Loan Quality | Note 6. Loan Quality Management utilizes a risk rating scale ranging from 1 (Prime) to 9 (Loss) to evaluate loan quality. This risk rating scale is used primarily for commercial purpose loans. Consumer purpose loans are identified as either a pass or substandard rating. Substandard consumer loans are loans that are 90 days or more past due and still accruing. Loans rated 1 – 4 are considered pass credits. Loans that are rated 5 are pass credits, but have been identified as credits that are likely to warrant additional attention and monitoring. Loans rated 6 (Special Mention) or worse begin to receive enhanced monitoring and reporting by the Bank. Loans rated 7 (Substandard) or 8 (Doubtful) exhibit the greatest financial weakness and present the greatest possible risk of loss to the Bank. Nonaccrual loans are rated no better than 7. The following represents some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt. The Bank monitors loan quality by reviewing four measurements: (1) loans rated 6 or worse (collectively “watch list”), (2) delinquent loans, (3) other real estate owned (OREO), and (4) net-charge-offs. The following table reports on the credit rating for those loans in the portfolio that are assigned an individual credit rating as of December 31, 201 6 and 201 5 (1-5) (6) (7) (8) (Dollars in thousands) Pass Special Mention Substandard Doubtful Total December 31, 2016 Residential Real Estate 1-4 Family First liens $ 167,199 $ 227 $ 1,144 $ - $ 168,570 Junior liens and lines of credit 50,017 28 168 - 50,213 Total 217,216 255 1,312 - 218,783 Residential real estate - construction 8,220 - 755 - 8,975 Commercial real estate 377,283 - 13,301 - 390,584 Commercial 267,901 957 1,968 - 270,826 Consumer 4,705 - - - 4,705 Total $ 875,325 $ 1,212 $ 17,336 $ - $ 893,873 December 31, 2015 Residential Real Estate 1-4 Family First liens $ 157,514 $ 2,122 $ 1,842 $ - $ 161,478 Junior liens and lines of credit 50,685 28 200 - 50,913 Total 208,199 2,150 2,042 - 212,391 Residential real estate - construction 7,386 - 502 - 7,888 Commercial real estate 319,985 6,175 14,535 - 340,695 Commercial 213,492 1,978 472 - 215,942 Consumer 5,100 - - - 5,100 Total $ 754,162 $ 10,303 $ 17,551 $ - $ 782,016 Delinquent loans are a result of borrowers’ cash flow and/or alternative sources of cash being insufficient to repay loans. The Bank’s likelihood of collateral liquidation to repay the loans becomes more probable the further behind a borrower falls, particularly when loans reach 90 days or more past due. Management monitors the performance status of loans by the use of an aging report. The aging report can provide an early indicator of loans that may become severely delinquent and possibly result in a loss to the Bank. The following table presents the aging of payments in the loan portfolio as of December 31, 2016 and 2015: (Dollars in thousands) Loans Past Due and Still Accruing Total Current 30-59 Days 60-89 Days 90 Days+ Total Non-Accrual Loans December 31, 2016 Residential Real Estate 1-4 Family First liens $ 166,689 $ 1,236 $ 414 $ - $ 1,650 $ 231 $ 168,570 Junior liens and lines of credit 50,031 96 - - 96 86 50,213 Total 216,720 1,332 414 - 1,746 317 218,783 Residential real estate - construction 8,495 - - - - 480 8,975 Commercial real estate 384,658 858 447 665 1,970 3,956 390,584 Commercial 270,478 250 75 - 325 23 270,826 Consumer 4,672 30 3 - 33 - 4,705 Total $ 885,023 $ 2,470 $ 939 $ 665 $ 4,074 $ 4,776 $ 893,873 December 31, 2015 Residential Real Estate 1-4 Family First liens $ 159,998 $ 44 $ 416 $ 214 $ 674 $ 806 $ 161,478 Junior liens and lines of credit 50,541 217 50 - 267 105 50,913 Total 210,539 261 466 214 941 911 212,391 Residential real estate - construction 7,209 177 - - 177 502 7,888 Commercial real estate 330,953 5,713 196 152 6,061 3,681 340,695 Commercial 215,449 210 5 2 217 276 215,942 Consumer 5,041 55 4 - 59 - 5,100 Total $ 769,191 $ 6,416 $ 671 $ 368 $ 7,455 $ 5,370 $ 782,016 Impaired loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Nonaccrual loans are rated no better than 7 (Substandard). Interest not recognized on nonaccrual loans was $114 thousand, $335 thousand and $752 thousand for the years ended December 31, 2016, 2015 and 2014, respectively. In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Nonaccrual loans, excluding consumer purpose loans, and troubled-debt restructuring (TDR) loans are considered impaired. For impaired loans with balances less than $250 thousand and consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. Management does not believe that excluding these loans from the specific reserve analysis presents any additional risk. Impaired loans totaled $15.1 million at year -end 201 6 compared to $16.8 million at December 31, 201 5. The following table s present information on impaired loans. Impaired Loans With No Allowance With Allowance (Dollars in thousands) Unpaid Unpaid Recorded Principal Recorded Principal Related December 31, 2016 Investment Balance Investment Balance Allowance Residential Real Estate 1-4 Family First liens $ 956 $ 1,030 $ - $ - $ - Junior liens and lines of credit 85 93 - - - Total 1,041 1,123 - - - Residential real estate - construction 480 535 - - - Commercial real estate 13,523 14,133 - - - Commercial 23 35 - - - Consumer - - - - - Total $ 15,067 $ 15,826 $ - $ - $ - December 31, 2015 Residential Real Estate 1-4 Family First liens $ 1,523 $ 1,725 $ - $ - $ - Junior liens and lines of credit 105 133 - - - Total 1,628 1,858 - - - Residential real estate - construction 502 546 - - - Commercial real estate 14,431 15,007 - - - Commercial 267 330 9 10 9 Consumer - - - - - Total $ 16,828 $ 17,741 $ 9 $ 10 $ 9 Twelve Months Ended Twelve Months Ended Twelve Months Ended December 31, 2016 December 31, 2015 December 31, 2014 Average Interest Average Interest Average Interest (Dollars in thousands) Recorded Income Recorded Income Recorded Income Investment Recognized Investment Recognized Investment Recognized Residential Real Estate 1-4 Family First liens $ 1,194 $ 38 $ 1,531 $ 13 $ 2,619 $ 4 Junior liens and lines of credit 93 1 105 - 136 - Total 1,287 39 1,636 13 2,755 4 Residential real estate - construction 492 4 505 - 686 - Commercial real estate 17,806 589 14,509 122 23,801 118 Commercial 32 - 278 - 1,890 - Consumer - - - - - - Total $ 19,617 $ 632 $ 16,928 $ 135 $ 29,132 $ 122 A loan is considered a troubled debt restructuring (TDR) if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the interest rate, extending the maturity, reamortization of payment, or a combination of multiple concessions. The Bank reviews all loans rated 6 or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR. If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance. Trouble Debt Restructurings That Have Defaulted on Modified Terms in the (Dollars in thousands) Troubled Debt Restructurings Last Twelve Months Number of Recorded Number of Recorded Contracts Investment Performing* Nonperforming* Contracts Investment December 31, 2016 Residential real estate - construction 1 $ 480 $ 480 $ - - $ - Residential real estate 5 875 724 151 1 151 Commercial real estate 11 12,064 10,814 1,250 1 1,250 Total 17 $ 13,419 $ 12,018 $ 1,401 2 $ 1,401 December 31, 2015 Residential real estate - construction 1 $ 502 $ 502 $ - - $ - Residential real estate 4 654 503 151 - - Commercial 10 12,125 12,125 - - - Total 15 $ 13,281 $ 13,130 $ 151 - $ - * The performing status is determined by the loan ’ s compliance with the modified terms. The following table reports new TDR loans made during 201 6 , concession granted and the recorded investment as of December 31, 201 6 . (Dollars in thousands) New During Period Number of Pre-TDR After-TDR Recorded Twelve Months Ended December 31, 2016 Contracts Modification Modification Investment Concession Commercial real estate 1 $ 525 $ 525 $ 513 multiple Residential real estate 1 238 238 237 maturity Total 2 $ 763 $ 763 $ 750 T he re were no new TDR loans made during the year ended December 31, 201 5. Allowance for Loan Losses: Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses (ALL). The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6 ( Special Mention ) or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and rated 7 ( S ubstandard) or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required. Valuation adjustments will be made as necessary based on factors, including, but not limited to: the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Credit Risk Oversight Committee of the Board of Directors. Management believes that the allowance for loan losses at December 31, 2016 is adequate. The following table shows, by loan class, the activity in the Allowance for Loan Loss ( ALL ) , for the years ended December 31, 201 6 , 201 5 and 201 4 . Residential Real Estate 1-4 Family Junior Liens First & Lines Commercial (Dollars in thousands) Liens of Credit Construction Real Estate Commercial Consumer Unallocated Total ALL at December 31, 2013 $ 913 $ 228 $ 276 $ 5,196 $ 2,099 $ 138 $ 852 $ 9,702 Charge-offs (291) - (41) (408) (644) (189) - (1,573) Recoveries 21 - - 50 65 82 - 218 Provision 351 43 (21) 140 (5) 96 160 764 ALL at December 31, 2014 $ 994 $ 271 $ 214 $ 4,978 $ 1,515 $ 127 $ 1,012 $ 9,111 ALL at December 31, 2014 $ 994 $ 271 $ 214 $ 4,978 $ 1,515 $ 127 $ 1,012 $ 9,111 Charge-offs (43) (39) (21) - (270) (198) - (571) Recoveries 7 - 18 14 148 74 - 261 Provision 31 76 (17) 657 126 99 313 1,285 ALL at December 31, 2015 $ 989 $ 308 $ 194 $ 5,649 $ 1,519 $ 102 $ 1,325 $ 10,086 ALL at December 31, 2015 $ 989 $ 308 $ 194 $ 5,649 $ 1,519 $ 102 $ 1,325 $ 10,086 Charge-offs (49) - (41) (2,751) (74) (167) - (3,082) Recoveries 35 - - 19 167 75 - 296 Provision 130 15 71 3,192 281 90 (4) 3,775 ALL at December 31, 2016 $ 1,105 $ 323 $ 224 $ 6,109 $ 1,893 $ 100 $ 1,321 $ 11,075 The following table shows, by loan class, the loans that were evaluated for the Allowance for Loan Loss ( ALL ) under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the allowance established in each category as of December 31, 201 6 and 201 5 . Residential Real Estate 1-4 Family Junior Liens First & Lines Commercial (Dollars in thousands) Liens of Credit Construction Real Estate Commercial Consumer Unallocated Total December 31, 2016 Loans evaluated for ALL: Individually $ 628 $ 52 $ 480 $ 13,523 $ - $ - $ - $ 14,683 Collectively 167,942 50,161 8,495 377,061 270,826 4,705 - 879,190 Total $ 168,570 $ 50,213 $ 8,975 $ 390,584 $ 270,826 $ 4,705 $ - $ 893,873 ALL established for loans evaluated: Individually $ - $ - $ - $ - $ - $ - $ - $ - Collectively 1,105 323 224 6,109 1,893 100 1,321 11,075 ALL at December 31, 2016 $ 1,105 $ 323 $ 224 $ 6,109 $ 1,893 $ 100 $ 1,321 $ 11,075 December 31, 2015 Loans evaluated for ALL: Individually $ 930 $ 51 $ 502 $ 14,309 $ 230 $ - $ - $ 16,022 Collectively 160,548 50,862 7,386 326,386 215,712 5,100 - 765,994 Total $ 161,478 $ 50,913 $ 7,888 $ 340,695 $ 215,942 $ 5,100 $ - $ 782,016 ALL established for loans evaluated: Individually $ - $ - $ - $ - $ 9 $ - $ - $ 9 Collectively 989 308 194 5,649 1,510 102 1,325 10,077 ALL at December 31, 2015 $ 989 $ 308 $ 194 $ 5,649 $ 1,519 $ 102 $ 1,325 $ 10,086 |