Loans

The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses for the past two years:



(In thousands)	December 31, 2019		December 31, 2018
SBA loans held for investment	$	35,767	$	39,333
Commercial loans
SBA 504 loans	26,726		29,155
Commercial other	112,014		104,587
Commercial real estate	578,643		510,370
Commercial real estate construction	47,649		49,990
Residential mortgage loans	467,706		436,056
Consumer loans
Home equity	69,589		59,887
Consumer other	73,935		64,017
Total loans held for investment	$	1,412,029	$	1,293,395
SBA loans held for sale	13,529		11,171
Total loans	$	1,425,558	$	1,304,566

Loans are made to individuals as well as commercial entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type. A description of the Company's different loan segments follows:

SBA Loans: SBA 7(a) loans, on which the SBA has historically provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses' major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Loans will generally be guaranteed in full or for a meaningful amount by the businesses' major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.

Residential Mortgage and Consumer Loans: The Company originates mortgage and consumer loans including principally residential real estate, home equity lines and loans and consumer construction lines. The Company originates qualified mortgages which are generally sold in the secondary market and nonqualified mortgages which are generally held for investment. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and Company relationship with the borrower.

Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when the Company initiates contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.

The Company's extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company's loans. These policies and procedures are reviewed and approved by the Board of Directors on a regular basis.

Credit Ratings

For SBA 7(a), and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.

Pass: Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed “Pass”.

Special Mention: Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in start up or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. This definition is intended to ensure that the “Special Mention” category is not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.

Substandard: Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”. A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.

A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.

Loss: Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.

For residential mortgage and consumer loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2019:



	December 31, 2019
	SBA & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	34,202	$	1,115	$	450	$	35,767
Commercial loans
SBA 504 loans	24,878		1,808		40		26,726
Commercial other	107,220		3,361		1,433		112,014
Commercial real estate	576,326		758		1,559		578,643
Commercial real estate construction	47,649		—		—		47,649
Total commercial loans	756,073		5,927		3,032		765,032
Total SBA and commercial loans	$	790,275	$	7,042	$	3,482	$	800,799
	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	463,770	$	3,936	$	467,706
Consumer loans
Home equity			69,589		—		69,589
Consumer other			73,915		20		73,935
Total consumer loans			143,504		20		143,524
Total residential mortgage and consumer loans			$	607,274	$	3,956	$	611,230

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2018:



	December 31, 2018
	SBA & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	37,198	$	601	$	1,534	$	39,333
Commercial loans
SBA 504 loans	28,105		—		1,050		29,155
Commercial other	103,806		322		459		104,587
Commercial real estate	504,022		2,879		3,469		510,370
Commercial real estate construction	49,990		—		—		49,990
Total commercial loans	685,923		3,201		4,978		694,102
Total SBA and commercial loans	$	723,121	$	3,802	$	6,512	$	733,435
	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	431,845	$	4,211	$	436,056
Consumer loans
Home equity			59,861		26		59,887
Consumer other			64,017		—		64,017
Total consumer loans			123,878		26		123,904
Total residential mortgage and consumer loans			$	555,723	$	4,237	$	559,960

Nonperforming and Past Due Loans

Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well secured and in process of collection. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.

The following tables set forth an aging analysis of past due and nonaccrual loans as of December 31, 2019 and December 31, 2018:



	December 31, 2019
(In thousands)	30-59 days past due		60-89 days past due		90+ days and still accruing		Nonaccrual (1)		Total past due		Current		Total loans
SBA loans held for investment	$	1,048	$	—	$	—	$	1,164	$	2,212	$	33,555	$	35,767
Commercial loans
SBA 504 loans	—		1,808		—		—		1,808		24,918		26,726
Commercial other	71		—		—		316		387		111,627		112,014
Commercial real estate	215		—		—		213		428		578,215		578,643
Commercial real estate construction	—		—		—		—		—		47,649		47,649
Residential mortgage loans	4,383		1,676		930		3,936		10,925		456,781		467,706
Consumer loans
Home equity	1,446		178		—		—		1,624		67,965		69,589
Consumer other	—		113		—		20		133		73,802		73,935
Total loans held for investment	$	7,163	$	3,775	$	930	$	5,649	$	17,517	$	1,394,512	$	1,412,029
SBA loans held for sale	—		—		—		—		—		13,529		13,529
Total loans	$	7,163	$	3,775	$	930	$	5,649	$	17,517	$	1,408,041	$	1,425,558


(1)	At December 31, 2019, nonaccrual loans included $59 thousand of loans guaranteed by the SBA.



	December 31, 2018
(In thousands)	30-59 days past due		60-89 days past due		90+ days and still accruing		Nonaccrual (1)		Total past due		Current		Total loans
SBA loans held for investment	$	—	$	—	$	—	$	1,560	$	1,560	$	37,773	$	39,333
Commercial loans
SBA 504 loans	—		—		—		—		—		29,155		29,155
Commercial other	—		—		—		30		30		104,557		104,587
Commercial real estate	301		—		—		1,046		1,347		509,023		510,370
Commercial real estate construction	—		—		—		—		—		49,990		49,990
Residential mortgage loans	3,801		1,204		98		4,211		9,314		426,742		436,056
Consumer loans
Home equity	396		—		—		26		422		59,465		59,887
Consumer other	300		—		—		—		300		63,717		64,017
Total loans held for investment	$	4,798	$	1,204	$	98	$	6,873	$	12,973	$	1,280,422	$	1,293,395
SBA loans held for sale	—		—		—		—		—		11,171		11,171
Total loans	$	4,798	$	1,204	$	98	$	6,873	$	12,973	$	1,291,593	$	1,304,566


(1)	At December 31, 2018, nonaccrual loans included $89 thousand of loans guaranteed by the SBA.

Impaired Loans

The Company has defined impaired loans to be all nonperforming loans and troubled debt restructurings. Management considers a loan impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract.

The following tables provide detail on the Company’s loans individually evaluated for impairment with the associated allowance amount, if applicable, as of December 31, 2019 and December 31, 2018:



	December 31, 2019
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	1,224	$	1,064	$	—
Commercial loans
Commercial real estate	213		213		—
Total commercial loans	213		213		—
Total impaired loans with no related allowance	1,437		1,277		—
With an allowance:
SBA loans held for investment (1)	157		41		41
Commercial loans
Commercial other	816		316		316
Commercial real estate	705		705		57
Total commercial loans	1,521		1,021		373
Total impaired loans with a related allowance	1,678		1,062		414
Total individually evaluated impaired loans:
SBA loans held for investment (1)	1,381		1,105		41
Commercial loans
Commercial other	816		316		316
Commercial real estate	918		918		57
Total commercial loans	1,734		1,234		373
Total individually evaluated impaired loans	$	3,115	$	2,339	$	414


(1)	Balances are reduced by amount guaranteed by the SBA of $59 thousand at December 31, 2019.



	December 31, 2018
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	359	$	353	$	—
Commercial loans
Commercial real estate	1,046		1,046		—
Total commercial loans	1,046		1,046		—
Total impaired loans with no related allowance	1,405		1,399		—
With an allowance:
SBA loans held for investment (1)	1,257		1,118		540
Commercial loans
Commercial other	30		30		30
Commercial real estate	745		745		97
Total commercial loans	775		775		127
Total impaired loans with a related allowance	2,032		1,893		667
Total individually evaluated impaired loans:
SBA loans held for investment (1)	1,616		1,471		540
Commercial loans
Commercial other	30		30		30
Commercial real estate	1,791		1,791		97
Total commercial loans	1,821		1,821		127
Total individually evaluated impaired loans	$	3,437	$	3,292	$	667


(1)	Balances are reduced by amount guaranteed by the SBA of $89 thousand at December 31, 2018.

The following table presents the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the years ended December 31, 2019, 2018 and 2017. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, therefore no interest income is recognized. The interest recognized on impaired loans noted below represents accruing troubled debt restructurings only and nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.



	For the years ended December 31,
	2019				2018				2017
(In thousands)	Average recorded investment		Interest income recognized on impaired loans		Average recorded investment		Interest income recognized on impaired loans		Average recorded investment		Interest income recognized on impaired loans
SBA loans held for investment (1)	$	679	$	17	$	1,063	$	3	$	668	$	47
Commercial loans
SBA 504 loans	—		—		—		—		82		—
Commercial other	264		6		12		—		25		—
Commercial real estate	1,258		36		2,092		100		685		43
Total	$	2,201	$	59	$	3,167	$	103	$	1,460	$	90


(1)	Balances are reduced by the average amount guaranteed by the SBA of $124 thousand, $85 thousand and $318 thousand for years ended December 31, 2019, 2018 and 2017, respectively.

Troubled Debt Restructurings

The Company's loan portfolio includes certain loans that have been modified in a troubled debt restructuring (“TDR”). TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, other modifications of payment terms, or a combination of modifications. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs if the loan is collateral-dependent. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.

The company had one performing TDR with a balance of $705 thousand and $745 thousand as of December 31, 2019 and December 31, 2018, respectively, which was included in the impaired loan numbers as of such dates. At December 31, 2019, and December 31, 2018, there were specific reserves on the performing TDR of $57 thousand and $97 thousand, respectively. The loan remains in accrual status since it continues to perform in accordance with the restructured terms.

To date, the Company’s TDRs consisted of interest rate reductions, interest only periods, principal balance reductions, and maturity extensions. There were no loans modified as a TDR within the previous 12 months that subsequently defaulted at some point during the years ended December 31, 2019 or 2018. In this case, the subsequent default is defined as 90 days past due or transferred to nonaccrual status.

Other Loan Information

Servicing Assets:

Loans sold to others and serviced by the Company are not included in the accompanying Consolidated Balance Sheets. The total amount of such loans serviced, but owned by third party investors, amounted to approximately $130.6 million and $143.7 million at December 31, 2019 and 2018, respectively. At December 31, 2019 and 2018, the carrying value, which approximates fair value, of servicing assets was $2.0 million and $2.4 million, respectively, and is included in Other Assets. The fair value of SBA servicing assets was determined using a discount rate of 15%, constant prepayment speeds ranging from 15% to 18%, and interest strip multiples ranging from 2.08% to 3.80%, depending on each individual credit. The fair value of mortgage servicing assets was determined using a discount rate of 12% and the present value of excess servicing over 7 years. A summary of the changes in the related servicing assets for the past three years follows:



	For the years ended December 31,
(In thousands)	2019			2018			2017
Balance, beginning of year	$	2,375		$	1,800		$	2,086
Servicing assets capitalized	643			939			172
Amortization of expense	(992		)	(364		)	(458		)
Balance, end of year	$	2,026		$	2,375		$	1,800

In addition, the Company had a $1.3 million and $1.5 million discount related to the retained portion of the unsold SBA loans at December 31, 2019 and 2018, respectively.

Officer and Director Loans:

In the ordinary course of business, the Company may extend credit to officers, directors or their associates. These loans are subject to the Company’s normal lending policy. An analysis of such loans, all of which are current as to principal and interest payments, is as follows:



(In thousands)	December 31, 2019			December 31, 2018
Balance, beginning of year	$	22,429		$	33,109
New loans and advances	73			4,083
Loan repayments	(4,661		)	(14,763		)
Balance, end of year	$	17,841		$	22,429

Loan Portfolio Collateral:

The majority of the Company’s loans are secured by real estate. Declines in the market values of real estate in the Company’s trade area impact the value of the collateral securing its loans. This could lead to greater losses in the event of defaults on loans secured by real estate. At December 31, 2019, and December 31, 2018 approximately 94% of the Company’s loan portfolio was secured by real estate.