ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY OF FINANCING RECEIVABLES

The following table presents changes in the allowance for loan losses disaggregated by the class of loans receivable for the three and six months ended June 30, 2017 and 2016: ໿

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(Dollars in thousands)	Commercial and Industrial			Construction			Commercial Real Estate			Residential Real Estate			Consumer and Other			Unallocated			Total
Three Months Ended:
June 30, 2017
Beginning balance	$	92		$	425		$	4,025		$	925		$	17		$	1,313		$	6,797
Charge-offs	—			—			—			(8		)	(8		)	—			(16		)
Recoveries	—			—			2			1			1			—			4
Provision	109			53			216			(1		)	10			(7		)	380
Ending balance	$	201		$	478		$	4,243		$	917		$	20		$	1,306		$	7,165

June 30, 2016
Beginning balance	$	98		$	267		$	3,847		$	908		$	121		$	571		$	5,812
Charge-offs	(138		)	—			(65		)	(25		)	—			—			(228		)
Recoveries	9			—			3			6			1			—			19
Provision	230			(59		)	235			25			(105		)	59			385
Ending balance	$	199		$	208		$	4,020		$	914		$	17		$	630		$	5,988

Six Months Ended:
June 30, 2017
Beginning balance	$	110		359			$	3,932		$	899		$	19		$	1,377		$	6,696
Charge-offs	(13		)	—			(266		)	(42		)	(13		)	—			(334		)
Recoveries	—			—			4			9			3			—			16
Provision	104			119			573			51			11			(71		)	787
Ending balance	$	201		$	478		$	4,243		$	917		$	20		$	1,306		$	7,165

June 30, 2016
Beginning balance	$	85		220			$	3,646		$	784		$	87		$	768		$	5,590
Charge-offs	(138		)	—			(65		)	(34		)	(19		)	—			(256		)
Recoveries	16			—			34			6			2			—			58
Provision	236			(12		)	405			158			(53		)	(138		)	596
Ending balance	$	199		$	208		$	4,020		$	914		$	17		$	630		$	5,988

The following table presents the balance of the allowance of loan losses and loans receivable by class at June 30, 2017 and December 31, 2016 disaggregated on the basis of our impairment methodology.

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	Allowance for Loan Losses						Loans Receivable
(Dollars in thousands)	Balance		Balance Loans Individually Evaluated for Impairment		Balance Related to Loans Collectively Evaluated for Impairment		Balance		Individually Evaluated for Impairment		Collectively Evaluated for Impairment
June 30, 2017
Commercial and industrial	$	201	$	—	$	201	$	40,802	$	20	$	40,782
Construction	478		—		478		41,213		—		41,213
Commercial real estate	4,243		28		4,221		526,054		4,509		521,545
Residential real estate	917		—		917		164,181		2,038		162,143
Consumer and other loans	20		—		20		967		—		967
Unallocated	1,306		—		—		—		—		—
Total	$	7,165	$	28	$	5,837	$	773,217	$	6,567	$	766,650



December 31, 2016
Commercial and industrial	$	110	$	14	$	96	$	40,280	$	33	$	40,247
Construction	359		—		359		25,360		—		25,360
Commercial real estate	3,932		135		3,797		479,227		4,597		474,630
Residential real estate	899		6		893		150,237		1,967		148,270
Consumer and other loans	19		—		19		1,038		—		1,038
Unallocated	1,377		—		—		—		—		—
Total	$	6,696	$	155	$	5,164	$	696,142	$	6,597	$	689,545

An age analysis of loans receivable, which were past due as of June 30, 2017 and December 31, 2016, is as follows:

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(Dollars in thousands)	30-59 Days Past Due		60-89 days Past Due		Greater Than 90 Days (a)		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing
June 30, 2017
Commercial and industrial	$	—	$	—	$	1,020	$	1,020	$	39,782	$	40,802	$	1,000
Construction	—		—		—		—		41,213		41,213		—
Commercial real estate	355		—		5,282		5,637		520,417		526,054		1,229
Residential real estate	161		—		1,550		1,711		162,470		164,181		—
Consumer and other	5		—		—		5		962		967		—
Total	$	521	$	—	$	7,852	$	8,373	$	764,844	$	773,217	$	2,229



December 31, 2016
Commercial and industrial	$	—	$	—	$	137	$	137	$	40,143	$	40,280	$	104
Construction	—		—		309		309		25,051		25,360		309
Commercial real estate	84		719		4,103		4,906		474,321		479,227		55
Residential real estate	786		247		1,752		2,785		147,452		150,237		—
Consumer and other	4		—		—		4		1,034		1,038		—
Total	$	874	$	966	$	6,301	$	8,141	$	688,001	$	696,142	$	468

(a) includes loans greater than 90 days past due and still accruing and non-accrual loans.

Loans for which the accrual of interest has been discontinued at June 30, 2017 and December 31, 2016 were:

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(Dollars in thousands)	June 30, 2017		December 31, 2016
Commercial and industrial	$	20	$	33
Commercial real estate	4,053		4,048
Residential real estate	1,550		1,752
Total	$	5,623	$	5,833

In determining the adequacy of the allowance for loan losses, we estimate losses based on the identification of specific problem loans through our credit review process and also estimate losses inherent in other loans on an aggregate basis by loan type. The credit review process includes the independent evaluation of the loan officer assigned risk ratings by the Chief Credit Officer and a third party loan review company. Such risk ratings are assigned loss component factors that reflect our loss estimate for each group of loans. It is management’s and the Board of Directors’ responsibility to oversee the lending process to ensure that all credit risks are properly identified, monitored, and controlled, and that loan pricing, terms and other safeguards against non-performance and default are commensurate with the level of risk undertaken and is rated as such based on a risk-rating system. Factors considered in assigning risk ratings and loss component factors include: borrower specific information related to expected future cash flows and operating results, collateral values, financial condition and payment status; levels of and trends in portfolio charge-offs and recoveries; levels in portfolio delinquencies; effects of changes in loan concentrations and observed trends in the economy and other qualitative measurements.

Our risk-rating system is consistent with the classification system used by regulatory agencies and with industry practices. Loan classifications of Substandard, Doubtful or Loss are consistent with the regulatory definitions of classified assets. The classification system is as follows:


•	Pass: This category represents loans performing to contractual terms and conditions and the primary source of repayment is adequate to meet the obligation. We have five categories within the Pass classification depending on strength of repayment sources, collateral values and financial condition of the borrower.


•	Special Mention: This category represents loans performing to contractual terms and conditions; however the primary source of repayment or the borrower is exhibiting some deterioration or weaknesses in financial condition that could potentially threaten the borrowers’ future ability to repay our loan principal and interest or fees due.

•

Substandard: This category represents loans that the primary source of repayment has significantly deteriorated or weakened which has or could threaten the borrowers’ ability to make scheduled payments. The weaknesses require close supervision by management and there is a distinct possibility that we could sustain some loss if the deficiencies are not corrected. Such weaknesses could jeopardize the timely and ultimate collection of our loan principal and interest or fees due. Loss may not be expected or evident, however, loan repayment is inadequately supported by current financial information or pledged collateral.

•

Doubtful: Loans so classified have all the inherent weaknesses of a substandard loan with the added provision that collection or liquidation in full is highly questionable and not reasonably assured. The probability of at least partial loss is high, but extraneous factors might strengthen the asset to prevent loss. The validity of the extraneous factors must be continuously monitored. Once these factors are questionable the loan should be considered for full or partial charge-off.


•	Loss: Loans so classified are considered uncollectible, and of such little value that their continuance as active assets is not warranted. Such loans are fully charged off.

The following tables illustrate our corporate credit risk profile by creditworthiness category as of June 30, 2017 and December 31, 2016: ໿

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(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total
June 30, 2017
Commercial and industrial	$	40,684	$	98	$	20	$	—	$	40,802
Construction	41,213		—		—		—		41,213
Commercial real estate	510,655		6,461		8,938		—		526,054
Residential real estate	161,400		464		2,317		—		164,181
Consumer and other	967		—		—		—		967
	$	754,919	$	7,023	$	11,275	$	—	$	773,217



December 31, 2016
Commercial and industrial	$	40,247	$	—	$	33	$	—	$	40,280
Construction	25,360		—		—		—		25,360
Commercial real estate	463,889		7,461		7,877		—		479,227
Residential real estate	147,526		584		2,127		—		150,237
Consumer and other	1,038		—		—		—		1,038
	$	678,060	$	8,045	$	10,037	$	—	$	696,142

The following table reflects information about our impaired loans by class as of June 30, 2017 and December 31, 2016:



	June 30, 2017						December 31, 2016
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance

With no related allowance recorded:
Commercial and industrial	$	20	$	20	$	—	$	19	$	19	$	—
Commercial real estate	4,183		4,442		—		2,324		2,324		—
Residential real estate	2,038		2,076		—		1,604		1,629		—



With an allowance recorded:
Commercial and industrial	—	—	—	14	14	14
Commercial real estate	326	326	28	2,273	2,364	135
Residential real estate	—	—	—	363	363	6



Total:
Commercial and industrial	20		20		—		33		33		14
Commercial real estate	4,509		4,768		28		4,597		4,688		135
Residential real estate	2,038		2,076		—		1,967		1,992		6
	$	6,567	$	6,864	$	28	$	6,597	$	6,713	$	155

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The following tables presents the average recorded investment and income recognized for the three and six months ended June 30, 2017 and 2016:



	For the Three Months Ended June 30, 2017				For the Three Months Ended June 30, 2016
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	20	$	—	$	20	$	—
Commercial real estate	3,237		8		2,113		5
Residential real estate	1,742		8		1,123		2
Total impaired loans without a related allowance	4,999		16		3,256		7

With an allowance recorded:
Commercial real estate	1,168		—		2,701		8
Residential real estate	134		—		239		—
Total impaired loans with an allowance	1,302		—		2,940		8
Total impaired loans	$	6,301	$	16	$	6,196	$	15



	For the Six Months Ended June 30, 2017				For the Six Months Ended June 30, 2016
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	20	$	—	$	20	$	—
Commercial real estate	2,560		8		2,230		13
Residential real estate	1,544		9		1,035		3
Total impaired loans without a related allowance	4,124		17		3,285		16

With an allowance recorded:
Commercial and industrial	3		—		—		—
Commercial real estate	1,879		8		2,680		16
Residential real estate	200		—		577		—
Consumer and other	—		—		111		—
Total impaired loans with an allowance	2,082		8		3,368		16
Total impaired loans	$	6,206	$	25	$	6,653	$	32

We recognize interest income on performing impaired loans as payments are received. On non-performing impaired loans we do not recognize interest income as all payments are recorded as a reduction of principal on such loans.

Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, postponement or forgiveness of principal, forbearance or other actions intended to maximize collection. The concessions rarely result in the forgiveness of principal or accrued interest. In addition, we attempt to obtain additional collateral or guarantor support when modifying such loans. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.

The following table presents the recorded investment in troubled debt restructured loans, based on payment performance status:



(Dollars in thousands)	Commercial Real Estate		Residential Real Estate		Total
June 30, 2017
Performing	$	456	$	488	$	944
Non-performing	2,232		249		2,481
Total	$	2,688	$	737	$	3,425



December 31, 2016
Performing	$	550	$	129	$	679
Non-performing	2,258		—		2,258
Total	$	2,808	$	129	$	2,937

Troubled debt restructured loans are considered impaired and are included in the previous impaired loans disclosures in this footnote. As of June 30, 2017, we have not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructuring.

There were three troubled debt restructuring in the amount of $637 thousand that occurred during the three and six months ended June 30, 2017. There were no troubled debt restructuring that occurred during the three and six months ended June 30, 2016. The following table summarizes troubled debt restructuring that occurred during the three and six months ended June 30, 2017.

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	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
(Dollars in thousands)
Residential real estate	3	$	637	$	615

There were no troubled debt restructuring for which there was a payment default within twelve months following the date of the restructuring for the three months ended June 30, 2017 and 2016.

We may obtain physical possession of residential real estate collateralizing a consumer mortgage loan via foreclosure on an in-substance repossession. As of June 30, 2017 and December 31, 2016, we did not hold any foreclosed residential real estate properties. In addition, as of June 30, 2017 and December 31, 2016, respectively, we had consumer loans with a carrying value of $640 thousand and $666 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process.