| Loan Quality and Allowance for Credit Losses | Note 6. Loan Quality and Allowance for Credit Losses The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the collectability of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience, derived from peer group data, provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a modification will be executed with an individual borrower, or the extension or renewal options are included int eh original or modified contract at the reporting date and are not unconditionally cancellable by the Bank. The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Bank measures the Allowance for Credit Loss (ACL) using the following inputs to calculate the quantitative component for the pool: Segregating loans into homogeneous pools by the FRB Call Code which is primarily a collateral-based and secondarily a purpose-based segmentation. The average remaining life of each pool is calculated using the weighted average remaining maturity method (WARM). The WARM method produces an estimated remaining balance by pool, by year, until maturity. Using third party data, the Bank determines a reasonable and supportable economic forecast that it believes is likely to exist for the next four quarters. A historical credit loss rate is calculated for each pool, using the average historical loss, by FRB Call Code, for a peer group of Pennsylvania community banks over the last eight quarters. The historical loss rate is calculated over a historical period the Bank believes best represents a period that will be similar to the next four quarters. The historical peer credit loss rate is applied to each WARM bucket through the initial four quarter forecast period. At the end of the four quarter forecast period, the credit loss rate applied to each WARM bucket reverts to the peer group historical loss rate for the respective pool. Collectively these estimated losses represent the quantitative component of the pooled reserve. The qualitative component for the pool utilizes a risk matrix comprised of eight risk factors and assigns a risk level to each factor. The risk factors consider changes in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. The risk factors are weighted to reflect Management’s estimate of how the factor affects potential losses. The risk levels within each factor are measured in basis points and range from minimal risk to very high risk and are determined independently for commercial loans, residential mortgage loans and consumer loans. The ACL for pooled loans is the sum of the quantitative and qualitative loss estimates. The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, and current economic trends, among other factors. 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 performing or nonperforming based on the payment status of the loans. Nonperforming consumer loans are loans that are nonaccrual or 90 days or more past due and still accruing. The Bank uses the following definitions for risk ratings: Pass (1-5 ): are considered pass credits with lower or average risk and are not otherwise classified. OAEM (6) : Loans classified as OAEM have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date. Substandard (7) : Loans classified as Substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Doubtful (8) : Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the pool evaluation. When management determines that foreclosure is probable or when the borrower is experiencing financial difficulty at the reporting date and repayment is expected to be provided substantially through the sale of the collateral, the expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for any discounts and selling costs as appropriate. Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the Allowance for Credit Loss for loans (ACL). The Bank begins enhanced monitoring of all loans rated 6–OAEM or worse and obtains a new appraisal or asset valuation for any loans 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 ACL, 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. Management monitors the adequacy of the ACL on an ongoing basis and reports its adequacy quarterly to the Board Enterprise Risk Management Committee of the Board of Directors. Management believes the ACL at September 30, 2023 is adequate. The following table presents loans by year of origination and internally assigned risk ratings: (Dollars in thousands, except per share) Revolving Revolving Term Loans Loans Loans Amortized Cost Basis by Origination Year Amortized Converted As of September 30, 2023 2023 2022 2021 2020 2019 Prior Cost Basis to Term Total Residential real estate 1-4 family: Commercial: Risk rating: Pass (1-5) $ 7,702 $ 9,386 $ 11,426 $ 9,807 $ 2,454 $ 23,930 $ 1,824 $ — $ 66,529 OAEM (6) — — — — — — — — — Substandard (7) — — — — — 98 — — 98 Doubtful (8) — — — — — — — — — Total Commercial 7,702 9,386 11,426 9,807 2,454 24,028 1,824 — 66,627 Consumer: Performing 37,186 30,157 15,746 10,893 5,684 29,605 42,554 20,605 192,430 Nonperforming — — — — — — — — — Total Consumer 37,186 30,157 15,746 10,893 5,684 29,605 42,554 20,605 192,430 Total $ 44,888 $ 39,543 $ 27,172 $ 20,700 $ 8,138 $ 53,633 $ 44,378 $ 20,605 $ 259,057 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — $ — $ — Residential real estate construction: Commercial: Risk rating: Pass (1-5) $ 3,420 $ 2,849 $ 1,503 $ 229 $ — $ 1,819 $ — $ — $ 9,820 OAEM (6) — — — — — — — — — Substandard (7) — — — — — — — — — Doubtful (8) — — — — — — — — — Total Commercial 3,420 2,849 1,503 229 — 1,819 — — 9,820 Consumer: Performing 7,434 3,830 — — — — — — 11,264 Nonperforming — — — — — — — — — Total Consumer 7,434 3,830 — — — — — — 11,264 Total $ 10,854 $ 6,679 $ 1,503 $ 229 $ — $ 1,819 $ — $ — $ 21,084 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — $ — $ — Commercial real estate: Risk rating: Pass (1-5) $ 140,948 $ 118,484 $ 99,775 $ 41,944 $ 39,762 $ 219,830 $ 5,310 $ — $ 666,053 OAEM (6) — — — — — 2,203 144 — 2,347 Substandard (7) — — — — — 2,732 50 — 2,782 Doubtful (8) — — — — — — — — — Total $ 140,948 $ 118,484 $ 99,775 $ 41,944 $ 39,762 $ 224,765 $ 5,504 $ — $ 671,182 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — $ — $ — Commercial: Risk rating: Pass (1-5) $ 28,531 $ 35,229 $ 47,478 $ 23,762 $ 4,121 $ 65,513 $ 39,315 $ — $ 243,949 OAEM (6) — — — — — — — — — Substandard (7) 116 340 — — — 3,642 1,072 — 5,170 Doubtful (8) — — — — — — — — — Total $ 28,647 $ 35,569 $ 47,478 $ 23,762 $ 4,121 $ 69,155 $ 40,387 $ — $ 249,119 Current period gross charge-offs $ ( 8 ) $ — $ ( 81 ) $ — $ — $ — $ — $ — $ ( 89 ) Consumer: Performing 1,421 759 2,053 181 114 8 1,858 — 6,394 Nonperforming — — — — — — 14 — 14 Total $ 1,421 $ 759 $ 2,053 $ 181 $ 114 $ 8 $ 1,872 $ — $ 6,408 Current period gross charge-offs $ ( 37 ) $ ( 16 ) $ ( 10 ) $ ( 2 ) $ ( 6 ) $ — $ ( 26 ) $ — $ ( 97 ) The following table presents the amortized cost basis of loans on nonaccrual status and loans past due over 90 days and still accruing as of September 30, 2023: (Dollars in thousands) Nonaccrual and Loans Past Due Over 90 Days+ Loans Past Due Nonaccrual Nonaccrual Over 90 Days Without ACL With ACL Still Accruing September 30, 2023 Residential Real Estate 1-4 Family First liens $ 98 $ — $ — Junior liens and lines of credit — — — Total 98 — — Residential real estate - construction — — — Commercial real estate — — — Commercial 115 — — Consumer — — 14 Total $ 213 $ — $ 14 The following table reports the risk rating for those loans in the portfolio that were assigned an individual risk rating at December 31, 2022: Pass OAEM Substandard Doubtful (Dollars in thousands) (1-5) (6) (7) (8) Total December 31, 2022 Residential Real Estate 1-4 Family First liens $ 144,377 $ — $ 120 $ — $ 144,497 Junior liens and lines of credit 73,688 — — — 73,688 Total 218,065 — 120 — 218,185 Residential real estate - construction 24,393 — — — 24,393 Commercial real estate 562,665 1,095 2,902 — 566,662 Commercial 228,085 2,751 4,766 — 235,602 Consumer 6,199 — — — 6,199 Total $ 1,039,407 $ 3,846 $ 7,788 $ — $ 1,051,041 At September 30, 2023 the Bank had $ 0 of residential properties in the process of foreclosure compared to $ 94 thousand at December 31, 2022. The following table presents the aging of payments of the loan portfolio : (Dollars in thousands) Loans Past Due Total Total 30-59 Days 60-89 Days 90 Days+ Past Due Current Loans September 30, 2023 Residential Real Estate 1-4 Family First liens $ 21 $ 232 $ 98 $ 351 $ 186,880 $ 187,231 Junior liens and lines of credit 399 — — 399 71,427 71,826 Total 420 232 98 750 258,307 259,057 Residential real estate - construction — — — — 21,084 21,084 Commercial real estate 311 — — 311 670,871 671,182 Commercial 662 — 115 777 248,342 249,119 Consumer 10 16 14 40 6,368 6,408 Total $ 1,403 $ 248 $ 227 $ 1,878 $ 1,204,972 $ 1,206,850 Total Past Due & Total December 31, 2022 30-59 Days 60-89 Days 90 Days+ Nonaccrual Nonaccrual Current Loans Residential Real Estate 1-4 Family First liens $ 340 $ 177 $ — $ 120 $ 637 $ 143,860 $ 144,497 Junior liens and lines of credit 490 — — — 490 73,198 73,688 Total 830 177 — 120 1,127 217,058 218,185 Residential real estate - construction — — — — — 24,393 24,393 Commercial real estate 649 — — — 649 566,013 566,662 Commercial 681 50 — — 731 234,871 235,602 Consumer 29 5 13 — 47 6,152 6,199 Total $ 2,189 $ 232 $ 13 $ 120 $ 2,554 $ 1,048,487 $ 1,051,041 The following table presents, by class, the activity in the Allowance for Credit Losses (ACL) for the periods shown: Residential Real Estate 1-4 Family First Junior Liens & Commercial (Dollars in thousands) Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total ACL at June 30, 2023 $ 1,720 $ 683 $ 177 $ 9,083 $ 2,854 $ 98 $ — $ 14,615 Charge-offs — — — — ( 2 ) ( 21 ) — ( 23 ) Recoveries — — 4 — 15 51 — 70 Provision ( 519 ) ( 265 ) 61 1,124 503 ( 38 ) — 866 ACL at September 30, 2023 $ 1,201 $ 418 $ 242 $ 10,207 $ 3,370 $ 90 $ — $ 15,528 ALL at December 31, 2022 $ 459 $ 234 $ 343 $ 7,493 $ 4,846 $ 133 $ 667 $ 14,175 Impact of adopting ASU 2016-13 1,096 493 ( 95 ) 584 ( 1,907 ) ( 40 ) ( 667 ) ( 56 ) Charge-offs — — — — ( 89 ) ( 97 ) — ( 186 ) Recoveries 2 — 46 — 94 76 — 218 Provision ( 356 ) ( 309 ) ( 52 ) 2,130 426 18 — 1,857 ACL at September 30, 2023 $ 1,201 $ 418 $ 242 $ 10,207 $ 3,370 $ 90 $ — $ 15,528 ALL at June 30, 2022 $ 465 $ 245 $ 289 $ 8,096 $ 5,076 $ 119 $ 725 $ 15,015 Charge-offs — — — — ( 6 ) ( 33 ) — ( 39 ) Recoveries — 1 — — 8 4 — 13 Provision ( 4 ) 3 75 9 ( 33 ) 38 ( 88 ) — ALL at September 30, 2022 $ 461 $ 249 $ 364 $ 8,105 $ 5,045 $ 128 $ 637 $ 14,989 ALL at December 31, 2021 $ 475 $ 252 $ 325 $ 8,168 $ 5,127 $ 130 $ 589 $ 15,066 Charge-offs ( 20 ) — — — ( 69 ) ( 79 ) — ( 168 ) Recoveries 47 2 — — 20 22 — 91 Provision ( 41 ) ( 5 ) 39 ( 63 ) ( 33 ) 55 48 — ALL at September 30, 2022 $ 461 $ 249 $ 364 $ 8,105 $ 5,045 $ 128 $ 637 $ 14,989 The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of December 31, 2022: 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, 2022 Loans evaluated for ALL: Individually $ 619 $ — $ — $ 2,331 $ — $ — $ — $ 2,950 Collectively 143,878 73,688 24,393 564,331 235,602 6,199 — 1,048,091 Total $ 144,497 $ 73,688 $ 24,393 $ 566,662 $ 235,602 $ 6,199 $ — $ 1,051,041 ALL established for loans evaluated: Individually $ — $ — $ — $ — $ — $ — $ — $ — Collectively 459 234 343 7,493 4,846 133 667 14,175 ALL at December 31, 2022 $ 459 $ 234 $ 343 $ 7,493 $ 4,846 $ 133 $ 667 $ 14,175 At September 30, 2023, there were no loans evaluated individually for the ACL. On January 1, 2023, The Bank adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for troubled debt restructurings (“TDRs”) while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. No loan modifications were made to borrowers experiencing financial difficulties during the first nine months of 2023. Prior to the adoption of ASU 2022-02, certain modified loans were reported as TDRs and impaired. The following table presents impaired loans as of December 31, 2022. Impaired Loans With No Allowance With Allowance (Dollars in thousands) Unpaid Unpaid Recorded Principal Recorded Principal Related December 31, 2022 Investment Balance Investment Balance Allowance Residential Real Estate 1-4 Family First liens $ 619 $ 619 $ — $ — $ — Junior liens and lines of credit — — — — — Total 619 619 — — — Residential real estate - construction — — — — — Commercial real estate 2,331 2,331 — — — Commercial — — — — — Total $ 2,950 $ 2,950 $ — $ — $ — The following table presents TDR loans as of December 31, 2022: 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, 2022 Residential real estate - construction — $ — $ — $ — — $ — Residential real estate 5 619 619 — — — Commercial real estate - owner occupied 3 783 783 — — — Commercial real estate - farm land 3 1,466 1,466 — — — Commercial real estate - construction and land development — — — — — — Commercial real estate - other 1 82 82 — — — Total 12 $ 2,950 $ 2,950 $ — — $ — *The performing status is determined by the loans compliance with the modified terms. Nonperforming is considered 90 days or more past due. |
