Note 5. Loans and Allowance for Credit Losses | Note 5. Loans and Allowance for Credit Losses The Bank makes loans to customers primarily in the Washington, D.C. metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets. Loans, net of unamortized net deferred fees, at September 30, 2019 and December 31, 2018 are summarized by type as follows: September 30, 2019 December 31, 2018 (dollars in thousands) Amount % Amount % Commercial $ 1,466,862 19 % $ 1,553,112 22 % Income producing - commercial real estate 3,812,284 51 % 3,256,900 46 % Owner occupied - commercial real estate 956,345 13 % 887,814 13 % Real estate mortgage - residential 104,563 1 % 106,418 2 % Construction - commercial and residential 1,053,789 14 % 1,039,815 15 % Construction - C&I (owner occupied) 81,916 1 % 57,797 1 % Home equity 81,117 1 % 86,603 1 % Other consumer 2,285 — 2,988 — Total loans 7,559,161 100 % 6,991,447 100 % Less: allowance for credit losses ( 73,720 ) ( 69,944 ) Net loans $ 7,485,441 $ 6,921,503 Unamortized net deferred fees amounted to $ 24.5 26.5 As of September 30, 2019 and December 31, 2018, the Bank serviced $ 102.9 111.1 Loan Origination / Risk Management The Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations. The composition of the Company’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and income producing real estate. At September 30, 2019, owner occupied - commercial real estate and construction - C&I (owner occupied) represent approximately 14 65 79 85 80 1.15 1.0 The Company is also an active traditional commercial lender providing loans for a variety of purposes, including working capital, equipment and account receivable financing. This loan category represents approximately 19 2 Approximately 1 Approximately 1 22 Loans are secured primarily by duly recorded first deeds of trust or mortgages. In some cases, the Bank may accept a recorded junior trust position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is customarily required. Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank. Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects. Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures, and; 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing. Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums. Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination. Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 Substantially all construction draw requests must be presented in writing on American Institute of Architects documents and certified either by the contractor, the borrower and/or the borrower’s architect. Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or their Chief Financial Officer. Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition. Commercial permanent loans are generally secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. The debt service coverage ratio is ordinarily at least 1.15 to 1.0 . As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels. Commercial permanent loans generally are underwritten with a term not greater than 10 5 7 25 The Company’s loan portfolio includes ADC real estate loans including both investment and owner occupied projects. ADC loans amounted to $ 1.66 71 The following tables detail activity in the allowance for credit losses by portfolio segment for the three and nine months ended September 30, 2019 and 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories. Income Producing - Commercial Owner Occupied - Commercial Real Estate Mortgage - Construction - Commercial and Home Other (dollars in thousands) Commercial Real Estate Real Estate Residential Residential Equity Consumer Total Three Months Ended September 30, 2019 Allowance for credit losses Balance at beginning of period $ 18,136 $ 27,010 $ 5,756 $ 1,355 $ 19,006 $ 581 $ 242 $ 72,086 Loans charged-off (1,794 ) — — — — — — (1,794 ) Recoveries of loans previously charged-off 210 — — — 15 — 17 242 Net loans charged-off (1,584 ) — — — 15 — 17 (1,552 ) Provision for credit losses 1,617 1,517 (158 ) (3 ) 251 (6 ) (32 ) 3,186 Ending balance $ 18,169 $ 28,527 $ 5,598 $ 1,352 $ 19,272 $ 575 $ 227 $ 73,720 Nine Months Ended September 30, 2019 Allowance for credit losses Balance at beginning of period $ 15,857 $ 28,034 $ 6,242 $ 965 $ 18,175 $ 599 $ 72 $ 69,944 Loans charged-off (1,799 ) (5,343 ) — — — — (2 ) (7,144 ) Recoveries of loans previously charged-off 377 302 2 3 52 — 38 774 Net loans (charged-off) recoveries (1,422 ) (5,041 ) 2 3 52 — 36 (6,370 ) Provision for credit losses 3,734 5,534 (646 ) 384 1,045 (24 ) 119 10,146 Ending balance $ 18,169 $ 28,527 $ 5,598 $ 1,352 $ 19,272 $ 575 $ 227 $ 73,720 As of September 30, 2019 Allowance for credit losse Individually evaluated for impairment $ 8,196 $ 1,200 $ 375 $ 650 $ — $ 13 $ — $ 10,434 Collectively evaluated for impairment 9,973 27,327 5,223 702 19,272 562 227 63,286 Ending balance $ 18,169 $ 28,527 $ 5,598 $ 1,352 $ 19,272 $ 575 $ 227 $ 73,720 Three Months Ended September 30, 2018 Allowance for credit losses Balance at beginning of period $ 12,206 $ 27,988 $ 6,003 $ 757 $ 18,651 $ 673 $ 331 $ 66,609 Loans charged-off (1,174 ) — — — (643 ) — (15 ) (1,832 ) Recoveries of loans previously charged-off 60 — — 1 899 6 5 971 Net loans (charged-off) recoveries (1,114 ) — — 1 256 6 (10 ) (861 ) Provision for credit losses 4,557 (601 ) (72 ) (9 ) (1,368 ) (48 ) (18 ) 2,441 Ending balance $ 15,649 $ 27,387 $ 5,931 $ 749 $ 17,539 $ 631 $ 303 $ 68,189 Nine Months Ended September 30, 2018 Allowance for credit losses Balance at beginning of period $ 13,102 $ 25,376 $ 5,934 $ 944 $ 18,492 $ 770 $ 140 $ 64,758 Loans charged-off (2,435 ) (121 ) (132 ) — (1,160 ) — (15 ) (3,863 ) Recoveries of loans previously charged-off 86 2 2 4 994 133 13 1,234 Net loans (charged-off) recoveries (2,349 ) (119 ) (130 ) 4 (166 ) 133 (2 ) (2,629 ) Provision for credit losses 4,896 2,130 127 (199 ) (787 ) (272 ) 165 6,060 Ending balance $ 15,649 $ 27,387 $ 5,931 $ 749 $ 17,539 $ 631 $ 303 $ 68,189 As of September 30, 2018 Allowance for credit losses Individually evaluated for impairment $ 6,271 $ 3,043 $ 500 $ — $ — $ — $ 56 $ 9,870 Collectively evaluated for impairment 9,378 24,344 5,431 749 17,539 631 247 58,319 Ending balance $ 15,649 $ 27,387 $ 5,931 $ 749 $ 17,539 $ 631 $ 303 $ 68,189 The Company’s recorded investments in loans as of September 30, 2019 and December 31, 2018 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows: Income Owner Real Estate Construction - Commercial Commercial Mortgage - Commercial and Home Other (dollars in thousands) Commercial Real Estate Real Estate Residential Residential Equity Consumer Total September 30, 2019 Recorded investment in loans Individually evaluated for impairment $ 28,155 $ 39,089 $ 6,616 $ 5,365 $ 9,148 $ 750 $ — $ 89,123 Collectively evaluated for impairment 1,438,707 3,773,195 949,729 99,198 1,126,557 80,367 2,285 7,470,038 Ending balance $ 1,466,862 $ 3,812,284 $ 956,345 $ 104,563 $ 1,135,705 $ 81,117 $ 2,285 $ 7,559,161 December 31, 2018 Recorded investment in loans Individually evaluated for impairment $ 8,738 $ 61,747 $ 5,307 $ 1,228 $ 7,012 $ 487 $ — $ 84,519 Collectively evaluated for impairment 1,544,374 3,195,153 882,507 105,190 1,090,600 86,116 2,988 6,906,928 Ending balance $ 1,553,112 $ 3,256,900 $ 887,814 $ 106,418 $ 1,097,612 $ 86,603 $ 2,988 $ 6,991,447 Credit Quality Indicators The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company’s primary credit quality indicators are to use an internal credit risk rating system that categorizes loans into pass, watch, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes which comprise the consumer portfolio segment. The following are the definitions of the Company’s credit quality indicators: Pass: Loans in all classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes that there is a low likelihood of loss related to those loans that are considered pass. Watch: Loan paying as agreed with generally acceptable asset quality; however the obligor’s performance has not met expectations. Balance sheet and/or income statement has shown deterioration to the point that the obligor could not sustain any further setbacks. Credit is expected to be strengthened through improved obligor performance and/or additional collateral within a reasonable period of time. Special Mention: Loans in the classes that comprise the commercial portfolio segment that have potential weaknesses that deserve management’s close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. The special mention credit quality indicator is not used for classes of loans that comprise the consumer portfolio segment. Management believes that there is a moderate likelihood of some loss related to those loans that are considered special mention. Classified: Classified (a) Substandard Classified (b) Doubtful The Company’s credit quality indicators are updated generally on a quarterly basis, but no less frequently than annually. The following table presents by class and by credit quality indicator, the recorded investment in the Company’s loans and leases as of September 30, 2019 and December 31, 2018. Watch and Total (dollars in thousands) Pass Special Mention Substandard Doubtful Loans September 30, 2019 Commercial $ 1,392,189 $ 46,518 $ 28,155 $ — $ 1,466,862 Income producing - commercial real estate 3,662,436 110,759 39,089 — 3,812,284 Owner occupied - commercial real estate 892,720 57,009 6,616 — 956,345 Real estate mortgage – residential 98,564 634 5,365 — 104,563 Construction - commercial and residential 1,126,557 — 9,148 — 1,135,705 Home equity 79,681 686 750 — 81,117 Other consumer 2,285 — — — 2,285 Total $ 7,254,432 $ 215,606 $ 89,123 $ — $ 7,559,161 December 31, 2018 Commercial $ 1,505,477 $ 25,584 $ 22,051 $ — $ 1,553,112 Income producing - commercial real estate 3,172,479 1,536 82,885 — 3,256,900 Owner occupied - commercial real estate 844,286 38,221 5,307 — 887,814 Real estate mortgage – residential 104,543 647 1,228 — 106,418 Construction - commercial and residential 1,090,600 — 7,012 — 1,097,612 Home equity 85,434 682 487 — 86,603 Other consumer 2,988 — — — 2,988 Total $ 6,805,807 $ 66,670 $ 118,970 $ — $ 6,991,447 Nonaccrual and Past Due Loans Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The following table presents, by class of loan, information related to nonaccrual loans as of September 30, 2019 and December 31, 2018. (dollars in thousands) September 30, December 31, Commercial $ 16,074 $ 7,115 Income producing - commercial real estate 5,654 1,766 Owner occupied - commercial real estate 4,124 2,368 Real estate mortgage - residential 5,635 1,510 Construction - commercial and residential 9,148 3,031 Home equity 487 487 Total nonaccrual loans (1)(2) $ 41,122 $ 16,277 (1) Excludes troubled debt restructurings (“TDRs”) that were performing under their restructured terms totaling $ 8.6 million at September 30, 2019 and $ 24.0 million at December 31, 2018. (2) Gross interest income of $ 2.7 million 707 thousand 598 thousand 193 thousand The following table presents, by class of loan, an aging analysis and the recorded investments in loans past due as of September 30, 2019 and December 31, 2018. Loans Loans Loans Total Recorded 30-59 Days 60-89 Days 90 Days or Total Past Current Investment in (dollars in thousands) Past Due Past Due More Past Due Due Loans Loans Loans September 30, 2019 Commercial $ 4,639 $ 3,509 $ 16,074 $ 24,222 $ 1,442,640 $ 1,466,862 Income producing - commercial real estate 21,737 22,190 5,654 66,109 3,746,175 3,812,284 Owner occupied - commercial real estate 3,626 21,768 4,124 29,518 926,827 956,345 Real estate mortgage – residential 634 — 5,635 6,269 98,294 104,563 Construction - commercial and residential — 1,866 9,148 11,014 1,124,691 1,135,705 Home equity 86 130 487 703 80,414 81,117 Other consumer 13 8 — 21 2,264 2,285 Total $ 30,735 $ 49,471 $ 41,122 $ 137,856 $ 7,421,305 $ 7,559,161 December 31, 2018 Commercial $ 4,535 $ 2,870 $ 7,115 $ 14,520 $ 1,538,592 $ 1,553,112 Income producing - commercial real estate 5,855 27,479 1,766 35,100 3,221,800 3,256,900 Owner occupied - commercial real estate 5,051 2,370 2,368 9,789 878,025 887,814 Real estate mortgage – residential 2,456 1,698 1,510 5,664 100,754 106,418 Construction - commercial and residential 4,392 — 3,031 7,423 1,090,189 1,097,612 Home equity 630 47 487 1,164 85,439 86,603 Other consumer — — — — 2,988 2,988 Total $ 22,919 $ 34,464 $ 16,277 $ 73,660 $ 6,917,787 $ 6,991,447 Impaired Loans Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged-off when deemed uncollectible. The following table presents, by class of loan, information related to impaired loans for the periods ended September 30, 2019 and December 31, 2018. Unpaid Recorded Recorded Contractual Investment Investment Total Average Recorded Investment Interest Income Recognized Principal With No With Recorded Related Quarter Year Quarter Year (dollars in thousands) Balance Allowance Allowance Investment Allowance To Date To Date To Date To Date September 30, 2019 Commercial $ 18,243 $ 5,641 $ 11,331 $ 16,972 $ 8,196 $ 16,967 $ 15,638 $ 117 $ 220 Income producing - commercial real estate 10,041 1,853 8,188 10,041 1,200 9,497 19,479 412 510 Owner occupied - commercial real estate 7,407 6,630 777 7,407 375 6,113 5,693 120 213 Real estate mortgage – residential 5,635 3,179 2,456 5,635 650 5,638 5,640 — — Construction - commercial and residential 10,308 9,148 — 9,148 — 9,152 7,111 — 15 Home equity 487 487 — 487 13 487 487 — — Other consumer — — — — — — — — — Total $ 52,121 $ 26,938 $ 22,752 $ 49,690 $ 10,434 $ 47,854 $ 54,048 $ 649 $ 958 December 31, 2018 Commercial $ 8,613 $ 2,057 $ 6,084 $ 8,141 $ 4,803 $ 10,306 $ 8,359 $ ( 126 ) $ 190 Income producing - commercial real estate 21,402 1,720 19,682 21,402 2,465 15,331 12,309 189 550 Owner occupied - commercial real estate 5,731 4,361 1,370 5,731 600 5,746 6,011 47 196 Real estate mortgage – residential 1,510 1,510 — 1,510 — 1,516 1,688 — 2 Construction - commercial and residential 3,031 3,031 — 3,031 1,050 3,031 2,028 — 68 Home equity 487 487 — 487 — 487 491 — — Other consumer — — — — — 46 69 — — Total $ 40,774 $ 13,166 $ 27,136 $ 40,302 $ 8,918 $ 36,463 $ 30,955 $ 110 $ 1,006 Modifications A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period. As of September 30, 2019, all performing TDRs were categorized as interest-only modifications. Loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates. The following table presents by class, the recorded investment of loans modified in TDRs held by the Company for the periods ended September 30, 2019 and 2018. For the nine months Ended September 30, 2019 Number of Income Producing - Owner Occupied - Construction - (dollars in thousands) Contracts Commercial Commercial Real Estate Commercial Real Estate Commercial Real Estate Total Troubled debt restructurings Restructured accruing 7 $ 898 $ 4,387 $ 3,283 $ — $ 8,568 Restructured nonaccruing 3 1,521 — — — 1,521 Total 10 $ 2,419 $ 4,387 $ 3,283 $ — $ 10,089 Specific allowance $ — $ 1,000 $ — $ — $ 1,000 Restructured and subsequently defaulted $ $ 2,300 $ — $ — $ 2,300 For the nine months Ended September 30, 2018 Number of Income Producing - Owner Occupied - Construction - (dollars in thousands) Contracts Commercial Commercial Real Estate Commercial Real Estate Commercial Real Estate Total Troubled debt restructurings Restructured accruing 10 $ 4,942 $ 9,212 $ 3,391 $ — $ 17,545 Restructured nonaccruing 4 723 — — — 723 Total 14 $ 5,665 $ 9,212 $ 3,391 $ — $ 18,268 Specific allowance $ 2,000 $ 3,500 $ — $ — $ 5,500 Restructured and subsequently defaulted $ — $ 937 $ — $ — $ 937 The Company had ten TDR’s at September 30, 2019 totaling approximately $ 10.1 million . Seven of these loans totaling approximately $ 8.6 million are performing under their modified terms. There was one performing TDR totaling $ 2.3 million that defaulted on its modified terms which was reclassified to nonperforming loans during the nine months ended September 30, 2019. During the nine months ended September 30, 2018, there were two performing TDRs totaling $ 937 thousand that defaulted on their modified terms which were reclassified to nonperforming loans. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual. For the three months ended September 30, 2019, there was one 309 thousand one 2.4 million |