Loans Receivable, Net and Allowance for Loan Losses | 7. Loans Receivable, Net and Allowance for Loan Losses Loans receivable consist of the following (in thousands): December 31, September 30, Real estate loans: Residential $ 610,041 $ 610,582 Construction 1,864 878 Commercial 289,838 200,004 Commercial 52,277 34,314 Obligations of states and political subdivisions 57,903 59,820 Home equity loans and lines of credit 47,940 39,903 Auto Loans 173,775 162,193 Other 3,626 3,343 1,237,264 1,111,037 Less allowance for loan losses 9,257 8,919 Net loans $ 1,228,007 $ 1,102,118 Included in the December 31, 2015 balances are loans acquired from Eagle National Bank, as of the acquisition date of December 4, 2015 as follows: 2015 Real estate loans: Residential $ 10,743 Commercial 87,336 Commercial 16,604 Home equity loans and lines of credit 8,632 Other 65 Total loans $ 123,380 Purchased loans acquired in a business combination are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses. Upon acquisition, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. The fair value of purchased credit-impaired loans, on the acquisition date of December 4, 2015, was determined, primarily based on the fair value of loan collateral. The carrying value of all purchased loans acquired with deteriorated credit quality was $6.4 million at December 31, 2015. On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the ENB acquisition was $3.5 million and the estimated fair value of the loans was $2.0 million. Total contractually required payments on these loans, including interest, at the acquisition date was $4.2 million. However, the Company’s preliminary estimate of expected cash flows was $2.2 million. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $2.0 million relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $240,000 on the acquisition date relating to these impaired loans. The carrying value of the loans acquired and accounted for in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality Unpaid principal balance $ 3,468 Interest 717 Contractual cash flows 4,185 Non-accretable discount (1,973 ) Expected cash flows 2,212 Accretable discount (240 ) Estimated fair value $ 1,972 Changes in the accretable yield for purchased credit-impaired loans were as follows, since acquisition, for the periods ended December 31, 2015 and September 30, 2015: December 31, 2015 September 30, 2015 Balance at beginning of period $ 258 $ 170 Reclassification, new additions and other 240 228 Accretion (50 ) (140 ) Balance at end of period $ 448 $ 258 The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands): December 31, 2015 September 30, 2015 Acquired Loans with Specific Acquired Loans with Specific Outstanding balance $ 8,061 $ 4,779 Carrying amount $ 6,428 $ 4,162 The following table shows the amount of loans in each category that was individually and collectively evaluated for impairment at the dates indicated (in thousands): Total Loans Individually Loans Acquired Collectively December 31, 2015 Real estate loans: Residential $ 610,041 $ 10,546 $ — $ 599,495 Construction 1,864 — — 1,864 Commercial 289,838 13,173 5,790 270,875 Commercial 52,277 2,020 — 50,257 Obligations of states and political subdivisions 57,903 — — 57,903 Home equity loans and lines of credit 47,940 688 638 46,614 Auto loans 173,775 547 — 173,228 Other 3,626 18 — 3,608 Total $ 1,237,264 $ 26,992 $ 6,428 $ 1,203,844 Total Loans Individually Loans Acquired Collectively September 30, 2015 Real estate loans: Residential $ 610,582 $ 11,985 $ — $ 598,597 Construction 878 — — 878 Commercial 200,004 15,100 4,108 180,796 Commercial 34,314 204 54 34,056 Obligations of states and political subdivisions 59,820 — — 59,820 Home equity loans and lines of credit 39,903 795 — 39,108 Auto loans 162,193 625 — 161,568 Other 3,343 — — 3,343 Total $ 1,111,037 $ 28,709 $ 4,162 $ 1,078,166 We maintain a loan review system that allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring. A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial condition that it would not otherwise consider. Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk. TDR loans that are in compliance with their modified terms and that yield a market rate may be removed from the TDR status after one year of performance. The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable (in thousands): Recorded Unpaid Associated December 31, 2015 With no specific allowance recorded: Real estate loans Residential $ 7,833 $ 9,549 $ — Construction — — — Commercial 17,589 19,106 — Commercial 2,011 2,027 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 1,264 1,339 — Auto loans 298 415 — Other 18 43 — Total 29,013 32,479 — With an allowance recorded: Real estate loans Residential 2,713 3,125 349 Construction — — — Commercial 1,374 1,448 144 Commercial 9 9 9 Obligations of states and political subdivisions — — — Home equity loans and lines of credit 62 91 62 Auto loans 249 249 159 Other — — — Total 4,407 4,922 723 Total: Real estate loans Residential 10,546 12,674 349 Construction — — — Commercial 18,963 20,554 144 Commercial 2,020 2,036 9 Obligations of states and political subdivisions — — — Home equity loans and lines of credit 1,326 1,430 62 Auto loans 547 664 159 Other 18 43 — Total Impaired Loans $ 33,420 $ 37,401 $ 723 Recorded Unpaid Associated September 30, 2015 With no specific allowance recorded: Real Estate Loans Residential $ 9,552 $ 11,521 $ — Construction — — — Commercial 19,208 20,167 — Commercial 258 270 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 731 743 — Auto Loans 350 464 — Other — — — Total 30,099 33,165 — With an allowance recorded: Real Estate Loans Residential 2,433 2,639 373 Construction — — — Commercial — — — Commercial — — — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 64 93 64 Auto Loans 275 275 131 Other — — — Total 2,772 3,007 568 Total: Real Estate Loans Residential 11,985 14,160 373 Construction — — — Commercial 19,208 20,167 — Commercial 258 270 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 795 836 64 Auto Loans 625 739 131 Other — — — Total Impaired Loans $ 32,871 $ 36,172 $ 568 The following table represents the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired (in thousands): Three months ended December 31, 2015 2014 2015 2014 Average Average Interest Interest With no specific allowance recorded: Real estate loans Residential $ 8,785 $ 10,929 $ 27 $ 99 Construction — — — — Commercial 18,574 20,983 176 194 Commercial 820 889 15 2 Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 962 202 2 2 Auto loans 282 — 1 — Other — — — — Total 29,423 33,003 221 297 With an allowance recorded: Real estate loans Residential 2,592 2,496 5 24 Construction — — — — Commercial 457 578 — — Commercial 3 — — — Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 73 13 — — Auto loans 141 51 1 2 Other — — — — Total 3,266 3,138 6 26 Total: Real estate loans Residential 11,377 13,425 32 123 Construction — — — — Commercial 19,031 21,561 176 194 Commercial 823 889 15 2 Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 1,035 215 2 2 Auto loans 423 51 2 2 Other — — — — Total Impaired Loans $ 32,689 $ 36,141 $ 227 $ 323 The Company uses a ten-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized and are aggregated as Pass-rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are fundamentally sound yet, exhibit potentially unacceptable credit risk or deteriorating trends or characteristics which if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Loans in the Doubtful category have all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans in the Loss category are considered uncollectible and of little value that their continuance as bankable assets is not warranted. Certain residential real estate loans, construction loans, home equity loans and lines of credit, auto loans and other consumer loans are underwritten and structured using standardized criteria and characteristics, primarily payment performance, and are normally risk rated and monitored collectively on a monthly basis. These are typically loans to individuals in the consumer categories and are delineated as either performing or non-performing. To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Bank’s Commercial Loan Officers perform an annual review of all commercial relationships $500,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Bank engages an external consultant to conduct loan reviews on at least a semi-annual basis. Generally, the external consultant reviews commercial relationships greater than $1,000,000 and/or all criticized relationships. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance. The following tables present the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system as of December 31, 2015 and September 30, 2015 (in thousands): Pass Special Substandard Doubtful Total December 31, 2015 Commercial real estate loans $ 255,955 $ 10,926 $ 22,957 $ — $ 289,838 Commercial 48,672 320 3,285 — 52,277 Obligations of states and political subdivisions 57,903 — — — 57,903 Total $ 362,530 $ 11,246 $ 26,242 $ — $ 400,018 Pass Special Substandard Doubtful Total September 30, 2015 Commercial real estate loans $ 174,516 $ 4,521 $ 20,967 $ — $ 200,004 Commercial 33,801 — 513 — 34,314 Obligations of states and political subdivisions 59,820 — — — 59,820 Total $ 268,137 $ 4,521 $ 21,480 $ — $ 294,138 All other loans are underwritten and structured using standardized criteria and characteristics, primarily payment performance, and are normally risk rated and monitored collectively on a monthly basis. These are typically loans to individuals in the consumer categories and are delineated as either performing or non-performing. The following tables present the risk ratings in the consumer categories of performing and non-performing loans at December 31, 2015 and September 30, 2015 (in thousands): Performing Non-performing Total December 31, 2015 Real estate loans: Residential $ 600,544 $ 9,497 $ 610,041 Construction 1,864 — 1,864 Home equity loans and lines of credit 46,615 1,325 47,940 Auto loans 173,228 547 173,775 Other 3,608 18 3,626 Total $ 825,859 $ 11,387 $ 837,246 Performing Non-performing Total September 30, 2015 Real estate loans: Residential $ 600,810 $ 9,772 $ 610,582 Construction 878 — 878 Home equity loans and lines of credit 39,213 690 39,903 Auto loans 161,827 366 162,193 Other 3,322 21 3,343 Total $ 806,050 $ 10,849 $ 816,899 Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2015 and September 30, 2015 (in thousands): Current 31-60 Days 61-90 Days Greater than Non-Accrual Total Past Total December 31, 2015 Real estate loans Residential $ 597,903 $ 1,883 $ 758 $ — $ 9,497 $ 12,138 $ 610,041 Construction 1,864 — — — — — 1,864 Commercial 278,220 507 337 — 10,774 11,618 289,838 Commercial 51,673 116 51 — 437 604 52,277 Obligations of states and political subdivisions 57,903 — — — — — 57,903 Home equity loans and lines of credit 46,414 157 44 — 1,325 1,526 47,940 Auto loans 171,599 1,399 230 — 547 2,176 173,775 Other 3,586 22 — — 18 40 3,626 Total $ 1,209,162 $ 4,084 $ 1,420 $ — $ 22,598 $ 28,102 $ 1,237,264 Current 31-60 Days 61-90 Days Greater than Non-Accrual Total Past Total September 30, 2015 Real estate loans Residential $ 598,190 $ 1,575 $ 1,045 $ — $ 9,772 $ 12,392 $ 610,582 Construction 878 — — — — — 878 Commercial 190,440 137 587 — 8,840 9,564 200,004 Commercial 33,545 346 7 — 416 769 34,314 Obligations of states and political subdivisions 59,820 — — — — — 59,820 Home equity loans and lines of credit 39,136 32 45 — 690 767 39,903 Auto loans 160,272 1,375 180 — 366 1,921 162,193 Other 3,295 27 — — 21 48 3,343 Total $ 1,085,576 $ 3,492 $ 1,864 $ — $ 20,105 $ 25,461 $ 1,111,037 Our allowance for loan losses is maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in its loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. Our allowance for loan losses consists of two elements: (1) an allocated allowance, which comprises allowances established on specific loans and class allowances based on historical loss experience and current trends, and (2) an allocated allowance based on general economic conditions and other risk factors in our markets and portfolios. We maintain a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions, management’s judgment and losses which are probable and reasonably estimable. The allowance is increased through provisions charged against current earnings and recoveries of previously charged-off loans. Loans that are determined to be uncollectible are charged against the allowance. While management uses available information to recognize probable and reasonably estimable loan losses, future loss provisions may be necessary, based on changing economic conditions. Payments received on impaired loans generally are either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. The allowance for loan losses as of December 31, 2015 is maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio, and such losses were both probable and reasonably estimable. In addition, the FDIC and the Pennsylvania Department of Banking and Securities, as an integral part of their examination process, have periodically reviewed our allowance for loan losses. The banking regulators may require that we recognize additions to the allowance based on its analysis and review of information available to it at the time of its examination. Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL. The following tables summarize changes in the primary segments of the ALL for the three month periods ending December 31, 2015 and 2014 (in thousands): Real Estate Loans Residential Construction Commercial Commercial Obligations of Home Auto Loans Other Unallocated Total ALL balance at September 30, 2015 $ 5,140 $ 7 $ 671 $ 693 $ 189 $ 461 $ 1,570 $ 27 $ 161 $ 8,919 Charge-offs (91 ) — — (3 ) — (25 ) (188 ) — — (307 ) Recoveries 3 — — 1 — 1 37 3 — 45 Provision (305 ) 7 187 14 (2 ) (48 ) 335 (3 ) 415 600 ALL balance at December 31, 2015 $ 4,747 $ 14 $ 858 $ 705 $ 187 $ 389 $ 1,754 $ 27 $ 576 $ 9,257 September 30, 2014 $ 5,573 $ 11 $ 663 $ 528 $ 163 $ 470 $ 459 $ 32 $ 735 $ 8,634 Charge-offs (509 ) — (11 ) (27 ) — (19 ) (40 ) — — (606 ) Recoveries 18 — 11 — — 8 1 — — 38 Provision 489 2 13 14 (18 ) 86 254 (6 ) (384 ) 450 ALL balance at December 31, 2014 $ 5,571 $ 13 $ 676 $ 515 $ 145 $ 545 $ 674 $ 26 $ 351 $ 8,516 Acquired loans are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses. The following table summarizes the primary segments of the ALL, segregated into amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of December 31, 2015 and September 30, 2015 (in thousands): Real Estate Loans Residential Construction Commercial Commercial Obligations of Home Auto Loans Other Unallocated Total Individually evaluated for impairment $ 349 $ — $ 144 $ 9 $ — $ 62 $ 159 $ — $ — $ 723 Collectively evaluated for impairment 4,398 14 714 696 187 327 1,595 27 576 8,534 ALL Balance at December 31, 2015 $ 4,747 $ 14 $ 858 $ 705 $ 187 $ 389 $ 1,754 $ 27 $ 576 $ 9,257 Individually evaluated for impairment $ 373 $ — $ — $ — $ — $ 64 $ 131 $ — $ — $ 568 Collectively evaluated for impairment 4,767 7 671 693 189 397 1,439 27 161 8,351 ALL balance at September 30, 2015 $ 5,140 $ 7 $ 671 $ 693 $ 189 $ 461 $ 1,570 $ 27 $ 161 $ 8,919 The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date. The Company allocated decreased provisions to residential real estate, obligations of states and political subdivisions and home equity loans and lines of credit for the three month period ending December 31, 2015 due to declining loan balances and impairment evaluations in those segments. The Company allocated increased provisions to commercial real estate, commercial loans and construction loans for the three month period ending December 31, 2015 due primarily to increased loan balances and increased classified assets. The Company allocated increased provisions in auto loans due to increased loan balances, increased classified assets and increased charge off activity. Despite the above allocations, the allowance for loan losses is general in nature and is available to absorb losses from any loan segment. The following is a summary of troubled debt restructuring granted during the three months ended December 31, 2015 and 2014 (dollars in thousands). For the Three Months Ended December 31, 2015 Dollars in thousands Number of Pre-Modification Post-Modification Troubled Debt Restructurings Real estate loans: Residential 1 $ 81 $ 81 Construction — — — Commercial — — — Commercial — — — Obligations of states and political subdivisions — — — Home equity loans and lines of credit — — — Auto loans — — — Other — — — Total 1 $ 81 $ 81 For the Three Months Ended December 31, 2014 Dollars in thousands Number of Pre-Modification Post-Modification Recorded Troubled Debt Restructurings Real estate loans: Residential 7 $ 1,073 $ 1,073 Construction — — — Commercial — — — Commercial — — — Obligations of states and political subdivisions — — — Home equity loans and lines of credit — — — Auto loans — — — Other — — — Total 7 $ 1,073 $ 1,073 The one new troubled debt restructuring granted for the three months ended December 31, 2015 was granted term concessions. Of the seven new troubled debt restructurings granted for the three months ended December 31, 2014, four loans totaling $548,000 were granted term and rate concessions, two loans totaling $348,000 were granted term concessions and one loan totaling $177,000 was granted a rate concession. For the three months ended December 31, 2015, no loans defaulted on a restructuring agreement within one year of modification. For the three months ended December 31, 2014, one residential real estate loan totaling $156,000 defaulted on a restructuring agreement within one year of modification. Foreclosed assets acquired in settlement of loans are carried at fair value, less estimated costs to sell, and are included in other assets on the Consolidated Balance Sheet. As of December 31, 2015 and September 30, 2015 included with other assets are $2.7 million and $2.5 million, respectively, of foreclosed assets. As of December 31, 2015, included within the foreclosed assets is $2.2 million of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of December 31, 2015, the Company has initiated formal foreclosure proceedings on $4.6 million of consumer residential mortgages which have not yet been transferred into foreclosed assets. |