CECIL BANCORP INC [CECL] Filings

10-Q 1 f10q_093013-0424.htm FORM 10-Q 9-30-13 - CECIL BANCORP, INC. f10q_093013-0424.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________________________

FORM 10-Q

	x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
		SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2013.

	o	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 0-24926

CECIL BANCORP, INC.

(Name of registrant as specified in its charter)

Maryland	52-1883546
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

127 North Street, P.O. Box 568 Elkton, Maryland	21921
(Address of principal executive office)	(Zip Code)

Registrant’s telephone number, including area code: (410) 398-1650

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.

[ x ] YES [ ] NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

[ x ] YES [ ] NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller reporting company [ x]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

[ ] YES [ x ] NO

APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

At October 31, 2013, there were 7,425,869 shares of common stock outstanding

CECIL BANCORP, INC. AND SUBSIDIARIES

CONTENTS

	PAGE
PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (unaudited)

Consolidated Balance Sheets -
September 30, 2013 and December 31, 2012		3

Consolidated Statements of Operations and Comprehensive Loss
for the Three and Nine Months Ended September 30, 2013 and 2012		4-5

Consolidated Statements of Cash Flows
for the Nine Months Ended Sepember 30, 2013 and 2012		6

Notes to Consolidated Financial Statements		7-28


ITEM 2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations		29-39

ITEM 3. Qantitative and Qualitative Disclosures About Market Risk		39

ITEM 4. Controls and Procedures		39

PART II. OTHER INFORMATION		39-41

SIGNATURES		42

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CECIL BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

	September 30,			December 31,
	2013			2012
	(Unaudited)
ASSETS:
Cash and due from banks	$	1,382		$	2,012
Interest bearing deposits with banks		26,687			39,188
Federal funds sold		251			606
Total cash and cash equivalents		28,320			41,806
Investment securities:
Securities available-for-sale at fair value		44,421			33,504
Securities held-to-maturity (fair value of $2,268
in 2013 and $3,927 in 2012)		2,250			3,887
Restricted investment securities – at cost		3,977			4,204
Loans receivable		245,775			306,751
Less: allowance for loan losses		(8,919	)		(10,297	)
Net loans receivable		236,856			296,454
Other real estate owned		34,945			33,871
Premises and equipment, net		8,458			9,679
Accrued interest receivable		1,064			1,323
Mortgage servicing rights		381			441
Bank owned life insurance		8,561			8,465
Income taxes receivable		3,770			3,770
Other assets		3,936			2,417
TOTAL ASSETS	$	376,939		$	439,821
LIABILITIES:
Deposits	$	285,475		$	341,219
Other liabilities		15,305			12,863
Junior subordinated debentures		17,000			17,000
Advances from Federal Home Loan Bank of Atlanta		53,500			53,500
Other borrowed funds		-			1,088
Total liabilities		371,280			425,670
STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value; authorized 1,000,000 shares
Series A issued and outstanding 11,560 shares, liquidation
preference $1,000 per share, in 2013 and 2012		11,481			11,356
Series B issued and outstanding 164,450 shares, liquidation
preference $17.20 per share, in 2013 and 164,575 in 2012		2,794			2,796
Common stock, $.01 par value; authorized 100,000,000
shares, issued and outstanding 7,425,869 shares in
2013 and 7,424,572 in 2012		75			75
Additional paid in capital		12,302			12,300
Accumulated deficit		(19,555	)		(12,556	)
Accumulated other comprehensive (loss) income		(1,438	)		180
Total stockholders’ equity		5,659			14,151
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	376,939		$	439,821

See accompanying notes to consolidated financial statements.

CECIL BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)

(dollars in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
INTEREST INCOME:
Interest and fees on loans	$	3,111		$	4,425		$	11,170		$	13,570
Interest on investment securities		212			111			504			294
Dividends on FHLB and FRB stock		34			27			100			83
Other interest income		20			16			67			45
Total interest income		3,377			4,579			11,841			13,992

INTEREST EXPENSE:
Interest expense on deposits		709			935			2,349			2,845
Interest expense on junior subordinated debentures		89			96			256			354
Interest expense on advances from FHLB		493			493			1,463			1,649
Interest expense on other borrowed funds		-			-			-			20
Total interest expense		1,291			1,524			4,068			4,868

NET INTEREST INCOME		2,086			3,055			7,773			9,124

PROVISION FOR LOAN LOSSES		2,900			2,850			4,350			5,910

NET INTEREST (LOSS) INCOME AFTER
PROVISION FOR LOAN LOSSES		(814	)		205			3,423			3,214

NONINTEREST INCOME:
Deposit account fees		113			125			357			361
ATM fees		119			117			347			355
Commission income		-			-			1			1
Gain on sale of loans		24			28			200			1,381
Loss on sale of other real estate owned		(331	)		-			(312	)		(225	)
Gain on sale of investments		-			-			375			-
Income from bank owned life insurance		23			46			95			138
Premium received on sale of deposits		240			-			240			-
Other		59			147			134			399
Total noninterest income		247			463			1,437			2,410

NONINTEREST EXPENSE:
Salaries and employee benefits		1,276			1,307			3,892			3,789
Occupancy expense		187			184			635			543
Equipment and data processing expense		312			310			952			944
FDIC deposit insurance premiums		215			272			689			802
Other real estate owned expense and valuation		1,063			4,520			1,862			6,362
Professional fees		461			413			1,196			1,327
Loan collection expense		109			86			491			516
Provision for off-balance sheet credit losses		-			-			323			-
Other		383			350			1,154			1,113
Total noninterest expense		4,006			7,442			11,194			15,396

NET LOSS BEFORE INCOME TAXES		(4,573	)		(6,774	)		(6,334	)		(9,772	)
INCOME TAX EXPENSE		-			9,081			-			7,869
NET LOSS (CARRIED FORWARD)	$	(4,573	)	$	(15,855	)	$	(6,334	)	$	(17,641	)

CECIL BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)

(dollars in thousands, except per share data)

(Continued)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012

NET LOSS (BROUGHT FORWARD)	$	(4,573	)	$	(15,855	)	$	(6,334	)	$	(17,641	)

OTHER COMPREHENSIVE (LOSS) GAIN
Amounts reclassified to gain on sale of investments		-			-			(375	)		-
Unrealized (losses) gains on
investment securities,
net of taxes of $0 and $60 for the quarter
ended September 30, 2013 and 2012, respectively,
and $0 and $121 for the nine months ended
September 30, 2013 and 2012, respectively		(120	)		100			(1,243	)		202

TOTAL COMPREHENSIVE LOSS	$	(4,693	)	$	(15,755	)	$	(7,952	)	$	(17,439	)

NET LOSS	$	(4,573	)	$	(15,855	)	$	(6,334	)	$	(17,641	)

PREFERRED STOCK DIVIDENDS
AND DISCOUNT ACCRETION		(222	)		(359	)		(664	)		(726	)

NET LOSS AVAILABLE TO
COMMON STOCKHOLDERS	$	(4,795	)	$	(16,214	)	$	(6,998	)	$	(18,367	)

Loss per common share - basic	$	(0.65	)	$	(2.18	)	$	(0.94	)	$	(2.47	)

Loss per common share - diluted	$	(0.65	)	$	(2.18	)	$	(0.94	)	$	(2.47	)

Dividends declared per common share	$	0.00		$	0.00		$	0.00		$	0.00

See accompanying notes to consolidated financial statements.

CECIL BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012

(dollars in thousands)

	2013			2012

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(6,334	)	$	(17,641	)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization		892			1,014
Provision for loan losses		4,350			5,910
Gain on sale of loans		(200	)		(1,381	)
Loss on sale of other real estate owned		312			225
Gain on sale of investments		(375	)		-
Loss on premises and equipment		10			6
Gain on assets held for sale		-			(18	)
Increase in cash surrender value of bank owned life insurance		(95	)		(138	)
Valuation allowance on other real estate owned		992			5,338
Valuation allowance on deferred tax assets		-			9,187
Excess servicing rights		(47	)		(58	)
Origination of loans held for sale		(5,296	)		(19,427	)
Proceeds from sales of loans held for sale		5,454			20,789
Net change in:
Accrued interest receivable and other assets		(1,058	)		(323	)
Other liabilities		1,903			913
Net cash provided by operating activities		508			4,396
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investment securities available-for-sale		(25,050	)		(13,692	)
Purchases of investment securities held-to-maturity		(500	)		(500	)
Net redemption of restricted investment securities		226			92
Proceeds from sales, maturities, calls and principal payments of
investment securities available-for-sale		12,493			8,054
Proceeds from maturities, calls and principal payments of
investment securities held-to-maturity		2,092			5,253
Proceeds received from sale of branch		1,869			-
Net decrease (increase) in loans		9,090			(10,728	)
Proceeds from sale of other real estate owned		6,547			2,768
Proceeds from sale of premises and equipment		975			25
Proceeds from sale of assets held for sale		-			5,911
Purchases of premises and equipment		(106	)		(143	)
Net cash provided by (used in) investing activities		7,636			(2,960	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits		(20,561	)		3,039
Net decrease in advances from Federal Home Loan Bank of Atlanta		-			(10,000	)
Net decrease in other borrowed funds		(1,069	)		-
Proceeds from issuance of preferred stock		-			2,796
Net cash used in financing activities		(21,630	)		(4,165	)
DECREASE IN CASH AND CASH EQUIVALENTS		(13,486	)		(2,729	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		41,806			34,411
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	28,320		$	31,682

Supplemental disclosures of cash flows information:
Cash paid for interest	$	3,820		$	4,595
Transfer of loans to other real estate owned	$	9,146		$	18,044

See accompanying notes to consolidated financial statements.

CECIL BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012

1. GENERAL

In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company’s financial position as of September 30, 2013, the results of its operations and comprehensive loss and cash flows for the three and nine months ended September 30, 2013 and 2012. These statements are condensed and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the full year or for any other period.

2. FINANCIAL STATEMENT PREPARATION

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used when accounting for uncollectible loans, depreciation and amortization, intangible assets, deferred income taxes, and contingencies, among others. Actual results could differ from those estimates.

3. GOING CONCERN CONSIDERATION

Due to our elevated level of nonperforming assets and recurring operating losses, there is substantial doubt regarding our ability to continue as a going concern. Management is taking steps to improve our financial condition. The financial statements and the accompanying footnotes have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustment to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result from the outcome of any extraordinary regulatory action, which would affect our ability to continue as a going concern.

4. BRANCH SALE

On August 16, 2013, the Bank sold its Aberdeen, Maryland branch office to Howard Bank (“Howard”), Ellicott City, Maryland. As part of the transaction, Howard acquired a pool of loans with an unpaid principal balance of approximately $37.1 million at book value. Under the agreement, Howard paid a 5.0% premium on the balance of non-interest bearing deposits and 4.0% on all other transaction accounts assumed. Certificates of deposit were assumed at the current balance on the closing date, with no premium or discount applied. As part of the transaction, the deposits assumed by Howard totaled approximately $35.2 million. The premium received on the assumption of deposits totaled approximately $240,000 and is included in other noninterest income on the consolidated statement of operations and comprehensive loss. Howard also purchased the branch premises and selected equipment at their book value, which totaled approximately $977,000.

The following table shows the composition of the loans (in thousands) sold as part of the agreement.

Real estate loans:
Construction and land development	$	870
1-4 family residential and home equity		6,755
Multi-family residential		394
Commercial		27,779
Total real estate loans		35,798
Commercial business loans		1,228
Consumer loans		26
Total loans sold	$	37,052

The following table shows the composition of the premises and equipment (in thousands) sold as part of the agreement.

Land	$	190
Building and improvements		948
Furniture, fixtures and equipment		96
		1,234
Less: accumulated depreciation		257
Total premises and equipment sold	$	977

The following table shows the composition of the deposits (in thousands) sold as part of the agreement.

Regular checking	$	1,707
NOW accounts		1,323
Passbook savings		48
Statement savings		238
Money market		2,254
Certificates of deposit		24,397
IRA certificates of deposit		2,866
Money market certificates		2,351
Total deposits sold	$	35,184

5. RECENT ACCOUNTING PRONOUNCEMENTS

FASB ASU 2013-02, “Comprehensive Income – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”

The objective of this ASU, issued in February 2013, is to improve the transparency of reporting reclassifications out of accumulated other comprehensive income (“OCI”) by requiring entities to present in one place information about significant amounts reclassifies and, in some cases, to provide cross references to related footnote disclosures. The amendments do not change the current requirements for reporting net income or OCI, nor do they require new information to be disclosed. The amendments were applied prospectively and were effective for public entities in both interim and annual reporting periods beginning after December 15, 2012.

6. EARNINGS PER SHARE

Basic earnings per common share are computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share are computed after adjusting the denominator of the basic earnings per share computation for the effects of all dilutive potential common shares outstanding during the period. The dilutive effects of options, warrants, and their equivalents are computed using the “treasury stock” method. For the three and nine months ended September 30, 2013 and 2012, all 523,076 options and warrants were excluded from the diluted earnings per share calculation because their effect was antidilutive. The calculation of net loss per common share for the three and nine months ended September 30, 2013 and 2012 is as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012

Basic and diluted:
Net loss	$	(4,573,000	)	$	(15,855,000	)	$	(6,334,000	)	$	(17,641,000	)
Preferred stock dividends and discount accretion		(222,000	)		(359,000	)		(664,000	)		(7,26,000	)
Net loss available to common stockholders	$	(4,795,000	)	$	(16,214,000	)	$	(6,998,000	)	$	(18,367,000	)

Average common shares outstanding		7,425,869			7,422,164			7,425,864			7,422,164

Basic and diluted loss per common share	$	(0.65	)	$	(2.18	)	$	(0.94	)	$	(2.47	)

7. ACCOUNTING FOR STOCK BASED COMPENSATION PLANS

In November 2009, the Company approved the granting of 120,250 restricted stock awards with a fair market value of $2.00 per share. The awards vest over a period of five years, with 2,408 shares vesting in November 2013 and 2,412 shares vesting in November 2014. The vesting of the remaining 103,686 shares is restricted due to the Company’s participation in the Department of Treasury’s Troubled Asset Relief Program Capital Purchase Program. A summary of the Company’s activity and related information for restricted stock for the periods indicated is as follows:

	Nine Months Ended			Year Ended
	September 30, 2013			December 31, 2012
		Weighted-				Weighted-
		Average				Average
	Shares	Exercise Price		Shares		Exercise Price

Unvested at beginning of period	108,506	$	2.00	111,694		$	2.00
Forfeited	—		—	(780	)		2.00
Awarded	—		—	—			—
Released	—		—	(2,408	)		2.00
Unvested at end of period	108,506	$	2.00	108,506		$	2.00

8. ASSETS MEASURED AT FAIR VALUE

In September 2006, the Financial Accounting Standards Board (“FASB”) issued ASC Topic 820. ASC Topic 820 establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. While the Statement applies under other accounting pronouncements that require or permit fair value measurements, it does not require any new fair value measurements. ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. In addition, the Statement establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Lastly, ASC Topic 820 requires additional disclosures for each interim and annual period separately for each major category of assets and liabilities. For Level 2 assets, the Company uses information from a third party pricing service, which is estimated using market prices of comparable instruments or other methods, such as the present value of future cash flows. The following table shows the value (in thousands) at September 30, 2013 and December 31, 2012 of each major category of assets measured on a recurring basis at fair value on the consolidated balance sheets, which consists of investment securities available-for-sale. The changes in fair value were reflected as a component of other comprehensive income and did not affect net income.

	Fair Value Measurements at Reporting Date Using
Description	Carrying Value		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2013
Investment securities available-for-sale
Mutual funds – mortgage securities	$	708	$	708	$	—	$	—
Mutual funds – U.S. Government
securities		662		662		—		—
SBA securitized loan pools		4,324		—		4,324		—
Other debt securities		599		—		599		—
Residential mortgage-backed securities		38,128		—		38,128		—
Total investment securities available-for-sale	$	44,421	$	1,370	$	43,051	$	—

December 31, 2012
Investment securities available-for-sale
Mutual funds – mortgage securities	$	709	$	709	$	—	$	—
Mutual funds – U.S. Government
securities		673		673		—		—
Equity securities		482		482		—		—
SBA securitized loan pools		3,658		—		3,658		—
Other debt securities		732		—		732		—
Mortgage-backed securities		27,250		—		27,250		—
Total investment securities available-for-sale	$	33,504	$	1,864	$	31,640	$	—

We may be required from time to time to measure certain other financial assets and liabilities at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower of cost or market accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis at September 30, 2013 and December 31, 2012, the following table provides (in thousands) the level of valuation assumptions used to determine each adjustment and the carrying value of the assets. For both other real estate owned and impaired loans, Level 3 assets are valued at the lesser of the unpaid principal balance of the loan, or the appraised value of the underlying collateral, net of estimated selling costs, as determined by a third party appraiser. There were no transfers between valuation levels for any assets during the nine months ended September 30, 2013 or the year ended December 31, 2012.

	Fair Value Measurements at Reporting Date Using
			Quoted Prices
			In Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2013
Other real estate owned:
Construction & Land Development	$	24,332	$	0	$	0	$	24,332
1-4 Family Residential		3,308		0		0		3,308
Commercial Real Estate		7,305		0		0		7,305
Total	$	34,945	$	0	$	0	$	34,945

Impaired loans:
Construction & Land Development	$	13,616	$	0	$	0	$	13,616
1-4 Family Residential		12,981		0		0		12,981
Commercial Real Estate		27,114		0		0		27,114
Commercial Business		48		0		0		48
Total	$	53,759	$	0	$	0	$	53,759
December 31, 2012
Other real estate owned:
Construction & Land Development	$	19,915	$	0	$	0	$	19,915
1-4 Family Residential		6,070		0		0		6,070
Commercial Real Estate		7,886		0		0		7,886
Total	$	33,871	$	0	$	0	$	33,871

Impaired loans:
Construction & Land Development	$	19,674	$	0	$	0	$	19,674
1-4 Family Residential		14,386		0		0		14,386
Commercial Real Estate		18,139		0		0		18,139
Commercial Business		6		0		0		6
Total	$	52,205	$	0	$	0	$	52,205

9. FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB ASC 825-10-50 requires that the Company disclose estimated fair values for both its on and off-balance-sheet financial instruments. The following methods and assumptions were used to estimate the fair value of the Company’s financial instruments. Changes in estimates and assumptions could have a significant impact on these fair values.

Investment Securities - The fair values of investment securities are based on quoted market prices, where available. If a quoted market price is not available, fair value is estimated using quoted market prices of comparable instruments.

Loans Receivable - The fair value of the loan portfolio is estimated by evaluating homogeneous categories of loans with similar financial and credit risk characteristics. Loans are segregated by types, such as residential mortgage, commercial real estate and consumer. Each loan category is further segmented into fixed and adjustable-rate interest terms.

The fair values of each loan category are estimated by discounting contractual cash flows adjusted for estimated prepayments. Assumptions regarding prepayment estimates and discount rates are judgmentally determined by using available market information.

Restricted Investment Securities - The fair value of the Company’s investment in stock of the FHLB and FRB approximates its carrying value.

Deposits - The fair values of deposits are estimated using a discounted cash flow calculation, adjusted for estimated decay rates, that applies interest rates currently offered for funding sources with similar maturities. Assumptions regarding discount rates and decay estimates are judgmentally determined by using available market information.

Junior Subordinated Debentures – The fair value was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms.

Advances from the FHLB - The fair value of FHLB advances was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms.

Other Borrowed Funds – The fair value was estimated by computing the discounted value of contractual cash flows at current interest rates for obligations with similar remaining terms.

Commitments to Extend Credit - The Company charges fees for commitments to extend credit. Interest rates on loans for which these commitments are extended are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.

The estimated fair values of financial instruments (in thousands) at September 30, 2013 are as follows:

							Fair Value Measurements at Reporting Date Using
							Quoted Prices
							In Active			Significant
							Markets for			Other			Significant
							Identical			Observable			Unobservable
	Carrying						Assets			Inputs			Inputs
	Value			Fair Value			(Level 1)			(Level 2)			(Level 3)
Financial assets:
Investment securities:
Available-for-sale		$	44,421		$	44,421		$	1,370		$	43,051		$	—
Held-to-maturity			2,250			2,268			—			2,268			—
Loans receivable			245,775			268,685			—			—			268,685
Restricted investment securities			3,977			3,977			—			3,977			—
Financial liabilities:
Deposits			285,475			252,649			—			—			252,649
Junior subordinated debentures			17,000			17,000			—			17,000			—
Advances from FHLB			53,500			53,494			—			53,494			—

The estimated fair values of financial instruments (in thousands) at December 31, 2012 are as follows:

							Fair Value Measurements at Reporting Date Using
							Quoted Prices
							In Active			Significant
							Markets for			Other			Significant
							Identical			Observable			Unobservable
	Carrying						Assets			Inputs			Inputs
	Value			Fair Value			(Level 1)			(Level 2)			(Level 3)
Financial assets:
Investment securities:
Available-for-sale		$	33,504		$	33,504		$	1,864		$	31,640		$	—
Held-to-maturity			3,887			3,927			—			3,927			—
Loans receivable			306,751			337,044			—			—			337,044
Restricted investment securities			4,204			4,204			—			4,204			—
Financial liabilities:
Deposits			341,219			325,272			—			—			325,272
Junior subordinated debentures			17,000			17,000			—			17,000			—
Advances from FHLB			53,500			53,558			—			53,558			—
Other borrowed funds			1,088			1,088			—			1,088			—

10. INVESTMENT SECURITIES

Investment securities have been classified in the consolidated balance sheets according to management’s intent and ability to hold the investment. Investment securities at September 30, 2013 and December 31, 2012 are summarized in the following table (in thousands).

	September 30, 2013
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
Available-for-Sale:
Mutual funds - mortgage securities	$	747	$	5	$	44	$	708
Mutual funds - U.S. Government securities		686		—		24		662
SBA securitized loan pools		4,402		12		90		4,324
Other debt securities		595		4		—		599
Residential mortgage-backed securities		39,312		77		1,261		38,128
	$	45,742	$	98	$	1,419	$	44,421

Held-to-Maturity:
SBA securitized loan pools	$	940	$	—	$	8	$	932
Other debt securities		500		5		—		505
Residential mortgage-backed securities		560		21		—		581
U. S. Treasury securities and obligations		250		—		—		250
	$	2,250	$	26	$	8	$	2,268

	September 30, 2013
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
Available-for-Sale:
Mutual funds - mortgage securities	$	747	$	2	$	40	$	709
Mutual funds - U.S. Government securities		686		—		13		673
Equity securities		226		256		—		482
SBA securitized loan pools		3,658		10		10		3,658
Other debt securities		732		—		—		732
Residential mortgage-backed securities		27,159		192		101		27,250
	$	33,208	$	460	$	164	$	33,504

Held-to-Maturity:
SBA securitized loan pools	$	1,389	$	—		17	$	1,372
Other debt securities		500		9		—		509
Residential mortgage-backed securities		1,748		51		3		1,796
U. S. Treasury securities and obligations		250		—		—		250
	$	3,887	$	60	$	20	$	3,927

As of September 30, 2013, unrealized losses (in thousands) on securities were comprised of the following based on the length of time that the securities have been in a continuous loss position:

	Less than 12 Months				More than 12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
Available-for-Sale:
Mutual funds – mortgage securities	$	—	$	—	$	132	$	44	$	132	$	44
Mutual funds – US Govt securities		—		—		662		24		662		24
SBA securitized loan pools		1,883		82		399		8		2,282		90
Residential mortgage-backed securities		29,548		1,202		2,644		59		32,192		1,261
Held-to-Maturity:
SBA securitized loan pools		—		—		887		8		887		8
	$	31,431	$	1,284	$	4,724	$	143	$	36,155	$	1,427

As of December 31, 2012, unrealized losses (in thousands) on securities were comprised of the following based on the length of time that the securities have been in a continuous loss position:

	Less than 12 Months				More than 12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
Available-for-Sale:
Mutual funds – mortgage securities	$	—	$	—	$	136	$	40	$	136	$	40
Mutual funds – US Govt securities		—		—		673		13		673		13
SBA securitized loan pools		—		—		480		10		480		10
Residential mortgage-backed securities		13,554		98		95		3		13,649		101
Held-to-Maturity:
SBA securitized loan pools		275		2		1,017		15		1,292		17
Residential mortgage-backed securities		—		—		270		3		270		3
	$	13,829	$	100	$	2,671	$	84	$	16,500	$	184

Management has the intent to hold the securities classified as held-to-maturity in the table above until they mature, at which time the Company will receive full value for the securities. Furthermore, as of September 30, 2013 and December 31, 2012, management does not have the intent to sell any of the securities classified as available-for-sale in the table above and

believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. Management does not believe that any of the securities are impaired due to reasons of credit quality. Accordingly, as of September 30, 2013 and December 31, 2012, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Company’s consolidated income statement.

11. CREDIT QUALITY OF LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The Company has segregated its loan portfolio into six segments, including construction and land development, 1-4 family residential, multi-family residential, commercial real estate, commercial business, and consumer. The Company’s primary market area is in Northeastern Maryland in Cecil and Harford Counties, so exposure to credit risk is significantly affected by changes in these counties.

Construction lending primarily involves lending for construction of single family residences, although the Bank does lend funds for the construction of commercial properties and multi-family real estate. All loans for the construction of speculative sale homes have a loan-to-value ratio of not more than 80%. The Bank has financed the construction of non-residential properties on a case by case basis. Loan proceeds are disbursed during the construction phase according to a draw schedule based on the stage of completion. Construction projects are inspected by contracted inspectors or bank personnel. Construction loans are underwritten on the basis of the estimated value of the property as completed. The Bank originates loans secured by raw land, which are generally granted to developers have terms of up to three years. The substantial majority of land loans have a loan-to-value ratio not exceeding 75%. Land loans have a higher level of risk than loans for the purchase of existing homes since collateral values can only be estimated at the time the loan is approved. The Bank has sought to minimize this risk by offering such financing primarily to builders and developers to whom the Bank has loaned funds in the past and to persons who have previous experience in such projects.

The Bank offers fixed and adjustable rate conventional mortgage loans on one-to-four family residential dwellings. Most loans are originated in amounts up to $350,000 on properties located in the Bank’s primary market area. These loans are generally for terms of 15, 20 and 30 years amortized on a monthly basis with interest and principal due each month. The Bank retains all adjustable rate mortgage loans it originates and sells the majority of fixed rate loans, primarily to FHLMC, with servicing retained by the Bank. The retention of adjustable rate loans helps reduce the Bank’s exposure to rising interest rates. However, it is possible that during periods of rising interest rates, the risk of default on adjustable rate mortgage loans may increase due to the upward adjustment of the interest cost to the borrower.

The Bank originates multi-family residential loans in its market area. These loans are generally larger and involve greater risks than one-to-four family residential loans. Because payments on these loans are often dependent on the successful operation or management of the property, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks in a variety of ways, including limiting the size and loan-to-value ratios. The loans typically have terms of 20 to 40 years, with rate adjustments every one, three, or five years. They generally have imbedded interest rate floors, with no interest rate ceilings, and have no interest rate change limitations.

The Bank primarily originates commercial real estate loans in its market area. These loans are generally larger and involve greater risks that one-to-four family residential loans. Because payments on these loans are often dependent on the successful operation or management of the property, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks in a variety of ways, including limiting the size and loan-to-value ratios. The loans typically have terms of 20 to 40 years, with rate adjustments every one, three, or five years. They generally have imbedded interest rate floors, with no interest rate ceilings, and have no interest rate change limitations. The Bank’s commercial real estate loans are typically secured by retail or wholesale establishments, motels/hotels, service industries, and industrial or warehouse facilities. During 2011, the Bank began making loans under the Small Business Administration (“SBA”) Section 7(a) program, under which the SBA guarantees up to 75% of loans of up to $5 million for the purchase or expansion of small businesses. The Bank may sell the guaranteed portion of SBA loans into the secondary market and retain the unguaranteed portion in its portfolio.

The Bank offers secured and unsecured commercial business loans and lines of credit to businesses located in its primary market area. Most business loans have a one-year term, while lines of credit can remain open for longer periods. All owners, partners, and officers must sign the loan agreement. The security for a business loan depends on the amount borrowed, the business involved, and the strength of the borrower’s firm. Commercial business lending entails significant risk, as the payments on such loans may depend upon the successful operation or management of the business involved. Although the Bank

attempts to limit its risk of loss on such loans by limiting the amount and the term, and by requiring personal guarantees of the principals of the business, the risk of loss on these loans is substantially greater than the risk of loss from residential real estate lending.

The Bank’s consumer loans consist of automobile loans, deposit account loans, home improvement loans, and other consumer loans. The loans are generally offered for terms of up to five years at fixed interest rates. Consumer loans are generally originated at higher interest rates than residential mortgage loans because of their higher risk. Repossessed collateral for a defaulted loan may not provide an adequate source of repayment as a result of damage, loss, or depreciation. In addition, collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.

On an ongoing basis, the Bank assigns a grade to each of its loans. The internal grades are pass, special mention, substandard, doubtful, and loss. Loans graded pass are loans where the borrower exhibits a strong balance sheet position and good earnings and cash flow history. Loans graded special mention show potential weaknesses that deserve the Bank’s close attention. If these potential weaknesses are not corrected, they may result in deterioration of the repayment prospects for the loan in the Bank’s credit position at some future date. Substandard loans are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well defined weakness that could jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the weaknesses are not corrected. Loans graded doubtful have all the weaknesses inherent in substandard loans with the added characteristic that the weaknesses make collection or liquidation in full highly improbable. Assets graded loss are considered uncollectible and of such little value that their continuance as an asset is not warranted. The classification does not mean the loan has absolutely no recovery value, but that it is not practical to defer charging off the loan even though partial recovery may be effected in the future.

The following table shows the composition of the loan portfolio held for investment (in thousands) at September 30, 2013 and December 31, 2012.

	2013			2012
Real estate loans:
Construction and land development	$	38,586		$	57,731
1-4 family residential and home equity		82,768			90,406
Multi-family residential		4,845			5,306
Commercial		111,140			143,263
Total real estate loans		237,339			296,706
Commercial business loans		6,806			7,879
Consumer loans		1,630			2,166
Gross loans		245,775			306,751
Less allowance for loan losses		(8,919	)		(10,297	)
Net loans	$	236,856		$	296,454

In accordance with the standards issued under the Disclosures of Credit Quality of Financing Receivables and the Allowance for Loan Losses, the following tables show credit quality indicators, the aging of receivables, and disaggregated balances of loans receivable and the allowance for loan losses (in thousands) as of September 30, 2013 and December 31, 2012.

Credit Quality Indicators
As of September 30, 2013
	Construction
	& Land		1-4 Family		Multi-Family		Commercial		Commercial
	Development		Residential		Residential		Real Estate		Business		Consumer		Total

Credit risk profile by internally assigned grade:

Pass	$	7,524	$	65,010	$	4,567	$	87,669	$	6,644	$	1,610	$	173,024
Special mention		15,935		6,086		278		11,286		61		20		33,666
Substandard		15,127		11,672		-		12,185		101		-		39,085
Total	$	38,586	$	82,768	$	4,845