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LOANS AND ALLOWANCE FOR LOAN LOSSES
 9 Months Ended
Sep. 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 nine months ended September 30, 2013 and 2012 and related asset balances at September 30, 2013 and December 31, 2012 is summarized as follows:

 

   For the Three Months Ended September 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  $241   $806   $1,278   $831   $22   $43   $13   $3,234 
Charge-offs   —    —    —    (40)   (1)   (4)   —    (45)
Recoveries   —    25    —    4    6    3    —    38 
Provision for loan losses   203    52    (170)   (57)   (8)   3    (13)   10 
Balance at September 30, 2013  $444   $883   $1,108   $738   $19   $45   $—   $3,237 

 

   For the Three Months Ended September 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  $61   $1,187   $1,091   $1,243   $46   $51   $—   $3,679 
Charge-offs   —    —    —    (303)   —    (8)   —    (311)
Recoveries   —    —    —    4    4    —    —    8 
Provision for loan losses   (36)   (18)   (60)   230    2    4    —    122 
Balance at September 30, 2012  $25   $1,169   $1,031   $1,174   $52   $47   $—   $3,498 

 

   For the Nine Months Ended September 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)   —    (73)   (3)   (14)   —    (327)
Recoveries   —    27    —    12    7    9    —    55 
Provision for loan losses   354    212    (138)   (138)   (15)   (4)   (261)   10 
Balance at September 30, 2013  $444   $883   $1,108   $738   $19   $45   $—   $3,237 

 

   For the Nine Months Ended September 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   —    (56)   —    (539)   (1)   (26)   —    (622)
Recoveries   —    1         93    1    9    —    104 
Provision for loan losses   (323)   253    (97)   321    (10)   22    —    166 
Balance at September 30, 2012  $25   $1,169   $1,031   $1,174   $52   $47   $—   $3,498 

 

   September 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  $—   $—   $87   $265   $—   $—   $—   $352 
Collectively evaluated for impairment   444    883    1,021    473    19    45    —    2,885 
Total ending ALLL balance  $444   $883   $1,108   $738   $19   $45   $—   $3,237 
                                         
Loans:                                        
Loans individually evaluated for impairment  $—   $8,476   $17,052   $4,051   $12   $—   $—   $29,591 
Loans collectively evaluated for imapirment   12,658    46,381    68,875    26,024    1,200    2,427    —    157,565 
Total ending loans balance  $12,658   $54,857   $85,927   $30,075   $1,212   $2,427   $—   $187,156 

 

   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 $7 thousand and $303 thousand in net charge-offs for the three months ended September 30, 2013 and 2012, respectively. Annualized net charge-offs as a percent of average loan balances outstanding totaled .02% and .66% during the three month periods ended September 30, 2013 and 2012, respectively. The Bank experienced $272 thousand in net charge-offs for the nine months ended September 30, 2013 compared to $518 thousand in net loan charge-offs for the nine months ended September 30, 2012. Annualized net charge-offs as a percent of average loan balances outstanding totaled .20% and .38% during the nine month periods ended September 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 September 30, 2013 and December 31, 2012 was as follows:

 

(Dollars in thousands)  September 30, 2013   December 31, 2012 
Commercial  $12,658   $3,282 
Commercial real estate:          
Construction   4,359    3,621 
Owner occupied   21,649    18,377 
Other   28,849    26,171 
Faith-based non-profit          
Construction   —    2,344 
Owner Occupied   79,447    76,418 
Other   6,480    7,135 
Residential real estate:          
First mortgage   23,159    24,702 
Multifamily   3,776    5,828 
Home equity   3,140    3,161 
Construction   —    83 
Consumer   1,212    1,346 
Other loans   2,427    2,754 
Loans, net of deferred fees   187,156    175,222 
ALLL   (3,237)   (3,499)
Loans, net of ALLL  $183,919   $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 September 30, 2013, the percentage of loans in this niche, which included construction, real estate secured, and lines of credit, comprised approximately 45.91% of the total loan portfolio and the reserve for these loans was 34.23% 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 September 30, 2013 and December 31, 2012:

 

September 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  $4   $5   $2   $11   $12,647   $12,658 
Commercial real estate:                              
Construction   —    —    —    —    4,359    4,359 
Owner occupied   —    —    129    129    21,520    21,649 
Other   —    —    572    572    28,277    28,849 
Faith-based non-profit                              
Construction   —    —    —    —    —    — 
Owner Occupied   613    —    —    613    78,834    79,447 
Other   —    —    —    —    6,480    6,480 
Residential real estate:                              
First mortgage   75    —    1,148    1,223    21,936    23,159 
Multifamily   —    —    —    —    3,776    3,776 
Home equity   256    94    19    369    2,771    3,140 
Construction   —    —    —    —    —    — 
Consumer   13    —    —    13    1,199    1,212 
Other loans   —    —    —    —    2,427    2,427 
Total  $961   $99   $1,870   $2,930   $184,226   $187,156 

 

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 September 30, 2013 and December 31, 2012, the total recorded investment in impaired loans amounted to $29.7 million and $24.1 million, respectively.

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

 

   September 30, 2013 
   At end of period   For Nine 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  $—   $—   $—   $—   $98   $—   $— 
Commercial real estate:                                   
Construction   362    364    —    21    276    10    274 
Owner occupied   3,418    3,184    —    84    706    67    1,067 
Other   4,931    4,948    —    170    4,265    56    4,025 
Faith based non-profit:                                   
Construction   —    —    —    —    —    —    — 
Owner occupied   16,593    16,648    —    663    10,764    365    11,511 
Other   —    —    —    —    —    —    — 
Residential real estate:                                   
First mortgage   2,712    2,680    —    155    1,668    145    2,120 
Multifamily   —    —    —    —    —    —    — 
Home equity   8    8    —    —    50    —    30 
Construction   —    —    —    —    —    —    — 
Consumer   12    13    —    —    7    —    10 
Impaired loans with no allowance recorded  $28,036   $27,845   $—   $1,093   $17,834   $643   $19,037 
                                    
With an allowance recorded:                                   
Commercial  $—   $—   $—   $—   $—   $—   $— 
Commercial real estate:                                   
Construction   —    —    —    —    —    —    — 
Owner occupied   —    —    —    —    59    —    59 
Other   —    —    —    —    334    —    — 
Faith based non-profit:                                   
Construction   —    —    —    —    —    —    — 
Owner occupied   458    459    87    29    364    —    442 
Other   —    —    —    —    —    —    — 
Residential real estate:                                   
First mortgage   1,273    1,276    239    58    877    58    960 
Multifamily   —    —    —    —    —    —    — 
Home equity   91    91    26    4    23    4    46 
Construction   —    —    —    —    —    —    — 
Consumer   —    —    —    —    —    —    — 
Impaired loans with allowance recorded  $1,822   $1,826   $352   $91   $1,657   $62   $1,507 
Impaired loans  $29,858   $29,671   $352   $1,184   $19,491   $705   $20,544 

  

   September 30, 2012 
   At end of period   For Nine 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    —    24    499    7    374 
Owner occupied   551    551    —    28    805    6    638 
Other   4,962    5,964    —    143    5,162    58    5,832 
Faith based non-profit:                                   
Construction   —    —    —    —    —    —    — 
Owner occupied   13,133    13,126    —    331    12,384    69    13,171 
Other   —    —    —    —    —    —    — 
Residential real estate:                                   
First mortgage   889    889    —    18    797    4    834 
Multifamily   —    —    —    —    —    —    — 
Home equity   —    —    —    —    —    —    — 
Construction   —    —    —    —    —    —    — 
Consumer   —    —    —    —    —    —    — 
Impaired loans with no allowance recorded  $21,476   $21,494   $—   $544   $20,237   $144   $21,439 
                                    
With an allowance recorded:                                   
Commercial  $—   $—   $—   $—   $—   $—   $— 
Commercial real estate:                                   
Construction   —    —    —    —    283    —    189 
Owner occupied   239    239    102    12    468    3    241 
Other   2,005    2,005    211    91    625    6    1,211 
Faith based non-profit:                                   
Construction   —    —    —    —    —    —    — 
Owner occupied   430    430    52    22    788    5    667 
Other   —    —    —    —    —    —    — 
Residential real estate:                                   
First mortgage   1,298    1,298    342    44    731    12    666 
Multifamily   —    —    —    —    —    —    — 
Home equity   —    —    —    —    231    —    — 
Construction   —    —    —    —    —    —    — 
Consumer   —    —    —    —    1    —    — 
Impaired loans with allowance recorded  $3,972   $3,972   $707   $169   $3,127   $26   $2,974 
Impaired loans  $25,448   $25,466   $707   $713   $23,364   $170   $24,413 

 

   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 $24.5 million, $25.5 million and $20.2 million at September 30, 2013, September 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 September 30, 2013, there were 87 loans evaluated based upon collateral dependency, and one loan evaluated based upon present value of cash flows compared to 55 loans evaluated based upon collateral dependency and no loans evaluated based upon present value of cash flows 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 $39 thousand and $54 thousand at September 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 September 30, 2013 and December 31, 2012, respectively:

 

           90 Days     
           or More     
           Past Due     
September 30, 3013          Still     
(Dollars in thousands)  Non-accrual   Number   Accruing   Number 
                 
Commercial  $2    1   $—    — 
Commercial real estate:                    
Construction   —    —    —    — 
Owner occupied   78    2    52    1 
Other   45    1    526    3 
Faith-based non-profit                    
Construction   —    —    —    — 
Owner Occupied   1,285    2    —    — 
Other   —    —    —    — 
Residential real estate:                    
First mortgage   3,092    39    814    16 
Multifamily   —    —    —    — 
Home equity   14    3    19    1 
Construction   —    —    —    — 
Consumer   12    2    —    — 
Other loans   —    —    —    — 
Total  $4,528    50   $1,411    21 

 

           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 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 September 30, 2013 and December 31, 2012:

 

September 30, 2013                    
(Dollars in thousands)  Pass   Special Mention   Substandard   Doubtful   Total 
                     
Commercial  $9,802   $2,850   $6   $—   $12,658 
Commercial real estate:                         
Construction   3,812    —    547    —    4,359 
Owner occupied   17,023    608    4,018    —    21,649 
Other   24,326    961    3,562    —    28,849 
Faith-based non-profit                         
Construction   —    —    —    —    — 
Owner Occupied   65,252    8,255    5,940    —    79,447 
Other   6,478    2    —    —    6,480 
Residential real estate:                         
First mortgage   18,832    684    3,643    —    23,159 
Multifamily   3,675    39    62    —    3,776 
Home equity   2,820    —    320    —    3,140 
Construction   —    —    —    —    — 
Consumer   1,194    —    18    —    1,212 
Other loans   2,427    —    —    —    2,427 
Total  $155,641   $13,399   $18,116   $—   $187,156 

 

December 31, 2012                    
(Dollars in thousands)  Pass   Special Mention   Substandard   Doubtful   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 September 30, 2013 and December 31, 2012.

 

   Troubled Debt Restructurings 
   September 30, 2013 
           Non-accrual   Total 
   Accrual Status   Status   Modifications 
(Dollars in thousands)  Number   Amount   Number   Amount   Number   Amount 
                         
Commercial real estate:                              
Construction   2   $362    —   $—    2   $362 
Owner occupied   5    3,105    —    —    5    3,105 
Other   5    4,886    —    —    5    4,886 
Faith-based non-profit:                              
Owner occpied   20    15,767    1    30    21    15,797 
Residential real estate:                              
First mortgage   1    31    3    251    4    282 
    33   $24,151    4   $281    37   $24,432 

 

   Troubled Debt Restructurings 
   December 31, 2012 
           Non-accrual   Total 
   Accrual Status   Status   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 

 

 

The following table shows loans restructured during the three and nine months ended September 30, 2013.

 

   September 30, 2013 
       Pre-modification Outstanding   Post-Modification Outstanding 
(Dollars in thousands)  Number of loans   Recorded Investment   Recorded Investment 
             
Extended payment terms               
Commercial real estate:               
Owner occupied   1   $40   $21 
Faith-based non-profit:               
Owner Occupied   1    1,284    1,276 
    2   $1,324   $1,297 

 

 

   For the Nine Months Ended 
   September 30, 2013 
       Pre-modification Outstanding   Post-Modification Outstanding 
(Dollars in thousands)  Number of loans   Recorded Investment   Recorded Investment 
Extended payment terms               
Commercial real estate:               
Owner occupied   1   $40   $21 
Faith-based non-profit:               
Owner Occupied   1    1,284    1,276 
    2   $1,324   $1,297 

 

 

The following table shows loans restructured during the three and nine months ended September 30, 2012.

 

   For the Three Months Ended 
   September 30, 2012 
       Pre-modification Outstanding   Post-Modification Outstanding 
(Dollars in thousands)  Number of loans   Recorded Investment   Recorded Investment 
             
Below market interest rate               
Owner Occupied   1   $2,522   $2,522 
Other loans   —    —    — 
    1   $2,522   $2,522 

 

   For the Nine Months Ended 
   September 30, 2012 
       Pre-modification Outstanding   Post-Modification Outstanding 
(Dollars in thousands)  Number of loans   Recorded Investment   Recorded Investment 
                
Below market interest rate               
Owner Occupied   1    2,522    2,522 
                
Extended payment terms               
Owner occupied   1    80    80 
Other loans   1    1,353    1,353 
    3   $3,955   $3,955 

 

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 nine months ended September 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 affect the sale of collateral.