Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10‑‑K
☑ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number 0‑‑49731
SEVERN BANCORP, INC.
(Exact name of registrant as specified in its charter)
Maryland
(State or other jurisdiction of incorporation or organization)
52‑‑1726127
(I.R.S. Employer Identification Number)
200 Westgate Circle, Suite 200
Annapolis, Maryland
(Address of principal executive offices)
21401
(Zip Code)
410‑‑260‑‑2000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, par value $.01 per share
Name of each exchange on which registered
The NASDAQ Stock Market, LLC
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes☐ No ☑
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes☐ No ☑
Securities registered pursuant to Section 12(g) of the Act:
None
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 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10‑K or any amendment to this
Form 10‑K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 ☐
Smaller reporting company ☑ Emerging growth company ☐
Non-accelerated filer ☐
Accelerated filer ☑
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 Rule12b‑2 of the Act). Yes☐ No ☑
The aggregate market value of the 8,824,205 shares of common stock held by non-affiliates of the registrant, based on the closing sale price of the registrant’s common stock on
June 30, 2018 of $8.65 per share was $76,329,373.
Indicate the number of shares outstanding for each of the registrant’s classes of common stock, as of the latest practicable date.
As of March 18, 2019, there were issued and outstanding 12,775,087 shares of the registrant’s common stock.
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Documents incorporated by reference:
Portions of the registrant’s Definitive Proxy Statement for its 2019 Annual Meeting of Stockholders to be held on May 16, 2019 are incorporated by reference into Part III of
this Form 10‑K.
Table of Contents
Section
PART I
Item 1
Item 1A
Item 1B
Item 2
Item 3
Item 4
PART II
Item 5
Item 6
Item 7
Item 7A
Item 8
Item 9
Item 9A
Item 9B
PART III
Item 10
Item 11
Item 12
Item 13
Item 14
PART IV
Item 15
Item 16
SIGNATURES
TABLE OF CONTENTS
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity
Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers, and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules
Form 10‑K Summary
i
Page
1
1
16
25
25
26
26
26
26
28
29
47
47
47
48
49
50
50
50
50
50
50
50
50
51
52
Table of Contents
Caution Note Regarding Forward-Looking Statements
This Annual Report on Form 10‑K, as well as other periodic reports filed with the Securities and Exchange Commission (“SEC”),
and written or oral communications made from time to time by or on behalf of Severn Bancorp and its subsidiaries (the
“Company”), may contain statements relating to future events or future results of the Company that are considered “forward-
looking statements” under the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be
identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “intend,” and “potential,” or words of
similar meaning, or future or conditional verbs such as “should,” “could,” or “may.” Forward-looking statements include
statements of our goals, intentions and expectations; statements regarding our business plans, prospects, growth, and operating
strategies; statements regarding the quality of our loan and investment portfolios; and estimates of our risks and future costs and
benefits.
Forward-looking statements reflect our expectation or prediction of future conditions, events, or results based on information
currently available. These forward-looking statements are subject to significant risks and uncertainties that may cause actual
results to differ materially from those in such statements. These risks and uncertainties include, but are not limited to, the risks
identified in Item 1A of this Annual Report on Form 10‑K and the following:
·
·
·
·
·
·
·
·
·
·
·
·
general business and economic conditions nationally or in the markets that the Company serves could adversely affect,
among other things, real estate prices, unemployment levels, and consumer and business confidence, which could lead to
decreases in the demand for loans, deposits, and other financial services that we provide and increases in loan
delinquencies and defaults;
changes or volatility in the capital markets and interest rates may adversely impact the value of securities, loans,
deposits, and other financial instruments and the interest rate sensitivity of our balance sheet as well as our liquidity;
our liquidity requirements could be adversely affected by changes in our assets and liabilities;
our investment securities portfolio is subject to credit risk, market risk, and liquidity risk as well as changes in the
estimates we use to value certain of the securities in our portfolio;
the effect of legislative or regulatory developments including changes in laws concerning taxes, banking, securities,
insurance, and other aspects of the financial services industry;
competitive factors among financial services companies, including product and pricing pressures, and our ability to
attract, develop, and retain qualified banking professionals;
the effect of fiscal and governmental policies of the United States (“U.S.”) federal government;
the effect of any mergers, acquisitions, or other transactions to which we or our subsidiary may from time to time be a
party;
costs and potential disruption or interruption of operations due to cyber-security incidents;
the effect of any change in federal government enforcement of federal laws affecting the medical-use cannabis industry;
the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards
Board, the SEC, the Public Company Accounting Oversight Board, and other regulatory agencies; and
geopolitical conditions, including acts or threats of terrorism, actions taken by the U.S. or other governments in response
to acts or threats of terrorism, and/or military conflicts, which could impact business and economic conditions in the U.S.
and abroad.
Forward-looking statements speak only as of the date of this report. The Company does not undertake to update forward-looking
statements to reflect circumstances or events that occur after the date of this report or to reflect the occurrence of unanticipated
events except as required by federal securities laws.
ii
Table of Contents
PART I
ITEM 1 BUSINESS
General
Severn Bancorp and Subsidiaries (the “Company,” “we,” “our,” or “us”) is a savings and loan holding company incorporated in
the state of Maryland in 1990. The Company conducts business primarily through four subsidiaries, Severn Savings Bank, FSB
(the “Bank”), Mid-Maryland Title Company, Inc. (“the Title Company”), SBI Mortgage Company (“SBI”), and the Bank’s
principal subsidiary Louis Hyatt, Inc. (“Hyatt Commercial”), which conducts business as Hyatt Commercial. SBI is the parent
company of Crownsville Development Corporation (“Crownsville”), which does business as Annapolis Equity Group.
Hyatt Commercial is a real estate brokerage company specializing in commercial real estate sales, leasing, and property
management.
SBI engages in the origination of mortgages that do not meet the underwriting criteria of the Bank. It owns subsidiary companies
that purchase real estate for investment purposes. As of December 31, 2018, SBI had $1.3 million in outstanding mortgage loans
and it had $630,000 invested in subsidiaries, which funds were held in cash, pending potential acquisition of investment real
estate.
Crownsville, doing business as Annapolis Equity Group, is engaged in the business of acquiring real estate for investment and
syndication purposes.
HS West, LLC (“HS”) is a subsidiary of the Bank which constructed a building in Annapolis, Maryland that serves as the
Company’s and the Bank’s administrative headquarters. A branch office of the Bank is also located in the building. In addition,
HS leases space to four unrelated companies and to a law firm of which the President of the Company and the Bank is a partner.
The Title Company engages in title work related to real estate transactions.
Severn Financial Services Corporation is a subsidiary of the Bank that is part of a joint venture with a local insurance agency to
provide various insurance products to customers of the Bank.
The Bank has six branches in Anne Arundel County, Maryland, which offer a full range of deposit products and 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 December 31, 2018, we had consolidated total assets of $974.2 million, total loans of $682.3 million, total deposits of
$779.5 million, and total stockholders’ equity of $98.5 million. Net income for the year ended December 31, 2018 was $8.6
million. At December 31, 2018, we had approximately 164 full-time equivalent employees.
Acquisition
On September 1, 2017, we acquired the Title Company by issuing common stock in a business combination. We issued 108,084
shares in the transaction valued at $775,000. We recorded $770,000 in goodwill in the transaction. The acquisition continues our
growth strategy and focus on being a full-service provider of financial services and complements the mortgage services,
commercial banking services, and commercial real estate services we provide.
Availability of Information
The Company makes available through the Investor Relations area of the Company website, at www.severnbank.com, annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. Access to these reports
1
Table of Contents
is provided by means of a link to a third-party vendor that maintains a database of such filings. In general, the Company intends
that these reports be available as soon as practicable after they are filed with or furnished to the Securities and Exchange
Commission (“SEC”). Technical and other operational obstacles or delays caused by the vendor may delay their availability. The
SEC maintains a website (www.sec.gov) where these filings also are available through the SEC’s EDGAR system. There is no
charge for access to these filings through either the Company’s site or the SEC’s site. The information on the website listed above
is not and should not be considered part of this Annual Report on Form 10‑K and is not incorporated by reference in this
document.
Business of the Bank
The Bank was organized in 1946 in Baltimore, Maryland as Pompeii Permanent Building and Loan Association. It relocated to
Annapolis, Maryland in 1980 and its name was changed to Severn Savings Association. Subsequently, the Bank obtained a
federal charter and changed its name to Severn Savings Bank, FSB. The Bank operates six full-service branch offices and one
administrative office, all in Anne Arundel County, Maryland. The Bank operates as a federally chartered savings bank whose
principal business is attracting deposits from the general public and investing those funds in mortgage and commercial loans. The
Bank also uses advances, or loans, from the Federal Home Loan Bank of Atlanta, (“FHLB”) to fund its lending activities. The
Bank provides a wide range of personal and commercial banking services. Personal services include mortgage lending and
various other lending services as well as checking, savings, money market, time deposit, and individual retirement accounts, as
well as Internet and mobile banking. Commercial services include commercial secured and unsecured lending services as well as
business Internet banking, corporate cash management services, and deposit services. The Bank also provides safe deposit boxes,
ATMs, debit cards, credit cards, personal Internet banking including on-line bill pay, and telephone banking, among other
products and services.
Revenues are derived principally from interest earned on mortgage, commercial, and other loans, and fees charged in connection
with the loans and banking services. The Bank’s primary sources of funds are deposits, advances from the FHLB, proceeds from
loans sold on the secondary market, sales and maturities of securities, and repayments and principal prepayment of loans. The
principal executive offices of the Bank are maintained at 200 Westgate Circle, Suite 200, Annapolis Maryland, 21401 and the
telephone number is 410‑260‑2000.
Medical-Use Cannabis Related Business
In 2017, we began providing banking services to customers that are licensed by the state of Maryland to do business in the
medical-use cannabis industry as growers, processors, and dispensaries. Medical-use cannabis businesses are legal in the State of
Maryland. We maintain stringent written policies and procedures related to the on-boarding of such businesses and to the
monitoring and maintenance of such business accounts.
We do a deep upfront due diligence review of a medical-use cannabis business before the business is on-boarded, including a site
visit and confirmation that the business is properly licensed by the state of Maryland. Throughout the relationship, we continue
monitoring the business, including site visits, to ensure that the medical-use cannabis business continues to meet our stringent
requirements, including maintenance of required licenses. We perform periodic financial reviews of the business and monitor the
business in accordance with Bank Secrecy Act (“BSA”) and State Commission requirements.
Following is a summary of the level of business activities with our medical-use cannabis customers:
· Deposit and loan balances at December 31, 2018 were approximately $17.0 million, or 2.2% of total deposits, and $14.1
million, or 2.1% of total loans, respectively. Deposit and loan balances at December 31, 2017 were approximately $19.2
million, or 3.2% of total deposits, and $11.9 million, or 1.8% of total loans, respectively.
·
·
Interest and noninterest income for the year ended December 31, 2018 were approximately $720,000 and $1.4 million,
respectively. Interest and noninterest income for the year ended December 31, 2017 were approximately $280,000 and
$230,000, respectively.
The volume of deposits accepted by these customers from the date of their license approval by the Maryland Medical
Cannabis Commission through December 31, 2018 was approximately $138.9 million. The volume of
2
Table of Contents
deposits accepted by these customers from the date of their license approval by the Maryland Medical Cannabis
Commission through December 31, 2017 was approximately $45.1 million.
Our Business Strategy
We are currently focused on growing assets and earnings by capitalizing on the network of Bank branches, mortgage offices, and
ATMs that we have established.
To continue asset growth and profitability, our business strategy is targeted to:
·
·
·
·
·
·
·
capitalize on our personal relationship approach that we believe differentiates us from our larger competitors;
provide our customers with access to local executives who make key credit and other decisions;
pursue commercial lending opportunities with small to mid-sized businesses that are underserved by our larger
competitors;
develop innovative financial products and services to generate additional sources of revenue;
cross-sell our products and services to our existing customers to leverage relationships and enhance our profitability;
expand our closely monitored medical-use cannabis customer base; and
adhere to rigorous credit standards to maintain good quality assets as we implement our growth strategy.
Our Lending Activities
We originate loans of all types, including residential mortgage, commercial, commercial mortgage, home equity, residential
construction, commercial construction, land, and residential lot loans.
We originate residential mortgage loans that are to be held in our loan portfolio as well as loans that are intended for sale in the
secondary market. Loans sold in the secondary market are primarily sold to investors with which the Bank maintains a
correspondent relationship. These loans are made in conformity with standard government-sponsored enterprise (“GSE”)
underwriting criteria required by the investors to assure maximum eligibility for possible resale in the secondary market and are
approved either by the Bank’s underwriter or the correspondent’s underwriter. Loans considered for our portfolio with borrowers
that have lending relationships up to $250,000 are approved by any member of the Officers Loan Committee, which includes the
Chief Executive Officer (“CEO”), the Chief Operating Officer, the Chief Financial Officer (“CFO”), the Chief Credit Officer, and
the Chief Lending Officer. Loans considered for our portfolio with balances from $250,000 to $2.0 million are approved by a
majority vote of the Officers Loan Committee. Loans considered for our portfolio with borrowers that have lending relationships
of $2.0 million or greater are approved by the Bank’s Directors Loan Committee. Meetings of the Directors Loan Committee are
open to attendance by any member of the Bank’s Board of Directors who wishes to attend. The loan committee reports to and
consults with the Board of Directors in interpreting and applying our lending policy. Single loans greater than $3.0 million, or
loans to one borrower aggregating more than $5.0 million, up to $18.4 million (the maximum amount of loans to one borrower as
of December 31, 2018), must also have approval of the Board of Directors.
Loans that are sold into the secondary market are typically residential long-term loans (15 or more years), generally with fixed
rates of interest. Loans retained for our portfolio typically include construction loans, commercial loans, and loans that
periodically reprice or mature prior to the end of an amortized term. Generally, loans are sold with servicing released, however
for loans sold to the Federal National Mortgage Association (“FNMA”) or the Federal Home Loan Mortgage Corporation
(“FHLMC”), the servicing rights have been retained. As of December 31, 2018, the Bank was servicing $29.4 million in loans for
FNMA and $15.1 million in loans for FHLMC.
Our lending activities are subject to written policies approved by our Board of Directors to ensure proper management of credit
risk. We make loans that are subject to a well-defined credit process that includes credit evaluation of borrowers, risk-rating of
credits, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and
the maintenance of compensating balances, as well as procedures for on-going identification and management of credit
deterioration. We conduct regular portfolio reviews to identify potential under-performing credits, estimate loss exposure,
geographic and industry concentrations, and to ascertain compliance with our policies. For
3
Table of Contents
significant problem loans, we review and evaluate the financial strengths of our borrower and the guarantor, the related collateral
and the effects of economic conditions.
We generally do not make loans to be held in our loan portfolio outside our market area unless the borrower has an established
relationship with us and conducts its principal business operations within our market area. Consequently, we and our borrowers
are affected by the economic conditions prevailing in our market area.
Loan Approval Process
Our loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy
of the value of the collateral that will secure the loan. The authority of the Directors Loan Committee to approve loans is
established by the Board of Directors and currently is commensurate with the limitation on loans to one borrower. Our maximum
amount of loans to one borrower is equal to 15% of the Bank’s unimpaired capital, or $18.4 million as of December 31, 2018.
Loans greater than this amount require participation by one or more additional lenders. We also maintain an in-house loans-to-
one-borrower limit (lending relationship) of $10.0 million. Any loan greater than $10.0 million requires Board of Director
approval. Letters of credit are subject to the same limitations as direct loans. For real estate collateral, we utilize independent
qualified appraisers approved by management to appraise the collateral securing the loan and require title insurance or title
opinions so as to ensure that we have a valid lien on the collateral. We require borrowers to maintain fire and casualty insurance
on secured real estate.
The procedure for approval of construction loans is the same as above, except that the appraiser evaluates the building plans,
construction specifications, and estimates of construction costs as well. The Bank also evaluates the feasibility of the proposed
construction project and the experience and track record of the developer.
Consumer loans are underwritten on the basis of the borrower’s credit history and an analysis of the borrower’s income and
expenses, ability to repay the loan, and the value of the collateral, if any.
Residential Mortgage Loans
At December 31, 2018, our residential mortgage loan portfolio totaled $274.8 million, or 40.3% of our loan portfolio. All of our
residential mortgage loans are secured by one-to-four family residential properties and are primarily located in the Bank’s market
area.
Commercial Loans
The Bank offers other business and commercial loans. These are loans to businesses and are typically lines of credit or other loans
that , in general, are not secured by real estate. If not secured by real estate, they are usually secured by business assets, including
accounts receivable, inventory, equipment, securities, or other collateral. At December 31, 2018, $35.9 million, or 5.2% of our
loan portfolio, consisted of commercial loans.
Commercial loans generally involve a greater degree of risk than residential mortgage loans. Because payments on commercial
loans secured by business assets or other collateral are often dependent on the successful operation or management of the
commercial enterprise, repayment of these loans may be subject to a greater extent to adverse conditions in the economy.
Commercial Real Estate Loans
At December 31, 2018, our commercial real estate loan portfolio totaled $242.7 million, or 35.6% of our loan portfolio. All of our
commercial real estate loans are secured by improved property such as office buildings, retail strip shopping centers, industrial
condominium units, and other small businesses, most of which are located in the Bank’s primary lending area.
Loans secured by commercial real estate properties generally involve a greater degree of risk than residential mortgage loans.
Because payments on loans secured by commercial real estate properties are often dependent on the successful
4
Table of Contents
operation or management of the properties, repayment of these loans may be subject to a greater extent to adverse conditions in
the real estate market or the economy.
Construction, Land Acquisition, and Development Loans (“ADC”)
We originate loans to finance the construction of one-to-four family dwellings, and to a lesser extent, commercial real estate. We
also originate loans for the acquisition and development of unimproved property to be used for residential and/or commercial
purposes, generally in cases where the Bank is to provide the construction funds to improve the properties. As of
December 31, 2018, we had ADC loans outstanding in the amount of $114.5 million, or 16.8% of our loan portfolio.
Construction loan amounts are based on the appraised value of the property. Construction loans generally have terms of up to
one year, with reasonable extensions as needed, and typically have interest rates that float monthly at margins ranging from the
prime rate to 200 basis points above the prime rate. In addition to builders’ projects, we finance the construction of single-family,
owner-occupied homes where qualified contractors are involved and on the basis of strict written underwriting and construction
loan guidelines. Construction loans are structured either to be converted to permanent loans with the Bank upon the expiration of
the construction phase or to be paid off by financing from another financial institution.
Construction loans afford the Bank the opportunity to increase the interest rate sensitivity of the loan portfolio and to receive
yields higher than those obtainable on loans secured by existing residential properties. These higher yields correspond to the
higher risks associated with construction lending. Construction loans involve additional risks attributable to the fact that loan
funds are advanced upon the security of the project under construction that is of uncertain value prior to its completion. Because
of the uncertainties inherent in estimating construction costs as well as the market value of the completed project and the effects
of governmental regulation of real property, it is relatively difficult to value accurately the total funds required to complete a
project and the related loan-to-value ratio (“LTV”). As a result, construction lending often involves the disbursement of
substantial funds with repayment dependent, in part, on the ultimate success of the project rather than the ability of the borrower
or guarantor to repay principal and interest. If we are forced to foreclose on a project prior to or at completion, due to a default,
there can be no assurance that we will be able to recover all of the unpaid balance of the loan as well as related foreclosure and
holding costs. In addition, we may be required to fund additional amounts to complete the project and may have to hold the
property for an unspecified period of time. We have attempted to address these risks through our underwriting procedures and our
limited amount of construction lending on multi-family and commercial real estate properties.
It is our policy to obtain third-party physical inspections of each property secured by a construction or rehabilitation loan for the
purpose of reporting upon the progress of the project. These inspections, referred to as “construction draw inspections,” are to be
performed at the time of a request for an advance of construction funds.
Home Equity and Other Consumer Loans
We offer various consumer loans including home equity loans, home equity lines of credit, and other personal loans. At
December 31, 2018, $14.5 million, or 2.1% of our loan portfolio consisted of consumer loans. The majority of consumer loans
are home equity lines of credit.
Our Deposit Activities
Subject to the Company’s Asset/Liability Committee (“ALCO”) policies and current business plan, the Treasury function (see
information on Treasury activities below) works closely with the Company’s retail deposit operations to accomplish the
objectives of maintaining deposit market share within the Company’s primary markets and managing funding costs to preserve
the net interest margin.
One of the Company’s primary objectives as a community bank is to develop long-term, multi-product customer relationships
from its comprehensive menu of financial products, which include both interest-bearing and noninterest-bearing checking
accounts, savings accounts, money market accounts, and certificates of deposit (“CDs”). To that end, the
5
Table of Contents
lead product to develop such relationships is typically a deposit product. The Company intends to rely on deposit growth to fund
long-term loan growth.
Core deposits are deposits that provide stable funding sources and are generally not reactive to changes in the interest rate
environment. We consider all deposits, except CDs of $100,000 or more to be core deposits. Our experience has been that a
substantial portion of CDs renew at time of maturity and remain on deposit with the Bank. Core deposits amounted to $635.8
million, or 81.6% of total deposits, and $452.1 million, or 75.1% of total deposits, at December 31, 2018 and 2017, respectively.
Our Treasury Activities
The Treasury function manages the wholesale segments of the balance sheet, including investments, purchased funds and long-
term debt, and is responsible for all facets of interest rate risk management for the Company, which includes the pricing of
deposits consistent with conservative interest rate risk and liquidity practices. Management’s objective is to achieve the maximum
level of consistent earnings over the long term, while minimizing interest rate risk, credit risk, and liquidity risk and optimizing
capital utilization. In managing the investment portfolio under its stated objectives, we invest primarily in United States of
America (“U.S.”) Treasury and Agency securities, U.S Agency mortgage-backed securities (“MBS”), and U.S. Agency
Collateralized Mortgage Obligations (“CMO”). Treasury strategies and activities are overseen by the Risk Committee of the
Board of Directors, ALCO and the Company’s Investment Committee, which reviews all investment and funding transactions.
The ALCO activities are summarized and reviewed quarterly with the Company’s Board of Directors.
The primary objective of the investment portfolio is to provide the necessary liquidity consistent with anticipated levels of deposit
funding and loan demand with a minimal level of risk. The overall average life of 2.4 years of the investment portfolio together
with the types of investments is intended to provide sufficient cash flows to support the Company’s lending goals. Liquidity is
also provided by lines of credit maintained with the FHLB, the Federal Reserve (“FRB”), and to a lesser extent, lines of credit
from other banks.
Our Borrowing Activities
Management utilizes a variety of sources to raise borrowed funds at competitive rates, including federal funds purchased, FHLB
borrowings, and retail repurchase agreements. FHLB borrowings typically carry rates at varying spreads from the LIBOR rate or
treasury yield curve for the equivalent term because they may be secured with investments or high quality loans. Federal funds
purchased, which are generally overnight borrowings, are typically purchased at the FRB target rate.
The Company’s borrowing activities are achieved through the use of the previously mentioned lines of credit to address overnight
and short-term funding needs, match-fund loan activity and, when opportunities are present, to lock in attractive rates due to
market conditions.
Competition
The Annapolis, Maryland area has a high density of financial institutions, many of which are significantly larger and have greater
financial resources than the Bank, and all of which are competitors of the Bank to varying degrees. Competition for loans comes
primarily from savings and loan associations, savings banks, mortgage-banking companies, insurance companies, commercial
banks, and Internet-based financial institutions. Many of our competitors have higher legal lending limits than we do. Our most
direct competition for deposits has historically come from savings and loan associations, savings banks, commercial banks, and
credit unions. We face additional competition for deposits from short-term money market funds and other corporate and
government securities funds. We also face increased competition for deposits from other financial institutions such as brokerage
firms, insurance companies, and mutual funds, as well as Internet-based financial institutions. We are a community-oriented
financial institution serving our market area with a wide selection of mortgage loans and other consumer and commercial
financial products and services. Management considers the Bank’s reputation for financial strength and customer service as its
major competitive advantage in attracting and retaining customers in our market area. We also believe we benefit from our
community engagement activities.
6
Table of Contents
Market Area
Our market area is primarily Anne Arundel County, Maryland and nearby areas, and our six branch locations are all located in
Anne Arundel County. Anne Arundel county maintains a diverse set of economic drivers such as a large international airport, the
defense industry, a large number of large private sector employers as well as telecommunications, retail, and distribution
operations. The population of Anne Arundel County has been growing steadily since 2000 and is projected to continue such
growth through 2020. The largest population demographic of Anne Arundel County is in the 20-44 age category.
We continue to expand our business relationship banking program by focusing on the needs of the business community in Anne
Arundel County, Maryland. We focus our lending activities primarily on first mortgage loans secured by real estate for the
purpose of purchasing, refinancing, developing, and constructing one-to-four family residences and commercial properties in and
near Anne Arundel County, Maryland. We strive to offer competitive deposit and loan products that fit the needs of the Anne
Arundel County community. Our desire is to be a one-stop shop for all of the community’s banking needs.
Supervision and Regulation
The Company and its subsidiaries operate in an industry that is subject to laws and regulations that are enforced by a number of
federal and state agencies. Changes in these laws and regulations, including interpretation and enforcement activities, could
impact the cost of operating in the financial services industry, limit or expand permissible activities, or affect competition among
banks and other financial institutions.
Regulation of the Company
General
We are a unitary savings and loan holding company within the meaning of the Home Owners’ Loan Act (“HOLA”). As such, we
are registered with the FRB and are subject to regulations, examinations, supervision, and reporting requirements applicable to
savings and loan holding companies. In addition, the FRB has enforcement authority over us and any nonsavings bank
subsidiaries. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a
serious risk to the subsidiary savings institution.
As a unitary savings and loan holding company, we generally are not subject to activity restrictions, provided the Bank satisfies
the Qualified Thrift Lender (“QTL”) test (see “ Qualified Thrift Lender Test” under “Regulation of the Bank” below). If the Bank
failed to meet the QTL test, then we would become subject to the activities restrictions applicable to multiple savings and loan
holding companies and, unless the Bank qualifies as a QTL within one year thereafter, we would be required to register as, and
would become subject to the restrictions applicable to, a bank holding company. Additionally, if we acquired control of another
savings institution, other than in a supervisory acquisition where the acquired institution also met the QTL test, we would
thereupon become a multiple savings and loan holding company and thereafter be subject to further restrictions on our activities.
We currently intend to continue to operate as a unitary savings and loan holding company.
Regulatory Capital Requirements
Under capital regulations adopted pursuant to the Dodd-Frank Act, savings and loan holding companies became subject to
additional regulatory capital requirements. However, in May 2015, amendments to the FRB’s small bank holding company policy
statement (the “SBHC Policy”) became effective. The amendments made the SBHC Policy applicable to savings and loan holding
companies such as us and increased the asset threshold to qualify to be subject to the provisions of the SBHC Policy from $500.0
million to $1.0 billion. In August, 2018, the SBHC Policy was increased to $3.0 billion in assets. Savings and loan holding
companies that have total assets of $3.0 billion or less are subject to the SBHC Policy and are not required to comply with the
additional regulatory capital requirements provided that such holding company (i) is not engaged in significant nonbanking
activities either directly or through a nonbank subsidiary; (ii) does not conduct significant off-balance sheet activities (including
securitization and asset management or administration) either directly or
7
Table of Contents
through a nonbank subsidiary; and (iii) does not have a material amount of debt or equity securities outstanding (other than trust
preferred securities) that are registered with the SEC. The FRB may in its discretion exclude any savings and loan holding
company, regardless of asset size, from the SBHC Policy if such action is warranted for supervisory purposes. The exemption
continues until our total assets exceed $3.0 billion, we do not meet the other requirements discussed above, or the FRB deems it
to be warranted for supervisory purposes.
Restrictions on Acquisitions
Except under limited circumstances, savings and loan holding companies, such as us, are prohibited from (i) acquiring, without
approval of the FRB, control of a savings institution or a savings and loan holding company or all or substantially all of the assets
of any such institution or holding company; (ii) acquiring, without prior approval of the FRB, more than 5% of the voting shares
of a savings institution or a holding company which is not a subsidiary thereof; or (iii) acquiring control of an uninsured
institution, or retaining, for more than one year after the date of any savings institution becomes uninsured, control of such
institution. In evaluating proposed acquisitions of savings institutions by holding companies, the FRB considers the financial and
managerial resources and future prospects of the holding company and the target institution, the effect of the acquisition on the
risk to the Federal Deposit Insurance Corporation (“FDIC”) fund, the convenience and the needs of the community, and
competitive factors.
No director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than
25% of such company’s stock, may acquire control of any savings institution, other than a subsidiary savings institution, or of any
other savings and loan holding company, without written approval of the FRB.
The FRB is prohibited from approving any acquisition that would result in a multiple savings and loan holding company
controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit
interstate savings and loan holding company acquisitions.
Federal Securities Law
The Company’s securities are registered with the SEC under the Securities Exchange Act of 1934, as amended. As such, we are
subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Securities Exchange
Act of 1934.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) established a broad range of corporate governance and accounting measures
intended to increase corporate responsibility and protect investors by improving the accuracy and reliability of disclosures under
federal securities laws. The Company is subject to Sarbanes-Oxley because it is required to file periodic reports with the SEC
under the Securities Exchange Act of 1934. Among other things, Sarbanes-Oxley regulations and related NASDAQ Stock Market
rules have established membership requirements and additional responsibilities for the Company’s audit committee, imposed
restrictions on the relationship between the Company and its outside auditors (including restrictions on the types of nonaudit
services the auditors may provide to the Company), imposed additional financial statement certification responsibilities for the
Company’s CEO and CFO, expanded the disclosure requirements for corporate insiders, required management to evaluate the
Company’s disclosure controls and procedures and its internal control over financial reporting, and required the Company’s
auditors to issue a report on its internal control over financial reporting.
Financial Services Modernization Legislation
In November 1999, the Gramm-Leach-Bliley Act of 1999 (“GLBA”) was enacted. The GLBA generally permits banks, other
depository institutions, insurance companies, and securities firms to enter into combinations that result in a single financial
services organization to offer customers a wider array of financial services and products provided that they do not pose a
substantial risk to the safety and soundness of depository institutions or the financial system in general.
8
Table of Contents
GLBA resulted in increased competition for the Company and the Bank from larger institutions and other types of companies
offering financial products, many of which may have substantially more financial resources than we do.
Maryland Corporation Law
We are incorporated under the laws of the State of Maryland, and are therefore subject to regulation by the state of Maryland. The
rights of our stockholders are governed by the Maryland General Corporation Law.
Tax Cuts and Jobs Act (“Tax Act”)
The Tax Act was enacted on December 22, 2017. Among other things, the new law (i) establishes a new, flat corporate federal
statutory income tax rate of 21%; (ii) eliminates the corporate alternative minimum tax and allows the use of any such
carryforwards to offset regular tax liability for any taxable year; (iii) limits the deduction for net interest expense incurred by U.S.
corporations; (iv) allows businesses to immediately expense, for tax purposes, the cost of new investments in certain qualified
depreciable assets; (v) eliminates or reduces certain deductions related to meals and entertainment expenses; (vi) modifies the
limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the
definition of a covered employee; and (vii) limits the deductibility of deposit insurance premiums. The Tax Act also significantly
changes U.S. tax law related to foreign operations, however, such changes do not currently impact us.
Regulation of the Bank
General
As a federally chartered, FDIC insured savings institution, the Bank is subject to extensive regulation, primarily by the Office of
the Comptroller of the Currency (“OCC”) and secondarily, by the FDIC. Lending activities and other investments of the Bank
must comply with various statutory and regulatory requirements. The Bank is also subject to certain reserve requirements
promulgated by the FRB. The OCC regularly examines the Bank and prepares reports for the consideration of the Bank’s Board
of Directors on the operations of the Bank. The relationship between the Bank and depositors and borrowers is also regulated by
federal and state laws, especially in such matters as the ownership of savings accounts and the form and content of mortgage
documents utilized by the Bank.
The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition, in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions.
The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018
On May 24, 2018, The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (the “Regulatory Relief Act”)
was enacted, which repeals or modifies certain provisions of the Dodd-Frank Act and eases regulations on all but the largest
banks. The Regulatory Relief Act’s provisions include, among other things: (i) exempting banks with less than $10 billion in
assets from the ability-to-repay requirements for certain qualified residential mortgage loans held in portfolio; (ii) not requiring
appraisals for certain transactions valued at less than $400,000 in rural areas; (iii) exempting banks that originate fewer than 500
open-end and 500 closed-end mortgages from the Home Mortgage Disclosure Act’s (“HMDA”) expanded data disclosures; (iv)
clarifying that, subject to various conditions, reciprocal deposits of another depository institution obtained using a deposit broker
through a deposit placement network for purposes of obtaining maximum deposit insurance would not be considered brokered
deposits subject to the FDIC’s brokered-deposit regulations; (v) raising eligibility for the 18-month exam cycle from $1 billion to
banks with $3 billion in assets; (vi) allowing qualifying federal savings banks to elect to operate with National Bank powers; and
(vii) simplifying capital calculations by requiring regulators to establish for institutions under $10 billion in assets a community
bank leverage ratio (tangible equity to average consolidated assets) at a percentage not less than 8% and not greater than 10% that
such institutions may elect to replace the general applicable risk-based capital requirements for determining well-capitalized
status.
9
Table of Contents
Regulatory Capital Requirements
Federal regulations require all FDIC insured depository institutions to meet several minimum capital standards: a common equity
Tier 1 capital to total risk-based assets ratio of 4.5%; a Tier 1 capital to total risk-based assets ratio of 6.0%, a total capital to total
risk-based assets ratio of 8%, a leverage ratio of 4%, and a tangible capital, measured as core capital (Tier 1 capital), to average
total assets ratio of 1.5%.
Common equity Tier 1 capital generally consists of common stock and related surplus, retained earnings, accumulated other
comprehensive gain/loss, and, subject to certain adjustments, minority common equity interests in subsidiaries, reduced by
goodwill and other intangible assets (other than certain mortgage servicing assets), net of associated deferred tax liabilities.
Tier 1 capital consists of the sum of common equity Tier 1 capital and additional Tier 1 capital. Additional Tier 1 capital
generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of
consolidated subsidiaries. Under the amendments, cumulative preferred stock no longer qualifies as additional Tier 1 capital.
Trust preferred securities and other nonqualifying capital instruments issued prior to May 19, 2010 by bank and savings and loan
holding companies with less than $15.0 billion in assets as of December 31, 2009 or by mutual holding companies may continue
to be included in Tier 1 capital but will be phased out over 10 years beginning in 2016 for all other banking organizations.
Total Capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus
meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory
convertible securities, intermediate preferred stock, and subordinated debt.
Tangible Capital means the amount of core capital (Tier 1 capital), plus the amount of outstanding perpetual preferred stock
(including related surplus) not included in Tier 1 capital.
Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, assets, including certain
off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, and residual interests) are multiplied by a risk-weight
factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for
asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government
securities, a risk weight of 50% is generally assigned to prudently underwritten first-lien residential mortgage loans, a risk weight
of 100% is assigned to first-lien residential mortgage loans not qualifying under the prudently underwritten standards as well as
commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans, a risk weight of 250% is assigned to
certain mortgage serving rights (“MSRs”), and a risk weight of between 0% to 600% is assigned to permissible equity interests,
depending on certain specified factors.
In addition to higher capital requirements, the amended regulations provide that depository institutions and their holding
companies are required to maintain a common equity Tier 1 capital conservation buffer of at least 2.5% of risk-weighted assets
over and above the minimum risk-based capital requirements. Institutions that do not maintain the required capital buffer will
become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used
for stock repurchases or for the payment of discretionary bonuses to senior executive management. The capital conservation
buffer requirement has been phased in over four years beginning on January 1, 2016 at 0.625% of risk-weighted assets, increasing
each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer requirement effectively raises the
minimum required risk-based capital ratios to 7% common equity Tier 1 capital, 8.5% Tier 1 capital, and 10.5% total capital on a
fully phased-in basis.
Notwithstanding the foregoing, pursuant to the Regulatory Relief Act, the OCC proposed a rule that establishes a community
bank leverage ratio (tangible equity to average total assets) at 9% for institutions under $10 billion in assets that such institutions
may elect to utilize in lieu of the general applicable risk-based capital requirements under Basel III. Such institutions that meet
the community bank leverage ratio and certain other qualifying criteria will automatically be
10
Table of Contents
deemed to be well-capitalized. Until the OCC’s proposed rule is finalized, the Basel III risk-based and leverage ratios remain in
effect.
In addition to requiring institutions to meet the applicable capital standards for savings institutions, the OCC may require
institutions to meet capital standards in excess of the prescribed standards as the OCC determines necessary or appropriate for
such institution in light of the particular circumstances of the institution. Such circumstances would include a high degree of
exposure to interest rate risk, concentration of credit risk, and certain risks arising from nontraditional activity. The OCC may
treat the failure of any savings institution to maintain capital at or above such level as an unsafe or unsound practice and may
issue a directive requiring any savings institution which fails to maintain capital at or above the minimum level required by the
OCC to submit and adhere to a plan for increasing capital.
Enforcement
The OCC has primary enforcement responsibility over federal savings institutions and has the authority to bring enforcement
action against the institution and all “institution-affiliated parties,” including stockholders, attorneys, appraisers, and accountants
who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal
enforcement actions by the OCC may range from issuance of a capital directive or a cease and desist order, to removal of officers
or directors of the institution and the appointment of a receiver or conservator. The FDIC also has the authority to terminate
deposit insurance or recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If
action is not taken by the OCC, the FDIC has authority to take action under specific circumstances.
Safety and Soundness Standards
Federal law requires each federal banking agency, including the OCC, to prescribe to certain standards relating to internal
controls, information and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset
growth, compensation, fees, and benefits. In general, the guidelines require, among other things, appropriate systems and
practices to identify and manage the risks and exposures specified in the guidelines. The guidelines further provide that savings
institutions should maintain safeguards to prevent the payment of compensation, fees, and benefits that are excessive or that could
lead to material financial loss, and should take into account factors such as comparable compensation practices at comparable
institutions. If the OCC determines that a savings institution is not in compliance with the safety and soundness guidelines, it may
require the institution to submit an acceptable plan to achieve compliance with the guidelines. A savings institution must submit
an acceptable compliance plan to the OCC within 30 days of receipt of a request for such a plan. If the institution fails to submit
an acceptable plan, the OCC must issue an order directing the institution to correct the deficiency. Failure to submit or implement
a compliance plan may subject the institution to regulatory sanctions.
Prompt Corrective Action
Under the prompt corrective action regulations, the OCC is required and authorized to take supervisory actions against
undercapitalized savings institutions. For this purpose, a savings institution is placed into one of the following five categories
dependent on their respective capital ratios:
· An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-
based capital ratio of 8.0% or greater, a common equity Tier 1 risk-based capital ratio of 6.5% or greater, and a leverage
ratio of 5.0% or greater.
· An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based
capital ratio of 6.0% or greater, a common equity Tier 1 risk-based capital ratio of 4.5% or greater, and a leverage ratio
of 4.0% or greater.
· An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital
ratio of less than 6.0%, a common equity Tier 1 risk-based capital ratio of less than 4.5%, or a leverage ratio of less than
4.0%.
11
Table of Contents
· An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a
Tier 1 risk-based capital ratio of less than 4.0%, a common equity Tier 1 risk-based capital ratio of less than 3.0%, or a
leverage ratio of less than 3.0%.
· An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the
regulations) to total assets that is equal to or less than 2.0%.
As noted above, the Regulatory Relief Act has eliminated the Basel III requirements for banks with less than $10.0 billion in
assets who elect to follow the community bank leverage ratio once the OCC’s rule is finalized. The OCC’s proposed rule provides
that the Bank will be well-capitalized with a community bank leverage ratio of 9% or greater, adequately capitalized with a
community bank leverage ratio of 7.5% or greater, undercapitalized if the Bank’s community bank leverage ratio is less than
7.5% and greater than 6% and significantly undercapitalized if the Bank’s community bank leverage ratio is less than 6%. The
definition of critically undercapitalized is unchanged from the current regulations.
Generally, the FDIC Improvement Act (“FDICIA”) requires the OCC to appoint a receiver or conservator for an institution within
90 days of that institution becoming “critically undercapitalized.” The regulation also provides that a capital restoration plan must
be filed with the OCC within 45 days after an institution receives notice that it is “undercapitalized,” “significantly
undercapitalized,” or “critically undercapitalized.” In addition, numerous mandatory supervisory actions become immediately
applicable to the institution, including, but not limited to, restrictions on growth, investment activities, payment of dividends and
other capital distributions, and affiliate transactions. The OCC may also take any one of a number of discretionary supervisory
actions against the undercapitalized institutions, including the issuance of a capital directive and, in the case of an institution that
fails to file a required capital restoration plan, the replacement of senior executive officers and directors.
As of December 31, 2018, the Bank met the capital requirements of a “well capitalized” institution under applicable OCC
regulations.
Premiums for Deposit Insurance
The deposits of the Bank are insured up to the applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC, generally up
to $250,000 per insured depositor. The Bank pays deposit insurance premiums based on assessment rates established by the
FDIC. The FDIC has established a risk-based assessment system under which institutions are classified and pay premiums
according to their perceived risk to the DIF. An institution’s base assessment rate is generally subject to the following
adjustments: (1) a decrease for the institution’s long-term unsecured debt, including most senior and subordinated debt; (2) an
increase for brokered deposits above a threshold amount; and (3) an increase for unsecured debt held that is issued by another
insured depository institution.
On April 1, 2011, as required by the Dodd-Frank Act, the deposit insurance assessment base changed from total domestic deposits
to average total assets, minus average tangible equity. In addition, the FDIC also created a two scorecard system, one for large
depository institutions that have $10.0 billion or more in assets and another for highly complex institutions that have $50.0 billion
or more in assets.
Pursuant to the Dodd-Frank Act, the FDIC has backup enforcement authority over a depository institution holding company, such
as us, if the conduct or threatened conduct of such holding company poses a risk to the DIF, although such authority may not be
used if the holding company is generally in sound condition and does not pose a foreseeable and material risk to the DIF.
The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s
financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any
applicable rule, regulation, order, or condition enacted or imposed by the institution’s regulatory agency. Additionally, the FDIC
has authority to increase insurance assessments. The termination of deposit insurance for the Bank or an increase in the Bank’s
insurance assessments could have a material adverse effect on our earnings.
12
Table of Contents
Privacy
The Bank is subject to the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial
records and prescribes procedures for complying with administrative subpoenas of financial records. Additionally, GLBA places
limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Pursuant to
GLBA and rules adopted thereunder, financial institutions must provide an initial notice to customers about their privacy policies,
describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and
affiliates.
Since GLBA’s enactment, a number of states have implemented their own versions of privacy laws. The Bank has implemented
its privacy policies in accordance with all applicable laws.
Qualified Thrift Lender Test
Savings institutions must meet a QTL test, which may be met either by maintaining, on average, at least 65% of its portfolio
assets in qualified thrift investments in at least nine of the most recent twelve month period, or meeting the definition of a
“domestic building and loan association” as defined in the Code. “Portfolio Assets” generally means total assets of a savings
institution, less the sum of (i) specified liquid assets up to 20% of total assets; (ii) goodwill and other intangible assets; and
(iii) the value of property used in the conduct of the savings institution’s business. Qualified thrift investments are primarily
residential mortgages and related investments, including certain mortgage‑related securities. Institutions that fail to meet the QTL
test are subject to OCC enforcement action for a violation of law. As of December 31, 2018, the Bank was in compliance with its
QTL requirement and met the definition of a domestic building and loan institution.
Affiliate Transactions
Transactions between savings institutions and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act as
made applicable to savings institutions by Section 11 of the HOLA. A savings institution affiliate includes any company or entity
which controls the savings institution or that is controlled by a company that controls the savings institution. For example, the
holding company of a savings institution and any companies which are controlled by such holding company, are affiliates of the
savings institution. Generally, Section 23A limits the extent to which the savings institution or its subsidiaries may engage in
“covered transactions” with any one affiliate to an amount equal to 10% of such institution’s capital stock and surplus, as well as
contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus.
Section 23B applies to “covered transactions,” as well as certain other transactions and requires that all transactions be on terms
substantially the same, or at least as favorable, to the savings institution as those provided to a nonaffiliate. “Covered transaction”
include the making of loans to, purchase of assets from, and issuance of a guarantee to an affiliate and similar transactions.
Section 23B transactions also include the provision of services and the sale of assets by a savings institution to an affiliate. In
addition to the restrictions imposed by Sections 23A and 23B, Section 11 of HOLA prohibits a savings institution from (i) making
a loan or other extension of credit to an affiliate, except for any affiliate which engages only in certain activities which are
permissible for bank holding companies or (ii) purchasing or investing in any stocks, bonds, debentures, notes, or similar
obligations of any affiliate, except for affiliates which are subsidiaries of the savings institution.
The Bank’s authority to extend credit to executive officers, directors, trustees, and 10% stockholders, as well as entities under
such person’s control, is currently governed by Section 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated
by the FRB. Among other things, these regulations generally require such loans to be made on terms substantially similar to those
offered to unaffiliated individuals, place limits on the amounts of the loans the Bank may make to such persons based, in part, on
the Bank’s capital position, and require certain board of directors’ approval procedures to be followed.
Capital Distribution Limitations
OCC regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to
repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger, and other
distributions charged against capital.
13
Table of Contents
The OCC regulations require a savings institution to file an application for approval of a capital distribution if:
·
·
·
·
the institution is not eligible for expedited treatment of its filings with the OCC;
the total amount of all of capital distributions, including the proposed capital distribution, for the applicable
calendar year exceeds net income for that year to date plus retained net income for the preceding two years;
the institution would not be at least adequately capitalized, as determined under the capital requirements described above
under “ Prompt Corrective Action ,” following the distribution; or
the proposed capital distribution would violate any applicable statute, regulation, or regulatory agreement or condition.
In addition, a savings institution must give the OCC notice of a capital distribution if the savings institution is not required to file
an application, but:
·
·
· would not be well capitalized, as determined under the capital requirements described above under “ Prompt Corrective
Action ,” following the distribution;
the proposed capital distribution would reduce the amount of or retire any part of the savings institution’s common or
preferred stock or retire any part of debt instruments such as notes or debentures included in capital, other than regular
payments required under a debt instrument; or
the savings institution is a subsidiary of a savings and loan holding company, is filing a notice of the distribution with the
FRB and is not otherwise required to file an application or notice regarding the proposed distribution with the OCC, in
which case an information copy of the notice filed by the holding company with the FRB needs to be simultaneously
provided to the OCC.
Further, any savings institution subsidiary of a savings and loan holding company, such as the Bank, also must file a notice with
the FRB of any proposed dividend or distribution.
The application or notice, as applicable, must be filed with the regulators at least 30 days before the proposed declaration of
dividend or approval of the proposed capital distribution by its board of directors.
The OCC or FRB may prohibit a proposed dividend or capital distribution that would otherwise be permitted if it determines that:
·
·
·
following the distribution, the savings institution will be undercapitalized, significantly undercapitalized, or critically
undercapitalized, as determined under the capital requirements described above under “ Prompt Corrective Action ;”
the proposed distribution raises safety or soundness concerns; or
the proposed capital distribution would violate any applicable statute, regulation, or regulatory agreement or condition.
In addition, as noted above, beginning in 2016, if the Bank does not have the required capital conservation buffer under the
amended capital rules, its ability to pay dividends to the Company may be limited. See “Regulation of the Bank - Prompt
Corrective Action” above for additional information on the capital conservation buffer.
Branching
Under OCC branching regulations, the Bank is generally authorized to open branches in any state of the U.S. (i) if the Bank
qualifies as a “domestic building and loan association” under the Code, which qualification requirements are similar to those for a
QTL under HOLA or (ii) if the law of the state in which the branch is located, or is to be located, would permit establishment of
the branch if the savings institution were a state savings institution chartered by such state. The OCC authority preempts any state
law purporting to regulate branching by federal savings banks.
14
Table of Contents
Community Reinvestment Act (“CRA”) and the Fair Lending Laws
Federal savings banks have a responsibility under the CRA and related regulations of the OCC to help meet the credit needs of
their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the
Fair Housing Act prohibits lenders from discriminating in their lending practices on the basis of characteristics specified in those
statutes. An institution’s failure to comply with the provisions of the CRA could, at a minimum, result in regulatory restrictions
on its activities and the denial of applications. In addition, an institution’s failure to comply with the Equal Credit Opportunity
Act and the Fair Housing Act could result in the OCC, other federal regulatory agencies, as well as the Department of Justice,
taking enforcement actions. We received a satisfactory rating from our most recent examination.
FHLB System
The Bank is a member of the FHLB. Among other benefits, each FHLB serves as a reserve or central bank for its members within
its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB
makes available loans or advances to its members in compliance with the policies and procedures established by the Board of
Directors of the individual FHLB.
Under the capital plan of the FHLB, as of December 31, 2018, the Bank was required to own at least $3.7 million of the capital
stock of the FHLB. As of such date, we were in compliance with the capital plan requirements.
Federal Reserve System
The FRB requires all depository institutions to maintain noninterest-bearing reserves at specified levels against their transaction
accounts (primarily checking, NOW, and Super NOW checking accounts) and nonpersonal time deposits. For transaction
accounts, the first $15.5 million is exempt from reserve requirements. A 3% reserve ratio is assessed on transaction accounts over
$15.5 million up to and including $115.1 million. A 10% reserve ratio is assessed on transaction accounts in excess of $115.1
million. At December 31, 2018, we were in compliance with the reserve requirements.
Effective January 1, 2019, the $15.5 million exemption will increase to $16.3 million. The 3% reserve ratio will be assessed on
transactions over $16.3 million up to $124.2 million. Any transactions that exceed $124.2 million will be assessed $3.2 million
plus 10% of the amount over $124.2 million. Nonpersonal time deposits will have a 0% reserve.
Activities of Subsidiaries
A federal savings bank seeking to establish a new subsidiary, acquire control of an existing company, or conduct a new activity
through an existing subsidiary must provide 30 days prior notice to the OCC and conduct any activities of the subsidiary in
compliance with regulations and orders of the OCC. The OCC has the power to require a savings institution to divest any
subsidiary or terminate any activity conducted by a subsidiary that the OCC determines to pose a serious threat to the financial
safety, soundness, or stability of the savings institution or to be otherwise inconsistent with sound banking practices.
Tying Arrangements
Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other services, or fixing
or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional
service from the institution or its affiliates or not obtain services of a competitor of the institution.
U.S. Patriot Act (“Patriot Act”)
Anti-terrorism legislation enacted under the Patriot Act of 2001 expanded the scope of anti-money laundering laws and
regulations and imposed significant new compliance obligations for financial institutions, including the Bank. The Patriot Act
gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing, and broadened anti-money laundering requirements. By way of amendments
to the BSA, Title III of the Patriot Act takes measures intended to encourage information sharing
15
Table of Contents
among bank regulatory agencies and law enforcement bodies. Further, these regulations impose affirmative obligations on a wide
range of financial institutions to maintain appropriate policies, procedures, and controls to detect, prevent, and report money
laundering and terrorist financing.
Other Regulations
Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning
interest rates. The Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:
Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
·
· Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one-to-four family residential
real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing, and escrow
account practices, and prohibiting certain practices that increase the cost of settlement services;
· HMDA, requiring financial institutions to provide information to enable the public and public officials to determine
whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and
withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines
and other electronic banking services;
·
·
·
· Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital
check images and copies made from that image, the same legal standing as the original paper check; and
rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
·
In addition, the Consumer Financial Protection Bureau issues regulations and standards under these federal consumer protection
laws that affect our consumer loan transactions. These include regulations setting “ability to repay” and “qualified mortgage”
standards for residential mortgage loans and mortgage loan servicing and originator compensation standards.
ITEM 1A RISK FACTORS
We provide banking services to customers who do business in the medical-use cannabis industry and the strict
enforcement of federal laws regarding medical-use cannabis would likely result in our inability to continue to provide
banking services to these customers and we could have legal action taken against us by the federal government.
We have deposit and loan customers that are licensed by the state of Maryland to do business in the medical-use cannabis
industry as growers, processors, and dispensaries. While medical-use cannabis is legal in the state of Maryland, it remains
classified as a Schedule I controlled substance under the Federal Controlled Substances Act (“CSA”). As such, the cultivation,
use, distribution and possession of marijuana is a violation of federal law that is punishable by imprisonment and fines. Moreover,
the U.S. Supreme Court ruled in USA v. Oakland Cannabis Buyers’ Coop. that the federal government has the authority to
regulate and criminalize cannabis, including medical marijuana.
In January 2018, the U.S. Department of Justice (“DOJ”) rescinded the “Cole Memo” and related memoranda which
characterized the enforcement of the CSA against persons and entities complying with state regulatory systems permitting the use,
manufacture and sale of medical marijuana as an inefficient use of their prosecutorial resources and discretion. The impact of the
DOJ’s recent rescission of the Cole Memo and related memoranda is unclear, but may result in the DOJ increasing its
enforcement actions against the regulated cannabis industry generally.
16
Table of Contents
The U.S. Congress previously enacted an omnibus spending bill that includes a provision prohibiting the DOJ and the U.S. Drug
Enforcement Administration from using funds appropriated by that bill to prevent states from implementing their medical-use
cannabis laws. This provision, however, expires September 30, 2019. Further, the U.S. Court of Appeals for the Ninth Circuit
held in USA v. McIntosh that this provision prohibits the DOJ from spending funds from relevant appropriations acts to prosecute
individuals who engage in conduct permitted by state medical-use cannabis laws and who strictly comply with such laws. There is
no guarantee that the U.S. Congress will extend this provision or that U.S. Federal courts located outside the Ninth Circuit will
follow the ruling in USA v. MacIntosh .
Federal prosecutors have significant discretion and there can be no assurance that the federal prosecutor for the District of
Maryland will not choose to strictly enforce the federal laws governing cannabis, including medical-use cannabis, or that the
federal courts in Maryland will follow the Ninth Circuit’s ruling in USA v. MacIntosh . Any change in the federal government’s
enforcement position, could cause us to immediately cease providing banking services to the medical-use cannabis industry in
Maryland.
Additionally, as the possession and use of cannabis remains illegal under the CSA, we may be deemed to be aiding and abetting
illegal activities through the services that we provide to these customers and could have legal action taken against us by the
Federal government, including imprisonment and fines. Any change in position or potential action taken against us could result in
significant financial damage to us and our stockholders.
The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) published guidelines in 2014 for
financial institutions servicing state legal cannabis business. A financial institution that provides services to a medical-use
cannabis related business can comply with BSA disclosure standards by following the FinCEN guidelines. Any adverse change in
this FinCEN guidance, any new regulations or legislation, any change in existing regulations or oversight, whether a change in
regulatory policy or a change in a regulator’s interpretation of a law or regulation, could have a negative impact on our interest
income and noninterest income, as well as the cost of our operations, increasing our cost of regulatory compliance and of doing
business, and/or otherwise affect us, which may materially affect our profitability.
Changes in interest rates could adversely affect our financial condition and results of operations.
The operations of financial institutions such as ours are dependent to a large degree on net interest income, which is the difference
between interest income from loans and investments and interest expense on deposits and borrowings. Our net interest income is
significantly affected by market rates of interest that in turn are affected by prevailing economic conditions, fiscal and monetary
policies of the federal government, and the policies of various regulatory agencies. Like all financial institutions, our balance
sheet is affected by fluctuations in interest rates. Volatility in interest rates can also result in disintermediation, which is the flow
of funds away from financial institutions into direct investments, such as U.S. Government bonds, corporate securities, and other
investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve
requirements, generally pay higher rates of return than those offered by financial institutions such as ours.
Sharply rising interest rates could disrupt domestic and world markets and could adversely affect the value of our investment
portfolio or our liquidity and results of operations. We expect to experience continual competition for deposit accounts which
may make it difficult to reduce the interest paid on some deposits.
During 2018, we experienced a slight rise in the interest rate environment. However, we believe that in the current market
environment, we have adequate policies and procedures for maintaining a conservative interest rate sensitive position. There is
no assurance that this condition will continue. A sharp movement up or down in deposit rates, loan rates, investment fund rates,
and other interest-sensitive instruments on our balance sheet could have a significant, adverse impact on our net interest income
and operating results.
Reforms to and uncertainty regarding LIBOR may adversely affect our business.
In 2017, a committee of private-market derivative participants and their regulators convened by the Federal Reserve, the ARRC,
was created to identify an alternative reference interest rate to replace LIBOR. The ARRC announced SOFR, a
17
Table of Contents
broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, as its preferred alternative to LIBOR.
The Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced its intention to
stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021.
Subsequently, the FRB announced final plans for the production of SOFR, which resulted in the commencement of its published
rates by the Federal Reserve Bank of New York on April 2, 2018. Whether or not SOFR attains market traction as a LIBOR
replacement tool remains in question and the future of LIBOR at this time is uncertain. The uncertainty as to the nature and effect
of such reforms and actions and the political discontinuance of LIBOR may adversely affect the value of and return on our
financial assets and liabilities that are based on or are linked to LIBOR, our results of operations or financial condition. In
addition, these reforms may also require extensive changes to the contracts that govern these LIBOR based products, as well as
our systems and processes.
Most of our loans are secured by real estate located in our market area. If there is a downturn in the real estate market,
additional borrowers may default on their loans and we may not be able to fully recover our investment in such loans.
A downturn in the real estate market could adversely affect our business because most of our loans are secured by real estate.
Substantially all of our real estate collateral is located in the states of Maryland, Virginia, and Delaware. Real estate values and
real estate markets are generally affected by changes in national, regional, or local economic conditions, fluctuations in interest
rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and
policies, and acts of nature.
In addition to the risks generally present with respect to mortgage-lending activities, our operations are affected by other factors
affecting our borrowers, including:
·
·
·
·
the ability of our customers to make loan payments;
the ability of our borrowers to attract and retain buyers or tenants, which may in turn be affected by local conditions such
as an oversupply of space or a reduction in demand for rental space in the area, the attractiveness of properties to buyers
and tenants, and competition from other available space, or by the ability of the owner to pay leasing commissions,
provide adequate maintenance and insurance, pay tenant improvements costs, and make other tenant concessions;
interest rate levels and the availability of credit to refinance loans at or prior to maturity; and
increased operating costs, including energy costs, real estate taxes, and costs of compliance with environmental controls
and regulations.
As of December 31, 2018, approximately 95% of the book value of our loan portfolio consisted of loans collateralized by various
types of real estate. If real estate prices decline, the value of real estate collateral securing our loans will be reduced. Our ability
to recover loans in default through the process of foreclosure and subsequent sale of the real estate collateral would then be
diminished and we would be more likely to incur financial losses on such loans.
In addition, approximately 52% of the book value of our loans consisted of ADC and commercial real estate loans, which present
additional risks described in “Item 1. Business – “ Lending Activities ” of this Annual Report on Form 10‑K.
Our loan portfolio exhibits a high degree of risk.
We have a significant amount of nonresidential loans, as well as construction and land loans granted on a speculative basis.
Although permanent single-family, owner-occupied loans currently represent the largest single component of assets and impaired
loans, we have a significant level of nonresidential loans, construction loans, and land loans that have an above-average risk
exposure.
At December 31, 2018 and December 31, 2017, our nonaccrual loans equaled $4.7 million and $5.7 million, respectively. For
the years ended December 31, 2018 and December 31, 2017, we recognized $289,000 and $(264,000) in net loan recoveries
(charge-offs), respectively. At December 31, 2018, the total allowance for loan losses (“Allowance”) was $8.0 million, which
was 1.18% of total loans, compared with $8.1 million, which was 1.21% of total loans, as of December 31, 2017.
18
Table of Contents
We are exposed to risk of environmental liabilities with respect to properties on which we take title.
In the course of our business, we may foreclose upon and take title to real estate and could be subject to environmental liabilities
with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal
injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be
required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with
investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated
site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental
contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial
condition, results of operations, and cash flows could be materially and adversely affected.
Our operations are located in Anne Arundel County, Maryland, which makes our business highly susceptible to local
economic conditions. An economic downturn or recession in this area may adversely affect our ability to operate
profitably.
Unlike larger banking organizations that are geographically diversified, our operations are concentrated in Anne Arundel County,
Maryland. In addition, nearly all of our loans have been made to borrowers in the states of Maryland, Virginia, and Delaware. As
a result of this geographic concentration, our financial results depend largely upon economic conditions in our market area. A
deterioration or recession in economic conditions in this market could result in one or more of the following:
·
·
·
·
·
a decrease in deposits;
an increase in loan delinquencies;
an increase in problem assets and foreclosures;
a decrease in the demand for our products and services; and
a decrease in the value of collateral for loans, especially real estate, and reduction in customers’ borrowing capacities.
Any of the foregoing factors may adversely affect our ability to operate profitably.
We are subject to federal and state regulation and the monetary policies of the FRB. Such regulation and policies can have
a material adverse effect on our earnings and prospects.
Our operations are heavily regulated and will be affected by present and future legislation and by the policies established from
time to time by various federal and state regulatory authorities. In particular, the monetary policies of the FRB have had a
significant effect on the operating results of banks in the past and are expected to continue to do so in the future. Among the
instruments of monetary policy used by the FRB to implement its objectives are changes in the discount rate charged on bank
borrowings and changes in the reserve requirements on bank deposits. It is not possible to predict what changes, if any, will be
made to the monetary policies of the FRB or to existing federal and state legislation or the effect that such changes may have on
our future business and earnings prospects.
The Dodd-Frank Act, among other things, has changed and will continue to change the bank regulatory framework. The
legislation has resulted in new regulations affecting the lending, funding, trading and investment activities of banks and bank
holding companies. An independent Consumer Financial Protection Bureau has assumed the consumer protection responsibilities
of the various federal banking agencies and has broad rule-making authority for a wide range of consumer protection laws that
apply to all banks and savings institutions such as the Bank, including the authority to prohibit "unfair, deceptive or abusive" acts
and practices. Banks and savings institutions with $10.0 billion or less in assets will continue to be examined by their applicable
bank regulators. The legislation also gives state attorneys general the ability to enforce applicable federal consumer protection
laws. The Dodd-Frank Act also required the federal banking agencies to promulgate rules requiring mortgage lenders to retain a
portion of the credit risk related to securitized loans. Bank regulatory agencies also have been responding aggressively to
concerns and adverse trends identified in examinations. These measures are likely to increase our costs of doing business and
increase our costs related to regulatory compliance, and may have a significant adverse effect on our lending activities, financial
performance and operating flexibility.
19
Table of Contents
If the Bank becomes “undercapitalized” as determined under the “prompt corrective action” initiatives of the federal bank
regulators, such regulatory authorities will have the authority to require the Bank to, among other things, alter, reduce, or
terminate any activity that the regulator determines poses an excessive risk to the Bank. The Bank could further be directed to
take any other action that the regulatory agency determines will better carry out the purpose of prompt corrective action. The
Bank could be subject to these prompt corrective action restrictions if federal regulators determine that the Bank is in an unsafe or
unsound condition or engaging in an unsafe or unsound practice.
We are subject to more stringent capital requirements, which may adversely impact our return on equity, require us to
raise additional capital, or constrain us from paying dividends or repurchasing shares.
Effective January 1, 2015, the OCC implemented a new rule that substantially amended the regulatory risk-based capital
rules applicable to the Bank. The rule implemented the Basel III regulatory capital reforms and changes required by the Dodd-
Frank Act. On May 24, 2018, the Regulatory Relief Act was enacted which repeals or modifies certain provisions of the Dodd-
Frank Act and eases regulations on all but the largest banks. See details of the capital rules under “ Supervision and Regulation ”
in Item 1 above.
The application of more stringent capital requirements for the Bank could, among other things, result in lower returns on equity,
require the raising of additional capital, and result in regulatory actions such as the inability to pay dividends or repurchase shares
if we were to be unable to comply with such requirements.
Our reliance on brokered deposits could adversely affect our liquidity and operating results.
Among other sources of funds, we rely on brokered deposits to provide funds with which to make loans and provide for other
liquidity needs. On December 31, 2018, brokered deposits totaled $10.2 million, or approximately 1.3% of total deposits. We
utilize a variety of sources for brokered deposits.
Generally, brokered deposits may not be as stable as other types of deposits. In the future, those depositors may not replace their
brokered deposits with us as they mature, or we may have to pay a higher rate of interest to keep those deposits or to replace them
with other deposits or other sources of funds. Not being able to maintain or replace those deposits as they mature would adversely
affect our liquidity. Paying higher deposit rates to maintain or replace brokered deposits would adversely affect our net interest
margin and operating results.
Income from mortgage-banking operations is volatile and we may incur losses with respect to our mortgage-banking
operations that could negatively affect our earnings.
A key component of our strategy is to sell on the secondary market the longer term, conforming fixed-rate residential mortgage
loans that we originate, earning noninterest income in the form of gains on the sale of the loans. When interest rates rise, the
demand for mortgage loans tend to fall and may reduce the number of loans we can originate for sale. Weak or deteriorating
economic conditions also tend to reduce loan demand. Although we sell, and intend to continue selling, most loans in the
secondary market with limited or no recourse, we are required, and will continue to be required, to give customary representations
and warranties to the buyers relating to compliance with applicable law. If we breach those representations and warranties, the
buyers will be able to require us to repurchase the loans and we may incur a loss on the repurchase.
We may be adversely affected by changes in economic and political conditions and by governmental monetary and fiscal
policies.
The banking industry is affected, directly and indirectly, by local, domestic, and international economic and political conditions,
and by governmental monetary and fiscal policies. Conditions such as inflation, recession, unemployment, volatile interest rates,
tight money supply, real estate values, international conflicts, and other factors beyond our control may adversely affect our
potential profitability. Any future rises in interest rates, while increasing the income yield on our earning assets, may adversely
affect loan demand and the cost of funds and, consequently, our profitability. Any future decreases in interest rates may adversely
affect our profitability because such decreases could reduce the amounts earned on our assets. Economic downturns have resulted
and may continue to result in the delinquency of outstanding loans. We
20
Table of Contents
do not expect any one particular factor to materially affect our results of operations. However, downtrends in several areas,
including real estate, construction, and consumer spending, have had and may continue to have, a material adverse impact on our
ability to remain profitable. Further, there can be no assurance that the asset values of the loans included in our loan portfolio, the
value of properties and other collateral securing such loans, or the value of real estate acquired through foreclosure will remain at
current levels.
Our stock price may be volatile due to limited trading volume.
Our common stock is traded on the NASDAQ Capital Market. However, the average daily trading volume in the Company’s
common stock has been relatively small. As a result, trades involving a relatively small number of shares may have a significant
effect on the market price of the common stock and it may be difficult for investors to acquire or dispose of large blocks of stock
without significantly affecting the market price.
We have established an Allowance based on management’s estimates. Actual losses could differ significantly from those
estimates. If the Allowance is not adequate, it could have a material adverse effect on our earnings and the price of our
common stock.
We maintain an Allowance, which is a reserve established through a provision for loan losses charged to expense, that represents
management’s best estimate of probable incurred losses within the existing portfolio of loans. The Allowance, in the judgment of
management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the Allowance
reflects management’s continuing evaluation of specific credit risks, loan loss experience, current loan portfolio quality, present
economic, political, and regulatory conditions, industry concentrations, and other unidentified losses inherent in the current loan
portfolio. The determination of the appropriate level of the Allowance inherently involves a high degree of subjectivity and
judgment and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material
changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of
additional problem loans, and other factors, both within and outside of our control, may require an increase in the Allowance.
In addition, bank regulatory agencies periodically review our Allowance and may require an increase in the provision for loan
losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in
future periods exceed the Allowance, we may need additional provisions to increase the Allowance. Furthermore, growth in the
loan portfolio would generally lead to an increase in the provision for loan losses.
Any increases in the Allowance will result in a decrease in net income and capital, and may have a material adverse effect on our
financial condition, results of operations, and cash flows.
We compete with a number of local, regional, and national financial institutions for customers.
We face strong competition from savings and loan institutions, banks, and other financial institutions that have branch offices or
otherwise operate in our market area, as well as many other companies now offering a range of financial services. Many of these
competitors have substantially greater financial resources and larger branch systems than us. In addition, many of our competitors
have higher legal lending limits than us. Particularly intense competition exists for sources of funds including savings and retail
time deposits, as well as for loans and other services we offer. In addition, over the last several years, the banking industry has
undergone substantial consolidation and this trend is expected to continue. Significant ongoing consolidation in the banking
industry may result in one or more large competitors emerging in our primary target market. The financial resources, human
capital, and expertise of one or more large institutions could threaten our ability to maintain our competitiveness.
We face intense competitive pressure on customer pricing, which may materially and adversely affect revenues and
profitability.
We generate net interest income and charge our customers fees based on prevailing market conditions for deposits, loans, and
other financial services. In order to increase deposit, loan, and other service volumes, enter new market segments, and expand our
base of customers and the size of individual relationships, we must provide competitive pricing for such
21
Table of Contents
products and services. In order to stay competitive, we have had to intensify our efforts around attractively pricing our products
and services. To the extent that we must continue to adjust our pricing to stay competitive, we will need to grow our volumes and
balances in order to offset the effects of declining net interest income and fee-based margins. Increased pricing pressure also
enhances the importance of cost containment and productivity initiatives and we may not succeed in these efforts.
Our brand, reputation, and relationship with our customers are key assets of our business and may be affected by how we
are perceived in the marketplace.
Our brand and its attributes are key assets of our business. The ability to attract and retain customers to our products and services
is highly dependent upon the external perceptions of us and the industry in which we operate. Our business may be affected by
actions taken by competitors, customers, third-party providers, employees, regulators, suppliers, or others that impact the
perception of the brand, such as creditor practices that may be viewed as “predatory,” customer service quality issues, and
employee relations issues. Adverse developments with respect to our industry may also, by association, impair our reputation, or
result in greater regulatory or legislative scrutiny.
The operations of our business, including our interaction with customers, are increasingly done via electronic means and
this has increased our risks related to cyber-attacks.
We are exposed to the risk of cyber-attacks in the normal course of business. In general, cyber incidents can result from deliberate
attacks or unintentional events. There has been an increased level of attention focused on cyber-attacks against large corporations
that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating cash, other
assets, or sensitive information, corrupting data, or causing operational disruption. Cyber-attacks may also be carried out in a
manner that does not require gaining unauthorized access, such as by causing denial-of-service attacks on websites. Cyber-attacks
may be carried out by third parties or insiders using techniques that range from highly sophisticated efforts to electronically
circumvent network security or overwhelm websites to more traditional intelligence gathering and social engineering aimed at
obtaining information necessary to gain access. The objectives of cyber-attacks vary widely and can include theft of financial
assets, intellectual property, or other sensitive information, including the information belonging to our banking customers. Cyber-
attacks may also be directed at disrupting our operations.
While we have not incurred any losses related to cyber-attacks, nor are we aware of any specific or threatened cyber-incidents as
of the date of this report, we may incur substantial costs and suffer other negative consequences if we fall victim to successful
cyber-attacks. Such negative consequences could include remediation costs that may include liability for stolen assets or
information and repairing system damage that may have been caused, increased cybersecurity protection costs that may include
organizational changes, deploying additional personnel and protection technologies, training employees, and engaging third-party
experts and consultants, lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract
customers following an attack, litigation, and reputational damage adversely affecting customer or investor confidence.
Our business is highly reliant on technology and our ability to manage the operational risks associated with technology.
We rely heavily on communications and information systems to conduct our business. Our business involves storing and
processing sensitive customer data. Any failure, interruption, or breach in security of these systems could result in theft of
customer data or failures or disruptions in our customer relationship management, general ledger, deposit, loan, data storage,
processing, and other systems. Our inability to access these information systems at critical points in time could unfavorably
impact the timeliness and efficiency of our business operations. In addition, we operate a number of money transfer and related
electronic, check, and other payment connections that are vulnerable to individuals engaging in fraudulent activities that seek to
compromise payments and related financial systems illegally. While we have policies and procedures designed to prevent or limit
the effect of the failure, interruption, or security breach of our information systems, there can be no assurance that failures,
interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of
any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of
customer business, subject us to additional regulatory scrutiny, result in
22
Table of Contents
increased expense to contain the event and/or require that we provide credit monitoring services for affected customers or expose
us to civil litigation and regulatory fines and sanctions, any of which could have a material adverse effect on our financial
condition and results of operations.
Our business is highly reliant on third-party vendors and our ability to manage the operational risks associated with
outsourcing those services.
We rely on third parties to provide services that are integral to our operations. These vendors provide services that support our
operations, including storage and processing of sensitive consumer date. A cyber-security breach of a vendor’s system may result
in theft of our data or disruption of business processes. A material breach of customer data at a service provider’s site may
negatively impact our business reputation and cause a loss of customer business, result in increased expense to contain the event
and/or require that we provide credit monitoring services for affected customers, result in regulatory fines and sanctions, and may
result in litigation. In most cases, we remain primarily liable to our customers for losses arising from a breach of a vendor’s data
security system. We rely on our outsourced service providers to implement and maintain prudent cyber-security controls. We
have procedures in place to assess a vendor’s cyber-security controls prior to establishing a contractual relationship and to
periodically review assessments of those control systems; however, these procedures are not infallible and a vendor’s system can
be breached despite the procedures we employ.
If our third-party providers experience financial, operational, or technological difficulties, or if there is any other disruption in our
relationships with them, we may be required to locate alternative sources of such services and we cannot ensure that we would be
able to negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing
systems, without the need to expend substantial resources, if at all.
We continually encounter technological change, and, if we are unable to develop and implement efficient and customer
friendly technology, we could lose business.
The financial services industry is continually undergoing rapid technological change, with frequent introductions of new
technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to
better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our
customers by using technology to provide products and services that will satisfy customer demands, as well as to achieve
additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological
improvements. We may not be able to effectively implement new technology-driven products and services or be successful in
marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the
financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of
operations.
Our success depends on our senior management team, and if we are not able to retain our senior management team, it
could have a material adverse effect on us.
We are highly dependent upon the continued services and experience of our senior management team, including Alan J. Hyatt,
our Chairman, President, and CEO. We depend on the services of Mr. Hyatt and the other members of our senior management
team to, among other things, continue the development and implementation of our strategies, and maintain and develop our
customer relationships. We do not have employment agreements with members of our senior management. If we are unable to
retain Mr. Hyatt and other members of our senior management team, our business could be materially and adversely affected.
If we fail to maintain an effective system of internal control over financial reporting and disclosure controls and
procedures, we may be unable to accurately report our financial results and comply with the reporting requirements
under the Securities Exchange Act of 1934. As a result, current and potential stockholders may lose confidence in our
financial reporting and disclosure required under the Securities Exchange Act of 1934, which could adversely affect our
business and stock price and could subject us to regulatory scrutiny.
Pursuant to Section 404 of Sarbanes-Oxley, referred to as Section 404, we are required to include in our Annual Reports on
Form 10‑K our management’s report on internal control over financial reporting. We are currently required to include
23
Table of Contents
an opinion of our independent registered public accounting firm as to our internal controls and, therefore, stockholders have the
benefit of such an independent review of our internal controls. Compliance with the requirements of Section 404 is expensive and
time-consuming. If we fail to complete this evaluation in a timely manner, or, our independent registered public accounting firm
cannot timely attest to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal
control over financial reporting. In addition, any failure to maintain an effective system of disclosure controls and procedures
could cause our current and potential stockholders and customers to lose confidence in our financial reporting and disclosures
required under the Securities Exchange Act of 1934, which could adversely affect our business and stock price.
Terrorist attacks and threats or actual war may impact all aspects of our operations, revenues, costs, and stock price in
unpredictable ways.
Terrorist attacks in the U.S. and abroad, as well as future events occurring in response to or in connection with them, including,
without limitation, future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the U.S. or its
allies, or military or trade disruptions, may impact our operations. Any of these events could cause consumer confidence and
savings to decrease or could result in increased volatility in the U.S. and worldwide financial markets and economy. Any of these
occurrences could have an adverse impact on our operating results, revenues, and costs and may result in the volatility of the
market price for our common stock and on the future price of our common stock.
There can be no assurance that we will pay dividends in the future.
Bank regulations govern and limit the payment of dividends and capital distributions to stockholders and purchases or redemption
by the Company of its stock. Although we paid dividends in 2018 and have declared a quarterly dividend payment for the first
quarter of 2019, this dividend policy will continue to be reviewed in light of future earnings, bank regulations, and other
considerations. No assurance can be given, therefore, that cash dividends on our common stock will be paid in the future.
Our 2035 Debentures contain restrictions on our ability to declare and pay dividends on or repurchase our common stock.
Under the terms of our Junior Subordinated Debt Securities due 2035, referred to as the 2035 Debentures, if (i) there has occurred
and is continuing an event of default; (ii) we are in default with respect to payment of any obligations under the related guarantee;
or (iii) we have given notice of our election to defer payments of interest on the 2035 Debentures by extending the interest
distribution period as provided in the indenture governing the 2035 Debentures and such period, or any extension thereof, has
commenced and is continuing, then we may not, among other things, declare or pay any dividends or distributions on, or redeem,
purchase, acquire, or make a liquidation payment with respect to, any of our capital stock, including our common stock. As of
December 31, 2018, we were current on all interest due on the 2035 Debentures.
An investment in our securities is not insured against loss.
Investments in our common stock are not deposits insured against loss by the FDIC or any other entity. As a result, an investor
may lose some or all of his, her, or its investment.
“Anti-takeover” provisions will make it more difficult for a third-party to acquire control of us, even if the change in
control would be beneficial to our equity holders.
Our charter presently contains certain provisions that may be deemed to be “anti-takeover” and “anti-greenmail” in nature in that
such provisions may deter, discourage, or make more difficult the assumption of control of us by another corporation or person
through a tender offer, merger, proxy contest, or similar transaction or series of transactions. For example, currently, our charter
provides that our Board of Directors may amend the charter, without stockholder approval, to increase or decrease the aggregate
number of shares of our stock or the number of shares of any class that we have authority to issue. In addition, our charter
provides for a classified Board, with each Board member serving a staggered three-year
24
Table of Contents
term. Directors may be removed only for cause and only with the approval of the holders of at least 75% of our common stock.
The overall effects of the “anti-takeover” and “anti-greenmail” provisions may be to discourage, make more costly or more
difficult, or prevent a future takeover offer, prevent stockholders from receiving a premium for their securities in a takeover offer,
and enhance the possibility that a future bidder for control of us will be required to act through arms-length negotiation with our
Board of Directors. These provisions may also have the effect of perpetuating incumbent management.
ITEM 1B UNRESOLVED STAFF COMMENTS
None.
ITEM 2 PROPERTIES
HS constructed a building in Annapolis, Maryland that serves as the Company’s and the Bank’s administrative headquarters. A
branch office of the Bank is also included in the building. The Company and the Bank lease their executive and administrative
offices from HS. In addition, HS leases space to four unrelated companies and to a law firm in which the President of the
Company and the Bank is a partner.
The Company has six retail branch locations in Anne Arundel County, Maryland (shown below), a mortgage loan office in
Frederick, Maryland, and also leases office space in Annapolis, Maryland from a third party. The leases are for various terms,
with the longest ending in 2035.
Headquarters Branch (1)
200 Westgate Circle
Annapolis, Maryland 21401
Annapolis Branch (1)
1917 West Street
Annapolis, Maryland 21401
Edgewater Branch (2)
3083 Solomon's Island Road
Edgewater, Maryland 21037
Glen Burnie Branch (1)
413 Crain Highway, S.E.
Glen Burnie, Maryland 21061
Lothian Branch (2)
5401 Southern Maryland Boulevard
Lothian, Maryland 20711
Severna Park Branch (2)
598 Benfield Road
Severna Park, Maryland 21146
Frederick Mortgage Office (2)
5291 Corporate Drive Ste. 202
Frederick, Maryland 21703
(1) Branch is owned by Company
(2) Branch/Office is leased by Company
Full Service Branch
Full Service Branch with drive-thru
Full Service Branch with drive-thru
Full Service Branch with drive-thru
Full Service Branch with drive-thru
Full Service Branch with drive-thru
Mortgage loan office
25
Table of Contents
ITEM 3 LEGAL PROCEEDINGS
At December 31, 2018, we were party to legal actions that are routine and incidental to our business. In management’s opinion,
the outcome of these matters, individually or in the aggregate, will not have a material effect on our results of operations or
financial position.
ITEM 4 MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of the Company is traded on the NASDAQ Capital Market under the symbol “SVBI.” As of March 8, 2019,
there were 173 stockholders of record of the Company’s common stock.
Equity Compensation Plan
The following table sets forth the securities authorized for issuance under the Company’s equity based compensation plans:
Plan Category
Equity compensation plan approved by security holders
Equity compensation plans not approved by security holders
Total
Number of
securities
Number of
securities to be
issued upon
exercise of
outstanding
and rights
options, warrants, options, warrants,
exercise price of
outstanding
Weighted-average remaining available
for future issuance
under equity
compensation
plans
and rights
349,023 $
—
349,023 $
6.32
—
6.32
—
—
—
The plan under which options are granted expired in March 2018 and no new plan had been approved as of December 31, 2018.
Dividend Policy
Federal banking regulations limit the amount of dividends that banking institutions may pay and may require prior approval or
non-objection from federal banking regulators before any dividends, capital distributions, or share redemptions can be made.
Our main source of income is dividends from the Bank. As a result, any dividends paid to our common shareholders depend
primarily upon regulatory approval and receipt of dividends from the Bank.
Previously, our ability to declare a dividend on our common stock was also limited by the terms of our Series A preferred stock.
We could not declare or pay any dividend on, make any distributions relating to, or redeem, purchase, acquire, or make a
liquidation payment relating to, or make any guarantee payment with respect to our common stock in any quarter until the
dividend on the Series A preferred stock had been declared and paid for such quarter, subject to certain minor exceptions.
Dividends on the Series A preferred stock have been declared and paid quarterly throughout 2017 and the first quarter of 2018 in
the amount of $70,000 each quarter. On March 13, 2018, the Company notified holders of its Series A preferred stock that the
Company would exercise its option to convert all 437,500 outstanding shares of Series A preferred stock for 437,500 shares of
common stock. The Company converted the Series A preferred stock on April 2, 2018 (“the Conversion Date”). As of the
Conversion Date, the Series A preferred stock was no longer deemed outstanding and all rights with respect to such stock ceased
and terminated.
Additionally, under the terms of the Company’s 2035 Debentures, if (i) there has occurred and is continuing an event of default;
(ii) the Company is in default with respect to payment of any obligations under the related guarantee; or (iii) the Company has
given notice of its election to defer payments of interest on the 2035 Debentures by extending the interest distribution period as
provided in the indenture governing the 2035 Debentures and such period, or any extension thereof, has commenced and is
continuing, then the Company may not, among other things, declare or pay any dividends or
26
Table of Contents
distributions on, or redeem, purchase, acquire, or make a liquidation payment with respect to any of its capital stock, including
common stock. As of December 31, 2018, the Company was current on all interest due on the 2035 Debentures.
As of December 31, 2017, we held a warrant for 556,976 shares of our common stock that was issued to the U.S. Department of
Treasury under the TARP program. On December 20, 2017, we repurchased the warrant for $520,000.
Any dividend amount is established by the board of directors each quarter. In making its decision on dividends, the Board of
Directors considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns, and
other factors. Shareholders received quarterly cash common stock dividends totaling $1.5 million in 2018. There were no
dividends declared or paid in 2017, 2016, 2015, or 2014. Dividends were reinstated in 2018 due to the Company’s improved
operating results. However, there is no guarantee that dividends will be paid any time in the future.
The Company did not repurchase any shares of common stock during the fourth quarter of 2018.
27
Table of Contents
ITEM 6 SELECTED FINANCIAL DATA
The following summary financial information as of and for the years ended December 31, 2018 and 2017 is derived from our
audited consolidated financial statements included in this Annual Report on Form 10‑K. The financial information for
previous years is derived from our audited consolidated financial statements included in previously filed Annual Reports on
Form 10‑K. The information is a summary and should be read in conjunction with our audited consolidated financial statements
and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below.
Consolidated Statement of Operations Data:
Net interest income
(Reversal of) provision for loan losses
Noninterest income
Noninterest expense
Income tax expense (benefit)
Net income
Consolidated Statement of Financial Condition Data:
Total assets
Loans receivable, net of Allowance
Deposits
Long-term borrowings
Subordinated debentures
Stockholders' equity
Average Balances:
Total assets
Loans receivable
Deposits
Stockholders' equity
Per Share Data:
Number of shares of common stock outstanding at year
end
Net income per common share:
Basic
Diluted
Dividends declared per common share
Performance and Capital Ratios:
Return on average assets
Return on average equity
Net interest margin
Average equity to average assets
Tier 1 leverage ratio (1)
Common equity Tier 1 capital ratio (1)
Tier 1 capital ratio (1)
Total capital ratio (1)
Dividend payout ratio
Asset Quality Ratios:
Nonperforming assets to total assets
Allowance to:
Total loans
Nonperforming loans
Net recoveries (charge-offs) to average total loans, net of
unearned income
(1) Bank only
$
$
$
2018
29,057
(300)
8,780
26,591
2,977
8,569
974,233
674,305
779,506
73,500
20,619
98,453
828,636
675,418
619,354
95,211
$
$
$
$
2015
2017
2016
(dollars in thousands, except per share data)
22,161
(280)
6,110
23,926
90
4,535
22,189
(350)
7,071
24,084
(10,014)
15,540
24,594
(650)
5,238
22,642
5,022
2,818
$
$
$
804,787
660,096
602,228
88,500
20,619
91,100
792,370
617,838
586,355
87,842
$
$
787,485
601,309
571,946
103,500
20,619
87,930
771,607
604,356
530,909
93,554
762,079
589,656
523,771
115,000
24,119
86,456
775,081
624,087
543,944
84,156
$
$
$
2014
23,182
831
4,325
23,736
31
2,909
776,328
633,882
543,814
115,000
24,119
83,810
785,606
622,935
555,195
81,832
12,759,576
12,233,424
12,123,179
10,088,879
10,067,379
$
$
0.68
0.67
0.12
$
0.21
0.21
—
$
1.16
1.15
—
$
0.21
0.21
—
1.03 %
9.00 %
3.66 %
11.49 %
13.5 %
17.4 %
17.4 %
18.7 %
17.6 %
0.36 %
3.21 %
3.32 %
11.09 %
13.5 %
16.5 %
16.5 %
17.7 %
—
2.01 %
16.61 %
3.13 %
12.12 %
12.9 %
16.5 %
16.5 %
17.8 %
—
0.59 %
5.39 %
3.09 %
10.86 %
14.8 %
19.6 %
19.6 %
20.8 %
—
0.64 %
0.76 %
1.37 %
1.41 %
1.18 %
172.77 %
1.21 %
141.07 %
1.47 %
91.04 %
1.46 %
97.59 %
0.06
0.06
—
0.37
3.55
3.26
10.42
13.8
NA
19.4
20.6
—
1.91
1.47
73.45
0.04 %
(0.04)%
0.09 %
(0.06)%
(0.50)
28
Table of Contents
ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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 four subsidiaries, the Bank, SBI, the Title Company, and Hyatt Commercial. Hyatt Commercial
conducts business as a commercial real estate brokerage and property management company. SBI holds mortgages that do not
meet the underwriting criteria of the Bank and is the parent company of Crownsville, which does business as Annapolis Equity
Group and acquires real estate for syndication and investment purposes. The Title Company engages in title work related to real
estate transactions. The Bank has six branches in Anne Arundel County, Maryland, which offer a full range of deposit products
and originate mortgages in its primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of
Maryland, Delaware, and Virginia.
Overview
The Company provides a wide range of personal and commercial banking services. Personal services include mortgage and
consumer lending 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. The Company also provides ATMs, credit cards, debit cards, safe deposit boxes, and telephone banking, among other
products and services.
In 2018, the Mid-Atlantic region in which we operate continued to experience continued improved regional economic
performance. The national economy improved as well throughout the year. Consumer confidence has been bolstered by certain
positive economic trends such as lower unemployment and increased housing metrics. These positive trends have been tempered
by international economic concerns together with concerns over a lack of wage growth and the rise in interest rates. These factors
can act to constrain economic activity on the part of both large and small businesses. Despite this challenging business
environment, we have experienced healthy loan growth while maintaining strong levels of liquidity, capital, and credit quality.
We have experienced an improved level of profitability in our operations in 2018, primarily due to a higher interest rate
environment, increased loan production, the payoff of high-costing FHLB advances, a reversal of the provision for loan losses,
and increased noninterest income. Our net income before income taxes amounted to $11.5 million in 2018, compared to $7.8
million in 2017. The interest rate spread between our cost of funds and what we earn on loans has increased from 2017 levels due
primarily to the higher interest rate environment, higher earning asset balances, and the payoff of the higher-costing FHLB
advances. During 2017, we recorded higher income tax provision due to the enactment of the Tax Act in December 2017, which
significantly reduced corporate tax rates for 2018. The effect of the revised corporate tax rates was a reduction of $1.9 million in
our net deferred tax asset (which had to be valued at the new corporate tax rate) at December 31, 2017, which was recorded
through the income tax provision. Our effective tax rate decreased from 64.1% in 2017 to 25.8% in 2018 due to the lower tax
rates in 2018.
The Company expects to experience similar stable market conditions during 2019. If interest rates increase, demand for
borrowing may decrease and our interest rate spread could decrease. We will continue to manage loan and deposit pricing against
the 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 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 mortgage loans and deposits, as will our continued focus on maintaining low overhead.
If the market and/or economy worsens, our business, financial condition, results of operations, access to funds, and the price of
our stock could be materially and adversely impacted.
29
Table of Contents
Critical Accounting Policies
Our accounting and financial reporting policies conform to accounting principles generally accepted in the U.S. (“GAAP”) and
general practice 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, the
valuation of securities, 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 this Annual Report on Form 10-K.
Results of Operations
Net Income
Net income increased by $5.8 million, or 204.1%, to $8.6 million for 2018, compared to $2.8 million for 2017. Basic and diluted
income per share increased to $0.68 and $0.67, respectively, for 2018, compared to $0.21 and $0.21, respectively, for 2017. We
recognized an increase in net interest income and noninterest income compared to 2017. Noninterest expenses increased in 2018
compared to 2017 and we recorded less of a reversal of the provision for loan losses in 2018 compared to 2017. Additionally, in
2017 we recognized $1.9 million in tax expense associated with the revaluation of our net deferred tax asset brought about by the
reduced corporate tax rates in the Tax Act.
Net Interest Income
Net interest income, which is interest earned net of interest expense, increased by $4.5 million, or 18.1%, to $29.1 million for
2018, compared to $24.6 million for 2017. The increase in net interest income was primarily due to increases in both the average
yield on and average balance of interest-earning assets, as well as the decrease in the average balance of our interest-bearing
liabilities. Our net interest margin increased from 3.32% in 2017 to 3.66% in 2018 and our net interest spread increased from
3.12% in 2017 to 3.29% in 2018.
Interest Income
Interest income increased by $5.4 million, or 16.9%, to $37.7 million for 2018, compared to $32.2 million for 2017. Average
interest-earning assets increased from $741.1 million in 2017 to $793.8 million in 2018. Average loans outstanding increased by
$57.6 million in 2018 compared to 2017 due to increased originations, primarily in the commercial real estate and construction
segments. Average held-to-maturity (“HTM”) securities decreased by $11.6 million in 2018 compared to 2017 due to maturities
of securities and repayments from MBS. The proceeds from the maturities and repayments were used to fund the purchase of
available-for-sale (“AFS”) securities and, along with other available funds, the origination of loans, which contributed to the
increase in average other interest-earning assets. The yield on average assets increased from 4.35% for 2017 to 4.74% in 2018
primarily as a result of rising interest rates.
Interest Expense
Interest expense increased by $973,000, or 12.8%, to $8.6 million for 2018, compared to $7.6 million for 2017. The increase was
primarily due to the increased average rate paid on our deposit accounts due to an increased interest rate environment. The
increase in interest expense related to deposit accounts was slightly offset by a decrease in interest expense related to
borrowings. Average borrowings decreased $3.8 million in 2018 compared to 2017 and the average rate paid on borrowings
decreased from 3.11% for 2017 to 2.61% for 2018. We paid off $75.0 million in long-term, high-costing FHLB advances in 2017,
some of which was replaced with lower-costing FHLB advances in 2018.
30
Table of Contents
The following table sets forth, for the years indicated, information regarding the average balances of interest-earning assets and
interest-bearing liabilities and the resulting yields on average interest-earning assets and rates paid on average interest-bearing
liabilities. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.
ASSETS
Loans
Loans held for sale ("LHFS")
AFS securities
HTM securities
Other interest-earning assets (3)
Restricted stock investments, at
cost
Total interest-earning assets
Allowance
Cash and other noninterest-
earning assets
Total assets
2018
Average
Balance
(1)
Interest
(2)
Yield/
Rate
Average
Balance
(1)
2017
Yield/
Interest
(2)
(dollars in thousands)
Rate
Average
Balance
(1)
2016
Yield/
Interest (2) Rate
$ 675,418 $ 34,643
234
208
988
1,338
5,598
11,795
49,867
46,470
5.13 % $ 617,838 $
4.18 %
1.76 %
1.98 %
2.88 %
3,550
5,164
61,514
48,276
4,612
793,760
(8,179)
249
37,660
4,750
5.40 %
4.74 % 741,092
(8,589)
30,142
152
92
1,141
472
225
32,224
4.88 % $ 604,356 $
4.28 %
1.78 %
1.85 %
0.98 %
9,496
—
74,186
15,394
5,817
4.74 %
4.35 % 709,249
(8,822)
28,827
435
—
1,149
72
267
30,750
4.77 %
4.58 %
—
1.55 %
0.47 %
4.59 %
4.34 %
43,055
$ 828,636
37,660
59,867
$ 792,370
32,224
71,180
$ 771,607
30,750
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Checking and savings
Certificates of deposit
Total interest-bearing deposits
Borrowings
Total interest-bearing liabilities
Noninterest-bearing deposit
accounts
Other noninterest-bearing
liabilities
Stockholders' equity
Total liabilities and
stockholders' equity
Net interest income/net interest
spread
Net interest margin
$ 255,665
224,222
479,887
111,788
591,675
1,794
3,894
5,688
2,915
8,603
0.70 % $ 286,738
1.74 % 215,924
1.19 % 502,662
2.61 % 115,574
1.45 % 618,236
713
3,324
4,037
3,593
7,630
0.25 % $ 268,591
1.54 % 221,523
0.80 % 490,114
3.11 % 140,932
1.23 % 631,046
676
3,357
4,033
4,528
8,561
0.25 %
1.52 %
0.82 %
3.21 %
1.36 %
139,467
2,283
95,211
83,693
2,599
87,842
40,795
6,212
93,554
$ 828,636
8,603
$ 792,370
7,630
$ 771,607
8,561
$ 29,057
3.29 %
3.66 %
$
24,594
3.12 %
3.32 %
$
22,189
2.98 %
3.13 %
(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.
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
31
Table of Contents
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.
Interest earned on:
Loans
LHFS
AFS securities
HTM Securities
Other interest-earning assets
Restricted stock investments, at cost
Total interest income
Interest paid on:
Interest-bearing deposits:
Checking and savings
Certificates of deposit
Total interest-bearing deposits
Borrowings
Total interest expense
Net interest income
Provision for Loan Losses
2018 vs. 2017
Due to Variances in
2017 vs. 2016
Due to Variances in
Rate
Volume Total
Rate
Volume Total
$ 1,599 $ 2,902 $ 4,501 $ 664 $
(dollars in thousands)
(4)
(1)
74
884
31
2,583
86
117
(227)
(18)
(7)
2,853
82
116
(153)
866
24
5,436
(27)
—
206
136
8
987
651 $ 1,315
(283)
(256)
92
92
(8)
(214)
400
264
(42)
(50)
1,474
487
1,152
438
1,590
(563)
1,027
37
(33)
4
(935)
(931)
$ 1,556 $ 2,907 $ 4,463 $ 1,085 $ 1,320 $ 2,405
1,081
570
1,651
(678)
973
(71)
132
61
(115)
(54)
(8)
53
45
(143)
(98)
45
(86)
(41)
(792)
(833)
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 origination 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. As a result of our Allowance analysis, for the years ended December 31, 2018 and 2017, we
determined that provision reversals of $300,000 and $650,000, respectively, were appropriate.
See additional information about the provision for loan losses under “ Credit Risk Management and the Allowance ” later in this
Item.
Noninterest Income
Total noninterest income increased by $3.5 million, or 67.6%, to $8.8 million for 2018 compared to $5.2 million for 2017,
primarily due to increased mortgage-banking revenue, increased real estate commissions, increased deposit service charges and
increased Title Company revenue. Mortgage-banking revenue increased $1.1 million, or 69.9%, to $2.6 million for 2018
compared to $1.5 million for 2017. This increase was the result of an increase in mortgage-banking activity in 2018. During 2018
we successfully made the transition away from our old E-Home Finance purchased lead model toward internally generated leads.
Real estate commissions by Hyatt Commercial increased by $349,000, or 25.7%, to $1.7 million for 2018 compared to $1.4
million for 2017. The increase was due to an increase in commercial sales activity in 2018.
32
Table of Contents
Deposit service charges increased $1.0 million, or 188.5%, to $1.6 million in 2018, compared to $538,000 in 2017 due primarily
to on-boarding fees charged to medical-use cannabis customers.
We recognized $1.0 million in Title company revenue in 2018 compared to $219,000 in 2017. We acquired the Title Company on
September 1, 2017 and therefore had the benefit of only four months of Title Company Revenue in 2017.
Other noninterest income includes a write off of $100,000 in restricted stock investments in 2018, which partially offset the
increase in noninterest income.
Noninterest Expense
Total noninterest expense increased $3.9 million, or 17.4%, to $26.6 million for 2018, compared to $22.6 million for 2017,
primarily due to increases in compensation and related expenses, occupancy costs, advertising costs, and data processing costs.
Compensation and related expenses increased by $3.1 million, or 20.9%, to $17.8 million for 2018, compared to $14.7 million for
2017. This increase was primarily due to annual salary increases, increased commissions, and bonuses. Net occupancy costs
increased by $197,000, or 14.5%, to $1.6 million for 2018 compared to $1.4 million for 2017, primarily due to additional
properties. We opened our Lothian branch and our Frederick mortgage office in 2018. Advertising costs increased by $233,000,
or 29.6%, to $1.0 million in 2018 compared to $788,000 in 2017, primarily due to marketing campaigns conducted in 2018.
Additionally, in 2018, we brought certain marketing services in-house that had previously been outsourced. Data processing costs
increased $191,000, or 21.1%, to $1.1 million for 2018, compared to $907,000 for 2017.
Income Tax Provision
We recognized a $3.0 million provision for income taxes on net income before income taxes of $11.5 million for an effective tax
rate of 25.8% during 2018 compared to a provision for income taxes of $5.0 million on net income before taxes of $7.8 million in
2017. The high effective tax rate of 64.1% in 2017 was due to the revaluation of our net deferred tax asset at the revised tax rates
established in the Tax Act.
Financial Condition
Total assets increased $169.4 million, or 21.1%, to $974.2 million at December 31, 2018 compared to $804.8 million at
December 31, 2017. Cash and cash equivalents increased by $166.5 million, or 761.8%, to $188.3 million at December 31, 2018
compared to $21.9 million at December 31, 2017 due to the success of our marketing campaigns to increase deposit accounts.
LHFS increased $5.2 million, or 113.8%, to $9.7 million at December 31, 2018 compared to $4.5 million at December 31, 2017.
This increase was due to an increased volume of originations from $60.8 million in 2017 to $100.8 million in 2018. Loans
increased $14.2 million, or 2.1%, to $682.3 million at December 31, 2018 compared to $668.2 million at December 31, 2017 due
to increased origination activity in 2018. Real estate acquired through foreclosure increased $1.1 million, or 281.4%, to $1.5
million at December 31, 2018 compared to $403,000 at December 31, 2017. This increase was due to the addition of two
properties. Total deposits increased $177.3 million, or 29.4%, to $779.5 million at December 31, 2018 compared to $602.2
million at December 31, 2017 due to successful marketing campaigns to bring in deposits. We utilized some of the liquidity that
came from increased deposits to pay off some of our higher-costing long-term FHLB advances. Long-term borrowings decreased
by $15.0 million, or 16.9%, to $73.5 million at December 31, 2018 compared to $88.5 million at December 31, 2017.
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 $12.0 million and $10.1 million in
securities classified as AFS as of December 31, 2018 and 2017, respectively. We held $38.9 million and $54.3 million in
securities classified as HTM as of December 31, 2018 and December 31, 2017, respectively.
33
Table of Contents
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 AFS portfolio to determine the nature of any
decline in value and evaluate if any impairment should be classified as other-than-temporary impairment (“OTTI”). Such
evaluations resulted in the determination that no OTTI charges were required during 2018.
All of the AFS and HTM securities that were impaired as of December 31, 2018 were so due to declines in fair values resulting
from changes in interest rates or increased credit/liquidity spreads compared to the time they were purchased. We have the intent
to hold these securities to maturity 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 at December 31:
AFS
2018
2017
2018
U.S. Treasury securities
U.S. government agency notes
Mortgage-backed securities
$
$
1,981 $
9,997
—
11,978 $
— $
10,119
—
10,119 $
1,991 $
11,992
24,929
38,912 $
(dollars in thousands)
HTM
2017
4,994 $
19,004
30,305
54,303 $
2016
12,998
20,027
29,732
62,757
The amortized cost, estimated fair values, and weighted average yields of debt securities at December 31, 2018, by contractual
maturity, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or
prepay obligations.
AFS Securities:
U.S. Treasury securities:
Due within one year
U.S. government agency notes:
Due within one year
Due one to five years
HTM Securities:
U.S. Treasury securities:
Due within one year
Due one to five years
US government agency notes:
Due within one year
Due one to five years
Mortgage-backed securities:
Due one to five years
Due five to ten years
Due after ten years
Amortized
Unrealized
Cost
Gains
Losses
(dollars in thousands)
Weighted
Estimated Average
Yield
Fair Value
$
1,992 $
— $
11 $
1,981
1.44 %
5,010
5,076
$ 12,078 $
—
—
— $
4,980
30
59
5,017
100 $ 11,978
$
1,003 $
988
3 $
14
— $
—
1,006
1,002
6,996
4,996
2,121
8,504
14,304
$ 38,912 $
—
45
—
—
6
68 $
37
55
6,959
4,986
2,060
61
8,326
178
437
13,873
768 $ 38,212
2.19 %
2.94 %
2.38 %
3.38 %
2.63 %
1.51 %
2.20 %
2.16 %
2.74 %
2.85 %
2.47 %
Weighted yields are based on amortized cost. Mortgage-backed securities are assigned to maturity categories based on their final
maturity.
We did not hold any securities with an aggregate book value and market value in excess of 10% of stockholders’ equity.
34
Table of Contents
LHFS
We originate residential mortgage loans for sale on the secondary market. At December 31, 2018 and 2017, such LHFS, which
are carried at fair value, amounted to $9.7 million and $4.5 million, respectively, the majority of which are subject to purchase
commitments from investors.
When we sell mortgage loans we make certain representations to the purchaser related to loan ownership, loan compliance and
legality, and accurate documentation, among other things. If a loan is found to be out of compliance with any of the
representations subsequent to the date of purchase, we may be required to repurchase the loan or indemnify the purchaser for
losses related to the loan, depending on the agreement with the purchaser. In addition other factors may cause us to be required to
repurchase or "make-whole" a loan previously sold.
The most common reason for a loan repurchase is due to a documentation error or disagreement with an investor, or on rare
occasions for fraud. Repurchase requests are negotiated with each investor at the time we are notified of the demand and an
appropriate reserve is taken at that time. We did not repurchase any loans during 2018. Repurchases amounted to $469,000 during
2017. Our reserve for potential repurchase losses was $91,000 and $63,000 as of December 31, 2018 and 2017, respectively. We
do not expect increases in repurchases or related losses to be a growing trend nor do we see it having a significant impact on our
financial results.
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 earning assets is an important determinant of
our net interest margin.
The following table sets forth the composition of our loan portfolio net of unearned loan fees as of December 31:
2018
2017
2016
2015
2014
Percent
Percent
Amount of Total Amount of Total Amount of Total
(dollars in thousands)
Percent
Percent
Amount of Total Amount of Total
Percent
Residential Mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
$ 274,759
35,884
242,693
114,540
13,386
1,087
$ 682,349
40.3 % $ 285,819
5.2 % 37,356
35.6 % 235,129
16.8 % 93,060
2.0 % 15,703
1,084
0.1 %
100.0 % $ 668,151
42.8 % $ 257,659
5.6 % 46,468
35.2 % 195,710
13.9 % 90,102
2.3 % 19,129
1,210
0.2 %
100.0 % $ 610,278
42.2 % $ 283,211
7.6 % 29,484
32.1 % 174,912
14.8 % 85,054
3.1 % 24,529
1,224
0.2 %
100.0 % $ 598,414
47.4 % $ 306,981
4.9 % 29,418
29.2 % 198,539
14.2 % 78,589
4.1 % 28,750
1,040
0.2 %
100.0 % $ 643,317
47.7 %
4.6 %
30.9 %
12.2 %
4.5 %
0.1 %
100.0 %
Loans increased by $14.2 million, or 2.1%, to $682.3 million at December 31, 2018 compared to $668.2 million at
December 31, 2017. This increase was primarily due to increased commercial real estate and construction loan demand.
Approximately 56.0% of our loans had adjustable rates as of December 31, 2018. Our variable-rate loans adjust to the current
interest rate environment, whereas fixed rates do not allow this flexibility. If interest rates were to increase in the future, our
interest earned on the variable-rate loans would improve, and if rates were to fall, the interest we earn on such loans would
decline, thus impacting our interest income. Some variable-rate loans have rate floors and/or ceilings which may delay and/or
limit changes in interest income in a period of changing rates. See our discussion in “ Interest Rate Sensitivity ” later in this
Item for more information on interest rate fluctuations.
35
Table of Contents
The following table sets forth the maturity distribution for our loan portfolio at December 31, 2018. Some of our loans may be
renewed or repaid prior to maturity. Therefore, the following table should not be used as a forecast of our future cash collections.
In one year or less After 1 through 5 years
After 5 years
Maturing
Residential Mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Fixed Variable
Fixed
Fixed
Variable Total
Variable
(dollars in thousands)
$ 616 $
64 $ 22,873 $ 17,967 $ 86,846 $146,393 $274,759
35,884
—
242,693
140
114,540
171
13,386
12,843
1,087
—
$2,405 $13,218 $105,789 $ 95,572 $192,022 $273,343 $682,349
8,177
16,774
52,654
—
—
6,965
34,354
41,597
—
—
11,741
96,175
19,034
—
—
9,001
95,091
1,084
—
—
—
159
—
543
1,087
$15,623
$201,361
$465,365
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. For more detailed information about our Allowance methodology and risk rating system, see
Note 3 to the Consolidated Financial Statements.
36
Table of Contents
The following table summarizes the activity in our Allowance by portfolio segment as of and for the years ended December 31:
Allowance, beginning of year
Charge-offs:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Total charge-offs
Recoveries:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Total recoveries
Net recoveries (charge-offs)
(Reversal of) provision for loan losses
Allowance, end of year
Loans:
Year-end balance
Average balance during year
Allowance as a percentage of
year-end loan balance
Percent of average loans:
(Reversal of) provision for loan losses
Net recoveries (charge-offs)
2018
2017
$
8,055
$
8,969
2016
(dollars in thousands)
$
8,758
$
2015
2014
9,435
$
11,739
(534)
—
(38)
(34)
—
—
(606)
228
—
424
—
243
—
895
289
(300)
8,044
682,349
675,418
$
$
(726)
—
—
—
(98)
(2)
(826)
375
—
157
—
30
—
562
(264)
(650)
8,055
668,151
617,838
(151)
(17)
(178)
(72)
(50)
—
(468)
324
54
23
157
421
50
1,029
561
(350)
8,969
610,278
604,356
$
$
$
$
(454)
(154)
(80)
—
(834)
—
(1,522)
629
284
—
49
163
—
1,125
(397)
(280)
8,758
598,414
624,087
$
$
(844)
(2,734)
(92)
(63)
(261)
—
(3,994)
306
174
25
349
—
5
859
(3,135)
831
9,435
643,317
622,935
$
$
1.18 %
1.21 %
1.47 %
1.46 %
1.47 %
(0.04)%
0.04 %
(0.11)%
(0.04)%
(0.06)%
0.09 %
(0.04)%
(0.06)%
0.13 %
(0.50)%
The following tables summarize our allocation of the Allowance by loan segment as of December 31:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Unallocated
Total
Amount
$
$
2,224
2,736
457
2,239
222
1
165
8,044
2018
Percent
of Loans
to Total
Loans
Percent
of Total
Amount
2017
Percent
of Loans
to Total
Loans
Percent
of Total
Amount
2016
Percent
of Loans
to Total
Loans
Percent
of Total
27.6 %
34.0 %
5.7 %
27.8 %
2.8 %
— %
2.1 %
100.0 %
40.3 % $
5.2 %
35.6 %
16.8 %
2.0 %
0.1 %
— %
100.0 % $
(dollars in thousands)
38.5 %
6.5 %
34.8 %
15.4 %
4.8 %
— %
— %
100.0 %
3,099
527
2,805
1,236
386
2
—
8,055
42.8 % $
5.6 %
35.2 %
13.9 %
2.3 %
0.2 %
— %
100.0 % $
3,833
478
2,535
1,390
728
5
—
8,969
42.7 %
5.3 %
28.3 %
15.5 %
8.1 %
0.1 %
— %
100.0 %
42.2 %
7.6 %
32.1 %
14.8 %
3.1 %
0.2 %
— %
100.0 %
37
Table of Contents
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Total
Amount
$
$
4,188
291
2,792
956
528
3
8,758
2015
Percent
of Total
Percent
of Loans
to Total
Loans
(dollars in thousands)
Amount
2014
Percent
of Loans
to Total
Loans
Percent
of Total
47.8 %
3.3 %
31.9 %
10.9 %
6.1 %
— %
100.0 %
47.4 %
4.9 %
29.2 %
14.2 %
4.1 %
0.2 %
100.0 %
$
$
4,664
292
2,504
1,008
963
4
9,435
49.4 %
3.1 %
26.6 %
10.7 %
10.2 %
— %
100.0 %
47.7 %
4.6 %
30.9 %
12.2 %
4.5 %
0.1 %
100.0 %
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 $8.0 million at December 31, 2018 and $8.1 million at December 31, 2017. Any changes in
the Allowance from period to period reflect management’s ongoing application of its methodologies to establish the Allowance,
which, for the year ended December 31, 2018, resulted in increased allocated Allowances for the commercial and ADC loan
segments. During the fourth quarter of 2018, the Bank changed its metholdology for estimating the adequacy of the
Allowance. The change in accounting estimate was due to the Bank identifying certain loss factors which allowed the us to
anchor the qualitative loss factor adjustments back to our loss history. This change in estimate did not have any impact on the
current period provision for loan losses, rather, it resulted in re-allocation of existing Allowances between loan classifications.
During 2018, as a result of our Allowance analysis, and overall improved asset quality, we released $300,000 from the
Allowance, compared to a release of $650,000 during 2017. We recorded net recoveries of $289,000 during the year ended
December 31, 2018 and net charge-offs of $264,000 during the year ended December 31, 2017. During 2018, net recoveries as
compared to average loans outstanding amounted to 0.04% compared to net charge-offs as compared to average loans outstanding
of
decreased from 1.21% as
a percentage of
of December 31, 2017 to 1.18% as of December 31, 2018, reflecting the improvement in our overall asset quality.
0.04% during 2017.
The Allowance as
outstanding loans
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 December 31, 2018 and is sufficient to address the
credit losses inherent in the current loan portfolio.
Nonperforming Assets (“NPAs”)
Given the volatility of the real estate market, it is very important for us to have current appraisals on our NPAs. In general, we
obtain appraisals on NPAs on an annual basis. As part of our asset monitoring activities, we maintain a Loss Mitigation
Committee that meets once a month. During these Loss Mitigation Committee meetings, all NPAs and loan delinquencies 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 and valuation date. Accordingly, these reports identify which assets will require an updated appraisal. As a result, we have
not experienced any internal delays in identifying which loans/credits require appraisals. With respect to the ordering process of
the 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 0.6% at December 31, 2018 and 0.8% at December 31, 2017. The ratio of
the Allowance to nonperforming loans was 172.8% at December 31, 2018 and 141.1% at December 31, 2017.
38
Table of Contents
The increase in this ratio from December 31, 2017 to December 31, 2018 was a reflection of the decrease in nonperforming loans.
The ratio of nonperforming loans to total loans was 0.7% at December 31, 2018 and 0.9% at December 31, 2017.
The distribution of our NPAs is illustrated in the following table as of December 31.
Nonaccrual Loans:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Real Estate Acquired Through Foreclosure:
Residential mortgage
Commercial
Commercial real estate
ADC
Total Nonperforming Assets
2018
2017
2016
(dollars in thousands)
2015
2014
$ 2,580 $ 3,891 $ 3,580 $ 3,191 $ 6,052
2,163
652
962
3,016
12,845
151
2,938
269
2,914
9,852
483
2,681
521
2,098
8,974
430
660
558
428
4,656
78
159
314
1,268
5,710
1,366
—
—
171
1,537
695
59
—
1,193
1,947
$ 6,193 $ 6,113 $10,825 $10,718 $14,792
1,381
37
—
326
1,744
206
—
528
239
973
—
—
187
216
403
Nonaccrual loans amounted to $4.7 million at December 31, 2018 and $5.7 million at December 31, 2017. Significant activity in
nonaccrual loans during 2018 included additions of $3.3 million, transfers to real estate acquired through foreclosure of $1.4
million, charge-offs of $362,000, returns to accrual status of $265,000, and pay-offs/sales of $2.2 million.
Real estate acquired through foreclosure increased $1.1 million to $1.5 million at December 31, 2018 compared to $403,000 at
December 31, 2017, due to the addition of two residential mortgage properties.
The activity in our real estate acquired through foreclosure was as follows as of and for the years ended December 31:
Balance at beginning of year
Real estate acquired in satisfaction of loans
Write-downs and losses on real estate acquired through foreclosure
Proceeds from sales of real estate acquired through foreclosure
Other
Balance at end of year
2018
$
403 $
1,366
(61)
(171)
—
$ 1,537 $
2017
2016
(dollars in thousands)
2015
2014
973 $ 1,744 $ 1,947 $ 8,972
847
703
2,234
1,575
—
(103)
(9)
(176)
(8,174)
(1,170)
(2,428)
(2,170)
—
—
302
—
973 $ 1,744 $ 1,947
403 $
There were no loans greater than 90 days past due and still accruing at December 31, 2018, 2017, 2016, 2015, or 2014.
Troubled Debt Restructured Loans (“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.
39
Table of Contents
The composition of our TDRs is illustrated in the following table as of December 31:
Residential mortgage:
Nonaccrual
<90 days past due/current
Commercial:
Nonaccrual
<90 days past due/current
Commercial real estate:
Nonaccrual
<90 days past due/current
ADC:
Nonaccrual
<90 days past due/current
Home equity/2nds:
Nonaccrual
<90 days past due/current
Consumer:
Nonaccrual
<90 days past due/current
Totals:
Nonaccrual
<90 days past due/current
2018
$
446 $
9,469
2017
2016
(dollars in thousands)
2015
2014
736 $ 2,137 $ 1,071 $ 2,402
22,154
15,648
20,831
11,631
—
—
—
—
—
—
—
103
124
150
—
1,019
78
1,862
249
1,914
252
2,464
109
3,623
—
134
—
—
—
76
6
137
—
—
—
84
6
170
—
238
—
96
6
978
6
1,785
—
—
—
10
—
—
—
12
446
10,698
2,641
27,724
$11,144 $14,534 $20,458 $25,715 $30,365
820
13,714
2,392
18,066
1,329
24,386
See additional information on TDRs in Note 3 to the Consolidated Financial Statements.
Deposits
Deposits were $779.5 million at December 31, 2018 and $602.2 million at December 31, 2017. During the year ended
December 31, 2018, we experienced increases in NOW accounts, money market accounts, and noninterest-bearing deposit
accounts due to new account openings and higher account balances. We obtained significant new noninterest-bearing deposits in
2018 through an aggressive campaign designed to attract commercial and consumer checking account deposits to drive down our
cost of funds. Additionally, we had increases in accounts of medical-use cannabis customers. The decrease in CDs was due to the
payoff of regularly maturing CDs.
The deposit breakdown is as follows as of December 31:
NOW
Money market
Savings
CDs
Total interest-bearing deposits
Noninterest-bearing deposits
Total deposits
40
2018
2017
2016
(dollars in thousands)
2015
2014
$106,508 $ 63,616 $ 63,137 $ 56,096 $ 54,827
39,579
126,062
298,489
518,957
24,857
$779,506 $602,228 $571,946 $523,771 $543,814
47,690
111,992
277,778
493,556
30,215
103,649
98,717
263,413
529,395
72,833
203,351
75,692
247,351
632,902
146,604
66,356
110,492
273,816
513,801
58,145
Table of Contents
The following table provides the maturities of CDs in amounts of $100,000 or more at December 31:
Maturing in:
3 months or less
Over 3 months through 6 months
Over 6 months through 12 months
Over 12 months
$
2017
2018
(dollars in thousands)
26,910 $
23,330
27,160
66,352
30,002
10,758
37,943
71,468
$ 143,752 $ 150,171
Borrowings
Our borrowings consist of advances from the FHLB and a term loan from a commercial bank.
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.
At December 31, 2018, our total available credit line with the FHLB was $265.7 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 December 31, 2018 and 2017 was $70.0 million and $85.0 million, respectively.
On September 30, 2016, we entered into a loan agreement with a commercial bank whereby we borrowed $3.5 million for a term
of 8 years. The unsecured note bears interest at a fixed rate of 4.25% for the first 36 months then, at the option of the Company,
converts to either (1) floating rate of the Wall Street Journal Prime plus 50 basis points or (2) fixed rate at 275 basis points over
the five year amortizing FHLB rate for the remaining five years. Repayment terms are monthly interest only payments for the first
36 months, then quarterly principal payments of $175,000 plus interest. The loan is subject to a prepayment penalty of 1% of the
principal amount prepaid during the first 36 months. If we elect the 5 year fixed rate of 275 basis points over the FHLB rate
(“FHLB Rate Period”), the loan will be subject to a prepayment penalty of 2% during the first and second years of the FHLB Rate
Period and 1% of the principal repaid during the third, fourth, and fifth years of the FHLB Rate Period. We may make additional
principal payments from internally generated funds of up to $875,000 per year during any fixed rate period without penalty. There
is no prepayment penalty during any floating rate period.
Certain information regarding our borrowings is as follows as of December 31:
2018
2017
Amount outstanding at year-end:
FHLB advances
Commercial note payable
Weighted-average interest rate at year-end:
FHLB advances
Commercial note payable
Maximum outstanding at any month-end:
FHLB advances
Commercial note payable
Average outstanding:
FHLB advances
Commercial note payable
Weighted-average interest rate during the year:
FHLB advances
Commercial note payable
41
$ 70,000
3,500
(dollars in thousands)
$
85,000
3,500
2.27 %
4.25 %
2.40 %
4.25 %
$ 96,000
3,500
$ 169,950
3,500
$ 87,669
3,500
$
91,456
3,500
2.17 %
5.04 %
3.03 %
5.04 %
Table of Contents
The following table sets forth information concerning the interest rates and maturity dates of the advances from the FHLB as of
December 31, 2018:
Principal
Amount (in thousands)
$
$
35,000
25,000
10,000
70,000
Fixed Rate
1.55% to 4.00%
1.75% to 1.92%
2.19%
Maturity
2019
2020
2022
Subordinated Debentures
As of December 31, 2018 and 2017, 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, 2016 (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 December 31, 2018,
we were current on all interest due on the 2035 Debentures.
Capital Resources
Total stockholders’ equity increased $7.4 million to $98.5 million at December 31, 2018 compared to $91.1 million at
December 31, 2017. The increase was principally a result of 2018 net income, net of common and preferred stock dividends.
Series A Preferred Stock
On November 15, 2008, the Company completed a private placement offering consisting of a total of 70 units, at an offering price
of $100,000 per unit, for gross proceeds of $7.0 million. Each unit consists of 6,250 shares of the Company’s Series A 8.0% Non-
Cumulative Convertible Preferred Stock. On March 13, 2018, the Company notified holders of its Series A preferred stock that
the Company had exercised its option to convert all 437,500 outstanding shares of Series A preferred stock for 437,500 shares of
common stock. The Company converted the Series A preferred stock on April 2, 2018 and as of that date, the Series A preferred
stock was no longer deemed outstanding and all rights with respect to such stock ceased and terminated.
Series B Preferred Stock
On November 21, 2008, we entered into an agreement with the U.S. Department of the Treasury (“Treasury”), pursuant to
which we issued and sold (i) shares of our Series B Fixed Rate Cumulative Perpetual Preferred Stock (“Preferred
42
Table of Contents
Stock”) and (ii) a warrant (the “Warrant”) to purchase 556,976 shares of the Company’s common stock, par value $0.01 per
share. As of December 31, 2017, the Company had redeemed all outstanding shares of the Preferred Stock and during 2017, the
Company repurchased the warrant from the Treasury.
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 December 31, 2018 and 2017, the Bank exceeded all capital adequacy requirements to which
it is subject and met the qualifications to be considered “well-capitalized.” See details of our capital ratios in Note 10 to the
Consolidated Financial Statements.
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. In addition, we have certain operating lease obligations.
Credit Commitment s
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 below under “ Liquidity .”
Derivatives
We maintain and account for derivatives, in the form of interest-rate lock commitments (“IRLCs”), mandatory forward contracts,
and best effort forward contracts, in accordance with the Financial Accounting Standards Board (“FASB”) 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 Operations.
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.
43
Table of Contents
Information pertaining to the carrying amounts of our derivative financial instruments follows as of December 31:
2018
2017
Notional Estimated Notional Estimated
Amount Fair Value Amount Fair Value
Asset - IRLCs
Asset - mandatory forward contracts
Asset - best effort forward contracts
Liability - mandatory forward contracts
$ 3,710 $
—
3,710
9,363
Contractual Obligations
(dollars in thousands)
100 $ 1,144 $
—
—
16
4,399
1,144
—
22
13
3
—
We have certain obligations to make future payments under contract. At December 31, 2018, the aggregate contractual
obligations and commitments were:
Total
Less than
one year
1-3
Years
4-5
years
After
5 years
CDs
Borrowings
Subordinated debentures
Estimated interest due on CDs and borrowings
Annual rental commitments under noncancelable leases
Liquidity
(dollars in thousands)
$247,351 $126,980 $100,180 $20,191 $
—
3,500
20,619
9,995
1,775
$368,165 $167,582 $131,449 $33,245 $35,889
73,500
20,619
23,452
3,243
35,000
—
5,236
366
25,000
—
5,670
599
10,000
—
2,551
503
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 our mortgage-banking operations, 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, sales of AFS securities, 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 CDs of $100,000 or more. The Bank’s experience has been that a substantial portion of CDs renew at time of maturity and
remain on deposit with the Bank. CDs scheduled to mature within one year amounted to $127.0 million at December 31, 2018.
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. Our credit availability under the FHLB’s credit
availability program was $265.7 million at December 31, 2018, of which $70.0 million was outstanding.
The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit
(collectively “commitments”), which totaled $115.0 million at December 31, 2018. Historically, many of the commitments expire
without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. As of
December 31, 2018, we had $17.0 million in unadvanced commitments for home equity
44
Table of Contents
lines of credit, $1.7 million outstanding in mortgage loan commitments, $75.3 million outstanding in unadvanced construction
commitments, and commitments under lines of credit for $21.0 million, which we expect to fund from the sources of liquidity
described above. Standby letters of credit amounted to $3.3 million at December 31, 2018.
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 December 31, 2018, 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. At
December 31, 2018, 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.
Interest Rate Sensitivity
Interest rate sensitivity is an important factor in the management of the composition and maturity configurations of our earning
assets and our funding sources. The primary objective of our asset/liability management is to ensure the steady growth of our
primary earnings component, net interest income. Our net interest income can fluctuate with significant interest rate movements.
We may attempt to structure the statement of financial condition so that repricing opportunities exist for both assets and liabilities
in roughly equivalent amounts at approximately the same time intervals. However, imbalances in these repricing opportunities at
any point in time may be appropriate to mitigate risks from fee income subject to interest rate risk, such as mortgage-banking
activities.
The measurement of our interest rate sensitivity, or “gap,” is one of the techniques used in asset/liability management. Interest
sensitive gap is the dollar difference between our assets and liabilities which are subject to interest rate pricing within a given
time period, including both floating-rate or adjustable-rate instruments and instruments which are approaching maturity. More
assets repricing or maturing than liabilities over a given time period is considered asset-sensitive and is reflected as a positive gap,
and more liabilities repricing or maturing than assets over a given time period is considered liability-sensitive and is reflected as
negative gap. An asset-sensitive position (i.e., a positive gap) will generally enhance earnings in a rising interest rate environment
and will negatively impact earnings in a falling interest rate environment, while a liability-sensitive position (i.e., a negative gap)
will generally enhance earnings in a falling interest rate environment and negatively impact earnings in a rising interest rate
environment. Fluctuations in interest rates are not predictable or controllable.
Our management and our board of directors oversee the asset/liability management function and meet periodically to monitor and
manage the statement of financial condition, control interest rate exposure, and evaluate pricing strategies. We evaluate the asset
mix of the statement of financial condition continually in terms of several variables: yield, credit quality, funding sources, and
liquidity. Our management of the liability mix of the statement of financial condition focuses on expanding our various funding
sources and promotion of deposit products with desirable repricing or maturity characteristics.
In theory, we can diminish interest rate risk through maintaining a nominal level of interest rate sensitivity. In practice, this is
made difficult by a number of factors including cyclical variation in loan demand, different impacts on our interest-sensitive
assets and liabilities when interest rates change, and the availability of our funding sources. Accordingly, we strive to manage the
interest rate sensitivity gap by adjusting the maturity of and establishing rates on the interest-earning asset portfolio and certain
interest-bearing liabilities commensurate with our expectations relative to market interest rates. Additionally, we may employ the
use of off-balance sheet instruments, such as interest rate swaps or caps, to manage our
45
Table of Contents
exposure to interest rate movements. Generally, we attempt to maintain a balance between rate-sensitive assets and liabilities that
is appropriate to minimize our overall interest rate risk, not just our net interest margin.
Our interest rate sensitivity position as of December 31, 2018 is presented in the following table. Our assets and liabilities are
scheduled based on maturity or repricing data except for core deposits which are based on internal core deposit analyses. These
assumptions are validated periodically by management. The difference between our rate-sensitive assets and rate-sensitive
liabilities, or the interest rate sensitivity gap, is shown at the bottom of the table. As of December 31, 2018, we had a one-year
cumulative negative gap of $88.3 million.
Interest-bearing deposits (1)
Securities
Restricted stock investments
LHFS
Loans
Savings
NOWs
Money market
CDs
Borrowings
Subordinated debentures
Period
% of Assets
Cumulative
% of Assets
Cumulative assets to liabilities
(1)
Includes CDs held for investment
> 5 years
Total
180 days
or less
$194,240
2,999
3,766
9,686
161,054
$371,745
$ 30,276
91,090
158,275
71,176
25,000
20,619
$396,436
181 days - One-five
one year
years
(dollars in thousands)
$
$
—
11,932
—
—
56,365
$ 68,297
$
—
13,177
—
—
298,684
$311,861
—
22,782
—
—
158,202
$ 180,984
$ 22,708
15,418
32,197
51,538
10,000
—
$131,861
$ 22,708
—
12,879
124,637
35,000
—
$195,224
$
$
—
—
—
—
3,500
—
3,500
$ 194,240
50,890
3,766
9,686
674,305
$ 932,887
$ 75,692
106,508
203,351
247,351
73,500
20,619
$ 727,021
$ (24,691)
$ (63,564)
$116,637
$ 177,484
(2.53)%
(6.53)%
11.97 %
18.22 %
$ (24,691)
$ (88,255)
$ 28,382
$ 205,866
(2.53)%
93.77 %
2.91 %
(9.06)%
83.29 % 103.92 %
21.13 %
1.28 %
While we monitor interest rate sensitivity gap reports, we primarily test our interest rate sensitivity through the deployment of
simulation analysis. We use earnings simulation models to estimate what effect specific interest rate changes would have on our
net interest income. Simulation analysis provides us with a more rigorous and dynamic measure of interest sensitivity. Changes in
prepayments have been included where changes in behavior patterns are assumed to be significant to the simulation, particularly
mortgage-related assets. Call features on certain securities and borrowings are based on their call probability in view of the
projected rate change, and pricing features such as interest rate floors are incorporated. We attempt to structure our asset and
liability management strategies to mitigate the impact on net interest income by changes in market interest rates. However, there
can be no assurance that we will be able to manage interest rate risk so as to avoid significant adverse effects on net interest
income. We use the PROFITstar® model to monitor our exposure to interest rate risk, which calculates changes in the economic
value of equity (“EVE”).
46
Table of Contents
At December 31, 2018, the simulation model provided the following interest-rate risk profile (changes in the EVE):
Change in Rates
Amount
$ Change
% Change
+400 bp
+300 bp
+200 bp
+100 bp
0 bp
(100)bp
(200)bp
(dollars in thousands)
$
$
187,739
192,877
197,544
199,236
198,792
179,160
140,299
(11,053)
(5,915)
(1,248)
444
(19,632)
(58,493)
(5.56)%
(2.98)%
(0.63)%
0.22 %
(9.88)%
(29.42)%
The preceding income simulation analysis does not represent a forecast of actual results and should not be relied upon as being
indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, which are subject to
change, including: the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and
securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows,
and others. Also, as market conditions vary, prepayment/refinancing levels, the varying impact of interest rate changes on caps
and floors embedded in adjustable-rate loans, early withdrawal of deposits, changes in product preferences, and other
internal/external variables will likely deviate from those assumed.
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 increases
in our revenues correspondingly. However, we believe that the impact of inflation on our operations was not material for 2018 or
2017.
Subsequent Event
On February 26, 2019, the Company’s Board of Directors declared a $0.03 per share dividend to stockholders of record on March
8, 2019, payable on March 18, 2019.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion of interest rate risk, see Item 7 of Part II of this Annual Report on Form 10‑K under the heading “ Interest Rate
Sensitivity .”
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The attestation reports by the Company’s independent registered public accounting firm, the Financial statements, and
supplementary data are included herein at pages F‑1 through F‑45, and incorporated herein by reference.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
47
Table of Contents
ITEM 9A CONTROLS AND PROCEDURES
Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to
be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company
files or submits under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) is accumulated and
communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.
The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that
the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission. As of December 31, 2018, the Company’s
management, including the Company’s Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer
(Principal Accounting Officer), has evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in
Rules 13a-15 and 15d-15(e) under the Exchange Act. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable
assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must
necessarily reflect the fact that there are resource constraints and that management is required to apply its judgement in evaluating
the benefits of possible controls and procedures relative to their costs. Based on this evaluation, the Company's Chief Executive
Officer and Chief Financial Officer concluded that, as of the end of the period covered by this annual report, the Company's
disclosure controls and procedures were not effective because of the material weaknesses described below.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.
Internal control over financial reporting is defined in Rule 13a-15(f) under the Exchange Act as a process designed by, or under
the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of
Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The
Company’s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflects the transactions and
disposition of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being
made only in accordance with authorization of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of
the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018. In
making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal Control-Integrated Framework (2013). Based on our assessment, management concluded that as
of December 31, 2018, the Company's internal control over financial reporting was not effective and did not meet the criteria of
the 2013 COSO Framework due to the material weaknesses identified below.
48
Table of Contents
A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the Company's annual financial statements will not be prevented or detected
on a timely basis. The identification of the material weaknesses did not impact any of our consolidated financial statements for
any prior annual or interim periods. Accordingly, management believes that the financial statements included in this Annual
Report on Form 10-K present fairly in all material respects the Company's financial condition, results of operations and cash
flows for the periods presented.
The Company has identified a material weakness in its internal control over financial reporting, specifically related to both
management’s review controls and risk rating controls over the Company’s allowance for loan losses. The material weakness in
internal control over financial reporting resulted from a lack of sufficient management review controls over the development and
monitoring of qualitative factors used in calculating the general component of the allowance for loan losses, a lack of sufficient
management review controls over the relevant inputs and assumptions used to measure the fair value of impaired loans, lack of
controls to identify the completeness of troubled debt restructurings (“TDR”), and review over the completeness of changes to
loans’ risk ratings that are required to be modified within the Company’s loan accounting system.
The Company has also identified a material weakness in its internal control over financial reporting, specifically related to its
reconciliation controls relating to loans held for sale. The material weakness in internal control over financial reporting resulted
from a current year material reclassification entry identified during the audit. The impact of this reclassification has been
corrected on the consolidated statement of financial condition.
Management has been actively engaged in developing remediation plans to address the above control deficiencies. The
remediation actions we are taking and expect to take include the following:
Allowance for Loan Loss Controls- The Company will enhance its management review controls over the development and
monitoring of qualitative factors and other relevant assumptions used in calculating the general component of the allowance for
loan losses. The Company will also enhance its current review process over impaired loans to ensure a timely review is being
performed at an appropriate level of precision as it pertains to the relevant inputs and assumptions to measure the fair value of
impaired loans, including appraisal review controls. The Company will also implement a process to ensure the completeness and
accuracy of the population to provide assurance that all required loans are properly evaluated for TDR classification. Finally, the
Company will enhance controls over the review of the completeness of changes to loans’ risk ratings that are required to be
modified within the Company’s loan accounting system.
Loans Held for Sale- The Company will enhance its reconciliation procedures over loans held for sale to ensure that all loan sale
activity is reflected.
Although the Company’s remediation efforts are well underway and are expected to be completed in the near future, the
Company’s material weaknesses will not be considered remediated until new internal controls are operational for a period of time
and are tested, and management concludes that these controls are operating effectively.
Other than the remediation described above, there has been no change in the Company’s internal control over financial reporting
during the fourth quarter of the fiscal year ended December 31, 2018 that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial reporting.
The Report of Independent Registered Public Accounting Firm on internal controls is located on page F-2 of this Annual Report
on Form 10-K.
ITEM 9B OTHER INFORMATION
None.
49
Table of Contents
PART III
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The Company has adopted a code of ethics that applies to its employees, including its CEO, CFO, and persons performing similar
functions, and directors. A copy of the code of ethics is filed as an exhibit to the Company’s Annual Report on Form 10‑K for
the year ended December 31, 2003, which was filed with the SEC on March 25, 2004. The Company intends to satisfy the
disclosure requirement under Item 10 of Form 8‑K regarding any future amendments to a provision of its code of ethics by
posting such information on the Company’s website: www.severnbank.com.
The additional information required by this item will be included in the Company’s definitive Proxy Statement relating to the
2019 Annual Stockholders Meeting (“Proxy Statement”) to be filed with the SEC and incorporated herein by reference.
ITEM 11 EXECUTIVE COMPENSATION
The information required by this item will be included in the Company’s Proxy Statement to be filed with the SEC and
incorporated herein by reference.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The information required by this item with respect to our equity compensation plans is incorporated herein by reference to the
section entitled “ Equity Compensation Plan ” contained in Item 5 of Part II of this Annual Report on Form 10‑K.
The additional information required by this item will be included in the Company’s Proxy Statement to be filed with the SEC and
incorporated herein by reference.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this item will be included in the Company’s Proxy Statement to be filed with the SEC and
incorporated herein by reference.
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item will be included in the Company’s Proxy Statement to be filed with the SEC and
incorporated herein by reference.
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1), (a)(2) and (c) Financial Statements
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition as of December 31, 2018 and 2017
Consolidated Statements of Operations for the years ended December 31, 2018 and 2017
Consolidated Statements of Comprehensive Income for the years ended December 31, 2018 and 2017
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2018 and 2017
Consolidated Statements of Cash Flows for the years ended December 31, 2018 and 2017
Notes to Consolidated Financial Statements as of and for the years ended December 31, 2018 and 2017
F‑1
F‑4
F‑5
F‑6
F‑7
F‑8
F‑9
(a)(3) and (b) Exhibits Required to be filed by Item 601 of Regulation S-K
50
Table of Contents
The following exhibits are filed as part of this Form 10‑K:
Exhibit No.
3.1
3.2
4.1
10.1+
10.2+
10.3+
10.4+
10.5+
10.6
10.7+
10.8+
14.1
21.1*
23.1*
31.1*
31.2*
32 *
101*
(3)
(2)
(1)
(4)
Description of Exhibit
Articles of Incorporation of Severn Bancorp, Inc., as amended
Bylaws of Severn Bancorp, Inc., as amended
Form of Common Stock Certificate
Stock Option Plan
Employee Stock Ownership Plan
Form of Common Stock Option Agreement
2008 Equity Incentive Plan
Form of Subscription Agreement
Form of Subordinated Note
(8)
Form of Director Option Award
Form of Employee Option Award
(9)
Code of Ethics
Subsidiaries of Severn Bancorp, Inc.
Consent of BDO USA, LLP
Certification of Principal Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
Certification of Principal Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of Sarbanes-
(5)
(8)
(7)
(7)
(6)
Oxley Act of 2002
The following financial statements from Severn Bancorp, Inc. Annual Report on Form 10‑K as of December 31,
2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of
Financial Condition; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of
Comprehensive Income; (iv) the Consolidated Statements of Stockholders’ Equity; (v) the Consolidated
Statements of Cash Flows; and (vi) the Notes to Consolidated Financial Statements.
+ Denotes management contract, compensatory plan, or arrangement.
* Filed herewith.
(1)
Incorporated by reference from the Company’s Annual Report on Form 10‑K for fiscal year ended December 31, 2008 and
filed with the Securities and Exchange Commission on March 11, 2009.
Incorporated by reference from the Company’s Annual Report on Form 10‑K for fiscal year ended December 31, 2007 and
filed with Securities and Exchange Commission on March 12, 2008.
Incorporated by reference from the Company’s Annual Report on Form 10‑K for fiscal year ended December 31, 2004 and
filed with the Securities and Exchange Commission on March 21, 2005.
Incorporated by reference from the Company’s Registration Statement on Form 10 filed with the Securities and Exchange
Commission on June 7, 2002.
Incorporated by reference from the Company’s Current Report on Form 8‑K filed with the Securities and Exchange
Commission on March 20, 2006.
Incorporated by reference from the Company’s 2008 Proxy Statement filed with Securities and Exchange Commission on
March 12, 2008.
Incorporated by reference from the Company’s Current Report on Form 8‑K filed with the Securities and Exchange
Commission on November 18, 2008.
Incorporated by reference from the Company’s Quarterly Report on Form 10‑Q for the quarter ended June 30, 2010 and filed
with the Securities and Exchange Commission on August 13, 2010.
Incorporated by reference from the Company’s Annual Report on Form 10‑K for fiscal year ended December 31, 2003 and
filed with the Securities and Exchange Commission on March 25, 2004.
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
ITEM 16 FORM 10‑‑K SUMMARY
None.
51
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
April 17, 2019
SEVERN BANCORP, INC.
/s/ Alan J. Hyatt
Alan J. Hyatt
Chairman of the Board, President, and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities as indicated on April 17 , 2019.
/ s / Alan J. Hyatt
Alan J. Hyatt
Chairman of the Board,
President, and Chief Executive Officer
(Principal Executive Officer)
/s/ Paul B. Susie
Paul B. Susie, Executive Vice
President and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ Konrad M. Wayson
Konrad M. Wayson, Director
Vice Chairman of the Board
/s/ Raymond S. Crosby
Raymond S. Crosby, Director
/ s / James H. Johnson, Jr.
James H. Johnson, Jr., Director
/s/ David S. Jones
David S. Jones, Director
/ s / Eric M. Keitz
Eric M. Keitz, Director
/s/ John A. Lamon III
John A. Lamon III, Director
/s/ Albert W. Shields
Albert W. Shields, Director
/s/ Mary Kathleen Sulick
Mary Kathleen Sulick, Director
52
Table of Contents
Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Severn Bancorp, Inc.
Annapolis, Maryland
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of financial condition of Severn Bancorp, Inc. and Subsidiaries, (the
“Company”) as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income,
changes in stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2018, and the related
notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements
present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2018 and 2017, and
the results of their operations and their cash flows for each of the two years in the period ended December 31, 2018, in conformity
with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(“PCAOB”), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in
Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) and our report dated April 17, 2019 expressed an adverse opinion thereon.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an
opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with
the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws
and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement,
whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements,
whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a
test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall
presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/BDO USA, LLP
We have served as the Company’s auditor since 2013.
Philadelphia, Pennsylvania
April 17 , 2019
F-1
Table of Contents
Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Severn Bancorp, Inc.
Annapolis, Maryland
Opinion on Internal Control over Financial Reporting
We have audited Severn Bancorp, Inc. and Subsidiaries’ (the “Company’s”) internal control over financial reporting as of
December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company did not maintain, in
all material respects, effective internal control over financial reporting as of December 31, 2018, based on the COSO criteria.
We do not express an opinion or any other form of assurance on management’s statements referring to any corrective actions
taken by the Company after the date of management’s assessment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(“PCAOB”), the consolidated statements of financial condition of Severn Bancorp, Inc. and Subsidiaries, (the “Company”) as of
December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income, changes in stockholders’
equity, and cash flows for each of the two years in the period ended December 31, 2018, and the related notes (collectively
referred to as the “consolidated financial statements”) and our report dated April 17, 2019 expressed an unqualified opinion
thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s
Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal
control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required
to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there
is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be
prevented or detected on a timely basis. Material weaknesses regarding management’s failure to design and maintain controls
over the allowance for loan losses and classifications of loans held for sale have been identified and described in management’s
assessment. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our
audit of the 2018 financial statements, and this report does not affect our report dated April 17, 2019 on those financial
statements.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes those policies
F-2
Table of Contents
and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/BDO USA, LLP
We have served as the Company’s auditor since 2013.
Philadelphia, Pennsylvania
April 17 , 2019
F-3
Table of Contents
Severn Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
ASSETS
Cash and due from banks
Federal funds sold and interest-bearing deposits in other banks
Cash and cash equivalents
Certificates of deposit held for investment
Securities available for sale, at fair value
Securities held to maturity (fair value of $38,212 and $54,004 at December 31, 2018 and 2017,
respectively)
Mortgage loans held for sale, at fair value
Loans receivable
Allowance for loan losses
Loans, net
Real estate acquired through foreclosure
Restricted stock investments
Premises and equipment, net
Accrued interest receivable
Deferred income taxes
Bank owned life insurance
Goodwill
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest bearing
Interest-bearing
Total deposits
Long-term borrowings
Subordinated debentures
Accrued expenses and other liabilities
Total liabilities
Stockholders' Equity:
Preferred stock, $0.01 par value, 1,000,000 shares authorized:
Preferred stock series ''A,'' 437,500 shares issued and outstanding and $3,500 liquidation
preference at December 31, 2017
Common stock, $0.01 par value, 20,000,000 shares authorized; 12,759,576 and 12,233,424 shares
issued and outstanding at December 31, 2018 and 2017, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total stockholders' equity
Total liabilities and stockholders' equity
See accompanying notes to consolidated financial statements
F-4
December 31,
2018
2017
$
2,880 $
185,460
188,340
8,780
11,978
2,382
19,471
21,853
8,780
10,119
38,912
9,686
682,349
(8,044)
674,305
1,537
3,766
22,745
2,848
2,363
5,225
1,104
2,644
54,303
4,530
668,151
(8,055)
660,096
403
4,489
23,139
2,640
5,302
5,064
1,099
2,970
$ 974,233 $ 804,787
$ 146,604 $
632,902
779,506
73,500
20,619
2,155
875,780
72,833
529,395
602,228
88,500
20,619
2,340
713,687
—
4
128
65,538
32,860
(73)
98,453
122
65,137
25,872
(35)
91,100
$ 974,233 $ 804,787
Table of Contents
Severn Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
Interest income:
Loans
Securities
Other earning assets
Total interest income
Interest expense:
Deposits
Borrowings and subordinated debentures
Total interest expense
Net interest income
Reversal of provision for loan losses
Net interest income after reversal of provision for loan losses
Noninterest income:
Mortgage-banking revenue
Real estate commissions
Real estate management fees
Credit report and appraisal fees
Deposit service charges
Loan fee income
Title company revenue
Other noninterest income
Total noninterest income
Noninterest expense:
Compensation and related expenses
Occupancy
Legal fees
Write-downs, losses, and costs of real estate acquired through foreclosure, net of gains
Federal Deposit Insurance Corporation insurance premiums
Professional fees
Advertising
Data processing
Credit report and appraisal fees
Licensing and software
Mortgage leads purchased
Other noninterest expense
Total noninterest expense
Net income before income tax provision
Income tax provision
Net income
Dividends on preferred stock
Net income available to common stockholders
Net income per common share - basic
Net income per common share - diluted
See accompanying notes to consolidated financial statements
F-5
$
$
$
Year Ended December 31,
2018
2017
$
34,877 $
1,196
1,587
37,660
30,294
1,233
697
32,224
4,037
3,593
7,630
24,594
(650)
25,244
1,507
1,358
675
464
538
292
219
185
5,238
14,734
1,358
143
132
115
462
788
907
594
423
235
2,751
22,642
7,840
5,022
2,818
(280)
2,538
0.21
0.21
5,688
2,915
8,603
29,057
(300)
29,357
2,561
1,707
674
351
1,552
410
1,045
480
8,780
17,819
1,555
149
83
229
498
1,021
1,098
536
596
—
3,007
26,591
11,546
2,977
8,569
(70)
8,499 $
0.68 $
0.67 $
Table of Contents
Severn Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)
Net income
Other comprehensive loss items:
Unrealized holding losses on available-for-sale securities arising during the period (net of tax
benefit of $14 and $21)
Realized gains (net of tax expense of $0 and $1)
Total other comprehensive loss
Total comprehensive income
See accompanying notes to consolidated financial statements
Year Ended December 31,
2018
2017
$
8,569 $
2,818
(38)
—
(38)
8,531 $
(34)
(1)
(35)
2,783
$
F-6
Table of Contents
Severn Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(dollars in thousands, except per share data)
Number of Number of
Shares of
Preferred Common Preferred Common
Shares of
Additional
Paid-In Retained Comprehensive Stockholders'
Accumulated
Other
Total
Stock
Stock
Stock
Capital
Earnings
Loss
Equity
12,123,179 $
4 $
Balance at January 1, 2017
Net income
Stock-based compensation
Stock issued in purchase
transaction
Dividend declared on Series A
preferred stock
Exercise of stock options
Repurchase of warrant
Other comprehensive loss
Balance at December 31, 2017
Net income
Stock-based compensation
Redemption of preferred stock
Dividend declared on Series A
preferred stock
Dividends paid on common stock
at $0.12 per share
Exercise of stock options
Other
Other comprehensive loss
Balance at December 31, 2018
—
108,084
Stock
437,500
—
—
—
—
—
—
437,500
—
—
(437,500)
—
—
—
—
—
—
—
—
—
2,161
—
—
—
—
437,500
—
—
88,652
—
—
12,759,576 $
See accompanying notes to consolidated financial statements
12,233,424 $
4 $
—
—
—
—
—
—
—
—
—
(4)
—
—
—
—
—
— $
F-7
121 $
—
—
1
—
—
—
—
122 $
—
—
4
—
—
2
—
—
128 $
64,471 $ 23,334 $
—
205
774
—
207
(520)
—
2,818
—
—
(280)
—
—
—
65,137 $ 25,872 $
—
218
—
—
—
372
(189)
—
8,569
—
—
(70)
(1,511)
—
—
—
65,538 $ 32,860 $
— $
—
—
—
—
—
—
(35)
(35) $
—
—
—
—
—
—
—
(38)
(73) $
87,930
2,818
205
775
(280)
207
(520)
(35)
91,100
8,569
218
—
(70)
(1,511)
374
(189)
(38)
98,453
Table of Contents
Severn Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands, except per share data)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization
Amortization of deferred loan fees
Net accretion (amortization) of premiums and discounts
Reversal of provision for loan losses
Write-downs and losses on real estate acquired through foreclosure, net of gains
Gain on sale of mortgage loans
Gain on sale of securities
Write off of restricted stock
Proceeds from sale of mortgage loans held for sale
Originations of mortgage loans held for sale
Stock-based compensation
Increase in cash surrender value of bank-owned life insurance
Deferred income taxes
Increase in accrued interest receivable
Decrease in other assets
Decrease in accrued expenses and other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of certificates of deposit held for investment
Loan principal (disbursements), net of repayments
Repurchases of loans orginated for sale
Redemption of restricted stock investments
Purchases of premises and equipment, net
Purchase of bank-owned life insurance
Activity in securities held to maturity:
Purchases
Maturities/calls/repayments
Activity in available-for-sale securities:
Purchases
Sales
Proceeds from sales of real estate acquired through foreclosure
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Net increase in deposits
Additional long-term borrowings
Repayments of long-term borrowings
Repurchase of warrant
Common stock dividends
Preferred stock dividends
Exercise of stock options
Net cash provided by financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental Information:
Interest paid on deposits and borrowed funds
Income taxes paid
Real estate acquired in satisfaction of loans
Transfers of loans held for sale to loan portfolio
Common stock issued upon conversion of preferred stock
Preferred stock converted to common stock
See accompanying notes to consolidated financial statements
F-8
Year Ended December 31,
2018
2017
$
8,569
$
2,818
1,312
(1,835)
219
(300)
61
(2,561)
—
100
98,224
(100,819)
218
(161)
2,952
(208)
132
(186)
5,717
—
(13,440)
—
623
(918)
—
—
15,263
(2,000)
—
171
(301)
177,278
46,500
(61,500)
—
(1,511)
(70)
374
161,071
166,487
21,853
188,340
8,578
103
1,366
—
4
(4)
$
$
$
$
1,234
(1,215)
(189)
(650)
103
(1,507)
(2)
—
67,396
(60,772)
205
(64)
4,794
(391)
246
(1,125)
10,881
(8,680)
(56,497)
(469)
614
(342)
(5,000)
(6,464)
14,937
(14,000)
4,000
1,170
(70,731)
30,282
59,950
(74,950)
(520)
—
(280)
207
14,689
(45,161)
67,014
21,853
7,773
92
703
660
—
—
Table of Contents
Severn Bancorp, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
Basis of Presentation
The accounting and reporting policies of Severn Bancorp, Inc. and subsidiaries (the “Company”) conform to accounting
principles generally accepted in the United States of America (“U.S.”) (“GAAP”). Events occurring after the date of the financial
statements up to April 17 , 2019, the date the financial statements were available to be issued, were considered in the preparation
of the consolidated financial statements.
Principles of Consolidation
The consolidated financial statements include the accounts of Severn Bancorp, Inc., and its wholly-owned subsidiaries, Mid-
Maryland Title Company, Inc. (the “Title Company”), SBI Mortgage Company and SBI Mortgage Company’s subsidiary,
Crownsville Development Corporation, and its subsidiary, Crownsville Holdings I, LLC, and Severn Savings Bank, FSB (the
“Bank”), and the Bank’s subsidiaries, Louis Hyatt, Inc., Homeowners Title and Escrow Corporation, Severn Financial Services
Corporation, SSB Realty Holdings, LLC, SSB Realty Holdings II, LLC, and HS West, LLC. All intercompany accounts and
transactions have been eliminated in the accompanying consolidated financial statements.
Business
We provide financial services to customers primarily within the Anne Arundel County region of Maryland. A portion of activities
related to mortgage lending are more dispersed and cover other parts of Maryland and the Mid-Atlantic region. We serve local
consumers, small and medium sized businesses, professionals, and other customers by offering a broad range of financial
products and services, including Internet and mobile banking, commercial banking, cash management, mortgage lending, and
retail banking. We fund a variety of loan types including commercial and residential real estate loans, commercial term loans and
lines and letters of credit, and consumer loans. We do not have any concentrations to any one industry or customer. However, our
customers’ ability to repay loan agreements is dependent on the real estate and general economic conditions of the market area.
We have no reportable segments. Management does not separately allocate expenses, including the cost of funding loan demand,
between any of the various operations of the Company. As such, discrete financial information is not available and segment
reporting would not be meaningful.
Acquisition
On September 1, 2017, we acquired the Title Company by issuing common stock in a business combination. We issued 108,084
shares in the transaction valued at $775,000. We recorded $770,000 in goodwill in the transaction. The acquisition continues our
growth strategy and focus on being a full-service provider and complements the mortgage services, commercial banking services,
and commercial real estate services we provide.
Use of Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, and affect the
reported amounts of revenues earned and expenses incurred during the reporting period. Actual results could differ from those
estimates. Estimates that could change significantly relate to the provision for loan losses and the related allowance for loan losses
(“Allowance”), determination of impaired loans and the related measurement of impairment, valuation of investment securities,
valuation of real estate acquired through foreclosure, valuation of share-based compensation, the assessment that a liability should
be recognized with respect to any matters under litigation, and the calculation of current and deferred income taxes and the
realizability of deferred tax assets.
Change in Accounting Estimate
F-9
Table of Contents
During the fourth quarter of 2018, the Bank changed its metholdology for estimating the adequacy of the Allowance. The change
in accounting estimate was due to the Bank identifying certain loss factors which allowed the us to anchor the qualitative loss
factor adjustments back to our loss history. This change in estimate did not have any impact on the current period provision for
loan losses, rather, it resulted in re-allocation of existing Allowances between loan classifications.
Cash and Cash Equivalents
We consider all highly liquid securities with original maturities of three months or less to be cash equivalents. For reporting
purposes, assets grouped in the Consolidated Statements of Financial Condition under the captions “Cash and due from banks”
and “Federal funds sold and interest‑bearing deposits in other banks” are considered cash or cash equivalents. For financial
statement purposes, these assets are carried at cost. Federal funds sold and interest-bearing deposits in other banks generally have
overnight maturities and are in excess of amounts that would be recoverable under Federal Deposit Insurance Corporation
(“FDIC”) insurance.
Significant Accounting Policies
Revenue Recognition
Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers , effective January 1, 2018, establishes
principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the
entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict
the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in
exchange for those goods or services recognized as performance obligations are satisfied.
The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial
instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our mortgage-
banking and mortgage servicing activities. Our revenue-generating activities that are within the scope of ASC 606, which are
presented in our income statements as components of noninterest income, are service charges on deposit accounts, real estate
commissions, real estate management fees, and title company revenue.
Service Charges on Deposit Accounts
Service charges on deposit accounts represent general service fees for monthly account maintenance and activity - or transaction-
based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other
individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally
monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such
performance obligations are generally received at the time the performance obligations are satisfied.
Real Estate Commissions
Real Estate Commissions represent commissions received on properties sold. Revenue is recognized when our performance
obligation is completed, which is generally the time the property is sold and payment has been received.
Real Estate Management Fees
Real Estate Management Fees represent monthly fees received on property maintenance and management. We perform daily
services for these fees and bill for those services on a monthly basis. We have determined that each day of the performance of the
services represents a distinct service. The overall service of property management each day is substantially the same and has the
same pattern of transfer (daily) over the term of the contract. Further, each distinct day of service represents a performance
obligation that would be satisfied over time (over the length of the contract, not at a point in time) and has the same measure of
progress (elapsed time). Management has therefore determined that property management services are a single performance
obligation composed of a series of distinct services. In performing the daily
F-10
Table of Contents
management activities, the customer is simultaneously receiving and consuming the benefits provided by our performance of the
contract. Revenue is earned evenly and daily over the life of the contract. For purposes of expedience, we record the fees when
monthly invoices are processed. Each month contains 1/12 of the contract revenue.
Title Company Revenue
Title Company Revenue consists of revenue earned on performing title work for real estate transactions. The revenue is earned
when the title work is performed. Payment for such performance obligations generally occurs at the time of the settlement of a
real estate transaction. As such settlement is generally within 90 days of the performance of the title work, we recognize the
revenue at the time of the settlement.
All contract acquisition costs are expensed as incurred. We had no contract assets or liabilities at December 31, 2018.
Securities
We designate securities into one of three categories at the time of purchase. Debt securities that we have the intent and ability to
hold to maturity are classified as held to maturity (“HTM”) and recorded at amortized cost. Debt securities are classified as
trading if bought and held principally for the purpose of sale in the near term. Trading securities are reported at estimated fair
value, with unrealized gains and losses included in earnings. Debt securities not classified as HTM securities or trading securities
are considered available for sale (“AFS”) and are reported at estimated fair value, with unrealized gains and losses reported as a
separate component of stockholders’ equity, net of tax effects, in accumulated other comprehensive loss.
AFS and HTM securities are evaluated periodically to determine whether a decline in their value is other than temporary. The
term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near-
term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater
than, the carrying value of the security.
The initial indications of other-than-temporary impairment (“OTTI”) for debt securities are a decline in the market value below
the amount recorded for a security and the severity and duration of the decline. In determining whether an impairment is other
than temporary, we consider the length of time and the extent to which the market value has been below cost, recent events
specific to the issuer, including investment downgrades by rating agencies and economic conditions of its industry, our intent to
sell the security, and if it is more likely than not that we will be required to sell the security before recovery of its amortized cost
basis. We also consider the cause of the price decline (general level of interest rates and industry- and issuer-specific factors), the
issuer’s financial condition, near-term prospects and current ability to make future payments in a timely manner, the issuer’s
ability to service debt, and any change in agencies’ ratings at evaluation date from acquisition date and any likely imminent
action. Once a decline in value is determined to be other than temporary, the security is segmented into credit- and noncredit-
related components. Any impairment adjustment due to identified credit-related components is recorded as an adjustment to
current period earnings, while noncredit-related fair value adjustments are recorded through accumulated other comprehensive
loss. In situations where we intend to sell or it is more likely than not that we will be required to sell the security, the entire OTTI
loss is recognized in earnings.
Loans Held for Sale (“LHFS”)
Mortgage loans originated for sale are carried at fair value. Fair value is determined based on outstanding investor commitments
or, in the absence of such commitments, on current investor yield requirements or third-party pricing models. Gains and losses on
loan sales are determined using the specific-identification method and are recognized through mortgage-banking revenue in the
Consolidated Statement of Operations. LHFS are sold either with the mortgage servicing rights (“MSRs”) released or retained by
the Bank.
Loans Receivable
Our loans receivable are stated at their principal balance outstanding, net of related deferred fees and costs. Residential lending is
generally considered to involve less risk than other forms of lending, although payment experience on these
F-11
Table of Contents
loans is dependent to some extent on economic and market conditions in the Bank’s lending area. Multifamily residential,
commercial, construction, and other loan repayments are generally dependent on the operations of the related properties or the
financial condition of the borrower or guarantor. Accordingly, repayment of such loans can be more susceptible to adverse
conditions in the real estate market and the regional economy. A substantial portion of the Bank’s loans receivable consists of
mortgage loans secured by residential and commercial real estate properties located in the State of Maryland. Loans are extended
only after evaluation by management of customers’ creditworthiness and other relevant factors on a case-by-case basis. The Bank
generally does not lend more than 80% of the appraised value of a property and requires private mortgage insurance on residential
mortgages with loan-to-value (“LTV”) ratios in excess of 80%. In addition, the Bank generally obtains personal guarantees of
repayment from borrowers and/or others for construction, commercial, and multifamily residential loans and disburses the
proceeds of construction and similar loans only as work progresses on the related projects.
Income recognition
Interest income on loans is accrued at the contractual rate based on the outstanding principal balance. Loan origination fees and
certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual loan term or until the
date of sale or disposition. Accrual of interest is discontinued when its receipt is in doubt, which typically occurs when a loan
becomes impaired. Any interest accrued to income in the year when interest accruals are discontinued is generally reversed.
Management may elect to continue the accrual of interest when a loan is in the process of collection and the estimated fair value
of the collateral is sufficient to satisfy the principal balance and accrued interest. See additional information on nonaccrual
interest and loan impairment later in this section.
Fees and costs
Origination and commitment fees and direct origination costs on loans held for investment generally are deferred and amortized
to income over the contractual lives of the related loans using the interest method. Under certain circumstances, commitment fees
are recognized over the commitment period or upon expiration of the commitment. Fees to extend loans three months or less are
recognized in income upon receipt. Unamortized loan fees are recognized in income when the related loans are sold or prepaid.
Transfers of LHFS
In accordance with Financial Accounting Standards Board (“FASB”) guidance on mortgage-banking activities, any loans which
are originally originated for sale into the secondary market and which we subsequently elect to transfer into the Company’s loan
portfolio are valued at lower of cost or market value (“LCM”) at the time of the transfer with any decline in value recorded as a
charge against mortgage-banking revenue.
Troubled Debt Restructured Loans (“TDR” or “TDRs”)
We strive to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their
loan reaches nonaccrual status. In situations where, for economic or legal reasons related to a borrower’s financial difficulties, we
may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the
related now-modified loan is classified as a TDR. These modified terms may include rate reductions, principal forgiveness,
payment extensions, payment forbearance, and/or other actions intended to minimize the economic loss and to avoid foreclosure
or repossession of the collateral. These loans are excluded from pooled loss forecasts and a separate reserve is provided under the
accounting guidance for loan impairment. At the time that a loan is modified, we evaluate any possible impairment based on the
present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when
the sole remaining source of repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value
of the collateral, less selling costs, instead of discounted cash flows. Any impairment amount is then set up as an allocated portion
of the Allowance.
F-12
Table of Contents
Loan Impairment
A loan is considered impaired if it meets any of the following three criteria:
·
·
·
Loans that are 90 days or more in arrears (nonaccrual loans);
Loans where, based on current information and events, it is probable that a borrower will be unable to pay all amounts
due according to the contractual terms of the loan agreement; or
Loans that are modified and qualify as TDRs.
If a loan is considered to be impaired, it is then determined to be either cash flow or collateral dependent for purposes of
measuring an apprpopriate Allowance (see Allowance discussion below).
Nonaccrual Interest
The accrual of interest on loans is discontinued at the time the loan is 90 days past due. Past due status is based on contractual
terms of the loan. In all cases, loans are placed in nonaccrual status or charged off at an earlier date if collection of principal or
interest is considered doubtful.
All interest accrued but not collected for loans that are placed in nonaccrual status or charged off is reversed against interest
income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to
accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and
future payments are reasonably assured, generally after six months of consecutive current payments and an updated analysis of
the borrower’s ability to service the loan. Our policy for recording payments received on nonaccrual loans is to record the
payment towards principal and interest on a cash basis until such time as the loan is returned to accrual status.
Loans that experience insignificant payment delays and payment shortfalls generally are not placed in nonaccrual status or
classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case
basis, taking into consideration all of circumstances surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest
owed.
Allowance for Loan Losses
The Allowance is maintained at an amount that management believes will be adequate to absorb losses on existing loans that may
become uncollectible, based on evaluations of the collectability of loans and prior loan loss experience. The evaluations take into
consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, and current economic conditions that may affect the borrowers’ ability to pay. Determining the amount of the
Allowance requires the use of estimates and assumptions. Actual results could differ significantly from those estimates.
Future additions or reductions in the Allowance may be necessary based on changes in economic conditions, particularly in Anne
Arundel County and the State of Maryland. In addition, various regulatory agencies, as an integral part of their examination
process, periodically review the Bank’s Allowance. Such agencies may require the Bank to recognize additions to the Allowance
based on their judgment about information available to them at the time of their examination.
The Allowance consists of specific and general components. The specific component relates to loans that are classified as
impaired. When a real estate secured loan becomes impaired, a decision is made as to whether an updated certified appraisal of
the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the
LTV ratio based on the original appraisal, and the condition of the property. Appraised values are discounted, if appropriate,
to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also
include estimated costs to sell the property. For loans secured by collateral other than real estate, such as accounts receivable,
inventory, and equipment, estimated fair values are determined based on the borrower’s
F-13
Table of Contents
financial statements, inventory reports, accounts receivable aging, or equipment appraisals or invoices. Indications of value from
these sources are generally discounted based on the age of the financial information or the quality of the assets.
For such loans that are classified as impaired, an Allowance is established when the current fair value of the underlying collateral
less its estimated disposal costs has not been finalized, but management determines that it is likely that the value is lower than the
carrying value of that loan. Once the net collateral value has been determined, a charge off is taken for the difference between the
net collateral value and the carrying value of the loan. For loans that are not solely collateral dependent, an Allowance is
established when the present value of the expected future cash flows of the impaired loan is lower than the carrying value of the
loan.
The general component relates to loans that are classified as doubtful, substandard, or special mention that are not considered
impaired, as well as nonclassified loans. The general reserve is based on historical loss experience adjusted for qualitative factors.
These qualitative factors include, but are not limited to:
Levels and trends in delinquencies and nonaccruals;
·
Inherent risk in the loan portfolio;
·
Trends in volume and terms of the loan;
·
Effects of any change in lending policies and procedures;
·
Experience, ability, and depth of management;
·
· National and local economic trends and conditions;
Effect of any changes in concentration of credit; and
·
Industry conditions.
·
We assign risk ratings to the loans in our portfolio. These credit quality risk ratings include regulatory classifications of special
mention, substandard, doubtful, and loss. Loans classified special mention have potential weaknesses that warrant management’s
close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified
substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are
inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any.
Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that
collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are
considered uncollectible and are charged to the Allowance. Loans not classified are rated pass.
With respect to all loan segments, we do not charge off a loan, or a portion of a loan, until one of the following conditions have
been met:
·
The property collateralizing the loan has been foreclosed upon. At the time of foreclosure, a charge-off is recorded for
the difference between the recorded amount of the loan and the net value of the underlying collateral;
· An agreement to accept less than the recorded balance of the loan has been made with the borrower. Once an agreement
has been finalized and any proceeds from the borrower are received, a charge-off is recorded for the difference between
the recorded amount of the loan and the net value of the underlying collateral; or
·
The collateral valuation on a collateral dependent impaired loan is less than the recorded balance. The loan is charged off
for accounting purposes by the amount of the difference between the recorded balance and collateral value.
Real Estate Acquired Through Foreclosure
Real estate acquired through or in the process of foreclosure is recorded at fair value less estimated disposal costs. Management
periodically evaluates the recoverability of the carrying value of the real estate acquired through foreclosure using estimates as
described under “Allowance for Loan Losses” above. In the event of a subsequent change in fair value, the carrying amount is
adjusted to the lesser of the new fair value, less disposal costs, or the carrying value recorded at
F-14
Table of Contents
acquisition. The amount of the change is charged or credited to noninterest expense. Expenses on real estate acquired through
foreclosure incurred prior to the disposition of the property, such as maintenance, insurance and taxes, and physical security, are
charged to expense. Material expenses that improve the property to its best use are capitalized to the property. If a foreclosed
property is sold for more or less than the carrying value, a gain or loss is recognized upon the sale of the property.
Restricted Stock Investments
Our restricted stock investments include stock of the Federal Home Loan Bank of Atlanta (the “FHLB”) and capital stock of a
bankers’ bank. Our investment in the FHLB stock is an equity interest in the FHLB, which does not have a readily determinable
fair value for purposes of GAAP because its ownership is restricted and it lacks a market. FHLB stock can be sold back only at
par value of $100 per share and only to the FHLB or another member institution. The Bank’s investment in the capital stock of
the bankers’ bank is carried at cost as no readily available market exists for this stock and it has no quoted market value. During
2018, we wrote off one such stock in the amount of $100,000 that we held at December 31, 2017 as the Bankers bank was
announced to be liquidating.
We evaluated the FHLB stock for impairment in accordance with GAAP. The Bank’s determination of whether this investment is
impaired is based on an assessment of the ultimate recoverability of its cost rather than by recognizing temporary declines in
value. The determination of whether a decline in value affects the ultimate recoverability of its cost is influenced by criteria such
as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the
length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the
level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes
on institutions and, accordingly, on the customer base of the FHLB, and (4) the liquidity position of the FHLB. Management has
evaluated the FHLB stock for impairment and believes that no impairment charge is necessary as of December 31, 2018.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation. Depreciation and amortization of premises and
equipment is accumulated by the use of the straight-line method over the estimated useful lives of the assets. Additions and
improvements are capitalized, and charges for repairs and maintenance are expensed when incurred. The related cost and
accumulated depreciation are eliminated from the accounts when an asset is sold or retired and the resultant gain or loss is
credited or charged to income.
Bank Owned Life Insurance (“BOLI”)
BOLI is carried at the aggregate cash surrender value of life insurance policies owned where the Company or its subsidiary is
named beneficiary. Increases in cash surrender value derived from crediting rates for underlying insurance policies is credited to
noninterest income.
Goodwill and Other Intangible Assets
Goodwill represents the excess purchase price paid over the fair value of the net assets acquired in a business combination and is
allocated to the Bank’s reporting units. Based upon an in-depth analysis performed in accordance with FASB guidance, we have
determined that we have one reporting unit – commercial and consumer banking.
Goodwill is not amortized but is tested for impairment periodically. We assess goodwill for potential impairment annually as of
September 30, or during the year if an event or other circumstance indicates that we may not be able to recover the carrying
amount of the asset. As of September 30, 2018, we determined that there was no evidence of impairment of goodwill.
Income Taxes
Deferred income taxes are recognized for the tax consequences of temporary differences between financial statement carrying
amounts and the tax bases of assets and liabilities. Deferred income taxes are provided on income and expense
F-15
Table of Contents
items when they are reported for financial statement purposes in periods different from the periods in which these items are
recognized in the income tax returns. Deferred tax assets are recognized only to the extent that it is more likely than not that such
amounts will be realized based upon consideration of available evidence, including tax planning strategies and other factors.
The calculation of tax assets and liabilities is complex and requires the use of estimates and judgment since it involves the
application of complex tax laws that are subject to different interpretations by us and the various tax authorities. These
interpretations are subject to challenge by the tax authorities upon audit or to reinterpretation based on management’s ongoing
assessment of facts and evolving case law.
Periodically and in the ordinary course of business, we are involved in inquiries and reviews by tax authorities that normally
require management to provide supplemental information to support certain tax positions we take in our tax returns. Uncertain tax
positions are initially recognized in the financial statements when it is more likely than not the position will be sustained upon
examination by the tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit
or liability that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full
knowledge of the position and all relevant facts. For tax positions not meeting the “more likely than not” test, no tax benefit or
liability is recorded. Management believes it has taken appropriate positions on its tax returns, although the ultimate outcome of
any tax review cannot be predicted with certainty. No assurance can be given that the final outcome of these matters will not be
different than what is reflected in the financial statements.
We recognize interest and penalties related to income tax matters in income tax expense.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain
changes in assets and liabilities, such as unrealized gains and losses on AFS securities, are reported as a separate component of
the equity section of the consolidated statements of financial condition, and, along with net income, are components of
comprehensive income. The Company’s sole component of accumulated other comprehensive loss is unrealized gains/losses on
AFS securities.
Derivative Financial Instruments and Hedging
We account for derivatives in accordance with FASB literature on accounting for derivative instruments and hedging activities.
When we enter into a derivative contract, we designate the derivative as held for trading, an economic hedge, or a qualifying
hedge as detailed in the literature. The designation may change based upon management’s reassessment or changing
circumstances. Derivatives utilized by the Company include interest rate lock commitments (“IRLC” or “IRLCs”) and forward
settlement contracts. IRLCs occur when we originate mortgage loans with interest rates determined prior to funding. Forward
settlement contracts are agreements to buy or sell a quantity of a financial instrument, index, currency, or commodity at a
predetermined future date, and rate or price.
We designate at inception whether a derivative contract is considered hedging or nonhedging. All of our derivatives are
nonexchange traded contracts, and as such, their fair value is based on dealer quotes, pricing models, discounted cash flow
methodologies, or similar techniques for which the determination of fair value may require significant management judgment or
estimation.
For qualifying hedges, we formally document at inception all relationships between hedging instruments and hedged items, as
well as risk management objectives and strategies for undertaking various accounting hedges. We utilize derivatives to manage
interest rate sensitivity in certain cases.
At December 31, 2018 and 2017, we did not have any designated hedges as we do not designate IRLCs or forward sales
commitments on residential mortgage originations as hedges. We recognize any gains and losses on IRLCs and forward sales
commitments on residential mortgage originations through mortgage-banking revenue in the Consolidated Statements of
Operations.
F-16
Table of Contents
Impairment of Long-Lived Assets
We continually monitor events and changes in circumstances that could indicate that our carrying amounts of long-lived assets,
including intangible assets, may not be recoverable. When such events or changes in circumstances occur, we assess the
recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through their
undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets,
we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred
assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right
(free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the
Company does not maintain effective control over the transferred assets through a requirement to repurchase them before their
maturity.
Advertising Costs
We expense our advertising costs as incurred, except payments for major sponsorships which are amortized over an estimated life
not to exceed one year. Advertising expenses were $1.0 million and $788,000 for the years ended December 31, 2018 and 2017,
respectively.
Recent Accounting Pronouncements
Pronouncements Adopted
In May 2014, FASB issued Accounting Standards Update (“ASU”) No. 2014 ‑
09, Revenue from Contracts with Customers , as
amended by ASU 2015 ‑
14, Revenue from Contracts with Customers: Deferral of the Effective Date , ASU 2016 ‑
08, Revenue
from Contracts with Customers: Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net) , ASU 2016 ‑
10, Revenue from Contracts with Customers, Identifying Performance Obligations and Licensing , ASU 2016 ‑
12, Revenue from
Contracts with Customers: Narrow-Scope Improvements and Practical Expedients, ASU 2016 ‑
20, Technical Corrections and
Improvements to Topic 606 , Revenue from Contracts with Customers , that provides accounting guidance for all revenue arising
from contracts with customers and affects all entities that enter into contracts to provide goods or services to customers. The
guidance also provides for a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial
assets, such as property and equipment, including real estate. We adopted the pronouncement on January 1, 2018 and elected the
modified retrospective transition method. There was no material impact to the financial statements. Our accounting policies and
revenue recognition principles did not change materially as the principles of ASC 606 are largely consistent with the previous
revenue recognition practices. See additional information on revenue recognition above.
In January 2016, FASB issued ASU No. 2016 ‑
01, Financial Instruments – Overall: Recognition and Measurement of
Financial Assets and Financial Liabilities , which requires entities to measure equity investments at fair value and recognize
changes on fair value in net income. The guidance also provides a new measurement alternative for equity investments that do not
have readily determinable fair values and don’t qualify for the net asset value practical expedient. The standard requires entities to
record changes in instrument–specific credit risk for financial liabilities measured under the fair value option in other
comprehensive income, except for certain financial liabilities of consolidated collateralized financing entities. Entities also have
to reassess the realizability of a deferred tax asset related to an AFS debt security in combination with their other deferred tax
assets. The adoption of this standard did not have a material impact on the Company’s financial position, results of operations, or
cash flows.
In August 2016, FASB issued ASU No. 2016 ‑
15, Classification of Certain Cash Receipts and Cash Payments , which provides
guidance regarding the presentation of certain cash receipts and cash payments in the statement of cash flows, addressing eight
specific cash flow classification issues, in order to reduce existing diversity in practice. The adoption of ASC No. 2016 ‑
15 did
not have a material impact on our financial position, results of operations, or cash flows.
F-17
Table of Contents
In May 2017, FASB issued ASU No. 2017 ‑
09, Stock Compensation (Topic718): Scope of Modification Accounting, which
amends ASC Topic 718, Stock Compensation, to provide guidance about which changes to the terms or conditions of a share-
based payment award require an entity to apply modification accounting per ASC Topic 718. The amendments clarify that
modification accounting only applies to an entity if the fair value, vesting conditions, or classification of the award changes as a
result of changes in the terms or conditions of a share-based payment award. The ASU should be applied prospectively to awards
modified on or after the adoption date. We adopted the standard on January 1, 2018 with no material impact on the Company’s
financial position, results of operations, or cash flows.
Pronouncements Issued
In February 2016, FASB issued ASU 2016‑02, Leases , which requires a lessee to recognize the assets and liabilities that arise
from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease
payments and a right-of-use (“ROU”) asset. The accounting applied by the lessor is relatively unchanged. The ASU also requires
expanded qualitative and quantitative disclosures. For public business entities, the guidance was effective for interim and annual
reporting periods beginning after December 15, 2018 and mandates a modified retrospective transition for all entities. We adopted
this standard in the first quarter of 2019 using the option to apply the transition provisions of the new standard at the adoption
date instead of the earliest period presented as provided in ASU 2018-11. Additionally, the Company elected to apply all practical
expedients as provided in ASU 2016-02, with the exception of the hindsight practical expedient which was not elected. As a result
of the adoption of this standard, effective January 1, 2019, the Company recognized an ROU asset of $2.6 million to be recorded
in other assets on the balance sheet and a lease liability of $2.7 million to be recorded in other liabilities on the balance sheet. The
lease liability represents the present value of the future payments on five leased properties and six leased pieces of equipment
within the Company’s footprint, while the ROU asset reflects the lease liability adjusted for deferred rent balances of the
respective properties as of the adoption date of January 1, 2019. The Company expects its regulatory capital ratios to remain
above the thresholds necessary to be classified as a “well capitalized” institution.
In June 2016, FASB issued ASU No. 2016 ‑
13, Financial Instruments – Credit Losses , which sets forth a current expected
credit loss (“CECL”) model which requires the Company to measure all expected credit losses for financial instruments held at
the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the
existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost
and applies to some off-balance sheet credit exposures. This ASU is effective for fiscal years beginning after December 15, 2019,
including interim periods within those fiscal years. While we are currently in the process of evaluating the impact of the amended
guidance on our Consolidated Financial Statements, we currently expect the Allowance to increase upon adoption given that the
Allowance will be required to cover the full remaining expected life of the portfolio upon adoption, rather than the incurred loss
model under current GAAP. The extent of this increase is still being evaluated and will depend on economic conditions and the
composition of our loan and lease portfolio at the time of adoption.
In March 2017, FASB issued ASU No. 2017 ‑
08, Receivables - Nonrefundable Fees and Other costs , which provides guidance
that calls for the shortening of the amortization period for certain callable debt securities held at a premium. The standard is
effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. We do not
expect the adoption of ASC No. 2017 ‑
08 to have a material impact on our financial position, results of operations, or cash
flows.
In February 2018, FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects From Accumulated Other
Comprehensive Income , which allows a reclassification from accumulated other comprehensive income to retained earnings for
stranded tax effects resulting from the Tax Cuts and Jobs Act (“Tax Act”). The ASU is effective for all entities for fiscal years
beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company
does not expect the adoption of ASU No. 2018-02 to have a material impact on its financial position, results of operations, or cash
flows.
F-18
Table of Contents
Note 2 - Securities
The amortized cost and estimated fair values of our AFS securities portfolio were as follows as of December 31:
2018
U.S. Treasury securities
U.S. government agency notes
U.S. government agency notes
Cost
Amortized Unrealized Unrealized
Gains
Losses
(dollars in thousands)
— $
—
— $
10,086
$ 12,078 $
1,992 $
$
11 $
1,981
89
9,997
100 $ 11,978
Fair Value
2017
Amortized Unrealized Unrealized
Losses
Gains
(dollars in thousands)
Cost
Fair Value
$ 10,169 $
$ 10,169 $
— $
— $
50 $ 10,119
50 $ 10,119
The amortized cost and estimated fair values of our HTM securities portfolio were as follows as of December 31:
2018
U.S. Treasury securities
U.S. government agency notes
Mortgage-backed securities
U.S. Treasury securities
U.S. government agency notes
Mortgage-backed securities
$
Cost
Amortized Unrealized Unrealized
Gains
Losses
(dollars in thousands)
17 $
45
6
68 $
11,992
24,929
$ 38,912 $
1,991 $
2,008
— $
11,945
92
676
24,259
768 $ 38,212
Fair
Value
2017
$
Cost
Amortized Unrealized Unrealized
Gains
Losses
(dollars in thousands)
68 $
81
27
176 $
19,004
30,305
$ 54,303 $
4,994 $
5,056
6 $
18,986
99
370
29,962
475 $ 54,004
Fair
Value
Gross unrealized losses and fair value by length of time that the individual AFS securities have been in an unrealized loss position
at the dates indicated are presented in the following tables as of December 31:
U.S. Treasury securities
U.S. government agency
notes
1 $ 990 $
—
1 $ 990 $
—
5
—
5
Less than 12 months
# of
Fair
Securities Value
Unrealized
Losses
# of
Securities
2018
12 months or more
Fair
Value
(dollars in thousands)
Unrealized
Losses
# of
Securities
Total
Fair
Value
Unrealized
Losses
1 $
991 $
6
2 $ 1,981 $
9,997
8
9 $ 10,988 $
89
95
9,997
8
10 $ 11,978 $
F-19
11
89
100
Table of Contents
# of
Securities
Less than 12 months
Fair
Value
Unrealized
Losses
# of
Fair
Securities Value
Unrealized
Losses
# of
Securities
2017
12 months or more
Total
Fair
Value
Unrealized
Losses
U.S. government agency
notes
8 $ 10,119 $
8 $ 10,119 $
50
50
— $
— $
— $
— $
—
—
8 $ 10,119 $
8 $ 10,119 $
50
50
(dollars in thousands)
Gross unrealized losses and fair value by length of time that the individual HTM securities have been in an unrealized loss
position at the dates indicated are presented in the following tables as of December 31:
U.S. government agency
notes
Mortgage-backed securities
Less than 12 months
# of
Fair
Securities Value
Unrealized
Losses
# of
Securities
2018
12 months or more
Fair
Value
(dollars in thousands)
Unrealized
Losses
# of
Securities
Total
Fair
Value
Unrealized
Losses
— $
—
— $
— $
—
— $
—
—
—
10 $ 9,927 $
18
24,011
28 $ 33,938 $
92
676
768
10 $ 9,927 $
18
24,011
28 $ 33,938 $
92
676
768
# of
Securities
Less than 12 months
Fair
Value
Unrealized
Losses
# of
Securities
# of
Securities
Total
Fair
Value
Unrealized
Losses
2017
12 months or more
Unrealized
Fair
Losses
Value
(dollars in thousands)
— $
— $
—
7
6,964
5
7,046
12 $ 14,010 $
76
153
229
2 $ 1,993 $
14
13,941
16
28,039
32 $ 43,973 $
6
99
370
475
U.S. Treasury securities
U.S. government agency
notes
Mortgage-backed
securities
2 $ 1,993 $
7
6,977
11
20,993
20 $ 29,963 $
6
23
217
246
All of the securities that are currently in a gross unrealized loss position are so due to declines in fair values resulting from
changes in interest rates or increased liquidity spreads since the time they were purchased. We have the intent and ability to hold
these debt securities to maturity (including the AFS securities) and do not intend to sell, nor do we believe it will be more likely
than not that we will be required to sell, any impaired securities prior to a recovery of amortized cost. We expect these securities
will be repaid in full, with no losses realized. As such, management considers any impairment to be temporary.
Contractual maturities of debt securities at December 31, 2018 are shown below. Actual maturities may differ from contractual
maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
AFS Securities
Amortized
Cost
Fair
Value
(dollars in thousands)
Amortized
Cost
HTM Securities
Fair
Value
$
7,002 $
5,076
—
7,965
6,961 $
5,988
5,017
24,259
—
$ 12,078 $ 11,978 $ 38,912 $ 38,212
7,999 $
5,984
24,929
Due in one year or less
Due after one through five years
Mortgage-backed securities
F-20
Table of Contents
There were no securities pledged as collateral as of December 31, 2018 or 2017.
Note 3 - Loans Receivable and Allowance for Loan Losses
Loans receivable are summarized as follows at December 31:
Residential mortgage
Commercial
Commercial real estate
Construction, land acquisition, and development
Home equity/2nds
Consumer
Total loans receivable
Unearned loan fees
Loans receivable
2018
2017
(dollars in thousands)
276,389 $
35,884
244,088
114,540
13,386
1,087
685,374
(3,025)
682,349 $
287,656
37,356
236,302
93,060
15,703
1,084
671,161
(3,010)
668,151
$
$
Certain loans in the amount of $169.8 million have been pledged under a blanket floating lien to the FHLB as collateral against
advances.
At December 31, 2018, the Bank was servicing $29.4 million in loans for the Federal National Mortgage Association and $15.1
million in loans for the Federal Home Loan Mortgage Corporation.
Credit Quality
An Allowance is provided through charges to income in an amount that management believes will be adequate to absorb losses on
existing loans that may become uncollectible, based on evaluations of the collectability of loans and prior loan loss experience.
Management has an established methodology to determine the adequacy of the Allowance that assesses the risks and losses
inherent in the loan portfolio. The methodology takes into consideration such factors as changes in the nature and volume of the
loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the
borrowers’ ability to pay. Determining the amount of the Allowance requires the use of estimates and assumptions. Actual results
could differ significantly from those estimates. While management uses available information to estimate losses on loans, future
additions to the Allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies
periodically review the Allowance as an integral part of their examination process. Such agencies may require us to recognize
additions 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 December 31, 2018 and 2017.
During 2018, we had a change in accounting estimate related to the metholdology used in calculating the Allowance. The change
included developing an anchoring analysis for our qualitative factors and establishing a loss emergence period. This change in
estimate did not have any impact on the recorded amount of the Allowance.
For purposes of determining the Allowance, we have segmented our loan portfolio by product type. Our portfolio loan segments
are residential mortgage, commercial, commercial real estate, construction, land acquisition, and development (“ADC”), home
equity/2nds, and consumer. We have looked at all segments and have determined that no additional subcategorization is
warranted based upon our credit review methodology and our portfolio classes are the same as our portfolio segments.
F-21
Table of Contents
Inherent Credit Risks
The inherent credit risks within the loan portfolio vary depending upon the loan class as follows:
Residential mortgage - secured by one to four family dwelling units. The loans have limited risk as they are secured by first
mortgages on the unit, which are generally the primary residence of the borrower, at a LTV of 80% or less.
Commercial - underwritten in accordance with our policies and include evaluating historical and projected profitability and cash
flow to determine the borrower’s ability to repay the obligation as agreed. Commercial loans are made primarily based on the
identified cash flow of the borrower and secondarily on the underlying collateral supporting the loan. Accordingly, the repayment
of a commercial loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of
collateral is a secondary and often insufficient source of repayment. Additionally, lines of credit are subject to the underwriting
standards and processes similar to commercial loans, in addition to those underwriting standards for real estate loans. These loans
are viewed primarily as cash flow dependent and, secondarily, as loans secured by real-estate and/or other assets. Repayment of
these loans is generally dependent upon the successful operation of the property securing the loan or the principal business
conducted on the property securing the loan. Line of credit loans may be adversely affected by conditions in the real estate
markets or the economy in general. Management monitors and evaluates line of credit loans based on collateral and risk-rating
criteria.
Commercial real estate - subject to the underwriting standards and processes similar to commercial and industrial loans, in
addition to those underwriting standards for real estate loans. These loans are viewed primarily as cash flow dependent and
secondarily as loans secured by real estate. Repayment of these loans is generally dependent upon the successful operation of the
property securing the loan or the principal business conducted on the property securing the loan. Commercial real estate loans
may be adversely affected by conditions in the real estate markets or the economy in general. Management monitors and
evaluates commercial real estate loans based on collateral and risk-rating criteria. The Bank also utilizes third-party experts to
provide environmental and market valuations. The nature of commercial real estate loans makes them more difficult to monitor
and evaluate.
ADC - underwritten in accordance with our underwriting policies which include a financial analysis of the developers, property
owners, construction cost estimates, and independent appraisal valuations. These loans will rely on the value associated with the
project upon completion. These cost and valuation estimates may be inaccurate. Construction loans generally involve the
disbursement of substantial funds over a short period of time with repayment substantially dependent upon the success of the
completed project rather than the ability of the borrower or guarantor to repay principal and interest. Additionally, land is
underwritten according to our policies which include independent appraisal valuations as well as the estimated value associated
with the land upon completion of development. These cost and valuation estimates may be inaccurate.
Sources of repayment of these loans typically are permanent financing expected to be obtained upon completion or sales of
developed property. These loans are closely monitored by onsite inspections and are considered to be of a higher risk than other
real estate loans due to their ultimate repayment being sensitive to general economic conditions, availability of long-term
financing, interest rate sensitivity, and governmental regulation of real property.
If the Bank is forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that the Bank
will be able to recover all of the unpaid balance of the loan as well as related foreclosure and holding costs. In addition, the Bank
may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period
of time.
Home equity/2nds - subject to the underwriting standards and processes similar to residential mortgages and are secured by one
to four family dwelling units. Home equity/2nds loans have greater risk than residential mortgages as a result of the Bank
generally being in a second lien position.
Consumer - consist of loans to individuals through the Bank’s retail network and are typically unsecured or secured by personal
property. Consumer loans have a greater credit risk than residential loans because of the lower value of the underlying collateral,
if any.
F-22
Table of Contents
The following tables present, by portfolio segment, the changes in the Allowance and the recorded investment in loans as of and
for the years ended December 31:
2018
Beginning Balance
$
Residential
Mortgage Commercial Real Estate
Commercial
Home Equity/
ADC
2nds
(dollars in thousands)
Consumer Unallocated
Total
3,099 $
(534)
228
527 $
—
—
2,805 $
(38)
424
1,236 $
(34)
—
386 $
—
243
2 $
—
—
— $
—
—
8,055
(606)
895
Charge-offs
Recoveries
Net (charge-offs)
recoveries
(Reversal of)
provision for loan
losses
Ending Balance
Ending balance -
individually
evaluated for
impairment
Ending balance -
collectively evaluated
for impairment
Ending loan balance -
individually
evaluated for
impairment
Ending loan balance -
collectively evaluated
for impairment
(306)
—
386
(34)
243
—
—
289
(569)
2,224 $
2,209
2,736 $
(2,734)
457 $
1,037
2,239 $
$
(407)
222 $
(1)
1 $
165
165 $
(300)
8,044
$
927 $
430 $
142 $
32 $
2 $
— $
— $
1,533
1,297
2,224 $
2,306
2,736 $
$
315
457 $
2,207
2,239 $
220
222 $
1
1 $
165
165 $
6,511
8,044
$
12,579 $
430 $
1,992 $
1,278 $
871 $
76
$
17,226
262,180
$ 274,759 $
35,454
35,884 $ 242,693 $ 114,540 $
240,701
113,262
12,515
1,011
13,386 $ 1,087
665,123
$ 682,349
F-23
Table of Contents
2017
Residential
Mortgage Commercial Real Estate
Commercial
ADC
Home Equity/
2nds
Consumer
Beginning Balance
$
Charge-offs
Recoveries
Net (charge-offs) recoveries
(Reversal of) provision for loan
losses
Ending Balance
$
3,833 $
(726)
375
(351)
(383)
3,099 $
478 $
—
—
—
(dollars in thousands)
1,390 $
—
—
—
2,535 $
—
157
157
49
527 $
113
2,805 $
(154)
1,236 $
728 $
(98)
30
(68)
(274)
386 $
5 $
(2)
—
(2)
(1)
2 $
Total
8,969
(826)
562
(264)
(650)
8,055
Ending balance - individually
evaluated for impairment
Ending balance - collectively
evaluated for impairment
Ending loan balance -
individually evaluated for
impairment
Ending loan balance -
collectively evaluated for
impairment
$
1,181 $
— $
182 $
48 $
— $
2 $
1,413
1,918
3,099 $
$
527
527 $
2,623
2,805 $
1,188
1,236 $
386
386 $
—
2 $
6,642
8,055
$
18,219 $
— $
2,917 $
991 $
— $
84 $
22,211
267,600
$ 285,819 $
37,356
37,356 $ 235,129 $ 93,060 $
232,212
92,069
15,703
645,940
1,000
15,703 $ 1,084 $ 668,151
The following tables present the credit quality breakdown of our loan portfolio by class as of December 31:
2018
Special
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Pass
Mention Substandard
(dollars in thousands)
Total
$ 270,727 $
35,435
237,387
113,072
12,536
1,087
827 $
19
3,523
—
434
—
$ 670,244 $ 4,803 $
2017
430
1,783
1,468
416
—
3,205 $ 274,759
35,884
242,693
114,540
13,386
1,087
7,302 $ 682,349
Pass
Special
Mention Substandard
(dollars in thousands)
Total
$ 279,040 $ 1,563 $
37,312
227,573
91,868
14,384
1,084
44
4,615
—
465
—
$ 651,261 $ 6,687 $
5,216 $ 285,819
37,356
235,129
93,060
15,703
1,084
10,203 $ 668,151
—
2,941
1,192
854
—
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as
determined by the length of time a recorded payment is past due.
F-24
Table of Contents
The following tables present the classes of the loan portfolio summarized by the aging categories of performing loans and
nonaccrual loans as of December 31:
30-59 60-89
Days
Days
90+
Days
2018
Total
Non-
Past Due Past Due Past Due Past Due
Current
Total
Accrual
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
$ 1,060 $
—
137
255
96
13
$ 1,561 $
(dollars in thousands)
— $ 1,794 $ 2,854 $ 271,905 $ 274,759 $ 2,580
430
—
660
—
558
—
428
—
—
—
— $ 3,699 $ 5,260 $ 677,089 $ 682,349 $ 4,656
35,884
242,693
114,540
13,386
1,087
35,454
241,896
113,898
12,862
1,074
430
797
642
524
13
430
660
387
428
—
2017
30-59 60-89
Days
Past Due Past Due Past Due Past Due Current
90+
Days
Total
Days
Non-
Total
Accrual
$ 1,006 $
—
948
—
—
—
$ 1,954 $
(dollars in thousands)
— $ 2,535 $ 3,541 $ 282,278 $ 285,819 $ 3,891
78
—
159
—
314
—
1,268
—
—
—
— $ 4,006 $ 5,960 $ 662,191 $ 668,151 $ 5,710
37,278
234,181
92,821
14,549
1,084
37,356
235,129
93,060
15,703
1,084
78
948
239
1,154
—
78
—
239
1,154
—
We did not have any loans greater than 90 days past due and still accruing as of December 31, 2018 or 2017.
The interest which would have been recorded on the above nonaccrual loans if those loans had been performing in accordance
with their contractual terms was approximately $716,000 and $688,000 for the years ended December 31, 2018 and 2017,
respectively. The actual interest income recorded on those loans was approximately $273,000 and $282,000 for the years ended
December 31, 2018 and 2017, respectively.
F-25
Table of Contents
The following tables summarize impaired loans as of and for the years ended December 31:
With no related Allowance:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
With a related Allowance:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Totals:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
With no related Allowance:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
With a related Allowance:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
Totals:
Residential mortgage
Commercial
Commercial real estate
ADC
Home equity/2nds
Consumer
2018
Unpaid
2017
Recorded Related Principal
Investment Allowance Balance
(dollars in thousands)
Recorded Related
Investment Allowance
Unpaid
Principal
Balance
$
7,054 $
—
1,244
1,142
1,290
—
6,808 $
—
1,206
1,143
859
—
— $ 12,929 $ 11,572 $
—
—
—
—
—
—
1,562
636
—
—
—
1,507
636
—
—
5,888
476
795
135
13
76
5,771
430
786
135
12
76
12,942
476
2,039
1,277
1,303
76
12,579
430
1,992
1,278
871
76
927
430
142
32
2
—
927
430
142
32
2
—
6,761
—
1,410
392
—
84
6,647
—
1,410
355
—
84
19,690
—
2,972
1,028
—
84
18,219
—
2,917
991
—
84
—
—
—
—
—
—
1,181
—
182
48
—
2
1,181
—
182
48
—
2
2018
2017
Average
Recorded
Interest
Income
Average
Recorded
Interest
Income
Investment Recognized
Investment Recognized
(dollars in thousands)
344 $ 10,072 $
30
52
52
42
—
—
2,423
516
543
—
288
71
26
8
1
2
632
101
78
60
43
2
8,714
30
1,817
379
572
90
18,786
30
4,240
895
1,115
90
504
44
70
29
46
—
294
—
73
22
1
2
798
44
143
51
47
2
$
9,232 $
47
1,223
542
570
—
6,673
86
1,151
909
7
80
15,905
133
2,374
1,451
577
80
F-26
Table of Contents
There were $1.4 million in consumer mortgage properties included in real estate acquired through foreclosure at
December 31, 2018. There were no such properties at December 31, 2017. Consumer mortgage loans secured by residential real
estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable
jurisdiction totaled $1.9 million as of December 31, 2018.
TDRs
The following table presents loans that were modified during the year ended December 31, 2018:
Recorded Recorded
Investment
Prior to
Modifications Modification Modification
Investment
After
Number of
Residential Mortgage
(dollars in thousands)
127 $
127 $
1 $
1 $
127
127
There were no loans modified during the year ended December 31, 2017.
Interest on our portfolio of TDRs was accounted for under the following methods as of December 31:
2018
Total
Number of
Modifications
Accrual
Status
Number of Nonaccrual Number of
Status
Modifications
(dollars in thousands)
Modifications Modifications
9,469
36 $
1,019
2
134
1
3
76
42 $ 10,698
42 $ 11,631
1,862
3
137
1
4
84
50 $ 13,714
3 $
—
—
—
3 $
2017
2 $
1
1
—
4 $
446
—
—
—
446
736
78
6
—
820
Number of
Modifications
Accrual
Status
Number of Nonaccrual Number of
Status
Modifications
(dollars in thousands)
Modifications Modifications
Total
39 $
2
1
3
45 $
Total
Balance of
9,915
1,019
134
76
11,144
Total
Balance of
44 $
4
2
4
54 $
12,367
1,940
143
84
14,534
Residential mortgage
Commercial real estate
ADC
Consumer
Residential mortgage
Commercial real estate
ADC
Consumer
During 2018 and 2017, there were no TDRs that subsequently defaulted during the 12 month period ended December 31, 2018
and 2017.
F-27
Table of Contents
Note 4 - Premises and Equipment
Premises and equipment are summarized by major classification as follows at December 31:
Land
Building
Leasehold improvements
Furniture, fixtures, and equipment
Total, at cost
Less: Accumulated depreciation and amortization
Net premises and equipment
2018
2017
(dollars in thousands)
$
1,537 $
29,755
2,792
3,178
37,262
(14,517)
1,537
29,500
2,485
2,868
36,390
(13,251)
$ 22,745 $ 23,139
Depreciation expense was $1.3 million and $1.2 million for the years ended December 31, 2018 and 2017, respectively.
We lease various branch and general office facilities and equipment to conduct our operations. The leases have remaining terms
which range from a period of less than one year to 17 years (through 2035). Most leases contain renewal options which are
generally exercisable at increased rates. Some of the leases provide for increases in the rental rates at specified times during the
lease terms, prior to the expiration dates.
The leases generally provide for payment of property taxes, insurance, and maintenance costs by the Company. The total rental
expense for all real property leases amounted to approximately $321,000 and $246,000 for the years ended December 31, 2018
and 2017, respectively.
Our minimum lease payments due for each of the next five years are as follows:
Years Ended December 31,
2019
2020
2021
2022
2023
Thereafter
Our minimum future annual rental income on leases is as follows:
Years Ended December 31,
2019
2020
2021
2022
2023
Thereafter
(in thousands)
366
$
332
267
274
229
1,775
3,243
$
(in thousands)
922
$
840
378
286
194
—
2,620
$
H.S. West, LLC, a subsidiary of the Bank, leases space to three unrelated companies and to a law firm of which the President of
the Company and the Bank is a partner. Total gross rental income included in occupancy expense on the Consolidated Statements
of Operations was approximately $1.0 million and $994,000 for the years ended December 31, 2018 and 2017, respectively.
F-28
Table of Contents
Note 5 - Goodwill and Other Intangible Assets
Our goodwill relates to the acquisition of Louis Hyatt, Inc. and the Title Company as follows as of and for the years ended
December 31. During 2018, we reached the end of the period for determination of the goodwill for the Title Company.
Louis Hyatt Title Co. Total
Louis Hyatt Title Co. Total
2018
2017
Beginning balance
Goodwill acquired
Ending balance
$
$
Note 6 - Deposits
Deposits are summarized as follows as of December 31:
(dollars in thousands)
334 $ 765 $ 1,099 $
—
5
334 $ 770 $ 1,104 $
5
334
— $
334 $
—
765
765
334 $ 765 $ 1,099
2018
2017
NOW
Money market
Savings
Certificates of deposit
Total interest-bearing deposits
Noninterest-bearing deposits
Total deposits
$ 106,508
203,351
75,692
247,351
632,902
146,604
$ 779,506
(dollars in thousands)
63,616
13.7 % $
26.1 % 103,649
9.7 %
98,717
31.7 % 263,413
81.2 % 529,395
18.8 %
72,833
100.0 % $ 602,228
10.6 %
17.2 %
16.4 %
43.7 %
87.9 %
12.1 %
100.0 %
Scheduled maturities of certificates of deposit were as follows as of December 31:
One year or less
Greater than one year to two years
Greater than two years to three years
Greater than three years to four years
Greater than four years to five years
2018
2017
(dollars in thousands)
$ 126,980 $ 137,357
43,020
33,791
34,680
14,565
$ 247,351 $ 263,413
62,040
38,140
16,942
3,249
Certificates of deposit of $250,000 or more totaled $46.4 million and $51.4 million as of December 31, 2018 and 2017,
respectively. We held $10.2 million and $11.3 million in brokered certificates of deposit at December 31, 2018 and 2017,
respectively.
Note 7 - Borrowings
Our borrowings consist of advances from the FHLB and a term loan from a commercial bank. 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 of 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. As of December 31, 2018, our total credit line
with the FHLB was $265.7 million, with outstanding balances of $70.0 million and $85.0 million at December 31, 2018 and
2017, respectively.
On September 30, 2016, we entered into a loan agreement with a commercial bank whereby we borrowed $3.5 million for a term
of eight years. The unsecured note bears interest at a fixed rate of 4.25% for the first 36 months then, at the option of the
Company, converts to either (1) floating rate of the Wall Street Journal Prime plus 50 basis points or (2) fixed rate
F-29
Table of Contents
at 275 basis points over the five year amortizing FHLB rate for the remaining five years. Repayment terms are monthly interest
only payments for the first 36 months, then quarterly principal payments of $175,000 plus interest. The loan is subject to a
prepayment penalty of 1% of the principal amount prepaid during the first 36 months. If we elect the five year fixed rate of 275
basis points over the FHLB rate (“FHLB Rate Period”), the loan will be subject to a prepayment penalty of 2% during the first
and second years of the FHLB Rate Period and 1% of the principal repaid during the third, fourth, and fifth years of the FHLB
Rate Period. We may make additional principal payments from internally generated funds of up to $875,000 per year during any
fixed rate period without penalty. There is no prepayment penalty during any floating rate period.
Certain information regarding our borrowings is as follows as of December 31:
2018
2017
Amount outstanding at year-end:
FHLB advances
Commercial note payable
Weighted-average interest rate at year-end:
FHLB advances
Commercial note payable
Maximum outstanding at any month-end:
FHLB advances
Commercial note payable
Average outstanding:
FHLB advances
Commercial note payable
Weighted-average interest rate during the year:
FHLB advances
Commercial note payable
$ 70,000
3,500
(dollars in thousands)
$
85,000
3,500
2.27 %
4.25 %
2.40 %
4.25 %
$ 96,000
3,500
$ 169,950
3,500
$ 87,669
3,500
$
91,456
3,500
2.17 %
5.04 %
3.03 %
5.04 %
The following table sets forth information concerning the interest rates and maturity dates of the advances from the FHLB as of
December 31, 2018. All of our borrowings are at fixed rates:
Principal
Amount (in thousands)
35,000
25,000
10,000
70,000
$
$
Fixed Rate
1.55% to 4.00%
1.75% to 1.92%
2.19%
Maturity
2019
2020
2022
Certain loans in the amount of $169.8 million have been pledged under a blanket floating lien to the FHLB as collateral against
advances.
Note 8 - Subordinated Debentures
As of December 31, 2018 and 2017, 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
F-30
Table of Contents
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 December 31, 2018,
we were current on all interest due on the 2035 Debentures.
Note 9 - Employee Benefit Plans
The Bank has a 401(k) Retirement Savings Plan. Employees may contribute a percentage of their salary up to the maximum
amount allowed by law. The Bank matches 50% of the first 6% of an employee’s contribution. All employees who have
completed one year of service with the Bank are eligible to participate in the company match. The Bank’s contributions to this
plan were $214,000, and $139,000 for the years ended December 31, 2018 and 2017, respectively.
The Bank has an Employee Stock Ownership Plan (“ESOP”) for the exclusive benefit of participating employees. The Bank
recognized ESOP expense of $129,000 and $140,000 for the years ended December 31, 2018 and 2017, respectively. The plan
had allocated shares totaling 518,654 and 530,138, respectively, and had unallocated shares to participants in the plan totaling
2,000 shares and 10,000 shares, respectively, as of December 31, 2018 and 2017. The fair value of the unallocated shares at
December 31, 2018 was approximately $16,000.
Note 10 - Regulatory Matters
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 possibly additional discretionary, actions by regulators that, if
undertaken, could have a direct material effect on our financial condition. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of
assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital
amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and
other factors.
In July 2013, federal bank regulatory agencies issued final results to revise their risk-based capital requirements and the method
for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on
Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became
effective and include transition provisions which implement certain portions of the rules through January 1, 2019. Under the final
rules, the effects of certain accumulated other comprehensive items are not excluded; however, banking organizations like us that
are not considered “advanced approaches” banking organizations may make a one-time permanent election to continue to exclude
these items. With the submission of the Call Report for the first quarter of 2015, we made this election in order to avoid
significant variations in the level of capital that can be caused by interest rate fluctuations on the fair value of the Bank’s AFS
securities portfolio.
The Basel III rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital
requirements, which must consist entirely of common equity Tier 1 capital. The new capital conservation buffer requirements
began phase in effective January 2016 at 0.625% of risk-weighted assets and increase by that amount each year until fully
implemented in January 2019 (1.875% at December 31, 2018). An institution would be subject to limitations on paying dividends,
engaging in share repurchases, and paying discretionary bonuses to executive officers if its capital level falls below the buffer
amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
F-31
Table of Contents
As of the date of the last regulatory exam, the Bank was considered “well capitalized” and as of December 31, 2018, the Bank
continued to meet the requirements to be considered “well capitalized” based on applicable U.S. regulatory capital ratio
requirements.
Our regulatory capital amounts and ratios were as follows:
Actual
Amount
Minimum
Requirements
for Capital Adequacy
Purposes
Minimum
Requirements
with Capital
Conservation Buffer
To be Well
Capitalized Under
Prompt Corrective
Action Provision
Ratio Amount Ratio
Ratio Amount
Ratio Amount
(dollars in thousands)
$ 114,749
17.4 % $ 29,651
4.5 % $ 42,006
6.4 % $ 42,830
6.5 %
122,889
18.7 %
52,713
8.0 % 65,068
9.9 % 65,892
10.0 %
114,749
17.4 %
39,535
6.0 % 51,890
7.9 % 52,713
8.0 %
114,749
13.5 %
33,932
4.0 % 49,838
5.9 % 42,415
5.0 %
$ 105,721
16.5 % $ 28,904
4.5 % $ 36,933
5.8 % $ 41,750
6.5 %
113,758
17.7 %
51,385
8.0 % 59,414
9.3 % 64,231
10.0 %
105,721
16.5 %
38,539
6.0 % 46,567
7.3 % 51,385
8.0 %
105,721
13.5 %
31,440
4.0 % 41,264
5.3 % 39,300
5.0 %
December 31, 2018
Common Equity Tier 1 Capital (to
risk-weighted assets)
Total capital (to risk-weighted
assets)
Tier 1 capital (to risk-weighted
assets)
Tier 1 capital (to average quarterly
assets)
December 31, 2017
Common Equity Tier 1 Capital (to
risk-weighted assets)
Total capital (to risk-weighted
assets)
Tier 1 capital (to risk-weighted
assets)
Tier 1 capital (to average quarterly
assets)
Note 11 - Stockholders’ Equity
Series A Preferred Stock
On November 15, 2008, the Company completed a private placement offering consisting of a total of 70 units, at an offering price
of $100,000 per unit, for gross proceeds of $7.0 million. Each unit consisted of 6,250 shares of the Company’s Series A 8.0%
Non-Cumulative Convertible Preferred Stock. On March 13, 2018, the Company notified holders of its Series A preferred stock
that the Company had exercised its option to convert each of the 437,500 outstanding shares of Series A preferred stock for one
share of common stock and converted such shares on April 2, 2018. As of that date, the Series A preferred stock was no longer
deemed outstanding and all rights with respect to such stock ceased and terminated.
Series B Preferred Stock
On November 21, 2008, we entered into an agreement with the U.S. Department of the Treasury (“Treasury”), pursuant to
which we issued and sold (i) shares of our Series B Fixed Rate Cumulative Perpetual Preferred Stock (“Preferred Stock”) and
(ii) a warrant (the “Warrant”) to purchase 556,976 shares of the Company’s common stock, par value $0.01 per share at an
exercise price of $6.30 per share of common stock. As of December 31, 2016, the Company had redeemed all outstanding shares
of the Preferred Stock. On December 20, 2017, the Company repurchased the warrant from the Treasury for a total repurchase
price of $520,000.
F-32
Table of Contents
Dividend Restrictions
The Company’s ability to declare dividends on its common stock was previously limited by the terms of the Company’s Series A
Preferred Stock and Series B Preferred Stock. As of December 31, 2018, those restrictions had been removed. In 2018, we paid
dividends of $1.5 million ($0.12 per share) to common stockholders.
Note 12 - Earnings Per Share
Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number
of shares of common stock outstanding for each period. Diluted earnings per share reflect additional common shares that would
have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the
Company relate to outstanding stock options, warrants, and convertible preferred stock, and are determined using the treasury
stock method. Not included in the diluted earnings per share calculation for the year ended December 31, 2017 because they were
anti-dilutive, were 135,800 shares of common stock issuable upon exercise of outstanding stock options. Also excluded from the
calculation for the year ended December 31, 2017 were 437,500 anti-dilutive shares of common stock issuable upon conversion
of the Company’s Series A Preferred Stock. There were no anti-dilutive shares for the year ended December 31, 2018.
Information relating to the calculations of our income per common share is summarized as follows for the years ended
December 31:
Weighted-average shares outstanding - basic
Dilution
Weighted-average share outstanding - diluted
2018
2017
(dollars in thousands, except for per share data)
12,160,983
116,753
12,277,736
12,585,961
111,659
12,697,620
Net income available to common stockholders
Net income per share - basic
Net income per share - diluted
$
$
$
8,499 $
0.68 $
0.67 $
2,538
0.21
0.21
Note 13 - Stock-Based Compensation
We maintain a stock-based compensation plan for directors, officers, and other key employees of the Company. The aggregate
number of shares of common stock that may be issued with respect to the awards granted under the plan is 500,000 plus any
shares forfeited under the Company’s old stock-based compensation plan. Under the terms of the stock-based compensation plan,
the Company has the ability to grant various stock compensation incentives, including stock options, stock appreciation rights,
and restricted stock. The stock-based compensation is granted under terms and conditions determined by the Compensation
Committee of the Board of Directors. Under the stock-based compensation plan, stock options generally have a maximum term of
ten years, and are granted with an exercise price at least equal to the fair market value of the common stock on the date the
options are granted. Generally, options granted to directors, officers, and employees of the Company vest over a five-year period,
although the Compensation Committee has the authority to provide for different vesting schedules. We recognize forfeitures as
they occur. The ability to grant new options from this plan expired in March of 2018 and no new plan had been approved as of
December 31, 2018.
We account for stock-based compensation in accordance with FASB ASC Topic 718, Compensation – Stock Compensation,
which requires all share-based payments to employees, including grants of employee stock options, to be recognized as
compensation expense in the Statement of Operations at fair value. Additionally, we are required to recognize the expense of
employee services received in share-based payment transactions and measure the expense based on the grant date fair value of the
award. The expense is recognized over the period during which an employee is required to provide service in exchange for the
award. Stock-based compensation expense included in the Consolidated Statements of Operations for the years ended
December 31, 2018 and 2017 totaled $218,000 and $205,000, respectively.
F-33
Table of Contents
Information regarding our stock-based compensation plan is as follows as of and for the years ended December 31:
2018
2017
Weighted-
Average
Weighted-
Average
Remaining
Number Exercise Contractual
of Shares
Price
Term
(in years)
Aggregate
Intrinsic
Value
Weighted-
Average
Weighted-
Average
Remaining
Number Exercise Contractual
(in thousands) of Shares
Price
Term
(in years)
339,500 $
115,800
(2,411)
(18,864)
5.31
7.22
3.37
4.59
Aggregate
Intrinsic
Value
(in thousands)
3.4 $
2.6 $
578
434,025 $
5.87
399
191,395 $
4.85
6.7 $
6.3 $
619
477
Outstanding at
beginning of period
Granted
Exercised
Forfeited
Outstanding at end of
period
Exercisable at end of
period
434,025 $
6,500
(88,652)
(2,850)
5.87
7.41
4.21
5.89
349,023 $
6.32
179,379 $
5.75
The cash received from the exercise of stock options during 2018 and 2017 was $374,000 and $207,000, respectively.
The stock-based compensation expense amounts and fair values of options at the time of the grants were derived using the Black-
Scholes option-pricing model. The following weighted average assumptions were used to value options granted for the years
ended December 31:
Expected life
Risk-free interest rate
Expected volatility
Expected dividend yield
Weighted average per share fair value of options granted
2018
5.5 years
2017
5.5 years
2.67 %
32.20 %
—
2.57
$
2.15 %
33.79 %
—
2.44
$
The expected life is based on the vesting period and the expiration date of the option granted. The Risk-free interest rate is based
on the US Treasury’s five year Treasury note rate at the time of the option grant. The expected volatility is based on the closing
common stock price of the Company over a five year period. The expected dividend yield was based on the Company’s prior
policy of not paying a common stock dividend. The grant that occurred in 2018 was prior to any dividend declaration and
therefore, did not contain an expected dividend yield component in the fair value calculation. In addition, option valuation models
require the input of highly subjective assumptions including the expected stock price volatility.
As of December 31, 2018, there was $495,000 of total unrecognized stock-based compensation expense related to nonvested
stock options, which is expected to be recognized over a period of 48 months.
F-34
Table of Contents
Note 14 – Other Noninterest Expense
The breakout of our other noninterest expenses is as follows for the years ended December 31:
Directors fees
Stock expense
Insurance
Internal audit and compliance
Office expense, printing, and postage
Telephone
Loan expenses
Dues and subscriptions
OCC assessments
Other
Total other noninterest expense
Note 15 - Income Taxes
Our income tax expense consists of the following for the years ended December 31:
Current
Deferred
Income tax expense
2018
2017
(dollars in thousands)
246 $
143
238
242
420
326
217
141
206
828
3,007 $
304
217
195
259
434
297
121
111
202
611
2,751
$
$
$
2017
2018
(dollars in thousands)
228
4,794
5,022
2,952
$ 2,977 $
25 $
The income tax expense is reconciled to the amount computed by applying the federal corporate tax rates of 21% in 2018 and
34% in 2017 to the net income before taxes as follows for the years ended December 31:
2018
2017
Tax at statutory federal rate
Adjustment for rate change
State tax net of Federal income tax benefit
Other adjustments
F-35
Amount Rate Amount Rate
(dollars in thousands)
$ 2,425
—
685
(133)
$ 2,977
21.0 % $ 2,666
— % 1,887
616
5.9 %
(1.1)%
(147)
25.8 % $ 5,022
34.0 %
24.1 %
7.9 %
(1.9)%
64.1 %
Table of Contents
The tax effects of temporary differences between the financial reporting basis and income tax basis of assets and liabilities relate
to the following at December 31:
2018
2017
Deferred tax assets:
Net operating loss carryforward
Allowance
Reserve on real estate acquired through foreclosure
Reserve for uncollected interest
Reserve for contingent liability
Charitable contributions
Unrealized losses on AFS securities
AMT
Total gross deferred tax assets
Deferred tax liabilities:
FHLB stock dividends
Loan origination costs
Accelerated depreciation
Prepaid expenses
MSRs
Reserve on real estate acquired through foreclosure
Other
Total gross deferred tax liabilities
Net deferred tax assets
$
(dollars in thousands)
972 $ 3,446
3,201
135
108
31
127
15
351
7,414
2,710
—
192
47
174
28
185
4,308
57
734
817
186
120
3
28
1,945
61
534
1,122
239
140
—
16
2,112
$ 2,363 $ 5,302
At December 31, 2018, federal net operating losses totaled $789,000 and expire in 2033 and 2034. The state net operating losses
totaled $12.4 million and expire at various times from 2023 through 2033.
In assessing the realizability of federal or state deferred tax assets at December 31, 2018, management considered whether it is
more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during periods in which those temporary differences become
deductible. Management considered the scheduled reversal of deferred tax liabilities, projected future taxable income and prudent,
feasible, and permissible, as well as available, tax planning strategies in making this assessment. Given the consistent earnings
and improving asset quality, the Company’s analysis concluded that, as of December 31, 2018, it was more likely than not that it
will generate sufficient taxable income within the applicable carry-forward periods to realize its net deferred tax asset. The
Company will continue to have the benefit of the net operating loss carryforward relating to the deferred tax asset and will have
the ability to utilize the carryforward against future federal and state income taxes.
On December 22, 2017, the Tax Act was signed into law. The Tax Act included many provisions that affect the Company’s
income tax expense, including reducing the corporate federal tax rate from 34% to 21% effective January 1, 2018. As a result of
the rate reduction, the Company was required to re-measure, through income tax expense in the period of enactment, its deferred
tax assets and liabilities using the enacted rate at which the Company expects them to be recovered or settled. The re-
measurement of the net deferred tax asset resulted in additional income tax expense of $1.9 million in 2017.
The statute of limitations for Internal Revenue Service examination of the Company’s federal consolidated tax returns remains
open for tax years 2015 through 2018.
Our income tax returns are subject to review and examination by federal and state taxing authorities. We are no longer subject to
examination by federal tax authorities for the years ended before 2014. The years open to examination by state taxing authorities
vary by jurisdiction.
F-36
Table of Contents
Note 16 - Commitments and Contingencies
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial
needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which
involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statements of financial
condition. The contract amounts of these instruments express the extent of involvement we have in each class of financial
instruments.
Our exposure to credit loss from nonperformance by the other party to the above mentioned financial instruments is represented
by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional
obligations as we do for on-balance sheet instruments. Unless otherwise noted, we require collateral or other security to support
financial instruments with off-balance sheet credit risk.
The following table shows the contract amounts for our off-balance sheet instruments as of December 31:
2018
2017
Standby letters of credit
Home equity lines of credit
Unadvanced construction commitments
Mortgage loan commitments
Lines of credit
Loans sold and serviced with limited repurchase provisions
$
3,321
17,015
75,326
1,649
20,990
49,623
3,480
13,321
74,720
595
16,612
21,409
(dollars in thousands)
$
Standby letters of credit are conditional commitments issued by the Bank guaranteeing performance by a customer to various
municipalities. These guarantees are issued primarily to support performance arrangements and are limited to real estate
transactions. The majority of these standby letters of credit expire within twelve months. The credit risk involved in issuing letters
of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting
these letters of credit as deemed necessary. Management believes, except for certain standby letters of credit, that the proceeds
obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments
required under the corresponding guarantees. The amount of the liability as of both December 31, 2018 and December 31, 2017
for guarantees under standby letters of credit issued was $42,000.
Home equity lines of credit are loan commitments to individuals as long as there is no violation of any condition established in
the contract. Commitments under home equity lines expire ten years after the date the loan closes and are secured by real estate.
We evaluate each customer’s credit worthiness on a case-by-case basis.
Unadvanced construction commitments are loan commitments made to borrowers for both residential and commercial projects
that are either in process or are expected to begin construction shortly.
Mortgage loan commitments not reflected in the accompanying statements of financial condition at December 31, 2018 included
three loans totaling $1.6 million. At December 31, 2017 such commitments included two loans totaling $595,000.
Lines of credit are loan commitments to individuals and companies as long as there is no violation of any condition established in
the contract. Lines of credit have a fixed expiration date. The Bank evaluates each customer’s credit worthiness on a case-by-case
basis.
The Bank has entered into several agreements to sell mortgage loans to third parties. These agreements contain limited provisions
that require the Bank to repurchase a loan if the loan becomes delinquent within a period ranging generally from 120 to 180 days
after the sale date depending on the investor’s agreement. The credit risk involved in these financial instruments is essentially the
same as that involved in extending loan facilities to customers. We established a reserve for potential repurchases for these loans,
which amounted to $91,000 at December 31, 2018 and $63,000 at December 31, 2017. Repurchases amounted to $469,000 for
the year ended December 31, 2017. There were no repurchases during the year ended December 31, 2018.
F-37
Table of Contents
The Company provides banking services to customers who do business in the medical-use cannabis industry. While the growing,
processing, and sales of medical-use cannabis is legal in the state of Maryland, the business currently violates Federal law. The
Company may be deemed to be aiding and abetting illegal activities through the services that it provides to these customers. The
strict enforcement of Federal laws regarding medical-use cannabis would likely result in the Company’s inability to continue to
provide banking services to these customers and the Company could have legal action taken against it by the Federal government,
including imprisonment and fines. There is an uncertainty of the potential impact to the Company’s consolidated financial
statements if the Federal government takes actions against the Company. As of December 31, 2018, the Company has not accrued
an amount for the potential impact of any such actions.
Following is a summary of the level of business activities with our medical-use cannabis customers:
· Deposit and loan balances at December 31, 2018 were approximately $17.0 million, or 2.2% of total deposits, and $14.1
million, or 2.1% of total loans, respectively. Deposit and loan balances at December 31, 2017 were approximately $19.2
million, or 3.2% of total deposits, and $11.9 million, or 1.8% of total loans, respectively.
·
·
Interest and noninterest income for the year ended December 31, 2018 were approximately $720,000 and $1.4 million,
respectively. Interest and noninterest income for the year ended December 31, 2017 were approximately $280,000 and
$230,000, respectively.
The volume of deposits accepted by these customers from the date of their license approval by the Maryland Medical
Cannabis Commission through December 31, 2018 was approximately $138.9 million. The volume of deposits accepted
by these customers from the date of their license approval by the Maryland Medical Cannabis Commission through
December 31, 2017 was approximately $45.1 million.
Note 17 - Fair Value of Financial Instruments
A fair value hierarchy that prioritizes the inputs to valuation methods is used to measure fair value. The hierarchy gives the
highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the
lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair market hierarchy are as follows:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical,
unrestricted assets or liabilities.
Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for
substantially the full term of the asset or liability.
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and
unobservable (i.e. supported with little or no market activity).
An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value
measurement.
We record transfers between levels at the end of the reporting period in which the change in significant inputs occurs.
F-38
Table of Contents
Assets and Liabilities Measured on a Recurring Basis
The following tables present fair value measurements for assets and liabilities that are measured at fair value on a recurring basis
as of and for the year ended December 31, 2018:
Assets:
AFS Securities - U.S. Treasury and government agency notes $ 11,978 $ 1,981 $
LHFS
MSRs
IRLCs
Liabilities:
Mandatory forward contracts
Best efforts forward contracts
9,686
437
100
—
—
—
—
—
16
—
Significant
Other
Significant
Quoted Observable Unobservable
Carrying
Value
Prices
(Level 1)
Inputs
(Level 3)
Inputs
(Level 2)
(dollars in thousands)
9,997 $
9,686
—
—
16
—
Total Changes
In Fair Values
Included In
Period Income
— $
—
437
100
—
—
—
192
(40)
78
(30)
(3)
The following tables present fair value measurements for assets and liabilities that are measured at fair value on a recurring basis
as of and for the year ended December 31, 2017:
Assets:
AFS Securities - U.S. government agency notes
LHFS
MSRs
IRLCs
Mandatory forward contracts
Best efforts forward contracts
Significant
Other
Significant
Quoted Observable Unobservable
Carrying
Value
Prices
(Level 1)
Inputs
(Level 2)
Inputs
(Level 3)
Total Changes
In Fair Values
Included In
Period Income
$ 10,119 $
4,530
477
22
13
3
(dollars in thousands)
— $ 10,119 $
—
—
—
—
—
4,530
—
—
13
3
— $
—
477
22
—
—
—
131
(80)
(140)
(140)
3
The following table provides additional quantitative information about assets measured at fair value on a recurring basis and for
which we have utilized Level 3 inputs to determine fair value:
Fair Value
Estimate
Valuation
Technique
Unobservable
Input
Range
(Weighted-Average)
December 31, 2018:
MSRs
IRLCs
December 31, 2017:
MSRs
IRLCs
$
$
(dollars in thousands)
437 Market Approach Weighted average prepayment speed
100 Market Approach Range of pull through rate
Average pull through rate
477 Market Approach Weighted average prepayment speed
22 Market Approach Range of pull through rate
Average pull through rate
9.80 %
70% - 95 %
84 %
3.94 %
80% - 95 %
90 %
F-39
Table of Contents
The activity in MSRs was as follows for the years ended December 31:
Beginning balance
Valuation adjustment
Ending balance
The activity in IRLCs was as follows for the years ended December 31:
Beginning balance
Valuation adjustment
Ending balance
AFS Securities
$
$
$
$
2018
2017
(dollars in thousands)
477
(40)
437
$
$
557
(80)
477
2018
2017
(dollars in thousands)
22
78
100
$
$
162
(140)
22
The estimated fair values of AFS debt securities are obtained from a nationally-recognized pricing service. This pricing service
develops estimated fair values by analyzing like securities and applying available market information through processes such as
benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing, to prepare valuations. Matrix pricing is
a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the
specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value
measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve,
live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond’s terms and
conditions, among other things, and are based on market data obtained from sources independent from the Bank. We consider our
U.S. Treasury securities to be Level 1. The Level 2 investments in the Bank’s portfolio are priced using those inputs that, based
on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets. The
Bank has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities,
those in the Bank’s portfolio are not exchange-traded, and such nonexchange-traded fixed income securities are typically priced
by correlation to observed market data.
LHFS
LHFS are carried at fair value, which is determined based on outstanding investor commitments or, in the absence of such
commitments, on current investor yield requirements or third-party pricing models.
MSRs
The fair value of MSRs is determined using a valuation model administered by a third party that calculates the present value of
estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net
servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service (including delinquency
and foreclosure costs), escrow account earnings, contractual servicing fee income, and other ancillary income such as late fees.
Management reviews all significant assumptions on a quarterly basis. Mortgage loan prepayment speed, a key assumption in the
model, is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate used to
determine the present value of estimated future net servicing income, another key assumption in the model, is an estimate of the
required rate of return investors in the market would require for an asset with similar risk. Both assumptions can, and generally
will, change as market conditions and interest rates change.
IRLCs
We utilize a third-party specialist model to estimate the fair value of our IRLCs, which are valued based upon mandatory pricing
quotes from correspondent lenders less estimated costs to process and settle the loan. Fair value is adjusted for the estimated
probability of the loan closing with the borrower.
F-40
Table of Contents
Forward Contracts
To avoid interest rate risk, we enter into best efforts forward sales commitments with investors at the time we make an IRLC to a
borrower. Once a loan has been closed and funded, the best efforts commitments convert to mandatory forward sales
commitments. The mandatory commitments are derivatives, and we measure and report them at fair value. Fair value is based on
the gain or loss that would occur if we were to pair-off the transaction with the investor at the measurement date. This is a level 2
input. We have elected to measure and report best efforts commitments at fair value using a valuation methodology similar to that
used for mandatory commitments.
Assets Measured on a Nonrecurring Basis
We may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis. These adjustments to
fair value usually result from application of LCM accounting or write-downs of individual assets.
For assets measured at fair value on a nonrecurring basis, the following tables provide the level of valuation assumptions used to
determine each adjustment and the carrying value of assets as of December 31:
2018
Significant
Other
Significant
Quoted Observable Unobservable
Carrying
Value
Prices
(Level 1)
Inputs
(Level 2)
Inputs
(Level 3)
Range of Weighted
Discount (1) Average
Impaired loans
$ 5,678 $
(1) Discount based on current market conditions and estimated selling costs
(dollars in thousands)
— $
— $
5,678 0% - 16%
6.7 %
2017
Significant
Other
Significant
Quoted Observable Unobservable
Carrying
Value
Prices
(Level 1)
Inputs
(Level 2)
Inputs
(Level 3)
Range of Weighted
Discount (1) Average
Impaired loans
Real estate acquired through foreclosure
$ 2,793 $
178
(1) Discount based on current market conditions and estimated selling costs
Impaired Loans
(dollars in thousands)
— $
—
— $
—
2,793 0% - 33%
178 0% - 22%
14.5 %
11.5 %
Impaired loans are those for which we have measured impairment based on the present value of expected future cash flows or on
the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the
properties, or discounted cash flows based upon the expected proceeds. If it is determined that the repayment of the loan will be
provided solely by the underlying collateral, and there are no other available and reliable sources of repayment, the loan is
considered collateral dependent. Impaired loans that are considered collateral dependent are carried at the LCM. Collateral may
be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The use of independent
appraisals and management’s best judgment are significant inputs in arriving at the fair value measure of the underlying collateral
and impaired loans are therefore classified within level 3 of the fair value hierarchy.
For such loans that are classified as impaired, an Allowance is established when the present value of the expected future cash
flows of the impaired loan is lower than the carrying value of that loan. For such impaired loans that are classified as collateral
dependent, an Allowance is established when the current market value of the underlying collateral less its estimated disposal costs
has not been finalized, but management determines that it is likely that the value is lower than the
F-41
Table of Contents
carrying value of that loan. Once the net collateral value has been determined, a charge-off is taken for the difference between the
net collateral value and the carrying value of the loan.
Real Estate Acquired Through Foreclosure
We record foreclosed real estate assets at the fair value less estimated selling costs on their acquisition dates and at the lower of
such initial amount or estimated fair value less estimated selling costs thereafter. We generally obtain certified external appraisals
of real estate acquired through foreclosure and estimate fair value using those appraisals. Other valuation sources may be used,
including broker price opinions, letters of intent, and executed sale agreements.
Fair Value of All Financial Instruments
The carrying value and estimated fair value of all financial instruments are summarized in the following tables. The descriptions
of the fair value calculations for AFS securities, LHFS, MSRs, IRLCs, best efforts forward contracts, mandatory forward
contracts, impaired loans, and real estate acquired through foreclosure are included in the discussions above.
Assets:
Cash and cash equivalents
Certificates of deposit held for investment
AFS securities
HTM securities
LHFS
Loans receivable, net
Restricted stock investments
Accrued interest receivable
MSRs
IRLCs
Liabilities:
Deposits
Accrued interest payable
Borrowings
Subordinated debentures
Mandatory forward contracts
Carrying
December 31, 2018
Fair Value
Value
Level 1
Level 2
Level 3
Total
$ 188,340 $ 188,340 $
(dollars in thousands)
— $
—
9,997
36,204
9,686
—
3,766
2,848
—
—
8,780
1,981
2,008
—
—
—
—
—
—
— $ 188,340
8,780
—
11,978
—
38,212
—
9,686
—
670,512
670,512
3,766
—
2,848
—
437
437
100
100
—
—
—
—
—
778,313
419
69,210
—
16
—
—
—
20,619
—
778,313
419
69,210
20,619
16
8,780
11,978
38,912
9,686
674,305
3,766
2,848
437
100
779,506
419
73,500
20,619
16
F-42
Table of Contents
Assets:
Cash and cash equivalents
Certificates of deposit held for investment
AFS securities
HTM securities
LHFS
Loans receivable, net
Restricted stock investments
Accrued interest receivable
MSRs
IRLCs
Mandatory forward contracts
Best effort forward contracts
Liabilities:
Deposits
Accrued interest payable
Borrowings
Subordinated debentures
Carrying
December 31, 2017
Fair Value
Value
Level 1 Level 2
Level 3
Total
$
21,853 $ 21,853 $
8,780
10,119
54,303
4,530
660,096
4,489
2,640
477
22
13
3
8,780
—
5,056
—
—
—
—
—
—
—
—
(dollars in thousands)
— $
—
10,119
48,948
4,530
—
4,489
2,640
—
—
13
3
— $
—
—
—
—
672,349
—
—
477
22
—
—
21,853
8,780
10,119
54,004
4,530
672,349
4,489
2,640
477
22
13
3
602,228
395
88,500
20,619
—
—
—
—
594,659
395
81,303
—
—
—
—
20,619
594,659
395
81,303
20,619
At December 31, 2018 and 2017, the Bank had loan funding commitments of $115.0 million and $105.2 million, respectively, and
standby letters of credit outstanding of $3.3 million and $3.5 million, respectively. The fair value of these commitments is
nominal.
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information and information about financial
instruments. These estimates do not reflect any premium or discount that could result from a one-time sale of our total holdings of
a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value
estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of
various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect
estimates. The above information should not be interpreted as an estimate of the fair value of the Company since a fair value
calculation is only provided for a limited portion of our assets and liabilities. Due to a wide range of valuation techniques and the
degree of subjectivity used in making the estimates, comparisons between our disclosures and those of other companies may not
be meaningful.
There were no transfers between any of Levels 1, 2, and 3 for the years ended December 31, 2018 or 2017.
Note 18 - Related Party Transactions
During the ordinary course of business, we make loans to our directors and their affiliates and several of our policy making
officers on substantially the same terms, including interest rates and collateral, as those prevailing for comparable transactions
with other customers.
F-43
Table of Contents
Transactions in related party loans were as follows for the years ended December 31:
Beginning Balance
Additions
Repayments
2018
2017
(dollars in thousands)
6,455 $ 3,060
3,667
771
(3,598)
(272)
3,628 $ 6,455
$
$
During January 2007, a law firm, in which the President of the Company and the Bank is a partner, entered into a five year lease
agreement with a subsidiary of the Company. The term of the lease is five years with the option to renew the lease for three
additional five year terms. The second option to renew was exercised in January 2017. The total rent payments received by the
subsidiary were $281,000 and $276,000 for the years ended December 31, 2018 and 2017, respectively. The law firm also
reimburses the Company for its share of common area maintenance and utilities. The total reimbursement amounted to $145,000
and $131,000, respectively, for the years ended December 31, 2018 and 2017. In addition, the law firm represents the Company
and the Bank in certain legal matters. The fees for services rendered by that firm were $158,000 and $149,000 for the years ended
December 31, 2018 and 2017 respectively.
Total related party deposits in the Bank amounted to $3.9 million at December 31, 2018. Additionally, the law firm of the
President of the Company and Bank, described above, maintained deposits in the Bank of $270,000 at December 31, 2018.
Note 19 - Parent Company Financial Statements
The following is financial information of Severn Bancorp (parent company only):
Statements of Financial Condition
ASSETS
Cash
Equity in net assets of subsidiaries:
Bank
Nonbank
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Subordinated debentures
Other liabilities
Total liabilities
Stockholders' Equity
Total liabilities and stockholders' equity
F-44
December 31,
2018
2017
(dollars in thousands)
1,378 $
1,310
$
115,799
4,152
1,431
108,735
3,886
1,421
$ 122,760 $ 115,352
$
20,619 $
3,688
24,307
98,453
20,619
3,633
24,252
91,100
$ 122,760 $ 115,352
Table of Contents
Statements of Operations
Interest income
Interest expense on subordinated debentures
Net interest expense
Dividend from subsidiary
General and administrative expenses
Loss before income taxes and equity in undistributed net income of subsidiaries
Income tax benefit
Equity in undistributed net income of subsidiaries
Net income
Other comprehensive loss item - Unrealized holding losses on AFS
securities arising during the period (net of tax benefit of $14 and $22)
Total comprehensive income
Statements of Cash Flows
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash from operating activities:
Equity in undistributed earnings of subsidiaries, net of dividend received from subsidiary
Stock-based compensation
Deferred income taxes
(Increase) decrease in other assets
Increase (decrease) in accrued expenses and other liabilities
Net cash used in operating activities
Cash flows from financing activities:
Preferred stock dividends
Common stock dividends
Repurchase of warrant
Proceeds from common stock issuance
Net cash used in financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Note 20 – Subsequent Event
Year Ended December 31,
2018
2017
(dollars in thousands)
1 $
$
1,006
(1,005)
2,215
(167)
1,043
159
7,367
8,569
—
824
(824)
820
(218)
(222)
71
2,969
2,818
(38)
8,531 $
(35)
2,783
$
Year Ended December 31,
2018
2017
(dollars in thousands)
8,569 $
2,818
(7,367)
218
(80)
(120)
55
1,275
(70)
(1,511)
—
374
(1,207)
68
1,310
1,378 $
(2,969)
205
(718)
562
(7)
(109)
(280)
—
(520)
207
(593)
(702)
2,012
1,310
$
$
On February 26, 2019, the Company’s Board of Directors declared a $0.03 per share dividend to stockholders of record on March
8, 2019, payable on March 18, 2019.
F-45
Subsidiaries of Severn Bancorp, Inc.
Exhibit 21.1
The following is a list of subsidiaries of Severn Bancorp, Inc. at December 31, 2018. All entities listed below are subsidiaries of
Severn Bancorp, Inc. and, if indented, subsidiaries of the entity under which they are listed.
Entity
Severn Savings Bank, FSB.
Louis Hyatt, Inc. (d/b/a Hyatt Commercial)
HS West, LLC
Severn Financial Services Corporation
SSB Realty Holdings, LLC
SSB Realty Holdings II, LLC
Homeowners Title and Escrow Corporation
SBI Mortgage Company
Crownsville Development Corporation (d/b/a Annapolis
Equity Group)
Crownsville Holdings I, LLC
Severn Mortgage Company
Mid-Maryland Title Company, Inc.
Jurisdiction of Formation
United States of America (federally chartered savings
association)
Maryland
Maryland
Maryland
Maryland
Maryland
Maryland
Maryland
Maryland
Maryland
Maryland
Maryland
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
Severn Bancorp, Inc.
Annapolis, Maryland
We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333-156343) and Forms S-
8 (No. 333-152657 and No. 333-133242) of Severn Bancorp, Inc. of our reports dated April 17, 2019, relating to the consolidated
financial statements and effectiveness of Severn Bancorp’s internal control over financial reporting, which is included in this
Annual Report on Form 10-K. Our report on the effectiveness of internal control over financial reporting expresses an adverse
opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018.
/s/ BDO USA, LLP
Philadelphia, Pennsylvania
April 17, 2019
Exhibit 31.1
Certification of Principal Executive Officer
I, Alan J. Hyatt, certify that:
1) I have reviewed this annual report on Form 10-K of Severn Bancorp, Inc.;
2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented
in this report;
4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange
Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial
information; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: April 17, 2019
/s/ Alan J. Hyatt
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
Certification of Principal Financial Officer
I, Paul B. Susie, certify that:
1) I have reviewed this annual report on Form 10-K of Severn Bancorp, Inc.;
2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods
presented in this report;
4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d‑15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;
and
5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial
information; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: April 17, 2019
/s/ Paul B. Susie
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code),
each of the undersigned officers of Severn Bancorp, Inc. (“Bancorp”) does hereby certify with respect to the Annual Report of
Bancorp on Form 10-K for the period ended December 31, 2018 (the “Report”) that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of Bancorp.
Date: April 17, 2019
Date: April 17, 2019
SEVERN BANCORP, INC.
/s/ Alan J. Hyatt
Alan J. Hyatt, President, Chief Executive Officer
and Chairman of the Board
(Principal Executive Officer)
/s/ Paul B. Susie
Paul B. Susie, Executive Vice President,
and Chief Financial Officer
(Principal Financial and Accounting Officer)
The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of
Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document.