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Loans and Credit Quality

12 Months Ended

Dec. 31, 2020

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends in past due and nonaccrual loans, gross and net charge-offs, and movement in loan balances within the risk classifications. The Company utilizes a loan risk grading system called the Asset Quality Rating (“AQR”) system to assign a risk classification to each of its loans. The risk classification is a dual rating system that contemplates both probability of default and risk of loss given default. Loans are graded on a scale of 1 to 10 and, loans graded 1 – 6 are considered “pass” grade loans. A description of the general characteristics of the AQR risk classifications are as follows:

Pass grade loans – 1 through 6: The borrower demonstrates sufficient cash flow to fund debt service, including acceptable profit margins, cash flows, liquidity and other balance sheet ratios. Historic and projected performance indicates that the borrower is able to meet obligations under most economic circumstances. The company has competent management with an acceptable track record. The category does not include loans with undue or unwarranted credit risks that constitute identifiable weaknesses.

Special Mention – 7: A "special mention" credit has weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of either the repayment prospects for the asset or the Bank's credit position at some future date. Special mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Loans are currently protected, but are weak due to negative trends in the balance sheet and income statement. Current cash flow may be insufficient to meet debt service, with prospects that the condition may not be temporary. Profitability and key balance sheet ratios are below peers. There is a lack of effective control over collateral or there are documentation deficiencies as well as a potential risk of payment default. Collateral coverage is minimal in gross dollars or due to quality issues. Financial information may be inadequate to show the recent condition of borrower. The loan would not be approved as a new credit, and new loans would not be granted. Management may not be adequately qualified or may have very limited prior experience with similar activities or markets. The ability of management to cope with current conditions is questionable. Internal conflict and turnover in key positions may be present. Succession is unclear. The borrower's asset quality is below average. The capital base may be insufficient to cover capital losses. Leverage is above average or increasing. The industry outlook is generally negative but there are reasonable expectations of a turnaround within 12-18 months. The firm may be new, resulting in competitive deficiencies in comparison to the older, more established firms in the industry. Over-capacity may be evident in the industry. Collateral and guarantor strength are comparable to Management Attention-6, but agings and certifications of accounts receivable and inventory are required and are not being provided on a regular basis.

Substandard – 8: A "substandard" credit is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans have well-defined weaknesses where a payment default and/or a loss are possible, but not yet probable. Cash flow is insufficient to service debt, with prospects that the condition is permanent. Assets classified as substandard are inadequately protected by the current net worth and paying capacity of the borrower, and there is a likelihood that collateral will have to be liquidated and/or the guarantor called upon to repay the debt. Generally, the loan is considered collectible as to both principal and interest, primarily because of collateral coverage. Loan(s) may have been restructured at less than market terms or have been partially charged off. If deficiencies are not corrected quickly, there is a probability of loss and the borrower’s ability to operate as a going concern may be deemed questionable/is questionable. Management has no prior experience with similar activities, demonstrating inability to realistically address problems and meet commitments. The borrower’s asset quality is poor. The capital base is weak and insufficient to absorb continuing losses, and leverage is significantly above peers. Liquidity is poor with significant reliance on short-term borrowing to support trade debt. Key balance sheet ratios are substantially inferior to industry norms. The industry is currently trending downward or demonstrating recovery from an adverse cycle. The outlook is generally negative at this time. Timing of recovery is unclear, but expectations are that market conditions will improve within 18-24 months. The borrower has substantial competitive deficiencies when compared to other firms, such as excess capacity and over-supply, resulting in frequent and significant concessions and discounting. Business failures are prevalent. Collateral coverage is marginal or non-existent. Collateral may be located outside the borrower’s market area. There are no agings or certifications of accounts receivable and inventory being received from the borrower, and collateral has doubtful marketability/convertibility. If guaranteed, the guarantor has limited outside worth and is highly leveraged with a poor credit report, which may reflect liens, collection problems, or lawsuits.

Doubtful – 9: An asset classified "doubtful" has all the weaknesses inherent in one that is classified "substandard-8" with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable. The loan has substandard characteristics, and available

information suggests that it is unlikely that the loan will be repaid in its entirety. Cash flow is insufficient to service debt. The company has had a series of substantial losses. If the current material adverse trends continue, it is unlikely the borrower will have the ability to meet the terms of the loan agreement. It may be difficult to predict the exact amount of loss, but the probability of some loss is greater than 50%. Loans are to be placed on non-accrual status when any portion is classified as doubtful. Non-accrual loans would not be classified "doubtful" as long as the collateral appears adequate to retire the outstanding balance. Management is clearly unable to address problems and meet commitments, and there is little expectation either of improvement or for sustaining the relationship with current management. The company is highly illiquid with excessive leverage. Key balance sheet ratios are at unacceptable levels, and downturn is severe. Timing of recovery is undeterminable. The company is unable to compete; collateral and guarantees provide limited support.

Loss – 10: An asset classified "loss" is considered uncollectable and of such little value that its continuance on the books is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset, even though partial recovery may be affected in the future. The loan has doubtful characteristics, but the loan will definitely not be repaid in full. Debt service coverage clearly reflects the company's inability to service debt. The borrower cannot generate sufficient cash flow to cover fixed charges. All near-term and long-term trends concerning cash flow and earnings are negative. The damage to the financial condition of the Company cannot be reversed at this point in time. Collateral and guarantees provide no support.

The composition of the loan portfolio as of the periods indicated is as follows:


(In Thousands)	Commercial	Real estate construction one-to-four family	Real estate construction other	Real estate term owner occupied	Real estate term non-owner occupied	Real estate term other	Consumer secured by 1st deeds of trust	Consumer other	Total
December 31, 2020
AQR Pass	$765,952	$37,380	$80,315	$153,607	$291,382	$43,290	$15,441	$21,963	$1,409,330
AQR Special Mention	6,241	385	—	3,028	17,097	2,154	—	—	28,905
AQR Substandard	6,378	702	—	6,962	595	1,176	144	106	16,063
AQR Doubtful	1,487	—	—	—	—	—	—	—	1,487

Subtotal	$780,058	$38,467	$80,315	$163,597	$309,074	$46,620	$15,585	$22,069	$1,455,785
Less: Unearned origination fees, net of origination costs									(11,735)
Total loans									$1,444,050
December 31, 2019
AQR Pass	$394,107	$34,132	$61,808	$129,959	$295,482	$38,771	$15,860	$24,464	$994,583
AQR Special Mention	2,279	3,337	—	3,828	17,478	2,559	179	—	29,660
AQR Substandard	16,304	1,349	—	5,104	—	1,176	159	121	24,213


Subtotal	$412,690	$38,818	$61,808	$138,891	$312,960	$42,506	$16,198	$24,585	$1,048,456
Less: Unearned origination fees, net of origination costs									(5,085)
Total loans									$1,043,371

The above table includes $310.5 million in PPP loans administered by the SBA within the Commercial loan segment as of December 31, 2020. Additionally, unearned origination fees, net of origination costs includes $5.9 million associated with SBA PPP loans as of December 31, 2020.

At December 31, 2020, approximately 73% of the Company’s loans, excluding PPP loans, are secured by real estate and 2% are unsecured. Approximately 25% are for general commercial uses, including professional, retail, and small businesses. Repayment is expected from the borrowers’ cash flow or, secondarily, the collateral. The Company’s exposure to credit loss, if any, is the outstanding amount of the loan if the collateral is determined to be of no value.

Nonaccrual Loans

Nonaccrual loans net of government guarantees totaled $9.6 million and $14.0 million at December 31, 2020 and December 31, 2019, respectively. Interest income which would have been earned on nonaccrual loans for 2020, 2019, and 2018 amounted to $856,000, $1.3 million, and $1.3 million, respectively. Additionally, the Company recognized interest income of $924,000, $301,000, and $159,000 in 2020, 2019, and 2018, respectively, related to interest collected on nonaccrual loans whose principal has been paid down to zero. Nonaccrual loans at the periods indicated, by segment are presented below:


(In Thousands)	30-59 Days Past Due	60-89 Days Past Due	Greater Than 90 Days Past Due	Current	Total
December 31, 2020
Commercial	$48	$229	$3,673	$1,626	$5,576
Real estate construction one-to-four family	—	—	702	—	702

Real estate term owner occupied	—	—	1,520	1,977	3,497

Real estate term other	—	—	1,176	—	1,176
Consumer secured by 1st deeds of trust	—	—	—	63	63
Consumer other	20	—	—	86	106
Total nonaccrual loans	68	229	7,071	3,752	11,120
Government guarantees on nonaccrual loans	(35)	(258)	—	(1,228)	(1,521)
Net nonaccrual loans	$33	($29)	$7,071	$2,524	$9,599
December 31, 2019
Commercial	$270	$385	$2,862	$5,636	$9,153
Real estate construction one-to-four family	—	—	1,349	—	1,349

Real estate term owner occupied	1,641	—	623	1,225	3,489

Real estate term other	—	—	1,176	—	1,176
Consumer secured by 1st deeds of trust	—	—	—	68	68
Consumer other	26	89	—	6	121
Total nonaccrual loans	1,937	474	6,010	6,935	15,356
Government guarantees on nonaccrual loans	(268)	—	—	(1,137)	(1,405)
Net nonaccrual loans	$1,669	$474	$6,010	$5,798	$13,951

Past Due Loans

There was one past due loan greater than 90 days and still accruing interest at December 31, 2020 and no past due loans greater than 90 days and still accruing interest at December 31, 2019. Past due loans and nonaccrual loans at the periods indicated are presented below by loan class:


(In Thousands)	30-59 Days Past Due Still Accruing	60-89 Days Past Due Still Accruing	Greater Than 90 Days Still Accruing	Total Past Due	Nonaccrual	Current	Total
December 31, 2020
Commercial	$387	$—	$—	$387	$5,576	$774,095	$780,058
Real estate construction one-to-four family	—	—	—	—	702	37,765	38,467
Real estate construction other	—	—	—	—	—	80,315	80,315
Real estate term owner occupied	—	—	449	449	3,497	159,651	163,597
Real estate term non-owner occupied	—	—	—	—	—	309,074	309,074
Real estate term other	—	—	—	—	1,176	45,444	46,620
Consumer secured by 1st deed of trust	483	—	—	483	63	15,039	15,585
Consumer other	18	—	—	18	106	21,945	22,069
Subtotal	$888	$—	$449	$1,337	$11,120	$1,443,328	$1,455,785
Less: Unearned origination fees, net of origination costs							(11,735)
Total							$1,444,050
December 31, 2019
Commercial	$270	$—	$—	$270	$9,153	$403,267	$412,690
Real estate construction one-to-four family	—	—	—	—	1,349	37,469	38,818
Real estate construction other	—	—	—	—	—	61,808	61,808
Real estate term owner occupied	338	—	—	338	3,489	135,064	138,891
Real estate term non-owner occupied	—	—	—	—	—	312,960	312,960
Real estate term other	26	—	—	26	1,176	41,304	42,506
Consumer secured by 1st deed of trust	750	—	—	750	68	15,380	16,198
Consumer other	150	—	—	150	121	24,314	24,585
Subtotal	$1,534	$—	$—	$1,534	$15,356	$1,031,566	$1,048,456
Less: Unearned origination fees, net of origination costs							(5,085)
Total							$1,043,371

Impaired Loans

At December 31, 2020 and 2019, the recorded investment in loans that are considered to be impaired was $18.0 million and $24.7 million, respectively. The following table presents information about impaired loans by class for the years ended December 31, 2020 and 2019:


(In Thousands)	Recorded Investment	Unpaid Principal Balance	Related Allowance
December 31, 2020
With no related allowance recorded


Commercial - AQR substandard	$6,299	$6,979	$—
Commercial - AQR doubtful	1,179	1,308	—
Real estate construction one-to-four family - AQR substandard	702	702	—



Real estate term owner occupied - AQR substandard	6,962	7,047	—
Real estate term non-owner occupied - AQR pass	176	176	—

Real estate term non-owner occupied - AQR substandard	595	595	—
Real estate term other - AQR pass	291	291	—
Real estate term other - AQR substandard	1,176	1,176	—
Consumer secured by 1st deeds of trust - AQR pass	114	114	—
Consumer secured by 1st deeds of trust - AQR substandard	144	144	—
Consumer other - AQR substandard	82	87	—
Subtotal	$17,720	$18,619	$—


With an allowance recorded

Commercial - AQR doubtful	$308	$308	$13
Subtotal	$308	$308	$13




Commercial - AQR substandard	$6,299	$6,979	$—
Commercial - AQR doubtful	1,487	1,616	13
Real estate construction one-to-four family - AQR substandard	702	702	—



Real estate term owner-occupied - AQR substandard	6,962	7,047	—
Real estate term non-owner occupied - AQR pass	176	176	—

Real estate term non-owner occupied - AQR substandard	595	595	—
Real estate term other - AQR pass	291	291	—
Real estate term other - AQR substandard	1,176	1,176	—
Consumer secured by 1st deeds of trust - AQR pass	114	114	—
Consumer secured by 1st deeds of trust - AQR substandard	144	144	—
Consumer other - AQR substandard	82	87	—
Total	$18,028	$18,927	$13


(In Thousands)	Recorded Investment	Unpaid Principal Balance	Related Allowance
December 31, 2019
With no related allowance recorded


Commercial - AQR substandard	$15,517	$15,582	$—
Real estate construction one-to-four family - AQR substandard	1,349	1,349	—




Real estate term owner occupied - AQR substandard	5,104	5,104	—
Real estate term non-owner occupied - AQR pass	178	178	—


Real estate term other - AQR pass	417	417	—

Real estate term other - AQR substandard	1,176	1,176	—
Consumer secured by 1st deeds of trust - AQR pass	122	122	—

Consumer secured by 1st deeds of trust - AQR substandard	159	163	—
Consumer other - AQR substandard	90	94	—
Subtotal	$24,112	$24,185	$—


With an allowance recorded
Commercial - AQR substandard	$561	$561	$17
Subtotal	$561	$561	$17




Commercial - AQR substandard	$16,078	$16,143	$17

Real estate construction one-to-four family - AQR substandard	1,349	1,349	—



Real estate term owner-occupied - AQR substandard	5,104	5,104	—
Real estate term non-owner occupied - AQR pass	178	178	—


Real estate term other - AQR pass	417	417	—

Real estate term other - AQR substandard	1,176	1,176	—
Consumer secured by 1st deeds of trust - AQR pass	122	122	—

Consumer secured by 1st deeds of trust - AQR substandard	159	163	—
Consumer other - AQR substandard	90	94	—
Total	$24,673	$24,746	$17

The unpaid principal balance included in the table above represents the recorded investment at the dates indicated, plus amounts charged-off for book purposes.

The following table summarizes our average recorded investment and interest income recognized on impaired loans for years ended December 31, 2020 and 2019, respectively:


Year Ended December 31,	2020				2019
(In Thousands)	Average Recorded Investment	Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded
Commercial - AQR pass	$—		$—		$532		$35

Commercial - AQR substandard	9,111		139		16,892		405
Commercial - AQR doubtful	433		—		—		—

Real estate construction one-to-four family - AQR substandard	781		—		1,933		—





Real estate term owner occupied - AQR substandard	6,739		125		5,747		113
Real estate term non-owner occupied - AQR pass	177		10		251		19

Real estate term non-owner occupied - AQR substandard	385		19		230		—
Real estate term other - AQR pass	362		20		448		31

Real estate term other - AQR substandard	1,189		—		1,046		—
Consumer secured by 1st deeds of trust - AQR pass	118		9		126		13

Consumer secured by 1st deeds of trust - AQR substandard	148		3		202		7
Consumer secured by 1st deeds of trust - AQR loss	33		—		—		—
Consumer other - AQR substandard	86		—		70		—
Subtotal	$19,562		$325		$27,477		$623


With an allowance recorded

Commercial - AQR substandard	$1,343	$8	$683	$—
Commercial - AQR doubtful	77	—	—	—

Real estate term other - AQR substandard	—	—	163	—
Consumer secured by 1st deeds of trust - AQR substandard	—	—	72	—

Subtotal	$1,420	$8	$918	$—


Total
Commercial - AQR pass	$—	$—	$532	$35

Commercial - AQR substandard	10,454	147	17,575	405
Commercial - AQR doubtful	510	—	—	—

Real estate construction one-to-four family - AQR substandard	781	—	1,933	—





Real estate term owner-occupied - AQR substandard	6,739	125	5,747	113
Real estate term non-owner occupied - AQR pass	177	10	251	19

Real estate term non-owner occupied - AQR substandard	385	19	230	—
Real estate term other - AQR pass	362	20	448	31

Real estate term other - AQR substandard	1,189	—	1,209	—
Consumer secured by 1st deeds of trust - AQR pass	118	9	126	13

Consumer secured by 1st deeds of trust - AQR substandard	148	3	274	7
Consumer secured by 1st deeds of trust - AQR loss	33	—	—	—
Consumer other - AQR substandard	86	—	70	—
Total Impaired Loans	$20,982	$333	$28,395	$623

The average recorded investment was $34.7 million, and interest income recognized on impaired loans was $847,000 for the year ended December 31, 2018.

Troubled Debt Restructurings

Loans classified as TDRs totaled $7.9 million and $10.1 million at December 31, 2020 and 2019, respectively. A TDR is a loan to a borrower that is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that the Company is granting the borrower a concession of some kind. The provisions of the Coronavirus Aid, Relief, and Economic Security ("CARES") Act included an election to not apply the guidance on accounting for TDRs to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) January 1, 2022 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Company has elected to adopt these provisions of the CARES Act. As of December 301 2020, the Company has made the following types of loan modifications related to COVID-19, which are not classified as TDRs with principal balance outstanding of:


(Dollars in thousands)	Interest Only	Full Payment Deferral	Total
Portfolio loans	$43,379	$22,165	$65,544
Number of modifications	23	11	34

The Company has granted a variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally be described in the following categories:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Payment Modification: A modification in which the dollar amount of the payment is changed, or in which a loan is converted to interest only payments for a period of time is included in this category.

Combination Modification: Any other type of modification, including the use of multiple categories above.

AQR pass graded loans included above in the impaired loan data are loans classified as TDRs. By definition, TDRs are considered impaired loans. All of the Company’s TDRs are included in impaired loans.

The following table presents the breakout between newly restructured loans that occurred during 2020 and restructured loans that occurred prior to 2020 that are still included in portfolio loans. As discussed above, the CARES Act provided banks an option to elect to not account for certain loan modifications related to COVID-19 as TDRs as long as the borrowers were not more than 30 days past due as of December 31, 2019. The below disclosed restructurings were not related to COVID-19 modifications:


	Accrual Status	Nonaccrual Status	Total Modifications
(In Thousands)
New Troubled Debt Restructurings

Commercial - AQR substandard	$1,590	$161	$1,751




Subtotal	$1,590	$161	$1,751
Existing Troubled Debt Restructurings	765	5,344	6,109
Total	$2,355	$5,505	$7,860

The following tables present newly restructured loans that occurred during 2020 and 2019, by concession (terms modified):


	December 31, 2020
(In Thousands)	Number of Contracts	Rate Modification	Term Modification	Payment Modification	Combination Modification	Total Modifications
Pre-Modification Outstanding Recorded Investment:
Commercial - AQR substandard	2	$—	$3,249	$164	$—	$3,413




Total	2	$—	$3,249	$164	$—	$3,413
Post-Modification Outstanding Recorded Investment:

Commercial - AQR substandard	2	$—	$1,590	$161	$—	$1,751




Total	2	$—	$1,590	$161	$—	$1,751


	December 31, 2019
(In Thousands)	Number of Contracts	Rate Modification	Term Modification	Payment Modification	Combination Modification	Total Modifications
Pre-Modification Outstanding Recorded Investment:
Commercial - AQR substandard	7	$—	$—	$509	$2,585	$3,094
Real estate term owner occupied - AQR substandard	1	—	—	192	—	192
Total	7	$—	$—	$701	$2,585	$3,286
Post-Modification Outstanding Recorded Investment:
Commercial - AQR substandard	7	$—	$—	$408	$2,561	$2,969
Real estate term owner occupied - AQR substandard	1	—	—	182	—	182
Total	7	$—	$—	$590	$2,561	$3,151

The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified in TDRs at December 31, 2020. There were zero charge-offs in 2020 on loans that were later classified as a TDR and there were $64,000 of charge-offs in 2019 on loans that were later classified as a TDR in 2019.

All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the Allowance. There was one TDR with specific impairment at December 31, 2020 and none at December 31, 2019, respectively.

There were no loans that were restructured during 2020 or 2019, that also subsequently defaulted within the first twelve months of restructure in those same periods. The following table presents TDRs that occurred during 2018 that subsequently defaulted during the twelve-months ended December 31, 2018:


		December 31, 2018
	Number of Contracts	Recorded Investment
(In Thousands)
Troubled Debt Restructurings that Subsequently Defaulted:
Commercial - AQR substandard	4	$1,166

Real estate term owner occupied - AQR substandard	2	1,694


Total	6	$2,860

Loans to Related Parties

Certain directors, and companies of which directors are principal owners, have loans and other transactions such as architectural fees with the Company. Such transactions are made on substantially the same terms, including interest rates and collateral required, as those prevailing for similar transactions of unrelated parties. An analysis of the loan transactions for the years indicated follows:


(In Thousands)	2020	2019	2018
Balance, beginning of the year	$309	$—	$—
Loans made	—	309	—
Repayments	92	—	—
Balance, end of year	$217	$309	$—

The Company had $15,000 of unfunded loan commitments to these directors or their related interests on December 31, 2020 and 2019.

Pledged Loans

At December 31, 2020 and 2019, there were no loans pledged as collateral to secure public deposits.