12.7 million, 1.9% of total loans, respectively. Deposit and loan balances at December 31, 2017 were approximately $19.2 million, 3.2% of total deposits, and $11.9 million, 1.8% of total loans, respectively.

Interest and noninterest income for the three months ended March 31, 2018 were approximately $176,000 and $230,000, respectively. There was no interest or noninterest income recognized on medical-use cannabis accounts for the three months ended March 31, 2017.

Volume of deposits in the accounts of medical-use cannabis customers for the three months ended March 31, 2018 was approximately $17.9 million. No deposits were made in medical-use cannabis accounts during the three months ended March 31, 2017.

Note 9 - Fair Value of Financial Instruments

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

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

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

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

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

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

22


 

Assets Measured on a Recurring Basis

The following tables present fair value measurements for assets that are measured at fair value on a recurring basis as of and for the three months ended March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

  

 

    

  

    

Significant

    

  

    

  

 

 

  

 

 

  

 

Other

 

Significant

 

Total Changes

 

 

  

 

 

Quoted

 

Observable

 

Unobservable

 

In Fair Values

 

 

Carrying

 

Prices

 

Inputs

 

Inputs

 

Included In

 

 

Value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Period Income

Assets:

 

(dollars in thousands)

AFS Securities - U.S. Treasury and government agency notes

 

$

12,011

 

$

1,975

 

$

10,036

 

$

 —

 

$

 —

Loans held for sale ("LHFS")

 

 

5,803

 

 

 —

 

 

5,803

 

 

 —

 

 

38

Mortgage servicing rights ("MSRs")

 

 

499

 

 

 —

 

 

 —

 

 

499

 

 

22

Interest-rate lock commitments ("IRLCs")

 

 

184

 

 

 —

 

 

 —

 

 

184

 

 

162

Mandatory forward contracts

 

 

41

 

 

 —

 

 

41

 

 

 —

 

 

28

Best efforts forward contracts

 

 

15

 

 

 —

 

 

15

 

 

 —

 

 

12

 

The following tables present fair value measurements for assets and liabilities that are measured at fair value on a recurring basis as of and for the year ended December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

  

    

  

    

Significant

    

  

    

  

 

 

  

 

  

 

Other

 

Significant

 

Total Changes

 

 

  

 

Quoted

 

Observable

 

Unobservable

 

In Fair Values

 

 

Carrying

 

Prices

 

Inputs

 

Inputs

 

Included In

 

 

Value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Period Income

Assets:

 

(dollars in thousands)

AFS Securities - U.S. Treasury and government agency notes

 

$

10,119

 

$

 —

 

$

10,119

 

$

 —

 

$

 —

LHFS

 

 

4,530

 

 

 —

 

 

4,530

 

 

 —

 

 

131

MSRs

 

 

477

 

 

 —

 

 

 —

 

 

477

 

 

(80)

IRLCs

 

 

22

 

 

 —

 

 

 —

 

 

22

 

 

(140)

Mandatory forward contracts

 

 

13

 

 

 —

 

 

13

 

 

 —

 

 

(140)

Best efforts forward contracts

 

 

 3

 

 

 —

 

 

 3

 

 

 —

 

 

 3

 

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

 

 

 

 

 

 

 

 

 

 

 

 

    

Fair Value

    

Valuation

    

Unobservable

    

Range

 

 

 

Estimate

 

Technique

 

Input

 

(Weighted-Average)

 

 

 

(dollars in thousands)

 

 

 

 

 

March 31, 2018:

 

 

  

 

  

 

  

 

  

 

MSRs

 

$

499

 

Market Approach

 

Weighted average prepayment speed

 

3.97

%

IRLCs

 

 

184

 

Market Approach

 

Average pull through rate

 

90.00

%

  

 

 

  

 

  

 

  

 

  

 

December 31, 2017:

 

 

  

 

  

 

  

 

  

 

MSRs

 

$

477

 

Market Approach

 

Weighted average prepayment speed

 

3.94

%

IRLCs

 

 

22

 

Market Approach

 

Average pull through rate

 

90.00

%

 

AFS Securities

The estimated fair values of AFS debt securities are obtained from a nationally-recognized pricing service. This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing to prepare valuations. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without relying

23


 

exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond’s terms and conditions, among other things, and are based on market data obtained from sources independent from the Bank. The Level 2 investments in the Bank’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets. The Bank has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in the Bank’s portfolio are not exchange-traded, and such nonexchange-traded fixed income securities are typically priced by correlation to observed market data.

LHFS

LHFS are carried at fair value, which is determined based on outstanding investor commitments or, in the absence of such commitments, on current investor yield requirements or third party pricing models. 

MSRs

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

IRLCs

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

Forward Contracts

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

24


 

Assets Measured on a Nonrecurring Basis

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

 

 

 

 

 

 

 

Significant

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other 

 

Significant

 

 

 

 

 

 

 

 

 

 

Quoted 

 

Observable

 

Unobservable

 

 

 

 

 

 

 

Carrying 

 

Prices

 

Inputs

 

Inputs

 

Range of

 

Weighted

 

 

    

Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

    

Discount (1)

    

Average

 

 

 

(dollars in thousands)

 

 

 

 

 

Impaired loans

 

$

8,697

 

$

 —

 

$

 —

 

$

8,697

 

0% - 19%

 

8.2

%

Real estate acquired through

 

 

  

 

 

  

 

 

  

 

 

  

 

  

 

 

 

foreclosure

 

 

23

 

 

 —

 

 

 —

 

 

23

 

0% - 36%

 

36.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

Significant

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other 

 

Significant

 

 

 

 

 

 

 

 

 

 

Quoted 

 

Observable

 

Unobservable

 

 

 

 

 

 

 

Carrying 

 

Prices

 

Inputs

 

Inputs

 

Range of

 

Weighted

 

 

    

Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

    

Discount (1)

    

Average

  

 

 

(dollars in thousands)

 

 

 

 

 

Impaired loans

 

$

2,793

 

$

 —

 

$

 —

 

$

2,793

 

0% - 33%

 

14.5

%

Real estate acquired through

 

 

  

 

 

  

 

 

  

 

 

  

 

  

 

 

 

foreclosure

 

 

178

 

 

 —

 

 

 —

 

 

178

 

0% - 22%

 

11.5

%

 

(1)

Discount based on current market conditions and estimated selling costs

Impaired Loans

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

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

Real Estate Acquired Through Foreclosure

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

25


 

Fair Value of All Financial Instruments

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

Carrying

 

Fair Value

 

    

Value

    

Level 1

    

Level 2

    

Level 3

    

 Total

Assets:

 

(dollars in thousands)

Cash and cash equivalents

 

$

18,307

 

$

18,307

 

$

 —

 

$

 —

 

$

18,307

Certificates of deposit held for investment

 

 

8,780

 

 

8,780

 

 

 —

 

 

 —

 

 

8,780

AFS securities

 

 

12,011

 

 

1,975

 

 

10,036

 

 

 —

 

 

12,011

HTM securities

 

 

49,911

 

 

5,025

 

 

44,001

 

 

 —

 

 

49,026

LHFS

 

 

5,803

 

 

 —

 

 

5,803

 

 

 —

 

 

5,803

Loans receivable, net

 

 

661,743

 

 

 —

 

 

 —

 

 

668,451

 

 

668,451

Restricted stock investments

 

 

4,844

 

 

 —

 

 

4,844

 

 

 —

 

 

4,844

Accrued interest receivable

 

 

2,454

 

 

 —

 

 

2,454

 

 

 —

 

 

2,454

MSRs

 

 

499

 

 

 —

 

 

 —

 

 

499

 

 

499

IRLCs

 

 

184

 

 

 —

 

 

 —

 

 

184

 

 

184

Mandatory forward contracts

 

 

41

 

 

 —

 

 

41

 

 

 —

 

 

41

Best effort forward contracts

 

 

15

 

 

 —

 

 

15

 

 

 —

 

 

15

Liabilities:

 

 

  

 

 

  

 

 

 

 

 

  

 

 

  

Deposits

 

 

589,916

 

 

 —

 

 

578,257

 

 

 —

 

 

578,257

Accrued interest payable

 

 

416

 

 

 —

 

 

416

 

 

 —

 

 

416

Borrowings

 

 

96,500

 

 

 —

 

 

89,198

 

 

 —

 

 

89,198

Subordinated debentures

 

 

20,619

 

 

 —

 

 

 —

 

 

20,619

 

 

20,619

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

Carrying

 

Fair Value

 

    

Value

    

Level 1

    

Level 2

    

Level 3

    

 Total

Assets:

 

(dollars in thousands) 

Cash and cash equivalents

 

$

21,853

 

$

21,853

 

$

 —

 

$

 —

 

$

21,853

Certificates of deposit held for investment

 

 

8,780

 

 

8,780

 

 

 —

 

 

 —

 

 

8,780

AFS securities

 

 

10,119

 

 

 —

 

 

10,119

 

 

 —

 

 

10,119

HTM securities

 

 

54,303

 

 

5,056

 

 

48,948

 

 

 —

 

 

54,004

LHFS

 

 

4,530

 

 

 —

 

 

4,530

 

 

 —

 

 

4,530

Loans receivable, net

 

 

660,096

 

 

 —

 

 

 —

 

 

672,349

 

 

672,349

Restricted stock investments

 

 

4,489

 

 

 —

 

 

4,489

 

 

 —

 

 

4,489

Accrued interest receivable

 

 

2,640

 

 

 —

 

 

2,640

 

 

 —

 

 

2,640

MSRs

 

 

477

 

 

 —

 

 

 —

 

 

477

 

 

477

IRLCs

 

 

22

 

 

 —

 

 

 —

 

 

22

 

 

22

Mandatory forward contracts

 

 

13

 

 

 —

 

 

13

 

 

 —

 

 

13

Best effort forward contracts

 

 

 3

 

 

 —

 

 

 3

 

 

 —

 

 

 3

Liabilities:

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Deposits

 

 

602,228

 

 

 —

 

 

594,659

 

 

 —

 

 

594,659

Accrued interest payable

 

 

395

 

 

 —

 

 

395

 

 

 —

 

 

395

Borrowings

 

 

88,500

 

 

 —

 

 

81,303

 

 

 —

 

 

81,303

Subordinated debentures

 

 

20,169

 

 

 —

 

 

 —

 

 

20,619

 

 

20,619

 

At March 31,2018 and December 31, 2017, the Bank had loan funding commitments of $84.2 million and $105.2 million, respectively, and standby letters of credit outstanding of $3.4 million and $3.5 million, respectively. The fair value of these commitments is nominal.

26


 

Cash and Cash Equivalents

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

Certificates Held for Investment

The carrying amount reported in the consolidated statements of financial condition for Certificates of Deposit Held for Investment approximate those assets’ fair values.

 

HTM securities

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

Loans Receivable

As of March 31, 2018, the fair value of loans receivable was estimated using an exit price analysis, in accordance with current FASB guidance, contracted through a third party service provider. As of December 31, 2017, the fair value of loans receivable was estimated using discounted cash flow analyses, using market interest rates then offered for loans with similar terms to borrowers of similar credit quality.  These rates were used for each aggregated category of loans.

Restricted Stock Investments

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

Accrued Interest Receivable and Payable

 

The carrying amount of accrued interest receivable and accrued interest payable approximates fair value. 

Deposits

 

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

Borrowings

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

Subordinated debentures

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

27


 

Limitations

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

There were no transfers between any of Levels 1, 2, and 3 for the three months ended March 31, 2018 or 2017 or for the year ended December 31, 2017.

28


 

 

Note 10 -  Subsequent Event

 

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

 

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

When used in this report, the terms “the Company,” “we,” “us,” and “our” refer to Severn Bancorp and, unless the context requires otherwise, its consolidated subsidiaries. The following discussion should be read and reviewed in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in Severn Bancorp’s Annual Report on Form 10‑K for the year ended December 31, 2017.

The Company

The Company is a savings and loan holding company chartered as a corporation in the state of Maryland in 1990. It conducts business primarily through three subsidiaries, Severn Savings Bank, FSB (the “Bank”), Mid-Maryland Title Company, Inc. (the “Title Company”), and SBI Mortgage Company (“SBI”). SBI holds mortgages that do not meet the underwriting criteria of the Bank, and is the parent company of Crownsville Development Corporation (“Crownsville”), which is doing business as Annapolis Equity Group, and acquires real estate for syndication and investment purposes. The Title Company is a real estate settlement company that handles commercial and residential real estate settlements in Maryland. The Bank’s principal subsidiary Louis Hyatt, Inc. (“Hyatt Commercial”), conducts business as Hyatt Commercial, a commercial real estate brokerage and property management company. The Bank has five branches in Anne Arundel County, Maryland, which offer a full range of deposit products, and originate mortgages in its primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware, and Virginia. As of March 31, 2018, we had 143 full-time equivalent employees.

Overview

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

We have experienced an improved level of profitability for the three months ended March 31, 2018, primarily due to the improved profitability of our mortgage-banking operations as well as an improvement in our net interest margin. We recognized increased deposit service charges as a result of fees from medical-use cannabis deposit accounts and realized lower income taxes due to a lower federal tax rate in 2018. 

The Company expects to experience similar market conditions during the remainder of 2018, provided interest rates do not increase rapidly. If interest rates increase rapidly, demand for loans may decrease and our interest rate spread could decrease. We will continue to manage loan and deposit pricing against the risks of rising costs of our deposits and borrowings. Interest rates are outside of our control, so we must attempt to balance the pricing and duration of the loan portfolio against the risks of rising costs of our deposits and borrowings. The continued success and attraction of Anne Arundel County, Maryland, and vicinity, will also be important to our ability to originate and grow mortgage loans and deposits, as will our continued focus on maintaining a low overhead. If volatility in the market and the economy occurs, our business, financial condition, results of operations, access to funds, and the price of our stock could be materially and adversely impacted.

29


 

Critical Accounting Policies

Our significant accounting policies are set forth in Note 1 of the audited consolidated financial statements for the year ended December 31, 2017 which were included in our Annual Report on Form 10‑K. Of these significant accounting policies, we consider our policies regarding the valuation of  investment securities, the Allowance for loan losses (“Allowance”), the valuation of real estate acquired through foreclosure, and the valuation of the net deferred tax asset to be our most critical accounting policies, due to the fact that these policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried in the consolidated financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. When applying accounting policies in such areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets and liabilities. Below is a discussion of our critical accounting policies.

Securities

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

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

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

Allowance for Loan Losses

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

30


 

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

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

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

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

·

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

·

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

·

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

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

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

·

Levels and trends in delinquencies and nonaccruals;

·

Inherent risk in the loan portfolio;

·

Trends in volume and terms of the loan;

·

Effects of any change in lending policies and procedures;

·

Experience, ability, and depth of management;

·

National and local economic trends and conditions;

·

Effect of any changes in concentration of credit; and

·

Industry conditions.

We assign risk ratings to the loans in our portfolio. These credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful, and loss. Loans classified special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the

31


 

debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the Allowance. Loans not classified are rated pass.

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

 

·

The property collateralizing the loan has been foreclosed upon. At the time of foreclosure, a charge-off is recorded for the difference between the recorded amount of the loan and the net value of the underlying collateral;

·

An agreement to accept less than the recorded balance of the loan has been made with the borrower. Once an agreement has been finalized and any proceeds from the borrower are received, a charge-off is recorded for the difference between the recorded amount of the loan and the net value of the underlying collateral; or

·

The collateral valuation on a collateral dependent impaired loan is less than the recorded balance. The loan is charged off for accounting purposes by the amount of the difference between the recorded balance and collateral value.

 

Real Estate Acquired Through Foreclosure

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

Deferred Income Taxes

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

The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. To the extent that current available evidence about the future raises doubt about the likelihood of a deferred tax asset being realized, a valuation allowance is established. We recognizes a tax position as a benefit only if it “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination presumed to occur. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The judgment about the level of future taxable income is inherently subjective and is reviewed on a continual basis as regulatory and business factors change.

Results of Operations

Net Income

Net income increased by $960,000, or 103.8%, to $1.9 million for the three months ended March 31, 2018, compared to $925,000 for the three months ended March 31, 2017. Basic and diluted income per share were $0.15 for the three months

32


 

ended March 31, 2018 compared to $0.07 for the three months ended March 31, 2017. The increase in net income reflected improved net interest income and noninterest income, partially offset by increased noninterest expense and provision for loan losses.

Net Interest Income

Net interest income, which is interest earned net of interest expense, increased by $1.4 million, or 25.0%, to $7.0 million for the three months ended March 31, 2018, compared to $5.6 million for the three months ended March 31, 2017. Our net interest margin increased from 3.09% for the first quarter of 2017 to 3.66% for the first quarter of 2018. Our net interest spread increased from 2.88% for the first quarter of 2017 to 3.46% for the first quarter of 2018.

Interest Income

Interest income increased by $1.3 million, or 17.5%, to $8.9 million for the three months ended March 31, 2018, compared to $7.6 million for the three months ended March 31, 2017. Average interest-earning assets increased from $732.3 million for the first quarter of 2017 to $773.9 million for the first quarter of 2018, due primarily to growth in average loans outstanding. Average loans outstanding increased by $60.2 milliondue to increased originations in all loan categories. The average yield on loans held for investment increased from 4.72% for the three months ended March 31, 2017 to 5.06% for the three months ended March 31, 2018 as a result of the increased interest rate environment. Average HTM securities decreased by $8.2 milliondue to security maturities and repayments from mortgage-backed securities. The proceeds were used to fund the purchase of AFS securities, the average balance of which increased $7.9 million during the three months ended March 31, 2018, and, along with other available funds, the increase in loan originations.

Interest Expense

Interest expense decreased by $78,000, or 4.0%, to $1.9 million for the three months ended March 31, 2018, compared to $2.0 million for the three months ended March 31, 2017. The decrease was primarily due to a decrease in the average rate paid on borrowings from 3.35% for the first quarter of 2017 to 2.63% for the first quarter of 2018. Additionally, average borrowings decreased by $3.2 million to $117.4 million for the three months ended March 31, 2018 compared to $120.6 million for the same period of 2017.  During the latter part of 2017, we paid off higher-costing Federal Home Loan Bank of Atlanta (“FHLB”) advances and replaced them with lower-costing advances.

33


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

 

 

2018

 

2017

 

 

 

Average

 

 

 

Yield/

 

Average

 

 

 

Yield/

 

 

    

Balance (1)

    

Interest (2)

    

Rate (4)

    

Balance (1)

    

Interest (2)

    

Rate (4)

  

ASSETS

 

(dollars in thousands)

 

Loans

 

$

668,615

 

$

8,335

 

5.06

%  

$

608,417

 

$

7,081

 

4.72

%

Loans held for sale ("LHFS")

 

 

3,421

 

 

36

 

4.27

%  

 

4,416

 

 

50

 

4.59

%

AFS securities

 

 

11,597

 

 

51

 

1.78

%  

 

3,671

 

 

15

 

1.66

%

HTM securities

 

 

52,586

 

 

269

 

2.07

%  

 

60,762

 

 

254

 

1.70

%

Other interest-earning assets (3)

 

 

32,852

 

 

126

 

1.56

%  

 

50,297

 

 

97

 

0.78

%

Restricted stock investments, at cost

 

 

4,847

 

 

60

 

5.02

%  

 

4,784

 

 

60

 

5.09

%

Total interest-earning assets

 

 

773,918

 

 

8,877

 

4.65

%  

 

732,347

 

 

7,557

 

4.18

%

Allowance

 

 

(8,141)

 

 

  

 

  

 

 

(9,000)

 

 

  

 

  

 

Cash and other noninterest-earning assets

 

 

43,233

 

 

  

 

  

 

 

65,926

 

 

  

 

  

 

Total assets

 

$

809,010

 

 

8,877

 

  

 

$

789,273

 

 

7,557

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Interest-bearing deposits:

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Checking and savings

 

$

304,037

 

 

332

 

0.44

%  

$

278,499

 

 

215

 

0.31

%

Certificates of deposit

 

 

222,508

 

 

801

 

1.46

%  

 

217,455

 

 

760

 

1.42

%

Total interest-bearing deposits

 

 

526,545

 

 

1,133

 

0.87

%  

 

495,954

 

 

975

 

0.80

%

Borrowings

 

 

117,352

 

 

760

 

2.63

%  

 

120,563

 

 

996

 

3.35

%

Total interest-bearing liabilities

 

 

643,897

 

 

1,893

 

1.19

%  

 

616,517

 

 

1,971

 

1.30

%

Noninterest-bearing deposits

 

 

88,160

 

 

  

 

  

 

 

81,569

 

 

  

 

  

 

Other noninterest-bearing liabilities

 

 

2,103

 

 

  

 

  

 

 

2,716

 

 

  

 

  

 

Stockholders' equity

 

 

74,850

 

 

  

 

  

 

 

88,471

 

 

  

 

  

 

Total liabilities and stockholders' equity

 

$

809,010

 

 

1,893

 

  

 

$

789,273

 

 

1,971

 

  

 

Net interest income/net interest spread

 

 

  

 

$

6,984

 

3.46

%  

 

  

 

$

5,586

 

2.88

%

Net interest margin

 

 

  

 

 

  

 

3.66

%  

 

  

 

 

  

 

3.09

%


(1)Nonaccrual loans are included in average loans.

(2)There are no tax equivalency adjustments.

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

(4)Annualized

34


 

The “Rate/Volume Analysis” below indicates the changes in our net interest income as a result of changes in volume and rates. We maintain an asset and liability management policy designed to provide a proper balance between rate-sensitive assets and rate-sensitive liabilities to attempt to optimize interest margins while providing adequate liquidity for our anticipated needs. Changes in interest income and interest expense that result from variances in both volume and rates have been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2018 vs. 2017

 

 

 

Due to Variances in

 

    

    

Rate

    

Volume

    

Total

Interest earned on:

 

 

(dollars in thousands)

Loans

 

 

$

524

 

$

730

 

$

1,254

LHFS

 

 

 

(3)

 

 

(11)

 

 

(14)

AFS securities

 

 

 

 1

 

 

35

 

 

36

HTM Securities

 

 

 

183

 

 

(168)

 

 

15

Other interest-earning assets

 

 

 

224

 

 

(195)

 

 

29

Restricted stock investments, at cost

 

 

 

(3)

 

 

 3

 

 

 —

Total interest income

 

 

 

926

 

 

394

 

 

1,320

 

 

 

 

 

 

 

 

 

 

 

Interest paid on:

 

 

 

  

 

 

  

 

 

  

Interest-bearing deposits:

 

 

 

  

 

 

  

 

 

  

Checking and savings

 

 

 

96

 

 

21

 

 

117

Certificates of deposit

 

 

 

23

 

 

18

 

 

41

Total interest-bearing deposits

 

 

 

119

 

 

39

 

 

158

Borrowings

 

 

 

(210)

 

 

(26)

 

 

(236)

Total interest expense

 

 

 

(91)

 

 

13

 

 

(78)

Net interest income

 

 

$

1,017

 

$

381

 

$

1,398

 

Provision for Loan Losses

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

We did not record a provision for loan losses during the three months ended March 31, 2018.  We recorded a reversal of the provision for loan losses of $275,000 during the three months ended March 31, 2017. See additional information about the provision for loan losses under “Credit Risk Management and the Allowance” later in this Item.

Noninterest Income

Total noninterest income increased by $511,000, or 37.6%, to $1.9 million for the three months ended March 31, 2018, compared to $1.4 million for the three months ended March 31, 2017, primarily due to increased mortgage-banking revenue, deposit service charges, and title company revenue. Mortgage-banking revenue increased $60,000, or 11.2%, due to an increased volume of loans originated in the first quarter of 2018 compared to the first quarter of 2017. In 2017, the decision was made to move away from the purchased lead model previously used and instead focus on internally generated leads. We are beginning to see increased origination volume from the switch in models. Deposit service charges increased $261,000 due primarily to fees associated with medical-use cannabis customer accounts. Other noninterest income includes $142,000 in revenue generated by the Title Company during the first quarter of 2018.

35


 

Noninterest Expense

Total noninterest expenses increased $548,000, or 9.7%, to $6.2 million for the three months ended March 31, 2018, compared to $5.7 million for the first quarter of 2017, primarily due to increases in compensation and related expenses.  Compensation and related expenses increased by $521,000, or 13.9%, to $4.3 million for the three months ended March 31, 2018, compared to $3.8 million for the three months ended March 31, 2017. This increase was primarily due to annual salary increases, as well as increased commission expense that corresponds with our increased loan origination and mortgage-banking volume. Partially offsetting the increase in compensation and related expenses, mortgage leads purchased decreased $95,000 due to the transition away from the purchased lead model.

Income Tax Provision

We recorded745,000 income tax provision on net income before income taxes of $2.6 million for the three months ended March 31, 2018, compared to a tax provision of $619,000 on net income before income taxes of $1.5 million for the three months ended March 31, 2017. The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017, which lowered the corporate federal tax rate from 35% to 21% effective January 1, 2018.  Among other things, the new law has significantly lowered our effective tax rate.

Financial Condition

Total assets decreased $3.7 million to $801.1 million at March 31, 2018, compared to $804.8 million at December 31, 2017. This decrease was primarily due to decreases in interest-bearing deposits in other banks and in total securities. Loans increased $1.8 million, or 0.3%, to $669.9 million at March 31, 2018 from $668.2 million at December 31, 2017. Total deposits decreased $12.3 million, or 2.0%, to $589.9 million at March 31, 2018 compared to $602.2 million at December 31, 2017. Total borrowings increased by $8.0 million, or 9.0%, to $96.5 million at March 31, 2018 compared to $88.5 million at December 31, 2017 due to an additional $8.0 million in short-term FHLB advances obtained in 2018.

Securities

We utilize the securities portfolio as part of our overall asset/liability management practices to enhance interest revenue while providing necessary liquidity for the funding of loan growth or deposit withdrawals. We continually monitor the credit risk associated with investments and diversify the risk in the securities portfolios. We held $12.0 million and $10.1 million in securities classified as AFS as of March 31, 2018 and December 31, 2017, respectively. We held $49.9 million and $54.3 million, respectively, in securities classified as HTM as of March 31, 2018 and December 31, 2017.

Changes in current market conditions, such as interest rates and the economic uncertainties in the mortgage, housing, and banking industries impact the securities market. Quarterly, we review each security in our portfolio to determine the nature of any decline in value and evaluate if any impairment should be classified as OTTI. For the three months ended March 31, 2018, we determined that no OTTI charges were required.

All of the AFS and HTM securities that are temporarily impaired as of March 31, 2018 are so due to declines in fair values resulting from changes in interest rates or decreased credit/liquidity spreads compared to the time they were purchased. We have the intent to hold these securities to maturity (including those designated as AFS) and it is more likely than not that we will not be required to sell the securities before recovery of value. As such, management considers the impairments to be temporary.

36


 

Our securities portfolio composition is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AFS

 

HTM

 

    

March 31, 2018

    

December 31, 2017

    

March 31, 2018

    

December 31, 2017

 

 

(dollars in thousands)

U.S. Treasury securities

 

$

1,975

 

$

 —

 

$

4,993

 

$

4,994

U.S. government agency notes

 

 

10,036

 

 

10,119

 

 

15,999

 

 

19,004

Mortgage-backed securities

 

 

 —

 

 

 —

 

 

28,919

 

 

30,305

 

 

$

12,011

 

$

10,119

 

$

49,911

 

$

54,303

 

LHFS

We originate residential mortgage loans for sale on the secondary market. At March 31, 2018, such LHFS, which are carried at fair value, amounted to $5.8 million at March 31, 2018 and $4.5 million at December 31, 2017, the majority of which are subject to purchase commitments from investors. LHFS increased by $1.3 million, or 28.1%, compared to December 31, 2017, primarily due to a higher origination volume and the timing of loans pending sale on the secondary market.

Loans

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

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

December 31, 2017

 

 

 

 

 

 

Percent

 

 

 

Percent

 

 

 

    

Amount

    

of Total

    

Amount

    

of Total

 

    

 

 

(dollars in thousands)

 

 

Residential Mortgage

 

$

285,023

 

42.5

%  

$

284,646

 

42.6

%

 

Commercial

 

 

39,015

 

5.8

%  

 

37,356

 

5.5

%

 

Commercial real estate

 

 

230,336

 

34.4

%  

 

236,302

 

35.4

%

 

Land acquisition, development, and construction ("ADC")

 

 

100,635

 

15.0

%  

 

93,060

 

13.9

%

 

Home equity/2nds

 

 

13,853

 

2.1

%  

 

15,703

 

2.4

%

 

Consumer

 

 

1,050

 

0.2

%  

 

1,084

 

0.2

%

 

 

 

$

669,912

 

100.0

%  

$

668,151

 

100.0

%

 

 

Loans increased by $1.8 million, or 0.3%, to $669.9 million at March 31, 2018, compared to $668.2 million at December 31, 2017. This increase was due to increased demand and originations of residential mortgages, commercial, and ADC loans.

Credit Risk Management and the Allowance

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

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

37


 

Management has an established methodology to determine the adequacy of the Allowance that assesses the risks and losses inherent in the loan portfolio. Our Allowance methodology employs management’s assessment as to the level of future losses on existing loans based on our internal review of the loan portfolio, including an analysis of the borrowers’ current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers and/or lines of business. In determining our ability to collect certain loans, we also consider the fair value of any underlying collateral. In addition, we evaluate credit risk concentrations, including trends in large dollar exposures to related borrowers, industry and geographic concentrations, and economic and environmental factors. Our risk management practices are designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may inherently exist within the loan portfolio. The assessment aspects involved in analyzing the quality of individual loans and assessing collateral values can also contribute to undetected, but probable, losses. For more detailed information about our Allowance methodology and risk rating system, see Note 4 to the Consolidated Financial Statements.

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

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

    

2018

    

2017

 

 

(dollars in thousands)

Allowance, beginning of year

 

$

8,055

 

$

8,969

 

Charge-offs:

 

 

  

 

 

  

 

Residential mortgage

 

 

(323)

 

 

(499)

 

Commercial

 

 

 —

 

 

 —

 

Commercial real estate

 

 

 —

 

 

 —

 

ADC

 

 

(13)

 

 

 —

 

Home equity/2nds

 

 

 —

 

 

 —

 

Consumer

 

 

 —

 

 

 —

 

Total charge-offs

 

 

(336)

 

 

(499)

 

Recoveries:

 

 

  

 

 

  

 

Residential mortgage

 

 

221

 

 

107

 

Commercial

 

 

 —

 

 

27

 

Commercial real estate

 

 

211

 

 

 —

 

ADC

 

 

 —

 

 

 —

 

Home equity/2nds

 

 

18

 

 

 3

 

Consumer

 

 

 —

 

 

 —

 

Total recoveries

 

 

450

 

 

137

 

Net recoveries (charge offs)

 

 

114

 

 

(362)

 

Reversal of provision for loan losses

 

 

 —

 

 

(275)

 

Allowance, end of period

 

$

8,169

 

$

8,332

 

Loans:

 

 

  

 

 

  

 

Period-end balance

 

$

669,912

 

$

609,741

 

Average balance during period

 

 

668,615

 

 

608,417

 

Allowance as a percentage of

 

 

 

 

 

 

 

   period-end loan balance

 

 

1.22

%  

 

1.37

%  

Percent of average loans:

 

 

 

 

 

  

 

Reversal of provision for loan losses

 

 

 —

%  

 

(0.18)

%  

Net recoveries (charge offs )

 

 

0.07

%  

 

(0.24)

%  

 

38


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

December 31, 2017

 

 

 

    

 

    

 

    

Percent

    

 

    

 

    

Percent

 

    

 

 

 

 

 

 

of Loans

 

 

 

 

 

of Loans

 

 

 

 

 

 

Percent

 

to Total

 

 

 

Percent

 

to Total

 

 

 

 

Amount

 

of Total

 

Loans

 

Amount

 

of Total

 

Loans

 

 

 

 

(dollars in thousands)

 

 

Residential mortgage

 

$

3,301

 

40.4

%  

42.5

%  

$

3,099

 

38.5

%  

42.6

%

 

Commercial

 

 

514

 

6.3

%  

5.8

%  

 

527

 

6.6

%  

5.5

%

 

Commercial real estate

 

 

2,995

 

36.7

%  

34.4

%  

 

2,805

 

34.8

%  

35.4

%

 

ADC

 

 

1,060

 

13.0

%  

15.0

%  

 

1,236

 

15.3

%  

13.9

%

 

Home equity/2nds

 

 

297

 

3.6

%  

2.1

%  

 

386

 

4.8

%  

2.4

%

 

Consumer

 

 

 2

 

0.0

%  

0.2

%  

 

 2

 

0.0

%  

0.2

%

 

Total

 

$

8,169

 

100.0

%  

100.0

%  

$

8,055

 

100.0

%  

100.0

%

 

 

Based upon management’s evaluation, provisions are made to maintain the Allowance as a best estimate of inherent losses within the portfolio. The Allowance totaled  $8.2  million at March 31, 2018 and  $8.1 million at December 31, 2017. Any changes in the Allowance from period to period reflect management’s ongoing application of its methodologies to establish the Allowance, which, for the three months ended March 31, 2018, resulted in increased allocated Allowances for residential mortgage and commercial real estate loans, with the other categories resulting in decreased allocated Allowances. The changes in the Allowances for the respective loan segments were a function of the changes in the corresponding loan balances and asset quality.

As result of our Allowance analysis, we did not record a provision, nor did we release any Allowance during the three months ended March 31, 2018. We recorded a $275,000 reversal of provision for losses for the three months ended March 31, 2017. We recorded net recoveries of $114,000 during the three months ended March 31, 2018 and net charge-offs of $362,000 during the three months ended March 31, 2017. During the three months ended March 31, 2018, annualized net recoveries as compared to average loans outstanding amounted to 0.07%, compared to annualized net charge-offs as compared to average loans outstanding of 0.24% during the first three months of 2017. The Allowance as a percentage of outstanding loans remained fairly stable at 1.22%  as of March 31, 2018 and 1.21% as of December 31, 2017. 

Although management uses available information to establish the appropriate level of the Allowance, future additions or reductions to the Allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions, and other factors. As a result, our Allowance may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our Allowance and related methodology. Such agencies may require us to recognize adjustments to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as of March 31, 2018 and is sufficient to address the credit losses inherent in the current loan portfolio.

Nonperforming Assets (“NPAs”)

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

39


 

NPAs, expressed as a percentage of total assets, totaled 0.74% at March 31, 2018 and 0.76% at December 31, 2017. The ratio of the Allowance to nonperforming loans was 143.3% at March 31, 2018 and 141.1% at December 31, 2017.

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

 

 

 

 

 

 

 

 

 

 

March 31, 2018

    

December 31, 2017

    

Nonaccrual Loans:

 

(dollars in thousands)

 

Residential mortgage

 

$

3,619

 

$

3,891

 

Commercial

 

 

296

 

 

78

 

Commercial real estate

 

 

216

 

 

159

 

ADC

 

 

310

 

 

314

 

Home equity/2nds

 

 

1,260

 

 

1,268

 

Consumer

 

 

 —

 

 

 —

 

 

 

 

5,701

 

 

5,710

 

Real Estate Acquired Through Foreclosure:

 

 

  

 

 

  

 

Residential mortgage

 

 

 —

 

 

 —

 

Commercial

 

 

 —

 

 

 —

 

Commercial real estate

 

 

90

 

 

187

 

ADC

 

 

147

 

 

216

 

Home equity/2nds

 

 

 —

 

 

 —

 

Consumer

 

 

 —

 

 

 —

 

 

 

 

237

 

 

403

 

Total Nonperforming Assets

 

$

5,938

 

$

6,113

 

 

Nonaccrual loans amounted to  $5.7 million, or 0.85% of total loans, at both March 31, 2018 and December 31, 2017. We added $377,000 in loans to nonaccrual status during the three months ended March 31, 2018.

Real estate acquired through foreclosure decreased $166,000 compared to December 31, 2017 due to the sale of two properties held at December 31, 2017.

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

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

    

2018

    

2017

 

 

(dollars in thousands)

Balance at beginning of year

 

$

403

 

$

973

Real estate acquired in satisfaction of loans

 

 

 —

 

 

515

Write-downs and losses on real estate acquired through foreclosure

 

 

(44)

 

 

(40)

Proceeds from sales of real estate acquired through foreclosure

 

 

(122)

 

 

(205)

Balance at end of year

 

$

237

 

$

1,243

 

TDRs

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

40


 

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

 

 

 

 

 

 

 

 

 

    

March 31, 2018

    

December 31, 2017

    

Residential mortgage:

 

(dollars in thousands)

 

Nonaccrual

 

$

811

 

$

736

 

<90 days past due/current

 

 

10,692

 

 

11,631

 

Commercial real estate:

 

 

  

 

 

  

 

Nonaccrual

 

 

 —

 

 

78

 

<90 days past due/current

 

 

1,848

 

 

1,862

 

ADC:

 

 

  

 

 

  

 

Nonaccrual

 

 

 —

 

 

 6

 

<90 days past due/current

 

 

136

 

 

137

 

Consumer:

 

 

  

 

 

  

 

Nonaccrual

 

 

 —

 

 

 —

 

<90 days past due/current

 

 

82

 

 

84

 

Totals:

 

 

  

 

 

  

 

Nonaccrual

 

 

811

 

 

820

 

<90 days past due/current

 

 

12,758

 

 

13,714

 

 

 

$

13,569

 

$

14,534

 

 

See additional information on TDRs in Note 4 to the Consolidated Financial Statements.

Deposits

Deposits amounted to $589.9 million at March 31, 2018 and $602.2 million at December 31, 2017. The decrease in certificates of deposit (“CDs”) was due to the payoff of regularly maturing CDs.

The deposit breakdown is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

December 31, 2017

 

 

 

    

 

    

Percent

    

 

    

Percent

 

    

 

 

Balance

 

of Total

 

Balance

 

of Total

 

 

 

 

(dollars in thousands)

 

 

NOW

 

$

66,121

 

11.2

%  

$

63,616

 

10.6

%

 

Money market

 

 

103,514

 

17.6

%  

 

103,649

 

17.2

%

 

Savings

 

 

95,092

 

16.1

%  

 

98,717

 

16.4

%

 

Certificates of deposit

 

 

251,519

 

42.6

%  

 

263,413

 

43.7

%

 

Total interest-bearing deposits

 

 

516,246

 

87.5

%  

 

529,395

 

87.9

%

 

Noninterest-bearing deposits

 

 

73,670

 

12.5

%  

 

72,833

 

12.1

%

 

Total deposits

 

$

589,916

 

100.0

%  

$

602,228

 

100.0

%

 

 

Borrowings

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

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

At March 31, 2018, our total credit line with the FHLB was $240.3 million. The Bank, from time to time, utilizes the line of credit when interest rates are more favorable than obtaining deposits from the public. Our outstanding FHLB advance balance at March 31, 2018 and December 31, 2017 was  $93.0 million and  $85.0 million, respectively. 

41


 

On September 30, 2016, we entered into a loan agreement with a commercial bank whereby we borrowed $3.5 million out of an available $7.5 million credit line for a term of 8 years. The unsecured note bears interest at a fixed rate of 4.25% for the first 36 months then, at the option of the Company, converts to either (1) floating rate of the Wall Street Journal Prime plus 50 basis points or (2) fixed rate at two hundred seventy five (275) basis points over the five year amortizing FHLB rate for the remaining five years. Repayment terms are monthly interest only payments for the first 36 months, then quarterly principal payments of $175,000 plus interest. The loan is subject to a prepayment penalty of 1% of the principal amount prepaid during the first 36 months. If we elect the 5 year fixed rate of 275 basis points over the FHLB rate (“FHLB Rate Period”), the loan will be subject to a prepayment penalty of 2% during the first and second years of the FHLB Rate Period and 1% of the principal repaid during the third, fourth, and fifth years of the FHLB Rate Period. We may make additional principal payments from internally generated funds of up to $875,000 per year during any fixed rate period without penalty. There is no prepayment penalty during any floating rate period.

The following table sets forth information concerning the interest rates and maturity dates of the advances from the FHLB as of March 31, 2018:

 

 

 

 

 

 

Principal

    

 

    

 

Amount (in thousands)

 

Rate

 

Maturity

$

15,000

 

2.58% to 3.43%

 

2018

 

43,000

 

1.55% to 4.00%

 

2019

 

25,000

 

1.75% to 1.92%

 

2020

 

10,000

 

2.19%

 

2022

$

93,000

 

  

 

  

 

Subordinated Debentures

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

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

Under the terms of the 2035 Debenture, we are permitted to defer the payment of interest on the 2035 Debentures for up to 20 consecutive quarterly periods, provided that no event of default has occurred and is continuing. As of March 31, 2018 we were current on all interest due on the 2035 Debenture.

Capital Resources

Total stockholders’ equity increased $1.3 million to $92.4 million at March 31, 2018 compared to $91.1 million as of December 31, 2017. The increase was principally the result of 2018 net income, partially offset by dividends paid during the first quarter of 2018.

42


 

Series A Preferred Stock

On November 15, 2008, the Company completed a private placement offering consisting of a total of 70 units, at an offering price of $100,000 per unit, for gross proceeds of $7.0 million. Each unit consists of 6,250 shares of the Company’s Series A 8.0% Non-Cumulative Convertible Preferred Stock. On March 13, 2018, the Company notified holders of its Series A preferred stock that the Company had exercised its option to convert all 437,500 outstanding shares of Series A preferred stock for one share of common stock.  The Company converted the Series A preferred stock on April 2, 2018.  As of that date, the Series A preferred stock was no longer deemed outstanding, and all rights with respect to such stock have ceased and terminated. 

Capital Adequacy

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. As of March 31, 2018 and December 31, 2017, the Bank exceeded all capital adequacy requirements to which it is subject and meets the qualifications to be considered “well capitalized.”  See details of our capital ratios in Note 5 of the Consolidated Financial Statements.

Liquidity

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

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

In addition to our ability to generate deposits, we have external sources of funds, which may be drawn upon when desired. The primary source of external liquidity is an available line of credit with the FHLB. The Bank’s total credit availability under the FHLB’s credit availability program was $240.3 million at March 31, 2018, of which $93.0 million was outstanding. We also have $7.5 million in credit availability with another financial institution, of which $3.5 million was outstanding at March 31, 2018.

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit (collectively “commitments”), which totaled $84.2 million at March 31, 2018. Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. We expect to fund these commitments from the sources of liquidity described above.

43


 

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

In addition to the foregoing, the payment of dividends is a use of cash, but is not expected to have a material effect on liquidity. As of March 31, 2018, we had no material commitments for capital expenditures.

Our ability to acquire deposits or borrow could be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. At March 31, 2018, management considered the Company’s liquidity level to be sufficient for the purposes of meeting our cash flow requirements. We are not aware of any undisclosed known trends, demands, commitments, or uncertainties that are reasonably likely to result in material changes in our liquidity.

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

Off-Balance Sheet Arrangements and Derivatives

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

Credit Commitments

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

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

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

Derivatives

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

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

44


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

December 31, 2017

 

    

Notional

    

Estimated

    

Notional

    

Estimated

 

 

Amount

 

Fair Value

 

Amount

 

Fair Value

 

 

(dollars in thousands)

Asset - IRLCs

 

$

9,050

 

$

184

 

$

1,144

 

$

22

Asset - Mandatory forward contracts

 

 

5,633

 

 

41

 

 

4,399

 

 

13

 

Inflation

The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the U.S. and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. As a financial institution, virtually all of our assets and liabilities are monetary in nature and interest rates have a more significant impact on our performance than the effects of general levels of inflation. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect our results of operations unless mitigated by a corresponding increase in our revenues. However, we believe that the impact of inflation on our operations was not material in the first quarter of 2018 or 2017.

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

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

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

The matching of maturity or repricing of interest-earning assets and interest-bearing liabilities may be analyzed by examining the extent to which these assets and liabilities are interest rate sensitive and by monitoring the Bank’s interest rate sensitivity gap. An interest-earning asset or interest-bearing liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. The difference between rate sensitive assets and rate sensitive liabilities represents the Bank’s interest sensitivity gap. At March 31, 2018, we had a one-year cumulative negative gap of $139.8 million.

Exposure to interest rate risk is actively monitored by management. The objective is to maintain a consistent level of profitability within acceptable risk tolerances across a broad range of potential interest rate environments. We use the

45


 

PROFITstar® model to monitor our exposure to interest rate risk, which calculates changes in the economic value of equity (“EVE”).

The following table represents our EVE as of March 31, 2018:

 

 

 

 

 

 

 

 

 

 

Change in Rates

    

Amount

    

$ Change

    

% Change

 

 

 

(dollars in thousands)

 

 

 

+400

bp

$

167,503

 

$

(40,124)

 

(0.19)

%

+300

bp

 

179,862

 

 

(27,765)

 

(0.13)

%

+200

bp

 

190,517

 

 

(17,110)

 

(0.08)

%

+100

bp

 

199,717

 

 

(7,910)

 

(0.04)

%

0

bp

 

207,627

 

 

  

 

  

 

-100

bp

 

200,706

 

 

(6,921)

 

(0.03)

%

-200

bp

 

184,128

 

 

(23,499)

 

(0.11)

%

 

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

Item 4.     Controls and Procedures

The Company’s management, under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated, as of the last day of the period covered by this report, the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a‑15 under the Securities Exchange Act of 1934. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective. There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a‑15 under the Securities Act of 1934) during the three months ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.     Legal Proceedings

In the normal course of business, we are party to litigation arising from the banking, financial, and other activities we conduct. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising from these matters will have a material effect on the Company’s financial condition, operating results, or liquidity as of March 31, 2018.

Item 1A.  Risk Factors

The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Annual Report on Form 10‑K of Severn Bancorp for the year ended December 31, 2017. There has been no material change in our risk factors since the filing of our December 31, 2017 Annual Report on Form 10‑K.

46


 

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

Exhibit No.

    

Description

31.1

 

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

 

 

 

31.2

 

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

 

 

 

32

 

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

 

 

 

101

 

The following financial statements from the Severn Bancorp, Inc. Quarterly Report on Form 10‑Q as of March 31, 2018 and for the three months ended March 31, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Accumulated Comprehensive Income; (iv) the Consolidated Statements of Changes in Stockholders’ Equity; (v) the Consolidated Statements of Cash Flows; and (vi) the Notes to Consolidated Financial Statements.

 

 

47


 

EXHIBIT INDEX

Exhibit No.

    

Description

31.1

 

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

 

 

 

31.2

 

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

 

 

 

32

 

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

 

 

 

101

 

The following financial statements from the Severn Bancorp, Inc. Quarterly Report on Form 10‑Q as of March 31, 2018 and for the three months ended March 31, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Accumulated Comprehensive Income; (iv) the Consolidated Statements of Changes in Stockholders’ Equity; (v) the Consolidated Statements of Cash Flows; and (vi) the Notes to Consolidated Financial Statements.

 

 

48


 

SIGNATURES

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

 

 

 

 

SEVERN BANCORP, INC.

 

 

May 15, 2018

/s/ Alan J. Hyatt

 

Alan J. Hyatt,
Chairman of the Board, President and Chief Executive Officer

 

(Principal Executive Officer)

 

 

May 15, 2018

/s/ Paul B. Susie

 

Paul B. Susie,
Executive Vice President, Chief Financial Officer

 

(Principal Financial and Accounting Officer)

 

 

49