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, 2017 September 30, 2017 Real estate loans: Residential $ 584,441 $ 586,708 Construction 4,269 3,097 Commercial 356,110 318,323 Commercial 48,750 44,129 Obligations of states and political subdivisions 55,555 58,079 Home equity loans and lines of credit 45,925 46,219 Auto Loans 188,410 186,646 Other 2,708 2,845 1,286,168 1,246,046 Less allowance for loan losses 9,833 9,365 Net loans $ 1,276,335 $ 1,236,681 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. Changes in the accretable yield for purchased credit-impaired loans were as follows, since acquisition, for the three months ended December 31, 2017 and 2016 (in thousands): For the Three Months Ended December 31, 2017 2016 Balance at beginning of period $ 471 $ 478 Reclassification, new additions and other 596 — Accretion (312 ) (25 ) Balance at end of period $ 755 $ 453 The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands): December 31, 2017 September 30, 2017 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 $ 5,162 $ 5,490 Carrying amount $ 4,387 $ 4,388 The following tables show the amount of loans in each category that were 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, 2017 Real estate loans: Residential $ 584,441 $ 5,623 $ — $ 578,818 Construction 4,269 — — 4,269 Commercial 356,110 6,887 3,856 345,367 Commercial 48,750 1,235 207 47,308 Obligations of states and political subdivisions 55,555 — — 55,555 Home equity loans and lines of credit 45,925 226 324 45,375 Auto loans 188,410 775 — 187,635 Other 2,708 29 — 2,679 Total $ 1,286,168 $ 14,775 $ 4,387 $ 1,267,006 Total Loans Individually Evaluated for Impairment Loans Acquired with Deteriorated Credit Quality Collectively Evaluated for Impairment September 30, 2017 Real estate loans: Residential $ 586,708 $ 6,202 $ — $ 580,506 Construction 3,097 — — 3,097 Commercial 318,323 7,211 3,775 307,337 Commercial 44,129 1,385 283 42,461 Obligations of states and political sub divisions 58,079 — — 58,079 Home equity loans and lines of credit 46,219 176 330 45,713 Auto loans 186,646 572 — 186,074 Other 2,845 30 — 2,815 Total $ 1,246,046 $ 15,576 $ 4,388 $ 1,226,082 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, 2017 With no specific allowance recorded: Real estate loans Residential $ 4,388 $ 5,833 $ — Construction — — — Commercial 6,868 8,901 — Commercial 1,234 1,477 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 221 305 — Auto loans 267 436 — Other 29 35 — Total 13,007 16,987 — With an allowance recorded: Real estate loans Residential 1,235 1,435 144 Construction — — — Commercial 19 97 16 Commercial 1 13 5 Obligations of states and political subdivisions — — — Home equity loans and lines of credit 5 5 1 Auto loans 508 526 215 Other — — — Total 1,768 2,076 381 Total: Real estate loans Residential 5,623 7,268 144 Construction — — — Commercial 6,887 8,998 16 Commercial 1,235 1,490 5 Obligations of states and political subdivisions — — — Home equity loans and lines of credit 226 310 1 Auto loans 775 962 215 Other 29 35 — Total Impaired Loans $ 14,775 $ 19,063 $ 381 Recorded Investment Unpaid Principal Balance Associated Allowance September 30, 2017 With no specific allowance recorded: Real Estate Loans Residential $ 4,392 $ 5,730 $ — Construction — — — Commercial 7,191 9,396 — Commercial 1,385 1,575 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 176 258 — Auto Loans 123 237 — Other 30 36 — Total 13,297 17,232 — With an allowance recorded: Real Estate Loans Residential 1,810 2,264 154 Construction — — — Commercial 20 1,193 19 Commercial — — — Obligations of states and political subdivisions — — — Home equity loans and lines of credit — — — Auto Loans 449 468 172 Other — — — Total 2,279 3,925 345 Total: Real Estate Loans Residential 6,202 7,994 154 Construction — — — Commercial 7,211 10,589 19 Commercial 1,385 1,575 — Obligations of states and political subdivisions — — — Home equity loans and lines of credit 176 258 — Auto Loans 572 705 172 Other 30 36 — Total Impaired Loans $ 15,576 $ 21,157 $ 345 The following tables represent 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): For the Three Months Ended December 31, 2017 2016 2017 2016 Average Recorded Investment Average Recorded Investment Interest Income Recognized Interest Income Recognized With no specific allowance recorded: Real estate loans Residential $ 4,429 $ 6,526 $ 10 $ 11 Construction — — — — Commercial 7,006 10,564 72 105 Commercial 1,289 1,693 27 33 Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 206 317 — — Auto loans 137 135 1 1 Other 10 8 — — Total 13,077 19,243 110 150 With an allowance recorded: Real estate loans Residential 1,527 2,066 — — Construction — — — — Commercial 20 348 — — Commercial — 19 — — Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 2 2 — — Auto loans 262 215 — 4 Other — — — — Total 1,811 2,650 — 4 Total: Real estate loans Residential 5,956 8,592 10 11 Construction — — — — Commercial 7,026 10,912 72 105 Commercial 1,289 1,712 27 33 Obligations of states and political subdivisions — — — — Home equity loans and lines of credit 208 319 — — Auto loans 399 350 1 5 Other 10 8 — — Total Impaired Loans $ 14,888 $ 21,893 $ 110 $ 154 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, 2017 and September 30, 2017 (in thousands): Pass Special Mention Substandard Doubtful or Loss Total December 31, 2017 Commercial real estate loans $ 344,891 $ 2,144 $ 9,075 $ — $ 356,110 Commercial 47,642 12 1,096 — 48,750 Obligations of states and political subdivisions 55,555 — — — 55,555 Total $ 448,088 $ 2,156 $ 10,171 $ — $ 460,415 Pass Special Mention Substandard Doubtful or Loss Total September 30, 2017 Commercial real estate loans $ 300,554 $ 3,376 $ 14,393 $ — $ 318,323 Commercial 40,996 32 3,101 — 44,129 Obligations of states and political subdivisions 58,079 — — — 58,079 Total $ 399,629 $ 3,408 $ 17,494 $ — $ 420,531 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, 2017 and September 30, 2017 (in thousands): Performing Non- performing Purchased Credit Impaired Total December 31, 2017 Real estate loans: Residential $ 577,708 $ 6,733 $ — $ 584,441 Construction 4,269 — — 4,269 Home equity loans and lines of credit 45,274 327 324 45,925 Auto loans 187,616 794 — 188,410 Other 2,675 33 — 2,708 Total $ 817,542 $ 7,887 $ 324 $ 825,753 Performing Non-performing Purchased Impaired Credit Total September 30, 2017 Real estate loans: Residential $ 580,116 $ 6,592 $ — $ 586,708 Construction 3,097 — — 3,097 Home equity loans and lines of credit 45,576 313 330 46,219 Auto loans 185,910 736 — 186,646 Other 2,807 38 — 2,845 Total $ 817,506 $ 7,679 $ 330 $ 825,515 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, 2017 and September 30, 2017 (in thousands): 31-60 Days 61-90 Days Greater than 90 Days Past Due and Total Purchased Credit Impaired Total Current Past Due Past Due Accruing Nonaccrual Past Due Accruing Nonaccrual Loans December 31, 2017 Real estate loans: Residential $ 574,224 $ 2,490 $ 994 $ — $ 6,733 $ 10,217 $ — $ — $ 584,441 Construction 4,269 — — — — - — — 4,269 Commercial 349,686 146 103 — 2,319 2,568 467 3,389 356,110 Commercial 48,367 — — — 176 176 — 207 48,750 Obligations of states and political subdivisions 55,555 — — — — — — — 55,555 Home equity loans and lines of credit 45,215 51 8 — 327 386 — 324 45,925 Auto loans 186,765 788 63 — 794 1,645 — — 188,410 Other 2,657 15 3 — 33 51 — — 2,708 Total $ 1,266,738 $ 3,490 $ 1,171 $ — $ 10,382 $ 15,043 $ 467 $ 3,920 $ 1,286,168 31-60 Days 61-90 Days Greater than 90 Days Past Due and Total Purchased Credit Impaired Total Current Past Due Past Due Accruing Nonaccrual Past Due Accruing Nonaccrual Loans September 30, 2017 Real estate loans: Residential $ 577,034 $ 2,661 $ 421 $ — $ 6,592 $ 9,674 $ — $ — $ 586,708 Construction 3,097 — — — — — — — 3,097 Commercial 312,098 172 — — 2,278 2,450 612 3,163 318,323 Commercial 43,298 18 — — 530 548 — 283 44,129 Obligations of states and political subdivisions 58,079 — — — — — — — 58,079 Home equity loans and lines of credit 45,460 101 15 — 313 429 — 330 46,219 Auto loans 185,247 631 32 — 736 1,399 — — 186,646 Other 2,789 14 4 — 38 56 — — 2,845 Total $ 1,227,102 $ 3,597 $ 472 $ — $ 10,487 $ 14,556 $ 612 $ 3,776 $ 1,246,046 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, 2017 was 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 allowance for loan losses (“ALL”). When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL. The following table summarizes changes in the primary segments of the ALL for the three month periods ended December 31, 2017 and 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 ALL balance at September 30, 2017 $ 3,878 $ 23 $ 1,758 $ 987 $ 248 $ 470 $ 1,836 $ 21 $ 144 $ 9,365 Charge-offs (43 ) — (1 ) (133 ) — — (536 ) (6 ) — (719 ) Recoveries 3 — 2 10 — 1 170 1 — 187 Provision (69 ) 10 560 190 (35 ) (22 ) 492 5 (131 ) 1,000 ALL balance at December 31, 2017 $ 3,769 $ 33 $ 2,319 $ 1,054 $ 213 $ 449 $ 1,962 $ 21 $ 13 $ 9,833 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 — — 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 Acquired loans are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses. The Company allocated increased provisions to commercial real estate loans due primarily to increased loan balances for the three month period ended December 31, 2017. The Company allocated increased provisions to commercial loans due primarily to increase loan balances and charge off activity for the three month period ended December 31, 2017. The Company allocated decreased provisions to commercial real estate loans for the three month period ended December 31, 2016 due to declining loss experience. The Company allocated increased provisions to commercial loans for the period ended December 31, 2016 due to increased balances and impairment evaluation in those segments. 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, 2017 and September 30, 2017 (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 $ 144 $ — $ 16 $ 5 $ — $ 1 $ 215 $ — $ — $ 381 Collectively evaluated for impairment 3,625 33 2,303 1,049 213 448 1,747 21 13 9,452 ALL balance at December 31, 2017 $ 3,769 $ 33 $ 2,319 $ 1,054 $ 213 $ 449 $ 1,962 $ 21 $ 13 $ 9,833 Individually evaluated for impairment $ 154 $ — $ 19 $ — $ — $ — $ 172 $ — $ — $ 345 Collectively evaluated for impairment 3,724 23 1,739 987 248 470 1,664 21 144 9,020 ALL balance at September 30, 2017 $ 3,878 $ 23 $ 1,758 $ 987 $ 248 $ 470 $ 1,836 $ 21 $ 144 $ 9,365 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. 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, 2017 and 2016 (dollars in thousands): For the Three Months Ended December 31, 2017 Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Troubled Debt Restructurings Real estate loans: Residential 2 $ 243 $ 240 Construction — — — Commercial — — — Commercial — — — Obligations of states and political subdivisions — — — Home equity loans and lines of credit — — — Auto loans — — — Other — — — Total 2 $ 243 $ 240 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 The two new troubled debt restructurings granted for the three months ended December 31, 2017, totaled $240,000 and were granted interest rate and principal concessions. 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. For the three months ended December 31, 2017, two loans totaling $95,000 defaulted on a restructuring agreement within one year of modification. For the three months ended December 31, 2016, one loan totaling $107,000 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 the Consolidated Balance Sheet. As of December 31, 2017, included within the foreclosed assets is $762,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu of foreclosure transaction prior to the period end. As of December 31, 2017, the Company has initiated formal foreclosure proceedings on $2.3 million of consumer residential mortgages which have not yet been transferred into foreclosed assets. |