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 nine months ended September 30, 2018 and 2017: ໿

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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:
September 30, 2018
Beginning balance	$	440		$	402		$	5,489		$	1,138		$	27		$	768		$	8,264
Charge-offs	—			—			—			—			(8		)	—			(8		)
Recoveries	—			—			5			11			1			—			17
Provision	127			70			342			6			4			(228		)	321
Ending balance	$	567		$	472		$	5,836		$	1,155		$	24		$	540		$	8,594

September 30, 2017
Beginning balance	$	201		$	478		$	4,243		$	917		$	20		$	1,306		$	7,165
Charge-offs	—			—			—			—			(7		)	—			(7		)
Recoveries	1			—			1			1			1			—			4
Provision	(31		)	(17		)	1,105			87			30			(834		)	340
Ending balance	$	171		$	461		$	5,349		$	1,005		$	44		$	472		$	7,502

Nine Months Ended:
September 30, 2018
Beginning balance	$	208		336			$	5,185		$	1,032		$	26		$	548		$	7,335
Charge-offs	(11		)	—			—			(22		)	(50		)	—			(83		)
Recoveries	2			—			11			83			19			—			115
Provision	368			136			640			62			29			(8		)	1,227
Ending balance	$	567		$	472		$	5,836		$	1,155		$	24		$	540		$	8,594

September 30, 2017
Beginning balance	$	110		359			$	3,932		$	899		$	19		$	1,377		$	6,696
Charge-offs	(13		)	—			(266		)	(42		)	(20		)	—			(341		)
Recoveries	1			—			5			10			4			—			20
Provision	73			102			1,678			138			41			(905		)	1,127
Ending balance	$	171		$	461		$	5,349		$	1,005		$	44		$	472		$	7,502

The following table presents the balance of the allowance of loan losses and loans receivable by class at September 30, 2018 and December 31, 2017 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 (a)		Collectively Evaluated for Impairment
September 30, 2018
Commercial and industrial	$	567	$	180	$	387	$	64,791	$	291	$	64,500
Construction	472		—		472		68,185		—		68,185
Commercial real estate	5,836		39		5,797		714,526		14,616		699,910
Residential real estate	1,155		2		1,153		323,194		3,879		319,315
Consumer and other loans	24		—		24		2,082		—		2,082
Unallocated	540		—		—		—		—		—
Total	$	8,594	$	221	$	7,833	$	1,172,778	$	18,786	$	1,153,992



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

(a) loans individually evaluated for impairment exclude PCI loans.

An age analysis of loans receivable, which were past due as of September 30, 2018 and December 31, 2017, 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
September 30, 2018
Commercial and industrial	$	—	$	—	$	291	$	291	$	64,500	$	64,791	$	—
Construction	—		—		—		—		68,185		68,185		—
Commercial real estate	2,693		193		15,199		18,085		696,441		714,526		—
Residential real estate	392		35		4,268		4,695		318,499		323,194		—
Consumer and other	6		20		—		26		2,056		2,082		—
Total	$	3,091	$	248	$	19,758	$	23,097	$	1,149,681	$	1,172,778	$	—



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, excluding PCI loans.

Loans for which the accrual of interest has been discontinued, excluding PCI loans, at September 30, 2018 and December 31, 2017 were:

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(Dollars in thousands)	September 30, 2018		December 31, 2017
Commercial and industrial	$	291	$	20
Construction	—		105
Commercial real estate	15,199		4,314
Residential real estate	4,268		1,581
Total	$	19,758	$	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 September 30, 2018 and December 31, 2017: ໿

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(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total
September 30, 2018
Commercial and industrial	$	64,159	$	—	$	632	$	—	$	64,791
Construction	68,185		—		—		—		68,185
Commercial real estate	692,848		3,025		18,653		—		714,526
Residential real estate	315,939		532		6,723		—		323,194
Consumer and other	2,082		—		—		—		2,082
	$	1,143,213	$	3,557	$	26,008	$	—	$	1,172,778



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 September 30, 2018 and December 31, 2017:



	September 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	14,577		14,578		—		3,834		4,158		—
Residential real estate	3,780		3,780		—		1,844		1,877		—



With an allowance recorded:
Commercial and industrial	291	491	180	—	—	—
Commercial real estate	39	39	39	929	1,392	28
Residential real estate	99	99	2	220	223	10



Total:
Commercial and industrial	291		501		180		20		20		—
Commercial real estate	14,616		14,617		39		4,763		5,550		28
Residential real estate	3,879		3,879		2		2,064		2,100		10
	$	18,786	$	18,997	$	221	$	6,847	$	7,670	$	38

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



	For the Three Months Ended September 30, 2018				For the Three Months Ended September 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	$	—
Commercial real estate	13,693		9		3,819		8
Residential real estate	3,858		9		1,880		5
Total impaired loans without a related allowance	17,551		18		5,719		13

With an allowance recorded:
Commercial and industrial	240		—		—		—
Commercial real estate	483		—		1,285		—
Residential real estate	50		—		51		—
Total impaired loans with an allowance	773		—		1,336		—
Total impaired loans	$	18,324	$	18	$	7,055	$	13



	For the Nine Months Ended September 30, 2018				For the Nine Months Ended September 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	$	8	$	—	$	20	$	—
Construction	21		—		—		—
Commercial real estate	7,716		92		2,848		21
Residential real estate	2,869		39		1,639		14
Total impaired loans without a related allowance	10,614		131		4,507		35

With an allowance recorded:
Commercial and industrial	96		—		3		—
Commercial real estate	1,014		—		1,832		8
Residential real estate	84		—		191		—
Total impaired loans with an allowance	1,194		—		2,026		8
Total impaired loans	$	11,808	$	131	$	6,533	$	43

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
September 30, 2018
Performing	$	431	$	476	$	907
Non-performing	1,545		528		2,073
Total	$	1,976	$	1,004	$	2,980



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 September 30, 2018, we have not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructuring.

There were no troubled debt restructuring during the three months ended September 30, 2018 and 2017. There was one troubled debt restructuring in the amount of $514 thousand that occurred during the nine months ended September 30, 2018. There were three troubled debt restructuring in the amount of $637 thousand that occurred during the nine months ended September 30, 2017.



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

September 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 September 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 September 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 September 30, 2018, we had four foreclosed residential real estate properties with a carrying value of $1.1 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 September 30, 2018 and December 31, 2017, respectively, we had consumer loans with a carrying value of $698 thousand and $180 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process. The increases in amounts at September 30, 2018, compared to December 31, 2017, were due to loans acquired in the Community acquisition.