Loans Receivable, Net and Allowance for Loan Losses | 6. Loans Receivable, Net and Allowance for Loan Losses Loans receivable consist of the following (in thousands): December 31, 2016 September 30, 2016 Real estate loans: Residential $ 597,888 $ 596,645 Construction 3,057 1,733 Commercial 293,570 288,447 Commercial 33,867 39,978 Obligations of states and political subdivisions 61,374 56,923 Home equity loans and lines of credit 46,785 48,163 Auto Loans 193,523 193,078 Other 3,299 3,302 1,233,363 1,228,269 Less allowance for loan losses 9,342 9,056 Net loans $ 1,224,021 $ 1,219,213 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 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, 2016 and December 31, 2015 (in thousands): Three Months Ended December 31, 2016 2015 Balance at beginning of period $ 478 $ 258 Reclassification, new additions and other — 240 Accretion (25 ) (50 ) Balance at end of period $ 453 $ 448 The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands): December 31, 2016 September 30, 2016 Acquired Loans with Specific Evidence or Deterioration in Credit Quality (ASC 310-30) Acquired Loans with Specific Evidence or Deterioration in Credit Quality (ASC 310-30) Outstanding balance $ 6,728 $ 6,893 Carrying amount $ 5,452 $ 5,563 The following tables show the amount of loans in each category that was individually and collectively evaluated for impairment at the dates indicated (in thousands): Total Loans Individually Evaluated for Impairment Loans Acquired with Deteriorated Credit Quality Collectively Evaluated for Impairment December 31, 2016 Real estate loans: Residential $ 597,888 $ 7,962 $ — $ 589,926 Construction 3,057 — — 3,057 Commercial 293,570 11,223 4,504 277,843 Commercial 33,867 1,824 411 31,632 Obligations of states and political subdivisions 61,374 — — 61,374 Home equity loans and lines of credit 46,785 208 537 46,040 Auto loans 193,523 569 — 192,954 Other 3,299 24 — 3,275 Total $ 1,233,363 $ 21,810 $ 5,452 $ 1,206,101 Total Loans Individually Evaluated for Impairment Loans Acquired with Deteriorated Credit Quality Collectively Evaluated for Impairment September 30, 2016 Real estate loans: Residential $ 596,645 $ 8,721 $ — $ 587,924 Construction 1,733 — — 1,733 Commercial 288,447 11,237 4,615 272,595 Commercial 39,978 1,698 411 37,869 Obligations of states and political sub divisions 56,923 — — 56,923 Home equity loans and lines of credit 48,163 361 537 47,265 Auto loans 193,078 526 — 192,552 Other 3,302 22 — 3,280 Total $ 1,228,269 $ 22,565 $ 5,563 $ 1,200,141 The Company maintains 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. The Company does 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 that it would not otherwise consider because of the borrower’s financial condition. 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 at the time of modification may be removed from TDR status after one year of performance. The following tables include the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount at the dates indicated, if applicable (in thousands): Recorded Investment Unpaid Principal Balance Associated Allowance December 31, 2016 With no specific allowance recorded: Real estate loans Residential $ 5,758 $ 7,807 $ — Construction — — — Commercial 10,770 12,828 — Commercial 1,767 1,808 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 202 274 — Auto loans 52 147 — Other 24 26 — Total 18,573 22,890 — With an allowance recorded: Real estate loans Residential 2,204 2,485 145 Construction — — — Commercial 453 666 32 Commercial 57 67 1 Obligations of states and political subdivisions — — — Home equity loans and lines of credit 6 6 6 Auto loans 517 517 282 Other — — — Total 3,237 3,741 466 Total: Real estate loans Residential 7,962 10,292 145 Construction — — — Commercial 11,223 13,494 32 Commercial 1,824 1,875 1 Obligations of states and political subdivisions — — — Home equity loans and lines of credit 208 280 6 Auto loans 569 664 282 Other 24 26 — Total Impaired Loans $ 21,810 $ 26,631 $ 466 Recorded Investment Unpaid Principal Balance Associated Allowance September 30, 2016 With no specific allowance recorded: Real Estate Loans Residential $ 6,721 $ 9,016 $ — Construction — — — Commercial 10,939 12,928 — Commercial 1,698 1,725 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 361 432 — Auto Loans 253 365 — Other 22 22 — Total 19,994 24,488 — With an allowance recorded: Real Estate Loans Residential 2,000 2,151 198 Construction — — — Commercial 298 303 36 Commercial — — — Obligations of states and political subdivisions — — — Home equity loans and lines of credit — — — Auto Loans 273 273 113 Other — — — Total 2,571 2,727 347 Total: Real Estate Loans Residential 8,721 11,167 198 Construction — — — Commercial 11,237 13,231 36 Commercial 1,698 1,725 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 361 432 — Auto Loans 526 638 113 Other 22 22 — Total Impaired Loans $ 22,565 $ 27,215 $ 347 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, 2016 2015 2016 2015 Average Recorded Investment Average Recorded Investment Interest Income Recognized Interest Income Recognized With no specific allowance recorded: Real estate loans Residential $ 6,526 $ 8,785 $ 11 $ 27 Construction — — — — Commercial 10,564 18,574 105 176 Commercial 1,693 820 33 15 Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 317 962 — 2 Auto loans 135 282 1 1 Other 8 — — — Total 19,243 29,423 150 221 With an allowance recorded: Real estate loans Residential 2,066 2,592 — 5 Construction — — — — Commercial 348 457 — — Commercial 19 3 — — Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 2 73 — — Auto loans 215 141 4 1 Other — — — — Total 2,650 3,266 4 6 Total: Real estate loans Residential 8,592 11,377 11 32 Construction — — — — Commercial 10,912 19,031 105 176 Commercial 1,712 823 33 15 Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 319 1,035 — 2 Auto loans 350 423 5 2 Other 8 — — — Total Impaired Loans $ 21,893 $ 32,689 $ 154 $ 227 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 more than 90 days past due are considered Substandard. Loans in the Doubtful category have all the weaknesses inherent in loans classified as Substandard with the added characteristic that their 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 recommendation for 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 $750,000 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 or Loss within the internal risk rating system at December 31, 2016 and September 30, 2016 (in thousands): Pass Special Mention Substandard Doubtful or Loss Total December 31, 2016 Commercial real estate loans $ 267,727 $ 7,525 $ 18,318 $ — $ 293,570 Commercial 30,273 171 3,423 — 33,867 Obligations of states and political subdivisions 61,374 — — — 61,374 Total $ 359,374 $ 7,696 $ 21,741 $ — $ 388,811 Pass Special Mention Substandard Doubtful or Loss Total September 30, 2016 Commercial real estate loans $ 260,088 $ 8,886 $ 19,473 $ — $ 288,447 Commercial 36,684 180 3,114 — 39,978 Obligations of states and political subdivisions 56,923 — — — 56,923 Total $ 353,695 $ 9,066 $ 22,587 $ — $ 385,348 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, 2016 and September 30, 2015 (in thousands): Performing Non-performing Purchased Credit Impaired Total December 31, 2016 Real estate loans: Residential $ 588,731 $ 9,157 $ — $ 597,888 Construction 3,057 — — 3,057 Home equity loans and lines of credit 45,686 562 537 46,785 Auto loans 193,147 376 — 193,523 Other 3,263 36 — 3,299 Total $ 833,884 $ 10,131 $ 537 $ 844,552 Performing Non-performing Purchased Impaired Credit Total September 30, 2016 Real estate loans: Residential $ 587,673 $ 8,972 $ — $ 596,645 Construction 1,733 — — 1,733 Home equity loans and lines of credit 47,213 413 537 48,163 Auto loans 192,734 344 — 193,078 Other 3,271 31 — 3,302 Total $ 832,624 $ 9,760 $ 537 $ 842,921 The Company 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, 2016 and September 30, 2016 (in thousands): Current 31-60 Days Past Due 61-90 Days Past Due Greater than 90 Days Past Due and still accruing Non-Accrual Total Past Due and Non- Accrual Purchased Credit Impaired Total Loans December 31, 2016 Real estate loans Residential $ 586,229 $ 2,076 $ 426 $ — $ 9,157 $ 11,659 $ — $ 597,888 Construction 3,057 — — — — — — 3,057 Commercial 284,669 167 135 — 4,095 4,397 4,504 293,570 Commercial 32,662 75 — — 719 794 411 33,867 Obligations of states and political subdivisions 61,374 — — — — — — 61,374 Home equity loans and lines of credit 45,609 47 30 — 562 639 537 46,785 Auto loans 192,264 614 269 — 376 1,259 — 193,523 Other 3,214 49 — — 36 85 — 3,299 Total $ 1,209,078 $ 3,028 $ 860 $ — $ 14,945 $ 18,833 $ 5,452 $ 1,233,363 Current 31-60 Days Past Due 61-90 Days Past Due Greater than 90 Days Past Due and still accruing Non-Accrual Total Past Due and Non- Accrual Purchased Credit Impaired Total Loans September 30, 2016 Real estate loans Residential $ 585,517 $ 1,496 $ 660 $ — $ 8,972 $ 11,128 $ — $ 596,645 Construction 1,733 — — — — — — 1,733 Commercial 279,019 1,093 191 — 3,529 4,813 4,615 288,447 Commercial 38,862 185 57 — 463 705 411 39,978 Obligations of states and political subdivisions 56,923 — — — — — — 56,923 Home equity loans and lines of credit 47,026 40 147 — 413 600 537 48,163 Auto loans 191,785 717 232 — 344 1,293 — 193,078 Other 3,264 7 — — 31 38 — 3,302 Total $ 1,204,129 $ 3,538 $ 1,287 $ — $ 13,752 $ 18,577 $ 5,563 $ 1,228,269 The 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. The 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, 2016 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 period ending December 31, 2016 and 2015 (in thousands): Home Obligations of Equity States and Loans and Real Estate Loans Commercial Political Lines of Other Residential Construction Commercial Loans Subdivisions Credit Auto Loans Loans Unallocated Total ALL balance at September 30, 2016 $ 4,426 $ 13 $ 852 $ 882 $ 215 $ 455 $ 1,880 $ 25 $ 308 $ 9,056 Charge-offs (76 ) — (91 ) (19 ) — — (517 ) (4 ) — (707 ) Recoveries 2 — 10 0 — 1 228 2 — 243 Provision 98 10 24 102 19 (15 ) 471 2 39 750 ALL balance at December 31, 2016 $ 4,450 $ 23 $ 795 $ 965 $ 234 $ 441 $ 2,062 $ 25 $ 347 $ 9,342 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 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 two categories, the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of December 31, 2016 and September 30, 2016 (in thousands): Home Obligations of Equity States and Loans and Real Estate Loans Commercial Political Lines of Other Residential Construction Commercial Loans Subdivisions Credit Auto Loans Loans Unallocated Total Individually evaluated for impairment $ 145 $ — $ 32 $ 1 $ — $ 6 $ 282 $ — $ — $ 466 Collectively evaluated for impairment 4,305 23 763 964 234 435 1,780 25 347 8,876 ALL Balance at December 31, 2016 $ 4,450 $ 23 $ 795 $ 965 $ 234 $ 441 $ 2,062 $ 25 $ 347 $ 9,342 Individually evaluated for impairment $ 198 $ — $ 36 $ — $ — $ — $ 113 $ — $ — $ 347 Collectively evaluated for impairment 4,228 13 816 882 215 455 1,767 25 308 8,709 ALL balance at September 30, 2016 $ 4,426 $ 13 $ 852 $ 882 $ 215 $ 455 $ 1,880 $ 25 $ 308 $ 9,056 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 increased provisions to residential real estate, construction loan, commercial loans, and obligations of states and political subdivisions for the three month period ending December 31, 2016 due to increased balances and impairment evaluations in those segments. The Company allocated decreased provisions to commercial real estate loans for the three month period ending December 31, 2016 due to declining loss experience. The Company allocated decreased provisions to home equity loans and lines of credit for the three month period ending December 31, 2016 due primarily to decreased loan balances. 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, 2016 and 2015 (dollars in thousands): For the Three Months Ended December 31, 2016 Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Troubled Debt Restructurings Real estate loans: Residential 2 $ 259 $ 259 Construction — — — Commercial — — — Commercial — — — Obligations of states and political subdivisions — — — Home equity loans and lines of credit — — — Auto loans — — — Other — — — Total 2 $ 259 $ 259 For the Three Months Ended December 31, 2015 Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment 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 The two new troubled debt restructurings granted for the three months ended December 31, 2016, totaled $259,000 and were granted term and rate concessions. The one new troubled debt restructurings granted for the three months ended December 31, 2015, totaled $81,000, and was granted terms and rate concessions. For the three months ended December 31, 2016, one loan totaling $107,000 defaulted on a restructuring agreement within one year of modification. For the three months ended December 31, 2015, no loans 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 the Consolidated Balance Sheet. As of December 31, 2016 and September 30, 2016, included with other assets are $2.4 million and $2.7 million, of foreclosed assets, respectively. As of December 31, 2016, included within the foreclosed assets is $1.9 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, 2016, the Company has initiated formal foreclosure proceedings on $2.7 million of consumer residential mortgages which have not yet been transferred into foreclosed assets. |