Loans and the Allowance for Loan Losses | Note 3. Loans and the Allowance for Loan Losses The following is a summary of the balances in each class of the Company’s portfolio of loans held for investment as of the dates indicated: (dollars in thousands) March 31, 2021 December 31, 2020 Mortgage loans on real estate: Residential 1-4 family $ 119,053 $ 122,800 Commercial - owner occupied 161,885 153,955 Commercial - non-owner occupied 158,528 162,896 Multifamily 23,010 22,812 Construction 39,253 43,732 Second mortgages 9,947 11,178 Equity lines of credit 49,770 50,746 Total mortgage loans on real estate 561,446 568,119 Commercial and industrial loans 124,040 141,746 Consumer automobile loans 76,831 80,390 Other consumer loans 38,182 37,978 Other (1) 7,162 8,067 Total loans, net of deferred fees 807,661 836,300 Less: Allowance for loan losses 9,661 9,541 Loans, net of allowance and deferred fees (2) $ 798,000 $ 826,759 (1) Overdrawn accounts are reclassified as loans and included in the Other category in the table above. Overdrawn deposit accounts, excluding internal use accounts, totaled $467 thousand and $271 thousand at March 31, 2021 and December 31, 2020, respectively. (2) Net deferred loan fees totaled $1.8 million and $2.1 million at March 31, 2021 and December 31, 2020, respectively. Acquired Loans The outstanding principal balance and the carrying amount of total acquired loans included in the consolidated balance sheets as of March 31, 2021 and December 31, 2020 are as follows: (dollars in thousands) March 31, 2021 December 31, 2020 Outstanding principal balance $ 7,739 $ 8,671 Carrying amount 7,685 8,602 The Company did not have any outstanding principal balance or related carrying amount of purchased credit-impaired loans as of March 31, 2021 and December 31, 2020. The following table presents changes in the accretable yield on purchased credit-impaired loans, for which the Company applies FASB ASC 310-30, at March 31, 2021 and 2020: (dollars in thousands) March 31, 2021 March 31, 2020 Balance at January 1 $ - $ 72 Accretion - (10 ) Other changes, net - - Balance at end of period $ - $ 62 CREDIT QUALITY INFORMATION The Company uses internally-assigned risk grades to estimate the capability of borrowers to repay the contractual obligations of their loan agreements as scheduled or at all. The Company’s internal risk grade system is based on experiences with similarly graded loans. Credit risk grades are updated at least quarterly as additional information becomes available, at which time management analyzes the resulting scores to track loan performance. The Company’s internally assigned risk grades are as follows: • Pass: • Other Assets Especially Mentioned (OAEM): • Substandard: • Doubtful: • Loss: The following tables present credit quality exposures by internally assigned risk ratings as of the dates indicated: Credit Quality Information As of March 31, 2021 (dollars in thousands) Pass OAEM Substandard Doubtful Total Mortgage loans on real estate: Residential 1-4 family $ 118,877 $ - $ 176 $ - $ 119,053 Commercial - owner occupied 158,564 2,444 877 - 161,885 Commercial - non-owner occupied 157,792 736 - - 158,528 Multifamily 23,010 - - - 23,010 Construction 38,255 998 - - 39,253 Second mortgages 9,947 - - - 9,947 Equity lines of credit 49,770 - - - 49,770 Total mortgage loans on real estate $ 556,215 $ 4,178 $ 1,053 $ - $ 561,446 Commercial and industrial loans 123,715 325 - - 124,040 Consumer automobile loans 76,520 - 311 - 76,831 Other consumer loans 38,182 - - - 38,182 Other 7,162 - - - 7,162 Total $ 801,794 $ 4,503 $ 1,364 $ - $ 807,661 Credit Quality Information As of December 31, 2020 (dollars in thousands) Pass OAEM Substandard Doubtful Total Mortgage loans on real estate: Residential 1-4 family $ 122,621 $ - $ 179 $ - $ 122,800 Commercial - owner occupied 148,738 2,462 2,755 - 153,955 Commercial - non-owner occupied 162,148 748 - - 162,896 Multifamily 22,812 - - - 22,812 Construction 42,734 998 - - 43,732 Second mortgages 11,178 - - - 11,178 Equity lines of credit 50,746 - - - 50,746 Total mortgage loans on real estate $ 560,977 $ 4,208 $ 2,934 $ - $ 568,119 Commercial and industrial loans 141,391 355 - - 141,746 Consumer automobile loans 79,997 - 393 - 80,390 Other consumer loans 37,978 - - - 37,978 Other 8,067 - - - 8,067 Total $ 828,410 $ 4,563 $ 3,327 $ - $ 836,300 AGE ANALYSIS OF PAST DUE LOANS BY CLASS All classes of loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Interest and fees continue to accrue on past due loans until the date the loan is placed in nonaccrual status, if applicable. The following table includes an aging analysis of the recorded investment in past due loans as of the dates indicated. Also included in the table below are loans that are 90 days or more past due as to interest and principal and still accruing interest, because they are well-secured and in the process of collection. Age Analysis of Past Due Loans as of March 31, 2021 (dollars in thousands) 30 - 59 Days Past Due 60 - 89 Days Past Due 90 or More Days Past Due and still Accruing PCI Nonaccrual (2) Total (1) Total Mortgage loans on real estate: Residential 1-4 family $ 480 $ - $ 36 $ - $ 251 $ 118,286 $ 119,053 Commercial - owner occupied - 278 - - 878 160,729 161,885 Commercial - non-owner occupied 185 - - - - 158,343 158,528 Multifamily - - - - - 23,010 23,010 Construction 46 130 88 - - 38,989 39,253 Second mortgages - - 14 - - 9,933 9,947 Equity lines of credit - - - - - 49,770 49,770 Total mortgage loans on real estate $ 711 $ 408 $ 138 $ - $ 1,129 $ 559,060 $ 561,446 Commercial and industrial loans 8 548 - - - 123,484 124,040 Consumer automobile loans 517 141 265 - - 75,908 76,831 Other consumer loans 695 218 715 - - 36,554 38,182 Other 19 2 1 - - 7,140 7,162 Total $ 1,950 $ 1,317 $ 1,119 $ - $ 1,129 $ 802,146 $ 807,661 (1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due. (2) For purposes of this table, if a loan is past due and on nonaccrual, it is included in the nonaccural column and not also in its respective past due column. In the table above, the past due totals include small business and student loans with principal and interest amounts that are 97 - 100% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $1.5 million at March 31, 2021. Age Analysis of Past Due Loans as of December 31, 2020 (dollars in thousands) 30 - 59 Days Past Due 60 - 89 Days Past Due 90 or More Days Past Due and still Accruing PCI Nonaccrual (2) Total Current Loans (1) Total Mortgage loans on real estate: Residential 1-4 family $ 478 $ 164 $ - $ - $ 311 $ 121,847 $ 122,800 Commercial - owner occupied - - - - 903 153,052 153,955 Commercial - non-owner occupied - - - - - 162,896 162,896 Multifamily - - - - - 22,812 22,812 Construction - 88 - - - 43,644 43,732 Second mortgages 41 - - - - 11,137 11,178 Equity lines of credit - - - - - 50,746 50,746 Total mortgage loans on real estate $ 519 $ 252 $ - $ - $ 1,214 $ 566,134 $ 568,119 Commercial and industrial loans 753 - - - - 140,993 141,746 Consumer automobile loans 1,159 190 196 - - 78,845 80,390 Other consumer loans 1,120 555 548 - - 35,755 37,978 Other 24 3 - - - 8,040 8,067 Total $ 3,575 $ 1,000 $ 744 $ - $ 1,214 $ 829,767 $ 836,300 (1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due. (2) For purposes of this table, if a loan is past due and on nonaccrual, it is included in the nonaccural column and not also in its respective past due column. In the table above, the past due totals include student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $1.2 million at December 31, 2020. Although the portions of the student and small business loan portfolios that are 90 days or more past due would normally be considered impaired, the Company does not include these loans in its impairment analysis. Because the federal government has provided guarantees of repayment of these student and small business loans in an amount ranging from 97% to 100% of the total principal and interest of the loans as of March 31, 2021, management does not expect significant increases in delinquencies of these loans to have a material effect on the Company. Under the CARES Act, borrowers who were making payments as required and were not considered past due prior to becoming affected by COVID-19 and then received payment accommodations as a result of the effects of COVID-19 generally would not be reported as past due. If the Company agreed to a payment deferral for a borrower under the CARES Act, this may result in no contractual payments being past due, and the loans are not considered past due during the period of the deferral. NONACCRUAL LOANS The Company generally places commercial and industrial loans (including construction loans and commercial loans secured and not secured by real estate) in nonaccrual status when the full and timely collection of interest or principal becomes uncertain, part of the principal balance has been charged off and no restructuring has occurred or the loan reaches 90 days past due, unless the credit is well-secured and in the process of collection. Under regulatory rules, consumer loans, which are loans to individuals for household, family and other personal expenditures, and consumer loans secured by real estate (including residential 1 - 4 family mortgages, second mortgages, and equity lines of credit) are not required to be placed in nonaccrual status. Although consumer loans and consumer loans secured by real estate are not required to be placed in nonaccrual status, the Company may elect to place these loans in nonaccrual status, if necessary to avoid a material overstatement of interest income. Generally, consumer loans secured by real estate are placed in nonaccrual status only when payments are 120 days past due. Generally, consumer loans not secured by real estate are placed in nonaccrual status only when part of the principal has been charged off. If a charge-off has not occurred sooner for other reasons, a consumer loan not secured by real estate will generally be placed in nonaccrual status when payments are 120 days past due. These loans are charged off or written down to the net realizable value of the collateral when deemed uncollectible, when classified as a “loss,” when repayment is unreasonably protracted, when bankruptcy has been initiated, or when the loan is 120 days or more past due unless the credit is well-secured and in the process of collection. When management places a loan in nonaccrual status, the accrued unpaid interest receivable is reversed against interest income and the loan is accounted for by the cost recovery method, until it qualifies for return to accrual status or is charged off. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, or when the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments for at least six months. The following table presents loans in nonaccrual status by class of loan as of the dates indicated: Nonaccrual Loans by Class (dollars in thousands) March 31, 2021 December 31, 2020 Mortgage loans on real estate: Residential 1-4 family $ 251 $ 311 Commercial - owner occupied 878 903 Total mortgage loans on real estate $ 1,129 $ 1,214 Total $ 1,129 $ 1,214 The following table presents the interest income that the Company would have earned under the original terms of its nonaccrual loans and the actual interest recorded by the Company on nonaccrual loans for the periods presented: Three Months Ended March 31, (dollars in thousand) 2021 2020 Interest income that would have been recorded under original loan terms $ 27 $ 78 Actual interest income recorded for the period - - Reduction in interest income on nonaccrual loans $ 27 $ 78 TROUBLED DEBT RESTRUCTURINGS The Company’s loan portfolio includes certain loans that have been modified in a TDR, where economic concessions have been granted to borrowers who are experiencing financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reduction in the interest rate below current market rates for borrowers with similar risk profiles, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The Company defines a TDR as nonperforming if the TDR is in nonaccrual status or is 90 days or more past due and still accruing interest at the report date. When the Company modifies a loan, management evaluates any possible impairment as stated in the impaired loan section below. There were no new TDRs in the three months ended March 31, 2021 and 2020. At March 31, 2021 and 2020, the Company had no outstanding commitments to disburse additional funds on any TDR. The Company had no loans secured by residential 1 - 4 family real estate in the process of foreclosure at March 31, 2021 and 2020. In the three months ended March 31, 2021 and 2020, there were no defaulting TDRs where the default occurred within twelve months of restructuring. The Company considers a TDR in default when any of the following occurs: the loan, as restructured, becomes 90 days or more past due; the loan is moved to nonaccrual status following the restructure; the loan is restructured again under terms that would qualify it as a TDR if it were not already so classified; or any portion of the loan is charged off. All TDRs are factored into the determination of the allowance for loan losses and included in the impaired loan analysis, as discussed below. Under Section 4013 of the CARES Act, as amended by the Consolidated Appropriations Act 2021, banks may elect not to categorize loan modifications as TDRs if the modifications are related to the COVID-19 pandemic, executed on a loan that was not more than 30 days past due as of December 31, 2019, and executed between March 1, 2020 and the earlier of 60 days after the date of termination of the National Emergency by the President and January 1, 2022. All short term loan modifications made on a good faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief are not considered TDRs. The Company has examined the payment accommodations granted to borrowers in response to COVID-19 and found that all borrowers were current prior to relief and were not experiencing financial difficulty prior to the COVID-19 pandemic. As of March 31, 2021, the Company had loan modifications on $7.1 million, or 0.9%, of the loan portfolio, granting primarily 60- or 90- day principal and interest payment deferrals. Loan modifications under the CARES Act are being monitored for indications of credit softening, at which time the credit will be analyzed under current underwriting standards for appropriate action and designation. The Company recognizes interest income as earned and management expects that the deferred interest will be repaid by the borrower in a future period. IMPAIRED LOANS A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts when due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans and loans modified in a TDR. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole or remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of the discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific allocation in the allowance or a charge-off to the allowance. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost-recovery method. For financial statement purposes, the recorded investment in the loan is the actual principal balance reduced by partial charge-offs and payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if these partial charge-offs did not occur and as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes. The following table includes the recorded investment and unpaid principal balances (a portion of which may have been charged off) for impaired loans, exclusive of purchased credit-impaired loans, with the associated allowance amount, if applicable, as of the dates presented. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized for the periods presented. The average balances are calculated based on daily average balances. Impaired Loans by Class For the Three Months Ended As of March 31, 2021 March 31, 2021 (Dollars in thousands) Unpaid Principal Balance Without Valuation Allowance With Valuation Allowance Associated Allowance Average Recorded Investment Interest Income Recognized Mortgage loans on real estate: Residential 1-4 family $ 420 $ 75 $ 316 $ 38 $ 395 $ - Commercial 2,597 950 441 13 1,407 - Construction 83 - 81 - 82 1 Second mortgages 133 - 131 4 132 1 Total mortgage loans on real estate 3,233 1,025 969 55 2,016 2 Commercial and industrial loans 6 5 - - 6 - Other consumer loans 14 12 - - 13 - Total $ 3,253 $ 1,042 $ 969 $ 55 $ 2,035 $ 2 Impaired Loans by Class For the Year Ended As of December 31, 2020 December 31, 2020 (Dollars in thousands) Unpaid Principal Balance Without Valuation Allowance With Valuation Allowance Associated Allowance Average Recorded Investment Interest Income Recognized Mortgage loans on real estate: Residential 1-4 family $ 474 $ 366 $ 87 $ 1 $ 458 $ 10 Commercial 3,490 1,306 121 1 2,559 46 Construction 83 - 83 - 84 5 Second mortgages 133 - 133 9 134 5 Total mortgage loans on real estate 4,180 1,672 424 11 3,235 66 Commercial and industrial loans 6 6 - - 7 - Other consumer loans 14 14 - - 15 1 Total $ 4,200 $ 1,692 $ 424 $ 11 $ 3,257 $ 67 ALLOWANCE FOR LOAN LOSSES Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and probable losses inherent in the loan portfolio. The Company segments the loan portfolio into categories as defined by Schedule RC-C of the Federal Financial Institutions Examination Council Consolidated Reports of Condition and Income Form 041 (Call Report). Loans are segmented into the following pools: commercial, real estate-construction, real estate-mortgage, consumer and other loans. The Company also sub-segments the real estate-mortgage segment into six classes: residential 1-4 family, commercial real estate - owner occupied, commercial real estate - non-owner occupied, multifamily, second mortgages and equity lines of credit. The Company uses an internally developed risk evaluation model in the estimation of the credit risk process. The model and assumptions used to determine the allowance are independently validated and reviewed to ensure that the theoretical foundation, assumptions, data integrity, computational processes and reporting practices are appropriate and properly documented. Each portfolio segment has risk characteristics as follows: • Commercial and industrial: • Real estate-construction: • Real estate-mortgage: • Consumer loans: • Other loans: Each segment of the portfolio is pooled by risk grade or by days past due. Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on days past due, while all other loans, including loans to consumers that are secured by real estate, are segmented by risk grades. A historical loss percentage is then calculated by migration analysis and applied to each pool. The migration analysis applied to all pools is able to track the risk grading and historical performance of individual loans throughout a number of periods set by management, which provides management with information regarding trends (or migrations) in a particular loan segment. At March 31, 2021 and December 31, 2020 management used eight twelve-quarter migration periods. Management also provides an allocated component of the allowance for loans that are specifically identified as impaired, and are individually analyzed for impairment. An allocated allowance is established when the present value of expected future cash flows from the impaired loan (or the collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan. Based on credit risk assessments and management’s analysis of qualitative factors, additional loss factors are applied to loan balances. These additional qualitative factors include: economic conditions (including uncertainties associated with the COVID-19 pandemic), trends in growth, loan concentrations, changes in certain loans, changes in underwriting, changes in management and changes in the legal and regulatory environment. Given the timing of the outbreak in the United States of the COVID-19 pandemic combined with government stimulus actions for both individuals and small businesses, management does not believe that the Company’s performance in relation to credit quality during 2020 or the first quarter of 2021 was significantly impacted. The COVID-19 pandemic represents an unprecedented challenge to the global economy in general and the financial services sector in particular. However, there is still significant uncertainty regarding the overall length of the pandemic and the aggregate impact that it will have on global and regional economies, including uncertainties regarding the potential positive effects of governmental actions taken in response to the pandemic. With so much uncertainty, it is impossible for the Company to accurately predict the impact that the pandemic will have on the Company’s primary market and the overall extent to which it will affect the Company’s financial condition and results of operations. The Company’s credit administration is closely monitoring and analyzing the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the Board of Directors. Based on capital levels, stress testing indications, prudent underwriting policies, watch credit processes, and loan concentration diversification, the Company currently expects to be able to manage the economic risks and uncertainties associated with the pandemic which may include additional provision for loan losses. Acquired loans are recorded at their fair value at acquisition date without carryover of the acquiree’s previously established ALL, as credit discounts are included in the determination of fair value. The fair value of the loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. During evaluation upon acquisition, acquired loans are also classified as either purchased credit-impaired or purchased performing. Purchased credit-impaired loans reflect credit quality deterioration since origination, as it is probable at acquisition that the Company will not be able to collect all contractually required payments. These purchased credit-impaired loans are accounted for under ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality Purchased performing loans are accounted for under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs ALLOWANCE FOR LOAN LOSSES BY SEGMENT The total allowance reflects management’s estimate of losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $9.7 million adequate to cover probable loan losses inherent in the loan portfolio at March 31, 2021. The following tables present, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods presented. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories. ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS For the Three Months ended March 31, 2021 (Dollars in thousands) Commercial and Industrial Real Estate Construction Real Estate - Mortgage (1) Real Estate - Commercial Consumer (2) Other Unallocated Total Allowance for loan losses: Balance, beginning $ 650 $ 339 $ 2,560 $ 4,434 $ 1,302 $ 123 $ 133 $ 9,541 Charge-offs (4 ) - (1 ) - (197 ) (114 ) - (316 ) Recoveries 2 - 14 1 213 56 - 286 Provision for loan losses 93 (17 ) (24 ) (118 ) (33 ) 196 53 150 Ending Balance $ 741 $ 322 $ 2,549 $ 4,317 $ 1,285 $ 261 $ 186 $ 9,661 Individually evaluated for impairment $ - $ - $ 42 $ 13 $ - $ - $ - $ 55 Collectively evaluated for impairment 741 322 2,507 4,304 1,285 261 186 9,606 Purchased credit-impaired loans - - - - - - - Ending Balance $ 741 $ 322 $ 2,549 $ 4,317 $ 1,285 $ 261 $ 186 $ 9,661 Loans Balances: Individually evaluated for impairment 5 81 522 1,391 12 - - 2,011 Collectively evaluated for impairment 124,035 39,172 201,258 319,022 115,001 7,162 - 805,650 Purchased credit-impaired loans - - - - - - - Ending Balance $ 124,040 $ 39,253 $ 201,780 $ 320,413 $ 115,013 $ 7,162 $ - $ 807,661 (1) (2) For the Year ended December 31, 2020 (Dollars in thousands) Commercial and Industrial Real Estate Construction Real Estate - Mortgage (1) Real Estate - Commercial Consumer (2) Other Unallocated Total Allowance for loan losses: Balance, beginning $ 1,244 $ 258 $ 2,505 $ 3,663 $ 1,694 $ 296 $ - $ 9,660 Charge-offs (25 ) - (149 ) (654 ) (822 ) (355 ) - (2,005 ) Recoveries 47 10 69 317 377 66 - 886 Provision for loan losses (616 ) 71 135 1,108 53 116 133 1,000 Ending Balance $ 650 $ 339 $ 2,560 $ 4,434 $ 1,302 $ 123 $ 133 $ 9,541 Individually evaluated for impairment $ - $ - $ 10 $ 1 $ - $ - $ - $ 11 Collectively evaluated for impairment 650 339 2,550 4,433 1,302 123 133 9,530 Purchased credit-impaired loans - - - - - - - Ending Balance $ 650 $ 339 $ 2,560 $ 4,434 $ 1,302 $ 123 $ 133 $ 9,541 Loans Balances: Individually evaluated for impairment 6 83 586 1,427 14 - - 2,116 Collectively evaluated for impairment 141,740 43,649 206,950 315,424 118,354 8,067 - 834,184 Purchased credit-impaired loans - - - - - - - Ending Balance $ 141,746 $ 43,732 $ 207,536 $ 316,851 $ 118,368 $ 8,067 $ - $ 836,300 (1) (2) |