The Bank makes loans to customers primarily in the Washington, D.C. metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

Loans, net of unamortized net deferred fees, at December 31, 2019 and 2018 are summarized by type as follows:

Unamortized net deferred fees amounted to $25.2 million and $26.5 million at December 31, 2019 and 2018, of which $32 thousand and $60 thousand at December 31, 2019 and 2018, respectively, represented net deferred costs on home equity loans.

As of December 31, 2019 and 2018, the Bank serviced $99 million and $111 million, respectively, of multifamily FHA loans, SBA loans and other loan participations, which are not reflected as loan balances on the Consolidated Balance Sheets.

The Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

The composition of the Company’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and income producing. At December 31, 2019, owner occupied commercial real estate and construction – C&I (owner occupied) represent approximately 14% of the loan portfolio while non-owner occupied commercial real estate and real estate construction represented approximately 64% of the loan portfolio. The combined owner occupied and commercial real estate loans represented approximately 78% of the loan portfolio. Real estate also serves as collateral for loans made for other purposes, resulting in 85% of all loans being secured or partially secured by real estate. These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. The Bank typically requires a maximum loan to value of 80% and minimum cash flow debt service coverage of 1.15 to 1.0. Personal guarantees may be required, but may be limited. In making real estate commercial mortgage loans, the Bank generally requires that interest rates adjust not less frequently than five years.

The Company is also an active traditional commercial lender providing loans for a variety of purposes, including working capital, equipment and account receivable financing. This loan category represents approximately 20% of the loan portfolio at December 31, 2019 and was generally variable or adjustable rate. Commercial loans meet reasonable underwriting standards, including appropriate collateral and cash flow necessary to support debt service. Personal guarantees are generally required, but may be limited. SBA loans represent approximately 1% of the commercial loan category. In originating SBA loans, the Company assumes the risk of non-payment on the unguaranteed portion of the credit. The Company generally sells the guaranteed portion of the loan generating noninterest income from the gains on sale, as well as servicing income on the portion participated. SBA loans are subject to the same cash flow analyses as other commercial loans. SBA loans are subject to a maximum loan size established by the SBA as well as internal loan size guidelines.

Approximately 1% of the loan portfolio at December 31, 2019 consists of home equity loans and lines of credit and other consumer loans. These credits, while making up a small portion of the loan portfolio, demand the same emphasis on underwriting and credit evaluation as other types of loans advanced by the Bank.

Approximately 1% of the loan portfolio consists of residential mortgage loans. The repricing duration of these loans was 22 months. These credits represent first liens on residential property loans originated by the Bank. While the Bank’s general practice is to originate and sell (servicing released) loans made by its Residential Lending department, from time to time certain loan characteristics do not meet the requirements of third party investors and these loans are instead maintained in the Bank’s portfolio until they are resold to another investor at a later date or mature.

Loans are secured primarily by duly recorded first deeds of trust or mortgages. In some cases, the Bank may accept a recorded junior trust position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is customarily required.

Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank. Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.

Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures; and 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing. Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums. Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination.

Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.

Substantially all construction draw requests must be presented in writing on American Institute of Architects documents and certified either by the contractor, the borrower and/or the borrower’s architect. Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or their Chief Financial Officer. Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition.

Commercial permanent loans are generally secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. The debt service coverage ratio is ordinarily at least 1.15 to 1.0. As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.

Commercial permanent loans generally are underwritten with a term not greater than 10 years or the remaining useful life of the property, whichever is lower. The preferred term is between 5 to 7 years, with amortization to a maximum of 25 years.

The Company’s loan portfolio includes ADC real estate loans including both investment and owner occupied projects. ADC loans amounted to $1.61 billion at December 31, 2019. A portion of the ADC portfolio, both speculative and non-speculative, includes loan funded interest reserves at origination. ADC loans that provide for the use of interest reserves represent approximately 65% of the outstanding ADC loan portfolio at December 31, 2019. The decision to establish a loan-funded interest reserve is made upon origination of the ADC loan and is based upon a number of factors considered during underwriting of the credit including: (1) the feasibility of the project; (2) the experience of the sponsor; (3) the creditworthiness of the borrower and guarantors; (4) borrower equity contribution; and (5) the level of collateral protection. When appropriate, an interest reserve provides an effective means of addressing the cash flow characteristics of a properly underwritten ADC loan. The Company does not significantly utilize interest reserves in other loan products. The Company recognizes that one of the risks inherent in the use of interest reserves is the potential masking of underlying problems with the project and/or the borrower’s ability to repay the loan. In order to mitigate this inherent risk, the Company employs a series of reporting and monitoring mechanisms on all ADC loans, whether or not an interest reserve is provided, including: (1) construction and development timelines which are monitored on an ongoing basis which track the progress of a given project to the timeline projected at origination; (2) a construction loan administration department independent of the lending function; (3) third party independent construction loan inspection reports; (4) monthly interest reserve monitoring reports detailing the balance of the interest reserves approved at origination and the days of interest carry represented by the reserve balances as compared to the then current anticipated time to completion and/or sale of speculative projects; and (5) quarterly commercial real estate construction meetings among senior Company management, which includes monitoring of current and projected real estate market conditions. If a project has not performed as expected, it is not the customary practice of the Company to increase loan funded interest reserves.

The following tables detail activity in the allowance for credit losses by portfolio segment for the years ended December 31, 2019 and 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

The Company’s recorded investments in loans as of December 31, 2019 and December 31, 2018 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows:

The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company’s primary credit quality indicators are to use an internal credit risk rating system that categorizes loans into pass, watch, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes which comprise the consumer portfolio segment.

The Company’s credit quality indicators are updated generally on a quarterly basis, but no less frequently than annually. The following table presents by class and by credit quality indicator, the recorded investment in the Company’s loans and leases as of December 31, 2019 and 2018.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following table presents, by class of loan, information related to nonaccrual loans as of December 31, 2019 and 2018.

The following table presents, by class of loan, an aging analysis and the recorded investments in loans past due as of December 31, 2019 and 2018.


	Loans		Loans		Loans						Total Recorded
	30-59 Days		60-89 Days		90 Days or		Total Past		Current		Investment in
(dollars in thousands)	Past Due		Past Due		More Past Due		Due Loans		Loans		Loans
December 31, 2019
Commercial	$	3,063	$	781	$	14,928	$	18,772	$	1,527,134	$	1,545,906
Income producing - commercial real estate		—		5,542		9,711		15,253		3,687,494		3,702,747
Owner occupied - commercial real estate		13,008		—		6,463		19,471		965,938		985,409
Real estate mortgage – residential		3,533		—		5,631		9,164		95,057		104,221
Construction - commercial and residential		—		—		11,509		11,509		1,113,735		1,125,244
Home equity		136		192		487		815		79,246		80,061
Other consumer		—		9		—		9		2,151		2,160
Total	$	19,740	$	6,524	$	48,729	$	74,993	$	7,470,755	$	7,545,748
December 31, 2018
Commercial	$	4,535	$	2,870	$	7,115	$	14,520	$	1,538,592	$	1,553,112
Income producing - commercial real estate		5,855		27,479		1,766		35,100		3,221,800		3,256,900
Owner occupied - commercial real estate		5,051		2,370		2,368		9,789		878,025		887,814
Real estate mortgage – residential		2,456		1,698		1,510		5,664		100,754		106,418
Construction - commercial and residential		4,392		—		3,031		7,423		1,090,189		1,097,612
Home equity		630		47		487		1,164		85,439		86,603
Other consumer		—		—		—		—		2,988		2,988
Total	$	22,919	$	34,464	$	16,277	$	73,660	$	6,917,787	$	6,991,447

Impaired Loans

Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

The following table presents, by class of loan, information related to impaired loans for the years ended December 31, 2019 and 2018.


	Unpaid		Recorded		Recorded
	Contractual		Investment		Investment		Total				Average Recorded Investment		Interest Income Recognized
	Principal		With No		With		Recorded		Related		Year		Year
(dollars in thousands)	Balance		Allowance		Allowance		Investment		Allowance		To Date		To Date
December 31, 2019
Commercial	$	15,814	$	11,858	$	3,956	$	15,814	$	5,714	$	15,682	$	270
Income producing - commercial real estate		14,093		2,713		11,380		14,093		2,145		18,133		382
Owner occupied - commercial real estate		7,349		6,388		961		7,349		415		6,107		197
Real estate mortgage – residential		5,631		3,175		2,456		5,631		650		5,638		—
Construction - commercial and residential		11,509		11,101		408		11,509		100		8,211		92
Home equity		487		—		487		487		100		487		—
Other consumer		—		—		—		—		—		—		—
Total	$	54,883	$	35,235	$	19,648	$	54,883	$	9,124	$	54,258	$	941
December 31, 2018
Commercial	$	8,613	$	2,057	$	6,084	$	8,141	$	4,803	$	8,359	$	190
Income producing - commercial real estate		21,402		1,720		19,682		21,402		2,465		12,309		550
Owner occupied - commercial real estate		5,731		4,361		1,370		5,731		600		6,011		196
Real estate mortgage - residential		1,510		1,510		—		1,510		—		1,688		2
Construction - commercial and residential		3,031		3,031		—		3,031		1,050		2,028		68
Home equity		487		487		—		487		—		491		—
Other consumer		—		—		—		—		—		69		—
Total	$	40,774	$	13,166	$	27,136	$	40,302	$	8,918	$	30,955	$	1,006

Modifications

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested.

Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period. As of December 31, 2019, all performing TDRs were categorized as interest-only modifications.

Loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates.

The following table presents, by class, the recorded investment of loans modified in TDRs held by the Company during the years ended December 31, 2019 and 2018.


	For the Year Ended December 31, 2019
					Income		Owner
	Number				Producing -		Occupied -		Construction -
	of				Commercial		Commercial		Commercial
(dollars in thousands)	Contracts		Commercial		Real Estate		Real Estate		Real Estate		Total
Troubled debt restructurings
Restructured accruing		7	$	885	$	14,806	$	887	$	—	$	16,578
Restructured nonaccruing		2		142		—		2,370		—		2,512
Total		9	$	1,027	$	14,806	$	3,257	$	—	$	19,090

Specific allowance			$	—	$	1,000	$	—	$	—	$	1,000

Restructured and subsequently defaulted			$	—	$	7,115	$	2,370	$	—	$	9,485


	For the Year Ended December 31, 2018
					Income		Owner
	Number				Producing -		Occupied -		Construction -
	of				Commercial		Commercial		Commercial
(dollars in thousands)	Contracts		Commercial		Real Estate		Real Estate		Real Estate		Total
Troubled debt restructings
Restructured accruing		9	$	1,026	$	19,636	$	3,363	$	—	$	24,025
Restructured nonaccruing		3		544		—		—		—		544
Total		12	$	1,570	$	19,636	$	3,363	$	—	$	24,569

Specific allowance			$	—	$	3,000	$	—	$	—	$	3,000

Restructured and subsequently defaulted			$	408	$	937	$	—	$	—	$	1,345

The Company had nine TDRs at December 31, 2019, totaling approximately $19.1 million, as compared to twelve TDRs totaling approximately $24.6 million at December 31, 2018. At December 31, 2019, seven of these TDR loans, totaling approximately $16.6 million, are performing under their modified terms, as compared to December 31, 2018, when there were nine performing TDR loans totaling approximately $24.0 million. During 2019, there were three performing TDRs totaling $9.5 million that defaulted on their modified terms which were reclassified to nonperforming loans, as compared to 2018, during which there were two performing TDR loans totaling approximately $460 thousand that defaulted on their modified terms and were reclassified to nonperforming loans. A default is considered to have occurred once the TDR is past due 90 days or more, or it has been placed on nonaccrual. During 2019, there were three restructured loans totaling approximately $9.5 million, one loan totaling $4.8 million had its collateral property sold for approximately $3 million and the remaining $1.8 million charged-off, the second loan totaling $2.3 million defaulted on its modified terms and was charged off, the third loan totaling $2.4 million defaulted on its modified terms and migrated to nonperforming. During 2018, there were four defaulted loans totaling approximately $1.4 million that were charged off. During 2019 there was one loan totaling $10.4 million that was re-underwritten into two new loans which provided better collateral for the Bank, and there was one restructured loan totaling approximately $309 thousand that was paid off from the sale proceeds of the collateral property, as compared to 2018, during which there were two loan payoffs on performing loans totaling approximately $3.9 million that were modified during the year. During 2018, there was a pay down of approximately $176 thousand on one nonperforming loan totaling approximately $183 thousand at December 31, 2017. Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. During 2019, there was one loan modified in a TDR totaling approximately $2.3 million, as compared to 2018, during which there were two loans totaling approximately $12.8 million modified in a TDR.

The criteria used to determine if a loan should be considered for charge off relates to its ultimate collectability includes the following:

●

All or a portion of the loan is deemed uncollectible;

●

Repayment is dependent upon secondary sources, such as liquidation of collateral, other assets, or judgment liens that may require an indefinite time period to collect.

Loans may be identified for charge off in whole or in part based upon an impairment analysis consistent with ASC 310. If all or a portion of a loan is deemed uncollectible, such amount shall be charged off in the month in which the loan or portion thereof is determined to be uncollectible.

Loans approved for non-accrual status, or charge off, are managed by the Chief Credit Officer or as dictated by the Directors Loan Committee and/or Credit Review Committee. The Chief Credit Officer is expected to position the loan in the best possible posture for recovery, including, among other actions, liquidating collateral, obtaining additional collateral, filing suit to obtain judgment or restructuring of repayment terms. A review of charged off loans is made on a monthly basis to assess the possibility of recovery from renewed collection efforts. All charged off loans that are deemed to have the possibility of recovery, whether partial or full, are actively pursued. Charged off loans that are deemed uncollectible will be placed in an inactive file with documentation supporting the suspension of further collection efforts.

In the process of collecting problem loans the Bank may resort to the acquisition of collateral through foreclosure and repossession actions, or may accept the transfer of assets in partial or full satisfaction of the debt. These actions may in turn result in the necessity of carrying real property or chattels as an asset of the Company pending sale.

For purchased loans acquired that are not deemed impaired at acquisition, credit marks representing the principal losses expected over the life of the loans are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit mark. The differences between the initial fair value and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.

The following table presents changes in the credit mark accretable yield, which includes income recognized from contractual interest cash flows, for the dates indicated.


(dollars in thousands)	2019		2018
Balance at January 1,	$	(1,495)	$	(2,459)
Net reclassifications from nonaccretable yield		—		—
Accretion		520		964
Balance at December 31,	$	(975)	$	(1,495)

Related Party Loans

Certain directors and executive officers of the Company and the Bank have had loan transactions with the Company. Such loans were made in the ordinary course of the Company’s lending business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with third parties; and, in the opinion of management, did not involve more than the normal risk of collectability or present other unfavorable features. All of such loans are performing and none of such loans are disclosed as nonaccrual, past due, restructured or potential problem loans.

The following table summarizes changes in amounts of loans outstanding, both direct and indirect, to those persons during 2019 and 2018.


(dollars in thousands)	2019		2018
Balance at January 1,	$	167,884	$	238,236
Additions		30,153		55,657
Repayments		(38,204)		(126,009)
Additions due to Changes in Related Parties		9,034		—
Deletions due to Changes in Related Parties		(116,499)		—
Balance at December 31,	$	52,368	$	167,884

During 2019, our related party loan balances decreased primarily due to the retirement of our former Chairman and Chief Executive Officer and the resignation of certain directors.