Note 5 - Allowance for Loan Losses

Management segregates the loan portfolio into loan types and analyzes the risk level for each loan type when determining its allowance for loan losses. The loan types are as follows:

Real Estate Loans:

One- to Four-Family – are loans secured by first lien collateral on residential real estate primarily held in the Western New York region. These loans can be affected by economic conditions and the value of underlying properties. Western New York’s housing market has consistently demonstrated stability in home prices despite economic conditions. Furthermore, the Company has conservative underwriting standards and its residential lending policies and procedures ensure that its one- to four-family residential mortgage loans generally conform to secondary market guidelines.

Home Equity - are loans or lines of credit secured by first or second liens on owner-occupied residential real estate primarily held in the Western New York region. These loans can also be affected by economic conditions and the values of underlying properties. Home equity loans may have increased risk of loss if the Company does not hold the first mortgage resulting in the Company being in a secondary position in the event of collateral liquidation. The Company does not originate interest only home equity loans.

Commercial Real Estate – are loans used to finance the purchase of real property, which generally consists of developed real estate that is held as first lien collateral for the loan. These loans are secured by real estate properties that are primarily held in the Western New York region. Commercial real estate lending involves additional risks compared with one- to four-family residential lending, because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, and/or the collateral value of the commercial real estate securing the loan, and repayment of such loans may be subject to adverse conditions in the real estate market or economic conditions to a greater extent than one- to four-family residential mortgage loans. Also, commercial real estate loans typically involve relatively large loan balances concentrated with single borrowers or groups of related borrowers.

Construction – are loans to finance the construction of either one- to four-family owner occupied homes or commercial real estate. At the end of the construction period, the loan automatically converts to either a one- to four-family or commercial mortgage, as applicable. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion compared to the actual cost of construction. The Company limits its risk during construction as disbursements are not made until the required work for each advance has been completed and an updated lien search is performed. The completion of the construction progress is verified by a Company loan officer or inspections performed by an independent appraisal firm. Construction loans also expose us to the risk of construction delays which may impair the borrower’s ability to repay the loan.

Other Loans:

Commercial – includes business installment loans, lines of credit, and other commercial loans. Most of our commercial loans have fixed interest rates, and are for terms generally not in excess of 5 years. Whenever possible, we collateralize these loans with a lien on business assets and equipment and require the personal guarantees from principals of the borrower. Commercial loans generally involve a higher degree of credit risk because the collateral underlying the loans may be in the form of intangible assets and/or inventory subject to market obsolescence. Commercial loans can also involve relatively large loan balances to a single borrower or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation of the commercial business and the income stream of the borrower. Such risks can be significantly affected by economic conditions. Although commercial loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default may be an insufficient source of repayment because the equipment or other business assets may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial loan depends primarily on the credit worthiness of the borrowers (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment.

Consumer – consist of loans secured by collateral such as an automobile or a deposit account, unsecured loans and lines of credit. Consumer loans tend to have a higher credit risk due to the loans being either unsecured or secured by rapidly depreciable assets. Furthermore, consumer loan payments are dependent on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

The allowance for loan losses is a valuation account that reflects the Company’s evaluation of the losses inherent in its loan portfolio. In order to determine the adequacy of the allowance for loan losses, the Company estimates losses by loan type using historical loss factors, as well as other environmental factors, such as trends in loan volume and loan type, loan concentrations, changes in the experience, ability and depth of the Company’s lending management, and national and local economic conditions. The Company's determination as to the classification of loans and the amount of loss allowances are subject to review by bank regulators, which can require the establishment of additional loss allowances.

The Company also reviews all loans on which the collectability of principal may not be reasonably assured, by reviewing payment status, financial conditions and estimated value of loan collateral. These loans are assigned an internal loan grade, and the Company assigns an amount of loss allowances to these classified loans based on loan grade.

The following tables summarize the activity in the allowance for loan losses for the years ended December 31, 2017, 2016 and 2015 and the distribution of the allowance for loan losses and loan receivable by loan portfolio class and impairment method as of December 31, 2017 and December 31, 2016:


	Real Estate Loans									Other Loans
	One- to Four-Family		Home Equity		Commercial			Construction		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)
December 31, 2017
Allowance for Loan Losses:
Balance – January 1, 2017	$	431	$	114		$	1,803	$	150	$	338	$	28	$	18	$	2,882
Charge-offs		-		(3)			(75)		-		(20)		(41)		-		(139)
Recoveries		3		4			-		-		9		14		-		30
Provision (Credit)		77		7			(65)		197		217		34		43		510
Balance – December 31, 2017	$	511	$	122		$	1,663	$	347	$	544	$	35	$	61	$	3,283
Ending balance: individually evaluated for impairment	$	-	$	-		$	-	$	-	$	-	$	-	$	-	$	-
Ending balance: collectively evaluated for impairment	$	511	$	122		$	1,663	$	347	$	544	$	35	$	61	$	3,283

Gross Loans Receivable (1):
Ending balance	$	144,565	$	38,078		$	122,747	$	30,851	$	27,612	$	1,355	$	-	$	365,208
Ending balance: individually evaluated for impairment	$	184	$	21		$	1,498	$	-	$	54	$	-	$	-	$	1,757
Ending balance: collectively evaluated for impairment	$	144,381	$	38,057		$	121,249	$	30,851	$	27,558	$	1,355	$	-	$	363,451

⁽¹⁾

Gross Loans Receivable does not include allowance for loan losses of $(3,283) or deferred loan costs of $3,138.


	Real Estate Loans									Other Loans
	One- to Four-Family		Home Equity		Commercial		Construction		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)

December 31, 2016
Allowance for Loan Losses:
Balance – January 1, 2016	$	351	$	120	$	1,204	$	59	$	197	$	22	$	32	$	1,985
Charge-offs		(107)		(19)		(1)		-		(76)		(54)		-		(257)
Recoveries		12		1		-		-		2		14		-		29
Provision (Credit)		175		12		600		91		215		46		(14)		1,125
Balance – December 31, 2016	$	431	$	114	$	1,803	$	150	$	338	$	28	$	18	$	2,882
Ending balance: individually evaluated for impairment	$	-	$	-	$	390	$	-	$	10	$	-	$	-	$	400
Ending balance: collectively evaluated for impairment	$	431	$	114	$	1,413	$	150	$	328	$	28	$	18	$	2,482

Gross Loans Receivable (1):
Ending Balance	$	149,333	$	35,534	$	107,243	$	12,361	$	20,447	$	1,313	$	-	$	326,231
Ending balance: individually evaluated for impairment	$	190	$	22	$	3,162	$	-	$	163	$	-	$	-	$	3,537
Ending balance: collectively evaluated for impairment	$	149,143	$	35,512	$	104,081	$	12,361	$	20,284	$	1,313	$	-	$	322,694

⁽¹⁾

Gross Loans Receivable does not include allowance for loan losses of $(2,882) or deferred loan costs of $3,016.


	Real Estate Loans									Other Loans
	One- to Four-Family		Home Equity		Commercial		Construction		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)

December 31, 2015
Allowance for Loan Losses:
Balance – January 1, 2015	$	446	$	106	$	1,163	$	-	$	184	$	22	$	-	$	1,921
Charge-offs		(64)		(29)		(267)		-		(9)		(46)		-		(415)
Recoveries		13		8		32		-		18		8		-		79
Provision (Credit)		(44)		35		276		59		4		38		32		400
Balance – December 31, 2015	$	351	$	120	$	1,204	$	59	$	197	$	22	$	32	$	1,985

Although the allocations noted above are by loan type, the allowance for loan losses is general in nature and is available to offset losses from any loan in the Company’s portfolio. The unallocated component of the allowance for loan losses reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for existing specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will not be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting scheduled payments when due. Impairment is measured on a loan-by-loan basis for commercial real estate loans and commercial loans. Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer, home equity, or one- to four-family loans for impairment disclosure, unless they are subject to a troubled debt restructuring.

The following is a summary of information pertaining to impaired loans for the periods indicated:


			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
							For the Year Ended
	At December 31, 2017						December 31, 2017
	(Dollars in thousands)
With no related allowance recorded:
Residential, one- to four-family	$	184	$	184	$	-	$	197	$	15
Home equity		21		21		-		21		-
Commercial real estate		1,498		1,498		-		1,674		222
Commercial loans		54		54		-		54		-
Total impaired loans with no related allowance		1,757		1,757		-		1,946		237

With an allowance recorded:
Commercial real estate(1)		-		-		-		230		-
Commercial loans(2)		-		-		-		50		6
Total impaired loans with an allowance		-		-		-		280		6

Total of impaired loans:
Residential, one- to four-family		184		184		-		197		15
Home equity		21		21		-		21		-
Commercial real estate		1,498		1,498		-		1,904		222
Commercial loans		54		54		-		104		6
Total impaired loans	$	1,757	$	1,757	$	-	$	2,226	$	243

(1) This loan was foreclosed upon during the year ended December 31, 2017 and was recorded in other assets at December 31, 2017.

(2) This loan was paid off during the year ended December 31, 2017.


			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
							For the Year Ended
	At December 31, 2016						December 31, 2016
	(Dollars in thousands)
With no related allowance recorded:
Residential, one- to four-family	$	190	$	190	$	-	$	224	$	14
Home equity		22		22		-		24		1
Commercial real estate		2,148		2,148		-		2,299		29
Commercial loans		54		54		-		71		-
Total impaired loans with no related allowance		2,414		2,414		-		2,618		44

With an allowance recorded:
Commercial real estate		1,014		1,014		390		1,011		31
Commercial loans		109		109		10		135		5
Total impaired loans with an allowance		1,123		1,123		400		1,146		36

Total of impaired loans:
Residential, one- to four-family		190		190		-		224		14
Home equity		22		22		-		24		1
Commercial real estate		3,162		3,162		390		3,310		60
Commercial loans		163		163		10		206		5
Total impaired loans	$	3,537	$	3,537	$	400	$	3,764	$	80



			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
							For the Year Ended
	At December 31, 2015						December 31, 2015
	(Dollars in thousands)
With no related allowance recorded:
Residential, one- to four-family	$	202	$	202	$	-	$	207	$	14
Home equity		8		8		-		9		-
Commercial real estate		1,503		1,503		-		1,931		-
Commercial loans		80		80		-		94		2
Total impaired loans with no related allowance		1,793		1,793		-		2,241		16

With an allowance recorded:
Commercial real estate		42		42		20		612		2
Total impaired loans with an allowance		42		42		20		612		2

Total of impaired loans:
Residential, one- to four-family		202		202		-		207		14
Home equity		8		8		-		9		-
Commercial real estate		1,545		1,545		20		2,543		2
Commercial loans		80		80		-		94		2
Total impaired loans	$	1,835	$	1,835	$	20	$	2,853	$	18

The following table provides an analysis of past due loans and non-accruing loans as of the dates indicated:


					90 Days or
	30-59 Days		60-89 Days		More		Total Past			Current	Total Loans		Loans on
	Past Due		Past Due		Past Due		Due			Due	Receivable		Non-Accrual
	(Dollars in thousands)
December 31, 2017:
Real Estate Loans:
Residential, one- to four-family	$	692	$	942	$	1,233	$	2,867	$	141,698	$	144,565	$	2,196
Home equity		27		59		212		298		37,780		38,078		235
Commercial		411		-		1,265		1,676		121,071		122,747		1,323
Construction		-		-		-		-		30,851		30,851		-
Other Loans:
Commercial		61		8		54		123		27,489		27,612		54
Consumer		22		2		22		46		1,309		1,355		25
Total	$	1,213	$	1,011	$	2,786	$	5,010	$	360,198	$	365,208	$	3,833

					90 Days or
	30-59 Days		60-89 Days		More		Total Past			Current	Total Loans		Loans on
	Past Due		Past Due		Past Due		Due			Due	Receivable		Non-Accrual
	(Dollars in thousands)
December 31, 2016:
Real Estate Loans:
Residential, one- to four-family	$	1,192	$	782	$	1,038	$	3,012	$	146,321	$	149,333	$	2,165
Home equity		141		206		158		505		35,029		35,534		329
Commercial		-		-		2,977		2,977		104,266		107,243		2,977
Construction		-		-		-		-		12,361		12,361		-
Other Loans:
Commercial		-		19		56		75		20,372		20,447		205
Consumer		31		-		28		59		1,254		1,313		28
Total	$	1,364	$	1,007	$	4,257	$	6,628	$	319,603	$	326,231	$	5,704

The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. A loan does not have to be 90 days delinquent in order to be classified as non-accrual. When interest accrual is discontinued, all unpaid accrued interest is reversed. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance. Interest income not recognized on non-accrual loans during the years ended December 31, 2017, 2016 and 2015 was $265,000, $366,000, and $391,000, respectively.

The Company’s policies provide for the classification of loans as follows:

Pass/Performing;

Special Mention – does not currently expose the Company to a sufficient degree of risk but does possess credit deficiencies or potential weaknesses deserving the Company’s close attention;

Substandard – has one or more well-defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. A substandard asset would be one inadequately protected by the current net worth and paying capacity of the obligor or pledged collateral, if applicable;

Doubtful – has all the weaknesses inherent in substandard loans with the additional characteristic that the weaknesses present make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss; and

Loss – loan is considered uncollectible and continuance without the establishment of a specific valuation reserve is not warranted.

The Company’s Asset Classification Committee is responsible for monitoring risk ratings and making changes as deemed appropriate. Each commercial loan is individually assigned a loan classification. The Company’s consumer loans, including residential one- to four-family loans and home equity loans, are not classified as described above. Instead, the Company uses the delinquency status as the basis for classifying these loans. Generally, all consumer loans more than 90 days past due are classified and placed in non-accrual. Such loans that are well-secured and in the process of collection will remain in accrual status.

The following table summarizes the internal loan grades applied to the Company’s loan portfolio as of December 31, 2017 and December 31, 2016:


	Pass/Performing		Special Mention		Substandard		Doubtful		Loss		Total
	(Dollars in thousands)
December 31, 2017
Real Estate Loans:
Residential, one- to four-family	$	141,751	$	-	$	2,814	$	-	$	-	$	144,565
Home equity		37,611		-		467		-		-		38,078
Commercial		118,977		866		2,904		-		-		122,747
Construction		30,851		-		-		-		-		30,851
Other Loans:
Commercial		26,165		1,093		354		-		-		27,612
Consumer		1,342		-		11		-		2		1,355
Total	$	356,697	$	1,959	$	6,550	$	-	$	2	$	365,208


	Pass/Performing		Special Mention		Substandard		Doubtful		Loss		Total
	(Dollars in thousands)
December 31, 2016
Real Estate Loans:
Residential, one- to four-family	$	146,333	$	-	$	3,000	$	-	$	-	$	149,333
Home equity		35,025		-		509		-		-		35,534
Commercial		102,216		1,759		3,268		-		-		107,243
Construction		12,361		-		-		-		-		12,361
Other Loans:
Commercial		19,865		297		270		15		-		20,447
Consumer		1,306		-		6		-		1		1,313
Total	$	317,106	$	2,056	$	7,053	$	15	$	1	$	326,231

Troubled debt restructurings (“TDRs”) occur when we grant borrowers concessions that we would not otherwise grant but for economic or legal reasons pertaining to the borrower’s financial difficulties. A concession is made when the terms of the loan modification are more favorable than the terms the borrower would have received in the current market under similar financial difficulties. These concessions may include, but are not limited to, modifications of the terms of the debt, the transfer of assets or the issuance of an equity interest by the borrower to satisfy all or part of the debt, or the addition of borrower(s). The Company identifies loans for potential TDRs primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future. Generally, we will not return a TDR to accrual status until the borrower has demonstrated the ability to make principal and interest payments under the restructured terms for at least six consecutive months. The Company’s TDRs are impaired loans, which may result in specific allocations and subsequent charge-offs if appropriate.

The following table summarizes the loans that were classified as TDRs as of the dates indicated:


					Non-Accruing				Accruing				TDRs That Have Defaulted on Modified Terms Year to Date
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(Dollars in thousands)
At December 31, 2017
Real Estate Loans:
Residential, one- to four-family		5	$	184		-	$	-		5	$	184		-	$	-
Home equity		2		21		1		19		1		2		-		-
Total		7	$	205		1	$	19		6	$	186		-	$	-


At December 31, 2016
Real Estate Loans:
Residential, one- to four-family		5	$	190		-	$	-		5	$	190		-	$	-
Home equity		2		22		1		19		1		3		-		-
Other Loans:
Commercial		1		109		1		109		-		-		-		-
Total		8	$	321		2	$	128		6	$	193		-	$	-

No additional loan commitments were outstanding to these borrowers at December 31, 2017 and 2016.

The following table details the activity in loans which were first deemed to be TDRs during the years ended December 31, 2017 and 2016:




	For the Year Ended December 31, 2017						For The Year Ended December 31, 2016
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
				(Dollars in thousands)			(Dollars in thousands)
Real Estate Loans:
Residential, one- to four-family		1	$	29	$	29		1	$	31	$	31
Home equity								1		19		19
Other Loans:
Commercial		-		-		-		1		118		118
Total		1	$	29	$	29		3	$	168	$	168

The loans above were deemed to be TDRs due to the borrower’s financial difficulties or due to modifications of the terms of the debt related to the bankruptcy of the borrower, or due to changes in the originally scheduled payment terms.

Some loan modifications classified as TDRs may not ultimately result in full collection of principal and interest, as modified, which may result in potential losses. These potential losses have been factored into our overall estimate of the allowance for loan losses.

Foreclosed real estate consists of property acquired in settlement of loans which is carried at its fair value less estimated selling costs. Write-downs from cost to fair value less estimated selling costs are recorded at the date of acquisition or repossession and are charged to the allowance for loan losses. Foreclosed real estate was $435,000 and $412,000 at December 31, 2017 and 2016, respectively, and was included as a component of other assets on the consolidated statements of financial condition. The recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction was $965,000 and $767,000 at December 31, 2017 and December 31, 2016, respectively.