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 June 30, 2019, and December 31, 2018: LOAN PORTFOLIO (DOLLARS IN THOUSANDS) June 30, December 31, 2019 2018 $ $ Commercial real estate Commercial mortgages 104,418 101,419 Agriculture mortgages 168,726 165,926 Construction 18,151 18,092 Total commercial real estate 291,295 285,437 Consumer real estate (a) 1-4 family residential mortgages 241,134 219,037 Home equity loans 10,536 10,271 Home equity lines of credit 66,535 64,413 Total consumer real estate 318,205 293,721 Commercial and industrial Commercial and industrial 61,298 61,043 Tax-free loans 16,815 22,567 Agriculture loans 20,641 20,512 Total commercial and industrial 98,754 104,122 Consumer 8,397 9,197 Gross loans prior to deferred fees 716,651 692,477 Less: Deferred loan costs, net 1,705 1,596 Allowance for loan losses (8,957 ) (8,666 ) Total net loans 709,399 685,407 (a) Real estate loans serviced for others, which are not included in the Consolidated Balance Sheets, totaled $138,468,000 and $126,916,000 as of June 30, 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 June 30, 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) June 30, 2019 Commercial Agriculture Construction Commercial Tax-free Agriculture Total $ $ $ $ $ $ $ Grade: Pass 102,033 156,264 17,300 55,245 16,618 18,745 366,205 Special Mention 170 3,197 851 4,252 197 1,128 9,795 Substandard 2,215 9,265 — 1,801 — 768 14,049 Doubtful — — — — — — — Loss — — — — — — — Total 104,418 168,726 18,151 61,298 16,815 20,641 390,049 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 June 30, 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 $3.7 million increase in commercial and industrial special mention loans since year end, and the majority of the increase in special mention loans for all commercial loan categories. This loan is current and has performed on a timely basis since origination. Agricultural loans not secured by real estate experienced a $675,000 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. 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 June 30, 2019 and December 31, 2018: CONSUMER CREDIT EXPOSURE CREDIT RISK PROFILE BY PAYMENT PERFORMANCE (DOLLARS IN THOUSANDS) June 30, 2019 1-4 Family Home Equity Home Equity Consumer Total Payment performance: $ $ $ $ $ Performing 240,900 10,536 66,535 8,389 326,360 Non-performing 234 — — 8 242 Total 241,134 10,536 66,535 8,397 326,602 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 June 30, 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 June 30, 2019 Past Due Past Due Days Due Current Receivable Accruing $ $ $ $ $ $ $ Commercial real estate Commercial mortgages — — 993 993 103,425 104,418 — Agriculture mortgages — 377 816 1,193 167,533 168,726 — Construction — — — — 18,151 18,151 — Consumer real estate 1-4 family residential mortgages 274 184 234 692 240,442 241,134 234 Home equity loans 32 24 — 56 10,480 10,536 — Home equity lines of credit 30 — — 30 66,505 66,535 — Commercial and industrial Commercial and industrial 2 — — 2 61,296 61,298 — Tax-free loans — — — — 16,815 16,815 — Agriculture loans 648 — — 648 19,993 20,641 — Consumer 1 — 8 9 8,388 8,397 8 Total 987 585 2,051 3,623 713,028 716,651 242 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 June 30, 2019 and December 31, 2018: NONACCRUAL LOANS BY LOAN CLASS (DOLLARS IN THOUSANDS) June 30, December 31, 2019 2018 $ $ Commercial real estate Commercial mortgages 993 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 1,809 1,833 As of June 30, 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 and six months ended June 30, 2019 and June 30, 2018, is as follows: IMPAIRED LOANS (DOLLARS IN THOUSANDS) Three months ended June 30, Six months ended June 30, 2019 2018 2019 2018 $ $ $ $ Average recorded balance of impaired loans 3,412 2,201 3,057 2,045 Interest income recognized on impaired loans 11 15 22 31 There were no loan modifications made during the three or six months ended June 30, 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 June 30, 2019, and December 31, 2018: IMPAIRED LOAN ANALYSIS (DOLLARS IN THOUSANDS) June 30, 2019 Recorded Unpaid Related Average Interest $ $ $ $ $ With no related allowance recorded: Commercial real estate Commercial mortgages 737 772 — 743 — Agriculture mortgages 2,393 2,393 — 2,054 22 Construction — — — — — Total commercial real estate 3,130 3,165 — 2,797 22 Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — — — Total commercial and industrial — — — — — Total with no related allowance 3,130 3,165 — 2,797 22 With an allowance recorded: Commercial real estate Commercial mortgages 256 274 106 260 — Agriculture mortgages — — — — — Construction — — — — — Total commercial real estate 256 274 106 260 — Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — — — Total commercial and industrial — — — — — Total with a related allowance 256 274 106 260 — Total by loan class: Commercial real estate Commercial mortgages 993 1,046 106 1,003 — Agriculture mortgages 2,393 2,393 — 2,054 22 Construction — — — — — Total commercial real estate 3,386 3,439 106 3,057 22 Commercial and industrial Commercial and industrial — — — — — Tax-free loans — — — — — Agriculture loans — — — — — Total commercial and industrial — — — — — Total 3,386 3,439 106 3,057 22 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 six months ended June 30, 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 Charge-offs — — — (6 ) — (6 ) Recoveries 43 — 1 3 — 47 Provision (114 ) 122 (204 ) (22 ) 248 30 Ending Balance - June 30, 2019 4,417 2,390 1,366 76 708 8,957 During the six months ended June 30, 2019, management charged off $23,000 in loans while recovering $104,000 and added $210,000 to the provision. The unallocated portion of the allowance did increase from 5.3% as of December 31, 2018, and 5.5% as of March 31, 2019, to 8.6% as of June 30, 2019. Management monitors the unallocated portion of the allowance and has guidelines for maintaining any unallocated allowance between 5.0% and 10.0% of the calculated required allowance for credit losses. During the six-months ended June 30, 2019, net provision expense was recorded for the commercial real estate segment, while net credit provisions were recorded in the consumer real estate, commercial and industrial, and consumer segments. This was due to continued very low historical loss experience for these three segments. 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 a slightly larger allowance for commercial real estate loans and slightly lower allowances for consumer real estate, commercial real estate and consumer, while the unallocated portion of the allowance increased. The Corporation’s commercial real estate allocation for credit losses was reduced by $114,000 in the second quarter of 2019, influenced by a reduction in real estate secured agricultural delinquencies that declined materially since March 31, 2019. The allowance for credit losses on consumer real estate grew in the second quarter of 2019 relative to the sharper growth in this segment offset partially by lower delinquencies than March 31, 2019 but unchanged from the prior June 30, 2019. The Commercial and industrial allocation for credit losses was reduced by $204,000 in the second quarter of 2019 as delinquencies declined significantly. The Corporation’s commercial and industrial loans continue to experience lower levels of delinquency than both commercial and agricultural mortgage loans. As of June 30, 2019 the commercial and industrial loan delinquencies were running at a fourth of the level of business mortgage delinquencies. The commercial and industrial delinquencies on June 30, 2019 were only one third of the level of delinquencies as of December 31, 2018. Therefore, the provision for commercial and industrial loans was lowered by $204,000 for the three-month period ended June 30, 2019. The provision for consumer loans was reduced by $22,000 in the second quarter of 2019 as a result of the reductions in consumer credit lines and loan delinquencies from March 31, 2019 to June 30, 2019. As of June 30, 2019, the 0.44% delinquency rate for all of the Corporation’s loans was down slightly from 0.46% as of December 31, 2018 levels, but was down moderately from 0.59% as of March 31, 2019. Charge-offs for the three and six months ended June 30, 2019, were very low at $5,000 and $22,000 compared to $8,000 and $360,000 for the same periods of 2018. The agricultural lending sector has generally been under stress over the past several years due to lower commodity prices within certain agricultural industries. 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. Due to abundant supplies of eggs forecasted through 2019, egg prices will continue to exhibit downward pressures on producers. Broiler prices have slightly increased in 2019 but are forecasted to show continued stress due to expected weak domestic demand for the second half of 2019. Slaughter levels have increased slightly year over year, but with slow growth in 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 half of 2019 slightly exceeded the average for the first half 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 delinquencies rose to $1.4 million, from zero at the end of 2017. As of June 30, 2019, total agricultural mortgage delinquencies rose to $1.9 million, but had declined from the recent high of $2.3 million as of March 31, 2019. The reduction since March 31, 2019 is consistent with slightly improved milk and poultry prices that began to improve in early 2019. Agricultural mortgages over 90 days delinquent remained unchanged at $816,000 from December 31, 2018 to June 30, 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. As of June 30, 2019, the Bank was proceeding on foreclosure proceedings on this loan. 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 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 half 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 half of 2019 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 Charge-offs — — — (8 ) — (8 ) Recoveries — — 2 4 — 6 Provision (43 ) (7 ) (21 ) 63 98 90 Balance - June 30, 2018 4,004 2,182 1,282 131 572 8,171 During the six months ended June 30, 2018, provision expenses were recorded for the commercial real estate, consumer real estate, and consumer segments with a credit provision recorded for the commercial and industrial segment. The increase in the allowance for commercial real estate loans was primarily a result of higher levels of charge-offs in the first six months of 2018. The increase in the amount of the allowance for loan losses allocated to the consumer real estate and consumer segment was primarily a result of growth in these portfolios during the six months ended June 30, 2018. The decrease in commercial and industrial loans from December 31, 2017 to June 30, 2018 was caused by a qualitative factor change across the portfolio and also by the declining level of substandard commercial and industrial loans. The qualitative factors were adjusted across the loan portfolio to better reflect the forward risk in each portfolio. Commercial and consumer real estate carried heavier risk factors, while commercial and industrial was adjusted down. While commercial and industrial did have charge-offs in the first quarter of 2018 they were relative to the size of the allowance and sufficiently covered with prior provisions. There was no commercial and industrial charge-offs in the second quarter of 2018, as well as the commercial and consumer real estate areas. Meanwhile the amount of commercial and industrial loans rated substandard, declined from $3.2 million on December 31, 2017, to $2.8 million as of March 31, 2018, and to $2.0 million as of June 30, 2018. While the balances of commercial and industrial loans increased moderately from December 31, 2017 to June 30, 2018, the required allowance and related provision for these loans is influenced more heavily by the amount of classified loans. 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 June 30, 2019 and December 31, 2018: ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE (DOLLARS IN THOUSANDS) As of June 30, 2019: Commercial Real Consumer Commercial Consumer Unallocated Total $ $ $ $ $ $ Allowance for credit losses: Ending balance: individually evaluated for impairment 106 — — — — 106 Ending balance: collectively evaluated for impairment 4,311 2,390 1,366 76 708 8,851 Loans receivable: Ending balance 291,295 318,205 98,754 8,397 716,651 Ending balance: individually evaluated for impairment 3,386 — — — 3,386 Ending balance: collectively evaluated for impairment 287,909 318,205 98,754 8,397 713,265 As of December 31, 2018: Commercial Real 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 1,428 102 432 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 |