Loans and the Allowance for Loan Losses | 7. LOANS AND THE ALLOWANCE FOR LOAN LOSSES The Company’s lending activities are conducted principally in Eastern Massachusetts. The Company grants single- and multi-family residential loans, commercial & industrial (“C&I”), commercial real estate (“CRE”), construction loans, and a variety of consumer loans. Most of the loans granted by the Company are secured by real estate collateral. Repayment of the Company’s residential loans is generally dependent on the health of the employment market in the borrowers’ geographic areas and that of the general economy with liquidation of the underlying real estate collateral being typically viewed as the primary source of repayment in the event of borrower default. The repayment of C&I loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral provided by the borrower. As borrower cash flow may be difficult to predict, liquidation of the underlying collateral securing these loans is typically viewed as the primary source of repayment in the event of borrower default. However, collateral in C&I loans typically consists of equipment, inventory, accounts receivable, or other business assets that may fluctuate in value, so the liquidation of collateral in the event of default is often an insufficient source of repayment. The Company’s CRE loans are primarily made based on the cash flow from the collateral property and secondarily on the underlying collateral provided by the borrower, with liquidation of the underlying real estate collateral typically being viewed as the primary source of repayment in the event of borrower default. The Company’s construction loans are primarily made based on the borrower’s expected ability to execute and the future completed value of the collateral property, with sale of the underlying real estate collateral typically being viewed as the primary source of repayment. Loans outstanding are detailed by category as follows: June 30, 2018 December 31, 2017 (dollars in thousands) Residential mortgage Mortgages - fixed rate $ 299,231 $ 298,851 Mortgages - adjustable rate 249,796 239,027 Deferred costs net of unearned fees 955 1,042 Total residential mortgages 549,982 538,920 Commercial mortgage Mortgages - nonowner occupied 587,183 562,203 Mortgages - owner occupied 38,349 35,343 Construction 36,890 35,904 Deferred costs net of unearned fees 191 199 Total commercial mortgages 662,613 633,649 Home equity Home equity - lines of credit 67,168 70,326 Home equity - term loans 4,434 3,863 Deferred costs net of unearned fees 251 255 Total home equity 71,853 74,444 Commercial & industrial Commercial & industrial 80,206 65,305 Deferred costs (fees) net of unearned fees (54 ) (10 ) Total commercial & industrial 80,152 65,295 Consumer Secured 35,461 37,272 Unsecured 1,132 1,303 Deferred costs net of unearned fees 15 16 Total consumer 36,608 38,591 Total loans $ 1,401,208 $ 1,350,899 Directors and officers of the Company and their associates are customers of, and have other transactions with, the Company in the normal course of business. All loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than normal risk of collection or present other unfavorable features. At June 30, 2018 and December 31, 2017, total loans outstanding to such directors and officers were $408,000 and $516,000, respectively. During the six months ended June 30, 2018, $8,000 of additions and $116,000 of repayments were made to these loans. There were $124,000 of additions and $298,000 of repayments during the year ended December 31, 2017. At June 30, 2018 and December 31, 2017, all of the loans to directors and officers were performing according to their original terms. The following tables set forth information regarding non-performing loans disaggregated by loan category: June 30, 2018 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Total (dollars in thousands) Non-performing loans: Non-accrual loans $ 801 $ 213 $ 14 $ — $ — $ 1,028 Loans past due >90 days, but still accruing — — — — — — Troubled debt restructurings 116 — — 17 — 133 Total $ 917 $ 213 $ 14 $ 17 $ — $ 1,161 December 31, 2017 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Total (dollars in thousands) Non-performing loans: Non-accrual loans $ 918 $ 213 $ 17 $ — $ — $ 1,148 Loans past due >90 days, but still accruing — — — — — — Troubled debt restructurings 121 — — 29 — 150 Total $ 1,039 $ 213 $ 17 $ 29 $ — $ 1,298 There were no Troubled Debt Restructurings (“TDRs”) Loans are considered restructured in a troubled debt restructuring when the Company has granted concessions to a borrower due to the borrower’s financial condition that it otherwise would not have considered. These concessions may include modifications of the terms of the debt such as deferral of payments, extension of maturity, reduction of principal balance, reduction of the stated interest rate other than normal market rate adjustments, or a combination of these concessions. Debt may be bifurcated with separate terms for each tranche of the restructured debt. Restructuring a loan in lieu of aggressively enforcing the collection of the loan may benefit the Company by increasing the ultimate probability of collection. Restructured loans are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan. Loans which are already on nonaccrual status at the time of the restructuring generally remain on nonaccrual status for approximately six months or longer before management considers such loans for return to accruing status. Accruing restructured loans are placed into nonaccrual status if and when the borrower fails to comply with the restructured terms and management deems it unlikely that the borrower will return to a status of compliance in the near term. Troubled debt restructurings are classified as impaired loans. The Company identifies loss allocations for impaired loans on an individual loan basis. There were no new TDRs during the three months and six months ended June 30, 2018. At June 30, 2018, three loans were determined to be TDRs with a total carrying value of $133,000. There were no TDR defaults during the six months ended June 30, 2018. During the year ended December 31, 2017, the Company modified one loan with a pre-modification carrying value (which consists of the unpaid principal balance, net of charge-offs and unamortized deferred loan origination fees and costs, at the time of the restructuring) of $65,000 and a post-modification carrying value of $48,000. At December 31, 2017, this loan had a carrying value of $29,000. At December 31, 2017, three loans were determined to be TDRs with a total carrying value of $150,000. Two loans designated as TDRs were charged-off during the fourth quarter of 2017. There were no TDR defaults during the year ended December 31, 2017. There were no specific allowances for TDRs at June 30, 2018 and December 31, 2017. As of June 30, 2018, there were no significant commitments to lend additional funds to borrowers whose loans were restructured. Loans by Credit Quality Indicator. The following tables contain period-end balances of loans receivable disaggregated by credit quality indicator: June 30, 2018 Residential Mortgages Home Equity Consumer (dollars in thousands) Credit risk profile based on payment activity: Performing $ 549,065 $ 71,839 $ 36,608 Non-performing 917 14 — Total $ 549,982 $ 71,853 $ 36,608 Commercial Mortgages Commercial & Industrial Credit risk profile by internally assigned grade: 1-6 (Pass) $ 657,714 $ 72,058 7 (Special Mention) 4,686 4,275 8 (Substandard) 213 3,819 9 (Doubtful) — — 10 (Loss) — — Total $ 662,613 $ 80,152 December 31, 2017 Residential Mortgages Home Equity Consumer (dollars in thousands) Credit risk profile based on payment activity: Performing $ 537,881 $ 74,427 $ 38,591 Non-performing 1,039 17 — Total $ 538,920 $ 74,444 $ 38,591 Commercial Mortgages Commercial & Industrial Credit risk profile by internally assigned grade: 1-6 (Pass) $ 629,852 $ 56,755 7 (Special Mention) 3,584 8,126 8 (Substandard) 213 414 9 (Doubtful) — — 10 (Loss) — — Total $ 633,649 $ 65,295 With respect to residential mortgages, home equity, and consumer loans, the Bank utilizes the following categories as indicators of credit quality: • Performing – These loans are accruing and are considered having low to moderate risk. • Non-performing – These loans either have been placed on non-accrual, or are past due more than 90 days but are still accruing, and may contain greater than average risk. With respect to CRE and C&I loans, the Bank utilizes a 10 grade internal loan rating system as an indicator of credit quality. The grades are as follows: • Loans rated 1-6 (Pass) – These loans are considered “pass” rated with low to moderate risk. • Loans rated 7 (Special Mention) – These loans have potential weaknesses warranting close attention, which, if left uncorrected, may result in deterioration of the credit at some future date. • Loans rated 8 (Substandard) – These loans have well-defined weaknesses that jeopardize the orderly liquidation of the debt under the original loan terms. Loss potential exists but is not identifiable in any one customer. • Loans rated 9 (Doubtful) – These loans have pronounced weaknesses that make full collection highly questionable and improbable. • Loans rated 10 (Loss) – These loans are considered uncollectible and continuance as a bankable asset is not warranted. Delinquencies The past due status of a loan is determined in accordance with its contractual repayment terms. All loan types are reported past due when one scheduled payment is due and unpaid for 30 days or more. Loan delinquencies can be attributed to many factors, such as but not limited to a continuing weakness in, or deteriorating economic conditions in, the region in which the collateral is located, the loss of a tenant or lower lease rates for commercial borrowers, or the loss of income for consumers and the resulting liquidity impacts on the borrowers. The following tables contain period-end balances of loans receivable disaggregated by past due status: June 30, 2018 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Total Past Due Current Loans Total (dollars in thousands) Residential Mortgages $ 795 $ 395 $ 673 $ 1,863 $ 548,119 $ 549,982 Commercial Mortgages 238 — 213 451 662,162 662,613 Home Equity — — — — 71,853 71,853 Commercial & Industrial 152 163 — 315 79,837 80,152 Consumer loans 4 2 — 6 36,602 36,608 Total $ 1,189 $ 560 $ 886 $ 2,635 $ 1,398,573 $ 1,401,208 December 31, 2017 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Total Past Due Current Loans Total (dollars in thousands) Residential Mortgages $ 1,353 $ 706 $ 64 $ 2,123 $ 536,797 $ 538,920 Commercial Mortgages — 32 — 32 633,617 633,649 Home Equity 1 — 17 18 74,426 74,444 Commercial & Industrial — — — — 65,295 65,295 Consumer loans 176 — — 176 38,415 38,591 Total $ 1,530 $ 738 $ 81 $ 2,349 $ 1,348,550 $ 1,350,899 Foreclosure Proceedings As of June 30, 2018 and December 31, 2017, loans secured by one- to four-family residential property amounting to $351,000 and $64,000, respectively, were in process of foreclosure Impaired Loans Impaired loans are loans for which it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreements and loans restructured in a troubled debt restructuring. The recorded investment in impaired loans consists of unpaid principal balance, net of charge-offs, interest payments received applied to principal and unamortized deferred loan origination fees and costs. The following tables present information pertaining to impaired loans: For the Three Months Ended June 30, 2018 Carrying Value Average Carrying Value Unpaid Principal Balance Related Allowance Interest Income Recognized (dollars in thousands) With no required reserve recorded: Commercial and industrial $ 17 $ 20 $ 17 $ — $ — Commercial mortgage 213 213 227 — — Residential mortgage 845 848 1,051 — — Home equity 66 67 98 — — Total 1,141 1,148 1,393 — — With required reserve recorded: Commercial and industrial — — — — — Commercial mortgage — — — — — Residential mortgage — — — — — Home equity — — — — — Total — — — — — Total: Commercial and industrial 17 20 17 — — Commercial mortgage 213 213 227 — — Residential mortgage 845 848 1,051 — — Home equity 66 67 98 — — Total $ 1,141 $ 1,148 $ 1,393 $ — $ — For the Six Months Ended June 30, 2018 Carrying Value Average Carrying Value Unpaid Principal Balance Related Allowance Interest Income Recognized (dollars in thousands) With no required reserve recorded: Commercial and industrial $ 17 $ 22 $ 17 $ — $ 1 Commercial mortgage 213 213 227 — — Residential mortgage 845 851 1,051 — — Home equity 66 68 98 — — Total 1,141 1,154 1,393 — 1 With required reserve recorded: Commercial and industrial — — — — — Commercial mortgage — — — — — Residential mortgage — — — — — Home equity — — — — — Total — — — — — Total: Commercial and industrial 17 22 17 — 1 Commercial mortgage 213 213 227 — — Residential mortgage 845 851 1,051 — — Home equity 66 68 98 — — Total $ 1,141 $ 1,154 $ 1,393 $ — $ 1 For the Three Months Ended June 30, 2017 Carrying Value Average Carrying Value Unpaid Principal Balance Related Allowance Interest Income Recognized (dollars in thousands) With no required reserve recorded: Commercial and industrial $ 43 $ 39 $ 43 $ — $ — Commercial mortgage 224 228 231 — — Residential mortgage 1,207 1,213 1,393 — 2 Home equity 187 188 215 — 1 Total 1,661 1,668 1,882 — 3 With required reserve recorded: Commercial and industrial 278 280 287 268 — Commercial mortgage — — — — — Residential mortgage 66 66 66 89 — Home equity — — — — — Total 344 346 353 357 — Total: Commercial and industrial 321 319 330 268 — Commercial mortgage 224 228 231 — — Residential mortgage 1,273 1,279 1,459 89 2 Home equity 187 188 215 — 1 Total $ 2,005 $ 2,014 $ 2,235 $ 357 $ 3 For the Six Months Ended June 30, 2017 Carrying Value Average Carrying Value Unpaid Principal Balance Related Allowance Interest Income Recognized (dollars in thousands) With no required reserve recorded: Commercial and industrial $ 43 $ 37 $ 43 $ — $ 1 Commercial mortgage 224 230 231 — 2 Residential mortgage 1,207 1,221 1,393 — 4 Home equity 187 190 215 — 2 Total 1,661 1,678 1,882 — 9 With required reserve recorded: Commercial and industrial 278 282 287 268 — Commercial mortgage — — — — — Residential mortgage 66 67 66 89 1 Home equity — — — — — Total 344 349 353 357 1 Total: Commercial and industrial 321 319 330 268 1 Commercial mortgage 224 230 231 — 2 Residential mortgage 1,273 1,288 1,459 89 5 Home equity 187 190 215 — 2 Total $ 2,005 $ 2,027 $ 2,235 $ 357 $ 10 Allowance for Loan Losses The Company maintains an allowance for loan losses in an amount determined by management on the basis of the character of the loans, loan performance, financial condition of borrowers, the value of collateral securing loans, and other relevant factors. We provide for loan losses based upon the consistent application of our documented allowance for loan loss methodology. All loan losses are charged to the allowance for loan losses and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio, including a review of our classified assets, and make provisions for loan losses in order to maintain the allowance for loan losses in accordance with GAAP. The allowance for loan losses consists primarily of two components: 1. Specific allowances established for impaired loans, as defined by GAAP. The amount of impairment provided for as a specific allowance is measured based on the deficiency, if any, between the present value of expected future cash flows discounted at the loan’s effective interest rate at the time of impairment or, as a practical expedient, at the loan’s observable market price, or the fair value of the collateral if the loan is collateral-dependent, and the carrying value of the loan; and 2. General allowances established for loan losses on a portfolio basis for loans that do not meet the definition of impaired loans. The portfolio is grouped into homogenous pools by similar risk characteristics, primarily by loan type and regulatory classification. We apply an estimated incurred loss rate to each loan group. The loss rates applied are based upon our historical loss experience over a designated look back period adjusted, as appropriate, for the quantitative, qualitative, and environmental factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be significantly more than the allowance for loan losses we have established, which could have a material negative effect on our financial results. The adjustments to historical loss experience are based on our evaluation of several quantitative, qualitative, and environmental factors, including: • the loss emergence period, which represents the average amount of time between when loss events occur for specific loan types and when such problem loans are identified and the related loss amounts are confirmed through charge-offs; • changes in any concentration of credit (including, but not limited to, concentrations by geography, industry, or collateral type); • changes in the number and amount of non-accrual loans and past due loans; • changes in national, state, and local economic trends; • changes in the types of loans in the loan portfolio; • changes in the experience and ability of personnel; • changes in lending strategies; and • changes in lending policies and procedures. In addition, we may establish an unallocated allowance to provide for probable losses that have been incurred as of the reporting date but are not reflected in the allocated allowance. We evaluate the allowance for loan losses based upon the combined total of the specific and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally, when the loan portfolio decreases, absent other factors, the allowance for loan losses methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease. Periodically, management conducts an analysis to estimate the loss emergence period for various loan categories based on samples of historical charge-offs. Model output by loan category is reviewed to evaluate the reasonableness of the reserve levels in comparison to the estimated loss emergence period applied to historical loss experience. We evaluate the loan portfolio on a quarterly basis, and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, will periodically review the allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination. The following tables contain changes in the allowance for loan losses disaggregated by loan category for the periods noted: For the Three Months Ended June 30, 2018 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Impaired Total (dollars in thousands) Allowance for loan losses: Balance at March 31, 2018 $ 4,692 $ 8,937 $ 570 $ 1,145 $ 298 $ 90 $ 15,732 Charge-offs — — — (6 ) (17 ) — (23 ) Recoveries — — — 12 3 — 15 Provision for (Release of) 187 (263 ) 31 44 12 (90 ) (79 ) Balance at June 30, 2018 $ 4,879 $ 8,674 $ 601 $ 1,195 $ 296 $ — $ 15,645 For the Six Months Ended June 30, 2018 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Impaired Total (dollars in thousands) Allowance for loan losses: Balance at December 31, 2017 $ 5,047 $ 8,289 $ 630 $ 946 $ 315 $ 93 $ 15,320 Charge-offs — — — (11 ) (21 ) — (32 ) Recoveries — — — 22 5 — $ 27 Provision for (Release of) (168 ) 385 (29 ) 238 (3 ) (93 ) 330 Balance at June 30, 2018 $ 4,879 $ 8,674 $ 601 $ 1,195 $ 296 $ — $ 15,645 For the Three Months Ended June 30, 2017 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Impaired Total (dollars in thousands) Allowance for loan losses: Balance at March 31, 2017 $ 4,812 $ 8,626 $ 616 $ 658 $ 269 $ 308 $ 15,289 Charge-offs — — — (4 ) (6 ) — (10 ) Recoveries — — — 2 2 — 4 Provision for (Release of) (29 ) (177 ) 16 102 59 49 20 Balance at June 30, 2017 $ 4,783 $ 8,449 $ 632 $ 758 $ 324 $ 357 $ 15,303 For the Six Months Ended June 30, 2017 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Impaired Total (dollars in thousands) Allowance for loan losses: Balance at December 31, 2016 $ 4,898 $ 8,451 $ 651 $ 807 $ 264 $ 190 $ 15,261 Charge-offs — — — (1 ) (13 ) — (14 ) Recoveries — — — 3 3 — 6 Provision for (Release of) (115 ) (2 ) (19 ) (51 ) 70 167 50 Balance at June 30, 2017 $ 4,783 $ 8,449 $ 632 $ 758 $ 324 $ 357 $ 15,303 The following tables contain period-end balances of the allowance for loan losses and related loans receivable disaggregated by impairment method: June 30, 2018 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Total (dollars in thousands) Allowance for loan losses Individually evaluated for impairment $ — $ — $ — $ — $ — $ — Collectively evaluated for impairment 4,879 8,674 601 1,195 296 15,645 Total $ 4,879 $ 8,674 $ 601 $ 1,195 $ 296 $ 15,645 Loans receivable Individually evaluated for impairment $ 845 $ 213 $ 66 $ 17 $ — $ 1,141 Collectively evaluated for impairment 549,137 662,400 71,787 80,135 36,608 1,400,067 Total $ 549,982 $ 662,613 $ 71,853 $ 80,152 $ 36,608 $ 1,401,208 December 31, 2017 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Total (dollars in thousands) Allowance for loan losses Individually evaluated for impairment $ 93 $ — $ — $ — $ — $ 93 Collectively evaluated for impairment 5,047 8,289 630 946 315 15,227 Total $ 5,140 $ 8,289 $ 630 $ 946 $ 315 $ 15,320 Loans receivable Individually evaluated for impairment $ 968 $ 213 $ 86 $ 29 $ — $ 1,296 Collectively evaluated for impairment 537,952 633,436 74,358 65,266 38,591 1,349,603 Total $ 538,920 $ 633,649 $ 74,444 $ 65,295 $ 38,591 $ 1,350,899 |