Loans and Allowance for Loan Losses

9 Months Ended

Sep. 30, 2018

For financial reporting purposes, the Company classifies its loan portfolio based on the underlying collateral utilized to secure each loan. This classification is consistent with those utilized in the Quarterly Report of Condition and Income filed by the Bank with the Federal Deposit Insurance Corporation (“FDIC”).

The following schedule details the loans of the Company at September 30, 2018 and December 31, 2017:



	(In Thousands)
	September 30, 2018			December 31, 2017
Mortgage loans on real estate
Residential 1-4 family	$	443,392		$	406,667
Multifamily	124,515			91,992
Commercial	709,067			661,223
Construction and land development	478,835			392,039
Farmland	24,834			34,212
Second mortgages	9,424			8,952
Equity lines of credit	75,713			60,650
Total mortgage loans on real estate	1,865,780			1,655,735
Commercial loans	51,226			47,939
Agricultural loans	1,737			1,665
Consumer installment loans
Personal	43,412			39,624
Credit cards	3,494			3,385
Total consumer installment loans	46,906			43,009
Other loans	9,231			10,193
Total loans before net deferred loan fees	1,974,880			1,758,541
Net deferred loan fees	(7,136		)	(7,379		)
Total loans	1,967,744			1,751,162
Less: Allowance for loan losses	(26,628		)	(23,909		)
Net loans	$	1,941,116		$	1,727,253

Risk characteristics relevant to each portfolio segment are as follows:

Construction and land development: Loans for non-owner-occupied real estate construction or land development are generally repaid through cash flow related to the operation, sale or refinance of the property. The Company also finances construction loans for owner-occupied properties. A portion of the Company’s construction and land portfolio segment is comprised of loans secured by residential product types (residential land and single-family construction). With respect to construction loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction and land development loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates, market sales activity, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayments substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

1-4 family residential real estate: Residential real estate loans represent loans to consumers or investors to finance a residence. These loans are typically financed on 15 to 30 year amortization terms, but generally with shorter maturities of 5 to 15 years. Many of these loans are extended to borrowers to finance their primary or secondary residence. Loans to an investor secured by a 1-4 family residence will be repaid from either the rental income from the property or from the sale of the property. This loan segment also includes closed-end home equity loans that are secured by a first or second mortgage on the borrower’s residence. This allows customers to borrow against the equity in their home. Loans in this portfolio segment are underwritten and approved based on a number of credit quality criteria including limits on maximum Loan-to-Value ("LTV") ratios, minimum credit scores, and maximum debt to income ratios. Real estate market values as of the time the loan is made directly affect the amount of credit extended and, in addition, changes in these residential property values impact the depth of potential losses in this portfolio segment.

1-4 family HELOC: This loan segment includes open-end home equity loans that are secured by a first or second mortgage on the borrower’s residence. This allows customers to borrow against the equity in their home utilizing a revolving line of credit. These loans are underwritten and approved based on a number of credit quality criteria including limits on maximum LTV ratios, minimum credit scores, and maximum debt to income ratios. Real estate market values as of the time the loan is made directly affect the amount of credit extended and, in addition, changes in these residential property values impact the depth of potential losses in this portfolio segment. Because of the revolving nature of these loans, as well as the fact that many represent second mortgages, this portfolio segment can contain more risk than the amortizing 1-4 family residential real estate loans.

Multi-family and commercial real estate: Multi-family and commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.

Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting the market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. Non-owner occupied commercial real estate loans are loans secured by multifamily and commercial properties where the primary source of repayment is derived from rental income associated with the property (that is, loans for which 50 percent or more of the source of repayment comes from third party, nonaffiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. These loans are made to finance income-producing properties such as apartment buildings, office and industrial buildings, and retail properties. Owner-occupied commercial real estate loans are loans where the primary source of repayment is the cash flow from the ongoing operations and business activities conducted by the party, or affiliate of the party, who owns the property.

Commercial and Industrial: The commercial and industrial loan portfolio segment includes commercial and industrial loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases or other expansion projects. Collection risk in this portfolio is driven by the creditworthiness of underlying borrowers, particularly cash flow from customers’ business operations. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower, if any. The cash flows of borrowers, however, may not be as expected and any collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and usually incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Consumer: The consumer loan portfolio segment includes non-real estate secured direct loans to consumers for household, family, and other personal expenditures. Consumer loans may be secured or unsecured and are usually structured with short or medium term maturities. These loans are underwritten and approved based on a number of consumer credit quality criteria including limits on maximum LTV ratios on secured consumer loans, minimum credit scores, and maximum debt to income ratios. Many traditional forms of consumer installment credit have standard monthly payments and fixed repayment schedules of one to five years. These loans are made with either fixed or variable interest rates that are based on specific indices. Installment loans fill a variety of needs, such as financing the purchase of an automobile, a boat, a recreational vehicle or other large personal items, or for consolidating debt. These loan may be unsecured or secured by an assignment of title, as in an automobile loan, or by money in a bank account. In addition to consumer installment loans, this portfolio segment also includes secured and unsecured personal lines of credit as well as overdraft protection lines. Loans in this portfolio segment are sensitive to unemployment and other key consumer economic measures.

The adequacy of the allowance for loan losses is assessed at the end of each calendar quarter. The level of the allowance is based upon evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, current and anticipated economic conditions, historical loss experience, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations.

Transactions in the allowance for loan losses for the nine months ended September 30, 2018 and year ended December 31, 2017 are summarized as follows:



	(In Thousands)
	Residential 1-4 Family			Multifamily	Commercial Real Estate	Construction		Farmland		Second Mortgages	Equity Lines of Credit	Commercial	Agricultural, Installment and Other		Total
September 30, 2018
Allowance for loan losses:
Beginning balance	$	5,156		1,011	9,267	6,094		487		94	723	401	676		23,909
Provision	1,147			296	322	1,001		(271	)	1	123	4	578		3,201
Charge-offs	(78		)	—	—	(18	)	—		—	—	—	(839	)	(935	)
Recoveries	40			—	—	68		—		—	1	3	341		453
Ending balance	$	6,265		1,307	9,589	7,145		216		95	847	408	756		26,628
Ending balance individually evaluated for impairment	$	884		—	310	—		—		—	—	—	—		1,194
Ending balance collectively evaluated for impairment	$	5,381		1,307	9,279	7,145		216		95	847	408	756		25,434
Loans:
Ending balance	$	443,392		124,515	709,067	478,835		24,834		9,424	75,713	51,226	57,874		1,974,880
Ending balance individually evaluated for impairment	$	3,342		—	2,477	844		310		—	—	—	—		6,973
Ending balance collectively evaluated for impairment	$	440,050		124,515	706,590	477,991		24,524		9,424	75,713	51,226	57,874		1,967,907



	Residential 1-4 Family			Multifamily	Commercial Real Estate		Construction	Farmland		Second Mortgages		Equity Lines of Credit	Commercial	Agricultural, Installment and Other		Total
December 31, 2017
Allowance for loan losses:
Beginning balance	$	4,571		839	9,541		5,387	658		112		675	386	562		22,731
Provision	675			172	(414	)	586	(168	)	(10	)	45	9	786		1,681
Charge-offs	(118		)	—	—		—	(3	)	(11	)	—	—	(1,090	)	(1,222	)
Recoveries	28			—	140		121	—		3		3	6	418		719
Ending balance	$	5,156		1,011	9,267		6,094	487		94		723	401	676		23,909
Ending balance individually evaluated for impairment	$	136		—	291		—	—		—		—	—	—		427
Ending balance collectively evaluated for impairment	$	5,020		1,011	8,976		6,094	487		94		723	401	676		23,482
Loans:
Ending balance	$	406,667		91,992	661,223		392,039	34,212		8,952		60,650	47,939	54,867		1,758,541
Ending balance individually evaluated for impairment	$	2,678		—	3,046		1,182	—		—		—	—	—		6,906
Ending balance collectively evaluated for impairment	$	403,989		91,992	658,177		390,857	34,212		8,952		60,650	47,939	54,867		1,751,635

Impaired Loans

At September 30, 2018, the Company had certain impaired loans of $2.1 million which were on non-accruing interest status. At December 31, 2017, the Company had certain impaired loans of $1.7 million which were on non-accruing interest status. In each case, at the date such loans were placed on nonaccrual status, the Company reversed all previously accrued interest income against current year earnings. The following table presents the Company’s impaired loans at September 30, 2018 and December 31, 2017.



	In Thousands
	Recorded Investment		Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
September 30, 2018
With no related allowance recorded:
Residential 1-4 family	$	1,654	1,629	—	2,141	99
Multifamily	—		—	—	—	—
Commercial real estate	318		318	—	464	12
Construction	846		844	—	946	32
Farmland	310		310	—	233	—
Second mortgages	—		—	—	—	—
Equity lines of credit	—		—	—	—	—
Commercial	—		—	—	—	—
Agricultural, installment and other	—		—	—	—	—
	$	3,128	3,101	—	3,784	143
With related allowance recorded:
Residential 1-4 family	$	1,768	1,988	884	1,474	63
Multifamily	—		—	—	—	—
Commercial real estate	2,161		2,159	310	2,161	13
Construction	—		—	—	—	—
Farmland	—		—	—	—	—
Second mortgages	—		—	—	—	—
Equity lines of credit	—		—	—	—	—
Commercial	—		—	—	—	—
Agricultural, installment and other	—		—	—	—	—
	$	3,929	4,147	1,194	3,635	76
Total
Residential 1-4 family	$	3,422	3,617	884	3,615	162
Multifamily	—		—	—	—	—
Commercial real estate	2,479		2,477	310	2,625	25
Construction	846		844	—	946	32
Farmland	310		310	—	233	—
Second mortgages	—		—	—	—	—
Equity lines of credit	—		—	—	—	—
Commercial	—		—	—	—	—
Agricultural, installment and other	—		—	—	—	—
	$	7,057	7,248	1,194	7,419	219



	In Thousands
	Recorded Investment		Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
December 31, 2017
With no related allowance recorded:
Residential 1-4 family	$	2,314	2,322	—	742	103
Multifamily	—		—	—	—	—
Commercial real estate	893		889	—	902	39
Construction	1,185		1,182	—	1,354	64
Farmland	—		—	—	26	—
Second mortgages	—		—	—	—	—
Equity lines of credit	—		—	—	—	—
Commercial	—		—	—	—	—
Agricultural, installment and other	—		—	—	—	—
	$	4,392	4,393	—	3,024	206
With related allowance recorded:
Residential 1-4 family	$	409	581	136	461	29
Multifamily	—		—	—	—	—
Commercial real estate	2,157		2,157	291	2,894	17
Construction	—		—	—	—	—
Farmland	—		—	—	—	—
Second mortgages	—		—	—	—	—
Equity lines of credit	—		—	—	—	—
Commercial	—		—	—	—	—
Agricultural, installment and other	—		—	—	—	—
	$	2,566	2,738	427	3,355	46
Total:
Residential 1-4 family	$	2,723	2,903	136	1,203	132
Multifamily	—		—	—	—	—
Commercial real estate	3,050		3,046	291	3,796	56
Construction	1,185		1,182	—	1,354	64
Farmland	—		—	—	26	—
Second mortgages	—		—	—	—	—
Equity lines of credit	—		—	—	—	—
Commercial	—		—	—	—	—
Agricultural, installment and other	—		—	—	—	—
	$	6,958	7,131	427	6,379	252

Impaired loans also include loans that the Bank may elect to formally restructure due to the weakening credit status of a borrower such that the restructuring may facilitate a repayment plan that minimizes the potential losses that the Bank may otherwise incur. These loans are classified as impaired loans and, if on non-accruing status as of the date of restructuring, the loans are included in the nonperforming loan balances. Not included in nonperforming loans are loans that have been restructured that were performing as of the restructure date.

Troubled Debt Restructuring

The Bank’s loan portfolio includes certain loans that have been modified in a troubled debt restructuring ("TDR"), where economic or other concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Bank’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

The following table summarizes the carrying balances of TDRs at September 30, 2018 and December 31, 2017.



	September 30, 2018		December 31, 2017
	(In thousands)
Performing TDRs	$	1,758	$	2,250
Nonperforming TDRs	1,324		1,834
Total TDRS	$	3,082	$	4,084

The following table outlines the amount of each troubled debt restructuring categorized by loan classification for the nine months ended September 30, 2018 and the year ended December 31, 2017 (in thousands, except for number of contracts):



	September 30, 2018					December 31, 2017
	Number of Contracts	Pre Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment, Net of Related Allowance		Number of Contracts	Pre Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment, Net of Related Allowance
Residential 1-4 family	3	$	49	$	49	6	$	610	$	535
Multifamily	—	—		—		—	—		—
Commercial real estate	—	—		—		—	—		—
Construction	—	—		—		—	—		—
Farmland	1	310		310		1	86		86
Second mortgages	—	—		—		—	—		—
Equity lines of credit	—	—		—		—	—		—
Commercial	—	—		—		—	—		—
Agricultural, installment and other	1	92		92		1	3		3
Total	5	$	451	$	451	8	$	699	$	624

As of September 30, 2018 the Company had two loan relationships totaling $551,000 that had been previously classified as TDRs subsequently default within twelve months of restructuring. As of December 31, 2017, the Company had one loan relationship totaling $103,000 that had been previously classified as a TDR subsequently default within twelve months of restructuring. A default is defined as an occurrence which violates the terms of the receivable’s contract.

As of September 30, 2018 and December 31, 2017, the Company’s recorded investment in consumer mortgage loans in the process of foreclosure amounted to $280,000 and $201,000, respectively.

Potential problem loans, which include nonperforming loans, amounted to approximately $13.3 million at September 30, 2018 and $16.2 million at December 31, 2017. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the FDIC, the Bank’s primary federal regulator, for loans classified as special mention, substandard, or doubtful.

The following summary presents the Bank's loan balances by primary loan classification and the amount classified within each risk rating category. Pass rated loans include all credits other than those included in special mention, substandard and doubtful which are defined as follows:


•	Special mention loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.


•	Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.


•	Doubtful loans have all the characteristics of substandard loans 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. The Bank considers all doubtful loans to be impaired and places such loans on nonaccrual status.

The following table is a summary of the Bank’s loan portfolio by risk rating at September 30, 2018 and December 31, 2017:



	(In Thousands)
	Residential 1-4 Family		Multifamily	Commercial Real Estate	Construction	Farmland	Second Mortgages	Equity Lines of Credit	Commercial	Agricultural, installment and other	Total
September 30, 2018
Credit Risk Profile by Internally Assigned Rating
Pass	$	434,841	124,515	705,453	478,670	24,365	9,203	75,557	51,226	57,750	1,961,580
Special Mention	3,876		—	1,690	68	93	181	—	—	82	5,990
Substandard	4,675		—	1,924	97	376	40	156	—	41	7,309
Doubtful	—		—	—	—	—	—	—	—	1	1
Total	$	443,392	124,515	709,067	478,835	24,834	9,424	75,713	51,226	57,874	1,974,880
December 31, 2017
Credit Risk Profile by Internally Assigned Rating
Pass	$	395,664	91,992	657,456	391,778	33,500	8,765	60,553	47,937	54,697	1,742,342
Special Mention	5,677		—	646	84	125	43	41	2	77	6,695
Substandard	5,326		—	3,121	177	587	144	56	—	93	9,504
Doubtful	—		—	—	—	—	—	—	—	—	—
Total	$	406,667	91,992	661,223	392,039	34,212	8,952	60,650	47,939	54,867	1,758,541

- Definition

The entire disclosure for claims held for amounts due a entity, excluding financing receivables. Examples include, but are not limited to, trade accounts receivables, notes receivables, loans receivables. Includes disclosure for allowance for credit losses.

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