Loan Quality and Allowance for Loan Losses | 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 based on the performance status of the loans. 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-Substandard. The following factors represent 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 three primary measurements: (1) loans rated 6-Special Mention or worse (collectively “watch list”), (2) delinquent loans and (3) net-charge-offs. The following table reports on the risk rating for those loans in the portfolio that are assigned an individual risk rating as of December 31, 2018 and 2017 Pass Special Mention Substandard Doubtful (Dollars in thousands) (1-5) (6) (7) (8) Total December 31, 2018 Residential Real Estate 1-4 Family First liens $ 148,453 $ — $ 447 $ — $ 148,900 Junior liens and lines of credit 47,171 — 49 — 47,220 Total 195,624 — 496 — 196,120 Residential real estate - construction 9,572 — 653 — 10,225 Commercial real estate 479,969 660 7,351 — 487,980 Commercial 272,959 — 1,095 — 274,054 Consumer 4,991 — 5 — 4,996 Total $ 963,115 $ 660 $ 9,600 $ — $ 973,375 December 31, 2017 Residential Real Estate 1-4 Family First liens $ 157,395 $ — $ 1,039 $ — $ 158,434 Junior liens and lines of credit 50,371 — — — 50,371 Total 207,766 — 1,039 — 208,805 Residential real estate - construction 8,893 — 1,008 — 9,901 Commercial real estate 419,277 680 8,471 — 428,428 Commercial 289,916 — 1,603 — 291,519 Consumer 5,047 — — — 5,047 Total $ 930,899 $ 680 $ 12,121 $ — $ 943,700 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, 2018 and 2017 (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, 2018 Residential Real Estate 1-4 Family First liens $ 148,183 $ 322 $ 202 $ 113 $ 637 $ 80 $ 148,900 Junior liens and lines of credit 47,040 131 — 26 157 23 47,220 Total 195,223 453 202 139 794 103 196,120 Residential real estate - construction 9,572 — 198 — 198 455 10,225 Commercial real estate 481,774 1,343 3,323 113 4,779 1,427 487,980 Commercial 273,534 65 40 100 205 315 274,054 Consumer 4,933 46 12 5 63 — 4,996 Total $ 965,036 $ 1,907 $ 3,775 $ 357 $ 6,039 $ 2,300 $ 973,375 December 31, 2017 Residential Real Estate 1-4 Family First liens $ 157,247 $ 485 $ 534 $ — $ 1,019 $ 168 $ 158,434 Junior liens and lines of credit 50,202 139 30 — 169 — 50,371 Total 207,449 624 564 — 1,188 168 208,805 Residential real estate - construction 9,435 — — — — 466 9,901 Commercial real estate 425,806 421 347 — 768 1,854 428,428 Commercial 291,221 111 — — 111 187 291,519 Consumer 5,017 23 7 — 30 — 5,047 Total $ 938,928 $ 1,179 $ 918 $ — $ 2,097 $ 2,675 $ 943,700 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 . At December 31, 201 8 , the Bank had $129 thousand of residential properties in the process of foreclosure compared to $132 thousand at the end of 201 7 . Interest not recognized on nonaccrual loans was $108 thousand, $159 thousan d and $175 thousand for the years ended December 31, 2018 , 2017 and 2016 , respectively. In addition to monitoring nonaccrual loans, the Bank als o 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. These loans totaled $786 thousand at December 31, 20 1 8 and are comprised primarily of loans secured by residential real estate. Management does not believe that excluding these loans from the specific reserve analysis presents any additional risk. Impaired loans totaled $11.9 million at December 31, 201 8 compared to $12.6 million at December 31, 201 7 . The following tables present information on impaired loans: Impaired Loans With No Allowance With Allowance (Dollars in thousands) Unpaid Unpaid Recorded Principal Recorded Principal Related December 31, 2018 Investment Balance Investment Balance Allowance Residential Real Estate 1-4 Family First liens $ 871 $ 958 $ — $ — $ — Junior liens and lines of credit 49 49 — — — Total 920 1,007 — — — Residential real estate - construction 455 531 — — — Commercial real estate 10,236 10,808 — — — Commercial 315 9,763 — — — Total $ 11,926 $ 22,109 $ — $ — $ — December 31, 2017 Residential Real Estate 1-4 Family First liens $ 869 $ 950 $ — $ — $ — Junior liens and lines of credit — — — — — Total 869 950 — — — Residential real estate - construction 466 531 — — — Commercial real estate 11,061 11,541 — — — Commercial 187 201 — — — Total $ 12,583 $ 13,223 $ — $ — $ — Twelve Months Ended December 31, 2018 December 31, 2017 December 31, 2016 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 $ 914 $ 45 $ 1,083 $ 39 $ 1,194 $ 38 Junior liens and lines of credit 85 1 64 — 93 1 Total 999 46 1,147 39 1,287 39 Residential real estate - construction 462 — 473 — 492 4 Commercial real estate 10,809 417 11,938 435 17,806 589 Commercial 4,329 — 245 — 32 — Total $ 16,599 $ 463 $ 13,803 $ 474 $ 19,617 $ 632 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. The following table presents TDR loans as of December 31, 2018 and 2017: Troubled Debt Restructurings Within the Last 12 Months That Have Defaulted (Dollars in thousands) Troubled Debt Restructurings on Modified Terms Number of Recorded Number of Recorded Contracts Investment Performing* Nonperforming* Contracts Investment December 31, 2018 Residential real estate - construction 1 $ 455 $ — $ 455 — $ — Residential real estate 4 678 678 — — — Commercial real estate 11 10,099 8,809 1,290 — — Total 16 $ 11,232 $ 9,487 $ 1,745 — $ — December 31, 2017 Residential real estate - construction 1 $ 466 $ 466 $ — — $ — Residential real estate 5 737 701 36 1 39 Commercial real estate 11 10,983 10,388 595 1 595 Total 17 $ 12,186 $ 11,555 $ 631 2 $ 634 * The performing status is determined by the loan’s compliance with the modified terms. There were no new TDR loans made during the years ended December 31, 2018 and 2017. Al lowance 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 - Substandard 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, 2018 is adequate. The following table shows the activity in the Allowance for Loan Loss (ALL), for the years ended December 31, 2018 , 2017 and 2016 Residential Real Estate 1-4 Family First Junior Liens & Commercial (Dollars in thousands) Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total 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 ALL at December 31, 2016 $ 1,105 $ 323 $ 224 $ 6,109 $ 1,893 $ 100 $ 1,321 $ 11,075 Charge-offs (13) — — (14) (8) (102) — (137) Recoveries 2 11 — 17 117 37 — 184 Provision (34) (4) — 414 108 70 116 670 ALL at December 31, 2017 $ 1,060 $ 330 $ 224 $ 6,526 $ 2,110 $ 105 $ 1,437 $ 11,792 ALL at December 31, 2017 $ 1,060 $ 330 $ 224 $ 6,526 $ 2,110 $ 105 $ 1,437 $ 11,792 Charge-offs — — — — (9,482) (107) — (9,589) Recoveries 2 8 — 60 157 31 — 258 Provision (571) (205) (116) (888) 11,726 41 (33) 9,954 ALL at December 31, 2018 $ 491 $ 133 $ 108 $ 5,698 $ 4,511 $ 70 $ 1,404 $ 12,415 The following table shows 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, 2018 and 2017 Residential Real Estate 1-4 Family First Junior Liens & Commercial (Dollars in thousands) Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total December 31, 2018 Loans evaluated for ALL: Individually $ 405 $ — $ 455 $ 10,099 $ 181 $ — $ — $ 11,140 Collectively 148,495 47,220 9,770 477,881 273,873 4,996 — 962,235 Total $ 148,900 $ 47,220 $ 10,225 $ 487,980 $ 274,054 $ 4,996 $ — $ 973,375 ALL established for loans evaluated: Individually $ — $ — $ — $ — $ — $ — $ — $ — Collectively 491 133 108 5,698 4,511 70 1,404 12,415 ALL at December 31, 2018 $ 491 $ 133 $ 108 $ 5,698 $ 4,511 $ 70 $ 1,404 $ 12,415 December 31, 2017 Loans evaluated for ALL: Individually $ 459 $ — $ 466 $ 10,981 $ — $ — $ — $ 11,906 Collectively 157,975 50,371 9,435 417,447 291,519 5,047 — 931,794 Total $ 158,434 $ 50,371 $ 9,901 $ 428,428 $ 291,519 $ 5,047 $ — $ 943,700 ALL established for loans evaluated: Individually $ — $ — $ — $ — $ — $ — $ — $ — Collectively 1,060 330 224 6,526 2,110 105 1,437 11,792 ALL at December 31, 2017 $ 1,060 $ 330 $ 224 $ 6,526 $ 2,110 $ 105 $ 1,437 $ 11,792 |