Loans and Allowance for Loan Losses | 4. Loans and Allowance for Loan Losses The following table presents the Corporation’s loan portfolio by category of loans as of March 31, 2019, and December 31, 2018: LOAN PORTFOLIO (DOLLARS IN THOUSANDS) March 31, December 31, 2019 2018 $ $ Commercial real estate Commercial mortgages 104,041 101,419 Agriculture mortgages 166,950 165,926 Construction 18,302 18,092 Total commercial real estate 289,293 285,437 Consumer real estate (a) 1-4 family residential mortgages 231,538 219,037 Home equity loans 10,011 10,271 Home equity lines of credit 64,408 64,413 Total consumer real estate 305,957 293,721 Commercial and industrial Commercial and industrial 60,893 61,043 Tax-free loans 22,031 22,567 Agriculture loans 21,627 20,512 Total commercial and industrial 104,551 104,122 Consumer 8,713 9,197 Gross loans prior to deferred fees 708,514 692,477 Less: Deferred loan costs, net 1,621 1,596 Allowance for loan losses (8,886 ) (8,666 ) Total net loans 701,249 685,407 (a) Real estate loans serviced for others, which are not included in the Consolidated Balance Sheets, totaled $131,584,000 and $126,916,000 as of March 31, 2019, and December 31, 2018, respectively. The Corporation grades commercial credits differently than consumer credits. The following tables represent all of the Corporation’s commercial credit exposures by internally assigned grades as of March 31, 2019 and December 31, 2018. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans. The Corporation's internally assigned grades for commercial credits are as follows: · Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. · Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. · Substandard – loans that have a well-defined weakness based on objective evidence and characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. · Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances. · Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. COMMERCIAL CREDIT EXPOSURE CREDIT RISK PROFILE BY INTERNALLY ASSIGNED GRADE (DOLLARS IN THOUSANDS) March 31, 2019 Commercial Agriculture Mortgages Construction Commercial Tax-free Agriculture Total $ $ $ $ $ $ $ Grade: Pass 101,241 154,120 17,782 54,986 21,833 19,688 369,650 Special Mention 590 4,393 520 4,807 198 1,325 11,833 Substandard 2,210 8,437 — 1,100 — 614 12,361 Doubtful — — — — — — — Loss — — — — — — — Total 104,041 166,950 18,302 60,893 22,031 21,627 393,844 December 31, 2018 Commercial Agriculture Construction Commercial Tax-free Agriculture Total $ $ $ $ $ $ $ Grade: Pass 99,013 154,132 17,567 59,348 22,367 19,487 371,914 Special Mention 176 3,478 525 518 200 453 5,350 Substandard 2,230 8,316 — 1,177 — 572 12,295 Doubtful — — — — — — — Loss — — — — — — — Total 101,419 165,926 18,092 61,043 22,567 20,512 389,559 The largest movement in credit risk profile from December 31, 2018 to March 31, 2019 was a $3.9 million commercial and industrial (C&I) relationship that was downgraded from pass to special mention. This larger relationship, which provides a wide complement of leased equipment, accounted for the vast majority of the $4.3 million increase in commercial and industrial special mention loans since year-end, and well over half of the increase in special mention loans for all commercial loan categories. Agricultural loans not secured by real estate experienced an $872,000 increase in special mention loans from year-end. This was primarily the result of a downgrading of one farmer with $920,000 of C&I balance, who has a mix of operations. This same borrower had $500,000 in an agricultural mortgage that was also downgraded to special mention in the first quarter of 2019 that contributed to the $915,000 increase in special mention agricultural mortgages. The remainder of the increase in special mention agricultural mortgage loans was over several relationships. Lastly, the commercial mortgage special mention increase of $414,000 was caused by one commercial borrower with a $407,000 balance as of March 31, 2019. For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. Non-performing loans consist of those loans greater than 90 days delinquent and nonaccrual loans. The following tables present the balances of consumer loans by classes of the loan portfolio based on payment performance as of March 31, 2019 and December 31, 2018: CONSUMER CREDIT EXPOSURE CREDIT RISK PROFILE BY PAYMENT PERFORMANCE (DOLLARS IN THOUSANDS) March 31, 2019 1-4 Family Home Equity Home Equity Consumer Total Payment performance: $ $ $ $ $ Performing 231,281 10,011 64,408 8,708 314,408 Non-performing 257 — — 5 262 Total 231,538 10,011 64,408 8,713 314,670 December 31, 2018 1-4 Family Home Equity Home Equity Consumer Total Payment performance: $ $ $ $ $ Performing 218,641 10,271 64,413 9,196 302,521 Non-performing 396 — — 1 397 Total 219,037 10,271 64,413 9,197 302,918 The following tables present an age analysis of the Corporation’s past due loans, segregated by loan portfolio class, as of March 31, 2019 and December 31, 2018: AGING OF LOANS RECEIVABLE (DOLLARS IN THOUSANDS) Loans Greater Receivable > 30-59 Days 60-89 Days than 90 Total Past Total Loans 90 Days and March 31, 2019 Past Due Past Due Days Due Current Receivable Accruing $ $ $ $ $ $ $ Commercial real estate Commercial mortgages — — 1,003 1,003 103,038 104,041 — Agriculture mortgages 254 784 816 1,854 165,096 166,950 — Construction — — — — 18,302 18,302 — Consumer real estate 1-4 family residential mortgages 649 263 257 1,169 230,369 231,538 257 Home equity loans 95 — — 95 9,916 10,011 — Home equity lines of credit 40 — — 40 64,368 64,408 — Commercial and industrial Commercial and industrial — 5 — 5 60,888 60,893 — Tax-free loans — — — — 22,031 22,031 — Agriculture loans 76 — — 76 21,551 21,627 — Consumer 11 3 5 19 8,694 8,713 5 Total 1,125 1,055 2,081 4,261 704,253 708,514 262 Loans Greater Receivable > 30-59 Days 60-89 Days than 90 Total Past Total Loans 90 Days and December 31, 2018 Past Due Past Due Days Due Current Receivable Accruing $ $ $ $ $ $ $ Commercial real estate Commercial mortgages — — 237 237 101,182 101,419 — Agriculture mortgages 326 — 816 1,142 164,784 165,926 — Construction — — — — 18,092 18,092 — Consumer real estate 1-4 family residential mortgages 455 201 396 1,052 217,985 219,037 396 Home equity loans 62 35 — 97 10,174 10,271 — Home equity lines of credit 95 — — 95 64,318 64,413 — Commercial and industrial Commercial and industrial 24 — — 24 61,019 61,043 — Tax-free loans — — — — 22,567 22,567 — Agriculture loans 118 — — 118 20,394 20,512 — Consumer 10 15 1 26 9,171 9,197 1 Total 1,090 251 1,450 2,791 689,686 692,477 397 The following table presents nonaccrual loans by classes of the loan portfolio as of March 31, 2019 and December 31, 2018: NONACCRUAL LOANS BY LOAN CLASS (DOLLARS IN THOUSANDS) March 31, December 31, 2019 2018 $ $ Commercial real estate Commercial mortgages 1,003 1,017 Agriculture mortgages 816 816 Construction — — Consumer real estate 1-4 family residential mortgages — — Home equity loans — — Home equity lines of credit — — Commercial and industrial Commercial and industrial — — Tax-free loans — — Agriculture loans — — Consumer — — Total 1,819 1,833 As of March 31, 2019 and December 31, 2018, all of the Corporation’s commercial loans on nonaccrual status were also considered impaired. Information with respect to impaired loans for the three months ended March 31, 2019 and March 31, 2018, is as follows: IMPAIRED LOANS (DOLLARS IN THOUSANDS) Three months ended March 31, 2019 2018 $ $ Average recorded balance of impaired loans 2,697 1,836 Interest income recognized on impaired loans 11 20 There were no loan modifications made during the three months ended March 31, 2019 or 2018 causing a loan to be considered a troubled debt restructuring (TDR). A TDR is a loan where management has granted a concession to a borrower that is experiencing financial difficulty. A concession is generally defined as more favorable payment or credit terms granted to a borrower in an effort to improve the likelihood of the lender collecting principal in its entirety. Concessions usually are in the form of interest only for a period of time, or a lower interest rate offered in an effort to enable the borrower to continue to make normally scheduled payments. The following tables summarize information regarding impaired loans by loan portfolio class as of March 31, 2019, and December 31, 2018: IMPAIRED LOAN ANALYSIS (DOLLARS IN THOUSANDS) March 31, 2019 Recorded Unpaid Related Average Interest $ $ $ $ $ With no related allowance recorded: Commercial real estate Commercial mortgages 744 774 — 747 — Agriculture mortgages 1,683 1,683 — 1,688 11 Construction — — — — — Total commercial real estate 2,427 2,457 — 2,435 11 Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — — — Total commercial and industrial — — — — — Total with no related allowance 2,427 2,457 — 2,435 11 With an allowance recorded: Commercial real estate Commercial mortgages 260 276 113 262 — Agriculture mortgages — — — — — Construction — — — — — Total commercial real estate 260 276 113 262 — Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — — — Total commercial and industrial — — — — — Total with a related allowance 260 276 113 262 — Total by loan class: Commercial real estate Commercial mortgages 1,004 1,050 113 1,009 — Agriculture mortgages 1,683 1,683 — 1,688 11 Construction — — — — — Total commercial real estate 2,687 2,733 113 2,697 11 Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — — — Total commercial and industrial — — — — — Total 2,687 2,733 113 2,697 11 IMPAIRED LOAN ANALYSIS (DOLLARS IN THOUSANDS) December 31, 2018 Recorded Unpaid Related Average Interest $ $ $ $ $ With no related allowance recorded: Commercial real estate Commercial mortgages 370 901 — 396 — Agriculture mortgages 1,692 1,692 — 1,063 45 Construction — — — — — Total commercial real estate 2,062 2,593 — 1,459 45 Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — — — Total commercial and industrial — — — — — Total with no related allowance 2,062 2,593 — 1,459 45 With an allowance recorded: Commercial real estate Commercial mortgages 647 694 132 484 — Agriculture mortgages — — — — — Construction — — — — — Total commercial real estate 647 694 132 484 — Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — 124 6 Total commercial and industrial — — — 124 6 Total with a related allowance 647 694 132 608 6 Total by loan class: Commercial real estate Commercial mortgages 1,017 1,595 132 880 — Agriculture mortgages 1,692 1,692 — 1,063 45 Construction — — — — — Total commercial real estate 2,709 3,287 132 1,943 45 Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — 124 6 Total commercial and industrial — — — 124 6 Total 2,709 3,287 132 2,067 51 The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2019: ALLOWANCE FOR CREDIT LOSSES (DOLLARS IN THOUSANDS) Commercial Consumer Commercial Consumer Unallocated Total $ $ $ $ $ $ Allowance for credit losses: Beginning balance - December 31, 2018 4,296 2,408 1,428 102 432 8,666 Charge-offs — — — (17 ) — (17 ) Recoveries 44 — 13 — — 57 Provision 148 (140 ) 128 16 28 180 Balance - March 31, 2019 4,488 2,268 1,569 101 460 8,886 During the three months ended March 31, 2019, management charged off $17,000 in loans while recovering $57,000 and added $180,000 to the provision. The growth in the loan portfolio was primarily responsible for the $180,000 of additional provision. During the three months ended March 31, 2019, provision expenses were primarily recorded for the commercial real estate and commercial and industrial segments, while a credit provision was recorded in the consumer real estate segment due to very low historical loss experience. In the past two quarters, management has adjusted the qualitative factors across the loan portfolio to better reflect the forward risk in each loan segment. This has resulted in more provision expense being allocated to commercial real estate loans and less to residential real estate loans. While the Corporation has been experiencing more residential real estate growth than commercial real estate growth, when the performance of these respective borrowers declines, the potential for loan losses is more pronounced with commercial real estate loans. The impact of negative economic events is more volatile with commercial real estate loans. Supporting this conclusion, the Corporation’s level of delinquencies has remained higher with commercial real estate loans than residential real estate loans. The Corporation’s commercial real estate and commercial and industrial loan provision allocations are also influenced by the levels of classified loans. For both of these categories the level of classified loans increased significantly since December 31, 2018, with commercial real estate increasing 31.7% and commercial and industrial increasing over four fold, but on a much smaller loan segment. This is what caused the Corporation to allocate $148,000 of provision expense to commercial real estate and $128,000 to commercial and industrial, while reducing consumer real estate by $140,000. The smallest out of all the loan segments is the unsecured consumer loan segment, where the $16,000 provision allocation was nearly a match to the $17,000 of consumer charge-offs that occurred in the first quarter of 2019. Delinquency rates among the Corporation’s loan pools remain low and made up 0.59% of total loans as of March 31, 2019, compared to 0.46% of total loans as of December 31, 2018. Charge-offs for the three months ended March 31, 2019, were very low at $17,000. The agricultural lending sector has generally been under stress over the past several years due to lower commodity prices. The Corporation’s agricultural portfolio is highly affected by volatility in the protein sector; particularly dairy and broiler prices. These are the two commodity price indicators that have the most immediate impact to the majority of the Corporation’s agricultural borrowers. In 2019, egg prices improved with better pricing on average than 2018. Broiler prices are considered to be stable but on the weaker side of their recent range. Slaughter levels have increased slightly year over year, but with weaker meat demand, poultry integrators are taking active measures to control production. Milk prices remain historically low and have not broken out of a historical low three-year range. The average milk price for the first quarter of 2019 slightly exceeded the average for the first quarter of 2018, but income over feed costs remain low. The local dairy industry continues to undergo consolidation as it deals with overcapacity. These agricultural challenges did not adversely impact the Corporation’s agricultural loans until the end of 2018 when total agricultural mortgage delinquencies rose to $1.1 million, from zero at the end of 2017. As of March 31, 2019, total agricultural mortgage delinquencies rose to $1.9 million. While agricultural mortgage delinquencies have risen significantly since the end of 2018, they still represent only 1.1% of all agricultural mortgages. Agricultural mortgages over 90 days delinquent remained unchanged at $816,000 from December 31, 2018 to March 31, 2019. The agricultural mortgages over 90 days delinquent are made up of two loans to one dairy farmer, with the largest loan of $766,000 backed by a 90% FSA guarantee. Both of the loans were placed on non-accrual at the end of the fourth quarter of 2018. The borrower has been trying to sell the property since mid-2018. The Bank will proceed on foreclosure if the customer is not successful in selling the farm by mid-year. Management does not anticipate any charge-off on this loan due to the sufficiency of collateral and the FSA guarantee. Outside of this relationship, it was the 60-89 days past due delinquencies that were primarily responsible for the increase in total agricultural mortgage delinquencies. Management will continue to closely monitor the level of agricultural mortgage delinquencies for trends like declining borrower performance. Outside of the agricultural economy, the health of the Corporation’s commercial real estate and commercial and industrial borrowers is generally stable with no material trends related to certain types of industries. Total delinquencies for commercial mortgages as of March 31, 2019, were less than 0.4%, while total commercial and industrial delinquencies declined from December 31, 2018 to March 31, 2019. Outside of the above measurements and indicators, management continues to utilize nine qualitative factors to continually refine the potential credit risks across the Corporation’s various loan types. The majority of the qualitative factors had little change during the first quarter of 2019. Minor adjustments to the qualitative factors covering changes in lending policies and procedures, trends in the nature and volume of the loan portfolio, and levels of and trends in delinquency, non-accruals, and charge-offs were made throughout the first quarter as these levels increased or decreased. The other qualitative factors remained consistent since December 31, 2018, requiring no adjustments to the allowance. T ALLOWANCE FOR CREDIT LOSSES (DOLLARS IN THOUSANDS) Commercial Consumer Commercial Consumer Unallocated Total $ $ $ $ $ $ Allowance for credit losses: Beginning balance - December 31, 2017 3,863 2,052 1,829 98 398 8,240 Charge-offs (224 ) — (110 ) (18 ) — (352 ) Recoveries — — 4 1 — 5 Provision 408 137 (422 ) (9 ) 76 190 Balance - March 31, 2018 4,047 2,189 1,301 72 474 8,083 During the three months ended March 31, 2018, provision expenses were recorded for the commercial real estate and consumer real estate segments with credit provisions recorded for the commercial and industrial and consumer loan segments. The increase in the allowance for commercial real estate loans was primarily a result of higher levels of charge-offs in the first three months of 2018. The increase in the amount of the allowance for loan losses allocated to the consumer real estate segment was primarily a result of growth in the residential real estate portfolio during the three months ended March 31, 2018. The following tables present the balance in the allowance for credit losses and the recorded investment in loans receivable by portfolio segment based on impairment method as of March 31, 2019 and December 31, 2018: ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE (DOLLARS IN THOUSANDS) As of March 31, 2019: Commercial Consumer Commercial Consumer Unallocated Total $ $ $ $ $ $ Allowance for credit losses: Ending balance: individually evaluated for impairment 113 — — — — 113 Ending balance: collectively evaluated for impairment 4,375 2,268 1,569 102 459 8,773 Loans receivable: Ending balance 289,293 305,957 104,551 8,713 708,514 Ending balance: individually evaluated for impairment 2,687 — — — 2,687 Ending balance: collectively evaluated for impairment 286,606 305,957 104,551 8,713 705,827 As of December 31, 2018: Commercial Consumer Commercial Consumer Unallocated Total $ $ $ $ $ $ Allowance for credit losses: Ending balance: individually evaluated for impairment 132 — — — — 132 Ending balance: collectively evaluated for impairment 4,164 2,408 1,428 103 431 8,534 Loans receivable: Ending balance 285,437 293,721 104,122 9,197 692,477 Ending balance: individually evaluated for impairment 2,709 — — — 2,709 Ending balance: collectively evaluated for impairment 282,728 293,721 104,122 9,197 689,768 |