LOANS AND ALLOWANCE FOR LOAN LOSSES

As of September 30, 2018, the Company had $1.2 billion in loans receivable outstanding. Loans held for sale totaled $2.2 million at September 30, 2018. The portfolios of loans receivable at September 30, 2018 and December 31, 2017, consist of the following:



	September 30, 2018		December 31, 2017
	Amount		Amount
	(amounts in thousands)
Commercial and Industrial	$	37,689	$	38,972
Construction	134,436		95,625
Real Estate Mortgage:
Commercial – Owner Occupied	130,491		126,250
Commercial – Non-owner Occupied	291,700		270,472
Residential – 1 to 4 Family	518,561		416,317
Residential – Multifamily	52,038		47,832
Consumer	14,934		16,249
Total Loans	$	1,179,849	$	1,011,717

An age analysis of past due loans by class at September 30, 2018 and December 31, 2017 as follows:



September 30, 2018	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days and Not Accruing		Total Past Due		Current		Total Loans		Loans > 90 Days and Accruing
	(amounts in thousands)
Commercial and Industrial	$	—	$	128	$	14	$	142	$	37,547	$	37,689	$	—
Construction	—		—		1,365		1,365		133,071		134,436		—
Real Estate Mortgage:
Commercial – Owner Occupied	—		—		—		—		130,491		130,491		—
Commercial – Non-owner Occupied	—		—		290		290		291,410		291,700		—
Residential – 1 to 4 Family			928		1,417		2,345		516,216		518,561		—
Residential – Multifamily	—		—		—		—		52,038		52,038		—
Consumer	134		—		—		134		14,800		14,934		—
Total Loans	$	134	$	1,056	$	3,086	$	4,276	$	1,175,573	$	1,179,849	$	—



December 31, 2017	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days and Not Accruing		Total Past Due		Current		Total Loans		Loans > 90 Days and Accruing
	(amounts in thousands)
Commercial and Industrial	$	—	$	—	$	17	$	17	$	38,955	$	38,972	$	—
Construction	—		—		1,392		1,392		94,233		95,625		—
Real Estate Mortgage:
Commercial – Owner Occupied	—		—		155		155		126,095		126,250		—
Commercial – Non-owner Occupied	—		—		597		597		269,875		270,472		—
Residential – 1 to 4 Family	—		352		2,292		2,644		413,673		416,317		—
Residential – Multifamily	—		—		—		—		47,832		47,832		—
Consumer	92		—		81		173		16,076		16,249		—
Total Loans	$	92	$	352	$	4,534	$	4,978	$	1,006,739	$	1,011,717	$	—

Allowance For Loan and Lease Losses (ALLL)

We maintain the ALLL at a level that we believe to be appropriate to absorb estimated probable credit losses incurred in the loan portfolios as of the balance sheet date. We established our allowance in accordance with guidance provided in Accounting Standard Codification ("ASC") - Contingencies (ASC 450) and Receivables (ASC 310).

Determining the appropriateness of the allowance is complex and requires significant judgment reflecting the best estimate of credit losses related to specifically identified impaired loans as well as probable loan losses in the remaining loan portfolio. These evaluations are inherently subjective, as they require material estimates and may be susceptible to significant change. The allowance for loan and lease losses is reviewed by the management of the Company monthly and discussed with the audit committee at least quarterly.

Our allowance for loan losses includes a formula-based component and an asset-specific component. The asset-specific component of the allowance relates to loans considered to be impaired, which includes loans that have been modified in troubled debt restructuring (TDRs) as well as nonperforming loans. To determine the asset-specific component of the allowance, the loans are evaluated individually based on the borrower's ability to repay amounts owed, collateral, relative risk grade of the loans, and other factors given current events and conditions. The Company generally measures the asset-specific allowance as the difference between the fair value (net realizable value) and the recorded investment of a loan.

The formula-based component of the allowance incorporates historical valuation allowance and general valuation allowance. The historical loss experience is measured by type of credit and internal risk grade, loss severity, specific homogeneous risk pools. A historical loss ratio and valuation allowance are established for each pool of similar loans and updated periodically based on actual charge-off experience and current events. The general valuation allowance is based on general economic conditions and other qualitative risk factors both internal and external to the Company. It is generally determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Bank's lending management and staff; (ii) the effectiveness of the Bank's loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; (ix) the impact of rising interest rates on portfolio risk; and (x) national and local economic trends and conditions, and industry conditions. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, high-moderate, moderate, low-moderate or low degree of risk. The results are then input into a "general allocation matrix" to determine an appropriate general valuation allowance.

When evaluating the adequacy of the allowance, the assessment is highly judgmental as the measurement relies upon estimates such as loss severity, asset valuations, default rates, the amounts and timing of interest or principal payments or other factors that are reflective of current and expected market conditions. These estimates are, in turn, dependent on factors such as the duration of current overall economic conditions, industry, portfolio, or borrower-specific factors, the expected outcome of insolvency proceedings as well as, in certain circumstances, other economic factors, including the level of future home prices. All of these estimates and assumptions require significant management judgment and certain assumptions are highly subjective.

The following tables present the information regarding the allowance for loan and lease losses and associated loan data:



						Real Estate Mortgage
	Commercial and Industrial		Construction			Commercial Owner Occupied			Commercial Non-owner Occupied			Residential 1 to 4 Family		Residential Multifamily		Consumer			Total
Allowance for loan losses	(amounts in thousands)
Three months ended Sept.30, 2018
June 30, 2018	$	539	$	1,998		$	1,961		$	5,260		$	6,666	$	619	$	230		17,273
Charge-offs	—		—			—			—			—		—		(1		)	(1		)
Recoveries	10		—			12			6			18		—		—			46
Provisions	298		30			(12		)	(314		)	575		32		(9		)	600
Ending Balance at Sept. 30, 2018	$	847	$	2,028		$	1,961		$	4,952		$	7,259	$	651	$	220		$	17,918

Allowance for loan losses
Nine months ended Sept. 30, 2018
December 31, 2017	$	684	$	2,068		$	2,017		$	4,630		$	6,277	$	627	$	230		16,533
Charge-offs	—		(27		)	—			(49		)	—		—		(19		)	(95		)
Recoveries	40		—			153			61			26		—		—			280
Provisions	123		(13		)	(209		)	310			956		24		9			1,200
Ending Balance at Sept. 30, 2018	$	847	$	2,028		$	1,961		$	4,952		$	7,259	$	651	$	220		$	17,918

Allowance for loan losses
Individually evaluated for impairment	$	14	$	71		$	49		$	194		$	14	$	—	$	—		$	342
Collectively evaluated for impairment	833		1,957			1,912			4,758			7,245		651		220			17,576
Balance at Sept. 30, 2018	$	847	$	2,028		$	1,961		$	4,952		$	7,259	$	651	$	220		$	17,918

Loans
Individually evaluated for impairment	$	14	$	5,690		$	3,320		$	11,716		$	2,294	$	—	$	—		$	23,034
Collectively evaluated for impairment	37,675		128,746			127,171			279,984			516,267		52,038		14,934			1,156,815
Balance at Sept. 30, 2018	$	37,689	$	134,436		$	130,491		$	291,700		$	518,561	$	52,038	$	14,934		$	1,179,849



							Real Estate Mortgage
	Commercial and Industrial			Construction			Commercial Owner Occupied			Commercial Non-owner Occupied			Residential 1 to 4 Family			Residential Multifamily			Consumer			Total
Allowance for loan losses	(amounts in thousands)
Three months ended Sept. 30, 2017
June 30, 2017	$	1,202		$	2,258		$	1,835		$	4,915		$	5,422		$	699		$	228		16,559
Charge-offs	—			(687		)	—			(621		)	—			(50		)	—			(1,358		)
Recoveries	3			—			25			102			10			—			—			140
Provisions	(549		)	454			(33		)	225			386			18			(1		)	500
Ending Balance at Sept. 30, 2017	$	656		$	2,025		$	1,827		$	4,621		$	5,818		$	667		$	227		$	15,841

Allowance for loan losses
Nine months ended Sept. 30, 2017
December 31, 2016	$	1,188		$	2,764		$	2,082		$	3,889		$4,916			$	505		$	236		$	15,580
Charge-offs	(134		)	(687		)	(430		)	(622		)	(118		)	(50		)	—			(2,041		)
Recoveries	45			—			94			148			15			—			—			302
Provisions	(443		)	(52		)	81			1,206			1,005			212			(9		)	2,000
Ending Balance at Sept. 30, 2017	$	656		$	2,025		$	1,827		$	4,621		$	5,818		$	667		$	227		$	15,841

Allowance for loan losses
Individually evaluated for impairment	$	—		$	124		$	55		$	208		$	15		$	—		$	—		$	402
Collectively evaluated for impairment	656			1,901			1,772			4,413			5,803			667			227			15,439
Balance at Sept. 30, 2017	$	656		$	2,025		$	1,827		$	4,621		$	5,818		$	667		$	227		$	15,841

Loans
Individually evaluated for impairment	$	18		$	6,146		$	3,881		$	12,523		$	4,339		$	—		$	17		$	26,924
Collectively evaluated for impairment	28,028			81,679			110,265			262,791			377,128			50,532			15,999			926,422
Balance at Sept. 30, 2017	$	28,046		$	87,825		$	114,146		$	275,314		$	381,467		$	50,532		$	16,016		$	953,346

Impaired Loans

A loan is considered impaired when, based on the current information and events, it is probable that the Company will be unable to collect the payments of principal and interest as of the date such payments were due. Loans are placed on non-accrual status when, in management's opinion, the borrower may be unable to meet payment obligations as they become due, as well as when a loan is 90 days past due, unless the loan is well secured and in the process of collection, as required by regulatory provisions. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

All our impaired loans are assessed for recoverability based on an independent third-party full appraisal to determine the net realizable value (“NRV”) based on the fair value of the underlying collateral, less cost to sell and other costs or the present value of discounted cash flows in the case of certain impaired loans that are not collateral dependent.

The following tables provide further detail on impaired loans and the associated ALLL at September 30, 2018 and December 31, 2017:



September 30, 2018	Recorded Investment		Unpaid Principal Balance		Related Allowance
	(amounts in thousands)
With no related allowance recorded:
Commercial and Industrial	$	—	$	—	$	—
Construction	—		—		—
Real Estate Mortgage:
Commercial – Owner Occupied	—		—		—
Commercial – Non-owner Occupied	290		290		—
Residential – 1 to 4 Family	1,417		1,417		—
Residential – Multifamily	—		—		—
Consumer	—		—		—
	1,707		1,707		—
With an allowance recorded:
Commercial and Industrial	14		19		14
Construction	5,690		10,180		71
Real Estate Mortgage:
Commercial – Owner Occupied	3,320		3,350		49
Commercial – Non-owner Occupied	11,426		11,426		194
Residential – 1 to 4 Family	877		877		14
Residential – Multifamily	—		—		—
Consumer	—		—		—
	21,327		25,852		342
Total:
Commercial and Industrial	14		19		14
Construction	5,690		10,180		71
Real Estate Mortgage:
Commercial – Owner Occupied	3,320		3,350		49
Commercial – Non-owner Occupied	11,716		11,716		194
Residential – 1 to 4 Family	2,294		2,294		14
Residential – Multifamily	—		—		—
Consumer	—		—		—
	$	23,034	$	27,559	$	342



December 31, 2017	Recorded Investment		Unpaid Principal Balance		Related Allowance
	(amounts in thousands)
With no related allowance recorded:
Commercial and Industrial	$	17	$	21	$	—
Construction	1,365		5,856		—
Real Estate Mortgage:
Commercial – Owner Occupied	155		155		—
Commercial – Non-owner Occupied	277		277		—
Residential – 1 to 4 Family	2,292		2,354		—
Residential – Multifamily	—		—		—
Consumer	81		81		—
	4,187		8,744		—
With an allowance recorded:
Commercial and Industrial	—		—		—
Construction	4,587		4,684		135
Real Estate Mortgage:
Commercial – Owner Occupied	3,635		3,665		58
Commercial – Non-owner Occupied	12,124		13,941		250
Residential – 1 to 4 Family	919		919		15
Residential – Multifamily	—		—		—
Consumer	—		—		—
	21,265		23,209		458
Total:
Commercial and Industrial	17		21		—
Construction	5,952		10,540		135
Real Estate Mortgage:
Commercial – Owner Occupied	3,790		3,820		58
Commercial – Non-owner Occupied	12,401		14,218		250
Residential – 1 to 4 Family	3,211		3,273		15
Residential – Multifamily	—		—		—
Consumer	81		81		—
	$	25,452	$	31,953	$	458

The following table presents by loan portfolio class, the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2018 and 2017:



	Three Months Ended September 30,
	2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(amounts in thousands)
Commercial and Industrial	$	15	$	—	$	22	$	—
Construction	5,735		48		10,760		51
Real Estate Mortgage:
Commercial – Owner Occupied	3,465		41		3,955		49
Commercial – Non-owner Occupied	11,773		155		14,392		153
Residential – 1 to 4 Family	2,302		10		4,410		20
Residential – Multifamily	—		—		—		—
Consumer	—		—		17		—
Total	$	23,290	$	254	$	33,556	$	273



	Nine Months Ended September 30,
	2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(amounts in thousands)
Commercial and Industrial	$	16	$	1	$	23	$	1
Construction	5,830		145		8,863		152
Real Estate Mortgage:
Commercial – Owner Occupied	3,605		137		4,018		146
Commercial – Non-owner Occupied	11,988		451		13,733		463
Residential – 1 to 4 Family	2,751		37		4,420		63
Residential – Multifamily	—		—		—		—
Consumer	20		—		18		1
Total	$	24,210	$	771	$	31,075	$	826

Troubled debt restructuring (TDRs)

A TDR is a loan the terms of which have been restructured in a manner that grants a concession to a borrower experiencing financial difficulty. TDRs result from our loss mitigation activities that include rate reductions, extension of maturity, or a combination of both, which are intended to minimize economic loss and to avoid foreclosure or repossession of collateral. TDRs are classified as impaired loans and are included in the impaired loan disclosures. TDRs are also evaluated to determine whether they should be placed on non-accrual status. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is repaid in full, foreclosed, sold or it meets the criteria to be removed from TDR status.

At the time a loan is modified in a TDR, we consider the following factors to determine whether the loan should accrue interest:


•	Whether there is a period of current payment history under the current terms, typically 6 months;


•	Whether the loan is current at the time of restructuring; and


•	Whether we expect the loan to continue to perform under the restructured terms with a debt coverage ratio that complies with the Bank’s credit underwriting policy of 1.25 times debt service.

We also review the financial performance of the borrower over the past year to be reasonably assured of repayment and performance according to the modified terms. This review consists of an analysis of the borrower’s historical results; the borrower’s projected results over the next four quarters; and current financial information of the borrower and any guarantors. The projected repayment source needs to be reliable, verifiable, quantifiable and sustainable. In addition, all TDRs are reviewed quarterly to determine the amount of any impairment. At the time of restructuring, the amount of the loan principal for which we are not reasonably assured of repayment is charged-off, but not forgiven.

As September 30, 2018 and December 31, 2017, we reported TDR loans of $20.2 million and $21.2 million, respectively. There were no new loans modified as a TDR and no additional commitments to lend additional funds to debtors whose loans have been modified in TDRs during the nine months ended September 30, 2018 and the year ended December 31, 2017, respectively. Performing TDRs (not reported as non-accrual loans) totaled $19.9 million and $20.9 million as of September 30, 2018 and December 31, 2017, respectively. Nonperforming TDRs were $290,000 and $277,000 at September 30, 2018 and December 31, 2017, respectively.

Loans modified in a TDR are evaluated for impairment. The nature and extent of impairment of TDRs, including those that have experienced a subsequent default, is considered in the determination of an appropriate level of allowance for loan losses. For the TDR loans, we had specific reserves of $323,000 and $457,000 in the allowance at September 30, 2018 and December 31, 2017, respectively.

TDRs are generally included in nonaccrual loans and may return to performing status after a minimum of six consecutive monthly payments under restructured terms and also meeting other performance indicators.

Credit Quality Indicators: As part of the on-going monitoring of the credit quality of the Company's loan portfolio, management tracks certain credit quality indicators including trends related to the risk grades of loans, the level of classified loans, net charge-offs, nonperforming loans (see details above) and the general economic conditions in the region.

The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 7. Grades 1 through 4 are considered “Pass”. A description of the general characteristics of the seven risk grades is as follows:


1.	Good: Borrower exhibits the strongest overall financial condition and represents the most creditworthy profile.


2.	Satisfactory (A): Borrower reflects a well-balanced financial condition, demonstrates a high level of creditworthiness and typically will have a strong banking relationship with the Bank.


3.	Satisfactory (B): Borrower exhibits a balanced financial condition and does not expose the Bank to more than a normal or average overall amount of risk. Loans are considered fully collectable.


4.	Watch List: Borrower reflects a fair financial condition, but there exists an overall greater than average risk. Risk is deemed acceptable by virtue of increased monitoring and control over borrowings. Probability of timely repayment is present.

Other Assets Especially Mentioned (OAEM): Financial condition is such that assets in this category have a potential weakness or pose unwarranted financial risk to the Bank even though the asset value is not currently impaired. The asset does not currently warrant adverse classification but if not corrected could weaken and could create future increased risk exposure. Includes loans that require an increased degree of monitoring or servicing as a result of internal or external changes.

Substandard: This classification represents more severe cases of #5 (OAEM) characteristics that require increased monitoring. Assets are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral. Asset has a well-defined weakness or weaknesses that impairs the ability to repay debt and jeopardizes the timely liquidation or realization of the collateral at the asset’s net book value.

Doubtful: Assets which have all the weaknesses inherent in those assets classified #6 (Substandard) but the risks are more severe relative to financial deterioration in capital and/or asset value; accounting/evaluation techniques may be questionable and the overall possibility for collection in full is highly improbable. Borrowers in this category require constant monitoring, are considered work-out loans and present the potential for future loss to the Bank.

An analysis of the credit risk profile by internally assigned grades as of September 30, 2018 and December 31, 2017 is as follows:



At September 30, 2018	Pass		OAEM		Substandard		Doubtful		Total
	(amounts in thousands)
Commercial and Industrial	$	37,610	$	79	$	—	$	—	$	37,689
Construction	121,078		5,447		7,911		—		134,436
Real Estate Mortgage:
Commercial – Owner Occupied	128,162		2,329		—		—		130,491
Commercial – Non-owner Occupied	291,275		—		425		—		291,700
Residential – 1 to 4 Family	516,255		764		1,542		—		518,561
Residential – Multifamily	52,038		—		—		—		52,038
Consumer	14,934		—		—		—		14,934
Total	$	1,161,352	$	8,619	$	9,878	$	—	$	1,179,849



At December 31, 2017	Pass		OAEM		Substandard		Doubtful		Total
	(amounts in thousands)
Commercial and Industrial	$	38,875	$	97	$	—	$	—	$	38,972
Construction	82,351		5,056		8,218		—		95,625
Real Estate Mortgage:
Commercial – Owner Occupied	123,491		2,604		155		—		126,250
Commercial – Non-owner Occupied	269,736		—		736		—		270,472
Residential – 1 to 4 Family	413,327		560		2,430		—		416,317
Residential – Multifamily	47,832		—		—		—		47,832
Consumer	16,168		—		81		—		16,249
Total	$	991,780	$	8,317	$	11,620	$	—	$	1,011,717