Loans And Leases | 5. Loans and leases The classifications of loans and leases at March 31, 2020 and December 31, 2019 are summarized as follows: (dollars in thousands) March 31, 2020 December 31, 2019 Commercial and industrial $ 118,140 $ 122,594 Commercial real estate: Non-owner occupied 95,630 99,801 Owner occupied 125,976 130,558 Construction 3,196 4,654 Consumer: Home equity installment 35,456 36,631 Home equity line of credit 46,850 47,282 Auto loans 102,213 105,870 Direct finance leases 17,356 16,355 Other 7,025 5,634 Residential: Real estate 175,453 167,164 Construction 18,767 17,770 Total 746,062 754,313 Less: Allowance for loan losses (10,017) (9,747) Unearned lease revenue (938) (903) Loans and leases, net $ 735,107 $ 743,663 Net deferred loan costs of $3.0 million have been included in the carrying values of loans at both March 31, 2020 and December 31, 2019. Direct finance leases include the lease receivable and the guaranteed lease residual. Unearned lease revenue represents the difference between the lessor’s investment in the property and the gross investment in the lease. Unearned revenue is accrued over the life of the lease using the effective interest method. The Company services real estate loans for investors in the secondary mortgage market which are not included in the accompanying consolidated balance sheets. The approximate unpaid principal balance of mortgages serviced amounted to $299.0 million as of March 31, 2020 and $302.3 million as of December 31, 2019. Mortgage servicing rights amounted to $1.0 million and $1.0 million as of March 31, 2020 and December 31, 2019, respectively. Management is responsible for conducting the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial and industrial and commercial real estate loans. Commercial and industrial and commercial real estate loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed as the case may be. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The Company utilizes an external independent loan review firm that reviews and validates the credit risk program on at least an annual basis. Results of these reviews are presented to management and the board of directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures. Non-accrual loans The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. C&I and CRE loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by real estate and residential mortgage loans are placed on non-accrual status at 120 days past due as to principal and interest and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. The Company considers all non-accrual loans to be impaired loans. Non-accrual loans, segregated by class, at March 31, 2020 and December 31, 2019, were as follows: (dollars in thousands) March 31, 2020 December 31, 2019 Commercial and industrial $ 310 $ 336 Commercial real estate: Non-owner occupied 419 510 Owner occupied 1,465 1,447 Consumer: Home equity installment 62 65 Home equity line of credit 340 294 Auto loans 92 16 Residential: Real estate 966 1,006 Total $ 3,654 $ 3,674 Troubled Debt Restructuring (TDR) A modification of a loan constitutes a troubled debt restructuring (TDR) when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company considers all TDRs to be impaired loans. The Company typically considers the following concessions when modifying a loan, which may include lowering interest rates below the market rate, temporary interest-only payment periods, term extensions at interest rates lower than the current market rate for new debt with similar risk and/or converting revolving credit lines to term loans. The Company typically does not forgive principal when granting a TDR modification. Of the TDRs outstanding as of March 31, 2020 and December 31, 2019, when modified, the concessions granted consisted of temporary interest-only payments, extensions of maturity date, or a reduction in the rate of interest to a below-market rate for a contractual period of time. Other than the TDRs that were placed on non-accrual status, the TDRs were performing in accordance with their modified terms. There were no loans modified as TDRs for the three months ended March 31, 2020 and 2019. Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. There were no loans modified as a TDR within the previous twelve months that subsequently defaulted during the three months ended March 31, 2020 and 2019. The allowance for loan losses (allowance) may be increased, adjustments may be made in the allocation of the allowance or partial charge-offs may be taken to further write-down the carrying value of the loan. An allowance for impaired 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 or the loan’s observable market price. If the loan is collateral dependent, the estimated fair value of the collateral is used to establish the allowance. As of March 31, 2020 and 2019, respectively, the allowance for impaired loans that have been modified in a TDR was $0.2 million and $0.2 million, respectively. Past due loans Loans are considered past due when the contractual principal and/or interest is not received by the due date. For loans reported 30-59 days past due, certain categories of loans are reported past due as and when the loan is in arrears for two payments or billing cycles. An aging analysis of past due loans, segregated by class of loans, as of the period indicated is as follows (dollars in thousands): Recorded Past due investment past 30 - 59 Days 60 - 89 Days 90 days Total Total due ≥ 90 days March 31, 2020 past due past due or more (1) past due Current loans (3) and accruing Commercial and industrial $ 1,590 $ 1,009 $ 310 $ 2,909 $ 115,231 $ 118,140 $ - Commercial real estate: Non-owner occupied 1,137 380 419 1,936 93,694 95,630 - Owner occupied 783 360 1,465 2,608 123,368 125,976 - Construction - - - - 3,196 3,196 - Consumer: Home equity installment 63 28 62 153 35,303 35,456 - Home equity line of credit 362 13 340 715 46,135 46,850 - Auto loans 888 23 92 1,003 101,210 102,213 - Direct finance leases 294 - - 294 16,124 16,418 (2) - Other 25 3 - 28 6,997 7,025 - Residential: Real estate - 1,350 966 2,316 173,137 175,453 - Construction - - - - 18,767 18,767 - Total $ 5,142 $ 3,166 $ 3,654 $ 11,962 $ 733,162 $ 745,124 $ - (1) Includes non-accrual loans. (2) Net of unearned lease revenue of $0.9 million. (3) Includes net deferred loan costs of $3.0 million. Recorded Past due investment past 30 - 59 Days 60 - 89 Days 90 days Total Total due ≥ 90 days December 31, 2019 past due past due or more (1) past due Current loans (3) and accruing Commercial and industrial $ 33 $ 171 $ 336 $ 540 $ 122,054 $ 122,594 $ - Commercial real estate: Non-owner occupied - 70 510 580 99,221 99,801 - Owner occupied 180 89 1,447 1,716 128,842 130,558 - Construction - - - - 4,654 4,654 - Consumer: Home equity installment - 5 65 70 36,561 36,631 - Home equity line of credit 49 - 294 343 46,939 47,282 - Auto loans 316 46 16 378 105,492 105,870 - Direct finance leases 59 79 - 138 15,314 15,452 (2) - Other 15 1 - 16 5,618 5,634 - Residential: Real estate 29 224 1,006 1,259 165,905 167,164 - Construction - - - - 17,770 17,770 - Total $ 681 $ 685 $ 3,674 $ 5,040 $ 748,370 $ 753,410 $ - (1) Includes non-accrual loans. (2) Net of unearned lease revenue of $0.9 million. (3) Includes net deferred loan costs of $3.0 million. Impaired loans A loan is considered impaired when, based on current information and events; it is probable that the Company will be unable to collect the payments in accordance with the contractual terms of the loan. Factors considered in determining impairment include payment status, collateral value and the probability of collecting payments when due. The significance of payment delays and/or shortfalls is determined on a case-by-case basis. All circumstances surrounding the loan are taken into account. Such factors include the length of the delinquency, the underlying reasons and the borrower’s prior payment record. Impairment is measured on these loans on a loan-by-loan basis. Impaired loans include non-accrual loans, TDRs and other loans deemed to be impaired based on the aforementioned factors. At March 31, 2020, impaired loans totaled $4.6 million consisting of $1.0 million in accruing TDRs and $3.6 million in non-accrual loans. At December 31, 2019, impaired loans totaled $4.7 million consisting of $1.0 million in accruing TDRs and $3.7 million in non-accrual loans. As of March 31, 2020, the non-accrual loans included two TDRs to two unrelated borrowers totaling $0.6 million compared with two TDRs to two unrelated borrowers totaling $0.6 million as of December 31, 2019. Impaired loans, segregated by class, as of the period indicated are detailed below: Recorded Recorded Unpaid investment investment Total principal with with no recorded Related (dollars in thousands) balance allowance allowance investment allowance March 31, 2020 Commercial and industrial $ 310 $ 310 $ - $ 310 $ 195 Commercial real estate: Non-owner occupied 1,098 203 628 831 118 Owner occupied 2,352 1,121 920 2,041 194 Consumer: Home equity installment 104 39 23 62 1 Home equity line of credit 407 135 205 340 74 Auto loans 108 - 92 92 - Residential: - Real estate 1,044 627 339 966 137 Total $ 5,423 $ 2,435 $ 2,207 $ 4,642 $ 719 Recorded Recorded Unpaid investment investment Total principal with with no recorded Related (dollars in thousands) balance allowance allowance investment allowance December 31, 2019 Commercial and industrial $ 336 $ 336 $ - $ 336 $ 221 Commercial real estate: Non-owner occupied 1,047 333 591 924 232 Owner occupied 2,336 1,052 972 2,024 194 Consumer: Home equity installment 106 - 65 65 - Home equity line of credit 362 88 206 294 87 Auto loans 32 - 16 16 - Residential: - Real estate 1,053 678 328 1,006 174 Total $ 5,272 $ 2,487 $ 2,178 $ 4,665 $ 908 The following table presents the average recorded investments in impaired loans and related amount of interest income recognized during the periods indicated below. The average balances are calculated based on the quarter-end balances of impaired loans. Payments received from non-accruing impaired loans are first applied against the outstanding principal balance, then to the recovery of any charged-off amounts. Any excess is treated as a recovery of interest income. Payments received from accruing impaired loans are applied to principal and interest, as contractually agreed upon. March 31, 2020 March 31, 2019 Cash basis Cash basis Average Interest interest Average Interest interest recorded income income recorded income income (dollars in thousands) investment recognized recognized investment recognized recognized Commercial and industrial $ 252 $ - $ - $ 178 $ 1 $ - Commercial real estate: Non-owner occupied 884 6 - 1,701 8 - Owner occupied 2,327 6 - 2,589 10 - Construction - - - 75 - - Consumer: Home equity installment 49 - - 381 - - Home equity line of credit 245 - - 42 - - Auto Loans 52 - - 35 - - Other - - - 4 - - Residential: Real estate 1,102 - - 1,347 9 - Total $ 4,911 $ 12 $ - $ 6,352 $ 28 $ - Credit Quality Indicators Commercial and industrial and commercial real estate The Company utilizes a loan grading system and assigns a credit risk grade to its loans in the C&I and CRE portfolios. The grading system provides a means to measure portfolio quality and aids in the monitoring of the credit quality of the overall loan portfolio. The credit risk grades are arrived at using a risk rating matrix to assign a grade to each of the loans in the C&I and CRE portfolios. The following is a description of each risk rating category the Company uses to classify each of its C&I and CRE loans: Pass Loans in this category have an acceptable level of risk and are graded in a range of one to five. Secured loans generally have good collateral coverage. Current financial statements reflect acceptable balance sheet ratios, sales and earnings trends. Management is considered to be competent, and a reasonable succession plan is evident. Payment experience on the loans has been good with minor or no delinquency experience. Loans with a grade of one are of the highest quality in the range. Those graded five are of marginally acceptable quality. Special Mention Loans in this category are graded a six and may be protected but are potentially weak. They constitute a credit risk to the Company, but have not yet reached the point of adverse classification. Some of the following conditions may exist: little or no collateral coverage; lack of current financial information; delinquency problems; highly leveraged; available financial information reflects poor balance sheet ratios and profit and loss statements reflect uncertain trends; and document exceptions. Cash flow may not be sufficient to support total debt service requirements. Substandard Loans in this category are graded a seven and have a well-defined weakness which may jeopardize the ultimate collectability of the debt. The collateral pledged may be lacking in quality or quantity. Financial statements may indicate insufficient cash flow to service the debt; and/or do not reflect a sound net worth. The payment history indicates chronic delinquency problems. Management is considered to be weak. There is a distinct possibility that the Company may sustain a loss. All loans on non-accrual are rated substandard. Other loans that are included in the substandard category can be accruing, as well as loans that are current or past due. Loans 90 days or more past due, unless otherwise fully supported, are classified substandard. Also, borrowers that are bankrupt or have loans categorized as TDRs can be graded substandard. Doubtful Loans in this category are graded an eight and have a better than 50% possibility of the Company sustaining a loss, but the loss cannot be determined because of specific reasonable factors which may strengthen credit in the near-term. Many of the weaknesses present in a substandard loan exist. Liquidation of collateral, if any, is likely. Any loan graded lower than an eight is considered to be uncollectible and charged-off. Consumer and residential The consumer and residential loan segments are regarded as homogeneous loan pools and as such are not risk rated. For these portfolios, the Company utilizes payment activity and history in assessing performance. Non-performing loans are comprised of non-accrual loans and loans past due 90 days or more and accruing. All loans not classified as non-performing are considered performing. The following table presents loans including $3.0 million and $3.0 million of deferred costs, segregated by class, categorized into the appropriate credit quality indicator category as of March 31, 2020 and December 31, 2019, respectively: Commercial credit exposure Credit risk profile by creditworthiness category March 31, 2020 (dollars in thousands) Pass Special mention Substandard Doubtful Total Commercial and industrial $ 110,927 $ 1,820 $ 5,393 $ - $ 118,140 Commercial real estate - non-owner occupied 88,576 1,090 5,964 - 95,630 Commercial real estate - owner occupied 117,458 1,890 6,628 - 125,976 Commercial real estate - construction 2,389 56 751 - 3,196 Total commercial $ 319,350 $ 4,856 $ 18,736 $ - $ 342,942 Consumer & Mortgage lending credit exposure Credit risk profile based on payment activity March 31, 2020 (dollars in thousands) Performing Non-performing Total Consumer Home equity installment $ 35,394 $ 62 $ 35,456 Home equity line of credit 46,510 340 46,850 Auto loans 102,121 92 102,213 Direct finance leases (1) 16,418 - 16,418 Other 7,025 - 7,025 Total consumer 207,468 494 207,962 Residential Real estate 174,487 966 175,453 Construction 18,767 - 18,767 Total residential 193,254 966 194,220 Total consumer & residential $ 400,722 $ 1,460 $ 402,182 (1) Net of unearned lease revenue of $0.9 million. Commercial credit exposure Credit risk profile by creditworthiness category December 31, 2019 (dollars in thousands) Pass Special mention Substandard Doubtful Total Commercial and industrial $ 115,585 $ 2,061 $ 4,948 $ - $ 122,594 Commercial real estate - non-owner occupied 92,016 1,360 6,425 - 99,801 Commercial real estate - owner occupied 121,887 2,065 6,606 - 130,558 Commercial real estate - construction 3,687 17 950 - 4,654 Total commercial $ 333,175 $ 5,503 $ 18,929 $ - $ 357,607 Consumer & Mortgage lending credit exposure Credit risk profile based on payment activity December 31, 2019 (dollars in thousands) Performing Non-performing Total Consumer Home equity installment $ 36,566 $ 65 $ 36,631 Home equity line of credit 46,988 294 47,282 Auto loans 105,854 16 105,870 Direct finance leases (2) 15,452 - 15,452 Other 5,634 - 5,634 Total consumer 210,494 375 210,869 Residential Real estate 166,158 1,006 167,164 Construction 17,770 - 17,770 Total residential 183,928 1,006 184,934 Total consumer & residential $ 394,422 $ 1,381 $ 395,803 (2) Net of unearned lease revenue of $0.9 million. Allowance for loan losses Management continually evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, past experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received. Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows: § identification of specific impaired loans by loan category; § identification of specific loans that are not impaired, but have an identified potential for loss; § calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence; § determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans; § application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation; § application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio. § Qualitative factor adjustments include: o levels of and trends in delinquencies and non-accrual loans; o levels of and trends in charge-offs and recoveries; o trends in volume and terms of loans; o changes in risk selection and underwriting standards; o changes in lending policies and legal and regulatory requirements; o experience, ability and depth of lending management; o national and local economic trends and conditions; and o changes in credit concentrations. Allocation of the allowance for different categories of loans is based on the methodology as explained above. A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual C&I and CRE loans. C&I and CRE loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed as the case may be. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The credit risk grades for the C&I and CRE loan portfolios are taken into account in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what we believe to be best practices and common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the C&I and CRE loan portfolio from period to period are based upon the credit risk grading system and from periodic reviews of the loan portfolio. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies. Each quarter, management performs an assessment of the allowance. The Company’s Special Assets Committee meets quarterly and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due in payment. The assessment process also includes the review of all loans on a non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating. The Company’s policy is to charge-off unsecured consumer loans when they become 90 days or more past due as to principal and interest. In the other portfolio segments, amounts are charged-off at the point in time when the Company deems the balance, or a portion thereof, to be uncollectible. Information related to the change in the allowance and the Company’s recorded investment in loans by portfolio segment as of the period indicated is as follows: As of and for the three months ended March 31, 2020 Commercial & Commercial Residential (dollars in thousands) industrial real estate Consumer real estate Unallocated Total Allowance for Loan Losses: Beginning balance $ 1,484 $ 3,933 $ 2,013 $ 2,278 $ 39 $ 9,747 Charge-offs (64) (163) (43) (31) - (301) Recoveries 12 2 64 193 - 271 Provision 121 171 60 (47) (5) 300 Ending balance $ 1,553 $ 3,943 $ 2,094 $ 2,393 $ 34 $ 10,017 Ending balance: individually evaluated for impairment $ 195 $ 312 $ 75 $ 137 $ - $ 719 Ending balance: collectively evaluated for impairment $ 1,358 $ 3,631 $ 2,019 $ 2,256 $ 34 $ 9,298 Loans Receivables: Ending balance (2) $ 118,140 $ 224,802 $ 207,962 (1) $ 194,220 $ - $ 745,124 Ending balance: individually evaluated for impairment $ 310 $ 2,872 $ 494 $ 966 $ - $ 4,642 Ending balance: collectively evaluated for impairment $ 117,830 $ 221,930 $ 207,468 $ 193,254 $ - $ 740,482 (1) Net of unearned lease revenue of $0.9 million. (2) Includes $3.0 million of net deferred loan costs. As of and for the year ended December 31, 2019 Commercial & Commercial Residential (dollars in thousands) industrial real estate Consumer real estate Unallocated Total Allowance for Loan Losses: Beginning balance $ 1,432 $ 3,901 $ 2,548 $ 1,844 $ 22 $ 9,747 Charge-offs (184) (597) (398) (330) - (1,509) Recoveries 32 317 67 8 - 424 Provision 204 312 (204) 756 17 1,085 Ending balance $ 1,484 $ 3,933 $ 2,013 $ 2,278 $ 39 $ 9,747 Ending balance: individually evaluated for impairment $ 221 $ 426 $ 87 $ 174 $ - $ 908 Ending balance: collectively evaluated for impairment $ 1,263 $ 3,507 $ 1,926 $ 2,104 $ 39 $ 8,839 Loans Receivables: Ending balance (2) $ 122,594 $ 235,013 $ 210,869 (1) $ 184,934 $ - $ 753,410 Ending balance: individually evaluated for impairment $ 336 $ 2,948 $ 375 $ 1,006 $ - $ 4,665 Ending balance: collectively evaluated for impairment $ 122,258 $ 232,065 $ 210,494 $ 183,928 $ - $ 748,745 (1) Net of unearned lease revenue of $ 0.9 million. (2) Includes $3.0 million of net deferred loan costs. As of and for the three months ended March 31, 2019 Commercial & Commercial Residential (dollars in thousands) industrial real estate Consumer real estate Unallocated Total Allowance for Loan Losses: Beginning balance $ 1,432 $ 3,901 $ 2,548 $ 1,844 $ 22 $ 9,747 Charge-offs (28) (361) (89) (35) - (513) Recoveries 6 2 25 - - 33 Provision (3) 485 (354) 101 26 255 Ending balance $ 1,407 $ 4,027 $ 2,130 $ 1,910 $ 48 $ 9,522 Direct finance leases On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842) , and subsequent related updates to revise the accounting for leases. Lessor accounting was largely unchanged as a result of the standard. Additional disclosures required under the standard are included in this section and in Footnote 12, “Leases”. The Company originates direct finance leases through two automobile dealerships. The carrying amount of the Company’s lease receivables, net of unearned income, was $5.0 million and $4.7 million as of March 31, 2020 and December 31, 2019, respectively. The residual value of the direct finance leases is fully guaranteed by the dealerships. Residual values amounted to $11.4 million and $10.8 million at March 31, 2020 and December 31, 2019, respectively, and are included in the carrying value of direct finance leases. The undiscounted cash flows to be received on an annual basis for the direct finance leases are as follows: (dollars in thousands) Amount 2020 $ 5,344 2021 6,005 2022 3,720 2023 2,039 2024 248 Total future minimum lease payments receivable 17,356 Less: Unearned income (938) Undiscounted cash flows to be received $ 16,418 |