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LOANS AND ALLOWANCE FOR LOAN LOSSES
 6 Months Ended
Jun. 30, 2013
Loans And Allowance For Loan Losses  
LOANS AND ALLOWANCE FOR LOAN LOSSES
6. LOANS AND ALLOWANCE FOR LOAN LOSSES

 

The activity in the Allowance for Loan Losses (“ALLL”) for the three and six months of ended June 30, 2013 and 2012 and related asset balances at June 30, 2013 and December 31, 2012 is summarized as follows:

 

 

    For the Three Months Ended June 30, 2013  
                Faith-                                
                Based     Residential                          
          Commercial     Non-     Real           Other              
(Dollars in thousands)   Commercial     Real Estate     Profit     Estate     Consumer     Loans     Unallocated     Total  
ALLL:                                                                
                                                                 
Beginning of quarter balance   $ 76     $ 1,192     $ 1,278     $ 851     $ 27     $ 48     $ 29     $ 3,501  
Charge-offs     —       (237 )     —       (33 )     —       (5 )     —       (275 )
Recoveries     —       2       —       4       (4 )     6       —       8  
Provision for loan losses     165       (151 )     —       9       (1 )     (6 )     (16 )     —  
Balance at June 30, 2013   $ 241     $ 806     $ 1,278     $ 831     $ 22     $ 43     $ 13     $ 3,234  

 

    For the Three Months Ended June 30, 2012  
                Faith-                                
                Based     Residential                          
          Commercial     Non-     Real           Other              
(Dollars in thousands)   Commercial     Real Estate     Profit     Estate     Consumer     Loans     Unallocated     Total  
ALLL:                                                                
                                                                 
Beginning of quarter balance   $ 64     $ 1,052     $ 1,107     $ 1,309     $ 46     $ 52     $ 67     $ 3,697  
Charge-offs     —       —       —       (137 )     (7 )     —       —       (144 )
Recoveries     —       —       —       80       2       —       —       82  
Provision for loan losses     (3 )     135       (16 )     (9 )     5       (1 )     (67 )     44  
Balance at June 30, 2012   $ 61     $ 1,187     $ 1,091     $ 1,243     $ 46     $ 51     $ —     $ 3,679  

 

    For the Six Months Ended June 30, 2013  
                Faith-                                
                Based     Residential                          
          Commercial     Non-     Real           Other              
(Dollars in thousands)   Commercial     Real Estate     Profit     Estate     Consumer     Loans     Unallocated     Total  
ALLL:                                                                
                                                                 
Beginning of year balance   $ 90     $ 881     $ 1,246     $ 937     $ 30     $ 54     $ 261     $ 3,499  
Charge-offs     —       (237 )     —       (33 )     (2 )     (10 )     —       (282 )
Recoveries     —       2       —       8       1       6       —       17  
Provision for loan losses     151       160       32       (81 )     (7 )     (7 )     (248 )     —  
Balance at June 30, 2013   $ 241     $ 806     $ 1,278     $ 831     $ 22     $ 43     $ 13     $ 3,234  

 

    For the Six Months Ended June 30, 2012  
                Faith-                                
                Based     Residential                          
          Commercial     Non-     Real           Other              
(Dollars in thousands)   Commercial     Real Estate     Profit     Estate     Consumer     Loans     Unallocated     Total  
ALLL:                                                
                                                                 
Beginning of year balance   $ 348     $ 971     $ 1,128     $ 1,299     $ 62     $ 42     $ —     $ 3,850  
Charge-offs     —       (57 )     —       (236 )     (17 )     —       —       (310 )
Recoveries     —       —       1       88       6       —       —       95  
Provision for loan losses     (287 )     273       (38 )     92       (5 )     9       —       44  
Balance at June 30, 2012   $ 61     $ 1,187     $ 1,091     $ 1,243     $ 46     $ 51     $ —     $ 3,679  

 

    June 30, 2013  
                Faith                                
                Based                                
          Commercial     Non-     Residential           Other              
(Dollars in thousands)   Commercial     Real Estate     Profit     Real Estate     Consumer     Loans     Unallocated     Total  
ALLL:                                                                
  Ending ALLL balance attributable to loans:                                                
Individually evaluated for impairment   $ —     $ —     $ 115     $ 321     $ —     $ —     $ —     $ 436  
Collectively evaluated for impairment     241       806       1,163       510       22       43       13       2,798  
Total ending ALLL balance   $ 241     $ 806     $ 1,278     $ 831     $ 22     $ 43     $ 13     $ 3,234  
                                                                 
Loans:                                                                
Loans individually evaluated for impairment   $ —     $ 5,775     $ 15,918     $ 4,247     $ 13     $ —     $ —     $ 25,953  
Loans collectively evaluated for imapirment     8,191       39,127       69,602       27,394       1,146       2,424       —       147,884  
Total ending loans balance   $ 8,191     $ 44,902     $ 85,520     $ 31,641     $ 1,159     $ 2,424     $ —     $ 173,837  

 

    December 31, 2012  
                Faith                                
                Based                                
          Commercial     Non-     Residential           Other              
(Dollars in thousands)   Commercial     Real Estate     Profit     Real Estate     Consumer     Loans     Unallocated     Total  
ALLL:                                                
  Ending ALLL balance attributable to loans:                                                
Individually evaluated for impairment   $ —     $ 87     $ 44     $ 349     $ —     $ —     $ —     $ 480  
Collectively evaluated for impairment     90       794       1,202       588       30       54       261       3,019  
Total ending ALLL balance   $ 90     $ 881     $ 1,246     $ 937     $ 30     $ 54     $ 261     $ 3,499  
                                                                 
Loans:                                                                
Loans individually evaluated for impairment   $ —     $ 4,837     $ 14,907     $ 2,443     $ 16     $ —     $ —     $ 22,203  
Loans collectively evaluated for impairment     3,282       43,332       70,990       31,331       1,330       2,754       —       153,019  
Total ending loans balance   $ 3,282     $ 48,169     $ 85,897     $ 33,774     $ 1,346     $ 2,754     $ —     $ 175,222  

 

The Bank experienced $267 thousand and $62 thousand in net charge-offs for the three months ended June 30, 2013 and 2012, respectively. Annualized net charge-offs/(recoveries) as a percent of average loan balances outstanding totaled .61% and .14% during the three month periods ended June 30, 2013 and 2012, respectively. The Bank experienced $265 thousand in net charge-offs for the six months ended June 30, 2013 compared to $215 thousand in net loan charge-offs for the six months ended June 30, 2012. Annualized net charge-offs/(recoveries) as a percent of average loan balances outstanding totaled .30% and .24% during the six month periods ended June 30, 2013 and 2012, respectively, and 0.27% for the year ended December 31, 2012.

 

Loans— Loans are stated at the amount of unpaid principal, net of deferred loan origination fees and costs. Nonrefundable loan fees, net of direct costs, associated with the origination or acquisition of loans are deferred and recognized as an adjustment of the loan yield over the life of the respective loan using the effective interest method. Loans (net) are reduced by the ALLL. Interest on loans is accrued on the daily balances of unpaid principal outstanding. Interest income is accrued and credited to income only if deemed collectible. Other loan fees and charges, representing service charges for the prepayment of loans, for delinquent payments, or for miscellaneous loan services, are recorded in income when collected.

 

A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its ALLL. The composition of the loan portfolio, net of deferred fees and costs, by loan classification as of June 30, 2013 and December 31, 2012 was as follows:

 

(Dollars in thousands)   June 30, 2013     December 31, 2012  
Commercial   $ 8,191     $ 3,282  
Commercial real estate:                
Construction     3,208       3,621  
Owner occupied     18,736       18,377  
Other     22,958       26,171  
Faith-based non-profit                
Construction     —       2,344  
Owner Occupied     79,001       76,418  
Other     6,519       7,135  
Residential real estate:                
First mortgage     24,647       24,702  
Multifamily     3,826       5,828  
Home equity     3,168       3,161  
Construction     —       83  
Consumer     1,159       1,346  
Other loans     2,424       2,754  
Loans, net of deferred fees     173,837       175,222  
ALLL     (3,234 )     (3,499 )
Loans, net of ALLL   $ 170,603     $ 171,723  

 

The Bank has a concentration of loans to faith-based non-profit organizations, in which the Bank has specialized lending experience. As of June 30, 2013, the percentage of loans in this niche, which included construction, real estate secured, and lines of credit, comprised approximately 49.20% of the total loan portfolio and the reserve for these loans was 39.52% of the total allowance. Historically the Bank has experienced low levels of loan losses in this niche; however, repayment of these loans is generally dependent on voluntary contributions which some have been adversely affected by the recent recession.

 

Non-Performing Loans and Leases - Generally, all classes of loans and leases are placed on non-accrual status upon becoming contractually past due 90 days or more as to principal or interest (unless loans are adequately secured by collateral, are in the process of collection, and are reasonably expected to result in repayment), or where substantial doubt about full repayment of principal or interest is evident.

 

When a loan is placed on non-accrual status, regardless of class, the accrued and unpaid interest receivable is reversed and the loan is accounted for on the cash or cost recovery method until qualifying for return to accrual status. All payments received on non-accrual loans and leases are applied against the principal balance of the loan or lease. Loans may be returned to accrual status when all principal and interest amounts contractually due (including any arrearages) are reasonably assured of repayment within a reasonable period, the borrower has demonstrated payment performance for a minimum of six months in accordance with the original or revised contractual terms of the loan, and when doubt about repayment is resolved.

Generally, for all classes of loans and leases, a charge-off is recorded when it is probable that a loss has been incurred and when it is possible to determine a reasonable estimate of the loss. For all classes of commercial loans and leases, a charge-off is determined on a subjective basis after due consideration of the debtor's prospects for repayment and the fair value of collateral. For closed-end consumer loans, the entire outstanding balance of the loan is charged-off during the month that the loan becomes 120 days past due as to principal or interest. Consumer loans with non-real estate collateral are written down to the value of the collateral, less estimated costs to sell, if repossession of collateral is assured and in process. For residential mortgage and home equity loan classes, a partial charge-off is recorded at 120 days past due as to principal or interest for the amount that the loan balance exceeds the fair value of the collateral less estimated costs to sell.

 

Impaired Loans - A loan is considered impaired when, based on current information and events, it is probable that the Company will not be able to collect all amounts due from the borrower in accordance with the original contractual terms of the loan, including scheduled interest payments. Impaired loans include all classes of commercial non-accruing loans and Troubled Debt Restructurings ("TDRs"). Impaired loans exclude smaller balance homogeneous loans (consumer and small business non-accruing loans) not in the process of foreclosure that are collectively evaluated for impairment.

 

For all classes of commercial loans, a quarterly evaluation of specific individual commercial borrowers with identified weaknesses is performed to identify impaired loans. The identification of specific borrowers for review is based on a review of non-accrual loans as well as those loans specifically identified by management as exhibiting above average levels of risk.

 

When a loan has been identified as being impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral-dependent. If the measurement of the impaired loan is less than the recorded investment in the loan (net of deferred loan fees or costs and unamortized premiums or discounts), impairment is recognized by creating or adjusting an existing allocation of the ALLL, or by recording a partial charge-off of the loan to its estimated fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income may be accrued or recognized on a cash basis.

 

Income Recognition on Impaired and Non-accrual Loans - Loans, including impaired loans, are generally classified as non-accrual if they are past due as to maturity, or payment of principal or interest for a period of more than 90 days, unless such loans are well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged off, the loan is generally classified as non-accrual. Loans that are on a current payment status or past due less than 90 days may also be classified as non-accrual if full repayment of principal and/or interest is in doubt.

 

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within a reasonable period of time, and the borrower has demonstrated payment performance for a minimum of six months in accordance with the contractual terms involving payments of cash or cash equivalents. During the non-accrual period, all payments received will be applied to principal. After a loan is returned to accruing status, foregone interest will be accreted to interest income on a pro-rata basis over the remaining term of the loan if full repayment of principal and interest is reasonably assured.

 

In the case where a non-accrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the remaining loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the ALLL until prior charged off balances have been fully recovered.

 

The following tables show past due loans at June 30, 2013 and December 31, 2012:

 

June 30, 2013               90 Days                    
    30-59 Days     60-89 Days     Or More     Total Past              
(Dollars in thousands)   Past Due     Past Due     Past Due     Due     Current     Total  
                                     
Commercial   $ 5     $ —     $ —     $ 5     $ 8,186     $ 8,191  
Commercial real estate:                                                
Construction     —       —       —       —       3,208       3,208  
Owner occupied     29       57       3,699       3,785       14,951       18,736  
Other     —       494       86       580       22,378       22,958  
Faith-based non-profit                                                
Construction     —       —       —       —       —       —  
Owner Occupied     —       488       —       488       78,513       79,001  
Other     —       —       —       —       6,519       6,519  
Residential real estate:                                                
First mortgage     339       192       2,003       2,534       22,113       24,647  
Multifamily     —       —       —       —       3,826       3,826  
Home equity     127       —       19       146       3,022       3,168  
Construction     —       —       —       —       —       —  
Consumer     2       —       —       2       1,157       1,159  
Other loans     —       —       —       —       2,424       2,424  
Total   $ 502     $ 1,231     $ 5,807     $ 7,540     $ 166,297     $ 173,837  

 

December 31, 2012               90 Days                    
    30-59 Days     60-89 Days     Or More     Total Past              
(Dollars in thousands)   Past Due     Past Due     Past Due     Due     Current     Total  
                                     
Commercial   $ —     $ 353     $ —     $ 353     $ 2,929     $ 3,282  
Commercial real estate:                                                
Construction     —       —       —       —       3,621       3,621  
Owner occupied     —       —       263       263       18,114       18,377  
Other     1,570       856       400       2,826       23,345       26,171  
Faith-based non-profit                                                
Construction     —       —       —       —       2,344       2,344  
Owner Occupied     1,845       —       661       2,506       73,912       76,418  
Other     —       —       —       —       7,135       7,135  
Residential real estate:                                                
First mortgage     787       548       2,812       4,147       20,555       24,702  
Multifamily     —       —       —       —       5,828       5,828  
Home equity     122       120       108       350       2,811       3,161  
Construction     —       —       —       —       83       83  
Consumer     8       9       —       17       1,329       1,346  
Other loans     —       —       —       —       2,754       2,754  
Total   $ 4,332     $ 1,886     $ 4,244     $ 10,462     $ 164,760     $ 175,222  

 

At June 30, 2013 and December 31, 2012, the total recorded investment in impaired loans amounted to $26.0 million and $24.1 million, respectively. Of these impaired loans, $2.9 million and $5.5 million were on non-accrual at June 30, 2013 and December 31, 2012, respectively.

The recorded investment and related information for impaired loans is summarized as follows for June 30, 2013, June 30, 2012 and December 31, 2012:

 

    June 30, 2013  
    At end of period     For Six Months Ended     For Three Months Ended  
    Unpaid                 Interest     Average     Interest     Average  
    Principal     Recorded     ALLL     Income     Recorded     Income     Recorded  
(Dollars in thousands)   Balance     Investment     Allocated     Recognized     Investment     Recognized     Investment  
                                           
With no related allowance recorded:                                                        
Commercial   $ —     $ —     $ —     $ —     $ 221     $ —     $ 147  
Commercial real estate:                                                        
Construction     361       365       —       12       278       5       276  
Owner occupied     795       559       —       17       525       9       468  
Other     4,856       4,873       —       113       4,385       54       4,028  
Faith based non-profit:                                                        
Construction     —       —       —       —       —       —       —  
Owner occupied     15,036       15,061       —       299       10,391       157       10,589  
Other     —       —       —       —       —       —       —  
Residential real estate:                                                        
First mortgage     2,770       2,739       —       10       1,441       3       1,625  
Multifamily     —       —       —       —       —       —       —  
Home equity     9       9       —       —       60       —       28  
Construction     —       —       —       —       —       —       —  
Consumer     13       13       —       —       5       —       8  
Impaired loans with no allowance recorded   $ 23,840     $ 23,619     $ —     $ 451     $ 17,306     $ 228     $ 17,169  
                                                         
With an allowance recorded:                                                        
Commercial   $ —     $ —     $ —     $ —     $ —     $ —     $ —  
Commercial real estate:                                                        
Construction     —       —       —       —       —       —       —  
Owner occupied     —       —       —       —       59       —       59  
Other     —       —       —       —       501       —       501  
Faith based non-profit:                                                        
Construction     —       —       —       —       —       —       —  
Owner occupied     882       885       115       34       324       27       435  
Other     —       —       —       —       —       —       —  
Residential real estate:                                                        
First mortgage     1,408       1,412       294       —       836       —       1,013  
Multifamily     —       —       —       —       —       —       —  
Home equity     91       92       27       —       12       —       23  
Construction     —       —       —       —       —       —       —  
Consumer     —       —       —       —       —       —       —  
Impaired loans with allowance recorded   $ 2,381     $ 2,389     $ 436     $ 34     $ 1,732     $ 27     $ 2,031  
Impaired loans   $ 26,221     $ 26,008     $ 436     $ 485     $ 19,038     $ 255     $ 19,200  

 

 

    June 30, 2012  
    At end of period     For Six Months Ended     For Three Months Ended  
    Unpaid                 Interest     Average     Interest     Average  
    Principal     Recorded     ALLL     Income     Recorded     Income     Recorded  
(Dollars in thousands)   Balance     Investment     Allocated     Recognized     Investment     Recognized     Investment  
                                           
With no related allowance recorded:                                                        
Commercial   $ 1,567     $ 590     $ —     $ —     $ 590     $ —     $ 590  
Commercial real estate:                                                        
Construction     374       374       —       17       540       7       496  
Owner occupied     724       724       —       20       890       12       726  
Other     5,699       5,699       —       85       4,894       55       5,407  
Faith based non-profit:                                                        
Construction     —       —       —       —       —       —       —  
Owner occupied     13,222       13,216       —       263       12,137       150       11,752  
Other     —       —       —       —       —       —       —  
Residential real estate:                                                        
First mortgage     789       779       —       17       767       8       690  
Multifamily     —       —       —       —       —       —       —  
Home equity     —       —       —       —       —       —       —  
Construction     —       —       —       —       —       —       —  
Consumer     —       —       —       —       —       —       —  
Impaired loans with no allowance recorded   $ 22,375     $ 21,382     $ —     $ 402     $ 19,818     $ 232     $ 19,661  
                                                         
With an allowance recorded:                                                        
Commercial   $ —     $ —     $ —     $ —     $ —     $ —     $ —  
Commercial real estate:                                                        
Construction     —       —       —       10       378       5       —  
Owner occupied     285       285       121       37       469       28       59  
Other     2,027       2,026       229       —       228       —       501  
Faith based non-profit:                                                        
Construction     —       —       —       —       —       —       —  
Owner occupied     433       433       37       17       907       10       435  
Other     —       —       —       —       —       —       —  
Residential real estate:                                                        
First mortgage     672       673       238       3       415       1       1,013  
Multifamily     —       —       —       —       —       —       —  
Home equity     267       267       205       —       231       —       23  
Construction     —       —       —       —       —       —       —  
Consumer     —       —       —       —       1       —       —  
Impaired loans with allowance recorded   $ 3,684     $ 3,684     $ 830     $ 67     $ 2,629     $ 44     $ 2,031  
Impaired loans   $ 26,059     $ 25,066     $ 830     $ 469     $ 22,447     $ 276     $ 21,692  

 

    December 31, 2012  
    At end of period     For Period Ended  
    Unpaid                 Interest     Average  
    Principal     Recorded     ALLL     Income     Recorded  
(Dollars in thousands)   Balance     Investment     Allocated     Recognized     Investment  
                               
With no related allowance recorded:                                        
Commercial   $ —     $ —     $ —     $ —     $ 295  
Commercial real estate:                                        
Construction     371       371       —       31       300  
Owner occupied     530       530       —       38       635  
Other     4,312       3,698       —       129       4,473  
Faith based non-profit:                                        
Construction     —       —       —       —       —  
Owner occupied     14,479       14,479       —       567       12,261  
Other     —       —       —       —       1,611  
Residential real estate:                                        
First mortgage     814       814       —       19       2,671  
Multifamily     —       —       —       —       —  
Home equity     86       86       —       3       111  
Construction     —       —       —       —       —  
Consumer     16       16       —       —       4  
Impaired loans with no allowance recorded   $ 20,608     $ 19,994     $ —     $ 787     $ 22,361  
                                         
With an allowance recorded:                                        
Commercial   $ —     $ —     $ —     $ —     $ —  
Commercial real estate:                                        
Construction     —       —       —       —       —  
Owner occupied     238       238       87       15       60  
Other     —       —       —       —       500  
Faith based non-profit:                                        
Construction     —       —       —       —       214  
Owner occupied     428       428       44       30       —  
Other     —       —       —       —       —  
Residential real estate:                                        
First mortgage     1,543       1,543       349       45       757  
Multifamily     —       —       —       —       —  
Home equity     —       —       —       —       —  
Construction     —       —       —       —       —  
Consumer     —       —       —       —       —  
Impaired loans with allowance recorded   $ 2,209     $ 2,209     $ 480     $ 90     $ 1,531  
Impaired loans   $ 22,817     $ 22,203     $ 480     $ 877     $ 23,892  

 

Impaired loans not included in the above December 31, 2012 table are recorded investments of $1.9 million in homogeneous first mortgage residential real estate loans, which are collectively measured for impairment. Total impaired loans were $24.1 million as of December 31, 2012.

 

The recorded investment in TDRs, which are included in total impaired loans, was $20.9 million, $24.2 million and $20.2 million at June 30, 2013, June 30, 2012 and December 31, 2012, respectively.

 

Reserve for Credit Losses - The Company's reserve for credit losses is comprised of two components, the ALLL and the reserve for unfunded commitments (the “Unfunded Reserve”).

 

Allowances for Loan Losses - The ALLL is a valuation allowance that is established through a provision for loan losses charged to expense. When management believes that the collectability of the principal is unlikely, loans are charged against the ALLL. Subsequent recoveries, if any, are credited to the ALLL.

 

The ALLL is management's estimate of probable losses that are inherent in the loan portfolio. The ALLL is based on regular quarterly assessments. The methodologies for measuring the appropriate level of the ALLL include the combination of a quantitative historical loss history by loan type and a qualitative analysis for loans not classified as impaired or TDRs ("ASC 450 reserve"), and a specific allowance method for impaired and TDR loans ("ASC 310 reserve"). The qualitative analysis for the ASC 450 reserve is patterned after the guidelines provided under Securities Exchange Commission (“SEC”) Staff Accounting Bulletin 102 and the Federal Financial Institutions Examination Council (“FFIEC”) Interagency Policy Statement on the Allowance for Loan and Lease Losses and include the following:

  · Changes in lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices;
  · Changes in national economic and business conditions and developments and the effect of unemployment on African Americans, who are the majority of our customers;
  · Changes in the nature and volume of the loan portfolio;
  · Changes in the experience, ability, and depth of lending management and staff;
  · Changes in trends of the volume and severity of past due and classified loans; and changes in trends in the volume of non-accrual loans, troubled debt restructurings and classified loans;
  · Changes in the quality of the loan review system and the degree of oversight by the Bank’s Board of Directors;
  · The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
  · The effect of external factors such as competition and legal and regulatory requirements.

 

Management has developed, from historical loan and economic information, quantitative drivers for certain qualitative factors. Management has identified which factors, by nature, are subjective, such as lending policies, competition and regulatory requirements. The quantitative drivers of qualitative factors, to which different weights are assigned based on management’s judgment, are reviewed and updated quarterly based on updated quarterly and eight-quarter rolling data. The quantitative loss history is based on an eight-quarter rolling history of losses incurred by different loan types within the loan portfolio.

 

A specific ALLL is established for loans identified as impaired or TDRs, based on significant conditions or circumstances related to the specific credits. The specific allowance amounts are determined by a method prescribed by ASC 310, Receivables. Loans identified as impaired and non-accruing TDRs are accounted for in accordance with one of three valuations: (i) the present value of future cash flows discounted at the loan's effective interest rate; (ii) the loan's observable market price, or (iii) the fair value of the collateral, if the loan is collateral dependent, less estimated liquidation costs such as realtor fees, delinquent property taxes, and other miscellaneous recording fees and taxes. Generally, appraisals are considered current if performed within the past 12 months. At June 30, 2013, there were 87 loans evaluated based upon collateral dependency compared to 55 loans at December 31, 2012.

 

For commercial business, faith-based non-profit, real estate and certain consumer loans, the measurement of loan impairment is based on the present value of the expected future cash flows, discounted at the loan's effective interest rate, or on the fair value of the loan's collateral if the loan is collateral dependent. Most consumer loans are smaller balance and homogeneous, and are evaluated for impairment on a collective basis, applying the quantitative loss history and the qualitative factors. Impairment losses are included in the ALLL through a charge to the provision for loan losses.

 

The Company uses several credit quality indicators to manage credit risk on an ongoing basis. The Company's credit risk rating system was developed to aid in the risk management process by grouping credits with similar risk profiles into pass (which includes internal watch), special mention, or criticized categories, which includes substandard, doubtful, and loss. Credit risk ratings are applied individually to all classes of loans. Internal credit reviews and external contracted credit review examinations are used to determine and validate loan risk grades. The credit review system takes into consideration factors such as: borrower's background and experience; historical and current financial condition; credit history and payment performance; economic conditions and their impact on various industries; type, market value and volatility of the market value of collateral; lien position; and the financial strength of guarantors.

 

The process of assessing the adequacy of the ALLL is necessarily subjective. Further, and particularly in periods of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management's current estimates of incurred losses inherent within the loan portfolio. As such, there can be no assurance that future loan charge-offs will not exceed management's current estimate of what constitutes a reasonable ALLL.

 

The Company and the Bank are subject to periodic examination by their federal and state regulators, and may be required by such regulators to recognize additions to the allowance for loan losses based on the regulators' assessment of credit information available to them at the time of their examinations.

 

Reserve for Unfunded Commitments - The Unfunded Reserve is a component of other liabilities and represents the estimate for probable credit losses inherent in unfunded commitments to extend credit. Unfunded commitments to extend credit include loans with usable balances available, new commitments to lend that are not yet funded, and standby and commercial letters of credit. The process used to determine the Unfunded Reserve is consistent with the process for determining the quantitative portion of the ASC 450 reserve, as adjusted for estimated funding probabilities and historical eight quarter rolling quantitative loan loss factors. The level of the Unfunded Reserve is adjusted by recording an expense or recovery in other noninterest expense. The balances of $15.2 thousand and $54.4 thousand for June 30, 2013 and December 31, 2012, respectively, are reflected in other liabilities on the Consolidated Balance Sheets.

 

The following table presents the recorded investment in non-accrual loans and loans past due over 90 days still on accrual by class of loans as of June 30, 2013 and December 31, 2012, respectively:

 

                90 Days        
                or More        
                Past Due        
June 30, 3013               Still        
(Dollars in thousands)   Non-accrual     Number     Accruing     Number  
                         
Commercial   $ —       —     $ —       —  
Commercial real estate:                                
Construction     —       —       —       —  
Owner occupied     69       3       3,631       4  
Other     47       1       39       1  
Faith-based non-profit                                
Construction     —       —       —       —  
Owner Occupied     3,918       3       —       —  
Other     —       —       —       —  
Residential real estate:                                
First mortgage     3,281       42       1,684       11  
Multifamily     —       —       —       —  
Home equity     15       4       19       1  
Construction     —       —       —       —  
Consumer     13       5       —       —  
Other loans     —       —       —       —  
Total   $ 7,343       58     $ 5,373       17  

 

                90 Days        
                or More        
                Past Due        
December 31, 2012               Still        
(Dollars in thousands)   Non-accrual     Number     Accruing     Number  
                         
Commercial   $ —       —     $ —       —  
Commercial real estate:                                
Construction     —       —       —       —  
Owner occupied     39       1       224       4  
Other     49       1       351       1  
Faith-based non-profit                                
Construction     —       —       —       —  
Owner Occupied     5,241       4       661       3  
Other     —       —       —       —  
Residential real estate:                                
First mortgage     3,384       44       357       6  
Multifamily     —       —       —       —  
Home equity     3       1       101       1  
Construction     —       —       —       —  
Consumer     16       2       —       —  
Other loans     —       —       —       —  
Total   $ 8,732       53     $ 1,694       15  

 

Non-accrual loans and loans past due over 90 days still accruing interest include both smaller balance homogenous loans that are collectively evaluated for impairment and individually classified impaired loans. Loans for which principal or interest is in default for 90 days or more are classified as a non-accrual unless they are well secured and in process of collection.

 

Those loans over 90 days still accruing interest were in the process of modification. In these cases, the borrowers are still making payments. Borrowers have continued to make payments on these loans while administrative and legal due processes are proceeding which will enable the Bank to extend or modify maturity dates.

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans for reserves according to the loan's classification as to credit risk. This analysis includes non-homogenous loans, such as commercial, commercial real estate and faith-based non–profit entities, and mortgage loans in process of foreclosure for which the loan to value does not support repayment in full. This analysis is performed on at least a quarterly basis. The Company uses the following definitions for risk ratings:

 

  · Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Management believes that there is a moderate likelihood of some loss related to those loans and leases that are considered special mention.

 

  · Substandard. Loans classified as substandard are inadequately protected by the current sound financial repayment capacity and debt service coverage of the obligor or of the collateral pledge, if any. Loans so classified have a well-defined weakness or weaknesses that may jeopardize the liquidation of our repayment according to the original terms of the debt. In addition to commercial and faith-based non-profit loans with identified weaknesses, substandard loans include loans within the mortgage and consumer portfolio segments that are past due 90 days or more as to principal or interest if the loan to value does not support full repayment. Substandard loans are evaluated for impairment on an individual loan basis unless the substandard loan is a smaller homogeneous loan that is not a TDR and is not in the process of foreclosure. These loans exhibit a distinct possibility that the Company will sustain some loss if the deficiencies related to the loss are not corrected in a timely manner.

 

  · Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

  · Loss. Based on current facts and circumstances, loans classified as loss are not expected to be repaid, or that collateral will be difficult to liquidate. Loans classified as loss are charged off to the ALLL with board approval.

 

  · Pass. Loans not identified as special mention, substandard, doubtful or loss are classified as pass.

 

The following is a breakdown of loans by risk categories at June 30, 2013 and December 31, 2012:

 

June 30, 2013                              
(Dollars in thousands)   Pass     Special Mention     Substandard     Doubful     Total  
                               
Commercial   $ 8,184     $ —     $ 7     $ —     $ 8,191  
Commercial real estate:                                        
Construction     2,662       —       546       —       3,208  
Owner occupied     13,923       647       4,166       —       18,736  
Other     18,420       962       3,576       —       22,958  
Faith-based non-profit                                        
Construction     —       —       —       —       —  
Owner Occupied     62,000       5,529       11,472       —       79,001  
Other     6,519       —       —       —       6,519  
Residential real estate:                                        
First mortgage     20,082       694       3,871       —       24,647  
Multifamily     3,724       39       63       —       3,826  
Home equity     2,895       —       273       —       3,168  
Construction     —       —       —       —       —  
Consumer     1,142       —       17       —       1,159  
Other loans     2,424       —       —       —       2,424  
Total   $ 141,975     $ 7,871     $ 23,991     $ —     $ 173,837  

 

December 31, 2012                              
(Dollars in thousands)   Pass     Special Mention     Substandard     Doubful     Total  
                               
Commercial   $ 3,274     $ —     $ 8     $ —     $ 3,282  
Commercial real estate:                                        
Construction     3,065       —       556       —       3,621  
Owner occupied     13,379       3,151       1,847       —       18,377  
Other     21,582       966       3,623       —       26,171  
Faith-based non-profit                                        
Construction     2,344       —       —       —       2,344  
Owner Occupied     58,732       5,313       12,373       —       76,418  
Other     7,059       76       —       —       7,135  
Residential real estate:                                        
First mortgage     19,465       1,731       3,506       —       24,702  
Multifamily     5,702       63       63       —       5,828  
Home equity     2,853       —       308       —       3,161  
Construction     83       —       —       —       83  
Consumer     1,323       2       21       —       1,346  
Other loans     2,754       —       —       —       2,754  
Total   $ 141,615     $ 11,302     $ 22,305     $ —     $ 175,222  

 

Loans Modified as a TDR - Loans are considered to have been modified as a TDR when the Company makes certain concessions to a borrower experiencing financial difficulty. Concessions to the borrower at modification may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. Since the economic crisis began in 2008, management has elected to offer concessions to borrowers with identified financial weaknesses, even if the borrowers have continued making scheduled payments, working with the borrowers to enable them to continue meeting their obligations to repay the debt to the Company.

 

The following tables present TDRs as of June 30, 2013 and December 31, 2012.

 

    Troubled Debt Restructurings  
    June 30, 2013  
                Non-accrual     Total  
    Accrual Status     Stauts     Modifications  
(Dollars in thousands)   Number     Amount     Number     Amount     Number     Amount  
                                     
Commercial real estate:                                                
Construction     2     $ 361       —     $ —       2     $ 361  
Owner occupied     3       489       —       —       3       489  
Other     5       4,809       —       —       5       4,809  
Faith-based non-profit:                                                
Owner occpied     18       12,000       2       2,639       20       14,639  
Residential real estate:                                                
First mortgage     2       282       4       259       6       541  
      30     $ 17,941       6     $ 2,898       36     $ 20,839  

 

    Troubled Debt Restructurings  
    December 31, 2012  
                Non-accrual     Total  
    Accrual Status     Stauts     Modifications  
(Dollars in thousands)   Number     Amount     Number     Amount     Number     Amount  
                                     
Commercial real estate:                                                
Construction     2     $ 371       —     $ —       2     $ 371  
Owner occupied     4       730       —       —       4       730  
Other     5       3,648       —       —       5       3,648  
Faith-based non-profit:                                                
Owner occpied     17       9,666       4       5,241       21       14,907  
Residential real estate:                                                
First mortgage     2       285       4       309       6       594  
      30     $ 14,700       8     $ 5,550       38     $ 20,250  

 

No loans were restructured during the three or six months ended June 30, 2013 or during the three months ended June 30, 2012. During the six months ended June 30, 2012, there were two loans restructured totaling $1.4 million.

 

The following table shows loans newly restructured during the six months ended June 30, 2012.

 

    For the Six Months Ended  
    June 30, 2012  
          Pre-modification Outstanding     Post-Modification Oustanding  
(Dollars in thousands)   Number of loans     Recorded Investment     Recorded Investment  
                   
Extended payment terms                        
Commercial real estate:                        
Owner occupied     1     $ 82     $ 82  
Other     1       1,354       1,359  
      2     $ 1,436     $ 1,441  

 

There were no loans modified as TDRs and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the three and six months ended June 30, 2013 and 2012.

 

TDR defaults can result in a higher ALLL and a corresponding higher provision for loan losses because they generally negatively impact the timing of and expected collections from these impaired loans. Impaired loans, which include TDRs, are evaluated for specific additions to the ALLL by subtracting the recorded investment in these impaired loans from their fair values. Fair values is generally determined by the present value of future cash flows, collateral value, or liquidation value. Defaults generally reduce the present value of the future cash flows and can negatively influence the collateral values if the declining real estate values are affecting the sale of collateral.