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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Severn Bancorp, Inc.    SVBI

SEVERN BANCORP, INC.

(SVBI)
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SEVERN BANCORP : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

11/09/2020 | 10:31am EST
When used in this report, the terms "the Company," "we," "us," and "our" refer
to Severn Bancorp and, unless the context requires otherwise, its consolidated
subsidiaries. The following discussion should be read and reviewed in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations set forth in Severn Bancorp's Annual Report on Form 10-K
as of and for the year ended December 31, 2019.



The Company



The Company is a savings and loan holding company chartered as a corporation in
the state of Maryland in 1990. It conducts business primarily through three
subsidiaries, Severn Savings Bank, FSB (the "Bank"), Mid-Maryland Title
Company, Inc. (the "Title Company"), and SBI Mortgage Company ("SBI"). The Title
Company is a real estate settlement company that handles commercial and
residential real estate settlements in Maryland. SBI holds mortgages that do not
meet the underwriting criteria of the Bank, and is the parent company of
Crownsville Development Corporation ("Crownsville"), which is doing business as
Annapolis Equity Group and acquires real estate for syndication and investment
purposes. The Bank's principal subsidiary, Louis Hyatt, Inc. ("Hyatt
Commercial"), conducts business as Hyatt Commercial, a commercial real estate
brokerage and property management company. We maintained seven branches in Anne
Arundel County, Maryland at September 30, 2020. The branches offer a full range
of deposit products and we originate mortgages in the Bank's primary market of
Anne Arundel County, Maryland and, to a lesser extent, in other parts of
Maryland, Delaware, and Virginia. As of September 30, 2020, we had 181 full-time
equivalent employees.



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Significant Developments - COVID-19




On March 11, 2020, the World Health Organization declared the outbreak of a
novel coronavirus ("COVID-19") as a global pandemic, which continues to spread
throughout the United States of America ("U.S.") and around the world. The
declaration of a global pandemic indicates that almost all public commerce and
related business activities must be, to varying degrees, curtailed with the goal
of decreasing the rate of new infections. The COVID-19 pandemic in the U.S. has
had and is expected to continue to have a complex and significant adverse impact
on the economy, the banking industry, and the Company in future fiscal periods,
all subject to a high degree of uncertainty.



Effects on Our Market Areas



Our commercial and consumer banking products and services are offered primarily
in Maryland, where individual and governmental responses to the COVID-19
pandemic have led to a broad curtailment of economic activity since March 2020.
In Maryland, the Governor issued a series of orders, including ordering schools
to close for an indefinite period of time and an order that, subject to limited
exceptions, all individuals stay at home and non­essential businesses cease all
activities for an indeterminate amount of time. Since June 2020, many of these
restrictions have been removed and some non-essential businesses were allowed to
re-open in a limited capacity, adhering to social distancing and disinfection
guidelines. The Bank has remained open during these orders because banks have
been identified as essential services. The Bank has been serving its customers
through its drive-ups, ATMs, and in all of its branch offices by appointment
only.



Locally, as well as nationally, we have experienced an increase in unemployment
levels in our market area as a result of the curtailment of business activities,
the levels of which are expected to remain elevated for the foreseeable future.



Policy and Regulatory Developments

Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

? The Federal Reserve Board ("FRB") decreased the range for the federal funds

target rate by 0.5% on March 3, 2020, and by another 1.0% on March 16, 2020,

    reaching the current range of 0.0% - 0.25%.



? On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and

Economic Security Act ("CARES Act"), which established a $2.0 trillion

economic stimulus package, including cash payments to individuals,

supplemental unemployment insurance benefits and a $659.0 billion loan program

(revised by subsequent legislation) administered through the U.S. Small

Business Administration ("SBA"), referred to as the paycheck protection

program ("PPP"). Under the PPP, small businesses, sole proprietorships,

independent contractors and self-employed individuals were able to apply for

loans from existing SBA lenders and other approved regulated lenders that

enroll in the program, subject to numerous limitations and eligibility

criteria. PPP loans have an interest rate of 1.0%, a two-year or five-year

loan term to maturity, and principal and interest payments deferred until the

lender receives the applicable forgiven amount or the end of the borrower's

loan forgiveness. The Bank participated as a lender in the PPP. In addition,

the CARES Act provides financial institutions the option to temporarily

suspend certain requirements under accounting principles generally accepted in

the U.S. ("GAAP") related to troubled debt restructure loans ("TDR" or "TDRs")

    for a limited period of time to account for the effects of COVID-19.



? On April 7, 2020, federal banking regulators issued a revised Interagency

Statement on Loan Modifications and Reporting for Financial Institutions,

which, among other things, encouraged financial institutions to work prudently

with borrowers who are or may be unable to meet their contractual payment

obligations because of the effects of COVID-19, and stated that institutions

generally do not need to categorize COVID-19-related modifications as TDRs and

that the agencies will not direct supervised institutions to automatically

categorize all COVID-19 related loan modifications as TDRs. On August 3, 2020,

Interagency Statement on Additional Loan Accommodations Related to COVID-19

was issued that addresses loans nearing the end of their original relief

    period and provides guidance for extension of such relief period.




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? On April 9, 2020, the FRB announced additional measures aimed at supporting

small and mid-sized businesses, as well as state and local governments

impacted by COVID-19. The FRB announced the Main Street Business Lending

Program, which establishes two new loan facilities intended to facilitate

lending to small and mid-sized businesses: (1) the Main Street New Loan

Facility ("MSNLF") and (2) the Main Street Expanded Loan Facility ("MSELF").

MSNLF loans are unsecured term loans originated on or after April 8, 2020,

while MSELF loans are provided as upsized tranches of existing loans

originated before April 8, 2020. The combined size of the program is $600.0

billion. The program is designed for businesses with up to 10,000 employees or

$2.5 billion in 2019 revenues. To obtain a loan, borrowers must confirm that

they are seeking financial support because of COVID-19 and that they will not

use proceeds from the loan to pay off debt. The FRB also stated that it would

provide additional funding to banks offering PPP loans to help struggling

small businesses. The PPP Loan Facility ("PPPLF") was created by the FRB on

April 9, 2020 to facilitate lending by participating financial institutions to

small businesses under the PPP of the CARES Act. Under the facility, the FRB

lends to participating financial institutions on a non-recourse basis, taking

PPP loans as collateral. Lenders participating in the PPP will be able to

exclude loans financed by the facility from their leverage ratio. To date, due

to our high liquidity levels, we have not participated in the PPPLF.

The FRB also created a Municipal Liquidity Facility to support state and local

governments with up to $500.0 billion in lending, with the Treasury Department

backing $35.0 billion for the facility using funds appropriated by the CARES

Act. The facility will make short-term financing available to cities with a

population of more than one million or counties with a population of greater

than two million. The FRB expanded both the size and scope of its Primary and

Secondary Market Corporate Credit Facilities to support up to $750.0 billion

in credit to corporate debt issuers. This will allow companies that were

investment grade before the onset of COVID-19 but then subsequently downgraded

after March 22, 2020 to gain access to the facility. Finally, the FRB

announced that its Term Asset-Backed Securities Loan Facility will be scaled

up in scope to include the triple A-rated tranche of commercial

mortgage-backed securities and newly issued collateralized loan obligations.

    The size of the facility is $100.0 billion.




Effects on Our Business



The COVID-19 pandemic and the specific developments referred to above could have
and are expected to continue to have a significant impact on our business. The
outbreak of COVID-19 could continue to adversely impact a broad range of
industries in which the Company's customers operate and impair their ability to
fulfill their financial obligations to the Company. In particular, we anticipate
that a significant portion of the Bank's borrowers in the hotel, restaurant, and
retail industries will continue to endure significant economic distress, which
has caused, and may continue to cause, them to draw on their existing lines of
credit and adversely affect their ability to repay existing indebtedness, and is
expected to adversely impact the value of collateral. These developments,
together with economic conditions generally, are also expected to impact our
commercial real estate portfolio, particularly with respect to real estate with
exposure to these industries, and the value of certain collateral securing our
loans. As a result, we anticipate that our financial condition, capital levels,
and results of operations could be adversely affected. As of September 30, 2020,
we held $4.1 million, $14.5 million, and $42.9 million in hotel, restaurant, and
retail industry loans, respectively.



Our Response


We have taken numerous steps in response to the COVID-19 pandemic, including the following:

? actively working with loan customers to evaluate prudent loan modification

    terms;




  ? continuing to promote our digital banking options through our website.

Customers are encouraged to utilize online and mobile banking tools, and our

customer service and retail departments are fully staffed and available to

    assist customers remotely;




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  ? acted as a participating lender in the PPP. We believe it is our

responsibility as a community bank to assist the SBA in the distribution of

funds authorized under the CARES Act to our customers and communities, which

we have carried out in a prudent and responsible manner. As of September 30,

2020, we held $46.9 million in PPP loans in our loan portfolio, and are

working diligently with customers on the loan forgiveness aspect of the

program (see Note 3 to the Consolidated Financial Statements for more

information regarding PPP loans and loan modifications under the CARES Act);

    and



? closing all branches to customer activity indefinitely, except for drive-up

and appointment only services. We continue to pay all employees according to

their normal work schedule, even if their work has been reduced. No employees

have been furloughed. Employees whose job responsibilities can be effectively

carried out remotely are working from home. Employees whose critical duties

require their continued presence on-site are observing social distancing and

    cleaning protocols.




Overview



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



We have experienced a decline in profitability for the three and nine months
ended September 30, 2020, primarily due to a decrease in net interest income, an
increased provision for loan losses, and increased noninterest expenses,
partially offset by increased noninterest income. Net interest income decreased
primarily due to a declining interest rate environment, resulting from rate
reductions by the FRB in response to the COVID-19 pandemic (see additional
information on COVID-19 above and in Item 1A - Risk Factors of Part II of this
Quarterly Report on Form 10-Q). We recognized increased revenue from
mortgage-banking activities. We recorded $100,000 and $850,000 in provision for
loan losses for the three and nine months ended September 30, 2020,
respectively. Noninterest expenses increased for the nine months ended September
30, 2020 due to increased investments in staff, property, and systems to enhance
production and efficiency, as well as to increased commissions corresponding to
the increased mortgage production.



The Company expects to experience similar market conditions during the remainder
of 2020, provided interest rates do not increase or decrease rapidly. If
interest rates change rapidly, demand for loans may fluctuate and our interest
rate spread could change significantly. We continue to manage loan and deposit
pricing against the potential risks of rising costs of our deposits and
borrowings. Interest rates are outside of our control, so we must attempt to
balance the pricing and duration of the loan portfolio against the risks of
rising or declining costs of our deposits and borrowings. The continued success
and attraction of Anne Arundel County, Maryland, and vicinity, will also be
important to our ability to originate and grow loans and deposits, as will our
continued focus on maintaining a low overhead. If volatility in the market and
the economy continues to occur, our business, financial condition, results of
operations, access to funds, and the price of our stock could be materially and
adversely impacted. Despite our declining profitability in 2020, we believe the
Company is well prepared for the economic and social consequences of the
COVID-19 global pandemic in future periods.



Critical Accounting Policies



Our accounting and financial reporting policies conform to GAAP and prevailing
practices within the banking industry. Accordingly, preparation of the financial
statements requires management to exercise significant judgment or discretion or
make significant assumptions and estimates based on the information available
that have, or could have, a material impact on the carrying value of certain
assets or on income. These estimates and assumptions affect the reported amounts
of assets and liabilities at the date of the financial statements and the
reported amounts of income and expenses during the periods presented. The
accounting policies we view as critical are those relating to the allowance for
loan losses ("Allowance"), the valuation of real estate acquired through
foreclosure, and the valuation of deferred tax assets and liabilities.
Significant accounting policies are discussed in detail in "Notes to
Consolidated Financial Statements - Note 1 - Summary of Significant Account
Policies" in our Annual Report on Form 10-K as of and for the year ended
December 31, 2019. There have been no material changes to the significant
accounting policies as described in the Annual Report other than those that may
be mentioned in Note 1 to the financial statements in this Quarterly Report on
Form 10-Q. Disclosures regarding the effects of new accounting pronouncements
are included in Note 1 to our Consolidated Financial Statements included in this
Quarterly Report on Form 10-Q.



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Results of Operations



Net Income


Three Months Ended September 30




Net income decreased by $483,000, or 20.3%, to $1.9 million for the three months
ended September 30, 2020 compared to $2.4 million for the three months ended
September 30, 2019. Basic and diluted income per share were $0.15 for the three
months ended September 30, 2020, compared to $0.19 for the three months ended
September 30, 2019. The decrease in net income reflected decreased net interest
income, an increased provision for loan losses, and increased noninterest
expense, partially offset by increased noninterest income.



Nine Months Ended September 30




Net income decreased by $3.0 million, or 41.4%, to $4.2 million for the nine
months ended September 30, 2020 compared to $7.2 million for the nine months
ended September 30, 2019. Basic and diluted income per share were $0.33 for the
nine months ended September 30, 2020, compared to $0.56 for the nine months
ended September 30, 2019. The decrease in net income reflected decreased net
interest income, an increased provision for loan losses, and increased
noninterest expense, partially offset by increased noninterest income.



Net Interest Income



Net interest income was significantly impacted by a declining interest rate
environment directly related to the COVID-19 pandemic. The abrupt decline in
interest rates during 2020 not only reduced interest income on floating-rate
commercial loans and other liquid assets, but it also reduced competitive
pressures and depositor expectations concerning deposit interest rates. Because
of the need to maintain higher levels of liquidity and delays in business
investment activity due to COVID-19 disruptions, some further compression of our
net interest margin is likely in future periods, but a reasonably robust
recovery in business conditions could enable us to deploy our additional asset
generation resources and thus reallocate some of our excess liquidity.
Additionally, at September 30, 2020, we held $46.9 million in low-yielding PPP
loans, which reduced our net interest margin. Our yields and net interest margin
could be affected in future periods by the effect of the forgiveness aspect of
the PPP loans as the recognition of the net origination fees will be
accelerated once payments are received.



Three Months Ended September 30




Net interest income decreased by $1.1 million or 14.6%, to $6.5 million for the
three months ended September 30, 2020, compared to $7.6 million for the same
period of 2019. Our net interest margin decreased from 3.53% for the three
months ended September 30, 2019 to 3.05% for the three months ended September
30, 2020.


Nine Months Ended September 30




Net interest income decreased by $3.6 million or 15.5%, to $19.9 million for the
nine months ended September 30, 2020, compared to $23.6 million for the same
period of 2019. Our net interest margin decreased from 3.58% for the nine months
ended September 30, 2019 to 3.21% for the nine months ended September 30, 2020.



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Interest Income


Three Months Ended September 30




Interest income decreased by $1.9 million, or 19.4%, to $7.9 million for the
three months ended September 30, 2020, compared to $9.9 million for the three
months ended September 30, 2019, due primarily to the low interest rate
environment created by the COVID-19 pandemic. The average yield on
interest-earning assets decreased 83 basis points to 3.71% for the three months
ended September 30, 2020 from 4.54% for the three months ended September 30,
2019. The average yield on loans held for investment decreased from 5.33% for
the three months ended September 30, 2019 to 4.59% for the three months ended
September 30, 2020 as a result of the decreased interest rate environment in the
third quarter of 2020 compared to the third quarter of 2019. The average yield
on other interest-earning assets decreased to 0.18% for the three months ended
September 30, 2020 from 1.43% for the three months ended September 30, 2019,
primarily due to a change in the mix of other interest-earning asset types and
the decreased rate environment. We held less certificates of deposit held for
investment during the three months ended September 30, 2020 than during the
three months ended September 30, 2019. Average interest-earning assets decreased
from $860.3 million for the three months ended September 30, 2019 to $852.0
million for the three months ended September 30, 2020, due primarily to a
decline in average loans of $22.8 million, partially offset by an increase
in average other interest-earning assets of $10.2 million. The increase in
average other interest-earning assets resulted primarily from increased average
interest-earning deposits in banks, which was the result of increased loan
payoffs, which also reduced average loans in the third quarter of 2020.



Nine Months Ended September 30




Interest income decreased by $5.4 million, or 17.6%, to $25.2 million for the
nine months ended September 30, 2020, compared to $30.6 million for the nine
months ended September 30, 2019, due to both a low interest rate environment
created by the COVID-19 pandemic and a decreased level of average
interest-earning assets in 2020. Average interest-earning assets decreased from
$881.4 million for the nine months ended September 30, 2019 to $828.5 million
for the nine months ended September 30, 2020, due primarily to a decline in
average other interest-earning assets of $25.2 million and a decline in average
loans of $27.0 million. The decrease in average other interest-earning assets
resulted primarily from decreased average interest-earning deposits in banks,
which was the result of decreased deposits from our medical-use cannabis
customers. The decrease in average loans outstanding was a result of significant
loan payoffs in 2020. The average yield on interest-earning
assets decreased 57 basis points to 4.07% for the nine months ended September
30, 2020 from 4.64% for the nine months ended September 30, 2019. The average
yield on other interest-earning assets decreased to 0.48% for the nine months
ended September 30, 2020 from 2.06% for the nine months ended September 30,
2019, primarily due to a change in the mix of other interest-earning asset types
and the decreased rate environment. We held less certificates of deposit held
for investment during the nine months ended September 30, 2020 than during the
nine months ended September 30, 2019. The average yield on loans held for
investment decreased from 5.41% for the nine months ended September 30, 2019
to 4.87% for the nine months ended September 30, 2020 as a result of the
decreased interest rate environment compared to the same period of 2019 and
lower yielding PPP loans.



Interest Expense


Three Months Ended September 30




Total interest expense was $1.4 million for the three months ended September 30,
2020 and $2.2 million for the three months ended September 30, 2019. The
decrease in interest expense was due to both a decrease in the average balance
of interest-bearing liabilities from $649.9 million for the three months ended
September 30, 2019 to $565.4 million for the three months ended September 30,
2020 and a decrease in the average rate paid on interest-bearing liabilities
from 1.35% for the three months ended September 30, 2019 to 0.99% for the same
period of 2020. The average balance of interest-bearing checking and savings
accounts decreased from $378.4 million for the three months ended September 30,
2019 to $320.8 million for the three months ended September 30, 2020, primarily
due to decreases in our medical-use cannabis related accounts. The average
balance of certificates of deposit decreased from $199.1 million for the three
months ended September 30, 2019 to $190.7 million for the same period of 2020
due to runoff from maturing certificates of deposit. The average rate on
certificates of deposit decreased from 2.54% for the three months ended
September 30, 2019 to 1.37% for the three months ended September 30, 2020.
Average borrowings decreased $18.6 million during the three months ended
September 30, 2020 compared to the same period of 2019 due to payoffs of Federal
Home Loan Bank of Atlanta ("FHLB") advances.



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Nine Months Ended September 30




Total interest expense was $5.3 million for the nine months ended September 30,
2020 and $7.0 million for the nine months ended September 30, 2019. The decrease
in interest expense was primarily due to a decrease in the average balance of
interest-bearing liabilities from $674.0 million for the nine months ended
September 30, 2019 to $565.7 million for the nine months ended September 30,
2020. The average balance of interest-bearing checking and savings
accounts decreased from $391.6 million for the nine months ended September 30,
2019 to $317.3 million for the nine months ended September 30, 2020, primarily
due to decreases in our medical-use cannabis related accounts. The average
balance of certificates of deposit decreased from $205.4 million for the nine
months ended September 30, 2019 to $193.4 million for the same period of 2020
due to runoff from maturing certificates of deposit. Average
borrowings decreased $22.0 million during the nine months ended September 30,
2020 compared to the same period of 2019 due to payoffs of FHLB advances. The
average rate on interest-bearing liabilities decreased 15 basis points from
1.40% for the nine months ended September 30, 2019 to 1.25% for the nine months
ended September 30, 2020.



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



                                                               Three Months Ended September 30,
                                                      2020                                           2019
                                    Average                          Yield/        Average                          Yield/
                                    Balance      Interest (2)       Rate (4)       Balance      Interest (2)       Rate (4)
ASSETS                                                              (dollars in thousands)
Loans (1)                          $ 655,022$       7,550           4.59 %   $ 677,792$       9,109           5.33 %
Mortgage loans held for sale
("LHFS")                              17,774                51           1.14 %      12,797                37           1.15 %
Available-for-sale ("AFS")
securities                            23,776               162           2.71 %      11,169                47           1.67 %
Held-to-maturity ("HTM")
securities                            22,347               110           1.96 %      34,977               177           2.01 %
Other interest-earning assets
(3)                                  130,824                58           0.18 %     120,605               434           1.43 %
Restricted stock investments, at
cost                                   2,263                10           1.76 %       2,952                50           6.72 %
Total interest-earning assets        852,006             7,941           3.71 %     860,292             9,854           4.54 %
Allowance                             (7,816 )                                       (8,091 )
Cash and other
noninterest-earning assets            44,371                                         46,755
Total assets                       $ 888,561             7,941                    $ 898,956             9,854
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing deposits:
Checking and savings               $ 320,845               486           0.60 %   $ 378,360               459           0.48 %
Certificates of deposit              190,748               656           1.37 %     199,127             1,273           2.54 %
Total interest-bearing deposits      511,593             1,142           0.89 %     577,487             1,732           1.19 %
Borrowings                            53,758               269           1.99 %      72,397               473           2.59 %
Total interest-bearing
liabilities                          565,351             1,411           0.99 %     649,884             2,205           1.35 %
Noninterest-bearing deposit
accounts                             208,210                                        137,598
Other noninterest-bearing
liabilities                            7,292                                          8,181
Stockholders' equity                 107,708                                        103,293
Total liabilities and
stockholders' equity               $ 888,561             1,411                    $ 898,956             2,205
Net interest income/net interest
spread                                           $       6,530           2.72 %                 $       7,649           3.19 %
Net interest margin                                                      3.05 %                                         3.53 %



--------------------------------------------------------------------------------

(1) Nonaccrual loans are included in average loans.

(2) There are no tax equivalency adjustments.

(3) Other interest-earning assets include interest-earning deposits, federal

funds sold, and certificates of deposit held for investment.


(4) Annualized.




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                                                                 Nine Months Ended September 30,
                                                      2020                                            2019
                                    Average                           Yield/        Average                           Yield/
                                    Balance       Interest (2)       Rate (4)       Balance       Interest (2)       Rate (4)
ASSETS                                                               (dollars in thousands)
Loans (1)                          $ 651,491$       23,762           4.87 %   $ 678,495$       27,436           5.41 %
LHFS                                  16,588                255           2.05 %       9,851                103           1.40 %
AFS securities                        18,015                337           2.50 %      11,593                148           1.71 %
HTM securities                        23,278                370           2.12 %      36,336                576           2.12 %
Other interest-earning assets
(3)                                  116,804                418           0.48 %     142,039              2,192           2.06 %
Restricted stock investments, at
cost                                   2,353                 76           4.31 %       3,110                166           7.14 %
Total interest-earning assets        828,529             25,218           4.07 %     881,424             30,621           4.64 %
Allowance                             (7,522 )                                        (8,080 )
Cash and other
noninterest-earning assets            44,913                                          43,788
Total assets                       $ 865,920             25,218                    $ 917,132             30,621
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing deposits:
Checking and savings               $ 317,306              1,519           0.64 %   $ 391,596              2,083           0.71 %
Certificates of deposit              193,438              2,803           1.94 %     205,416              3,416           2.22 %
Total interest-bearing deposits      510,744              4,322           1.13 %     597,012              5,499           1.23 %
Borrowings                            54,999                966           2.35 %      77,005              1,543           2.68 %
Total interest-bearing
liabilities                          565,743              5,288           1.25 %     674,017              7,042           1.40 %
Noninterest-bearing deposits         184,707                                         135,763
Other noninterest-bearing
liabilities                            7,873                                           5,227
Stockholders' equity                 107,597                                         102,125
Total liabilities and
stockholders' equity               $ 865,920              5,288                    $ 917,132              7,042
Net interest income/net interest
spread                                           $       19,930           2.82 %                 $       23,579           3.24 %
Net interest margin                                                       3.21 %                                          3.58 %



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(1) Nonaccrual loans are included in average loans.

(2) There are no tax equivalency adjustments.

(3) Other interest-earning assets include interest-earning deposits, federal

funds sold, and certificates of deposit held for investment.


(4) Annualized.




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



                               Three Months Ended September 30, 2020 vs.
                                                 2019                              Nine Months Ended September 30, 2020 vs. 2019
                                          Due to Variances in                                   Due to Variances in
                                Rate            Volume            Total            Rate                Volume               Total
Interest earned on:                                                    (dollars in thousands)
Loans                         $  (1,258 )$      (301 )$  (1,559 )$       (2,619 )$       (1,055 )$       (3,674 )
LHFS                                 (1 )              15              14                 62                   90                  152
AFS securities                       42                73             115                 86                  103                  189
HTM Securities                       (5 )             (62 )           (67 )                1                 (207 )               (206 )
Other interest-earning
assets                             (609 )             233            (376 )           (1,441 )               (333 )             (1,774 )
Restricted stock
investments, at cost                (30 )             (10 )           (40 )              (56 )                (34 )                (90 )
Total interest income            (1,861 )             (52 )        (1,913 )           (3,967 )             (1,436 )             (5,403 )

Interest paid on:
Interest-bearing deposits:
Checking and savings                362              (335 )            27               (196 )               (368 )               (564 )
Certificates of deposit            (565 )             (52 )          (617 )             (423 )               (190 )               (613 )
Total interest-bearing
deposits                           (203 )            (387 )          (590 )             (619 )               (558 )             (1,177 )
Borrowings                          (96 )            (108 )          (204 )             (175 )               (402 )               (577 )
Total interest expense             (299 )            (495 )          (794 )             (794 )               (960 )             (1,754 )
Net interest income           $  (1,562 )$       443$  (1,119 )$       (3,173 )     $         (476 )     $       (3,649 )




Provision for Loan Losses



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



We recorded $100,000 and $850,000 in provision for loan losses for the three and
nine months ended September 30, 2020 primarily due to economic factors related
to the COVID-19 pandemic. We recorded a reversal of provision for loan losses of
$500,000 for both the three and nine months ended September 30, 2019.



.See additional information about the provision for loan losses under "Credit Risk Management and the Allowance" later in this Item.



Noninterest Income


Three Months Ended September 30




Total noninterest income increased by $1.9 million or 67.5%, to $4.7 million for
the three months ended September 30, 2020, compared to $2.8 million for the
three months ended September 30, 2019, with the majority of the increase from
mortgage-banking revenue. Mortgage-banking revenue increased $1.8 million, or
163.7%, due to the increased volume of loans originated from $46.9 million
during the three months ended September 30, 2019 to $88.9 million during the
three months ended September 30, 2020. The Title Company generated $426,000 in
revenue during the three months ended September 30, 2020 compared to $362,000
for the three months ended September 30, 2019 due to an increase in loan
closings and related title work.



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Nine Months Ended September 30




Total noninterest income increased by $3.3 million or 42.8%, to $11.0 million
for the nine months ended September 30, 2020, compared to $7.7 million for the
nine months ended September 30, 2019, with the majority of the increase from
mortgage-banking revenue. Mortgage-banking revenue increased $3.6
million or 124.6%, due to the increased volume of loans originated from $135.8
million during the nine months ended September 30, 2019 to $212.7 million during
the nine months ended September 30, 2020. A significant portion of the
originations were refinances due to the drop in interest rates. The Title
Company generated $890,000 in revenue during the nine months ended September 30,
2020 compared to $841,000 for the nine months ended September 30, 2019. Real
estate commissions decreased $434,000 primarily due to the lack of activity in
real estate sales as a result of the COVID-19 pandemic.



Noninterest Expense


Three Months Ended September 30




Total noninterest expense increased $692,000 or 9.0% to $8.4 million for the
three months ended September 30, 2020 compared to $7.7 million for the three
months ended September 30, 2019, primarily due to an increase in compensation
and related expenses. Compensation and related expenses increased by $981,000,
or 19.4%, to $6.0 million for the three months ended September 30, 2020,
compared to $5.1 million for the three months ended September 30, 2019. This
increase was primarily due to annual salary increases, additional hirings for
the Crofton branch, and increased commission expense that corresponds with our
increased mortgage-banking volumes. Writedowns, losses, and costs of real estate
acquired through foreclosure decreased $153,000 primarily due to a $77,000
recovery related to one property received during the three months
ended September 30, 2020. Professional fees decreased $105,000 primarily due to
less consulting fees for SOX related matters.



Nine Months Ended September 30




Total noninterest expense increased $2.2 million, or 9.9%, to $24.1 million for
the nine months ended September 30, 2020, compared to $21.9 million for the nine
months ended September 30, 2019, primarily due to increases in compensation and
related expenses, occupancy expenses, and data processing fees. Compensation and
related expenses increased by $2.2 million, or 15.0%, to $16.7 million for the
nine months ended September 30, 2020, compared to $14.5 million for the nine
months ended September 30, 2019. This increase was primarily due to annual
salary increases, additional hirings for our new Crofton branch, and increased
commission expense that corresponds with our increased mortgage-banking volumes.
Occupancy expenses increased $165,000, or 13.9%, primarily due to the addition
of the Crofton branch. We also incurred additional expenses related to COVID-19
protocols. Data processing fees increased $203,000 due to additional efficiency
and security enhancements to our core and related systems, as well as the
implementation in late 2019 of a new customer relationship management ("CRM")
system. We recognized a $76,000 loss on disposal of premises and equipment when
we terminated a lease agreement. We experienced a $214,000 decrease in
professional fees as we were no longer utilizing consultants in 2020 for SOX
related matters. Writedowns, losses, and costs of real estate acquired through
foreclosure decreased $212,000 due to the aforementioned recovery received in
2020 in addition to less activity related to real estate acquired through
foreclosure in 2020.



Income Tax Provision


Three Months Ended September 30




We recorded a $883,000 tax provision on net income before income taxes of $2.8
million for the three months ended September 30, 2020 for an effective tax rate
of 31.8%, compared to an income tax provision of $911,000 on net income before
income taxes of $3.3 million for the three months ended September 30, 2019, for
an effective tax rate of 27.7%.



Nine Months Ended September 30




We recorded a $1.8 million tax provision on net income before income taxes of
$6.0 million for the nine months ended September 30, 2020 for an effective tax
rate of 29.5%, compared to an income tax provision of $2.7 million on net income
before income taxes of $9.8 million for the nine months ended September 30,
2019, for an effective tax rate of 27.1%.



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Financial Condition



Total assets increased $112.0 million to $938.9 million at September 30, 2020,
compared to $826.9 million at December 31, 2019. This increase was primarily due
to a $54.6 million, or 61.9%, increase in cash and cash equivalents, to $142.8
million at September 30, 2020 from $88.2 million at December 31, 2019 due
primarily to increased deposits. We also experienced an increase in loans of
$14.6 million, or 2.3%, to $660.3 million at September 30, 2020 from $645.7
million at December 31, 2019. Additionally, we had approximately $2.5 million of
securities that had not yet settled at September 30, 2020, which grossed up
total assets. Total deposits increased $122.2 million, or 18.5%, to $783.2
million at September 30, 2020 compared to $661.0 million at December 31, 2019.
Stockholders' equity increased $2.8 million to $108.3 million at September 30,
2020 compared to $105.5 million at December 31, 2019, due to net income to
date for the year and decreased accumulated comprehensive loss, partially offset
by dividends paid to stockholders.



Securities



We utilize the securities portfolio as part of our overall asset/liability
management practices to enhance interest revenue while providing necessary
liquidity for the funding of loan growth or deposit withdrawals. We continually
monitor the credit risk associated with investments and diversify the risk in
the securities portfolios. We held $54.2 million and $12.9 million in securities
classified as AFS as of September 30, 2020 and December 31, 2019, respectively.
We held $19.7 million and $26.0 million, respectively, in securities classified
as HTM as of September 30, 2020 and December 31, 2019.



Changes in current market conditions, such as interest rates and the economic
uncertainties in the mortgage, housing, and banking industries impact the
securities market. Quarterly, we review each security in our portfolio to
determine the nature of any decline in value and evaluate if any impairment
should be classified as other-than-temporary impairment ("OTTI"). For the three
and nine months ended September 30, 2020, we determined that no OTTI charges
were required.



All of the AFS and HTM securities that are temporarily impaired as of September
30, 2020 were so due to declines in fair values resulting from changes in
interest rates or decreased credit/liquidity spreads compared to the time they
were purchased. We have the intent to hold these securities to maturity
(including those designated as AFS) and it is more likely than not that we will
not be required to sell the securities before recovery of value. As such,
management considers the impairments to be temporary.



Our securities portfolio composition is as follows:



                                                     AFS                               HTM
                                         September       December 31,      September       December 31,
                                          30, 2020           2019           30, 2020           2019
                                                            (dollars in thousands)
U.S. Treasury securities                $          -     $          -     $        999$        994
U.S. government agency notes                   6,384            5,019            2,985            4,986
Corporate obligations                          1,986                -                -                -
Mortgage-backed securities                    45,835            7,887           15,725           19,980
                                        $     54,205$     12,906$     19,709$     25,960




LHFS



We originate residential mortgage loans for sale on the secondary market. Such
LHFS, which are carried at fair value, amounted to $21.7 million at September
30, 2020 and $10.9 million at December 31, 2019, the majority of which are
subject to purchase commitments from investors. The increase in LHFS was
primarily due to increased originations and to the timing of loans pending sale
on the secondary market.



Loans



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



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



                                               September 30, 2020              December 31, 2019
                                                             Percent                        Percent
                                             Amount         of Total         Amount        of Total
                                                             (dollars in thousands)
Residential Mortgage                       $   237,771            35.8 %   $  269,654            41.6 %
Commercial                                      88,683            13.4 %       43,127             6.7 %
Commercial real estate                         239,570            36.1 %      229,257            35.3 %
Land acquisition, development, and
construction ("ADC")                            84,392            12.7 %       92,822            14.3 %
Home equity/2nds                                12,130             1.8 %       12,031             1.9 %
Consumer                                         1,436             0.2 %        1,541             0.2 %
Loans receivable, before net unearned
fees                                       $   663,982           100.0 %   $  648,432           100.0 %




Total loans, net of unearned loan fees, increased by $14.6 million, or 2.3%, to
$660.3 million at September 30, 2020, compared to $645.7 million at December 31,
2019. This increase was due primarily to the origination of PPP loans and
commercial real estate loans, partially offset by increased payoffs of
residential real estate and ADC loans.



Credit Risk Management and the Allowance




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



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



Management has an established methodology to determine the adequacy of the
Allowance that assesses the risks and losses inherent in the loan portfolio. Our
Allowance methodology employs management's assessment as to the level of future
losses on existing loans based on our internal review of the loan portfolio,
including an analysis of the borrowers' current financial position, and the
consideration of current and anticipated economic conditions and their potential
effects on specific borrowers and/or lines of business. In determining our
ability to collect certain loans, we also consider the fair value of any
underlying collateral. In addition, we evaluate credit risk concentrations,
including trends in large dollar exposures to related borrowers, industry and
geographic concentrations, and economic and environmental factors. Our risk
management practices are designed to ensure timely identification of changes in
loan risk profiles; however, undetected losses may inherently exist within the
loan portfolio. The assessment aspects involved in analyzing the quality of
individual loans and assessing collateral values can also contribute to
undetected, but probable, losses. In 2020, we adjusted our economic risk factors
to incorporate the current economic implications and rising unemployment rate
from the COVID-19 pandemic. For more detailed information about our Allowance
methodology and risk rating system, see Note 3 to the Consolidated Financial
Statements.



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



                                               Three Months Ended           Nine Months Ended September
                                                  September 30,                         30,
                                              2020             2019            2020             2019
                                                              (dollars in thousands)
Allowance, beginning of period             $    8,169$    8,093$    7,138$    8,044
Charge-offs:
Residential mortgage                              (39 )              -             (39 )            (20 )
Commercial                                          -                -               -                -
Commercial real estate                            (49 )           (199 )           (49 )           (199 )
ADC                                                 -                -               -                -
Home equity/2nds                                    -                -               -                -
Consumer                                            -               (2 )           (15 )            (14 )
Total charge-offs                                 (88 )           (201 )          (103 )           (233 )
Recoveries:
Residential mortgage                              453                3             633               11
Commercial                                          3                -              11                -
Commercial real estate                             34               30             136               97
ADC                                                 -                -               -                -
Home equity/2nds                                    4                3               7                9
Consumer                                            -                3               3                3
Total recoveries                                  494               39             790              120
Net recoveries (charge-offs)                      406             (162 )           687             (113 )
Provision for (reversal of) loan losses           100             (500 )           850             (500 )
Allowance, end of period                   $    8,675$    7,431$    8,675$    7,431
Loans:
Period-end balance                         $  660,315$  660,879$  660,315$  660,879
Average balance during period                 655,022          677,792         651,491          678,495
Allowance as a percentage of period-end
loan balance (1)                                 1.31 %           1.12 %          1.31 %           1.12 %
Percent of average loans (annualized):
Provision for (reversal of) loan losses          0.06 %          (0.29 )%         0.17 %          (0.10 )%
Net recoveries (charge-offs)                     0.25 %          (0.09 )%         0.14 %          (0.02 )%



(1) The Allowance at September 30, 2020, as a percentage of total loans, excluding PPP loans was 1.41%




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



                                 September 30, 2020                       December 31, 2019
                                                    Percent                                 Percent
                                                   of Loans                                of Loans
                                      Percent      to Total                   Percent      to Total
                         Amount      of Total        Loans       Amount      of Total        Loans
                                                   (dollars in thousands)

Residential mortgage $ 2,439 28.1 % 35.8 % $ 2,264

       31.7 %        41.6 %
Commercial                 1,683          19.4 %        13.4 %     1,421          19.9 %         6.7 %
Commercial real estate     1,569          18.1 %        36.1 %       984          13.8 %        35.3 %
ADC                        2,779          32.0 %        12.7 %     2,286          32.0 %        14.3 %
Home equity/2nds             178           2.1 %         1.8 %       134           1.9 %         1.9 %
Consumer                       -             - %         0.2 %         -             - %         0.2 %
Unallocated                   27           0.3 %           - %        49           0.7 %           - %
Total                    $ 8,675         100.0 %       100.0 %   $ 7,138         100.0 %       100.0 %




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Based upon management's evaluation, provisions are made to maintain the
Allowance as a best estimate of inherent losses within the portfolio. The
Allowance totaled $8.7 million at September 30, 2020 and $7.1 million at
December 31, 2019. Any changes in the Allowance from period to period reflect
management's ongoing application of its methodologies to establish the
Allowance, which, for the nine months ended September 30, 2020, resulted in
increased allocated Allowances for the majority of the loan segments, primarily
due to economic factors related to the COVID-19 pandemic.



As a result of our Allowance analysis, we recorded a provision for loan losses
of $100,000 and $850,000 during the three and nine months ended September 30,
2020, respectively. We recorded a reversal of provision for loan losses of
$500,000 for both the three and nine months ended September 30, 2019. We
recorded net recoveries of $406,000 and $687,000, respectively, during the three
and nine months ended September 30, 2020 and net charge-offs of $162,000 and
$113,000, respectively, during the three and nine months ended September 30,
2019. During the three and nine months ended September 30, 2020, annualized net
recoveries as a percentage of average loans outstanding amounted to 0.25% and
0.14%, respectively. During the three and nine months ended September 30, 2019,
annualized net charge-offs as a percentage of average loans outstanding amounted
to 0.09% and 0.02%, respectively. The Allowance as a percentage of outstanding
loans was 1.31% as of September 30, 2020 compared to 1.12% as of December 31,
2019, the increase in which was primarily the result of the net recoveries
recognized in 2020, an increase in the qualitative factors used in the
calculation of the Allowance, as well as the decrease in outstanding loans, net
of PPP loans. PPP loans are fully guaranteed by the SBA and, therefore, not
required to have an allocated Allowance. The Allowance as a percentage of
outstanding loans less PPP loans amounted to 1.41% at September 30, 2020.



Although management uses available information to establish the appropriate
level of the Allowance, future additions or reductions to the Allowance may be
necessary based on estimates that are susceptible to change as a result of
changes in economic conditions, and other factors. As a result, our Allowance
may not be sufficient to cover actual loan losses, and future provisions for
loan losses could materially adversely affect our operating results. In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review our Allowance and related methodology. Such
agencies may require us to recognize adjustments to the Allowance based on their
judgments about information available to them at the time of their examination.
Management believes the Allowance is adequate as of September 30, 2020 and is
sufficient to address the credit losses inherent in the current loan portfolio.
Management will continue to evaluate the adequacy of the Allowance as more
economic data becomes available and as changes within our portfolio are known.
The effects of the COVID-19 pandemic may require us to fund additional increases
in the Allowance in future periods.



Nonperforming Assets ("NPAs")



Given the volatility of the real estate market, it is very important for us to
have current valuations on our NPAs. Generally, we obtain appraisals or
alternative valuations on NPAs annually. In addition, as part of our asset
monitoring activities, we maintain a Loss Mitigation Committee that
meets monthly. During these Loss Mitigation Committee meetings, all NPAs and
loan delinquencies are reviewed. Additionally, loans in industries vulnerable to
the effects of COVID-19 and loans that were or continue to be on interest
deferral are reviewed. We also produce an NPA report which is
distributed monthly to senior management and is also discussed and reviewed at
the Loss Mitigation Committee meetings. This report contains all relevant data
on the NPAs, including the latest appraised value (or alternative valuation
vehicle) and valuation date. Accordingly, these reports identify which assets
will require an updated valuation. As a result, we have not experienced any
internal delays in identifying which loans/credits require updated valuations.
With respect to the ordering process of appraisals, we have not experienced any
delays in turnaround time nor has this been an issue over the past three years.
Furthermore, we have not had any delays in turnaround time or variances thereof
in our specific loan operating markets.



NPAs, expressed as a percentage of total assets, totaled 0.73% at September 30,
2020 and 0.80% at December 31, 2019. The ratio of the Allowance to nonperforming
loans was 148.7% at September 30, 2020 and 168.3% at December 31, 2019.



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The distribution of our NPAs is illustrated in the following table. We did not
have any loans greater than 90 days past due and still accruing at September 30,
2020 or December 31, 2019.



                                                       September 30, 2020       December 31, 2019
Nonaccrual Loans:                                                (dollars in thousands)
Residential mortgage                                   $             5,356     $             3,766
Commercial real estate                                                 288                     237
ADC                                                                     66                      89
Home equity/2nds                                                       122                     150
                                                                     5,832                   4,242
Real Estate Acquired Through Foreclosure:
Residential mortgage                                                     -                   1,377
Commercial real estate                                                 452                     452
ADC                                                                    558                     558
                                                                     1,010                   2,387
Total NPAs                                             $             6,842     $             6,629




Nonaccrual loans totaled $5.8 million, or 0.88% of total loans, at September 30,
2020 and $4.2 million, or 0.66% of total loans at December 31, 2019. Significant
activity in nonaccrual loans during the nine months ended September 30, 2020
included the addition of five loans in the amount of $3.0 million to nonaccrual
loans, one loan paid off in the amount of $111,000, one loan charged off for
$39,000, and one loan returned to accrual status in the amount of $808,000.



Real estate acquired through foreclosure decreased $1.4 million to $1.0 million
at September 30, 2020 compared to $2.4 million at December 31, 2019, primarily
due to the sale of three residential mortgage properties existing at December
31, 2019.



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



                                            Three Months Ended September 30,               Nine Months Ended September 30,
                                              2020                     2019                 2020                     2019
                                                                       

(dollars in thousands) Balance at beginning of period $ 1,010 $ 1,430 $

           2,387         $         1,537
Real estate acquired in satisfaction
of loans                                               -                      516                     -                     687
Write-downs and losses on real estate
acquired through foreclosure                           -                      (73 )                 (80 )                  (244 )
Proceeds from sales of real estate
acquired through foreclosure                           -                        -                (1,297 )                  (107 )
Balance at end of period                $          1,010         $          1,873     $           1,010         $         1,873




TDRs


In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR. See Significant Developments - COVID-19 for information regarding the CARES Act and its effect on modifications.




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



                            September 30, 2020       December 31, 2019
Residential mortgage:                 (dollars in thousands)
Nonaccrual                  $                80     $                85
<90 days past due/current                 6,716                   7,675
Commercial real estate:
Nonaccrual                                    -                       -
<90 days past due/current                   969                     984

ADC:

Nonaccrual                                    -                       -
<90 days past due/current                   129                     130

Consumer:

Nonaccrual                                    -                       -
<90 days past due/current                    64                      69

Totals:

Nonaccrual                                   80                      85
<90 days past due/current                 7,878                   8,858
                            $             7,958     $             8,943



See additional information on TDRs in Note 3 to the Consolidated Financial Statements herein.



Deposits



Deposits totaled $783.2 million at September 30, 2020 and $661.0 million
at December 31, 2019. The $122.2 million increase was primarily the result of
short-term medical-use cannabis related funds (funds that have not yet actually
been used in the medical-use cannabis industry) that account holders have placed
at the Bank temporarily while looking for desired investments in the industry.
Management is aware of the short-term nature of such medical-use cannabis
related deposits and offset those funds by maintaining short-term liquidity to
meet any deposit outflows.


The deposit breakdown is as follows:



                                     September 30, 2020            December 31, 2019
                                                   Percent                      Percent
                                    Balance       of Total       Balance       of Total
                                                  (dollars in thousands)
NOW                               $   104,491          13.3 %   $   83,612          12.6 %
Money market                          157,403          20.1 %      162,621          24.6 %
Savings                                62,000           7.9 %       61,514           9.3 %
Certificates of deposit               218,846          28.0 %      230,401          34.9 %
Total interest-bearing deposits       542,740          69.3 %      538,148          81.4 %
Noninterest-bearing deposits          240,498          30.7 %      122,901          18.6 %
Total deposits                    $   783,238         100.0 %   $  661,049         100.0 %




Borrowings


Our borrowings consist of advances from the FHLB.




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



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At September 30, 2020, our total credit line with the FHLB was $274.1 million.
The Bank, from time to time, utilizes the line of credit when interest rates are
more favorable than obtaining deposits from the public. Our outstanding FHLB
advance balance at September 30, 2020 and December 31, 2019 was $20.0
million and $35.0 million, respectively.



At September 30, 2020, we also maintained a line of credit with a bankers' bank in the amount of $11.0 million, which we had not drawn upon.

The following table sets forth information concerning the interest rates and maturity dates of the advances from the FHLB as of September 30, 2020:



       Principal
 Amount (in thousands)      Rate     Maturity
$                10,000     1.92 %     2020
                 10,000     2.19 %     2022
$                20,000



Certain loans in the amount of $128.4 million have been pledged under a blanket floating lien to the FHLB as collateral against advances at September 30, 2020.




Subordinated Debentures



As of both September 30, 2020 and December 31, 2019, the Company had outstanding
$20.6 million in principal amount of Junior Subordinated Debt Securities, due in
2035 (the "2035 Debentures"). The 2035 Debentures were issued pursuant to an
Indenture dated as of December 17, 2004 (the "2035 Indenture") between the
Company and Wells Fargo Bank, National Association as Trustee. The 2035
Debentures pay interest quarterly at a floating rate of interest of 3-month
LIBOR plus 200 basis points, and mature on January 7, 2035. Payments of
principal, interest, premium and other amounts under the 2035 Debentures are
subordinated and junior in right of payment to the prior payment in full of all
senior indebtedness of the Company, as defined in the 2035 Indenture. The 2035
Debentures became redeemable, in whole or in part, by the Company on January 7,
2010.



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


Under the terms of the 2035 Debentures, we are permitted to defer the payment of interest on the 2035 Debentures for up to 20 consecutive quarterly periods, provided that no event of default has occurred and is continuing. As of September 30, 2020, we were current on all interest due on the 2035 Debentures.




Capital Resources



Total stockholders' equity increased $2.8 million to $108.3 million at September
30, 2020 compared to $105.5 million as of December 31, 2019. The increase was
the result of 2020 net income to date and a decrease in accumulated other
comprehensive loss, partially offset by dividends paid to stockholders during
the nine months ended September 30, 2020.



Capital Adequacy



The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possible additional discretionary, actions by the
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classifications are also
subject to qualitative judgments by the regulators about components,
risk-weightings, and other factors. As of September 30, 2020 and December 31,
2019, the Bank exceeded all capital adequacy requirements to which it is subject
and meets the qualifications to be considered "well capitalized." As of January
1, 2020, the Bank elected to follow the Community Bank Leverage Ratio. See
details of our capital ratios in Note 4 of the Consolidated Financial
Statements.



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Liquidity



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



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



In addition to our ability to generate deposits, we have external sources of
funds, which may be drawn upon when desired. The primary source of external
liquidity is an available line of credit with the FHLB. The Bank's total credit
availability under the FHLB's credit availability program was $274.1 million at
September 30, 2020, of which $20.0 million was outstanding. In addition,
at September 30, 2020, we also maintained a line of credit with a bankers' bank
in the amount of $11.0 million, which we had not drawn upon.



The borrowing requirements of customers include commitments to extend credit and
the unused portion of lines of credit (collectively "commitments"), which
totaled $129.8 million at September 30, 2020. Historically, many of the
commitments expire without being fully drawn; therefore, the total commitment
amounts do not necessarily represent future cash requirements. We expect to fund
these commitments from the sources of liquidity described above.



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



In addition to the foregoing, the payment of dividends is a use of cash, but is
not expected to have a material effect on liquidity. As of September 30, 2020,
we had no material commitments for capital expenditures.



Our ability to acquire deposits or borrow could be impaired by factors that are
not specific to us, such as a severe disruption of the financial markets or
negative views and expectations about the prospects for the financial services
industry as a whole. As of September 30, 2020, we have not yet experienced any
negative impact on our liquidity due to COVID-19. At September 30, 2020,
management considered the Company's liquidity level to be sufficient for the
purposes of meeting our cash flow requirements. We are not aware of any
undisclosed known trends, demands, commitments, or uncertainties that are
reasonably likely to result in material changes in our liquidity.



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



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Off-Balance Sheet Arrangements and Derivatives




We enter into off-balance sheet arrangements in the normal course of business.
These arrangements consist primarily of commitments to extend credit, lines of
credit, and letters of credit.



Credit Commitments



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



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



See detailed information on credit commitments above under "Liquidity."



Derivatives


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




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



See Note 8 to the consolidated financial statements for more detailed information on our derivatives.



Inflation



The consolidated financial statements and related consolidated financial data
presented herein have been prepared in accordance with GAAP and practices within
the banking industry which require the measurement of financial condition and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. As a
financial institution, virtually all of our assets and liabilities are monetary
in nature and interest rates have a more significant impact on our performance
than the effects of general levels of inflation. A prolonged period of inflation
could cause interest rates, wages, and other costs to increase and could
adversely affect our results of operations unless mitigated by a corresponding
increase in our revenues. However, we believe that the impact of inflation on
our operations was not material for the three and nine months ended September
30, 2020 and 2019.

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