Note 6. Loan Quality

Management utilizes a risk rating scale ranging from 1-Prime to 9-Loss to evaluate loan quality. This risk rating scale is used primarily for commercial purpose loans. Consumer purpose loans are identified as either a pass or substandard rating based on the performance status of the loans. Substandard consumer loans are loans that are nonaccrual or 90 days or more past due and still accruing. Loans rated 1 – 4 are considered pass credits. Loans that are rated 5 are pass credits, but have been identified as credits that are likely to warrant additional attention and monitoring. Loans rated 6-OAEM or worse begin to receive enhanced monitoring and reporting by the Bank. Loans rated 7-Substandard or 8-Doubtful exhibit the greatest financial weakness and present the greatest possible risk of loss to the Bank. Nonaccrual loans are rated no better than 7-Substandard. The following factors represent some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt.

The following table reports on the risk rating for those loans in the portfolio that are assigned an individual risk rating as of December 31, 2019 and 2018



	Pass		OAEM		Substandard		Doubtful
(Dollars in thousands)	(1-5)		(6)		(7)		(8)		Total
December 31, 2019
Residential Real Estate 1-4 Family
First liens	$	142,847	$	—	$	99	$	—	$	142,946
Junior liens and lines of credit		47,520		—		77		—		47,597
Total		190,367		—		176		—		190,543
Residential real estate - construction		12,800		—		523		—		13,323
Commercial real estate		483,878		5,875		4,509		—		494,262
Commercial		229,465		4		538		—		230,007
Consumer		6,440		—		—		—		6,440
Total	$	922,950	$	5,879	$	5,746	$	—	$	934,575



December 31, 2018
Residential Real Estate 1-4 Family
First liens	$	148,453	$	—	$	447	$	—	$	148,900
Junior liens and lines of credit		47,171		—		49		—		47,220
Total		195,624		—		496		—		196,120
Residential real estate - construction		9,572		—		653		—		10,225
Commercial real estate		479,969		660		7,351		—		487,980
Commercial		272,959		—		1,095		—		274,054
Consumer		4,991		—		5		—		4,996
Total	$	963,115	$	660	$	9,600	$	—	$	973,375

Delinquent loans are a result of borrowers’ cash flow and/or alternative sources of cash being insufficient to repay loans. The Bank’s likelihood of collateral liquidation to repay the loans becomes more probable the further behind a borrower falls, particularly when loans reach 90 days or more past due. Management monitors the performance status of loans by the use of an aging report. The aging report can provide an early indicator of loans that may become severely delinquent and possibly result in a loss to the Bank.

The following table presents the aging of payments in the loan portfolio as of December 31, 2019 and 2018



(Dollars in thousands)			Loans Past Due and Still Accruing										Total
	Current		30-59 Days		60-89 Days		90 Days+		Total		Non-Accrual		Loans
December 31, 2019
Residential Real Estate 1-4 Family
First liens	$	141,843	$	646	$	358	$	31	$	1,035	$	68	$	142,946
Junior liens and lines of credit		47,420		70		30		46		146		31		47,597
Total		189,263		716		388		77		1,181		99		190,543
Residential real estate - construction		12,800		—		—		—		—		523		13,323
Commercial real estate		490,114		813		326		—		1,139		3,009		494,262
Commercial		229,659		31		120		—		151		197		230,007
Consumer		6,397		25		18		—		43		—		6,440
Total	$	928,233	$	1,585	$	852	$	77	$	2,514	$	3,828	$	934,575



December 31, 2018
Residential Real Estate 1-4 Family
First liens	$	148,183	$	322	$	202	$	113	$	637	$	80	$	148,900
Junior liens and lines of credit		47,040		131		—		26		157		23		47,220
Total		195,223		453		202		139		794		103		196,120
Residential real estate - construction		9,572		—		198		—		198		455		10,225
Commercial real estate		481,774		1,343		3,323		113		4,779		1,427		487,980
Commercial		273,534		65		40		100		205		315		274,054
Consumer		4,933		46		12		5		63		—		4,996
Total	$	965,036	$	1,907	$	3,775	$	357	$	6,039	$	2,300	$	973,375

Impaired loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Commercial loans are charge-off immediately upon identification of a loss. If a loan (commercial or mortgage) is collateral dependent (repayment provided solely by the collateral), the value of the collateral is determined and a partial charge-off may be recorded. Consumer loans are charged-off no later than 180 days past due. At December 31, 2019, the Bank had $41 thousand of residential properties in the process of foreclosure compared to $129 thousand at the end of 2018.

Interest not recognized on nonaccrual loans was $304 thousand and $108 thousand for the years ended December 31, 2019 and 2018, respectively. In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Nonaccrual loans, excluding consumer purpose loans, and troubled-debt restructuring (TDR) loans are considered impaired. Commercial loans with a balance less than $250 thousand, and all consumer purpose loans are not included in the specific reserve analysis as impaired loans, but are added to the general allocation pool. Impaired loans totaled $12.2 million at December 31, 2019 compared to $11.9 million at December 31, 2018.

The following tables present information on impaired loans:



	Impaired Loans
	With No Allowance				With Allowance
(Dollars in thousands)			Unpaid				Unpaid
	Recorded		Principal		Recorded		Principal		Related
December 31, 2019	Investment		Balance		Investment		Balance		Allowance
Residential Real Estate 1-4 Family
First liens	$	659	$	659	$	—	$	—	$	—
Junior liens and lines of credit		—		—		—		—		—
Total		659		659		—		—		—
Residential real estate - construction		523		729		—		—		—
Commercial real estate		10,994		12,096		—		—		—
Commercial		—		—		—		—		—
Total	$	12,176	$	13,484	$	—	$	—	$	—



December 31, 2018
Residential Real Estate 1-4 Family
First liens	$	871	$	958	$	—	$	—	$	—
Junior liens and lines of credit		49		49		—		—		—
Total		920		1,007		—		—		—
Residential real estate - construction		455		531		—		—		—
Commercial real estate		10,236		10,808		—		—		—
Commercial		315		9,763		—		—		—
Total	$	11,926	$	22,109	$	—	$	—	$	—


	Twelve Months Ended
	December 31, 2019				December 31, 2018
	Average		Interest		Average		Interest
(Dollars in thousands)	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
Residential Real Estate 1-4 Family
First liens	$	668	$	39	$	914	$	45
Junior liens and lines of credit		—		—		85		1
Total		668		39		999		46
Residential real estate - construction		619		—		462		—
Commercial real estate		13,319		397		10,809		417
Commercial		—		—		4,329		—
Total	$	14,606	$	436	$	16,599	$	463

A loan is considered a troubled debt restructuring (TDR) if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the interest rate, extending the maturity, reamortization of payment, or a combination of multiple concessions. The Bank reviews all loans rated 6-OAEM or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR. If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance. The cash basis income recognized is the same as the accrual basis income.

The following table presents TDR loans as of December 31, 2019 and 2018:


								Troubled Debt Restructurings
								Within the Last 12 Months
								That Have Defaulted
(Dollars in thousands)	Troubled Debt Restructurings							on Modified Terms
	Number of	Recorded						Number of	Recorded
	Contracts	Investment		Performing*		Nonperforming*		Contracts	Investment
December 31, 2019
Residential real estate - construction	1	$	444	$	444	$	—	—	$	—
Residential real estate	4		659		659		—	—		—
Commercial real estate	11		9,343		9,343		—	—		—
Total	16	$	10,446	$	10,446	$	—	—	$	—


December 31, 2018
Residential real estate - construction	1	$	455	$	—	$	455	—	$	—
Residential real estate	4		678		678		—	—		—
Commercial real estate	11		10,099		8,809		1,290	—		—
Total	16	$	11,232	$	9,487	$	1,745	—	$	—

*The performing status is determined by the loan’s compliance with the modified terms.

There were no new TDR loans made during the years ended December 31, 2019 and 2018.

Allowance for Loan Losses:

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses (ALL). The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6–OAEM or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and rated 7 - Substandard or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required. Valuation adjustments will be made as necessary based on factors, including, but not limited to: the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Credit Risk Oversight Committee of the Board of Directors. Management believes that the allowance for loan losses at December 31, 2019 is adequate.

The following table shows the activity in the Allowance for Loan Loss (ALL), for the years ended December 31, 2019 and 2018.


	Residential Real Estate 1-4 Family
	First		Junior Liens &				Commercial
(Dollars in thousands)	Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total

ALL at December 31, 2017	$	1,060	$	330	$	224	$	6,526	$	2,110	$	105	$	1,437	$	11,792
Charge-offs		—		—		—		—		(9,482)		(107)		—		(9,589)
Recoveries		2		8		—		60		157		31		—		258
Provision		(571)		(205)		(116)		(888)		11,726		41		(33)		9,954
ALL at December 31, 2018	$	491	$	133	$	108	$	5,698	$	4,511	$	70	$	1,404	$	12,415

ALL at December 31, 2018	$	491	$	133	$	108	$	5,698	$	4,511	$	70	$	1,404	$	12,415
Charge-offs		(52)		(12)		(123)		(564)		(93)		(125)		—		(969)
Recoveries		5		1		—		72		170		35		—		283
Provision		(28)		(3)		199		816		(773)		104		(78)		237
ALL at December 31, 2019	$	416	$	119	$	184	$	6,022	$	3,815	$	84	$	1,326	$	11,966

The following table shows the loans that were evaluated for the Allowance for Loan Loss (ALL) under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the allowance established in each category as of December 31, 2019 and 2018:



	Residential Real Estate 1-4 Family
	First		Junior Liens &				Commercial
(Dollars in thousands)	Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total

December 31, 2019
Loans evaluated for ALL:
Individually	$	659	$	—	$	523	$	10,994	$	—	$	—	$	—	$	12,176
Collectively		142,287		47,597		12,800		483,268		230,007		6,440		—		922,399
Total	$	142,946	$	47,597	$	13,323	$	494,262	$	230,007	$	6,440	$	—	$	934,575

ALL established for loans evaluated:
Individually	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively		416		119		184		6,022		3,815		84		1,326		11,966
ALL at December 31, 2019	$	416	$	119	$	184	$	6,022	$	3,815	$	84	$	1,326	$	11,966

December 31, 2018
Loans evaluated for ALL:
Individually	$	405	$	—	$	455	$	10,099	$	181	$	—	$	—	$	11,140
Collectively		148,495		47,220		9,770		477,881		273,873		4,996		—		962,235
Total	$	148,900	$	47,220	$	10,225	$	487,980	$	274,054	$	4,996	$	—	$	973,375

ALL established for loans evaluated:
Individually	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively		491		133		108		5,698		4,511		70		1,404		12,415
ALL at December 31, 2018	$	491	$	133	$	108	$	5,698	$	4,511	$	70	$	1,404	$	12,415