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: September 30, 2018 December 31, 2017 (dollars in thousands) Residential mortgage Mortgages - fixed rate $ 295,452 $ 298,851 Mortgages - adjustable rate 276,930 239,027 Deferred costs net of unearned fees 1,143 1,042 Total residential mortgages 573,525 538,920 Commercial mortgage Mortgages - nonowner occupied 610,966 562,203 Mortgages - owner occupied 37,347 35,343 Construction 40,076 35,904 Deferred costs net of unearned fees 147 199 Total commercial mortgages 688,536 633,649 Home equity Home equity - lines of credit 65,138 70,326 Home equity - term loans 4,788 3,863 Deferred costs net of unearned fees 247 255 Total home equity 70,173 74,444 Commercial & industrial Commercial & industrial 82,272 65,305 Deferred costs (fees) net of unearned fees (29 ) (10 ) Total commercial & industrial 82,243 65,295 Consumer Secured 35,890 37,272 Unsecured 1,399 1,303 Deferred costs net of unearned fees 15 16 Total consumer 37,304 38,591 Total loans $ 1,451,781 $ 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 September 30, 2018 and December 31, 2017, total loans outstanding to such directors and officers were $391,000 and $516,000, respectively. During the nine months ended September 30, 2018, $14,000 of additions and $139,000 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 September 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: September 30, 2018 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Total (dollars in thousands) Non-performing loans: Non-accrual loans $ 520 $ — $ 14 $ 148 $ — $ 682 Loans past due >90 days, but still accruing — — — — — — Troubled debt restructurings 114 — — 12 — 126 Total $ 634 $ — $ 14 $ 160 $ — $ 808 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 nine months ended September 30, 2018. At September 30, 2018, three no 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 September 30, 2018 and December 31, 2017. As of September 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: September 30, 2018 Residential Mortgages Home Equity Consumer (dollars in thousands) Credit risk profile based on payment activity: Performing $ 572,891 $ 70,159 $ 37,304 Non-performing 634 14 — Total $ 573,525 $ 70,173 $ 37,304 Commercial Mortgages Commercial & Industrial Credit risk profile by internally assigned grade: 1-6 (Pass) $ 683,883 $ 72,858 7 (Special Mention) 4,653 5,456 8 (Substandard) — 3,929 9 (Doubtful) — — 10 (Loss) — — Total $ 688,536 $ 82,243 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: September 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 $ 1,503 $ 264 $ 351 $ 2,118 $ 571,407 $ 573,525 Commercial Mortgages 301 — — 301 688,235 688,536 Home Equity — — 14 14 70,159 70,173 Commercial & Industrial 29 — 148 177 82,066 82,243 Consumer loans 6 2 — 8 37,296 37,304 Total $ 1,839 $ 266 $ 513 $ 2,618 $ 1,449,163 $ 1,451,781 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 September 30, 2018 and December 31, 2017, loans secured by one- to four-family residential property amounting to $ 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 September 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 $ 12 $ 14 $ 12 $ — $ — Commercial mortgage — — — — — Residential mortgage 565 569 712 — — Home equity 77 79 112 — — Total 654 662 836 — — With required reserve recorded: Commercial and industrial 148 148 148 77 1 Commercial mortgage — — — — — Residential mortgage — — — — — Home equity — — — — — Total 148 148 148 77 1 Total: Commercial and industrial 160 162 160 77 1 Commercial mortgage — — — — — Residential mortgage 565 569 712 — — Home equity 77 79 112 — — Total $ 802 $ 810 $ 984 $ 77 $ 1 For the Nine Months Ended September 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 $ 12 $ 20 $ 12 $ — $ 1 Commercial mortgage — — — — — Residential mortgage 565 574 712 — — Home equity 77 80 112 — — Total 654 674 836 — 1 With required reserve recorded: Commercial and industrial 148 148 148 77 6 Commercial mortgage — — — — — Residential mortgage — — — — — Home equity — — — — — Total 148 148 148 77 6 Total: Commercial and industrial 160 168 160 77 7 Commercial mortgage — — — — — Residential mortgage 565 574 712 — — Home equity 77 80 112 — — Total $ 802 $ 822 $ 984 $ 77 $ 7 For the Three Months Ended September 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 $ 38 $ 40 $ 38 $ — $ 1 Commercial mortgage 217 221 229 — — Residential mortgage 991 997 1,187 — — Home equity 98 99 128 — — Total 1,344 1,357 1,582 — 1 With required reserve recorded: Commercial and industrial 269 273 281 259 — Commercial mortgage — — — — — Residential mortgage 65 65 65 98 — Home equity — — — — — Total 334 338 346 357 — Total: Commercial and industrial 307 313 319 259 1 Commercial mortgage 217 221 229 — — Residential mortgage 1,056 1,062 1,252 98 — Home equity 98 99 128 — — Total $ 1,678 $ 1,695 $ 1,928 $ 357 $ 1 For the Nine Months Ended September 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 $ 38 $ 38 $ 38 $ — $ 2 Commercial mortgage 217 227 229 — 3 Residential mortgage 991 1,012 1,187 — — Home equity 98 102 128 — — Total 1,344 1,379 1,582 — 5 With required reserve recorded: Commercial and industrial 269 279 281 259 — Commercial mortgage — — — — — Residential mortgage 65 66 65 98 1 Home equity — — — — — Total 334 345 346 357 1 Total: Commercial and industrial 307 317 319 259 2 Commercial mortgage 217 227 229 — 3 Residential mortgage 1,056 1,078 1,252 98 1 Home equity 98 102 128 — — Total $ 1,678 $ 1,724 $ 1,928 $ 357 $ 6 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 September 30, 2018 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Impaired Total (dollars in thousands) Allowance for loan losses: Balance at June 30, 2018 $ 4,879 $ 8,674 $ 601 $ 1,195 $ 296 $ — $ 15,645 Charge-offs — — — — (10 ) — (10 ) Recoveries — — — 13 1 — 14 Provision for (Release of) 267 149 (56 ) 9 11 77 457 Balance at September 30, 2018 $ 5,146 $ 8,823 $ 545 $ 1,217 $ 298 $ 77 $ 16,106 For the Nine Months Ended September 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 ) (31 ) — (42 ) Recoveries — — — 35 6 — $ 41 Provision for (Release of) 99 534 (85 ) 247 8 (16 ) 787 Balance at September 30, 2018 $ 5,146 $ 8,823 $ 545 $ 1,217 $ 298 $ 77 $ 16,106 For the Three Months Ended September 30, 2017 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Impaired Total (dollars in thousands) Allowance for loan losses: Balance at June 30, 2017 $ 4,783 $ 8,449 $ 632 $ 758 $ 324 $ 357 $ 15,303 Charge-offs — — — — (1 ) — (1 ) Recoveries — — — 6 2 — 8 Provision for (Release of) 303 (126 ) (4 ) 94 43 — 310 Balance at September 30, 2017 $ 5,086 $ 8,323 $ 628 $ 858 $ 368 $ 357 $ 15,620 For the Nine Months Ended September 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 ) (14 ) — (15 ) Recoveries — — — 8 6 — 14 Provision for (Release of) 188 (128 ) (23 ) 44 112 167 360 Balance at September 30, 2017 $ 5,086 $ 8,323 $ 628 $ 858 $ 368 $ 357 $ 15,620 The following tables contain period-end balances of the allowance for loan losses and related loans receivable disaggregated by impairment method: September 30, 2018 Residential Mortgages Commercial Mortgages Home Equity Commercial & Industrial Consumer Total (dollars in thousands) Allowance for loan losses Individually evaluated for impairment $ — $ — $ — $ 77 $ — $ 77 Collectively evaluated for impairment 5,146 8,823 545 1,217 298 16,029 Total $ 5,146 $ 8,823 $ 545 $ 1,294 $ 298 $ 16,106 Loans receivable Individually evaluated for impairment $ 578 $ — $ 64 $ 160 $ — $ 802 Collectively evaluated for impairment 572,947 688,536 70,109 82,083 37,304 1,450,979 Total $ 573,525 $ 688,536 $ 70,173 $ 82,243 $ 37,304 $ 1,451,781 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 |