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, 2018 and 2017: ໿

໿



(Dollars in thousands)	Commercial and Industrial			Construction		Commercial Real Estate			Residential Real Estate			Consumer and Other			Unallocated			Total
Three Months Ended:
June 30, 2018
Beginning balance	$	389		$	345	$	5,801		$	972		$	31		$	290		$	7,828
Charge-offs	—			—		—			(10		)	(31		)	—			(41		)
Recoveries	1			—		5			62			11			—			79
Provision	50			57		(317		)	114			16			478			398
Ending balance	$	440		$	402	$	5,489		$	1,138		$	27		$	768		$	8,264

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

Six Months Ended:
June 30, 2018
Beginning balance	$	208		336		$	5,185		$	1,032		$	26		$	548		$	7,335
Charge-offs	(11		)	—		—			(22		)	(42		)	—			(75		)
Recoveries	2			—		6			72			18			—			98
Provision	241			66		298			56			25			220			906
Ending balance	$	440		$	402	$	5,489		$	1,138		$	27		$	768		$	8,264

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

The following table presents the balance of the allowance of loan losses and loans receivable by class at June 30, 2018 and December 31, 2017 disaggregated on the basis of our impairment methodology.

໿



	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, 2018
Commercial and industrial	$	440	$	78	$	362	$	62,418	$	189	$	62,229
Construction	402		—		402		62,135		—		62,135
Commercial real estate	5,489		27		5,462		687,810		13,736		674,074
Residential real estate	1,138		—		1,138		322,983		3,936		319,047
Consumer and other loans	27		—		27		2,205		—		2,205
Unallocated	768		—		—		—		—		—
Total	$	8,264	$	105	$	7,391	$	1,137,551	$	17,861	$	1,119,690



December 31, 2017
Commercial and industrial	$	208	$	—	$	208	$	54,759	$	20	$	54,739
Construction	336		—		336		42,484		—		42,484
Commercial real estate	5,185		28		5,157		551,445		4,763		546,682
Residential real estate	1,032		10		1,022		171,844		2,064		169,780
Consumer and other loans	26		—		26		1,130		—		1,130
Unallocated	548		—		—		—		—		—
Total	$	7,335	$	38	$	6,749	$	821,662	$	6,847	$	814,815

An age analysis of loans receivable, which were past due as of June 30, 2018 and December 31, 2017, is as follows:

໿



(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, 2018
Commercial and industrial	$	—	$	104	$	189	$	293	$	62,125	$	62,418	$	—
Construction	—		—		—		—		62,135		62,135		—
Commercial real estate	1,387		487		13,891		15,765		672,045		687,810		—
Residential real estate	683		53		4,521		5,257		317,726		322,983		—
Consumer and other	154		—		—		154		2,051		2,205		—
Total	$	2,224	$	644	$	18,601	$	21,469	$	1,116,082	$	1,137,551	$	—



December 31, 2017
Commercial and industrial	$	—	$	—	$	20	$	20	$	54,739	$	54,759	$	—
Construction	—		—		105		105		42,379		42,484		—
Commercial real estate	4,935		126		4,314		9,374		542,071		551,445		—
Residential real estate	1,304		122		1,581		3,007		168,837		171,844		—
Consumer and other	8		1		—		9		1,121		1,130		—
Total	$	6,247	$	249	$	6,020	$	12,515	$	809,147	$	821,662	$	—

(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, excluding PCI loans, at June 30, 2018 and December 31, 2017 were:

໿



(Dollars in thousands)	June 30, 2018		December 31, 2017
Commercial and industrial	$	189	$	20
Construction	—		105
Commercial real estate	13,891		4,314
Residential real estate	4,521		1,581
Total	$	18,601	$	6,020

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, 2018 and December 31, 2017: ໿

໿



(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total
June 30, 2018
Commercial and industrial	$	61,894	$	—	$	524	$	—	$	62,418
Construction	61,998		137		—		—		62,135
Commercial real estate	668,858		4,157		14,795		—		687,810
Residential real estate	315,862		349		6,772		—		322,983
Consumer and other	2,205		—		—		—		2,205
	$	1,110,817	$	4,643	$	22,091	$	—	$	1,137,551



December 31, 2017
Commercial and industrial	$	54,405	$	189	$	165	$	—	$	54,759
Construction	42,379		105		—		—		42,484
Commercial real estate	537,636		3,508		10,301		—		551,445
Residential real estate	169,395		228		2,221		—		171,844
Consumer and other	1,130		—		—		—		1,130
	$	804,945	$	4,030	$	12,687	$	—	$	821,662

The following table reflects information about our impaired loans, excluding PCI loans, by class as of June 30, 2018 and December 31, 2017:



	June 30, 2018						December 31, 2017
(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	$	—	$	10	$	—	$	20	$	20	$	—
Commercial real estate	12,808		12,808		—		3,834		4,158		—
Residential real estate	3,936		3,936		—		1,844		1,877		—



With an allowance recorded:
Commercial and industrial	189	189	78	—	—	—
Commercial real estate	928	928	27	929	1,392	28
Residential real estate	—	—	—	220	223	10



Total:
Commercial and industrial	189		199		78		20		20		—
Commercial real estate	13,736		13,736		27		4,763		5,550		28
Residential real estate	3,936		3,936		—		2,064		2,100		10
	$	17,861	$	17,871	$	105	$	6,847	$	7,670	$	38

໿

The following table presents the average recorded investment and income recognized for our impaired loans, excluding PCI loans, for the three and six months ended June 30, 2018 and 2017:



	For the Three Months Ended June 30, 2018				For the Three Months Ended June 30, 2017
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	—	$	—	$	20	$	—
Construction	53		—		—		—
Commercial real estate	8,358		71		3,237		8
Residential real estate	3,499		19		1,742		8
Total impaired loans without a related allowance	11,910		90		4,999		16

With an allowance recorded:
Commercial and industrial	94		—		—		—
Commercial real estate	929		—		1,168		—
Residential real estate	—		—		134		—
Total impaired loans with an allowance	1,023		—		1,302		—
Total impaired loans	$	12,933	$	90	$	6,301	$	16



	For the Six Months Ended June 30, 2018				For the Six Months Ended June 30, 2017
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	12	$	—	$	20	$	—
Construction	21		—		—		—
Commercial real estate	5,638		83		2,560		8
Residential real estate	2,520		30		1,544		9
Total impaired loans without a related allowance	8,191		113		4,124		17

With an allowance recorded:
Commercial and industrial	38		—		3		—
Commercial real estate	1,071		—		1,879		8
Residential real estate	64		—		200		—
Total impaired loans with an allowance	1,173		—		2,082		8
Total impaired loans	$	9,364	$	113	$	6,206	$	25

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, 2018
Performing	$	643	$	1,141	$	1,784
Non-performing	2,497		1,009		3,506
Total	$	3,140	$	2,150	$	5,290



December 31, 2017
Performing	$	449	$	483	$	932
Non-performing	1,594		242		1,836
Total	$	2,043	$	725	$	2,768

Troubled debt restructured loans are considered impaired and are included in the previous impaired loans disclosures in this footnote. As of June 30, 2018, we have not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructuring.

There was one troubled debt restructuring in the amount of $514 thousand that occurred during the three and six months ended June 30, 2018. There were three troubled debt restructuring in the amount of $637 thousand that occurred during the three and six months ended June 30, 2017. The increase in troubled debt restructured loans was due to loans acquired in the Community acquisition.



(Dollars in thousands)	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
June 30, 2018
Residential real estate	1	$	514	$	306

June 30, 2017
Residential real estate	3	$	637	$	615

There was 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, 2018. There was 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.

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, 2018, we had five foreclosed residential real estate properties with a carrying value of $1.2 million. As of December 31, 2017, we had one foreclosed residential real estate property with a carrying value of $179 thousand. In addition, as of June 30, 2018 and December 31, 2017, respectively, we had consumer loans with a carrying value of $1.4 million and $180 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process. The increases in amounts at June 30, 2018, compared to December 31, 2017, were due to loans acquired in the Community acquisition.