Allowance for Loan Losses and Credit Quality

The Company’s primary lending emphasis is the origination of commercial business and commercial real estate loans and mortgage warehouse lines of credit. Based on the composition of the loan portfolio, the inherent primary risks are deteriorating credit quality, a decline in the economy and a decline in New Jersey real estate market values. Any one, or a combination, of these events may adversely affect the loan portfolio and may result in increased delinquencies, loan losses and increased future provision levels.

The following table provides an aging of the loan portfolio by loan class at June 30, 2018:



(Dollars in thousands)	30-59 Days		60-89 Days		Greater than 90 Days		Total Past Due		Current		Total Loans Receivable		Recorded Investment > 90 Days Accruing		Non-accrual Loans
Commercial
Construction	$	—	$	—	$	—	$	—	$	138,144	$	138,144	$	—	$	—
Commercial Business	13		251		808		1,072		105,286		106,358		—		4,111
Commercial Real Estate	1,333		514		3,268		5,115		373,883		378,998		—		3,268
Mortgage Warehouse Lines	—		—		—		—		204,359		204,359		—		—
Residential Real Estate	—		60		1,123		1,183		44,865		46,048		—		1,123
Consumer
Loans to Individuals	—		—		205		205		25,357		25,562		—		411
Other	—		—		—		—		192		192		—		—
Total loans	$	1,346	$	825	$	5,404	$	7,575	$	892,086	899,661		$	—	$	8,913
Deferred loan costs, net											251
Total loans, including deferred loan costs, net											$	899,912

The following table provides an aging of the loan portfolio by loan class at December 31, 2017:



(Dollars in thousands)	30-59 Days		60-89 Days		Greater than 90 Days		Total Past Due		Current		Total Loans Receivable		Recorded Investment > 90 Days Accruing		Non-accrual Loans
Commercial
Construction	$	—	$	—	$	—	$	—	$	136,412	$	136,412	$	—	$	—
Commercial Business	180		545		619		1,344		91,562		92,906		—		4,212
Commercial Real Estate	540		—		2,465		3,005		305,919		308,924		—		2,465
Mortgage Warehouse Lines	—		—		—		—		189,412		189,412		—		—
Residential Real Estate	911		256		69		1,236		39,258		40,494		—		69
Consumer
Loans to Individuals	119		—		116		235		20,790		21,025		—		368
Other	—		—		—		—		183		183		—		—
Total loans	$	1,750	$	801	$	3,269	$	5,820	$	783,536	789,356		$	—	$	7,114
Deferred loan costs, net											550
Total loans, including deferred loan costs, net											$	789,906

As provided by ASC 310-30, the excess of cash flows expected at acquisition over the initial investment in the loan is recognized as interest income over the life of the loan. At June 30, 2018, there was one purchased credit impaired (“PCI”) loan for $514,000 that was not classified as a non-performing loan. At December 31, 2017, there were no PCI loans that were not classified as non-performing loans.

The Company’s internal credit risk grades are based on the definitions currently utilized by the banking regulatory agencies. The grades assigned and their definitions are as follows, and loans graded excellent, above average, good and watch list are treated as “pass” for grading purposes:

1. Excellent - Loans that are based upon cash collateral held at the Company and adequately margined. Loans that are based upon “blue chip” stocks listed on the major stock exchanges and adequately margined.

2. Above Average - Loans to companies whose balance sheets show excellent liquidity and long-term debt is on well-spread schedules of repayment easily covered by cash flow. Such companies have been consistently profitable and have diversification in their product lines or sources of revenue. The continuation of profitable operations for the foreseeable future is likely. Management is comprised of a mix of ages, experience and backgrounds and management succession is in place. Sources of raw materials and, for service companies, the sources of revenue are abundant. Future needs have been planned for. Character and management ability of individuals or company principals are excellent. Loans to individuals are supported by their high net worth and liquid assets.

3. Good - Loans to companies whose balance sheets show good liquidity and cash flow adequate to meet maturities of long-term debt with a comfortable margin. Such companies have established profitable records over a number of years, and there has been growth in net worth. Operating ratios are in line with those of the industry, and expenses are in proper relationship to the volume of business done and the profits achieved. Management is well-balanced and competent in their responsibilities. Economic environment is favorable; however, competition is strong. The prospects for growth are good. Loans in this category do not meet the collateral requirements of loans in categories 1 and 2 above. Loans to individuals are supported by their high net worth but whose supporting assets are illiquid.

3w. Watch - Included in this category are loans evidencing problems identified by Company management that require closer supervision. Such problems have not developed to the point that requires a “special mention” rating. This category also covers situations where the Company does not have adequate current information upon which credit quality can be determined. The account officer has the obligation to correct these deficiencies within 30 days from the time of notification.

4. Special Mention - A “special mention” loan has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Company's credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

5. Substandard - A “substandard” loan is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Loans so classified must 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.

6. Doubtful - A loan classified as “doubtful” has all the weaknesses inherent in a loan classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.

7. Loss - A loan classified as “loss” is considered uncollectible and of such little value that its continuance on the books is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this loan even though partial recovery may occur in the future.

The following table provides a breakdown of the loan portfolio by credit quality indicator at June 30, 2018:



(Dollars in thousands)
Commercial Credit Exposure - By Internally Assigned Grade	Construction		Commercial Business		Commercial Real Estate		Mortgage Warehouse Lines		Residential Real Estate
Grade:
Pass	$	133,827	$	93,532	$	357,024	$	204,359	$	44,579
Special Mention	4,317		8,535		11,083		—		116
Substandard	—		4,031		10,891		—		1,353
Doubtful	—		260		—		—		—
Total	$	138,144	$	106,358	$	378,998	$	204,359	$	46,048



Consumer Credit Exposure - By Payment Activity	Loans To Individuals		Other

Performing	$	25,151	$	192
Non-performing	411		—
Total	$	25,562	$	192

The following table provides a breakdown of the loan portfolio by credit quality indicator at December 31, 2017:



(Dollars in thousands)
Commercial Credit Exposure - By Internally Assigned Grade	Construction		Commercial Business		Commercial Real Estate		Mortgage Warehouse Lines		Residential Real Estate
Grade:
Pass	$	136,180	$	84,746	$	289,203	$	189,412	$	39,539
Special Mention	232		3,454		13,267		—		666
Substandard	—		1,252		6,454		—		289
Doubtful	—		3,454		—		—		—
Total	$	136,412	$	92,906	$	308,924	$	189,412	$	40,494



Consumer Credit Exposure - By Payment Activity	Loans To Individuals		Other
Performing	$	20,657	$	183
Non-performing	368		—
Total	$	21,025	$	183

Impaired Loans

Loans are considered to be impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan agreement, including scheduled interest payments. When a loan is placed on non-accrual status, it is also considered to be impaired. Loans are placed on non-accrual status when: (1) the full collection of interest or principal becomes uncertain or (2) they are contractually past due 90 days or more as to interest or principal payments unless the loans are both well secured and in the process of collection.

The following tables summarize the distribution of the allowance for loan losses and loans receivable by loan class and impairment method at June 30, 2018 and December 31, 2017:



	June 30, 2018
(Dollars in thousands)	Construction		Commercial Business		Commercial Real Estate		Mortgage Warehouse Lines		Residential Real Estate		Loans to Individuals		Other		Unallocated		Total
Allowance for loan losses:
Individually evaluated for impairment	$	—	$	487	$	229	$	—	$	—	$	—	$	—	$	—	$	716
Loans acquired with deteriorated credit quality	—		—		—		—		—		—		—		—		—
Collectively evaluated for impairment	1,661		1,178		3,085		920		462		169		—		307		7,782
Ending Balance	$	1,661	$	1,665	$	3,314	$	920	$	462	$	169	$	—	$	307	$	8,498

Loans receivable:
Individually evaluated for impairment	$	104	$	4,320	$	7,234	$	—	$	1,123	$	411	$	—	$	—	$	13,192
Loans acquired with deteriorated credit quality	—		303		1,452		—		—		—		—		—		1,755
Collectively evaluated for impairment	138,040		101,735		370,312		204,359		44,925		25,151		192		—		884,714
Ending Balance	$	138,144	$	106,358	$	378,998	$	204,359	$	46,048	$	25,562	$	192	$	—	899,661
Deferred loan costs, net																	251
																	$	899,912



	December 31, 2017
(Dollars in thousands)	Construction		Commercial Business		Commercial Real Estate		Mortgage Warehouse Lines		Residential Real Estate		Loans to Individuals		Other		Unallocated		Total
Allowance for loan losses:
Individually evaluated for impairment	$	—	$	592	$	92	$	—	$	—	$	—	$	—	$	—	$	684
Loans acquired with deteriorated credit quality	—		—		—		—		—		—		—		—		—
Collectively evaluated for impairment	1,703		1,128		2,857		852		392		114		—		283		7,329
Ending Balance	$	1,703	$	1,720	$	2,949	$	852	$	392	$	114	$	—	$	283	$	8,013

Loans receivable:
Individually evaluated for impairment	$	232	$	4,459	$	5,713	$	—	$	69	$	368	$	—	$	—	$	10,841
Loans acquired with deteriorated credit quality	—		274		590		—		—		—		—		—		864
Collectively evaluated for impairment	136,180		88,173		302,621		189,412		40,425		20,657		183		—		777,651
Ending Balance	$	136,412	$	92,906	$	308,924	$	189,412	$	40,494	$	21,025	$	183	$	—	789,356
Deferred loan costs, net																	550
																	$	789,906

The activity in the allowance for loan loss by loan class for the three and six months ended June 30, 2018 and 2017 was as follows:



(Dollars in thousands)	Construction		Commercial Business			Commercial Real Estate		Mortgage Warehouse Lines		Residential Real Estate		Loans to Individuals			Other		Unallocated			Total
Balance - March 31, 2018	$	1,612	$	1,675		$	3,166	$	732	$	446	$	129		$	—	$	537		$	8,297
Provision charged/(credited) to operations	49		16			140		188		16		46			—		(230		)	225
Loans charged off	—		(32		)	—		—		—		(7		)	—		—			(39		)
Recoveries of loans charged off	—		6			8		—		—		1			—		—			15
Balance - June 30, 2018	$	1,661	$	1,665		$	3,314	$	920	$	462	$	169		$	—	$	307		$	8,498

Balance - March 31, 2017	$	1,370	$	1,822		$	2,634	$	642	$	365	$	122		$	—	$	595		$	7,550
Provision charged/(credited) to operations	85		(386		)	352		260		20		(3		)	—		(178		)	150
Loans charged off	—		—			—		—		—		—			—		—			—
Recoveries of loans charged off	—		1			5		—		—		1			—		—			7
Balance - June 30, 2017	$	1,455	$	1,437		$	2,991	$	902	$	385	$	120		$	—	$	417		$	7,707



(Dollars in thousands)	Construction			Commercial Business			Commercial Real Estate		Mortgage Warehouse Lines			Residential Real Estate			Loans to Individuals			Other			Unallocated			Total
Balance - January 1, 2018	$	1,703		$	1,720		$	2,949	$	852		$	392		$	114		$	—		$	283		$	8,013
Provision charged/(credited) to operations	(42		)	(36		)	304		68			70			61			1			24			450
Loans charged off	—			(32		)	—		—			—			(7		)	(1		)	—			(40		)
Recoveries of loans charged off	—			13			61		—			—			1			—			—			75
Balance - June 30, 2018	$	1,661		$	1,665		$	3,314	$	920		$	462		$	169		$	—		$	307		$	8,498

Balance - January 1, 2017	$	1,204		$	1,732		$	2,574	$	973		$	367		$	112		$	—		$	532		$	7,494
Provision charged/(credited) to operations	251			(298		)	408		(71		)	119			6			—			(115		)	300
Loans charged off	—			—			—		—			(101		)	—			—			—			(101		)
Recoveries of loans charged off	—			3			9		—			—			2			—			—			14
Balance - June 30, 2017	$	1,455		$	1,437		$	2,991	$	902		$	385		$	120		$	—		$	417		$	7,707

When a loan is identified as impaired, the measurement of impairment is based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole remaining source of repayment for the loan is the liquidation of the collateral. In such cases, the current fair value of the collateral less selling costs is used. If the value of the impaired loan is less than the recorded investment in the loan, the impairment is recognized through an allowance estimate or a charge to the allowance.

Impaired Loans Receivables (By Class)



							Three Months Ended June 30, 2018				Six Months Ended June 30, 2018
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no allowance:
Commercial:
Construction	$	104	$	104	$	—	$	104	$	2	$	125	$	4
Commercial Business	1,318		1,573		—		1,332		27		1,291		54
Commercial Real Estate	2,435		2,808		—		4,089		1		3,027		18
Mortgage Warehouse Lines	—		—		—		—		—		—		—
Subtotal	3,857		4,485		—		5,525		30		4,443		76
Residential Real Estate	1,123		1,188		—		811		—		539		—
Consumer:
Loans to Individuals	411		487		—		424		—		415
Other	—		—		—		—		—
Subtotal	411		487		—		424		—		415		—
With no allowance:	$	5,391	$	6,160	$	—	$	6,760	$	30	$	5,397	$	76

With an allowance:
Commercial:
Construction	$	—	$	—	$	—	$	—	$	—			$	—
Commercial Business	3,305		3,356		487		3,328		46		3,376		92
Commercial Real Estate	6,251		7,044		229		4,127		59		4,204		100
Mortgage Warehouse Lines	—		—		—		—		—				—
Subtotal	9,556		10,400		716		7,455		105		7,580		192
Residential Real Estate	—		—		—		—		—
Consumer:
Loans to Individuals	—		—		—		—		—
Other	—		—		—		—		—
Subtotal	—		—		—		—		—		—		—
With an allowance:	$	9,556	$	10,400	$	716	$	7,455	$	105	$	7,580	$	192
Total:
Construction	104		104		—		104		2		125		4
Commercial Business	4,623		4,929		487		4,660		73		4,667		146
Commercial Real Estate	8,686		9,852		229		8,216		60		7,231		118
Mortgage Warehouse Lines	—		—		—		—		—		—		—
Residential Real Estate	1,123		1,188		—		811		—		539		—
Consumer	411		487		—		424		—		415		—
Total	$	14,947	$	16,560	$	716	$	14,215	$	135	$	12,977	$	268

Impaired Loans Receivables (By Class)



	December 31, 2017
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no allowance:
Commercial:
Construction	$	232	$	232	$	—
Commercial Business	1,271		1,419		—
Commercial Real Estate	1,348		1,372		—
Mortgage Warehouse Lines	—		—		—
Subtotal	2,851		3,023		—
Residential Real Estate	69		123		—
Consumer:
Loans to Individuals	368		438		—
Other	—		—		—
Subtotal	368		438		—
With no allowance	$	3,288	$	3,584	$	—
With an allowance:
Commercial:
Construction	$	—	$	—	$	—
Commercial Business	3,462		3,464		592
Commercial Real Estate	4,955		5,748		92
Mortgage Warehouse Lines	—		—		—
Subtotal	8,417		9,212		684
Residential Real Estate	—		—		—
Consumer:
Loans to Individuals	—		—		—
Other	—		—		—
Subtotal	—		—		—
With an allowance	$	8,417	$	9,212	$	684

Total:
Construction	232		232		—
Commercial Business	4,733		4,883		592
Commercial Real Estate	6,303		7,120		92
Mortgage Warehouse Lines	—		—		—
Residential Real Estate	69		123		—
Consumer	368		438		—
Total	$	11,705	$	12,796	$	684

Impaired Loans Receivables (By Class)



	Three Months Ended June 30, 2017				Six Months Ended June 30, 2017
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no allowance:
Commercial:
Construction	$	188	$	3	$	186	$	6
Commercial Business	688		82		741		86
Commercial Real Estate	2,723		92		2,772		105
Mortgage Warehouse Lines	—		—		—		—
Subtotal	3,599		177		3,699		197
Residential Real Estate	181		—		210		—

Consumer:
Loans to Individuals	297		—		316		—
Other	—		—		—		—
Subtotal	297		—		316		—
With no allowance:	$	4,077	$	177	$	4,225	$	197
With an allowance:
Commercial:
Construction	$	137	$	—	$	171	$	—
Commercial Business	3,680		60		2,595		127
Commercial Real Estate	2,989		43		2,600		85
Mortgage Warehouse Lines	—		—		—		—
Subtotal	6,806		103		5,366		212
Residential Real Estate	—		—		100		—
Consumer:
Loans to Individuals	—		—		—		—
Other	—		—		—		—
Subtotal	—		—		—		—
With an allowance:	$	6,806	$	103	$	5,466	$	212
Total:
Construction	325		3		357		6
Commercial Business	4,368		142		3,336		213
Commercial Real Estate	5,712		135		5,372		190
Mortgage Warehouse Lines	—		—		—		—
Residential Real Estate	181		—		310		—
Consumer	297		—		316		—
Total	$	10,883	$	280	$	9,691	$	409

Purchased Credit-Impaired Loans

Purchased credit-impaired loans (“PCI”) are loans acquired at a discount that are due in part to credit quality. On April 11, 2018, as part of the NJCB acquisition, the Company acquired purchased credit-impaired loans with loan balances totaling $1.1 million and fair values totaling $881,000. The following table presents additional information regarding purchased credit-impaired loans at June 30, 2018 and December 31, 2017:



(Dollars in thousands)	June 30, 2018		December 31, 2017
Outstanding balance	$	2,094	$	998
Carrying amount	$	1,755	$	860

Changes in accretable discount for purchased credit-impaired loans for the three and six months ended June 30, 2018 and June 30, 2017 were as follows:



	Three months ended June 30,						Six months ended June 30,
(Dollars in thousands)	2018			2017			2018			2017
Balance at beginning of period	$	103		$	23		$	126		$	30
Acquisition of impaired loans	168			—			168			—
Transfer from non-accretable discount	—			161			—			161
Accretion of discount	(38		)	(13		)	(61		)	(20		)
Balance at end of period	$	233		$	171		$	233		$	171

Consumer Mortgage Loans Secured by Residential Real Estate in Process of Foreclosure

The following table summarizes the recorded investment in consumer mortgage loans secured by residential real estate in the process of foreclosure (dollars in thousands):



June 30, 2018			December 31, 2017
Number of loans	Recorded Investment		Number of loans	Recorded Investment
1	$	77	1	$	77

At June 30, 2018, there was one residential property with a fair value of $1.1 million held in other real estate owned. At December 31, 2017, there were no residential properties held in other real estate owned.

Troubled Debt Restructurings

In the normal course of business, the Bank may consider modifying loan terms for various reasons. These reasons may include as a retention strategy to compete in the current interest rate environment or to re-amortize or extend a loan term to better match the loan’s repayment stream with the borrower’s cash flow. A modified loan would be considered a troubled debt restructuring (“TDR”) if the Bank grants a concession to a borrower and has determined that the borrower is troubled (i.e., experiencing financial difficulties).

If the Bank restructures a loan to a troubled borrower, the loan terms (i.e., interest rate, payment, amortization period and maturity date) may be modified in various ways to enable the borrower to cover the modified debt service payments based on current financial statements and cash flow adequacy. If a borrower’s hardship is thought to be temporary, then modified terms may only be offered for that time period. Where possible, the Bank would attempt to obtain additional collateral and/or secondary repayment sources at the time of the restructuring in order to put the Bank in the best possible position if the borrower is not able to meet the modified terms. The Bank will not offer modified terms if it believes that modifying the loan terms will only delay an inevitable permanent default. In evaluating whether a restructuring constitutes a troubled debt restructuring, applicable guidance requires that a creditor must separately conclude that the restructuring constitutes a concession and the borrower is experiencing financial difficulties.

There were no loans modified as a TDR during the six months ended June 30, 2018. There was one commercial real estate loan with a pre- and post-modification recorded investment of $2.3 million that was modified as a TDR during the six months ended June 30, 2017. There were no troubled debt restructurings that subsequently defaulted within twelve months of restructuring during the six months ended June 30, 2018. There was one troubled debt restructuring that defaulted within twelve months of restructuring in the amount of $458,000 during the six months ended June 30, 2017.