Note 4. Loans and Allowance

Major categories of loans are as follows:

	2015			2014			2013
Mortgage:
Residential	$	116,027,206		$	120,933,420		$	123,645,939
Commercial		62,469,425			62,601,469			67,195,806
Construction and land development		5,518,588			7,073,720			6,582,553
Demand and time		4,539,701			3,518,752			4,172,747
Installment		75,302,771			84,103,142			73,230,433
		263,857,691			278,230,503			274,827,478
Unearned income on loans		(1,070,734	)		(1,126,396	)		(1,171,339	)
		262,786,957			277,104,107			273,656,139
Allowance for credit losses		(3,150,251	)		(3,117,870	)		(2,972,019	)

	$	259,636,706		$	273,986,237		$	270,684,120

The Bank has an automotive indirect lending program where vehicle collateralized loans made by dealers to consumers are acquired by the Bank. The Bank’s installment loan portfolio included approximately $60,607,000, $67,551,000, and $55,400,000 of such loans at December 31, 2015, 2014, and 2013, respectively.

The Bank makes loans to customers located primarily in Anne Arundel County and surrounding areas of Central Maryland. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.

Executive officers, directors, and their affiliated interests enter into loan transactions with the Bank in the ordinary course of business. These loans are made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with unrelated borrowers. They do not involve more than normal risk of collectibility or present other unfavorable terms. At December 31, 2015, 2014, and 2013, the amounts of such loans outstanding totaled $787,894, $556,188, and $1,078,577 respectively. During 2015, loan additions and repayments/transfers totaled $569,000 and $337,294, respectively.

Allowance for Loan Losses

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented the loan portfolio into the following classifications:

Commercial and Industrial;

Commercial Real Estate;

Consumer and Indirect;

Residential Real Estate.

Each of these segments are reviewed and analyzed quarterly using the average historical charge-offs over a current four year period for their respective segments as well as the following qualitative factors:

Changes in asset quality including past due (30-89 days) loans, nonaccrual loans, classified assets, watch list loans all in relation to total loans. Also policy exception in relationship to loan volume.

Changes in the rate and direction of the loan volume of the portfolio

Concentration of credit including the percentage, changes, and relative to goals.

Changes in macro economic factors including the rates and direction of unemployment, median income and population.

Changes in internal factors including external loan review required reserve changes, internal review penetration, internal required reserve changes and weighted required reserve trends.

Changes in the charge offs / recoveries adjusting with rate and direction.

The above factors result in a FAS 5, as codified in FASB ASC 450-10-20, calculated reserve for environmental factors.

All credit exposures graded above a rating of “4” with outstanding balances (see ratings on page 21) are to be reviewed no less than quarterly for the purpose of determining if a specific allocation is needed for that credit. The determination for a specific reserve is evaluated relative to the general reserve factor for assets of the same type and grade. If a specific reserve is appropriate and exceeds the general reserve factor, a specific reserve is to be established. Otherwise, the asset is included in the portfolio of assets that comprise the base upon which the general reserve is calculated. The establishment of a specific reserve does not necessarily mean that the credit with the specific reserve will definitely incur loss at the reserve level. It is only an estimation of potential loss based upon anticipated events. A specific reserve will not be established unless loss elements can be determined and quantified based on known facts. The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio as of December 31, 2015.

The following table presents the total allowance by loan segment:

	Commercial						Consumer
	and			Commercial			and			Residential
2015	Industrial			Real Estate			Indirect			Real Estate			Unallocated			Total

Balance, beginning of year	$	385,631		$	335,009		$	1,281,222		$	1,169,627		$	(53,619	)	$	3,117,870
Provision for credit losses		(78,901	)		(23,814	)		296,437			1,299,194			202,084			1,695,000
Recoveries		1,400			13,468			486,776			10,473			-			512,117
Loans charged off		(2,807	)		(63,000	)		(1,260,533	)		(848,396	)		-			(2,174,736	)

Balance, end of year	$	305,323		$	261,663		$	803,902		$	1,630,898		$	148,465		$	3,150,251

Individually evaluated for impairment:
Balance in allowance	$	240,500		$	100,745		$	65,353		$	697,088		$	-		$	1,103,686
Related loan balance		240,500			1,143,317			950,722			2,792,239			-			5,126,778

Collectively evaluated for impairment:
Balance in allowance	$	64,823		$	160,918		$	738,549		$	933,810		$	148,465		$	2,046,565
Related loan balance		4,299,201			63,128,304			74,352,049			116,951,359			-			258,730,913

	Commercial						Consumer
	and			Commercial			and			Residential
2014	Industrial			Real Estate			Indirect			Real Estate			Unallocated			Total

Balance, beginning of year	$	412,909		$	898,362		$	1,187,604		$	593,463		$	(120,319	)	$	2,972,019
Provision for credit losses		(4,580	)		(448,027	)		601,522			805,261			66,700			1,020,876
Recoveries		6,440			128,068			331,108			5,714			-			471,330
Loans charged off		(29,138	)		(243,394	)		(839,012	)		(234,811	)		-			(1,346,355	)

Balance, end of year	$	385,631		$	335,009		$	1,281,222		$	1,169,627		$	(53,619	)	$	3,117,870

Individually evaluated for impairment:
Balance in allowance	$	252,500		$	148,791		$	186,226		$	682,642		$	-		$	1,270,159
Related loan balance		252,500			2,155,816			1,106,217			2,931,143			-			6,445,676

Collectively evaluated for impairment:
Balance in allowance	$	133,131		$	186,218		$	1,094,996		$	486,985		$	(53,619	)	$	1,847,711
Related loan balance		3,266,252			63,486,816			82,996,925			122,034,834			-			271,784,827

	Commercial						Consumer
	and			Commercial			and			Residential
2013	Industrial			Real Estate			Indirect			Real Estate			Unallocated			Total

Balance, beginning of year	$	541,916		$	1,183,240		$	1,057,531		$	392,506		$	132,727		$	3,307,920
Provision for credit losses		46,303			(374,067	)		468,559			372,251			(253,046	)		260,000
Recoveries		26,804			89,189			313,795			7,714			-			437,502
Loans charged off		(202,114	)		-			(652,281	)		(179,008	)		-			(1,033,403	)

Balance, end of year	$	412,909		$	898,362		$	1,187,604		$	593,463		$	(120,319	)	$	2,972,019

Individually evaluated for impairment:
Balance in allowance	$	278,786		$	550,794		$	178,657		$	155,330		$	-		$	1,163,567
Related loan balance		278,786			3,364,193			636,174			1,629,643			-			5,908,796

Collectively evaluated for impairment:
Balance in allowance	$	134,123		$	347,568		$	1,008,947		$	438,133		$	(120,319	)	$	1,808,452
Related loan balance		3,893,961			65,414,415			72,594,259			127,016,047			-			268,918,682

As of December 31, 2015, the allowance for loan losses included an overage of $148,465. As of December 31, 2014 and 2013, the allowance for loan losses included an unallocated shortfall of $53,619 and $120,319, respectively. The 2014 and 2013 shortfall is well within the internal Bank policy of 5% tolerance for actual to required reserves. Management is comfortable with the 2015 overage as they feel the amount is adequate to absorb inherent potential losses in the loan portfolio.

Credit Quality Information

The following table represents credit exposures by creditworthiness category for the year ending December 31, 2015. The use of creditworthiness categories to grade loans permits management to estimate a portion of credit risk. The Bank’s internal creditworthiness is based on experience with similarly graded credits. Loans that trend upward toward higher credit grades typically have less credit risk and loans that migrate downward typically have more credit risk.

The Bank’s internal risk ratings are as follows:

Superior – minimal risk. (normally supported by pledged deposits, United States government securities, etc.)

Above Average – low risk. (all of the risks associated with this credit based on each of the bank’s creditworthiness criteria are minimal)

Average – moderately low risk. (most of the risks associated with this credit based on each of the bank’s creditworthiness criteria are minimal)

Acceptable – moderate risk. (the weighted overall risk associated with this credit based on each of the bank’s creditworthiness criteria is acceptable)

Other Assets Especially Mentioned – moderately high risk. (possesses deficiencies which corrective action by the bank would remedy; potential watch list)

Substandard – (the bank is inadequately protected and there exists the distinct possibility of sustaining some loss if not corrected)

Doubtful – (weaknesses make collection or liquidation in full, based on currently existing facts, improbable)

Loss – (of little value; not warranted as a bankable asset)

Loans rated 1-4 are considered “Pass” for purposes of the risk rating chart below.

The Bank contracts with an independent 3^rd party loan review firm that reviews and validates the internal credit risk program on a quarterly basis. Results of these reviews are presented to the Audit Committee for approval and then to management for implementation. The loan review process compliments and reinforces the risk identification and assessment decisions made by the lenders and credit personnel as well as the Bank’s policies and procedures.

Risk ratings of loans by categories of loans are as follows:

	Commercial				Consumer
	and		Commercial		and		Residential
2015	Industrial		Real Estate		Indirect		Real Estate		Total

Pass	$	3,878,588	$	58,706,189	$	72,975,858	$	116,596,449	$	252,157,084
Special mention		168,113		4,422,115		1,652,579		539,483		6,782,290
Substandard		493,000		1,143,317		509,211		2,075,950		4,221,478
Doubtful		-		-		165,123		531,716		696,839
Loss		-		-		-		-		-

	$	4,539,701	$	64,271,621	$	75,302,771	$	119,743,598	$	263,857,691

Non-accrual		-		-		596,329		3,183,420		3,779,749
Troubled debt restructures		240,500		-		-		49,868		290,368
Number of TDRs accounts		1		-		-		1		2
Non-performing TDRs		-		-		-		-		-
Number of TDR accounts		-		-		-		-		-

	Commercial				Consumer
	and		Commercial		and		Residential
2014	Industrial		Real Estate		Indirect		Real Estate		Total

Pass	$	3,177,639	$	58,837,254	$	80,501,928	$	121,244,374	$	263,761,195
Special mention		88,613		4,649,562		2,555,654		832,546		8,126,375
Substandard		252,500		2,155,816		882,600		2,726,156		6,017,072
Doubtful		-		-		162,960		-		162,960
Loss		-		-		-		162,901		162,901

	$	3,518,752	$	65,642,632	$	84,103,142	$	124,965,977	$	278,230,503

Non-accrual		-		1,097,112		515,352		1,165,440		2,777,904
Troubled debt restructures		252,500		-		-		-		252,500
Number of TDRs accounts		1		-		-		-		1
Non-performing TDRs		-		-		-		-		-
Number of TDR accounts		-		-		-		-		-

	Commercial				Consumer
	and		Commercial		and		Residential
2013	Industrial		Real Estate		Indirect		Real Estate		Total

Pass	$	3,594,809	$	59,914,422	$	71,554,400	$	126,774,441	$	261,838,072
Special mention		299,152		5,499,993		1,102,091		1,312,103		8,213,339
Substandard		278,786		3,364,193		508,243		559,146		4,710,368
Doubtful		-		-		65,699		-		65,699
Loss		-		-		-		-		-

	$	4,172,747	$	68,778,608	$	73,230,433	$	128,645,690	$	274,827,478

Non-accrual		14,286		1,237,647		338,212		1,123,248		2,713,393
Troubled debt restructures		-		-		-		-		-
Number of TDRs contracts		-		-		-		-		-
Non-performing TDRs		-		-		-		-		-
Number of TDR accounts		-		-		-		-		-

At December 31, 2015, the recorded investment in TDR’s reflected one loan in the amount of $240,500 which is performing under the terms of the modified agreement and one loan in the amount of $49,868 which is on nonaccrual. At December 31, 2014, the recorded investment in TDR’s reflected one loan in the amount of $252,500 which is performing under the terms of the modified agreement. The TDR from 2012 that had a balance of $832,500 was brought into OREO in 2013 and later sold in 2014. The remaining TDR from 2012 in the amount of $1,369,768 was paid off in 2013.

The Bank has no commitments to loan additional funds to the borrowers of restructured, impaired, or non-accrual loans.

Current, past due, and nonaccrual loans by categories of loans are as follows:

					90 Days or
			30-89 Days		More and
2015	Current		Past Due		Still Accruing		Nonaccrual		Total

Commercial and industrial	$	4,539,701	$	-	$	-	$	-	$	4,539,701
Commercial real estate		64,270,345		1,276		-		-		64,271,621
Consumer and indirect		73,568,010		1,122,155		16,277		596,329		75,302,771
Residential real estate		115,715,127		806,566		38,485		3,183,420		119,743,598

	$	258,093,183	$	1,929,997	$	54,762	$	3,779,749	$	263,857,691

					90 Days or
			30-89 Days		More and
2014	Current		Past Due		Still Accruing		Nonaccrual		Total

Commercial and industrial	$	3,518,752	$	-	$	-	$	-	$	3,518,752
Commercial real estate		64,545,207		313		-		1,097,112		65,642,632
Consumer and indirect		81,315,689		2,272,101		-		515,352		84,103,142
Residential real estate		123,284,983		318,782		196,772		1,165,440		124,965,977

	$	272,664,631	$	2,591,196	$	196,772	$	2,777,904	$	278,230,503

					90 Days or
			30-89 Days		More and
2013	Current		Past Due		Still Accruing		Nonaccrual		Total

Commercial and industrial	$	4,158,461	$	-	$	-	$	14,286	$	4,172,747
Commercial real estate		66,191,062		173,000		1,176,899		1,237,647		68,778,608
Consumer and indirect		71,755,109		1,137,112		-		338,212		73,230,433
Residential real estate		126,934,475		157,123		430,844		1,123,248		128,645,690

	$	269,039,107	$	1,467,235	$	1,607,743	$	2,713,393	$	274,827,478

Loans on which the accrual of interest has been discontinued totaled $3,779,749, $2,777,904, and $2,713,393 at December 31, 2015, 2014, and 2013, respectively. Interest that would have been accrued under the terms of these loans totaled $239,038, $255,682, and $180,770 for the years ended December 31, 2015, 2014, and 2013, respectively. Loans past due 90 days or more and still accruing interest totaled $54,762, $196,772, and $1,607,743 at December 31, 2015, 2014, and 2013, respectively. Management believes these particular loans are well secured and in the process of full collection of all amounts owed.

Non-accrual loans with specific reserves at December 31, 2015 are comprised of:

Commercial Real Estate – One loan to one borrower in the amount of $300,112 secured by commercial and/or residential properties with specific reserves of $100,745 established for the loans.

Residential Real Estate – Eleven loans to five borrowers in the amount of $1,714,716 secured by residential properties with specific reserves of $668,721 established for the loans. Four of the five borrowers, consisting of ten loans, have a related interest and are considered to be one entity for loans-to-one borrower purposes. These are investor residential real estate properties with a carrying value of $1,664,848 and specific reserves of $656,947.

Consumer and Indirect Loans – Two loans to two borrowers in the amount of $145,874 with $65,353 of specific reserves established for the loans.

Impaired Loans

When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases management used the current fair value of the collateral, less selling cost when foreclosure is probable, instead of discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on nonaccrual status, contractual interest is credited to interest income when received, under the cash basis method.

The following table includes the recorded investment and unpaid principal balances for impaired financing receivables with the associated allowance amount, if applicable. Management determined the specific reserve in the allowance based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the remaining source of repayment for the loan is the operation or liquidation of the collateral. In those cases, the current fair value of the collateral, less selling costs was used to determine the specific allowance recorded.

Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal, under the cost recovery method.

2015	Recorded Investment		Unpaid Principal Balance		Interest Income Recognized		Specific Reserve		Average Recorded Investment
Impaired loans with specific reserves:
Real-estate - mortgage:
Residential	$	1,809,429	$	1,809,429	$	56,804	$	697,088	$	1,820,233
Commercial		300,112		300,112		-		100,745		314,929
Consumer		145,874		145,874		-		65,353		170,499
Installment		-		-		-		-		-
Home Equity		-		-		-		-		-
Commercial		240,500		240,500		10,517		240,500		246,571
Total impaired loans with specific reserves	$	2,495,915	$	2,495,915	$	67,321	$	1,103,686	$	2,552,232

Impaired loans with no specific reserve:
Real-estate - mortgage:
Residential	$	982,810	$	1,115,579	$	14,664		n/a	$	1,170,747
Commercial		843,205		843,205		37,786		n/a		876,376
Consumer		364,695		449,370		1,696		n/a		452,682
Installment		440,153		440,153		-		n/a		-
Home Equity		-		-		-		n/a		-
Commercial		-		-		-		n/a		-
Total impaired loans with no specific reserve	$	2,630,863	$	2,848,307	$	54,146		-	$	2,499,805

2014	Recorded Investment		Unpaid Principal Balance		Interest Income Recognized		Specific Reserve		Average Recorded Investment
Impaired loans with specific reserves:
Real-estate - mortgage:
Residential	$	2,726,247	$	2,726,247	$	177,707	$	682,642	$	2,747,299
Commercial		1,094,708		1,094,708		783		148,791		1,162,367
Consumer		611,728		611,728		30,903		186,226		622,854
Installment		-		-		-		-		-
Home Equity		-		-		-		-		-
Commercial		252,500		252,500		11,027		252,500		258,577
Total impaired loans with specific reserves	$	4,685,183	$	4,685,183	$	220,420	$	1,270,159	$	4,791,097

Impaired loans with no specific reserve:
Real-estate - mortgage:
Residential	$	204,896	$	266,091	$	2,641		n/a	$	340,435
Commercial		1,061,108		1,061,108		48,548		n/a		1,089,641
Consumer		60,656		60,656		-		n/a		-
Installment		433,833		433,833		-		n/a		-
Home Equity		-		-		-		n/a		-
Commercial		-		-		-		n/a		-
Total impaired loans with no specific reserve	$	1,760,493	$	1,821,688	$	51,189		-	$	1,430,076

2013	Recorded Investment		Unpaid Principal Balance		Interest Income Recognized		Specific Reserve		Average Recorded Investment
Impaired loans with specific reserves:
Real-estate - mortgage:
Residential	$	559,146	$	559,146	$	15,768	$	155,330	$	563,961
Commercial		2,187,294		2,187,294		55,535		550,794		2,271,949
Consumer		393,740		393,740		20,767		178,657		394,356
Installment		-		-		-		-		-
Home Equity		-		-		-		-		-
Commercial		278,786		278,786		11,541		278,786		286,433
Total impaired loans with specific reserves	$	3,418,966	$	3,418,966	$	103,611	$	1,163,567	$	3,516,699

Impaired loans with no specific reserve:
Real-estate - mortgage:
Residential	$	1,070,497	$	1,070,497	$	39,257		n/a	$	1,071,479
Commercial		1,176,899		1,176,899		46,583		n/a		1,231,505
Consumer		10,602		10,602		-		n/a		-
Installment		180,204		180,204		-		n/a		-
Home Equity		51,628		51,628		-		n/a		50,999
Commercial		-		-		-		n/a		-
Total impaired loans with no specific reserve	$	2,489,830	$	2,489,830	$	85,840		-	$	2,353,983