Loans

The following table presents the composition of the loans held for investment portfolio at September 30, 2017 and December 31, 2016:



	September 30, 2017				December 31, 2016
(In Thousands)	Outstanding Amount		Percent of Total Portfolio		Outstanding Amount		Percent of Total Portfolio
Commercial real estate - owner occupied	$	443,128	22.50	%	$	250,440	23.87	%
Commercial real estate - nonowner occupied	435,181		22.09		184,688		17.59
Real estate construction	104,193		5.29		91,822		8.75
Residential real estate	512,621		26.03		204,413		19.47
Commercial	449,450		22.82		311,486		29.67
Consumer	25,087		1.27		6,849		0.65
Total loans	$	1,969,660	100.00	%	$	1,049,698	100.00	%
Less allowance for loan losses	15,692				16,008
Net loans	$	1,953,968			$	1,033,690

Unearned income and net deferred loan fees and costs totaled $3.0 million and $2.4 million at September 30, 2017 and December 31, 2016, respectively. Loans pledged to secure borrowings at the FHLB totaled $491.4 million and $266.6 million at September 30, 2017 and December 31, 2016, respectively.

Loans acquired in a transfer, including in business combinations, where there is evidence of credit deterioration since origination and it is probable at the date of acquisition that the Corporation will not collect all contractually required principal and interest payments, are accounted for as purchased impaired loans. Purchased impaired loans are initially recorded at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the historical allowance for credit losses related to these loans is not carried over.

Accounting for purchased impaired loans involves estimating fair value, at acquisition, using the principal and interest cash flows expected to be collected discounted at the prevailing market rate of interest. The excess of cash flows expected to be collected over the estimated fair value at the acquisition date is referred to as the accretable yield and is recognized in interest income using an effective yield method over the remaining life of the loans. The difference between contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference and is not recorded. Any decreases in cash flows expected to be collected (other than due to decreases in interest rate indices and changes in prepayment assumptions) will be charged to the provision for loan losses, resulting in an increase to the allowance for loan losses.

The following table presents the changes in the accretable yield for purchased impaired loans for three and nine month periods ended September 30, 2017:



	September 30, 2017
(In Thousands)	Three Months Ended			Nine Months Ended
Accretable yield, beginning of period	$	466		$	—
Additions	—			557
Accretion	(146		)	(237		)
Reclassification from (to) nonaccretable difference	—			—
Other changes, net	—			—
Accretable yield, end of period	$	320		$	320

At September 30, 2017, none of the purchased impaired loans were classified as nonperforming assets. Therefore, interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, is being recognized on all purchased loans.

Loans are considered past due if a contractual payment is not made by the calendar day after the payment is due. However, for reporting purposes loans past due 1 to 29 days are excluded from loans past due and are included in the total for current loans in the table below. The delinquency status of the loans in the portfolio is shown below as of September 30, 2017 and December 31, 2016. Loans that were on non-accrual status are not included in any past due amounts.



	September 30, 2017
(In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Non-accrual Loans		Current Loans		Total Loans
Commercial real estate - owner occupied	$	892	$	—	$	—	$	892	$	—	$	442,236	$	443,128
Commercial real estate - nonowner occupied	—		—		—		—		—		435,181		435,181
Real estate construction	—		—		—		—		26		104,167		104,193
Residential real estate	677		160		—		837		572		511,212		512,621
Commercial	397		39		73		509		5,236		443,705		449,450
Consumer	41		1		—		42		3		25,042		25,087
Total	$	2,007	$	200	$	73	$	2,280	$	5,837	$	1,961,543	$	1,969,660



	December 31, 2016
(In Thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Non-accrual Loans		Current Loans		Total Loans
Commercial real estate - owner occupied	$	—	$	—	$	—	—		$	—	$	250,440	$	250,440
Commercial real estate - non-owner occupied	—		—		—		—		—		184,688		184,688
Real estate construction	—		—		—		—		940		90,882		91,822
Residential real estate	—		97		—		97		431		203,885		204,413
Commercial	438		—		—		438		5,551		305,497		311,486
Consumer	—		—		—		—		—		6,849		6,849
Total	$	438	$	97	$	—	$	535	$	6,922	$	1,042,241	$	1,049,698

The following table includes an aging analysis of the recorded investment of purchased impaired loans included in the table above:



	September 30, 2017
(In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Non-accrual Loans		Current Loans		Total Loans
Commercial real estate - owner occupied	$	653	$	—	$	—	$	653	$	—	$	442	$	1,095
Commercial real estate - nonowner occupied	—		—		—		—		—		920		920
Real estate construction	—		—		—		—		—		—		—
Residential real estate	186		—		—		186		—		2,189		2,375
Commercial	—		—		—		—		—		94		94
Consumer	—		—		—		—		—		6		6
Total	$	839	$	—	$	—	$	839	$	—	$	3,651	$	4,490

Loans listed as non-performing are also placed on non-accrual status. The accrual of interest is discontinued at the time a loan is 90 days delinquent or when the credit deteriorates and there is doubt that the credit will be paid as agreed, unless the credit is well-secured and in process of collection. Once the loan is on non-accrual status, all accrued but unpaid interest is also charged-off, and all payments are used to reduce the principal balance. Once the principal balance is repaid in full, additional payments are taken into income. A loan may be returned to accrual status if the borrower shows renewed willingness and ability to repay under the terms of the loan agreement. The risk profile based upon payment activity is shown below.



	September 30, 2017						December 31, 2016
(In Thousands)	Non-performing		Performing		Total Loans		Non-performing		Performing		Total Loans
Commercial real estate - owner occupied	$	—	$	443,128	$	443,128	$	—	$	250,440	$	250,440
Commercial real estate - nonowner occupied	—		435,181		435,181		—		184,688		184,688
Real estate construction	26		104,167		104,193		940		90,882		91,822
Residential real estate	572		512,049		512,621		431		203,982		204,413
Commercial	5,236		444,214		449,450		5,551		305,935		311,486
Consumer	3		25,084		25,087		—		6,849		6,849
Total	$	5,837	$	1,963,823	$	1,969,660	$	6,922	$	1,042,776	$	1,049,698

Identifying and Classifying Portfolio Risks by Risk Rating

At origination, loans are categorized into risk categories based upon original underwriting. Subsequent to origination, management evaluates the collectability of all loans in the portfolio and assigns a proprietary risk rating. Ratings range from the highest to lowest quality based on factors including measurements of ability to pay, collateral type and value, borrower stability, management experience, and credit enhancements. These ratings are consistent with the bank regulatory rating system.

A loan may have portions of its balance in one rating and other portions in a different rating. The Bank may use these “split ratings” when factors cause loan loss risk to exist for part, but not all of the principal balance. Split ratings may also be used where cash collateral or a government agency has provided a guaranty that partially covers a loan.

For clarity of presentation, the Corporation’s loan portfolio is profiled below in accordance with the risk rating framework that has been commonly adopted by the federal banking agencies. The definitions of the various risk rating categories are as follows:

Pass: The condition of the borrower and the performance of the loan are satisfactory or better.

Special Mention: Loans with one or more potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the borrower's credit position at some future date.

Substandard: Loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets 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 Bank will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans have all the weaknesses inherent in one classified 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.

Loss: Loans are considered uncollectible and their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, and a partial recovery may be effected in the future. It is the Bank’s policy to charge-off any loan once the risk rating is classified as loss.

The following tables present the recorded investment of loans that have been risk rated in accordance with the internal classification system:



September 30, 2017
(In Thousands)	Real Estate Construction			Commercial Real Estate Owner Occupied			Commercial Real Estate Non-Owner Occupied			Residential Real Estate			Commercial			Consumer		Total
Pass	$	98,263		$	438,924		$	434,911		$	509,478		$	433,861		$	25,077	$	1,940,514
Special Mention	5,419			1,452			284			647			2,520			—		10,322
Substandard	926			3,457			987			2,667			13,611			3		21,651
Doubtful	—			—			—			—			187			3		190
Loss	—			—			—			—			—			—		—
Unearned income	(415		)	(705		)	(1,001		)	(171		)	(729		)	4		(3,017		)
Ending Balance	$	104,193		$	443,128		$	435,181		$	512,621		$	449,450		$	25,087	$	1,969,660



December 31, 2016
(In Thousands)	Real Estate Construction			Commercial Real Estate Owner Occupied			Commercial Real Estate Non-Owner Occupied			Residential Real Estate			Commercial			Consumer		Total
Pass	$	91,296		$	247,001		$	185,020		$	202,762		$	287,978		$	6,848	$	1,020,905
Special Mention	—			1,213			300			932			4,544			—		6,989
Substandard	940			2,807			—			878			19,561			—		24,186
Doubtful	—			—			—			—			—			—		—
Loss	—			—			—			—			—			—		—
Unearned income	(414		)	(581		)	(632		)	(159		)	(597		)	1		(2,382		)
Ending Balance	$	91,822		$	250,440		$	184,688		$	204,413		$	311,486		$	6,849	$	1,049,698

Impaired Loans

A loan is classified as impaired when it is deemed probable by management’s analysis that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement, or the recorded investment in the impaired loan is greater than the present value of expected future cash flows, discounted at the loan's effective interest rate. In the case of an impaired loan, management conducts an analysis which identifies if a quantifiable potential loss exists, and takes the necessary steps to record that loss when it has been identified as uncollectible.

As the ultimate collectability of the total principal of an impaired loan is in doubt, the loan is placed on non-accrual status with all payments applied to principal under the cost-recovery method. As the Bank does not utilize the cash-basis method of accounting for impaired loans, the Bank did not recognize interest income in association with its impaired loans during the first nine months of 2017 and 2016.

The table below shows the results of management’s analysis of impaired loans, excluding purchased impaired loans, as of September 30, 2017 and December 31, 2016:



	September 30, 2017
(In Thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no specific related allowance recorded:
Commercial real estate - owner occupied	$	—	$	—	$	—
Commercial real estate - nonowner occupied	—		—		—
Real estate construction	26		35		—
Residential real estate	35		36		—
Commercial	3,220		4,378		—
Consumer	3		3		—
Total with no specific related allowance	$	3,284	$	4,452	$	—
With a specific related allowance recorded:
Commercial real estate loans - owner occupied	$	—	$	—	$	—
Commercial real estate loans - nonowner occupied	—		—		—
Real estate construction	903		974		223
Residential real estate	537		549		—
Commercial	1,113		1,268		477
Consumer	—		—		—
Total with a specific related allowance	$	2,553	$	2,791	$	700
Total	$	5,837	$	7,243	$	700



	December 31, 2016
(In Thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no specific related allowance recorded:
Commercial real estate - owner occupied	$	—	$	—	$	—
Commercial real estate - nonowner occupied	—		—		—
Real estate construction	—		—		—
Residential real estate	431		431		—
Commercial	2,748		3,771		—
Consumer	—		—		—
Total with no specific related allowance	$	3,179	$	4,202	$	—
With a specific related allowance recorded:
Commercial real estate - owner occupied	$	—	$	—	$	—
Commercial real estate - nonowner occupied	—		—		—
Real estate construction	940		994		221
Residential real estate	—		—		—
Commercial	2,803		2,900		2,805
Consumer	—		—		—
Total with a specific related allowance	$	3,743	$	3,894	$	3,026
Total	$	6,922	$	8,096	$	3,026

The table below shows the average recorded investment in impaired loans, excluding purchased impaired loans, by class of loan:



	Average Recorded Investment
	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
(In Thousands)	2017		2016		2017		2016
Commercial real estate - owner occupied	$	67	$	67	$	151	$	23
Commercial real estate - nonowner occupied	334		—		779		2,423
Real estate construction	939		1,003		953		1,022
Residential real estate	952		23		1,189		45
Commercial	4,508		4,969		4,273		4,970
Consumer	2		—		1		—
Total	$	6,802	$	6,062	$	7,346	$	8,483

The “Recorded Investment” amounts in the table above represent the outstanding principal balance net of charge-offs and non-accrual payments to principal on each loan represented in the table. The “Unpaid Principal Balance” represents the outstanding principal balance on each loan represented in the table plus any amounts that have been charged-off on each loan and non-accrual payments applied to principal.

Troubled Debt Restructurings ("TDR")

A TDR is a formal restructure of a loan when the Bank, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to a borrower. The Bank classifies these transactions as a TDR if the transaction meets the following conditions: an existing credit agreement must be formally renewed, extended and/or modified; the borrower must be experiencing financial difficulty; and the Bank has granted a concession that it would not otherwise consider.

Once identified as a TDR, a loan is considered to be impaired, and an impairment analysis is performed for the loan individually, rather than under a general loss allowance based on the loan type and risk rating. Any resulting shortfall is charged-off. This method is used consistently for all segments of the portfolio.

Normally, loans identified as TDRs would be placed on non-accrual status and considered non-performing until sufficient history of timely collection or payment has occurred that allows them to return to performing status, generally six months.

No loans were modified in connection with a TDR during the three and nine month periods ended September 30, 2017 and 2016.

The total balance of TDRs at September 30, 2017 and December 31, 2016 was $940 thousand and $4.1 million, respectively. The significant decrease was the result of a $3.8 million charge off done in the first quarter of 2017 on one of the TDR loans. The amount of the specific valuation allowance related to TDRs was $206 thousand and $2.2 million as of September 30, 2017 and December 31, 2016, respectively.

There were no outstanding commitments to lend additional amounts to TDR borrowers at September 30, 2017 or December 31, 2016.

There were no TDR payment defaults during the three and nine months ended September 30, 2017 and 2016. For purposes of this disclosure, a TDR payment default occurs when, within twelve months of the original TDR modification, either a full or partial charge-off occurs or a TDR becomes 90 or more past due.