Loans

6 Months Ended

Jun. 30, 2023

Loans

Loans

NOTE 7. Loans

The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses as of June 30, 2023 and December 31, 2022:

(In thousands)	June 30, 2023		December 31, 2022
SBA loans held for investment	$	39,878	$	38,468
SBA PPP loans		2,555		5,908
Commercial loans
SBA 504 loans		31,657		35,077
Commercial other		130,737		117,566
Commercial real estate		931,756		903,126
Commercial real estate construction		161,882		131,774
Residential mortgage loans		633,414		605,091
Consumer loans
Home equity		68,379		68,310
Consumer other		7,611		9,854
Residential construction loans		139,424		163,457
Total loans held for investment	$	2,147,293	$	2,078,631
SBA loans held for sale		20,074		27,928
Total loans	$	2,167,367	$	2,106,559

Loans held for investment are stated at the unpaid principal balance, net of unearned discounts and deferred loan origination fees and costs. In accordance with the level yield method, loan origination fees, net of direct loan origination costs, are deferred and recognized over the estimated life of the related loans as an adjustment to the loan yield. Interest is credited to operations primarily based upon the principal balance outstanding.

Loans are reported as past due when either interest or principal is unpaid in the following circumstances: fixed payment loans when the borrower is in arrears for two or more monthly payments; open end credit for two or more billing cycles; and single payment notes if interest or principal remains unpaid for 30 days or more.

Loans are charged off when collection is sufficiently questionable and when the Company can no longer justify maintaining the loan as an asset on the balance sheet. Loans qualify for charge-off when, after thorough analysis, all possible sources of repayment are insufficient. These include: 1) potential future cash flows, 2) value of collateral, and/or 3) strength of co-makers and guarantors. All unsecured loans are charged off upon the establishment of the loan’s nonaccrual status. Additionally, all loans classified as a loss or that portion of the loan classified as a loss is charged off.

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:

Small Business Administration (“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.

Loans held for sale represent the guaranteed portion of SBA loans and are reflected at the lower of aggregate cost or market value. The net amount of loan origination fees on loans sold is included in the carrying value and in the gain or loss on the sale. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets are recognized in income. All criteria for sale accounting must be met in order for the loan sales to occur.

Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions.

Serviced loans sold to others are not included in the accompanying Consolidated Balance Sheets. Income and fees collected for loan servicing are credited to noninterest income when earned, net of amortization on the related servicing assets.

Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company’s marketplace 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, Consumer and Residential Construction Loans: The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans and residential 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, loan to collateral value, credit history and the Company’s 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 commercial loan portfolio is then subject to on-going internal reviews for credit quality which in part is derived from ongoing collection and review of borrowers’ financial information, 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. This policy and the underlying procedures are reviewed and approved by the Board of Directors on a regular basis.

Credit Ratings

The Company places all SBA and commercial loans into various credit risk rating categories based on an assessment of the expected ability of the borrowers to properly service their debt. The assessment considers numerous factors including, but not limited to, current financial information on the borrower, historical payment experience, strength of any guarantor, nature of and value of any collateral, acceptability of the loan structure and documentation, relevant public information and current economic trends. This credit risk rating analysis is performed when the loan is initially underwritten and then annually based on set criteria in the loan policy.

The Company uses the following regulatory definitions for criticized and classified risk ratings:

Pass: 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: These loans have a potential weakness that deserves management’s close attention. If left uncorrected, the potential weaknesses may result in deterioration of the repayment prospects for the loans or of the institution’s credit position at some future date.

Substandard: These loans are inadequately protected by the current net worth and paying capacity of the obligor 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 institution will sustain some loss if the deficiencies are not corrected.

Loss: These loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable, based on currently existing facts, conditions and values. Once a borrower is deemed incapable of repayment of unsecured debt, the loan is termed a “Loss”, and charged off immediately.

For residential mortgage, consumer and residential construction 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 in default 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.

At June 30, 2023, the Company owned $0.3 million in commercial properties that were included in OREO in the Consolidated Balance Sheets, compared to none at December 31, 2022. Additionally, there were $13.7 million in the process of foreclosure at June 30, 2023, compared to $2.1 million at December 31, 2022. At June 30, 2023, foreclosures in process included loans in the Commercial, SBA, Residential mortgage loans, Consumer Construction and Home Equity categories.

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 in default 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. When a loan is classified as nonaccrual, interest accruals are discontinued and all past due interest previously recognized as income is reversed and charged against current period earnings. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans may be returned to an accrual status when the ability to collect is reasonably assured and when the loan is brought current as to principal and interest. 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 June 30, 2023 and December 31, 2022:

	June 30, 2023
					90+ days
	30‑59 days		60‑89 days		and still				Total past
(In thousands)	past due		past due		accruing		Nonaccrual		due		Current		Total loans
SBA loans held for investment	$	—	$	192	$	—	$	3,591	$	3,783	$	36,095	$	39,878
Commercial loans
SBA 504 loans		—		—		—		—		—		31,657		31,657
Commercial other		—		—		—		630		630		130,107		130,737
Commercial real estate		—		—		—		205		205		931,551		931,756
Commercial real estate construction		—		—		—		—		—		161,882		161,882
Residential mortgage loans		—		5,444		—		8,607		14,051		619,363		633,414
Consumer loans
Home equity		—		—		—		—		—		68,379		68,379
Consumer other		86		35		—		—		121		7,490		7,611
Residential construction loans		—		—		—		3,182		3,182		136,242		139,424
Total loans held for investment, excluding SBA PPP		86		5,671		—		16,215		21,972		2,122,766		2,144,738
SBA loans held for sale		—		—		—		—		—		20,074		20,074
Total loans, excluding SBA PPP	$	86	$	5,671	$	—	$	16,215	$	21,972	$	2,142,840	$	2,164,812

	December 31, 2022
					90+ days
	30‑59 days		60‑89 days		and still				Total past
(In thousands)	past due		past due		accruing		Nonaccrual		due		Current		Total loans
SBA loans held for investment	$	—	$	576	$	—	$	690	$	1,266	$	37,202	$	38,468
Commercial loans
SBA 504 loans		—		—		—		—		—		35,077		35,077
Commercial other		198		300		—		777		1,275		116,291		117,566
Commercial real estate		22		188		—		805		1,015		902,111		903,126
Commercial real estate construction		—		—		—		—		—		131,774		131,774
Residential mortgage loans		—		982		—		3,361		4,343		600,748		605,091
Consumer loans
Home equity		—		—		—		—		—		68,310		68,310
Consumer other		18		7		—		—		25		9,829		9,854
Residential construction loans		—		—		—		3,432		3,432		160,025		163,457
Total loans held for investment, excluding SBA PPP		238		2,053		—		9,065		11,356		2,061,367		2,072,723
SBA loans held for sale		2,195		—		—		—		2,195		25,733		27,928
Total loans, excluding SBA PPP	$	2,433	$	2,053	$	—	$	9,065	$	13,551	$	2,087,100	$	2,100,651

The company is using the practical expedient to exclude accrued interest receivable from credit loss measurement. At June 30, 2023, there was $1.3 million of accrued interest on securities and $12.6 million of accrued interest on loans.

The following table shows the internal loan classification risk by loan portfolio classification by origination year as of June 30, 2023:

	Term Loans
	Amortized Cost Basis by Origination Year
(In thousands)			2023		2022		2021		2020		2019		2018 and Earlier		Revolving Loans Amortized Cost Basis		Total
SBA loans held for investment
Risk Rating:
Pass		$	979	$	7,339	$	5,132	$	6,247	$	2,704	$	11,627	$	-	$	34,028
Special Mention			-		-		-		702		-		758		-		1,460
Substandard			-		1,361		2,237		-		-		792		-		4,390
Total SBA loans held for investment		$	979	$	8,700	$	7,369	$	6,949	$	2,704	$	13,177	$	-	$	39,878
SBA loans held for investment
Current-period gross writeoffs		$	-	$	-	$	-	$	-	$	113	$	-	$	-	$	113
SBA PPP loans
Risk Rating:
Pass		$	-	$	-	$	2,555	$	-	$	-	$	-	$	-	$	2,555
Special Mention			-		-		-		-		-		-		-		-
Substandard			-		-		-		-		-		-		-		-
Total SBA PPP loans		$	-	$	-	$	2,555	$	-	$	-	$	-	$	-	$	2,555
Commercial loans
Risk Rating:
Pass		$	84,290	$	345,498	$	185,728	$	138,087	$	103,348	$	286,754	$	93,312	$	1,237,017
Special Mention			-		86		2,100		-		2,251		11,386		395		16,218
Substandard			-		-		-		220		-		2,577		-		2,797
Total commercial loans		$	84,290	$	345,584	$	187,828	$	138,307	$	105,599	$	300,717	$	93,707	$	1,256,032
Residential mortgage loans
Risk Rating:
Performing		$	69,505	$	266,630	$	77,180	$	54,857	$	34,294	$	122,341	$	-	$	624,807
Nonperforming			1,711		2,331		2,413		795		276		1,081		-		8,607
Total residential mortgage loans		$	71,216	$	268,961	$	79,593	$	55,652	$	34,570	$	123,422	$	-	$	633,414
Consumer loans
Risk Rating:
Performing		$	1,562	$	5,438	$	5,650	$	724	$	3,399	$	8,321	$	50,626	$	75,720
Nonperforming			-		-		-		-		-		-		270		270
Total consumer loans		$	1,562	$	5,438	$	5,650	$	724	$	3,399	$	8,321	$	50,896	$	75,990
Consumer loans
Current-period gross writeoffs		$	-	$	-	$	345	$	-	$	-	$	-	$	-	$	345
Residential construction
Risk Rating:
Performing		$	13,093	$	76,151	$	37,515	$	7,751	$	500	$	1,232	$	-	$	136,242
Nonperforming			-		-		352		-		-		1,795		1,035		3,182
Total residential construction loans		$	13,093	$	76,151	$	37,867	$	7,751	$	500	$	3,027	$	1,035	$	139,424
Residential construction
Current-period gross writeoffs		$	-	$	-	$	-	$	-	$	-	$	500	$	400	$	900
Total loans held for investment		$	171,140	$	704,834	$	320,862	$	209,383	$	146,772	$	448,664	$	145,638	$	2,147,293

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, 2022:

	December 31, 2022
	SBA & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	37,163	$	558	$	747	$	38,468
SBA PPP loans		5,908		—		—		5,908
Commercial loans
SBA 504 loans		35,077		—		—		35,077
Commercial other		110,107		6,220		1,239		117,566
Commercial real estate		894,110		6,228		2,788		903,126
Commercial real estate construction		131,774		—		—		131,774
Total commercial loans		1,171,068		12,448		4,027		1,187,543
Total SBA and commercial loans	$	1,214,139	$	13,006	$	4,774	$	1,231,919
			Residential mortgage, Consumer & Residential construction loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	601,730	$	3,361	$	605,091
Consumer loans
Home equity				68,310		—		68,310
Consumer other				9,854		—		9,854
Total consumer loans				78,164		—		78,164
Residential construction loans				160,025		3,432		163,457
Total residential mortgage, consumer and residential construction loans			$	839,919	$	6,793	$	846,712

Modifications

The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon asset origination or acquisition. The starting point for the estimate of the allowance for creditlosses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. The Company uses a weighted-average remaining maturity model to determine the allowance for credit losses. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification.

Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification. Occasionally, the Company modifies loans by providing principal forgiveness on certain of its real estate loans. When principal forgiveness is provided, the amortized cost basis of the asset is written off against the allowance for credit losses. The amount of the principal forgiveness is deemed to be uncollectible; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses.

In some cases, the Company will modify a certain loan by providing multiple types of concessions. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted.

The following table shows the amortized cost basis at the end of the reporting period of the loans modified to borrowers experiencing financial difficulty, disaggregated by class of gross loans and type of concession granted (numbers in thousands) during the six months ended June 30, 2023:

	Term Extension
		Amortized Cost Basis	% of Total Class of
		June 30, 2023	Gross Loans
Commercial	$	954	0.08	%

Modifications for the year made to borrowers experiencing financial difficulty added a weighted average of 7.3 years to the life of the modified loans, which reduced monthly payment amounts for the borrowers.

Upon the Company's determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount. No loans that were modified during the three and six months ended June 30, 2023 had a payment default during the period and all loans were current as of June 30, 2023.