Loans and Allowance for Credit Losses

3 Months Ended

Mar. 31, 2016

Loans, Notes, Trade and Other Receivables Disclosure [Text Block]

Note 4 – Loans and Allowance for Credit Losses

The Company makes residential mortgage, commercial and consumer loans to customers primarily in Talbot County, Queen Anne’s County, Kent County, Caroline County and Dorchester County in Maryland and in Kent County, Delaware.

The following table provides information about the principal classes of the loan portfolio at March 31, 2016 and December 31, 2015.

(Dollars in thousands)	March 31, 2016		December 31, 2015
Construction	$	78,244	$	85,632
Residential real estate		310,575		307,063
Commercial real estate		334,754		330,253
Commercial		67,735		64,911
Consumer		7,613		7,255
Total loans		798,921		795,114
Allowance for credit losses		(8,309)		(8,316)
Total loans, net	$	790,612	$	786,798

Loans are stated at their principal amount outstanding net of any purchase premiums, deferred fees and costs. Interest income on loans is accrued at the contractual rate based on the principal amount outstanding. Fees charged and costs capitalized for originating loans are being amortized substantially on the interest method over the term of the loan. A loan is placed on nonaccrual (i.e., interest income is no longer accrued) when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more, unless the loan is well secured and in the process of collection. Any unpaid interest previously accrued on those loans is reversed from income.

Interest payments received on nonaccrual loans are applied as a reduction of the loan principal balance unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

A loan is considered impaired if it is probable that the Company will not collect all principal and interest payments according to the loan’s contractual terms. An impaired loan may show deficiencies in the borrower’s overall financial condition, payment history, support available from financial guarantors and/or the fair market value of collateral. The impairment of a loan is measured at the present value of expected future cash flows using the loan’s effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Generally, the Company measures impairment on such loans by reference to the fair value of the collateral. Once the amount of impairment has been determined, the uncollectible portion is charged off. Income on impaired loans is recognized on a cash basis, and payments are first applied against the principal balance outstanding (i.e., placing impaired loans on nonaccrual status). Generally, interest income is not recognized on impaired loans unless the likelihood of further loss is remote. The allowance for credit losses may include specific reserves related to impaired loans. Specific reserves remain until charge offs are made. Impaired loans do not include groups of smaller balance homogenous loans such as residential mortgage and consumer installment loans that are evaluated collectively for impairment. Reserves for probable credit losses related to these loans are based on historical loss ratios and are included in the formula portion of the allowance for credit losses. See additional discussion under the caption “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

A loan is considered a troubled debt restructuring (“TDR”) if a borrower is experiencing financial difficulties and a creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Loans are identified to be restructured when signs of impairment arise such as borrower interest rate reduction request, slowness to pay, or when an inability to repay becomes evident. The terms being offered are evaluated to determine if they are more liberal than those that would be indicated by policy or industry standards for similar, untroubled credits. In those situations where the terms or the interest rates are considered to be more favorable than industry standards or the current underwriting guidelines of the Company’s banking subsidiaries, the loan is classified as a TDR. All loans designated as TDRs are considered impaired loans and may be on either accrual or nonaccrual status. In instances where the loan has been placed on nonaccrual status, six consecutive months of timely payments are required prior to returning the loan to accrual status.

All loans classified as TDRs which are restructured and accrue interest under revised terms require a full and comprehensive review of the borrower’s financial condition, capacity for repayment, realistic assessment of collateral values, and the assessment of risk entered into any workout agreement. Current financial information on the borrower, guarantor, and underlying collateral is analyzed to determine if it supports the ultimate collection of principal and interest. For commercial loans, the cash flows are analyzed, both for the underlying project and globally. For consumer loans, updated salary, credit history and cash flow information is obtained. Current market conditions are also considered. Following a full analysis, the determination of the appropriate loan structure is made.

In the normal course of banking business, risks related to specific loan categories are as follows:

Construction loans – Construction loans generally finance the construction of residential real estate for builders and individuals for single family dwellings. In addition, the bank periodically finances the construction of commercial projects. Credit risk factors include the borrower’s ability to successfully complete the construction on time and within budget, changing market conditions which could affect the value and marketability of projects, changes in the borrower’s ability or willingness to repay the loan and potentially rising interest rates which can impact both the borrower’s ability to repay and the collateral value.

Residential real estate – Residential real estate loans are typically made to consumers and are secured by residential real estate. Credit risk arises from the borrower’s continuing financial stability, which can be adversely impacted by job loss, divorce, illness, or personal bankruptcy, among other factors. Also impacting credit risk would be a shortfall in the value of the residential real estate in relation to the outstanding loan balance in the event of a default or subsequent liquidation of the real estate collateral.

Commercial real estate – Commercial real estate loans consist of both loans secured by owner occupied properties and non-owner occupied where an established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of occupancy and cash flow. These loans are subject to adverse changes in the local economy and commercial real estate markets. Credit risk associated with owner occupied properties arises from the borrower’s financial stability and the ability of the borrower and the business to repay the loan. Non-owner occupied properties carry the risk of a tenant’s deteriorating credit strength, lease expirations in soft markets and sustained vacancies which can adversely impact cash flow.

Commercial – Commercial loans are secured or unsecured loans for business purposes. Loans are typically secured by accounts receivable, inventory, equipment and/or other assets of the business. Credit risk arises from the successful operation of the business which may be affected by competition, rising interest rates, regulatory changes and adverse conditions in the local and regional economy.

Consumer – Consumer loans include home equity loans and lines, installment loans and personal lines of credit. Credit risk is similar to residential real estate loans above as it is subject to the borrower’s continuing financial stability and the value of the collateral securing the loan.

The following tables include impairment information relating to loans and the allowance for credit losses as of March 31, 2016 and December 31, 2015.

(Dollars in thousands)	Construction		Residential real estate		Commercial real estate		Commercial		Consumer		Unallocated		Total
March 31, 2016
Loans individually evaluated for impairment	$	10,590	$	7,933	$	7,880	$	154	$	121	$	-	$	26,678
Loans collectively evaluated for impairment		67,654		302,642		326,874		67,581		7,492		-		772,243
Total loans	$	78,244	$	310,575	$	334,754	$	67,735	$	7,613	$	-	$	798,921

Allowance for credit losses allocated to:
Loans individually evaluated for impairment	$	783	$	189	$	552	$	-	$	-	$	-	$	1,524
Loans collectively evaluated for impairment		970		1,825		2,705		585		177		523		6,785
Total allowance for credit losses	$	1,753	$	2,014	$	3,257	$	585	$	177	$	523	$	8,309

(Dollars in thousands)	Construction		Residential real estate		Commercial real estate		Commercial		Consumer		Unallocated		Total
December 31, 2015
Loans individually evaluated for impairment	$	11,598	$	7,945	$	7,762	$	161	$	122	$	-	$	27,588
Loans collectively evaluated for impairment		74,034		299,118		322,491		64,750		7,133		-		767,526
Total loans	$	85,632	$	307,063	$	330,253	$	64,911	$	7,255	$	-	$	795,114

Allowance for credit losses allocated to:
Loans individually evaluated for impairment	$	619	$	435	$	340	$	-	$	7	$	-	$	1,401
Loans collectively evaluated for impairment		1,027		1,746		2,659		558		149		776		6,915
Total allowance for credit losses	$	1,646	$	2,181	$	2,999	$	558	$	156	$	776	$	8,316

The following tables provide information on impaired loans and any related allowance by loan class as of March 31, 2016 and December 31, 2015. The difference between the unpaid principal balance and the recorded investment is the amount of partial charge-offs that have been taken.

(Dollars in thousands)	Unpaid principal balance		Recorded investment with no allowance		Recorded investment with an allowance		Related allowance		Quarter-to- date average recorded investment		Interest income recognized
March 31, 2016
Impaired nonaccrual loans:
Construction	$	11,167	$	3,724	$	2,874	$	755	$	7,216	$	-
Residential real estate		2,600		2,079		199		77		2,292		-
Commercial real estate		3,854		2,774		-		-		2,559		-
Commercial		172		154		-		-		158		-
Consumer		128		121		-		-		121		-
Total		17,921		8,852		3,073		832		12,346		-

Impaired accruing TDRs:
Construction		3,992		3,194		798		28		4,041		25
Residential real estate		5,655		2,667		2,988		112		5,669		55
Commercial real estate		5,106		1,099		4,007		552		5,363		46
Commercial		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
Total		14,753		6,960		7,793		692		15,073		126

Total impaired loans:
Construction		15,159		6,918		3,672		783		11,257		25
Residential real estate		8,255		4,746		3,187		189		7,961		55
Commercial real estate		8,960		3,873		4,007		552		7,922		46
Commercial		172		154		-		-		158		-
Consumer		128		121		-		-		121		-
Total	$	32,674	$	15,812	$	10,866	$	1,524	$	27,419	$	126

									March 31, 2015
(Dollars in thousands)	Unpaid principal balance		Recorded investment with no allowance		Recorded investment with an allowance		Related allowance		Quarter-to- date average recorded investment		Interest income recognized
December 31, 2015

Impaired nonaccrual loans:
Construction	$	11,850	$	4,647	$	2,882	$	588	$	7,630	$	-
Residential real estate		2,563		1,773		487		208		3,360		-
Commercial real estate		2,988		1,813		209		9		1,401		-
Commercial		175		161		-		-		163		-
Consumer		128		98		23		7		121		-
Total		17,704		8,492		3,601		812		12,675		-

Impaired accruing TDRs:
Construction		4,069		3,266		803		31		4,073		84
Residential real estate		5,686		2,380		3,306		227		6,338		312
Commercial real estate		5,740		1,702		4,038		331		5,689		254
Commercial		-		-		-		-		-		1
Consumer		-		-		-		-		-		-
Total		15,495		7,348		8,147		589		16,100		651

Total impaired loans:
Construction		15,919		7,913		3,685		619		11,703		84
Residential real estate		8,249		4,153		3,793		435		9,698		312
Commercial real estate		8,728		3,515		4,247		340		7,090		254
Commercial		175		161		-		-		163		1
Consumer		128		98		23		7		121		-
Total	$	33,199	$	15,840	$	11,748	$	1,401	$	28,775	$	651

The following tables provide a roll-forward for troubled debt restructurings as of March 31, 2016 and March 31, 2015.

	1/1/16								Reclassification/				3/31/16
	TDR		New		Disbursements		Charge		Transfers				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		offs		In/(Out)		Payoffs		Balance		Allowance
For the three months ended 3/31/2016
Accruing TDRs
Construction	$	4,069	$	-	$	(77)	$	-	$	-	$	-	$	3,992	$	28
Residential Real Estate		5,686		-		(31)		-		-		-		5,655		112
Commercial Real Estate		5,740		-		(517)		(117)		-		-		5,106		552
Commercial		-		-		-		-		-		-		-		-
Consumer		-		-		-		-		-		-		-		-
Total	$	15,495	$	-	$	(625)	$	(117)	$	-	$	-	$	14,753	$	692

Nonaccrual TDRs
Construction	$	4,960	$	2,570	$	(691)	$	(241)	$	-	$	-	$	6,598	$	755
Residential Real Estate		445		-		(288)		-		-		-		157		11
Commercial Real Estate		-		-		-		-		-		-		-		-
Commercial		-		-		-		-		-		-		-		-
Consumer		23		-		-		-		-		-		23		-
Total	$	5,428	$	2,570	$	(979)	$	-	$	-	$	-	$	6,778	$	766

Total TDRs	$	20,923	$	2,570	$	(1,604)	$	(358)	$	-	$	-	$	21,531	$	1,458

	1/1/15								Reclassification/				3/31/15
	TDR		New		Disbursements				Transfers				TDR		Related
(Dollars in thousands)	Balance		TDRs		(Payments)		Charge offs		In/(Out)		Payoffs		Balance		Allowance
For the three months ended 3/31/2015
Accruing TDRs
Construction	$	4,022	$	-	$	(6)	$	-	$	-	$	-	$	4,016	$	39
Residential Real Estate		6,368		-		(46)		-		-		-		6,322		255
Commercial Real Estate		6,237		-		24		-		-		-		6,261		23
Commercial		47		-		(2)		-		-		-		45		-
Consumer		-		-		-		-		-		-		-		-
Total	$	16,674	$	-	$	(30)	$	-	$	-	$	-	$	16,644	$	317

Nonaccrual TDRs
Construction	$	3,321	$	-	$	(7)	$	(363)	$	2,911	$	-	$	5,862	$	690
Residential Real Estate		3,382		-		(9)		-		(2,911)		-		462		-
Commercial Real Estate		346		-		(2)		(40)		(238)		-		66		-
Commercial		-		-		-		-		-		-		-		-
Consumer		25		-		(1)		-		-		-		24		-
Total	$	7,074	$	-	$	(19)	$	(403)	$	(238)	$	-	$	6,414	$	690

Total TDRs	$	23,748	$	-	$	(49)	$	(403)	$	(238)	$	-	$	23,058	$	1,007

The following tables provide information on loans that were modified and considered TDRs during the three months ended March 31, 2016 and March 31, 2015.

			Premodification		Postmodification
			outstanding		outstanding
	Number of		recorded		recorded		Related
(Dollars in thousands)	contracts		investment		investment		allowance
TDRs:
For the three months ended March 31, 2016
Construction		1	$	2,570	$	2,570	$	-
Residential real estate		-		-		-		-
Commercial real estate		-		-		-		-
Commercial		-		-		-		-
Consumer		-		-		-		-
Total		1	$	2,570	$	2,570	$	-

For the three months ended March 31, 2015
Construction		-	$	-	$	-	$	-
Residential real estate		-		-		-		-
Commercial real estate		-		-		-		-
Commercial		-		-		-		-
Consumer		-		-		-		-
Total		-	$	-	$	-	$	-

The following tables provide information on TDRs that defaulted during the three months ended March 31, 2016 and March 31, 2015. Generally, a loan is considered in default when principal or interest is past due 90 days or more.

	Number of		Recorded		Related
(Dollars in thousands)	contracts		investment		allowance
TDRs that subsequently defaulted:
For the three months ended March 31, 2016
Construction		1	$	241	$	-
Residential real estate		-		-		-
Commercial real estate		1		117		-
Commercial		-		-		-
Consumer		-		-		-
Total		2	$	358	$	-

TDRs that subsequently defaulted:
For the three months ended March 31, 2015
Construction		3	$	363	$	-
Residential real estate		-		-		-
Commercial real estate		1		40		-
Commercial		-		-		-
Consumer		-		-		-
Total		4	$	403	$	-

Management uses risk ratings as part of its monitoring of the credit quality in the Company’s loan portfolio. Loans that are identified as special mention, substandard or doubtful are adversely rated. They are assigned higher risk ratings than favorably rated loans in the calculation of the formula portion of the allowance for credit losses.

The following tables provide information on loan risk ratings as of March 31, 2016 and December 31, 2015.

			Special
(Dollars in thousands)	Pass/Performing		mention		Substandard		Doubtful		Total
March 31, 2016
Construction	$	63,823	$	3,845	$	10,576	$	-	$	78,244
Residential real estate		294,844		8,735		6,996		-		310,575
Commercial real estate		307,769		17,158		9,827		-		334,754
Commercial		66,638		704		393		-		67,735
Consumer		7,468		24		121		-		7,613
Total	$	740,542	$	30,466	$	27,913	$	-	$	798,921

			Special
(Dollars in thousands)	Pass/Performing		mention		Substandard		Doubtful		Total
December 31, 2015
Construction	$	70,214	$	3,903	$	11,515	$	-	$	85,632
Residential real estate		290,857		8,837		7,369		-		307,063
Commercial real estate		302,438		18,699		9,116		-		330,253
Commercial		63,628		1,075		208		-		64,911
Consumer		7,107		26		122		-		7,255
Total	$	734,244	$	32,540	$	28,330	$	-	$	795,114

The following tables provide information on the aging of the loan portfolio as of March 31, 2016 and December 31, 2015.

	Accruing
				30-59			60-89			90 days
				days			days past			or more			Total past
(Dollars in thousands)	Current			past due			due			past due			due			Nonaccrual			Total
March 31, 2016
Construction	$	71,618		$	28		$	-		$	-		$	28		$	6,598		$	78,244
Residential real estate		303,339			2,113			2,823			22			4,958			2,278			310,575
Commercial real estate		330,129			1,591			260			-			1,851			2,774			334,754
Commercial		67,525			46			-			10			56			154			67,735
Consumer		7,461			26			2			3			31			121			7,613
Total	$	780,072		$	3,804		$	3,085		$	35		$	6,924		$	11,925		$	798,921
Percent of total loans		97.6	%		0.5	%		0.4	%		-	%		0.9	%		1.5	%		100	%

	Accruing
				30-59			60-89			90 days or
				days			days past			more past			Total past
(Dollars in thousands)	Current			past due			due			due			due			Nonaccrual			Total
December 31, 2015
Construction	$	78,082		$	21		$	-		$	-		$	21		$	7,529		$	85,632
Residential real estate		300,563			2,139			2,102			-			4,241			2,259			307,063
Commercial real estate		327,370			-			861			-			861			2,022			330,253
Commercial		64,670			49			31			-			80			161			64,911
Consumer		7,107			13			6			7			26			122			7,255
Total	$	777,792		$	2,222		$	3,000		$	7		$	5,229		$	12,093		$	795,114
Percent of total loans		97.8	%		0.3	%		0.4	%		-	%		0.7	%		1.5	%		100	%

Management evaluates the adequacy of the allowance for credit losses at least quarterly and adjusts the provision for credit losses based on this analysis. The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for the three months ended March 31, 2016 and 2015. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.

			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Unallocated		Total
For the three months ended March 31, 2016
Allowance for credit losses:
Beginning balance	$	1,646	$	2,181	$	2,999	$	558	$	156	$	776	$	8,316

Charge-offs		(241)		(16)		(238)		(67)		(8)		-		(570)
Recoveries		6		34		-		65		8		-		113
Net charge-offs		(235)		18		(238)		(2)		-		-		(457)

Provision		342		(185)		496		29		21		(253)		450
Ending balance	$	1,753	$	2,014	$	3,257	$	585	$	177	$	523	$	8,309

			Residential		Commercial
(Dollars in thousands)	Construction		real estate		real estate		Commercial		Consumer		Unallocated		Total
For the three months ended March 31, 2015
Allowance for credit losses:
Beginning balance	$	1,303	$	2,834	$	2,379	$	448	$	229	$	502	$	7,695

Charge-offs		(363)		(114)		(40)		(124)		(10)		-		(651)
Recoveries		3		23		13		47		18		-		104
Net charge-offs		(360)		(91)		(27)		(77)		8		-		(547)

Provision		941		(619)		(13)		70		(57)		328		650
Ending balance	$	1,884	$	2,124	$	2,339	$	441	$	180	$	830	$	7,798

Foreclosure Proceedings

Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $581 thousand as of March 31, 2016 and December 31, 2015.