Allowance for Loan Losses

Allowance for probable loan losses methodology

On a quarterly basis, management prepares an estimate of the allowance necessary to cover estimated probable credit losses. The Company uses a systematic methodology to measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology makes use of specific reserves for loans individually evaluated and deemed impaired, and general reserves for larger pools of homogeneous loans, which are collectively evaluated relying on a combination of qualitative and quantitative factors that may affect credit quality of the pool.

There have been no material changes to the Company's underwriting practices, credit risk management system, or to the allowance assessment methodology used to estimate loan loss exposure as reported in Note 4, "Allowance for Loan Losses," to the Company's audited consolidated financial statements contained in the Company's 2019 Annual Report on Form 10-K.

As previously noted above, the Company has elected to defer the adoption of CECL, as allowed under the CARES Act, until the earlier of: (1) the date on which the national emergency concerning the COVID-19 pandemic declared under the National Emergencies Act terminates; or (2) December 31, 2020. The information that follows is presented under the incurred loss model.

The balances of loans as of March 31, 2020 by portfolio classification and evaluation method are summarized as follows:



(Dollars in thousands)	Loans individually evaluated for impairment		Loans collectively evaluated for impairment		Gross Loans
Commercial real estate	$	14,166	$	1,427,984	$	1,442,150
Commercial and industrial	6,901		530,889		537,790
Commercial construction	5,304		340,379		345,683
Residential mortgages	1,206		252,982		254,188
Home equity	394		96,829		97,223
Consumer	38		10,156		10,194
Total gross loans	$	28,009	$	2,659,219	$	2,687,228

The balances of loans as of December 31, 2019 by portfolio classification and evaluation method are summarized as follows:



(Dollars in thousands)	Loans individually evaluated for impairment		Loans collectively evaluated for impairment		Gross Loans
Commercial real estate	$	17,515	$	1,376,664	$	1,394,179
Commercial and industrial	9,332		491,895		501,227
Commercial construction	3,347		314,130		317,477
Residential mortgages	1,229		246,144		247,373
Home equity	411		97,841		98,252
Consumer	44		10,010		10,054
Total gross loans	$	31,878	$	2,536,684	$	2,568,562

Credit quality indicators

Early detection of credit issues is critical to minimize credit losses. Accordingly, management regularly monitors internal credit quality indicators such as, among others, the risk classification of adversely classified loans, past due and non-accrual loans, impaired and restructured loans, and the level of foreclosure activity. These credit quality indicators are discussed below.

Adversely classified loans

The Company's loan risk rating system classifies loans depending on risk of loss characteristics. The classifications range from "substantially risk free" for the highest quality loans and loans that are secured by cash collateral, through a satisfactory range of "minimal," "moderate," "better than average," and "average" risk, to the regulatory problem-asset classifications of "criticized," for loans that may need additional monitoring, and the more severe adverse classifications of "substandard," "doubtful," and "loss" based on criteria established under banking regulations. Loans which are evaluated to be of weaker credit quality are placed on the "watch credit list" and reviewed on a more frequent basis by management.

Adversely classified loans may be accruing or in non-accrual status and may be additionally designated as impaired or restructured, or some combination thereof.

The following tables present the Company's credit risk profile for each portfolio classification by internally assigned adverse risk rating category as of the periods indicated:



	March 31, 2020
	Adversely Classified						Not Adversely
(Dollars in thousands)	Substandard		Doubtful		Loss		Classified		Gross Loans
Commercial real estate	$	13,273	$	—	$	—	$	1,428,877	$	1,442,150
Commercial and industrial	8,550		2,352		—		526,888		537,790
Commercial construction	5,809		—		—		339,874		345,683
Residential mortgages	1,799		—		—		252,389		254,188
Home equity	565		—		—		96,658		97,223
Consumer	65		1		—		10,128		10,194
Total gross loans	$	30,061	$	2,353	$	—	$	2,654,814	$	2,687,228



	December 31, 2019
	Adversely Classified						Not Adversely
(Dollars in thousands)	Substandard		Doubtful		Loss		Classified		Gross Loans
Commercial real estate	$	16,664	$	—	$	—	$	1,377,515	$	1,394,179
Commercial and industrial	10,900		2,370		—		487,957		501,227
Commercial construction	4,836		—		—		312,641		317,477
Residential mortgages	1,825		—		—		245,548		247,373
Home equity	455		—		—		97,797		98,252
Consumer	69		3		—		9,982		10,054
Total gross loans	$	34,749	$	2,373	$	—	$	2,531,440	$	2,568,562

Total adversely classified loans amounted to 1.21% of total loans at March 31, 2020, compared to 1.45% at December 31, 2019.

Past due and non-accrual loans

The following tables present an age analysis of past due loans by portfolio classification as of the dates indicated:



	Balance at March 31, 2020
(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Past Due 90 days or more		Total Past Due Loans		Current Loans		Gross Loans		Non-accrual Loans
Commercial real estate	$	8,687	$	265	$	3,886	$	12,838	$	1,429,312	$	1,442,150	$	8,605
Commercial and industrial	1,042		722		579		2,343		535,447		537,790		2,942
Commercial construction	2,591		720		2,831		6,142		339,541		345,683		2,831
Residential mortgages	1,346		—		301		1,647		252,541		254,188		394
Home equity	270		—		167		437		96,786		97,223		1,014
Consumer	34		7		—		41		10,153		10,194		15
Total gross loans	$	13,970	$	1,714	$	7,764	$	23,448	$	2,663,780	$	2,687,228	$	15,801



	Balance at December 31, 2019
(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Past Due 90 days or more		Total Past Due Loans		Current Loans		Gross Loans		Non-accrual Loans
Commercial real estate	$	1,469	$	3,914	$	4,158	$	9,541	$	1,384,638	$	1,394,179	$	8,280
Commercial and industrial	576		1,034		265		1,875		499,352		501,227		3,285
Commercial construction	576		3,325		1,735		5,636		311,841		317,477		1,735
Residential mortgages	700		283		623		1,606		245,767		247,373		411
Home equity	645		—		169		814		97,438		98,252		1,040
Consumer	12		—		6		18		10,036		10,054		20
Total gross loans	$	3,978	$	8,556	$	6,956	$	19,490	$	2,549,072	$	2,568,562	$	14,771

At March 31, 2020 and December 31, 2019, all loans past due 90 days or more were carried as non-accrual, in addition to those loans that were less than 90 days past due where reasonable doubt existed as to the full and timely collection of interest or principal that have also been designated as non-accrual, despite their payment due status shown in the tables above.

Non-accrual loans that were not adversely classified amounted to $59 thousand at March 31, 2020 and $84 thousand at December 31, 2019. These balances primarily represented the guaranteed portions of non-performing SBA loans. The majority of the non-accrual loan balances were also carried as impaired loans during the periods noted and are discussed further below.

The ratio of non-accrual loans to total loans amounted to 0.59% at March 31, 2020 and 0.58% and at December 31, 2019.

At March 31, 2020, additional funding commitments for non-accrual loans were not material.

Impaired loans

Impaired loans are individually significant loans for which management considers it probable that not all amounts due (principal and interest) will be collected in accordance with the original contractual terms. Impaired loans include loans that have been modified in a troubled debt restructuring ("TDR"), see "Troubled Debt Restructurings" below. Impaired loans are individually evaluated and exclude large groups of smaller-balance homogeneous loans, such as residential mortgage loans and consumer loans, which are collectively evaluated for impairment, and loans that are measured at fair value, unless the loan is amended in a TDR.

The carrying value of impaired loans amounted to $28.0 million and $31.9 million at March 31, 2020 and December 31, 2019, respectively. Total accruing impaired loans amounted to $12.2 million and $17.1 million at March 31, 2020 and December 31, 2019, respectively, while non-accrual impaired loans amounted to $15.8 million and $14.8 million as of March 31, 2020 and December 31, 2019, respectively.

The following tables set forth the recorded investment in impaired loans and the related specific allowance allocated by portfolio classification as of the dates indicated:



	Balance at March 31, 2020
(Dollars in thousands)	Unpaid contractual principal balance		Total recorded investment in impaired loans		Recorded investment with no allowance		Recorded investment with allowance		Related specific allowance
Commercial real estate	$	15,257	$	14,166	$	13,783	$	383	$	29
Commercial and industrial	9,015		6,901		5,264		1,637		908
Commercial construction	5,330		5,304		2,796		2,508		1,473
Residential mortgages	1,317		1,206		1,206		—		—
Home equity	575		394		394		—		—
Consumer	39		38		—		38		38
Total	$	31,533	$	28,009	$	23,443	$	4,566	$	2,448



	Balance at December 31, 2019
(Dollars in thousands)	Unpaid contractual principal balance		Total recorded investment in impaired loans		Recorded investment with no allowance		Recorded investment with allowance		Related specific allowance
Commercial real estate	$	18,537	$	17,515	$	17,129	$	386	$	31
Commercial and industrial	11,455		9,332		7,405		1,927		974
Commercial construction	3,359		3,347		3,347		—		—
Residential mortgages	1,331		1,229		1,229		—		—
Home equity	607		411		411		—		—
Consumer	44		44		—		44		44
Total	$	35,333	$	31,878	$	29,521	$	2,357	$	1,049

The following table presents the average recorded investment in impaired loans by portfolio classification and the related interest recognized during the three months indicated:



	Three months ended March 31, 2020				Three months ended March 31, 2019
(Dollars in thousands)	Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized
Commercial real estate	$	15,273	$	72	$	15,803	$	120
Commercial and industrial	7,808		28		11,919		115
Commercial construction	4,755		—		1,734		25
Residential mortgages	1,220		2		890		1
Home equity	402		—		507		—
Consumer	41		—		19		—
Total	$	29,499	$	102	$	30,872	$	261

At March 31, 2020, additional funding commitments for impaired loans were not material.

Troubled debt restructurings

Loans are designated as a TDR when, as part of an agreement to modify the original contractual terms of the loan as a result of financial difficulties of the borrower, the Bank grants the borrower a concession on the terms that would not otherwise be considered. Typically, such concessions may consist of one or a combination of the following: a reduction in interest rate to a below market rate, taking into account the credit quality of the note; extension of additional credit based on receipt of adequate collateral; or a deferment or reduction of payments (principal or interest) which materially alters the Bank's position or significantly extends the note's maturity date, such that the present value of cash flows to be received is materially less than those contractually established at the loan's origination. All loans that are modified are reviewed by the Company to identify if a TDR has occurred. TDR loans are included in the impaired loan category and, as such, these loans are individually reviewed and evaluated, and a specific reserve is assigned for the amount of the estimated probable credit loss.

Total TDR loans, included in the impaired loan balances above, as of March 31, 2020 and December 31, 2019, were $18.1 million and $21.1 million, respectively. TDR loans on accrual status amounted to $12.2 million and $17.1 million at March 31, 2020 and December 31, 2019, respectively. TDR loans included in non-performing loans amounted to $5.9 million at March 31, 2020 and $4.0 million at December 31, 2019. The Company continues to work with customers and enters into loan modifications (which may or may not be TDRs) to the extent deemed to be necessary or appropriate while attempting to achieve the best mutual outcome given the individual financial circumstances and future prospects of the borrower.

At March 31, 2020, additional funding commitments for TDR loans were not material.

The following table sets forth the post modification balances of TDRs listed by type of modification for TDRs that occurred during the periods indicated:



	Three months ended
	March 31, 2020			March 31, 2019
(Dollars in thousands)	Number of restructurings	Amount		Number of restructurings	Amount
Extended maturity date	2	$	1,697	—	$	—
Temporary payment reduction and payment re-amortization of remaining principal over extended term	2	978		6	607
Forbearance of post default rights	2	1,022		—	—
Other payment concessions	—	—		1	314
Total	6	$	3,697	7	$	921
Amount of specific reserves included in the allowance for loan losses associated with TDRs listed above		$	1,275		$	91

Loans modified as TDRs during the three months ended March 31, 2020 and March 31, 2019 are detailed below:



	Three months ended
	March 31, 2020					March 31, 2019
(Dollars in thousands)	Number of restructurings	Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment		Number of restructurings	Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Commercial real estate	—	$	—	$	—	1	$	421	$	415
Commercial and industrial	1	474		409		5	194		192
Commercial construction	4	3,440		3,287		—	—		—
Residential mortgages	—	—		—		1	315		314
Home equity	—	—		—		—	—		—
Consumer	1	1		1		—	—		—
Total	6	$	3,915	$	3,697	7	$	930	$	921

There were no subsequent charge-offs associated with the new TDRs noted in the table above during the three months ended March 31, 2020 or three months ended March 31, 2019.

Payment defaults, during the three months ended March 31, 2020 and March 31, 2019 on loans modified as TDRs within the preceding twelve months are detailed below:



	Three months ended
	March 31, 2020			March 31, 2019
(Dollars in thousands)	Number of TDRs that defaulted	Post- modification outstanding recorded investment		Number of TDRs that defaulted	Post- modification outstanding recorded investment
Commercial real estate	1	$	218	—	$	—
Commercial and industrial	1	151		2	174
Commercial construction	2	1,697		—	—
Residential mortgages	—	—		—	—
Home equity	—	—		—	—
Consumer	2	4		—	—
Total	6	$	2,070	2	$	174

See "Financial Condition" in Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations," under the headings "Credit Risk" and "Allowance for Loan Losses" in this Form 10-Q for additional information about changes in the Company's credit quality indicators since December 31, 2019.

Other real estate owned ("OREO")

Real estate acquired by the Company through foreclosure proceedings or the acceptance of a deed in lieu of foreclosure is classified as OREO. When property is acquired, it is recorded at estimated fair value of the property acquired, less estimated costs to sell, establishing a new cost basis and carried on the Consolidated Balance Sheet in the line item "Prepaid expenses and other assets." The estimated fair value is based on market appraisals and the Company's internal analysis. Any loan balance in excess of the estimated realizable fair value on the date of transfer is charged to the allowance for loan losses on that date. All costs incurred thereafter in maintaining the property, as well as subsequent declines in fair value are charged to non-interest expense.

The Company had no OREO at March 31, 2020, or December 31, 2019, and the OREO carry value at March 31, 2019 was $255 thousand. There were no OREO additions during the three months ended March 31, 2020 and one addition during the three months ended March 31, 2019. There were no sales, or subsequent write downs of OREO during the three months ended March 31, 2020 or 2019.

At both March 31, 2020 and December 31, 2019, the Company had no consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdictions.

Allowance for loan loss activity

The allowance for loan losses is an estimate of probable credit losses inherent in the loan portfolio as of the specified balance sheet dates. On a quarterly basis, management prepares an estimate of the allowance necessary to cover estimated probable credit losses. The Company maintains the allowance at a level that it deems adequate to absorb all reasonably anticipated probable losses from specifically known and other credit risks associated with the portfolio. The allowance for loan losses is established through a provision for loan losses, a direct charge to earnings. Loan losses are charged against the allowance when management believes that the collectability of the loan principal is unlikely. Recoveries on loans previously charged-off are credited to the allowance.

The allowance for loan losses amounted to $39.8 million at March 31, 2020, compared to $33.6 million at December 31, 2019, and $33.7 million at March 31, 2019. The allowance for loan losses to total loans ratio was 1.48% at March 31, 2020, 1.31% at December 31, 2019, and 1.41% at March 31, 2019. Based on management's judgment as to the existing credit risks inherent in the loan portfolio, as discussed above under the heading "Credit Quality Indicators," management believes that the Company's allowance for loan losses is adequate to absorb probable losses from specifically known and other probable credit risks associated with the portfolio as of March 31, 2020.

Changes in the allowance for loan losses by portfolio classification for the three months ended March 31, 2020 are presented below:



(Dollars in thousands)	Cmml Real Estate		Cmml and Industrial		Cmml Constr		Resid. Mortgage		Home Equity		Consumer		Total
Beginning Balance at December 31, 2019	$	18,338	$	9,129	$	4,149	$	1,195	$	536	$	267	$	33,614
Provision	2,523		1,104		2,012		403		97		8		6,147
Recoveries	—		107		—		—		3		10		120
Less: Charge offs	—		105		—		—		—		12		117
Ending Balance at March 31, 2020	$	20,861	$	10,235	$	6,161	$	1,598	$	636	$	273	$	39,764
Ending allowance balance:
Allocated to loans individually evaluated for impairment	$	29	$	908	$	1,473	$	—	$	—	$	38	$	2,448
Allocated to loans collectively evaluated for impairment	$	20,832	$	9,327	$	4,688	$	1,598	$	636	$	235	$	37,316

Changes in the allowance for loan losses by portfolio classification for the three months ended March 31, 2019 are presented below:



(Dollars in thousands)	Cmml Real Estate			Cmml and Industrial			Cmml Constr		Resid. Mortgage		Home Equity			Consumer		Total
Beginning Balance at December 31, 2018	$	18,014		$	10,493		$	3,307	$	1,160	$	629		$	246	$	33,849
Provision	(188		)	(406		)	145		24		(4		)	29		(400		)
Recoveries	—			316			—		—		2			5		323
Less: Charge offs	—			—			—		—		—			43		43
Ending Balance at March 31, 2019	$	17,826		$	10,403		$	3,452	$	1,184	$	627		$	237	$	33,729
Ending allowance balance:
Allocated to loans individually evaluated for impairment	$	6		$	2,112		$	—	$	12	$	—		$	14	$	2,144
Allocated to loans collectively evaluated for impairment	$	17,820		$	8,291		$	3,452	$	1,172	$	627		$	223	$	31,585