Edgar Filing: SEVERN BANCORP INC

svbi10q2q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2011

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 0-49731

SEVERN BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland	52-1726127
(State or other jurisdiction of incorporation or organization)	(I.R.S. employer identification no.)
200 Westgate Circle, Suite 200 Annapolis, Maryland	21401
(Address of principal executive offices)	(Zip Code)

410-260-2000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and formal fiscal year, if changed since last report)

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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). Yes þ No o

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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer o

Non- accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Number of shares of the registrant’s Common Stock, $0.01 par value, outstanding as of the close of business on August 12, 2011: 10,066,679 shares.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Table of Contents

PART I – FINANCIAL INFORMATION		Page
Item 1.	Financial Statements (Unaudited)

	Consolidated Statements of Financial Condition as of June 30, 2011 and December 31, 2010	1
	Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2011 and 2010	2
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010	3
	Notes to Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44

Item 4.	Controls and Procedures	44

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	44

Item 1A.	Risk Factors	45

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45

Item 3.	Defaults Upon Senior Securities	45

Item 4.	(Removed and Reserved)	45

Item 5.	Other Information	45

Item 6.	Exhibits	45

SIGNATURES		46

PART I– FINANCIAL INFORMATION

Item 1. Financial Statements

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(dollars in thousands, except per share amounts)

	June 30,		December 31,
	2011		2010
ASSETS
Cash and due from banks	$	32,825	$	33,339
Interest-bearing deposits in other banks		40,548		20,149
Federal funds sold		12,071		17,467
Cash and cash equivalents		85,444		70,955
Investment securities held to maturity		39,358		27,311
Loans held for sale		971		3,426
Loans receivable, net of allowance for loan losses of
$31,103 and $29,871, respectively		735,340		778,937
Premises and equipment, net		27,747		28,327
Foreclosed real estate		17,291		20,955
Federal Home Loan Bank stock at cost		7,322		7,692
Accrued interest receivable and other assets		23,899		24,940

Total assets	$	937,372	$	962,543

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits	$	687,842	$	714,776
Long-term borrowings		115,000		115,000
Subordinated debentures		24,119		24,119
Accrued interest payable and other liabilities		5,406		2,548

Total liabilities		832,367		856,443


Stockholders’ Equity
Preferred stock, $0.01 par value, 1,000,000 shares authorized;
Preferred stock series “A”, 437,500 shares issued and outstanding		4		4
Preferred stock series “B”, 23,393 shares issued and outstanding		-		-
Common stock, $0.01 par value, 20,000,000 shares authorized;
10,066,679 shares issued and outstanding		101		101
Additional paid-in capital		74,516		74,352
Retained earnings		30,384		31,643

Total stockholders' equity		105,005		106,100

Total liabilities and stockholders' equity	$	937,372	$	962,543

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

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(dollars in thousands, except per share data)

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010

Interest Income
Loans, including fees	$	11,047		$	13,004		$	22,576		$	25,546
Securities, taxable		150			11			272			51
Other		57			30			104			44
Total interest income		11,254			13,045			22,952			25,641

Interest Expense
Deposits		2,658			3,580			5,496			7,162
Long-term borrowings and subordinated debentures		1,288			1,415			2,576			2,813
Total interest expense		3,946			4,995			8,072			9,975

Net interest income		7,308			8,050			14,880			15,666
Provision for loan losses		2,987			1,000			3,621			3,544
Net interest income after provision for loan losses		4,321			7,050			11,259			12,122

Non-Interest Income
Real estate commissions		123			93			234			230
Real estate management fees		159			133			301			284
Mortgage banking activities		27			122			182			221
Other		138			189			292			365
Total non-interest income		447			537			1,009			1,100

Non-Interest Expenses
Compensation and related expenses		2,511			2,506			5,125			4,958
Occupancy		301			319			556			753
Foreclosed real estate expenses, net		1,489			1,641			3,434			3,263
Legal fees		253			341			437			609
FDIC assessments and regulatory expense		582			568			1,142			1,129
Other		1,035			1,158			2,186			2,285
Total non-interest expenses		6,171			6,533			12,880			12,997

Income (loss) before income tax provision (benefit)		(1,403	)		1,054			(612	)		225
Income tax provision (benefit)		(557	)		461			(213	)		160
Net income (loss)		(846	)		593			(399	)		65
Amortization of discount on preferred stock		(67	)		(67	)		(135	)		(135	)
Dividends on preferred stock		(363	)		(363	)		(725	)		(725	)
Net income (loss) available to common stockholders	$	(1,276	)	$	163		$	(1,259	)	$	(795	)
Basic earnings (loss) per share	$	(.13	)	$	.02		$	(.13	)	$	(.08	)
Diluted earnings (loss) per share	$	(.13	)	$	.02		$	(.13	)	$	(.08	)
Common stock dividends declared per share	$	-		$	-		$	-		$	-

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

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(dollars in thousands)

	For the Six Months Ended June 30,
	2011			2010

Cash Flows from Operating Activities

Net income (loss)	$	(399	)	$	65
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Amortization of deferred loan fees		(718	)		(818	)
Net amortization of premiums and
discounts		78			35
Provision for loan losses		3,621			3,544
Provision for depreciation		624			614
Gain on sale of loans		(182	)		(221	)
Loss on sale of foreclosed real estate		562			405
Provision for foreclosed real estate losses		2,253			2,221
Proceeds from loans sold to others		13,545			17,532
Loans originated for sale		(10,908	)		(14,085	)
Stock-based compensation expense		29			76
(Increase) decrease in net deferred tax asset		(804	)		51
Decrease in accrued interest receivable
and other assets		1,845			3,223
Increase in accrued interest payable and other liabilities		2,858			3,367

Net cash provided by operating activities		12,404			16,009

Cash Flows from Investing Activities

Purchase of investment securities held to maturity		(16,359	)		(15,103	)
Proceeds from maturing investment securities		4,000			-
Principal collected on mortgage-backed securities		234			14
Net (increase) decrease in loans		32,745			(4,993	)
Proceeds from sale of foreclosed real estate		9,288			13,396
Investment in foreclosed real estate		(490	)		(228	)
Investment in premises and equipment		(44	)		(316	)
Redemption of Federal Home Loan Bank Stock		370			-
Net cash provided by (used in) investing activities		29,744			(7,230	)

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) CONTINUED

(dollars in thousands)

	For the Six Months Ended June 30,
	2011			2010

Cash Flows from Financing Activities

Net increase (decrease) in deposits		(26,934	)		31,713
Series “A” preferred stock dividend paid		(140	)		(140	)
Series “B” preferred stock dividend paid		(585	)		(585	)

Net cash (used in) provided by financing activities		(27,659	)		30,988

Increase in cash and cash equivalents		14,489		39,767
Cash and cash equivalents at beginning of year		70,955		51,401

Cash and cash equivalents at end of period	$	85,444	$	91,168

Supplemental disclosure of cash flows information:
Cash paid during period for:

Interest	$	8,101	$	9,973

Income taxes	$	-	$	-

Transfer of loans to foreclosed real estate	$	7,949	$	10,492

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

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 - Principles of Consolidation

The unaudited consolidated financial statements include the accounts of Severn Bancorp, Inc. (“Bancorp”), and its subsidiaries, 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.

Note 2 - Basis of Presentation

Bancorp follows accounting standards set by the Financial Accounting Standards Board, commonly referred to as the “FASB”. The FASB sets generally accepted accounting principles in the United States (“GAAP”) that Bancorp follows. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards Codification, sometimes referred to as the Codification or ASC.

The accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the disclosures required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods presented have been made. Such adjustments were of a normal recurring nature. The results of operations for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011 or any other interim period. The unaudited consolidated financial statements for the three and six months ended June 30, 2011 should be read in conjunction with the audited consolidated financial statements and related notes, which were included in Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010. These consolidated financial statements consider events that occurred through the date the consolidated financial statements were issued.

Note 3 - Cash Flow Presentation

In the statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, Federal Home Loan Bank of Atlanta (“FHLB Atlanta”) overnight deposits, and federal funds sold. Generally, federal funds are sold for one-day periods.

Note 4 – Reclassifications

Amounts in the prior year’s consolidated financial statements have been reclassified whenever necessary to conform to the current year’s presentation. Such reclassifications had no impact on net income (loss).

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 5 - Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of shares of common stock outstanding for each period. Diluted earnings (loss) 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 Bancorp 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 three and six month periods ended June 30, 2011, because they were anti-dilutive, were 100,000 shares of common stock issuable upon exercise of outstanding stock options, 556,976 shares of common stock issuable upon the exercise of a warrant and 437,500 shares of common stock issuable upon conversion of Bancorp’s Series A Preferred Stock. Not included in the diluted earnings per share calculation for the three and six month periods ended June 30, 2010, because they were anti-dilutive, were 110,715 and 210,715 shares of common stock issuable upon the exercise of outstanding stock options, 556,976 shares of common stock issuable upon the exercise of a warrant and 437,500 shares of common stock issuable upon conversion of Bancorp’s Series A Preferred Stock.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010
Common shares – weighted average (basic)		10,066,679		10,066,679		10,066,679		10,066,679
Common share equivalents – weighted average		-		10,084		-		-
Common shares – diluted		10,066,679		10,076,763		10,066,679		10,066,679

Note 6 - Guarantees

Bancorp does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. See Note 10.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 7 - 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 possible additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on Bancorp’s consolidated 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. The following table presents the Bank’s capital position:

	Actual	Actual	To Be Well Capitalized Under
	at June 30, 2011	at December 31, 2010	Prompt Corrective Provisions
Tangible (1)	12.3%	12.3%	N/A
Tier I Capital (2)	16.2%	15.6%	6.0%
Core (1)	12.3%	12.3%	5.0%
Total Capital (2)	17.5%	16.8%	10.0%

(1) To adjusted total assets.

(2) To risk-weighted assets.

Note 8 - Stock-Based Compensation

Bancorp has a stock-based compensation plan for directors, officers, and other key employees of Bancorp. 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 Bancorp’s old stock-based compensation plan. Under the terms of the stock-based compensation plan, Bancorp 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 of Bancorp vest immediately, and options granted to officers and employees vest over a five-year period, although the Compensation Committee has the authority to provide for different vesting schedules.

Bancorp follows FASB ASC 718, “Compensation – Stock Compensation”, to account for stock-based compensation. FASB ASC 718 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. FASB ASC 718 requires an entity 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.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 8 - Stock-Based Compensation - continued

On March 16, 2010, Bancorp granted 100,000 options to certain officers and employees to purchase shares of Bancorp’s stock at a price ranging from $4.13 to $4.54 per share. The options vest over a five year period from the date of grant.

The grant-date fair value of options granted was $2.12. The fair value of the options awarded under the option plan is estimated on the date of grant using the Black-Scholes valuation model, which is dependent upon certain assumptions as presented below:

Expected life (in years)	5.00
Risk-free interest rate	2.37	%
Expected volatility	58.78	%
Expected dividend yield	0.00	%

The expected life of the options was estimated using the average vesting period of the options granted and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the grant date. Volatility of Bancorp’s stock price was based on historical volatility. Dividend yield was based on management’s projection of future dividends.

There were no options granted during the six months ended June 30, 2011.

Stock-based compensation expense for the three and six months ended June 30, 2011 totaled $1,000 and $29,000, respectively. Stock-based compensation expense for the three and six months ended June 30, 2010 totaled $43,000 and $76,000, respectively. There were no options granted or exercised during the six months ended June 30, 2011 and 100,000 options granted and no options exercised during the six months ended June 30, 2010.

Information regarding Bancorp’s stock-based compensation plan as of and for the six months ended June 30, 2011 is as follows:

	2011
				Weighted Average
	Shares			Price
Options outstanding, December 31, 2010		190,750		$	9.79
Options granted		-			-
Options exercised		-			-
Options forfeited		(90,750	)	$	15.93
Options outstanding, June 30, 2011		100,000		$	4.21
Options exercisable, June 30, 2011		25,834		$	4.21

The aggregate intrinsic value of the options outstanding as of June 30, 2011 and December 31, 2010 was $0.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 8 - Stock-Based Compensation - continued

The following table summarizes the stock options outstanding and exercisable as of June 30, 2011.

Options Outstanding and Exercisable

		Weighted Average Remaining	Weighted Average
Range of Exercise Prices	Number Outstanding	Contractual Life	Exercise Price

$4.13	20,667	3.71	$4.13
$4.54	5,167	3.71	$4.54
$4.13-$4.54	25,834	3.71	$4.21

As of June 30, 2011, there was $168,000 of total unrecognized stock-based compensation expense related to non-vested stock options, which is expected to be recognized over a period of forty-eight months.

Note 9 - Investment Securities

The amortized cost and fair value of investment securities held to maturity are as follows (dollars in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
June 30, 2011:
US Treasury securities	$	33,421	$	748	$	-		$	34,169
US Agency securities		5,202		23		(2	)		5,223
US government sponsored
mortgage-backed securities		735		52		-			787
Total	$	39,358	$	823	$	(2	)	$	40,179

December 31, 2010:

US Treasury securities	$	21,104	$	223	$	(2	)	$	21,325
US Agency securities		5,233		-		(37	)		5,196
US Government sponsored
mortgage-backed securities		974		61		-			1,035
Total	$	27,311	$	284	$	(39	)	$	27,556

The estimated fair value of debt securities at June 30, 2011, by contractual maturity are shown below. Expected maturities may differ from contractual maturities, because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 9 - Investment Securities

	Held to Maturity
	(dollars in thousands)
	Amortized		Estimated
	Cost		Fair Value

Due in one year or less	$	8,009	$	8,033
Due from one year to five years		22,390		22,880
Due from five years to ten years		8,224		8,479
US government sponsored mortgage-backed securities		735		787
	$	39,358	$	40,179

On June 30, 2011 and December 31, 2010, there were $7,518,000 and $8,760,000, respectively, in US Treasury securities and mortgage-backed securities pledged as collateral.

The following tables show fair value and unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position as of June 30, 2011 and December 31, 2010. Included in the table are one agency security in 2011 and one treasury security and five agency securities in 2010. Management believes that the unrealized losses are the result of interest rate levels differing from those existing at the time of purchase of the securities and actual and estimated prepayment speeds and are not necessarily related to the credit quality of the issuers of the securities. In addition, Bancorp does not intend to sell, nor does it believe it will be more likely than not that it will be required to sell, any impaired securities prior to a recovery of amortized cost. These unrealized losses are considered temporary as they reflect fair values on June 30, 2011 and December 31, 2010 and are subject to change daily as interest rates fluctuate.

	Less than 12 months					12 Months or More					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
June 30, 2011:	(dollars in thousands)

US Treasury securities	$	-	$	(-	)	$	-	$	(-	)	$	-	$	(-	)
US Agency securities		1,125		(2	)		-		(-	)		1,125		(2	)
Total	$	1,125	$	(2	)	$	-	$	(-	)	$	8,226	$	(2	)

December 31, 2010:

US Treasury securities	$	1,033	$	(2	)	$	-	$	(-	)	$	1,033	$	(2	)
US Agency securities		5,196		(37	)		-		(-	)		5,196		(37	)
Total	$	6,229	$	(39	)	$	-	$	(-	)	$	6,229	$	(39	)

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 10 - Loans Receivable

Loans receivable consist of the following:	June 30			December 31
	2011			2010
	(dollars in thousands)

Residential mortgage, total	$	312,507		$	326,255
Individually evaluated for impairment		52,087			59,189
Collectively evaluated for impairment		260,420			267,066
Home equity, total		42,880			43,501
Individually evaluated for impairment		1,994			975
Collectively evaluated for impairment		40,886			42,526
Lines of credit, total		34,529			36,642
Individually evaluated for impairment		3,239			4,564
Collectively evaluated for impairment		31,290			32,078
Commercial real estate, total		202,252			212,477
Individually evaluated for impairment		21,573			23,683
Collectively evaluated for impairment		180,679			188,794
Construction, land acquisition and
development, total		127,266			144,098
Individually evaluated for impairment		30,326			21,937
Collectively evaluated for impairment		96,940			122,161
Land, total		58,914			63,155
Individually evaluated for impairment		9,692			10,196
Collectively evaluated for impairment		49,222			52,959
Commercial non-real estate, total		8,394			8,434
Individually evaluated for impairment		453			305
Collectively evaluated for impairment		7,941			8,129
Consumer, total		1,929			1,302
Individually evaluated for impairment		837			61
Collectively evaluated for impairment		1,092			1,241
Total Loans		788,671			835,864
Individually evaluated for impairment		120,201			120,910
Collectively evaluated for impairment		668,470			714,954
Less
Loans in process		(19,456	)		(23,851	)
Allowance for loan losses		(31,103	)		(29,871	)
Deferred loan origination fees and costs, net		(2,772	)		(3,205	)
	$	735,340		$	778,937

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 10 – Loans Receivable - Continued

The inherent credit risks within the portfolio vary depending upon the loan class as follows:

Residential mortgage loans are 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 loan to value ratio of 80% or less.

Construction, land acquisition and development loans are underwritten based upon a financial analysis of the developers and property owners and construction cost estimates, in addition to 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. 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. 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.

Land loans are underwritten based upon the 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. These loans 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.

Commercial real estate loans are 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.

Commercial non-real estate loans are underwritten after evaluating historical and projected profitability and cash flow to determine the borrower's ability to repay their obligation as agreed. Commercial and industrial loans are made primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral supporting the loan facility. Accordingly, the repayment of a commercial and industrial 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.

Home equity loans are subject to the underwriting standards and processes similar to residential mortgages and are secured by one to four family dwelling units. Home equity loans have greater risk than residential mortgages as a result of the Bank being in a second lien position in the event collateral is liquidated.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

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Note 10 – Loans Receivable - Continued

Line of credit loans are subject to the underwriting standards and processes similar to commercial non-real estate 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.

Consumer loans 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 difference in the underlying collateral, if any. The application of various federal and state bankruptcy and insolvency laws may limit the amount that can be recovered on such loans.

The loan portfolio segments and loan classes disclosed above are the same because this is the level of detail management uses when the original loan is recorded and is the level of detail used by management to assess and monitor the risk and performance of the portfolio. Management has determined that this level of detail is adequate4 to understand and manage the inherent risks within each portfolio segment and loan class.

Allowance for Loan Losses - An allowance for loan losses 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. 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 for loan losses requires the use of estimates and assumptions, which is permitted under GAAP. Actual results could differ significantly from those estimates. Management believes the allowance for losses on loans is adequate. While management uses available information to estimate losses on loans, future additions to the allowances may be necessary based on changes in economic conditions, particularly in the State of Maryland. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowance based on their judgments 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 loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted 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 non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s 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 market value of the underlying collateral less its estimated disposal costs is lower than the carrying value of that loan. For loans that are not solely collateral dependent, an allowance is established when the present value of the expected

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 10 – Loans Receivable - Continued

future cash flows of the impaired loan is lower than the carrying value of that loan. The general component relates to loans that are classified as doubtful, substandard or special mention that are not considered impaired, as well as non-classified loans. The general reserve is based on historical loss experience adjusted for qualitative factors. Management uses the historical loss experience for the preceding three fiscal years and the twelve months ended one month prior to the reporting date when calculating the general reserve.

This historical loss data is weighted heavier to more recent periods. There have been no changes to these look-back periods during the periods presented in the Consolidated Statements of Operations. These qualitative factors include:

·	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; and

·	Effect of any changes in concentration of credit.

A loan is considered impaired if it meets either of the following two criteria:

·	Loans that are 90 days or more in arrears (nonaccrual loans); or

·	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.

Bancorp determines the likelihood that a borrower will pay all amounts due according to the contractual terms of the loan agreement by assessing various factors, including: (i) personal financial statements of net worth, cash flow statements and tax returns (for individual borrowers) and (ii) financial and operating statements, tax returns and financial projections (for legal entity borrowers). Bancorp’s evaluation is primarily focused on various key financial metrics, including net worth, leverage ratios, debt service coverage and liquidity.

Bancorp continues to accrue interest on impaired loans that are not in non-accrual status. These loans are less than 90 days in arrears, but are deemed impaired because it is probable, based on current information and events, that the borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. Cash receipts for these impaired loans are applied to the principal and interest due.

Interest on impaired loans that are in non-accrual status is accounted for on a cash basis until qualifying for return to accrual basis. Cash receipts for these non-accrual loans are applied to principal.

Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified special mention have potential weaknesses that deserve 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 inherited 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 for loan losses. Loans not classified are rated pass.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 10 – Loans Receivable - Continued

A loan is considered a troubled debt restructuring (“TDR”) when Bancorp for economic or legal reasons relating to the borrowers financial difficulties grants a concession to the borrower that it would not otherwise consider. Loan modifications made with terms consistent with current market conditions that the borrower could obtain in the open market are not considered troubled debt restructurings

Loans that experience insignificant payment delays and payment shortfalls generally are not 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.

With respect to all loan segments, management does not charge off a loan, or a portion of a loan, until one of the following conditions have been met:

·	The loan has been foreclosed on. Once the loan has been transferred from the Loans Receivable to Foreclosed Real Estate, 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.

Prior to either of the above conditions, a loan is assessed for impairment when: (i) a loan becomes 90 days or more in arrears or (ii) based on current information and events, it is probable that the borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. If, based on management’s assessment of the underlying collateral of the loan, it is determined that a reserve is needed, a specific reserve is recorded. That reserve is included in the Allowance for Loan Losses in the Consolidated Statement of Financial Condition.

Bancorp has experienced an increase in the number of extension requests for commercial real estate and construction loans, some of which have related repayment guarantees. An extension may be granted to allow for the completion of the project, marketing or sales of completed units, or to provide for permanent financing, and is based on a re-underwriting of the loan and management's assessment of the borrower's ability to perform according to the agreed-upon terms. Typically, at the time of an extension, borrowers are performing in accordance with contractual loan terms. Extension terms generally do not exceed 12 to 18 months and typically require that the borrower provide additional economic support in the form of partial repayment, additional collateral or guarantees. In cases where the fair value of the collateral or the financial resources of the borrower are deemed insufficient to repay the loan, reliance may be placed on the support of a guarantee, if applicable. However, such guarantees are not relied on when evaluating a loan for impairment and never considered the sole source of repayment.

Bancorp evaluates the financial condition of guarantors based on the most current financial information available. Most often, such information takes the form of (i) personal financial statements of net worth, cash flow statements and tax returns (for individual guarantors) and (ii) financial and operating statements, tax returns and financial projections (for legal entity guarantors). Bancorp’s evaluation is primarily focused on various key financial metrics, including net worth, leverage ratios, and liquidity. It is Bancorp's policy to update such information annually, or more frequently as warranted, over the life of the loan.

While Bancorp does not specifically track the frequency with which it has pursued guarantor performance under a guarantee, its underwriting process, both at origination and upon extension, as applicable, includes an assessment of the guarantor's reputation, creditworthiness and willingness to perform. Historically, when Bancorp has found it necessary to seek performance under a guarantee, it has been able to effectively mitigate its losses. As stated above, Bancorp’s ability to seek performance under a guarantee is directly related to the guarantor's reputation, creditworthiness and willingness to perform. When a loan becomes impaired, repayment is sought from both the underlying collateral and the guarantor (as applicable). In the event that the guarantor is unwilling or unable to perform, a legal remedy is pursued.

Construction loans are funded, at the request of the borrower, typically not more than once per month, based on the extent of work completed, and are monitored, throughout the life of the project, by independent professional construction inspectors and Bancorp's commercial real estate lending department. Interest is advanced to the borrower, upon request, based upon the progress of the project toward completion. The amount of interest advanced is added to the total outstanding principal under the loan commitment. Should the project not progress as scheduled, the adequacy of the interest reserve necessary to carry the project through to completion is subject to close monitoring by management. Should the interest reserve be deemed to be inadequate, the borrower is required to fund the deficiency. Similarly, once a loan is fully funded, the borrower is required to fund all interest payments.

Construction loans are reviewed for extensions upon expiration of the loan term. Provided the loan is performing in accordance with contractual terms, extensions may be granted to allow for the completion of the project, marketing or sales of completed units, or to provide for permanent financing. Extension terms generally do not exceed 12 to 18 months.

In general, Bancorp's construction loans are used to finance improvements to commercial, industrial or residential property. Repayment is typically derived from the sale of the property as a whole, the sale of smaller individual units, or by a take-out from a permanent mortgage. The term of the construction period generally does not exceed two years. Loan commitments are based on established construction budgets which represent an estimate of total costs to complete the proposed project including both hard (direct) costs (building materials, labor, etc.) and soft (indirect) costs (legal and architectural fees, etc.). In addition, project costs may include an appropriate level of interest reserve to carry the project through to completion. If established, such interest reserves are determined based on (i) a percentage of the committed loan amount, (ii) the loan term, and (iii) the applicable interest rate. Regardless of whether a loan contains an interest reserve, the total project cost statement serves as the basis for underwriting and determining which items will be funded by the loan and which items will be funded through borrower equity. Bancorp has not advanced additional interest reserves to keep a loan from becoming nonperforming.

Bancorp recognized $432,000 and $831,000 of interest income and capitalized interest in its loan portfolio from interest reserves during the six months ended June 30, 2011 and 2010, respectively. None of the loans where interest reserves were recorded as capitalized interest were non-performing.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 10 - Loans Receivable - Continued

The following is a summary of the allowance for loan losses at June 30, 2011 and December 31, 2010 and for the three and six month periods ended June 30, 2011 and the year ended December 31, 2010 (dollars in thousands):

December 2010	Total			Residential Mortgage			Acquisition and Development			Land			Lines of Credit			Commercial Real Estate			Commercial Non-Real Estate		Home Equity			Consumer
Beginning Balance	$	34,693		$	19,621		$	1,492		$	5,539		$	20		$	5,506		$	82	$	2,425		$	8
Provision		5,744			3,443			2,505			1,782			438			(1,034	)		49		(1,446	)		7
Charge-offs		(10,666	)		(6,825	)		-			(3,096	)		-			(523	)		-		(217	)		(5	)
Recoveries		100			100			-			-			-			-			-		-			-
Ending Balance	$	29,871		$	16,339		$	3,997		$	4,225		$	458		$	3,949		$	131	$	762		$	10
Ending balance related to:
Loans individually evaluated for impairment	$	14,540		$	8,149		$	2,645		$	2,282		$	264		$	766		$	-	$	434		$	-
Loans collectively evaluated for impairment	$	15,331		$	8,190		$	1,352		$	1,943		$	194		$	3,183		$	131	$	328		$	10

Six month-June 2011

Beginning Balance	$	29,871		$	16,339		$	3,997		$	4,225		$	458		$	3,949		$	131	$	762		$	10
Provision		3,621			(1,412	)		3,458			(329	)		(63	)		386			260		576			745
Charge-offs		(2,389	)		(1,533	)		(587	)		(217	)		-			(37	)		-		(13	)		(2	)
Recoveries		-			-			-			-			-			-			-		-			-
Ending Balance	$	31,103		$	13,394		$	6,868		$	3,679		$	395		$	4,298		$	391	$	1,325		$	753
Ending balance related to:
Loans individually evaluated for impairment	$	15,251		$	5,988		$	3,494		$	2,276		$	222		$	1,459		$	131	$	936		$	745
Loans collectively evaluated for impairment	$	15,852		$	7,406		$	3,374		$	1,403		$	173		$	2,839		$	260	$	389		$	8

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

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Note 10 - Loans Receivable - Continued

Three month-June 2011	Total			Residential Mortgage			Acquisition and Development			Land			Lines of Credit		Commercial Real Estate			Commercial Non-Real Estate		Home Equity		Consumer
Beginning Balance	$	29,252		$	14,765		$	5,436		$	2,958		$	320	$	4,559		$	179	$	1,024	$	11
Provision		2,987			(506	)		1,613			772			75		(224	)		212		301		744
Charge-offs		(1,136	)		(865	)		(181	)		(51	)		-		(37	)		-		-		(2	)
Recoveries		-			-			-			-			-		-			-		-		-
Ending Balance	$	31,103		$	13,394		$	6,868		$	3,679		$	395	$	4,298		$	391	$	1,325	$	753

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 10 - Loans Receivable - Continued

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 on non-accrual

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 on non-accrual 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. Bancorp’s policy for recording payments received on non-accrual financing receivables is to record the payment towards principal and interest on a cash basis until such time as the loan is returned to accrual status.

The following table presents Bancorp’s non-performing assets as of June 30, 2011 and December 31, 2010 (dollars in thousands):

	June 30, 2011			Number of loans		December 31, 2010			Number of loans

Loans accounted for on a non-accrual basis:
Residential mortgage	$	14,898			39	$	18,778			46
Home equity		318			3		118			2
Lines of credit		1,971			3		4,265			8
Commercial real estate		3,537			6		1,927			6
Acquisition and development		16,885			18		15,160			17
Land		4,455			16		5,890			21
Commercial non-real estate		-			-		-			-
Consumer		24			1		26			2
Total non-accrual loans	$	42,088			86	$	46,164			102
Accruing loans greater than 90 days past due	$	-				$	-
Foreclosed real-estate	$	17,291				$	20,955
Total non-performing assets	$	59,379				$	67,119
Total troubled debt restructurings	$	62,519			114	$	72,029			135
Total non-accrual loans to net loans		5.7	%				5.9	%
Allowance for loan losses	$	31,103				$	29,871
Allowance to total loans		4.1	%				3.7	%
Allowance for loan losses to total non-performing loans,
including loans contractually past due 90 days or more		73.9	%				64.7	%
Total non-accrual and accruing loans greater than
90 days past due to total assets		4.5	%				4.8	%
Total non-performing assets to total assets		6.3	%				7.0	%

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

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Note 10 - Loans Receivable - Continued

The following tables summarize impaired loans at June 30, 2011 and December 31, 2010 and the periods ended June 30, 2011 and the year ended December 31, 2010 (dollars in thousands):

	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance		Total Impaired Loans
	Recorded Investment		Related Allowance		Recorded Investment		Recorded Investment		Unpaid Principal Balance
June 30, 2011
Residential mortgage	$	30,986	$	5,988	$	21,101	$	52,087	$	52,087
Home equity		1,713		936		281		1,994		1,994
Lines of credit		642		222		2,597		3,239		3,239
Commercial real estate		5,139		1,459		16,434		21,573		21,573
Acquisition and development		21,218		3,494		9,108		30,326		30,326
Land		5,161		2,276		4,531		9,692		9,692
Commercial non-real estate		148		131		305		453		453
Consumer		778		745		59		837		837
Total impaired loans	$	65,785	$	15,251	$	54,416	$	120,201	$	120,201

	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance		Total Impaired Loans
	Recorded Investment		Related Allowance		Recorded Investment		Recorded Investment		Unpaid Principal Balance
December 31, 2010
Residential mortgage	$	38,251	$	8,149	$	20,938	$	59,189	$	59,189
Home equity		568		434		407		975		975
Lines of credit		836		264		3,728		4,564		4,564
Commercial real estate		3,975		766		19,708		23,683		23,683
Acquisition and development		17,273		2,645		4,664		21,937		21,937
Land		6,567		2,282		3,629		10,196		10,196
Commercial non-real estate		-		-		305		305		305
Consumer		-		-		61		61		61
Total impaired loans	$	67,470	$	14,540	$	53,440	$	120,910	$	120,910

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

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Note 10 - Loans Receivable - Continued

	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance				Total Impaired Loans
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Six month - June 30, 2011
Residential mortgage	$	31,561	$	523	$	21,310	$	468	$	52,871	$	991
Home equity		1,713		26		281		4		1,994		30
Lines of credit		804		19		2,597		28		3,401		47
Commercial real estate		5,154		113		16,504		492		21,658		605
Acquisition and development		21,006		448		9,343		148		30,349		596
Land		5,168		121		4,531		59		9,699		180
Commercial non-real estate		148		-		305		17		453		17
Consumer		778		-		59		-		837		-
Total impaired loans	$	66,332	$	1,250	$	54,930	$	1,216	$	121,262	$	2,466


	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance				Total Impaired Loans
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Three month - June 30, 2011
Residential mortgage	$	31,535	$	220	$	21,103	$	209	$	52,638	$	429
Home equity		1,713		12		281		2		1,994		14
Lines of credit		805		14		2,597		6		3,402		20
Commercial real estate		5,146		42		16,462		227		21,608		269
Acquisition and development		20,937		220		9,292		35		30,229		255
Land		5,163		60		4,531		12		9,694		72
Commercial non-real estate		148		-		305		10		453		10
Consumer		778		-		59		-		837		-
Total impaired loans	$	66,225	$	568	$	54,630	$	501	$	120,855	$	1,069

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED

Note 10 - Loans Receivable - Continued

	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance				Total Impaired Loans
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized

December 31, 2010
Residential mortgage	$	39,382	$	1,508	$	21,611	$	1,057	$	60,993	$	2,565
Home equity		568		21		407		17		975		38
Lines of credit		985		167		3,294		115		4,279		282
Commercial real estate		4,034		248		19,838		1,420		23,872		1,668
Acquisition and development		19,327		1,212		5,307		303		24,634		1,515
Land		6,572		288