Docoh
Loading...

HBMD Howard Bancorp

Filed: 9 Nov 20, 3:56pm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2020

OR

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

Commission File Number: 001-35489

HOWARD BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland

20-3735949

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

3301 Boston Street, Baltimore, MD

21224

(Address of principal executive offices)

(Zip Code)

(410) 750-0020

(Registrant’s telephone number, including area code)

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

Title of each class:

    

Trading Symbol

    

Name of each exchange on which registered:

Common Stock, par value $0.01 per share

HBMD

The Nasdaq Stock Market LLC

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 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 such files). Yes       No    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions 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  

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 

The number of shares of common stock outstanding as of November 6, 2020.

Common Stock, $0.01 par value – 18,742,300 shares

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (this “report”) contains “forward-looking statements,” as that phrase is defined in the Private Securities Litigation Reform Act of 1995, which can be identified by the use of words such as “estimate,” “project,” “believe,” “goal,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may,” “should,” “could” and words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. These forward-looking statements include, but are not limited to statements of our goals, intentions and expectations, including the expected impact of COVID-19 on our operations, the expected impact of exiting our mortgage banking activities, our expectations related to requests for payment deferrals on loans, our expectations that many of our unfunded commitments will expire without being drawn, and statements regarding our business plan and strategies. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and may be outside of the Company’s control. Actual events and results may differ materially from those described in such forward-looking statements due to numerous factors, including:

the impact of the outbreak of the novel coronavirus, or COVID-19, on our business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the United States economy (including, without limitation, the Coronavirus Aid, Relief and Economic Security Act, or the CARES Act), and the resulting effect of these items on our operations, liquidity and capital position, and on the financial condition of our borrowers and other customers;
negative economic conditions that adversely affect the economy, real estate values, the job market and other factors nationally and in our market area, in each case that may affect our liquidity and the performance of our loan portfolio;
any negative perception of our reputation or financial strength;
competition among depository and other financial institutions;
changes in U.S. monetary policy, the level and volatility of interest rates, the capital markets and other market conditions that may affect, among other things, our liquidity and the value of our assets and liabilities;
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
the composition of our management team and our ability to attract and retain key personnel;
our ability to enter new markets successfully and capitalize on growth opportunities, and to otherwise implement our growth strategy;
material weaknesses in our internal control over financial reporting;
our ability to successfully integrate acquired entities, if any;
our inability to replace income lost from exiting our mortgage banking activities with new revenues;
changes in consumer spending, borrowing and savings habits;
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the U.S. Securities and Exchange Commission and the Public Company Accounting Oversight Board;
changes in our organization, compensation and benefit plans;
negative reactions to our branch closures by our customers, employees and other counterparties;
execution risk related to the opening of new branches, including increased expenses;
our ability to maintain the asset quality of our investment portfolios and the anticipated recovery and collection of unrealized losses on securities available for sale;
impairment of goodwill, other intangible assets or deferred tax assets;
our ability to continue our expected focus on commercial customers as well as maintaining our residential mortgage loan portfolio;
changes in our expected occupancy and equipment expenses;
changes to our allowance for loan and lease losses, and the adequacy thereof;
our ability to maintain adequate liquidity levels and future sources of liquidity;
our ability to retain a large portion of maturing certificates of deposit;
the impact on us of recent changes to accounting standards;
the impact of future cash requirements relating to commitments to extend credit;
risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others;

1

the risk of changes in technology and customer preferences;
the impact of any material failure or breach in our infrastructure or the infrastructure of third parties on which we rely as a result of cyber-attacks;
the impact of interest rate changes on our net interest income;
the adverse effects of events such as outbreaks of contagious disease, war or terrorist activities, or essential utility outages, including deterioration in the global economy, instability in credit markets and disruptions in our customers’ supply chains and transportation;
other economic, competitive, governmental, regulatory, technological, and geopolitical factors affecting our operations, pricing, and services; and
each of the factors and risks under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019 and Part II, Item 1A, Risk Factors, in our Form 10-Qs and in subsequent filings we make with the SEC.

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. You should not put undue reliance on any forward-looking statements. These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not undertake any obligation to update any forward-looking statements after the date of this report, except as required by law.

2

PART I

Item 1. Financial Statements

Howard Bancorp, Inc. and Subsidiary

Consolidated Balance Sheets

Unaudited

September 30, 

December 31, 

(in thousands, except share data)

    

2020

    

2019

ASSETS

 

  

 

  

Cash and due from banks

$

11,043

$

12,992

Interest-bearing deposits with banks

 

59,539

 

96,985

Total cash and cash equivalents

 

70,582

 

109,977

Securities available for sale, at fair value

 

377,471

 

215,505

Securities held to maturity, at amortized cost

 

7,250

 

7,750

Nonmarketable equity securities

 

10,637

 

14,152

Loans held for sale, at fair value

 

0

 

30,710

Loans and leases, net of unearned income

 

1,884,405

 

1,745,513

Allowance for loan and lease losses

 

(17,657)

 

(10,401)

Net loans and leases

 

1,866,748

 

1,735,112

Bank premises and equipment, net

 

42,147

 

42,724

Goodwill

 

31,449

 

65,949

Core deposit intangible

 

6,431

 

8,469

Bank owned life insurance

 

77,157

 

75,830

Other real estate owned

 

1,155

 

3,098

Deferred tax assets, net

 

34,687

 

36,010

Interest receivable and other assets

 

33,470

 

29,333

Total assets

$

2,559,184

$

2,374,619

LIABILITIES

 

 

  

Noninterest-bearing deposits

$

657,028

$

468,975

Interest-bearing deposits

 

1,315,710

 

1,245,390

Total deposits

 

1,972,738

 

1,714,365

FHLB advances

200,000

285,000

Customer repurchase agreements and other borrowings

41,473

6,127

Subordinated debt

28,388

28,241

Total borrowings

269,861

319,368

Accrued expenses and other liabilities

 

27,085

 

26,738

Total liabilities

 

2,269,684

 

2,060,471

COMMITMENTS AND CONTINGENCIES

 

 

  

STOCKHOLDERS’ EQUITY

 

 

  

Common stock - par value of $0.01 authorized 20,000,000 shares; issued and outstanding 18,742,300 shares at September 30, 2020 and 19,066,913 at December 31, 2019

 

187

 

191

Capital surplus

 

270,445

 

276,156

Retained earnings

 

13,696

 

35,158

Accumulated other comprehensive income

 

5,172

 

2,643

Total stockholders’ equity

 

289,500

 

314,148

Total liabilities and stockholders’ equity

$

2,559,184

$

2,374,619

The accompanying notes are an integral part of these consolidated financial statements.

3

Consolidated Statements of Operations

Unaudited

For the nine months ended

For the three months ended

September 30, 

September 30, 

(in thousands, except per share data)

    

2020

    

2019

    

2020

    

2019

    

INTEREST INCOME

 

  

 

  

 

Interest and fees on loans and leases

$

58,642

$

62,024

$

19,124

$

20,839

Interest and dividends on securities

 

5,568

5,095

1,819

1,499

Other interest income

 

441

1,765

8

617

Total interest income

 

64,651

68,884

20,951

22,955

INTEREST EXPENSE

 

Deposits

 

7,307

11,630

1,714

4,062

FHLB advances

2,015

3,750

483

1,201

Customer repurchase agreements and other borrowings

52

28

35

2

Subordinated debt

1,360

1,433

447

475

Total interest expense

 

10,734

16,841

2,679

5,740

NET INTEREST INCOME

 

53,917

52,043

18,272

17,215

Provision for credit losses

 

8,145

3,443

1,700

608

Net interest income after provision for credit losses

 

45,772

48,600

16,572

16,607

NONINTEREST INCOME

 

Service charges on deposit accounts

 

1,581

2,037

506

726

Realized and unrealized gains on mortgage banking activity

 

1,036

5,847

0

2,054

Gain on the sale of securities

 

3,044

658

0

0

Gain (loss) on the disposal of bank premises & equipment

 

6

(83)

0

0

Income from bank owned life insurance

 

1,327

1,392

441

485

Loan related fees and service charges

 

1,120

3,022

365

984

Other operating income

 

2,100

2,537

777

784

Total noninterest income

 

10,214

15,410

2,089

5,033

NONINTEREST EXPENSE

 

Compensation and benefits

 

21,836

24,245

7,136

7,939

Occupancy and equipment

 

3,576

8,196

1,301

1,442

Marketing and business development

 

1,092

1,486

189

545

Professional fees

 

2,183

2,250

823

747

Data processing fees

 

2,673

3,697

897

1,172

FDIC assessment

 

915

604

416

36

Other real estate owned

 

461

524

115

393

Loan production expense

 

907

1,981

247

761

Amortization of core deposit intangible

2,038

2,296

659

745

Goodwill impairment

34,500

0

0

0

Other operating expense

 

4,715

4,438

926

1,625

Total noninterest expense

 

74,896

49,717

12,709

15,405

(LOSS) INCOME BEFORE INCOME TAXES

 

(18,910)

14,293

5,952

6,235

Income tax expense

 

2,552

3,312

1,348

1,598

NET (LOSS) INCOME

$

(21,462)

$

10,981

$

4,604

$

4,637

NET (LOSS) INCOME PER COMMON SHARE

 

  

  

 

  

  

Basic

$

(1.14)

$

0.58

$

0.25

$

0.24

Diluted

$

(1.14)

$

0.58

$

0.25

$

0.24

The accompanying notes are an integral part of these consolidated financial statements.

4

Consolidated Statements of Comprehensive (Loss) Income

Unaudited

 For the nine months ended

 For the three months ended

September 30, 

September 30, 

(in thousands)

    

2020

    

2019

    

2020

    

2019

    

Net (loss) income

$

(21,462)

$

10,981

$

4,604

$

4,637

Other comprehensive (loss) income

 

Investments available-for-sale:

 

Reclassification adjustment for realized gain

 

(3,044)

(658)

0

0

Related income tax

 

838

181

0

0

Unrealized holding gains

 

6,532

4,106

1,691

516

Related income tax expense

 

(1,798)

(1,130)

(465)

(141)

Comprehensive (loss) income

$

(18,934)

$

13,480

$

5,830

$

5,012

5

Consolidated Statements of Changes in Stockholders’ Equity

    

    

    

    

    

Accumulated

    

 

other

 

Unaudited

Number of

Common

Capital

Retained

comprehensive

 

(dollars in thousands, except share data)

shares

stock

surplus

earnings

income

Total

Nine months ended

Balances at December 31, 2018

 

19,039,347

$

190

$

275,843

$

18,277

$

373

$

294,683

Net income

 

0

0

0

10,981

0

10,981

Other comprehensive income

 

0

0

0

0

2,499

2,499

Director stock awards

 

9,202

0

127

0

0

127

Exercise of options

 

13,418

1

115

0

0

116

Employee stock purchase plan

 

19,539

0

280

0

0

280

Repurchased shares

(4,900)

0

(68)

0

0

(68)

Stock-based compensation

 

5,171

0

134

0

0

134

Balances at September 30, 2019

 

19,081,777

$

191

$

276,431

$

29,258

$

2,872

$

308,752

Balances at December 31, 2019

 

19,066,913

$

191

$

276,156

$

35,158

$

2,643

$

314,148

Net loss

 

0

0

0

(21,462)

0

(21,462)

Other comprehensive income

 

0

0

0

0

2,529

2,529

Director stock awards

 

22,616

0

275

0

0

275

Exercise of options

0

0

0

0

0

0

Employee stock purchase plan

 

22,749

0

303

0

0

303

Repurchased shares

 

(372,801)

(4)

(6,673)

0

0

(6,677)

Stock-based compensation

 

2,823

0

384

0

0

384

Balances at September 30, 2020

 

18,742,300

$

187

$

270,445

$

13,696

$

5,172

$

289,500

The accompanying notes are an integral part of these consolidated financial statements.

Accumulated

 

other

 

Unaudited

Number of

Common

Capital

Retained

comprehensive

 

(dollars in thousands, except share data)

    

shares

    

stock

    

surplus

    

earnings

    

 income

    

Total

Three months ended

 

Balances at June 30, 2019

 

19,063,080

$

191

$

276,218

$

24,621

$

2,497

$

303,527

Net income

 

0

0

0

4,637

0

4,637

Other comprehensive income

 

0

0

0

0

375

375

Director stock awards

 

4,400

0

65

0

0

65

Exercise of options

 

1,269

0

11

0

0

11

Employee stock purchase plan

12,757

0

183

0

0

183

Repurchased shares

(4,900)

0

(68)

0

0

(68)

Stock-based compensation

5,171

0

22

0

0

22

Balances at September 30, 2019

 

19,081,777

$

191

$

276,431

$

29,258

$

2,872

$

308,752

Balances at June 30, 2020

 

18,715,678

$

187

$

270,056

$

9,092

$

3,946

$

283,281

Net income

 

0

0

0

4,604

0

4,604

Other comprehensive income

0

0

0

0

1,226

1,226

Director stock awards

14,465

0

138

0

0

138

Exercise of options

0

0

0

0

0

0

Employee stock purchase plan

10,168

0

108

0

0

108

Repurchased shares

 

0

0

0

0

0

0

Stock-based compensation

 

1,989

0

143

0

0

143

Balances at September 30, 2020

 

18,742,300

$

187

$

270,445

$

13,696

$

5,172

$

289,500

The accompanying notes are an integral part of these consolidated financial statements.

6

Consolidated Statements of Cash Flows

Unaudited

Nine months ended

September 30, 

(in thousands)

    

2020

    

2019

    

CASH FLOWS FROM OPERATING ACTIVITIES:

 

  

 

  

 

Net (loss) income

$

(21,462)

$

10,981

Adjustments to reconcile net (loss) income to net cash from operating activities:

 

Provision for credit losses

 

8,145

3,443

Deferred income tax

 

363

3,034

Provision for other real estate owned

 

257

367

Depreciation and amortization

 

1,713

1,785

Stock-based compensation

 

659

529

Net accretion of discount on purchased loans

 

(999)

(1,309)

Gain on sale of securities

 

(3,044)

(658)

(Gain) loss on the sale of premises and equipment

 

(6)

83

Net amortization of intangible asset

 

2,038

2,296

Goodwill impairment

34,500

0

Loans originated for sale

 

(79,847)

(419,588)

Proceeds from sale of loans originated for sale

 

111,593

399,983

Realized and unrealized gains on mortgage banking activity

 

(1,036)

(5,847)

Loss on sale of other real estate owned, net

 

109

1

Cash surrender value of bank owned life insurance

 

(1,327)

(1,392)

Decrease in interest receivable and other assets

2,625

1,017

(Decrease) increase in accrued expenses and other liabilities

 

(1,664)

1,627

Other, net

51

22

Net cash provided by (used in) operating activities

 

52,668

(3,626)

CASH FLOWS FROM INVESTING ACTIVITIES:

 

  

 

  

Purchases of investment securities

 

(303,517)

(24,546)

Proceeds from sales, maturities and calls of investment securities

 

145,488

87,365

Net increase in loans and leases outstanding

 

(138,512)

(83,078)

Proceeds from the sale of other real estate owned

 

1,629

1,028

Purchase of premises and equipment

 

(386)

(539)

Proceeds from the sale of premises and equipment

 

743

1,392

Net cash used in investing activities

 

(294,555)

(18,378)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

Net increase (decrease) in deposits

 

258,373

(30,183)

Net increase (decrease) customer repurchase agreements and other borrowings

35,493

(15,361)

Net (decrease) increase in FHLB advances

(85,000)

41,000

Proceeds from issuance of common stock, net of cost

 

303

127

Repurchase of common stock

 

(6,677)

(68)

Net cash provided by (used in) financing activities

 

202,492

(4,485)

Net decrease in cash and cash equivalents

 

(39,395)

(26,489)

Cash and cash equivalents at beginning of period

 

109,977

101,498

Cash and cash equivalents at end of period

$

70,582

$

75,009

SUPPLEMENTAL INFORMATION

 

Cash payments for interest

$

10,459

$

16,732

Cash payments for income taxes

 

3,935

0

Transferred from loans to other real estate owned

 

51

375

Cash payments for operating leases

665

1,069

Lease liabilities arising from obtaining right of use assets (see Note 8)

2,011

18,009

Goodwill reduction for adjustments to acquired net deferred tax assets

 

0

4,748

The accompanying notes are an integral part of these consolidated financial statements.

7

Notes to Consolidated Financial Statements (unaudited)

Note 1:  Summary of Significant Accounting Policies

Nature of Operations

Howard Bancorp, Inc. (“Bancorp” or the “Company”) was incorporated in April 2005 under the laws of the State of Maryland.  On December 15, 2005, Bancorp acquired all of the stock of Howard Bank (the “Bank”) pursuant to the Plan of Reorganization approved by the stockholders of the Bank and by federal and state regulatory agencies. Each share of the Bank’s common stock was converted into 2 shares of Bancorp common stock effected by the filing of Articles of Exchange on that date, and the stockholders of the Bank became the stockholders of Bancorp. Bancorp is now a bank holding company registered under the Bank Holding Company Act of 1956, with a single bank subsidiary, Howard Bank, which operates as a state trust company with commercial banking powers regulated by the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”).

The Bank has 9 subsidiaries—6 were formed to hold foreclosed real estate (3 of which are currently inactive), 2 own and manage real estate used for corporate purposes, and 1  holds historic tax credit investments.  

The Company is a diversified financial services company providing commercial banking and consumer finance through banking branches, the internet and other distribution channels to businesses, business owners, professionals and other consumers located primarily in the Greater Baltimore Metropolitan Area.

These statements should be read in conjunction with the financial statements and accompanying notes included in the Company’s 2019 Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”) on March 16, 2020. There have been no significant changes to the Company’s accounting policies as disclosed in the 2019 Annual Report on Form 10-K.

The following is a description of the Company’s significant accounting policies.

Basis of Presentation

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and prevailing practices within the financial services industry for financial information.

Principles of Consolidation

The consolidated financial statements include the accounts of Bancorp, the Bank and the Bank’s subsidiaries.  All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for loan and lease losses, the valuation of goodwill and deferred tax assets, other-than-temporary impairment of investment securities and the fair value of loans held for sale.

8

Allowance for Loan and Lease Losses

The allowance for loan and lease losses (the "allowance") is maintained at a level believed adequate by management to absorb probable losses inherent in the loan and lease portfolio and is based on the size and current risk characteristics of the loan and lease portfolio, an assessment of individual problem loans and leases, actual loss experience, current economic events in specific industries and geographic areas including unemployment levels and other pertinent factors including general economic conditions.  Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogenous loans and leases based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Loan and lease losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance.  A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.  Evaluations are conducted at least quarterly and more often if deemed necessary.

The allowance consists of a specific component and a nonspecific component.  The components of the allowance  represent an estimation done pursuant to either the Financial Accounting Standards Board’s (the “FASB”) Accounting Standards Codification (“ASC”) Topic 450 Contingencies or ASC Topic 310 Receivables.  The specific component of the allowance reflects expected losses resulting from analysis developed through credit allocations for individual loans and leases.  The credit allocations are based on a regular analysis of all loans and leases over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification.  The specific component of the allowance for loan and lease losses also includes management’s determination of the amounts necessary given concentrations and changes in portfolio mix and volume.

The nonspecific portion of the allowance is determined based on management’s assessment of general economic conditions, as well as economic factors in the individual markets in which the Company operates including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle.  This determination inherently involves a higher risk of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the nonspecific component of the allowance, and it recognizes that knowledge of the portfolio may be incomplete.  The Bank’s historic loss factors are based upon actual losses incurred by portfolio segment over the preceding 24-month period.  In portfolio segments where no actual losses have been incurred within the most recent 24-month period, industry loss data for that portfolio segment, as provided by the Federal Deposit Insurance Corporation (“FDIC”), are utilized.  In addition to historic loss factors, the Bank’s methodology for the allowance for loan and lease losses incorporates other risk factors that may be inherent within the portfolio segments.  For each portfolio segment, in addition to the historic loss experience, the qualitative factors that are measured and monitored in the overall determination of the allowance include:

changes in lending policies, procedures, and practices;
changes in international, national, state and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments;
changes in the nature and volume of the loan portfolio;
changes in the experience, ability and depth of the lending staff;
changes in the volume and severity of past due, nonaccrual, and adversely classified loans;
changes in the quality of our loan review system;
changes in the value of underlying collateral for collateral-dependent loans;
the existence of any concentrations of credit, and changes in the level of such concentrations;
the effect of other external factors such as competition and legal and regulatory requirements; and
any other factors that management considers relevant to the quality or performance of the loan portfolio.

Each of these qualitative risk factors is measured based upon data generated either internally, or in the case of economic conditions utilizing independently provided data on items such as unemployment rates, commercial real estate vacancy rates, or other market data deemed relevant to the business conditions within the markets served.

9

The Company’s credit policies state that after all collection efforts have been exhausted, and the loan or lease is deemed to be a loss, then the remaining loan or lease balance will be charged to the Company’s established allowance for loan and lease losses.  All loans and leases are evaluated for loss potential once it has been determined by the Watch Committee that the likelihood of repayment is in doubt.  When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan or lease is deemed not to be well secured, the loan or lease would be moved to non-accrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s).  Once the actual loss value has been determined, a charge-off against the allowance for the amount of the loss is taken.  Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.

Acquired Loans

Acquired loans are recorded at fair value at the date of acquisition, and accordingly, no allowance for loan and lease losses is transferred to the acquiring entity under the acquisition method. The fair values of loans with evidence of credit deterioration (acquired credit impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For acquired credit impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the initial investment in the acquired credit impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The acquired credit impaired loan’s contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, but in the form of a loss accrual or a valuation allowance.

Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance through a provision for credit losses. Subsequent significant increases in cash flows result in a reversal of the provision for credit losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.

Goodwill, Other Intangible Assets and Long-Lived Assets

Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Long-lived assets are those that provide the Company with a future economic benefit beyond the current year or operating period. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the fair value, less costs to sell.

Effective April 1, 2020, the Company adopted ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit.

10

Management has determined that the Company has one reporting unit. The sudden and continuing decline in economic conditions triggered by the Coronavirus ("COVID-19") pandemic included a significant decline in stock market valuations and the stock price of the Company and peer banks. These events indicated that goodwill may be impaired and resulted in us performing a goodwill impairment assessment. Based on this assessment, the Company's estimated fair value was less than its book value, resulting in a goodwill impairment charge of $34.5 million recorded in the quarter ended June 30, 2020.

Income Taxes

The Company uses the asset/liability method of accounting for income taxes.  Under the asset/liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse.  As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.  In addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or the entire deferred tax asset will not be realized.  The Company does not have uncertain tax positions that are deemed material, and did not recognize any adjustments for unrecognized tax benefits.  The Company’s policy is to recognize interest and penalties on income taxes in other noninterest expenses.  The Company remains subject to examination by federal and state taxing authorities for income tax returns for the years ending after December 31, 2015.

Share-Based Compensation

Compensation cost is recognized for stock options and restricted stock issued to directors and employees.  Compensation cost is measured as the fair value of these awards on their date of grant.  A Black-Scholes model is utilized to estimate the fair value of stock options.  The market price of the Company’s common stock at the date of grant is used for restricted stock awards, which include restricted stock units. Compensation cost is recognized over the required service period, generally defined as the vesting period.  For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.  When an award is granted to an employee who is retirement eligible, the compensation cost of these awards is recognized over the period up to when the director or employee first becomes eligible to retire.

Compensation expense for non-vested common stock awards is based on the fair value of the awards, which is generally the market price of the common stock on the measurement date, which, for the Company, is the date of grant, and is recognized ratably over the service period of the award.

Reclassifications

Certain reclassifications to prior financial presentation were made to conform to the 2020 presentation. These reclassifications did not affect previously reported net income or total stockholders’ equity.

Recent Accounting Pronouncements

The FASB has issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (LIBOR), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation. ASU 2020-04 is effective between March 12, 2020 and December 31, 2020. The Company has identified our products that utilize LIBOR and continues to evaluate our transition to a new rate.

11

The FASB has issued ASU 2019-10, Financial Instruments – Credit losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This ASU amends the effective date of the credit loss standard (ASU 2016-13) for smaller reporting companies, as defined by the SEC. The one-time determination of whether an entity is eligible to be a smaller reporting company is based on an entity’s most recent determination as of November 15, 2019, in accordance with SEC regulations. The Company met this definition of smaller reporting company based on its most recent determination as of November 15, 2019. As a result, the effective date of this ASU for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years. In addition, this ASU amended the mandatory effective date for the elimination of Step 2 from the goodwill impairment test (ASU 2017-04 discussed below). As a smaller reporting company, the effective date of the goodwill impairment standard for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years.

The FASB has issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this Update simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. Impairment charges should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. As discussed above, this ASU, as amended by ASU 2019-10, was to be effective for the Company on January 1, 2023. However, the Company adopted ASU 2017-04 on April 1, 2020.

The FASB has issued ASU 2016-13, Financial Instruments—Loan Losses (Topic 326). The main objective of this update is to provide financial statement users with more decision-useful information about the expected loan losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the guidance in this update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected loan losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The measurement of expected loan losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. As discussed above, this ASU, as amended by ASU 2019-10, will be effective for the Company on January 1, 2023. The Company has engaged a third party vendor and is currently gathering historical data and reviewing the methodologies and assumptions utilized to determine the impact of this update on the Company’s Consolidated Financial Statements.

COVID-19 Risks and Uncertainties

The coronavirus (COVID-19) pandemic, which was declared a national emergency in the United States in March 2020, continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. Federal and state governments have taken, and may continue to take, unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed and businesses and schools have reopened with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief.

12

The impact of the COVID-19 pandemic is fluid and continues to evolve. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time, then declining further to a low of 0.52% in early August, before rising to 0.69% as of September 30, 2020. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic has had and is expected to continue to have, possibly materially, an adverse effect on the Company’s business, financial condition, and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and the Company’s customers, employees and vendors.

Note 2:  Exit of Mortgage Banking Activities

On December 18, 2019, the Company entered into an agreement to release certain management members of the mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring all remaining mortgage employees.  The Company also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of the mortgage employees, and the sale of the domain name, the LLC paid the Company $750 thousand. Under the agreement, there was a transition period of approximately 45 days, after which the Company agreed to cease originating residential first lien mortgage loans and exit all mortgage banking activities. Accordingly, all of the residential first lien mortgage pipeline loans were processed by the end of the first quarter of 2020 and the remaining loans held for sale were sold during the second quarter of 2020. In order to manage loan run-off within the residential mortgage loan portfolio, the Company plans on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.

The following table presents a roll forward of loans held for sale, showing loans originated for sale and loans sold into the secondary market, for the periods ended September 30, 2020 and, December 31, 2019. In addition, the volume of loans originated for the Company’s loan portfolio as well as a statement of operations for the mortgage banking activities for the same periods is presented.  Since the mortgage banking activities were conducted within a division of the Bank, formal financial statements were not prepared. The statement of operations presented below reflects only the direct costs associated with the Company’s mortgage banking activities and is thus representative of the incremental after tax impact of exiting this activity.

(in thousands)

    

September 30, 2020

    

December 31, 2019

    

Loans held for sale, January 1

$

30,710

$

21,261

Loans originated for sale

 

79,847

 

573,306

Loans sold into the secondary market

(110,557)

(563,857)

Loans held for sale, at end of period

$

0

$

30,710

Loans originated for the Bank's portfolio

$

11,378

$

114,561

13

For the nine months ended September 30, 

For the three months ended September 30, 

($ in thousands)

    

2020

    

2019

    

2020

    

2019

Statement of Operations:

 

  

 

  

 

  

 

  

Net interest income

 

$

143

 

$

517

 

$

0

 

$

177

Realized and unrealized gains on mortgage banking activity

1,036

5,795

0

2,058

Loan related fees and service charges

389

2,134

0

814

Total noninterest income

1,425

7,929

0

2,872

Salaries and benefits

928

5,027

0

1,964

Occupancy

20

275

0

121

All other operating expenses

490

1,677

0

627

Total noninterest expense

1,438

6,979

0

2,712

Pretax contribution

130

1,467

0

337

Income tax expense

36

404

0

93

After tax contribution

 

$

94

 

$

1,063

 

$

0

 

$

244

Since the Bank's 91 employees that were engaged in mortgage banking activities were hired by the LLC under the terms of the agreement, 0 severance costs were recorded. However, in the fourth quarter of 2019, the Company recorded $288 thousand of exit costs associated with change in control and retention agreements. Back office employees  remained with the bank for a portion of the first quarter  in order to process the pipeline. The LLC is subleasing the office space that was used by these employees; therefore, 0 exit costs associated with lease terminations were required.

Note 3:  Investment Securities

The Bank holds securities classified as available for sale and held to maturity.

The amortized cost and estimated fair values of investments are as follows:

(in thousands)

September 30, 2020

December 31, 2019

Gross

Gross

Gross

Gross

Amortized

Unrealized

Unrealized

Estimated

Amortized

Unrealized

Unrealized

Estimated

    

Cost

    

Gains

    

Losses

    

Fair Value

    

Cost

    

Gains

    

Losses

    

Fair Value

    

Available for sale

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

U.S. Government Agencies

$

72,318

$

1,598

$

0

$

73,916

$

66,428

$

963

$

79

$

67,312

Mortgage-backed

 

290,507

5,499

88

295,918

139,918

2,848

67

142,699

Other investments

 

7,509

146

18

7,637

5,510

4

20

5,494

$

370,334

$

7,243

$

106

$

377,471

$

211,856

$

3,815

$

166

$

215,505

Held to maturity Corporate debentures

$

7,250

$

75

$

28

$

7,297

$

7,750

$

147

$

0

$

7,897

14

Gross unrealized losses and fair value by investment category and length of time the individual securities have been in a continuous unrealized loss position at September 30, 2020 and December 31, 2019 are presented below:

September 30, 2020

(in thousands)

Less than 12 months

12 months or more

Total

Gross

Gross

Gross

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

    

Value

    

Losses

    

Value

    

Losses

    

Value

    

Losses

Available for sale

 

  

 

  

 

  

 

  

 

  

 

  

Mortgage-backed

$

36,301

$

88

$

0

$

0

$

36,301

$

88

Other investments

 

0

0

2,991

18

2,991

18

$

36,301

$

88

$

2,991

$

18

$

39,292

$

106

Held to maturity Corporate debentures

$

1,472

$

28

$

0

$

0

$

1,472

$

28

December 31, 2019

(in thousands)

Less than 12 months

12 months or more

Total  

Gross

Gross

Gross

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

    

Value

    

Losses

    

Value

    

Losses

    

Value

    

Losses

Available for sale

 

  

 

  

 

  

 

  

 

  

 

  

U.S. Government

 

  

 

  

 

  

 

  

 

  

 

  

Agencies

$

10,689

$

79

$

0

$

0

$

10,689

$

79

Mortgage-backed

 

35,512

60

975

7

36,487

67

Other investments

 

0

0

2,990

20

2,990

20

$

46,201

$

139

$

3,965

$

27

$

50,166

$

166

Held to maturity Corporate debentures

$

0

$

0

$

0

$

0

$

0

$

0

The unrealized losses that existed were a result of market changes in interest rates since the original purchase. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include the (1) duration and magnitude of the decline in value, (2) financial condition of the issuer or issuers and (3) structure of the security. The Company had 11 securities in the portfolio with unrealized losses at September 30, 2020 compared to 15 at December 31, 2019.

An impairment loss is recognized in earnings if any of the following are true: (1) the Company intends to sell the debt security; (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the Company does not expect to recover the entire amortized cost basis of the security. In situations where the Company intends to sell or when it is more likely than not that the Company will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in stockholders’ equity as a component of other comprehensive income, net of deferred tax.

The amortized cost and estimated fair values of available for sale and held to maturity securities by contractual maturity are shown below:

September 30, 

December 31, 

(in thousands)

2020

    

2019

 

Amortized

 

Estimated Fair

 

Amortized

 

Estimated Fair

 

    

Cost

    

Value

    

Cost

    

Value

    

Amounts maturing:

 

  

 

  

 

  

 

  

 

One year or less

$

4,027

$

4,097

$

1,497

$

1,500

After one through five years

 

43,753

45,074

49,166

50,048

After five through ten years

 

36,705

37,478

33,576

33,915

After ten years

 

293,099

298,119

135,367

137,939

$

377,584

$

384,768

$

219,606

$

223,402

15

At September 30, 2020 and December 31, 2019, $149.8 million and $11.6 million in fair value of securities, respectively, were pledged as collateral. These securities were pledged at the Federal Reserve’s Discount Window as well as for repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts. No single issuer of securities, except for government agency and mortgage backed securities, had outstanding balances that exceeded ten percent of stockholders’ equity at September 30, 2020.

Note 4:  Loans and Leases

The Company makes loans and leases to customers primarily in the Greater Baltimore Metropolitan Area and surrounding communities. A substantial portion of the Company’s loan portfolio consists of loans to businesses secured by real estate and/or other business assets.

The loan portfolio segment balances at September 30, 2020 and December 31, 2019 are presented in the following table:

September 30, 

December 31, 

2020

2019

% of

% of

(in thousands)

    

Total

    

Total

    

Total

    

Total

 

Real estate

  

  

  

  

 

Construction and land

$

104,361

5.5

%  

$

128,285

7.3

%

Residential - first lien

 

391,079

20.8

 

437,409

25.1

Residential - junior lien

 

62,728

3.3

 

74,164

4.2

Total residential real estate

 

453,807

24.1

 

511,573

29.3

Commercial - owner occupied

 

250,512

13.3

 

241,795

13.9

Commercial - non-owner occupied

 

471,753

25.0

 

444,052

25.4

Total commercial real estate

 

722,265

38.4

 

685,847

39.3

Total real estate loans

 

1,280,433

67.9

 

1,325,705

75.9

Commercial loans and leases 1

 

353,863

18.8

 

372,872

21.4

Consumer

 

53,734

2.9

 

46,936

2.7

Total portfolio loans and leases

$

1,688,030

89.6

$

1,745,513

100.0

Paycheck protection program loans

196,375

10.4

0

0

Total loans and leases

$

1,884,405

100.0

%  

$

1,745,513

100.0

%

1 Includes equipment financing leases of $4,234 and $6,382 at September 30, 2020 and December 31, 2019, respectively.

The Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”) was established under the Coronavirus Aid, Relief and Economic Security Act (“CARES” Act), which was signed into law on March 27, 2020. The PPP program provided financial relief and funding opportunities for small businesses from approved SBA lenders. In response to the COVID-19 pandemic, as an SBA lender, the Bank actively assisted its qualified customers with applications and lending through this program, as amended by subsequent legislation. The SBA ceased accepting applications under the program on August 8, 2020. During the quarter ended September 30, 2020, the Bank funded 36 PPP loans totaling $2.0 million; net of unamortized deferred fees and origination costs, PPP loans totaled $196.4 million at September 30, 2020. Loans funded through the PPP program are fully guaranteed by the U.S. government and the Company anticipates that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.

Net loan origination fees, which are included in the amounts in the above table, totaled $2.7 million and $1.3 million at September 30, 2020 and December 31, 2019, respectively. At September 30, 2020, net loan origination fees attributable to PPP loans totaled $4.6 million, consisting of unamortized processing fees of $5.2 million and $619 thousand in unamortized loan origination costs.

16

Acquired Credit Impaired Loans

The following table documents changes in the accretable discount on acquired credit impaired loans at:

For the nine months ended

For the three months ended

September 30, 

September 30, 

(in thousands)

    

2020

    

2019

    

2020

    

2019

    

Balance at beginning of period

$

689

$

877

$

574

$

767

Impaired loans acquired

 

0

0

0

0

Accretion of fair value discounts

 

(217)

(156)

(102)

(46)

Balance at end of period

$

472

$

721

$

472

$

721

The table below presents the outstanding balances and related carrying amounts for all acquired credit impaired loans at the end of the respective periods:

Contractually

Required

Payments

Carrying

(in thousands)

    

Receivable

    

Amount

At September 30, 2020

$

7,231

$

5,656

At December 31, 2019

 

10,929

8,706

Note 5:  Credit Quality Assessment

Allowance for Loan and Lease Losses

Summary information on activity in the allowance for loan and lease losses for the periods indicated is presented in the following table:

For the nine months ended

For the three months ended

September 30, 

September 30, 

(in thousands)

    

2020

    

2019

    

2020

    

2019

Beginning balance

 

$

10,401

 

$

9,873

 

$

16,356

 

$

9,120

Charge-offs

(814)

(3,960)

(200)

(232)

Recoveries

245

242

121

102

Net charge-offs

(569)

(3,718)

(79)

(130)

Provision for credit losses 1

7,825

3,443

1,380

608

Ending balance

 

$

17,657

 

$

9,598

 

$

17,657

 

$

9,598

1 Portion attributable to loan and lease losses.

The September 30, 2020 allowance reflects the Company’s assessment of the impact of COVID-19 on the national and local economies and the impact on various categories of our loan portfolio. Management’s approach to COVID-19 and the evaluation of the allowance considered the following: (1) any change in historical loss rates resulting from COVID-19; (2) any risk rating downgrades related to COVID-19; and (3) any changes to collateral valuations or cash flow assumptions for impaired loans. Based on this review, the Company determined that some risk rating downgrades had occurred and were factored into the quantitative allowance at September 30, 2020.

The Company then reviewed its qualitative factors and identified four factors that warranted further evaluation:

Changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments;
The existence and effect of any concentrations of credit, and changes in the level of such concentrations;
Changes in the value of underlying collateral for collateral-dependent loans; and

17

Changes in the volume and severity of past due, nonaccrual, and adversely classified loans.

The Company’s evaluation of changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, considered the abrupt slowdown in commercial economic activity resulting from actions announced by the State of Maryland between the March 5 disclosure of the first confirmed cases of COVID-19 in the state and the March 23 executive order closing all non-essential businesses in the state. In addition, management considered the dramatic rise in the unemployment rate in the Company’s market area. Based on U.S. Department of Labor weekly initial unemployment claims by state, management noted that the average weekly initial unemployment claims for the State of Maryland during the two weeks ending March 28, 2020 were 19 times higher than the average weekly claims for the first eleven weeks of 2020 (the "pre-COVID" period"). As a result, the Company increased this qualitative factor as of March 31, 2020.

During the quarter ended June 30, 2020, initial unemployment claims for the State of Maryland were still 12 times higher than the pre-COVID period.  While much of the Maryland economy had reopened by the end of the second quarter, the high level of economic slowdown, the high unemployment rate, and the heightened risk of setbacks in the pace of reopening the local economy resulted in an additional increase in this qualitative factor as of June 30, 2020.

During the quarter ended September 30, 2020, the rate of change in average weekly initial unemployment claims slowed significantly, but was still three times higher than the pre-COVID period.  While the Maryland economy has fully reopened with some limitations and a substantial amount of economic activity has returned, unemployment, while declining, still remains high, and many businesses are still experiencing significant drops in revenue. In addition, in many states and localities, the number of individuals diagnosed with COVID-19 has increased significantly since the end of September, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief. As a result, the Company made no adjustments to this qualitative factor as of September 30, 2020.

The Company also evaluated the existence and effect of any concentrations of credit, and changes in the level of such concentrations. Management performed an analysis of the loan portfolio to identify the Company’s exposure to industry segments that may potentially be the most highly impacted by COVID-19. Based on this evaluation, the Company identified the following industry segments as potentially highly impacted: commercial real estate (“CRE”) – retail; CRE – residential rental; hotels; restaurants and caterers; nursing and residential care; retail trade; religious and similar organizations; and arts, entertainment, and recreation.

The potentially highly impacted loan exposures at September 30, 2020 were concentrated in non-owner-occupied commercial real estate (63.7% of total high impacts), owner-occupied commercial real estate (18.6% of total high impacts), construction and land (9.7% of total high impacts), and commercial loans (7.4% of total high impacts). An increase in this qualitative factor was applied to these high impact loan portfolio categories at both March 31 and June 30, 2020. No adjustment was made to this factor at September 30, 2020.

The Company’s evaluation of potential changes in the value of underlying collateral for collateral-dependent loans considered the potential impact of the economic fallout from COVID-19 on commercial property values due to rent relief and possible business failures resulting in vacancies. In addition, the need for office space may diminish in the future as work from home policies have allowed much office-oriented business activity to continue.  Excluding the high impact portfolios, management concluded that 53% of the Company’s non-owner-occupied commercial real estate portfolio at September 30, 2020 was not included in the high impact exposure. An increase in this qualitative factor was applied to the Company’s non-owner-occupied commercial real estate portfolio at both March 31 and June 30, 2020. No adjustment was made to this factor at September 30, 2020.

The Company's evaluation of changes in the volume and severity of past due, nonaccrual, and adversely classified loans identified three loan portfolio segments where adverse risk rating migration warranted an upward revision to this qualitative factor at September 30, 2020; these portfolio segments were both non-owner-occupied and owner-occupied commercial real estate loans as well as commercial loans.

18

Loans funded through the PPP program are fully guaranteed by the U.S. government and the Company anticipates that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. Therefore, 0 allowance for loan and lease losses is attributable to this loan portfolio segment.

The following table provides information on the activity in the allowance for loan and lease losses by the respective loan portfolio segment for the nine and three months ended September 30, 2020 and 2019:

At September 30, 2020

Commercial real estate

Commercial

Paycheck

Construction

Residential real estate

owner

non-owner

loans

Consumer

Protection

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Program

    

Total

Allowance for loan and lease losses:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Nine months ended :

Beginning balance

$

1,256

$

2,256

$

478

$

788

$

2,968

$

2,103

$

552

$

0

$

10,401

Charge-offs

 

0

(41)

0

0

(37)

(549)

(187)

0

(814)

Recoveries

 

0

3

59

0

0

181

2

0

245

Provision for credit losses 1

 

(62)

138

303

1,297

3,748

1,621

780

0

7,825

Ending balance

$

1,194

$

2,356

$

840

$

2,085

$

6,679

$

3,356

$

1,147

$

0

$

17,657

Three months ended :

Beginning balance

$

1,525

$

2,714

$

924

$

1,806

$

5,590

$

3,056

$

741

$

0

$

16,356

Charge-offs

 

0

(8)

0

0

(14)

0

(178)

0

(200)

Recoveries

 

0

0

7

0

0

114

0

0

121

Provision for credit losses 1

 

(331)

(350)

(91)

279

1,103

186

584

0

1,380

Ending balance

$

1,194

$

2,356

$

840

$

2,085

$

6,679

$

3,356

$

1,147

$

0

$

17,657

Allowance allocated to:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

  

individually evaluated for impairment

$

0

$

0

$

0

$

0

$

0

$

0

$

0

$

0

$

0

collectively evaluated for impairment

$

1,194

$

2,356

$

840

$

2,085

$

6,679

$

3,356

$

1,147

$

0

$

17,657

Loans and leases:

 

Ending balance

$

104,361

$

391,079

$

62,728

$

250,512

$

471,753

$

353,863

$

53,734

$

196,375

$

1,884,405

individually evaluated for impairment

$

338

$

12,361

$

1,461

$

793

$

559

$

1,489

$

0

$

0

$

17,001

collectively evaluated for impairment

$

104,023

$

378,718

$

61,267

$

249,719

$

471,194

$

352,374

$

53,734

$

196,375

$

1,867,404

19

At September 30, 2019

Commercial real estate

Commercial

Construction

Residential real estate

owner

non-owner

loans

Consumer

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Total

Allowance for loan and lease losses:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Nine months ended :

Beginning balance

$

741

$

1,170

$

292

$

735

$

4,057

$

2,644

$

234

$

9,873

Charge-offs

 

(282)

(453)

(508)

(46)

(2,026)

(622)

(23)

(3,960)

Recoveries

 

79

0

114

0

12

35

2

242

Provision for credit losses 1

 

810

1,246

535

245

787

(320)

140

3,443

Ending balance

$

1,348

$

1,963

$

433

$

934

$

2,830

$

1,737

$

353

$

9,598

Three months ended :

Beginning balance

$

1,128

$

1,790

$

437

$

893

$

2,799

$

1,695

$

378

$

9,120

Charge-offs

 

0

(91)

(37)

(2)

0

(97)

(5)

(232)

Recoveries

 

79

0

10

0

9

3

1

102

Provision for credit losses 1

 

141

264

23

43

22

136

(21)

608

Ending balance

$

1,348

$

1,963

$

433

$

934

$

2,830

$

1,737

$

353

$

9,598

Allowance allocated to:

individually evaluated for impairment

$

0

$

0

$

0

$

0

$

0

$

0

$

0

$

0

collectively evaluated for impairment

$

1,348

$

1,963

$

433

$

934

$

2,830

$

1,737

$

353

$

9,598

Loans and leases:

 

Ending balance

$

124,326

$

415,688

$

76,272

$

239,464

$

442,813

$

383,557

$

47,760

$

1,729,880

individually evaluated for impairment

$

493

$

13,773

$

1,012

$

569

$

1,782

$

2,086

$

288

$

20,003

collectively evaluated for impairment

$

123,833

$

401,915

$

75,260

$

238,895

$

441,031

$

381,471

$

47,472

$

1,709,877

1 Portion attributable to loan and lease losses.

When potential losses are identified, a specific provision and/or charge-off may be taken, based on the then current likelihood of repayment, that is at least in the amount of the collateral deficiency, and any potential collection costs, as determined by the independent third party appraisal.

Loans that are considered impaired are subject to the completion of an impairment analysis. This analysis highlights any potential collateral deficiencies. A specific amount of impairment is established based on the Bank’s calculation of the probable loss inherent in the individual loan. The actual occurrence and severity of losses involving impaired credits can differ substantially from estimates.

Credit risk profile by portfolio segment based upon internally assigned credit quality indicators are presented below:

September 30, 2020

Commercial real estate

Commercial

Paycheck

Construction

Residential real estate

owner

non-owner

loans

Consumer

Protection

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Program

    

Total

Credit quality indicators:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Not classified

$

100,475

$

379,677

$

61,267

$

249,436

$

471,108

$

326,575

$

53,734

$

196,375

$

1,838,647

Special mention

 

3,548

0

0

 

283

49

 

25,879

0

0

29,759

Substandard

 

338

11,402

1,461

 

793

596

 

1,409

0

0

15,999

Doubtful

 

0

0

0

 

0

0

 

0

0

0

0

Total loans and leases

$

104,361

$

391,079

$

62,728

$

250,512

$

471,753

$

353,863

$

53,734

$

196,375

$

1,884,405

20

December 31, 2019

Commercial real estate

Commercial

Construction

Residential real estate

owner

non-owner

loans

Consumer

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Total

Credit quality indicators:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

Not classified

$

127,804

$

425,247

$

73,378

$

241,229

$

442,327

$

370,837

$

46,809

$

1,727,631

Special mention

 

0

 

0

 

0

 

0

 

0

 

0

 

0

 

0

Substandard

 

481

 

12,162

 

786

 

566

 

1,725

 

2,035

 

127

 

17,882

Doubtful

 

0

 

0

 

0

 

0

 

0

 

0

 

0

 

0

Total loans and leases

$

128,285

$

437,409

$

74,164

$

241,795

$

444,052

$

372,872

$

46,936

$

1,745,513

Special Mention - A Special Mention asset has potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.  Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard - Substandard loans and leases are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans and leases so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans and leases classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.

Loans and leases classified Special Mention, Substandard, and Doubtful are reviewed at least quarterly to determine their appropriate classification. All commercial credit relationships are reviewed annually. Non-classified residential mortgage loans and consumer loans are not evaluated unless a specific event occurs to raise the awareness of a possible credit deterioration.

An aged analysis of past due loans are as follows:

September 30, 2020

Commercial real estate

Commercial

Paycheck

Construction

Residential real estate

owner

non-owner

loans

Consumer

Protection

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Program

    

Total

Analysis of past due loans and leases:

Accruing loans and leases current

$

103,728

$

377,840

$

60,525

$

248,011

$

471,015

$

352,454

$

53,722

$

196,375

$

1,863,670

Accruing loans and leases past due:

30-59 days past due

 

0

0

116

30

0

0

0

0

146

60-89 days past due

 

0

1,478

626

0

0

298

12

0

2,414

Greater than 90 days past due

 

295

359

0

1,678

179

0

0

0

2,511

Total past due

 

295

1,837

742

1,708

179

298

12

0

5,071

Non-accrual loans and leases 1

 

338

11,402

1,461

793

559

1,111

0

0

15,664

Total loans and leases

$

104,361

$

391,079

$

62,728

$

250,512

$

471,753

$

353,863

$

53,734

$

196,375

$

1,884,405

21

    

December 31, 2019

Commercial real estate

Commercial

Construction

Residential real estate

owner

non-owner

loans

Consumer

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Total

Analysis of past due loans and leases:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

Accruing loans and leases current

$

127,804

$

418,668

$

71,634

$

241,062

$

442,132

$

370,877

$

46,776

$

1,718,953

Accruing loans and leases past due:

30-59 days past due

 

0

 

3,312

 

748

 

0

 

195

 

35

 

19

 

4,309

60-89 days past due

 

0

 

3,220

 

996

 

167

 

0

 

0

 

14

 

4,397

Greater than 90 days past due

 

0

 

47

 

0

 

0

 

0

 

0

 

0

 

47

Total past due

 

0

 

6,579

 

1,744

 

167

 

195

 

35

 

33

 

8,753

Non-accrual loans and leases 1

 

481

 

12,162

 

786

 

566

 

1,725

 

1,960

 

127

 

17,807

Total loans and leases

$

128,285

$

437,409

$

74,164

$

241,795

$

444,052

$

372,872

$

46,936

$

1,745,513

1

Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do not accrue interest based on the terms of the loan.

Total loans either in non-accrual status or in excess of 90 days delinquent totaled $18.2 million or 0.96% of total loans outstanding at September 30, 2020, compared to $17.9 million, or 1.0%, at December 31, 2019.

The Company had no impaired leases or PPP loans at September 30, 2020, September 30, 2019, and December 31, 2019. The impaired loans at September 30, 2020, and December 31, 2019 are as follows:

September 30, 2020

Commercial real estate

Commercial

Construction

Residential real estate

owner

non-owner

loans

Consumer

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Total

Impaired loans:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Recorded investment 1

$

338

$

12,361

$

1,461

$

793

$

559

$

1,489

$

0

$

17,001

With an allowance recorded

 

0

0

0

0

0

0

0

0

With no related allowance recorded

 

338

12,361

1,461

793

559

1,489

0

17,001

Related allowance

 

0

0

0

0

0

0

0

0

Unpaid principal

 

524

13,479

1,659

806

611

2,030

0

19,109

Nine months ended :

 

Average balance of impaired loans

 

664

14,366

1,827

816

647

2,514

0

20,834

Interest income recognized

 

0

237

47

7

13

47

0

351

Three months ended :

 

Average balance of impaired loans

658

14,318

1,847

815

645

2,453

0

20,736

Interest income recognized

 

0

81

19

2

2

26

0

130

December 31, 2019

Commercial real estate

Commercial

Construction

Residential real estate

owner

non-owner

loans

Consumer

(in thousands)

    

and land

    

first lien

    

junior lien

    

occupied

    

occupied

    

and leases

    

loans

    

Total

Impaired loans:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Recorded investment 1

$

481

$

13,131

$

786

$

566

$

1,725

$

2,360

$

127

$

19,176

With an allowance recorded

 

0

 

0

 

0

 

0

 

0

 

554

 

0

 

554

With no related allowance recorded

 

481

 

13,131

 

786

 

566

 

1,725

 

1,806

 

127

 

18,622

Related allowance

 

0

 

0

 

0

 

0

 

0

 

500

 

0

 

500

Unpaid principal

 

667

 

14,371

 

986

 

583

 

2,023

 

3,584

 

130

 

22,344

Average balance of impaired loans

814

 

15,586

 

1,338

 

594

 

2,105

 

4,392

 

141

 

24,970

Interest income recognized

 

5

 

400

 

106

 

30

 

11

 

195

 

1

 

748

1

Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do not accrue interest based on the terms of the loan.

22

Included in the total impaired loans above were non-accrual loans of $15.7 million and $17.8 million at September 30, 2020 and December 31, 2019, respectively. Interest income that would have been recorded if non-accrual loans had been current and in accordance with their original terms was $466 thousand and $657 thousand for the nine months ended September 30, 2020 and 2019, respectively.

Loans may have their terms restructured (e.g., interest rates, loan maturity date, payment and amortization period, etc.) in circumstances that provide payment relief to a borrower experiencing financial difficulty.  Such restructured loans are considered impaired loans that may either be in accruing status or non-accruing status.  Non-accruing restructured loans may return to accruing status provided there is a sufficient period of payment performance in accordance with the restructure terms.  Loans may be removed from the restructured category in the year subsequent to the restructuring if they have performed based on all of the restructured loan terms.

The Company had no troubled debt restructured (“TDR”) leases or PPP loans at September 30, 2020 and December 31, 2019. The TDR loans at September 30, 2020 and December 31, 2019 are as follows:

September 30, 2020

Number

Non-Accrual

Number

Accrual

Total

(dollars in thousands)

    

of Loans

    

Status

    

of Loans

    

Status

    

TDRs

Residential real estate - first lien

 

2

$

256

2

$

959

$

1,215

Commercial loans and leases

 

1

414

2

361

775

 

3

$

670

4

$

1,320

$

1,990

December 31, 2019

Number

Non-Accrual

Number

Accrual

Total

(dollars in thousands)

    

of Loans

    

Status

    

of Loans

    

Status

    

TDRs

Construction and land

 

1

$

125

0

$

0

$

125

Residential real estate - first lien

 

2

274

2

968

1,242

Commercial loans and leases

 

1

414

2

367

781

 

4

$

813

4

$

1,335

$

2,148

A summary of TDR modifications outstanding and performing under modified terms is as follows:

September 30, 2020

Not Performing

Performing

Related

to Modified

to Modified

Total

(in thousands)

    

Allowance

    

Terms

    

Terms

    

TDRs

Residential real estate - first lien

 

  

 

  

 

  

 

  

Extension or other modification

$

0

$

256

$

959

$

1,215

Commercial loans

 

  

 

Extension or other modification

0

0

361

361

Forbearance

 

0

 

414

0

414

Total troubled debt restructured loans

$

0

$

670

$

1,320

$

1,990

23

December 31, 2019

Not Performing

Performing

Related

to Modified

to Modified

Total

(in thousands)

    

Allowance

    

Terms

    

Terms

    

TDRs

Construction and land

 

  

 

  

 

  

 

  

Extension or other modification

$

0

$

125

$

0

$

125

Residential real estate - first lien

 

 

Extension or other modification

 

0

 

274

968

1,242

Commercial loans

 

 

Extension or other modification

 

0

 

0

367

367

Forbearance

 

0

 

414

0

414

Total troubled debt restructured loans

$

0

$

813

$

1,335

$

2,148

The CARES Act provides financial institutions with relief from certain accounting and disclosure requirements under GAAP for certain loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs. In addition, before the CARES Act was enacted, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

There were 0 new TDRs during the nine months ended September 30, 2020. There was 1 new commercial loan with its term extended and its payment restructured during the nine months ended September 30, 2019.

Performing TDRs were in compliance with their modified terms and there are no further commitments associated with these loans. During the three months ended September 30, 2020 and 2019 there were no TDRs that subsequently defaulted within twelve months of their modification dates.

At September 30, 2020 there were three loans secured by residential first liens totaling $2.6 million, one residential junior lien of $23 thousand and two commercial real estate loans totaling $367 thousand in the process of foreclosure.

Note 6:  Derivatives and Hedging Activities

Non-designated Hedges of Interest Rate Risk

The Company maintains interest rate swap contracts with customers that are classified as non-designated hedges and are not speculative in nature. These agreements are designed to convert customer’s variable rate loans with the Company to fixed rate. These interest rate swaps are executed with loan customers to facilitate a respective risk management strategy and allow the customer to pay a fixed rate of interest to the Company. These interest rate swaps are simultaneously hedged by executing offsetting interest rate swaps with unrelated market counterparties to minimize the net risk exposure to the Company resulting from the transactions and allow the Company to receive a variable rate of interest. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR plus credit spread with payment being calculated on the notional amount. The interest rate swaps are settled with varying maturities.

As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. The fair value of the interest swap derivatives are recorded in other assets and other liabilities. All changes in fair value are recorded through earnings as noninterest income. For the nine months ended September 30, 2020 and September 30, 2019, the Company recorded a net loss of $28 thousand and $9 thousand, respectively related  to the change in fair value of these interest rate swap derivatives.

24

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheet at September 30, 2020 and December 31, 2019:

September 30, 2020

Balance Sheet

Notional

Estimated Fair Value

(dollars in thousands)

    

Location

    

Amount

    

Gain

    

Loss

Not designated hedges of interest rate risk:

 

  

 

  

 

  

Customer related interest rate contracts:

 

  

 

  

 

  

 

  

Matched interest rate swaps with borrowers

 

Other assets and other liabilities

$

14,650

$

668

$

0

Matched interest rate swaps with counterparty

 

Other assets and other liabilities

$

14,650

$

0

$

707

December 31, 2019

Balance Sheet

Notional

Estimated Fair Value

(dollars in thousands)

    

Location

    

Amount

    

Gain

    

Loss

Not designated hedges of interest rate risk:

 

  

 

  

 

  

 

  

Customer related interest rate contracts:

 

  

 

  

 

  

 

  

Matched interest rate swaps with borrowers

 

Other assets and other liabilities

$

2,853

$

217

$

0

Matched interest rate swaps with counterparty

 

Other assets and other liabilities

$

2,853

$

0

$

228

Note 7:  Goodwill and Other Intangible Assets

Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset would more-likely-than-not reduce the fair value below the carrying amount. The Bank has 1 reporting unit, which is the core banking operation. The Company performs its annual impairment evaluation in the fourth quarter.

Due to the COVID-19 pandemic and the related economic fallout, including most specifically, declining stock prices at both the Company and peer banks, the Federal Reserve’s significant reduction in interest rates, and other business and market considerations, the Company performed an interim goodwill impairment analysis as of June 30, 2020. Based on this analysis, the estimated fair value of the Company was less than book value, resulting in a $34.5 million impairment charge, recorded in noninterest expense, in the second quarter of 2020. This was a non-cash charge to earnings and had no impact on the Company’s regulatory capital ratios, cash flows, or liquidity position.

The table below shows goodwill balances at:

(in thousands)

    

 

Goodwill:

 

  

December 31, 2019

 

$

65,949

Goodwill impairment

(34,500)

September 30, 2020

 

$

31,449

25

Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in either business combinations or other purchases of deposits and are amortized based upon the estimated economic benefits received. The gross carrying amount and accumulated amortization of other intangible assets are as follows:

September 30, 2020

Weighted  

Gross

Net

Average

Carrying

Accumulated

Carrying

Remaining Life

(in thousands)

    

Amount

    

Amortization

    

Amount

    

(Years)

Amortizing intangible assets:

 

  

 

  

 

  

 

  

Core deposit intangible

$

16,135

$

9,704

$

6,431

 

3.0

December 31, 2019

Weighted

Gross

Net

Average

Carrying

Accumulated

Carrying

Remaining Life

(in thousands)

    

Amount

    

Amortization

    

Amount

    

(Years)

Amortizing intangible assets:

 

  

 

  

 

  

 

  

Core deposit intangible

$

16,135

$

7,666

$

8,469

 

3.7

Estimated future amortization expense for amortizing intangibles are as follows:

(in thousands)

    

Remainder of 2020

$

636

2021

 

2,326

2022

 

1,915

2023

 

1,298

2024

 

256

Total amortizing intangible assets

$

6,431

Note 8:  Leases

The Company has operating leases on land and buildings with remaining lease terms ranging from 2020 to 2030. Many of the leases include renewal options, with renewal terms generally extending up to 10 years.

In 2019, with the execution of the Company’s branch optimization initiative, under which the closing of three branch locations and the consolidation of two other existing branch locations was announced, a $3.6 million charge to noninterest expenses, primarily related to the early termination of existing lease arrangements for the closing locations, was recorded in the second quarter of 2019. The closing of the three locations occurred in the third quarter of 2019, and the consolidation of the two branch locations into a single new location occurred in the first quarter of 2020. The early termination of these leases reduced the initial $18.0 million in right-of-use (“ROU”) assets recorded on January 1, 2019 to $14.5 million at December 31, 2019.  In the first quarter of 2020, the opening of the new location noted above increased ROU assets by $2.0 million.

Operating leases included the following at:

(in thousands)

    

September 30, 2020

    

December 31, 2019

    

Operating Leases

 

  

 

  

 

Operating leases ROU assets

$

14,954

$

14,092

Operating lease liabilities

$

15,477

$

14,507

26

The components of lease expense were as follows:

Nine months ended September 30, 

Three months ended September 30, 

(in thousands)

    

2020

    

2019

    

2020

    

2019

    

Operating lease cost

$

1,196

$

1,508

$

412

$

428

Sublease income

 

(531)

 

(437)

 

(187)

 

(144)

Amortization of ROU assets

108

116

31

34

$

773

$

1,187

$

256

$

318

Lease liability maturities are as follows:

(in thousands)

    

    

 

Remainder of 2020

$

427

2021

 

1,662

2022

 

1,520

2023

 

1,372

2024

 

1,170

Thereafter

13,033

Total future lease payments

$

19,184

Discount of cash flows

(3,707)

Present value on net future lease payments

$

15,477

Weighted average remaining term in years

 

6.31

Weighted average discount rate

 

2.89

%

Note 9:  Deposits

The following table details the composition of deposits and the related percentage mix of total deposits, respectively, at the dates indicated:

September 30, 2020

December 31, 2019

 

 

 

% of

% of

 

(dollars in thousands)

    

Amount

    

Total

    

Amount

    

Total

    

Noninterest-bearing demand

 

$

657,028

 

33

%  

$

468,975

 

27

%

 

Interest-bearing checking

 

185,561

 

10

183,447

 

11

 

Money market accounts

 

418,043

 

21

360,711

 

21

 

Savings

 

152,158

 

8

130,141

 

7

 

Certificates of deposit $250 and over

 

59,090

 

3

77,782

 

5

 

Certificates of deposit under $250

 

500,858

 

25

493,309

 

29

 

Total deposits

 

$

1,972,738

 

100

%  

$

1,714,365

 

100

%

 

Note 10:  Stock Options and Stock Awards

The Company’s equity incentive plan provides for awards of nonqualified and incentive stock options as well as vested and non-vested common stock awards.  As of September 30, 2020, 398,652 shares are reserved for issuance pursuant to future grants under the Company’s stock incentive plan. Employee stock options can be granted with exercise prices at the fair market value (as defined within the plan) of the stock at the date of grant and with terms of up to ten years and typically vest over a three  to five year period. Except as otherwise permitted in the plan, upon termination of employment for reasons other than retirement, permanent disability or death, the option exercise period is reduced or the options are canceled.

27

Stock awards may also be granted to non-employee members of the Company’s board of directors (the “Board of Directors” or “Board”) as compensation for attendance and participation at meetings of the Board of Directors and meetings of the various committees of the Board. For the nine months ended September 30, 2020 and 2019, the Company issued 22,616 and 9,202 shares of common stock, respectively, to directors as compensation for their service.

Stock Options

The fair value of the Company’s stock options granted as compensation is estimated on the measurement date, which, for the Company, is the date of grant.  The fair value of stock options is calculated using the Black-Scholes option-pricing model under which the Company estimates expected market price volatility and expected term of the options based on historical data and other factors. There were 0 stock options granted during the nine months ended September 30, 2020, while there were 25,000 options granted for the year ended December 31, 2019.

The following table summarizes the Company’s stock option activity and related information for the periods ended:

September 30, 2020

December 31, 2019

Weighted

Weighted

Average

Average

Exercise

Exercise

    

Shares

    

Price

    

Shares

    

Price

    

Balance at January 1,

 

25,000

$

14.54

 

15,268

$

8.76

 

Granted

 

0

 

0

 

25,000

 

14.54

 

Exercised

 

0

 

0

 

(13,418)

 

8.58

 

Forfeited

 

0

 

0

 

(1,850)

 

10.10

 

Balance at period end

 

25,000

$

14.54

 

25,000

$

14.54

 

Exercisable at period end

 

8,337

$

14.54

 

0

$

0

 

Weighted average fair value of options granted during the year

N/A

$

5.83

NaN stock options were exercised for the nine months ended September 30, 2020. The cash received from the exercise of stock options was $116 thousand for the nine months ended September 30, 2019. The intrinsic value of a stock option is the amount that the market value of the underlying stock exceeds the exercise price of the option.  Based upon a fair market value of $8.98 at September 30, 2020, the options outstanding had 0 aggregate intrinsic value. At December 31, 2019, based upon a fair market value of $16.88, the options outstanding had an aggregate intrinsic value of $59  thousand. At September 30, 2020, based on stock options outstanding at the time, the total unrecognized pre-tax compensation expense related to unvested options was $65 thousand.

Restricted Stock Units (“RSU”)

RSUs are equity awards where the recipient does not receive the stock immediately, but instead receives it according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time. Each RSU that vests entitles the recipient to receive one share of the Company’s common stock on a specified issuance date. The recipient does not have any stockholder rights, including voting, dividend or liquidation rights, with respect to the shares underlying awarded RSUs until the recipient becomes the record holder of those shares. The valuation of the Company’s RSUs is the closing price per share of the Company’s common stock on the date of grant.

The Company granted 164,383 RSUs during the first nine months of 2020 that are subject to vesting over a period of one to five years. The Company granted 18,500 RSUs during the first nine months of 2019, subject to a three-year vesting schedule.

28

A summary of the activity for the Company’s RSUs for the periods indicated is presented in the following table:

September 30, 

December 31, 

    

2020

2019

    

Weighted

Weighted

Average

Average

Grant Date

Grant Date

    

Shares

    

Fair Value

    

Shares

    

Fair Value

    

Balance at January 1,

 

11,032

$

17.48

 

9,731

$

17.29

 

Granted

 

164,383

 

14.65

 

26,500

 

15.16

 

Vested

 

(2,823)

 

12.75

 

(6,699)

 

16.13

 

Forfeited

 

(2,709)

 

18.14

 

(18,500)

 

14.54

 

Balance at period end

 

169,883

$

14.81

 

11,032

$

17.48

 

At September 30, 2020, based on RSUs outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested RSUs was $1.9 million. Based upon the contractual terms, this expense is expected to be recognized as follows:

(in thousands)

    

Remainder of 2020

$

135

2021

513

2022

 

484

2023

390

2024

357

2025

33

$

1,912

Stock-Based Compensation Expense

Stock-based compensation expense attributable to stock options and RSUs is based on their fair values on the measurement date, which, for the Company, is the date of the grant. This cost is then recognized in noninterest expense on a straight-line basis over the vesting period of the respective stock options and RSUs. The amount that the Company recognized in stock-based compensation expense related to the issuance of stock options and RSUs as well as director compensation paid in stock is presented in the following table:

Nine months ended

Three months ended

September 30, 

September 30, 

(in thousands)

    

2020

    

2019

    

2020

    

2019

    

Stock-based compensation expense

 

  

 

  

 

  

 

  

 

Related to the issuance of restricted stock and RSUs

$

348

$

134

$

131

$

22

Related to the issuance of stock options

36

32

12

12

Director compensation paid in stock

275

127

138

65

Total stock-based compensation expense

$

659

$

293

$

281

$

99

Note 11: Benefit Plans

Profit Sharing Plan

The Company sponsors a defined contribution retirement plan through a Section 401(k) profit sharing plan. Employees may contribute up to 15% of their pretax compensation. Participants are eligible for matching Company contributions up to 4% of eligible compensation dependent on the level of voluntary contributions. Company matching contributions totaled $657 thousand and $817 thousand, respectively, for the nine months ended September 30, 2020 and 2019. The Company’s matching contributions vest immediately.

29

Supplemental Executive Retirement Plan (“SERP”)

In 2014, the Bank created a SERP for the Chief Executive Officer ("CEO"). This plan was amended in 2016. Under the defined benefit SERP, the CEO will receive $150,000 each year for 15 years after attainment of the Normal Retirement Age (as defined in the SERP). The CEO earned vesting on a graduated schedule and she became fully vested on August 25, 2019, which had been established for purposes of the SERP as the commencement date for SERP distributions. Expense related to this SERP totaled $56 thousand and $158 thousand for the nine month periods ending September 30, 2020 and 2019, respectively.

Employee Stock Purchase Plan

The 2017 Employee Stock Purchase Plan (the “Plan”) provides eligible employees of the Company and certain of its subsidiaries with opportunities to purchase shares of the Company’s common stock. An aggregate of 250,000 shares of the Company’s common stock was approved for issuance under the Plan. The Plan is intended to qualify as an “employee stock purchase plan” as defined in Section 423 of the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder, and shall be interpreted consistent therewith. There was 0 expense related to this plan for the nine months ended September 30, 2020. The expense related to the Company's contribution to the Plan totaled $20 thousand for the nine months ended September 30, 2019.

Note 12: Net (Loss) Income per Common Share

The table below shows the presentation of basic and diluted (loss) income per common share for the periods indicated:

Nine months ended

Three months ended

September 30,

September 30,

(dollars in thousands, except per share data)

    

2020

    

2019

    

2020

    

2019

    

Net (loss) income available to common stockholders (numerator)

$

(21,462)

$

10,981

$

4,604

$

4,637

BASIC

 

 

 

 

Basic average common shares outstanding (denominator)

 

18,773,036

 

19,064,235

 

18,736,749

 

19,078,561

Basic (loss) income per common share

$

(1.14)

$

0.58

$

0.25

$

0.24

DILUTED

 

 

 

 

Average common shares outstanding

 

18,773,036

 

19,064,235

 

18,736,749

 

19,078,561

Dilutive effect of common stock equivalents

 

0

 

7,870

 

0

 

3,402

Diluted average common shares outstanding (denominator)

 

18,773,036

 

19,072,105

 

18,736,749

 

19,081,963

Diluted (loss) income per common share

$

(1.14)

$

0.58

$

0.25

$

0.24

Common stock equivalents were excluded from the calculation of diluted average shares outstanding, as their inclusion would have resulted in a lower diluted loss per share.

 

82,284

 

0

 

169,883

 

0

Common stock equivalents outstanding that are anti-dilutive and thus excluded from calculation of diluted number of shares presented above

 

25,000

 

25,000

 

25,000

 

25,000

30

Note 13: Regulatory Capital

The following table reflects Bancorp’s and the Bank’s capital at September 30, 2020 and December 31, 2019:

To be well

 

capitalized under

 

the FDICIA

 

For capital

prompt corrective

 

Actual

adequacy purposes (1)

action provisions

 

(dollars in thousands)

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

 

As of September 30, 2020:

 

  

 

  

 

  

 

  

 

  

 

  

Total capital (to risk-weighted assets)

 

  

 

  

 

  

 

  

 

  

 

  

Howard Bank

$

263,516

 

14.09

%  

$

149,592

 

8.00

%  

$

186,990

 

10.00

%

Howard Bancorp

$

266,075

 

14.11

%  

$

150,821

 

8.00

%  

 

N/A

 

Common equity tier 1 capital

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

Howard Bank

$

245,539

 

13.13

%  

$

84,146

 

4.50

%  

$

121,544

 

6.50

%

Howard Bancorp

$

219,710

 

11.65

%  

$

84,837

 

4.50

%  

 

N/A

 

Tier 1 capital (to risk-weighted assets)

 

 

 

 

 

 

Howard Bank

$

245,539

 

13.13

%  

$

112,194

 

6.00

%  

$

149,592

 

8.00

%

Howard Bancorp

$

219,710

 

11.65

%  

$

113,116

 

6.00

%  

 

N/A

 

Tier 1 capital (to average assets)

 

 

 

 

 

 

(Leverage ratio)

 

 

 

 

 

 

Howard Bank

$

245,539

 

10.14

%  

$

96,887

 

4.00

%  

$

121,109

 

5.00

%

Howard Bancorp

$

219,710

 

9.07

%  

$

96,889

 

4.00

%  

 

N/A

 

As of December 31, 2019:

Total capital (to risk-weighted assets)

Howard Bank

$

238,384

 

12.86

%  

$

148,314

 

8.00

%  

$

185,392

 

10.00

%

Howard Bancorp

$

247,761

 

13.14

%  

$

150,872

 

8.00

%  

 

N/A

Common equity tier 1 capital

(to risk-weighted assets)

Howard Bank

$

227,983

 

12.30

%  

$

83,427

 

4.50

%  

$

120,505

 

6.50

%

Howard Bancorp

$

209,119

 

11.09

%  

$

84,866

 

4.50

%  

 

N/A

Tier 1 capital (to risk-weighted assets)

 

 

 

 

 

 

Howard Bank

$

227,983

 

12.30

%  

$

111,235

 

6.00

%  

$

148,314

 

8.00

%

Howard Bancorp

$

209,119

 

11.09

%  

$

113,154

 

6.00

%  

 

N/A

 

Tier 1 capital (to average assets)

 

 

 

 

 

 

(Leverage ratio)

 

 

 

 

 

 

Howard Bank

$

227,983

 

10.43

%  

$

87,434

 

4.00

%  

$

109,293

 

5.00

%

Howard Bancorp

$

209,119

 

9.55

%  

$

87,599

 

4.00

%  

 

N/A

 

  

(1)  Amounts shown exclude the capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, Bancorp is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the FRB (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to Bancorp, the Company calculates these ratios for its own planning and monitoring purposes.

Bancorp and the Bank met all capital adequacy requirements to which they are subject as of September 30, 2020 and December 31, 2019.

31

Note 14: Contingencies

In the ordinary course of business, the Company and its subsidiaries are routinely defendants in or parties to pending and threatened legal and regulatory actions and proceedings. The most significant of these is described below. In view of the inherent difficulty of predicting the outcome of such matters, particularly where the claimants seek very large or indeterminate damages or where the matters present novel legal theories or involve a large number of parties, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties related to each matter may be. The Company establishes an accrued liability when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. The Company thereafter continues to monitor such matters for further developments that could affect the amount of the accrued liability that has been previously established.

Potential mortgage origination claims

The Bank has been notified of potential claims stemming from certain mortgages originated at First Mariner Bank prior to its merger into the Bank.  While 0 lawsuit has been filed with respect to such potential claims, the Bank has engaged in confidential discussions related to the potential claims.  Significant management judgment, which involves a variety of assumptions, estimates and known and unknown uncertainties, is required to assess whether a related loss resulting from such potential claims is probable and estimable, such that an accrued liability should be established.  The Company has accrued a liability of $1.0 million with respect to these potential claims. It is not possible to determine the outcome of these potential claims, and the amount of the accrued liability is subject to change as additional information becomes available.  The Company believes it is reasonably possible that the amount of the actual loss may be greater than the amount accrued.  However, the Company is currently unable to reasonably estimate the amount or range of additional loss, if any, or the range of additional loss, that is reasonably possible, due in significant part to (a) the preliminary nature of the potential claims, (b) the fact that no complaint has been filed and, accordingly, no discovery has been conducted, (c) potential damages related to the claims are currently unsubstantiated, and (d) uncertainty as to the legal and factual determinations that would be made during any potential litigation related to the claims.  

Based on current knowledge, management does not believe that losses resulting from these potential claims in excess of the accrued liability, if any, will have a material adverse effect on the consolidated financial position or liquidity of the Company. However, in light of the inherent uncertainties involved, some of which are beyond the Company’s control, an adverse outcome or settlement with respect to these potential claims could be material to the Company’s results of operations for any particular reporting period.

Note 15: Fair Value

FASB ASC Topic 820 “Fair Value Measurements” defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit p