Loan Quality And Allowance For Credit Losses

9 Months Ended

Sep. 30, 2023

Loan Quality And Allowance For Credit Losses [Abstract]

Loan Quality and Allowance for Credit Losses

Note 6. Loan Quality and Allowance for Credit Losses

The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the collectability of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience, derived from peer group data, provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a modification will be executed with an individual borrower, or the extension or renewal options are included int eh original or modified contract at the reporting date and are not unconditionally cancellable by the Bank.

The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Bank measures the Allowance for Credit Loss (ACL) using the following inputs to calculate the quantitative component for the pool:

Segregating loans into homogeneous pools by the FRB Call Code which is primarily a collateral-based and secondarily a purpose-based segmentation.

The average remaining life of each pool is calculated using the weighted average remaining maturity method (WARM). The WARM method produces an estimated remaining balance by pool, by year, until maturity.

Using third party data, the Bank determines a reasonable and supportable economic forecast that it believes is likely to exist for the next four quarters.

A historical credit loss rate is calculated for each pool, using the average historical loss, by FRB Call Code, for a peer group of Pennsylvania community banks over the last eight quarters. The historical loss rate is calculated over a historical period the Bank believes best represents a period that will be similar to the next four quarters.

The historical peer credit loss rate is applied to each WARM bucket through the initial four quarter forecast period.

At the end of the four quarter forecast period, the credit loss rate applied to each WARM bucket reverts to the peer group historical loss rate for the respective pool.

Collectively these estimated losses represent the quantitative component of the pooled reserve.

The qualitative component for the pool utilizes a risk matrix comprised of eight risk factors and assigns a risk level to each factor. The risk factors consider changes in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. The risk factors are weighted to reflect Management’s estimate of how the factor affects potential losses. The risk levels within each factor are measured in basis points and range from minimal risk to very high risk and are determined independently for commercial loans, residential mortgage loans and consumer loans.

The ACL for pooled loans is the sum of the quantitative and qualitative loss estimates.

The Bank 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, and current economic trends, among other factors. 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 performing or nonperforming based on the payment status of the loans. Nonperforming consumer loans are loans that are nonaccrual or 90 days or more past due and still accruing. The Bank uses the following definitions for risk ratings:

Pass (1-5): are considered pass credits with lower or average risk and are not otherwise classified.

OAEM (6): Loans classified as OAEM 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 Company’s credit position at some future date.

Substandard (7): Loans classified as Substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful (8): 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.

Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the pool evaluation. When management determines that foreclosure is probable or when the borrower is experiencing financial difficulty at the reporting date and repayment is expected to be provided substantially through the sale of the collateral, the expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for any discounts and selling costs as appropriate.

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the Allowance for Credit Loss for loans (ACL). The Bank begins enhanced monitoring of all loans rated 6–OAEM or worse and obtains a new appraisal or asset valuation for any loans 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 ACL, 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. Management monitors the adequacy of the ACL on an ongoing basis and reports its adequacy quarterly to the Board Enterprise Risk Management Committee of the Board of Directors. Management believes the ACL at September 30, 2023 is adequate.

‎

The following table presents loans by year of origination and internally assigned risk ratings:

(Dollars in thousands, except per share)													Revolving		Revolving
	Term Loans												Loans		Loans
	Amortized Cost Basis by Origination Year												Amortized		Converted
As of September 30, 2023	2023		2022		2021		2020		2019		Prior		Cost Basis		to Term		Total
Residential real estate 1-4 family:
Commercial:
Risk rating:
Pass (1-5)	$	7,702	$	9,386	$	11,426	$	9,807	$	2,454	$	23,930	$	1,824	$	—	$	66,529
OAEM (6)		—		—		—		—		—		—		—		—		—
Substandard (7)		—		—		—		—		—		98		—		—		98
Doubtful (8)		—		—		—		—		—		—		—		—		—
Total Commercial		7,702		9,386		11,426		9,807		2,454		24,028		1,824		—		66,627
Consumer:
Performing		37,186		30,157		15,746		10,893		5,684		29,605		42,554		20,605		192,430
Nonperforming		—		—		—		—		—		—		—		—		—
Total Consumer		37,186		30,157		15,746		10,893		5,684		29,605		42,554		20,605		192,430
Total	$	44,888	$	39,543	$	27,172	$	20,700	$	8,138	$	53,633	$	44,378	$	20,605	$	259,057
Current period gross charge-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Residential real estate construction:
Commercial:
Risk rating:
Pass (1-5)	$	3,420	$	2,849	$	1,503	$	229	$	—	$	1,819	$	—	$	—	$	9,820
OAEM (6)		—		—		—		—		—		—		—		—		—
Substandard (7)		—		—		—		—		—		—		—		—		—
Doubtful (8)		—		—		—		—		—		—		—		—		—
Total Commercial		3,420		2,849		1,503		229		—		1,819		—		—		9,820
Consumer:
Performing		7,434		3,830		—		—		—		—		—		—		11,264
Nonperforming		—		—		—		—		—		—		—		—		—
Total Consumer		7,434		3,830		—		—		—		—		—		—		11,264
Total	$	10,854	$	6,679	$	1,503	$	229	$	—	$	1,819	$	—	$	—	$	21,084
Current period gross charge-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial real estate:
Risk rating:
Pass (1-5)	$	140,948	$	118,484	$	99,775	$	41,944	$	39,762	$	219,830	$	5,310	$	—	$	666,053
OAEM (6)		—		—		—		—		—		2,203		144		—		2,347
Substandard (7)		—		—		—		—		—		2,732		50		—		2,782
Doubtful (8)		—		—		—		—		—		—		—		—		—
Total	$	140,948	$	118,484	$	99,775	$	41,944	$	39,762	$	224,765	$	5,504	$	—	$	671,182
Current period gross charge-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial:
Risk rating:
Pass (1-5)	$	28,531	$	35,229	$	47,478	$	23,762	$	4,121	$	65,513	$	39,315	$	—	$	243,949
OAEM (6)		—		—		—		—		—		—		—		—		—
Substandard (7)		116		340		—		—		—		3,642		1,072		—		5,170
Doubtful (8)		—		—		—		—		—		—		—		—		—
Total	$	28,647	$	35,569	$	47,478	$	23,762	$	4,121	$	69,155	$	40,387	$	—	$	249,119
Current period gross charge-offs	$	(8)	$	—	$	(81)	$	—	$	—	$	—	$	—	$	—	$	(89)
Consumer:
Performing		1,421		759		2,053		181		114		8		1,858		—		6,394
Nonperforming		—		—		—		—		—		—		14		—		14
Total	$	1,421	$	759	$	2,053	$	181	$	114	$	8	$	1,872	$	—	$	6,408
Current period gross charge-offs	$	(37)	$	(16)	$	(10)	$	(2)	$	(6)	$	—	$	(26)	$	—	$	(97)

‎

The following table presents the amortized cost basis of loans on nonaccrual status and loans past due over 90 days and still accruing as of September 30, 2023:

(Dollars in thousands)	Nonaccrual and Loans Past Due Over 90 Days+
					Loans Past Due
	Nonaccrual		Nonaccrual		Over 90 Days
	Without ACL		With ACL		Still Accruing
September 30, 2023
Residential Real Estate 1-4 Family
First liens	$	98	$	—	$	—
Junior liens and lines of credit		—		—		—
Total		98		—		—
Residential real estate - construction		—		—		—
Commercial real estate		—		—		—
Commercial		115		—		—
Consumer		—		—		14
Total	$	213	$	—	$	14

The following table reports the risk rating for those loans in the portfolio that were assigned an individual risk rating at December 31, 2022:

	Pass		OAEM		Substandard		Doubtful
(Dollars in thousands)	(1-5)		(6)		(7)		(8)		Total
December 31, 2022
Residential Real Estate 1-4 Family
First liens	$	144,377	$	—	$	120	$	—	$	144,497
Junior liens and lines of credit		73,688		—		—		—		73,688
Total		218,065		—		120		—		218,185
Residential real estate - construction		24,393		—		—		—		24,393
Commercial real estate		562,665		1,095		2,902		—		566,662
Commercial		228,085		2,751		4,766		—		235,602
Consumer		6,199		—		—		—		6,199
Total	$	1,039,407	$	3,846	$	7,788	$	—	$	1,051,041

‎

At September 30, 2023 the Bank had $0 of residential properties in the process of foreclosure compared to $94 thousand at December 31, 2022. The following table presents the aging of payments of the loan portfolio:

(Dollars in thousands)	Loans Past Due
							Total				Total
	30-59 Days		60-89 Days		90 Days+		Past Due		Current		Loans
September 30, 2023
Residential Real Estate 1-4 Family
First liens	$	21	$	232	$	98	$	351	$	186,880	$	187,231
Junior liens and lines of credit		399		—		—		399		71,427		71,826
Total		420		232		98		750		258,307		259,057
Residential real estate - construction		—		—		—		—		21,084		21,084
Commercial real estate		311		—		—		311		670,871		671,182
Commercial		662		—		115		777		248,342		249,119
Consumer		10		16		14		40		6,368		6,408
Total	$	1,403	$	248	$	227	$	1,878	$	1,204,972	$	1,206,850

									Total
									Past Due &				Total
December 31, 2022	30-59 Days		60-89 Days		90 Days+		Nonaccrual		Nonaccrual		Current		Loans
Residential Real Estate 1-4 Family
First liens	$	340	$	177	$	—	$	120	$	637	$	143,860	$	144,497
Junior liens and lines of credit		490		—		—		—		490		73,198		73,688
Total		830		177		—		120		1,127		217,058		218,185
Residential real estate - construction		—		—		—		—		—		24,393		24,393
Commercial real estate		649		—		—		—		649		566,013		566,662
Commercial		681		50		—		—		731		234,871		235,602
Consumer		29		5		13		—		47		6,152		6,199
Total	$	2,189	$	232	$	13	$	120	$	2,554	$	1,048,487	$	1,051,041

The following table presents, by class, the activity in the Allowance for Credit Losses (ACL) for the periods shown:

	Residential Real Estate 1-4 Family
	First		Junior Liens &				Commercial
(Dollars in thousands)	Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total
ACL at June 30, 2023	$	1,720	$	683	$	177	$	9,083	$	2,854	$	98	$	—	$	14,615
Charge-offs		—		—		—		—		(2)		(21)		—		(23)
Recoveries		—		—		4		—		15		51		—		70
Provision		(519)		(265)		61		1,124		503		(38)		—		866
ACL at September 30, 2023	$	1,201	$	418	$	242	$	10,207	$	3,370	$	90	$	—	$	15,528
ALL at December 31, 2022	$	459	$	234	$	343	$	7,493	$	4,846	$	133	$	667	$	14,175
Impact of adopting ASU 2016-13		1,096		493		(95)		584		(1,907)		(40)		(667)		(56)
Charge-offs		—		—		—		—		(89)		(97)		—		(186)
Recoveries		2		—		46		—		94		76		—		218
Provision		(356)		(309)		(52)		2,130		426		18		—		1,857
ACL at September 30, 2023	$	1,201	$	418	$	242	$	10,207	$	3,370	$	90	$	—	$	15,528
ALL at June 30, 2022	$	465	$	245	$	289	$	8,096	$	5,076	$	119	$	725	$	15,015
Charge-offs		—		—		—		—		(6)		(33)		—		(39)
Recoveries		—		1		—		—		8		4		—		13
Provision		(4)		3		75		9		(33)		38		(88)		—
ALL at September 30, 2022	$	461	$	249	$	364	$	8,105	$	5,045	$	128	$	637	$	14,989
ALL at December 31, 2021	$	475	$	252	$	325	$	8,168	$	5,127	$	130	$	589	$	15,066
Charge-offs		(20)		—		—		—		(69)		(79)		—		(168)
Recoveries		47		2		—		—		20		22		—		91
Provision		(41)		(5)		39		(63)		(33)		55		48		—
ALL at September 30, 2022	$	461	$	249	$	364	$	8,105	$	5,045	$	128	$	637	$	14,989

The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of December 31, 2022:

	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, 2022
Loans evaluated for ALL:
Individually	$	619	$	—	$	—	$	2,331	$	—	$	—	$	—	$	2,950
Collectively		143,878		73,688		24,393		564,331		235,602		6,199		—		1,048,091
Total	$	144,497	$	73,688	$	24,393	$	566,662	$	235,602	$	6,199	$	—	$	1,051,041
ALL established for ‎  loans evaluated:
Individually	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively		459		234		343		7,493		4,846		133		667		14,175
ALL at December 31, 2022	$	459	$	234	$	343	$	7,493	$	4,846	$	133	$	667	$	14,175

At September 30, 2023, there were no loans evaluated individually for the ACL.

On January 1, 2023, The Bank adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for troubled debt restructurings (“TDRs”) while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral.

No loan modifications were made to borrowers experiencing financial difficulties during the first nine months of 2023.

Prior to the adoption of ASU 2022-02, certain modified loans were reported as TDRs and impaired. The following table presents impaired loans as of December 31, 2022.

	Impaired Loans
	With No Allowance				With Allowance
(Dollars in thousands)			Unpaid				Unpaid
	Recorded		Principal		Recorded		Principal		Related
December 31, 2022	Investment		Balance		Investment		Balance		Allowance
Residential Real Estate 1-4 Family
First liens	$	619	$	619	$	—	$	—	$	—
Junior liens and lines of credit		—		—		—		—		—
Total		619		619		—		—		—
Residential real estate - construction		—		—		—		—		—
Commercial real estate		2,331		2,331		—		—		—
Commercial		—		—		—		—		—
Total	$	2,950	$	2,950	$	—	$	—	$	—

The following table presents TDR loans as of December 31, 2022:

								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, 2022
Residential real estate - construction	—	$	—	$	—	$	—	—	$	—
Residential real estate	5		619		619		—	—		—
Commercial real estate - owner occupied	3		783		783		—	—		—
Commercial real estate - farm land	3		1,466		1,466		—	—		—
Commercial real estate - construction and land development	—		—		—		—	—		—
Commercial real estate - other	1		82		82		—	—		—
Total	12	$	2,950	$	2,950	$	—	—	$	—
*The performing status is determined by the loans compliance with the modified terms. Nonperforming is considered 90 days or more past due.