4. LOANS AND ALLOWANCE FOR LOAN LOSSES

The following table summarizes the composition of our loan portfolio as of March 31, 2019 and December 31, 2018 (in thousands):


	March 31, 2019		December 31, 2018
Loans secured by real estate:
Commercial real estate - owner occupied	$	416,750	$	407,031
Commercial real estate - non-owner occupied		549,891		540,698
Secured by farmland		19,682		20,966
Construction and land loans		149,054		146,654
Residential 1-4 family(1)		568,616		565,083
Multi- family residential		83,219		82,516
Home equity lines of credit(1)		121,136		128,225
Total real estate loans		1,908,348		1,891,173

Commercial loans		218,375		255,441
Consumer loans		30,319		32,347
Subtotal		2,157,042		2,178,961
Less deferred costs (fees) on loans		173		(137)
Loans, net of deferred fees	$	2,157,215	$	2,178,824

(1)

Includes $18.7 million and $18.3 million of loans as of March 31, 2019 and December 31, 2018, respectively, acquired in the Greater Atlantic Bank (“GAB”) transaction covered under an FDIC loss-share agreement. The agreement covering single family loans expires in December 2019.

In the first quarter of 2019, $33.9 million of commercial loans were reclassified into loans secured by real estate, upon review and validation of collateral and Call Report codes.

Accounting policy related to the allowance for loan losses is considered a critical policy given the level of estimation, judgment, and uncertainty in the levels of the allowance required to account for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment, and uncertainty can have on the consolidated financial results.

As part of the GAB acquisition, the Bank and the FDIC entered into loss sharing agreements on approximately $143.4 million (contractual basis) of GAB’s assets. There were two agreements with the FDIC: one for single family loans which is a 10‑year agreement expiring in December 2019, and one for non-single family (commercial) assets which was a 5‑year agreement which expired in December 2014. The Bank will continue to share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement related to single family loans; we refer to these assets collectively as “covered assets.” Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans”. Covered loans totaled $18.7 million and $18.3 million at March 31, 2019 and December 31, 2018, respectively.

Accretable discount on the acquired EVBS, GAB, Prince George’s Federal Savings Bank (“PGFSB”), and the HarVest Bank (“HarVest”) loans totaled $12.6 million and $13.5 million at March 31, 2019 and December 31, 2018, respectively. Accretion of $749 thousand and $816 thousand associated with the acquired loans held for investment was recognized in the three months ended March 31, 2019 and 2018, respectively.

For the three acquisitions subsequent to the GAB acquisition noted above, management sold the majority of the purchased credit impaired loans immediately after closing of the acquisition.

Impaired loans for the covered and non-covered portfolios were as follows (in thousands):


	Total Loans
			Unpaid
	Recorded		Principal		Related
March 31, 2019	Investment (1)		Balance		Allowance
With no related allowance recorded
Commercial real estate - owner occupied	$	4,540	$	5,989	$	—
Commercial real estate - non-owner occupied (2)		3,927		4,421		—
Construction and land development		353		365		—
Commercial loans		3,560		4,240		—
Residential 1-4 family (3)		2,558		4,966		—
Other consumer loans		19		40		—
Total	$	14,957	$	20,021	$	—

With an allowance recorded
Commercial real estate - owner occupied	$	—	$	—	$	—
Commercial real estate - non-owner occupied (2)		—		—		—
Construction and land development		—		—		—
Commercial loans		2,810		4,670		600
Residential 1-4 family (3)		783		831		—
Other consumer loans		—		—		—
Total	$	3,593	$	5,501	$	600
Grand total	$	18,550	$	25,522	$	600

(1) Recorded investment is after cumulative prior charge offs of $2.0 million. These loans also have aggregate SBA guarantees of $4.8 million.

(2)

Includes loans secured by farmland and multi-family loans.

(3)

Includes home equity lines of credit.


	Total Loans
			Unpaid
	Recorded		Principal		Related
December 31, 2018	Investment (1)		Balance		Allowance
With no related allowance recorded
Commercial real estate - owner occupied	$	2,795	$	4,777	$	—
Commercial real estate - non-owner occupied (2)		171		333		—
Construction and land development		—		336		—
Commercial loans		3,450		6,013		—
Residential 1-4 family (3)		1,591		5,911		—
Other consumer loans		—		—		—
Total	$	8,007	$	17,370	$	—

With an allowance recorded
Commercial real estate - owner occupied	$	—	$	—	$	—
Commercial real estate - non-owner occupied (2)		—		—		—
Construction and land development		—		—		—
Commercial loans		2,626		3,276		612
Residential 1-4 family (3)		1,429		1,476		6
Other consumer loans		—		—		—
Total	$	4,055	$	4,752	$	618
Grand total	$	12,062	$	22,122	$	618

(1)

Recorded investment is after cumulative prior charge offs of $1.5 million. These loans also have aggregate SBA guarantees of $3.4 million.

(2)

Includes loans secured by farmland and multi-family loans.

(3)

Includes home equity lines of credit.

The following tables present the average recorded investment and interest income recognized for impaired loans recognized by class of loans for the three months ended March 31, 2019 and 2018 (in thousands):


	Total Loans
	Average		Interest
	Recorded		Income
Three Months Ended March 31, 2019	Investment		Recognized
With no related allowance recorded
Commercial real estate - owner occupied	$	6,034	$	66
Commercial real estate - non-owner occupied (1)		4,435		37
Construction and land development		370		14
Commercial loans		5,011		11
Residential 1-4 family (2)		5,305		59
Other consumer loans		40		—
Total	$	21,195	$	187

With an allowance recorded
Commercial real estate - owner occupied	$	—	$	—
Commercial real estate - non-owner occupied (1)		—		—
Construction and land development		—		—
Commercial loans		4,712		50
Residential 1-4 family (2)		984		18
Other consumer loans		—		—
Total	$	5,696	$	68
Grand total	$	26,891	$	255

(1)

Includes loans secured by farmland and multi-family loans.

(2)

Includes home equity lines of credit.


	Total Loans
	Average		Interest
	Recorded		Income
Three Months Ended March 31, 2018	Investment		Recognized
With no related allowance recorded
Commercial real estate - owner occupied	$	671	$	9
Commercial real estate - non-owner occupied (1)		877		14
Construction and land development		9,972		—
Commercial loans		4,842		3
Residential 1-4 family (2)		3,548		14
Other consumer loans		—		—
Total	$	19,910	$	40

With an allowance recorded
Commercial real estate - owner occupied	$	—	$	—
Commercial real estate - non-owner occupied (1)		—		—
Construction and land development		—		—
Commercial loans		929		—
Residential 1-4 family (2)		—		—
Other consumer loans		—		—
Total	$	929	$	—
Grand total	$	20,839	$	40

(1)

Includes loans secured by farmland and multi-family loans.

(2)

Includes home equity lines of credit.

The following tables present the aging of the recorded investment in past due loans by class of loans as of March 31, 2019 and December 31, 2018 (in thousands):


	30 - 59		60 - 89
	Days		Days		90 Days		Total		Nonaccrual		Loans Not		Total
March 31, 2019	Past Due		Past Due		or More		Past Due		Loans		Past Due		Loans
Total loans:
Commercial real estate - owner occupied	$	3,310	$	164	$	—	$	3,474	$	1,161	$	412,115	$	416,750
Commercial real estate - non-owner occupied (1)		100		200		—		300		1,387		651,105		652,792
Construction and land development		389		28		—		417		—		148,637		149,054
Commercial loans		114		176		—		290		3,375		214,710		218,375
Residential 1-4 family (2)		5,530		331		—		5,861		1,501		682,390		689,752
Other consumer loans		37		—		—		37		20		30,262		30,319
Total	$	9,480	$	899	$	—	$	10,379	$	7,444	$	2,139,219	$	2,157,042

(1)

Includes loans secured by farmland and multi-family loans.

(2)

Includes home equity lines of credit.


	30 - 59		60 - 89
	Days		Days		90 Days		Total		Nonaccrual		Loans Not		Total
December 31, 2018	Past Due		Past Due		or More		Past Due		Loans		Past Due		Loans
Total loans:
Commercial real estate - owner occupied	$	577	$	344	$	—	$	921	$	1,284	$	404,826	$	407,031
Commercial real estate - non-owner occupied (1)		581		617		—		1,198		—		642,982		644,180
Construction and land development		851		—		—		851		—		145,803		146,654
Commercial loans		319		168		—		487		3,391		251,563		255,441
Residential 1-4 family (2)		5,523		197		—		5,720		2,055		685,533		693,308
Other consumer loans		142		18		—		160		—		32,187		32,347
Total	$	7,993	$	1,344	$	—	$	9,337	$	6,730	$	2,162,894	$	2,178,961

(1)

Includes loans secured by farmland and multi-family loans.

(2)

Includes home equity lines of credit.

Nonaccrual loans include SBA guaranteed amounts totaling $4.8 million and $3.4 million at March 31, 2019 and December 31, 2018, respectively.

Activity in the allowance for non-covered loan and lease losses for the three months ended March 31, 2019 and 2018 is summarized below (in thousands):


	Commercial		Commercial
	Real Estate		Real Estate		Construction						Other
	Owner		Non-owner		and Land		Commercial		1-4 Family		Consumer
Three Months Ended March 31, 2019	Occupied		Occupied (1)		Development		Loans		Residential (2)		Loans		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	802	$	1,669	$	821	$	7,097	$	1,106	$	224	$	564	$	12,283
Provision (recovery)		11		624		99		(887)		56		83		214		200
Charge offs		—		(462)		—		(167)		—		(60)		—		(689)
Recoveries		3		—		—		63		8		6		—		80
Ending balance	$	816	$	1,831	$	920	$	6,106	$	1,170	$	253	$	778	$	11,874

Three Months Ended March 31, 2018
Allowance for loan losses:
Beginning balance	$	690	$	1,321	$	692	$	4,496	$	1,586	$	612	$	—	$	9,397
Provision (recovery)		165		229		112		831		(34)		297		—		1,600
Charge offs		—		—		—		(230)		(166)		(91)		—		(487)
Recoveries		4		—		—		175		64		2		—		245
Ending balance	$	859	$	1,550	$	804	$	5,272	$	1,450	$	820	$	—	$	10,755

(1)

Includes loans secured by farmland and multi-family loans.

(2)

Includes home equity lines of credit.

The following tables present the balance in the allowance for loan losses and the recorded investment in non-covered loans by portfolio segment and based on impairment method as of March 31, 2019 and December 31, 2018 (in thousands):


	Commercial		Commercial
	Real Estate		Real Estate		Construction						Other
	Owner		Non-owner		and Land		Commercial		1-4 Family		Consumer
March 31, 2019	Occupied		Occupied (1)		Development		Loans		Residential (2)		Loans		Unallocated		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	600	$	—	$	—	$	—	$	600
Collectively evaluated for impairment		816		1,831		920		5,506		1,170		253		778		11,274
Total ending allowance	$	816	$	1,831	$	920	$	6,106	$	1,170	$	253	$	778	$	11,874

Loans:
Individually evaluated for impairment	$	4,540	$	3,927	$	353	$	3,560	$	2,558	$	19	$	—	$	14,957
Collectively evaluated for impairment		412,210		648,865		148,701		214,815		687,194		30,300		—		2,142,085
Total ending loan balances	$	416,750	$	652,792	$	149,054	$	218,375	$	689,752	$	30,319	$	—	$	2,157,042

December 31, 2018
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	600	$	—	$	—	$	—	$	600
Collectively evaluated for impairment		802		1,669		821		6,497		1,106		224		564		11,683
Total ending allowance	$	802	$	1,669	$	821	$	7,097	$	1,106	$	224	$	564	$	12,283

Loans:
Individually evaluated for impairment	$	2,795	$	171	$	—	$	3,450	$	1,591	$	—	$	—	$	8,007
Collectively evaluated for impairment		404,236		644,009		146,654		251,991		691,717		32,347		—		2,170,954
Total ending loan balances	$	407,031	$	644,180	$	146,654	$	255,441	$	693,308	$	32,347	$	—	$	2,178,961

(1)

Includes loans secured by farmland and multi-family loans.

(2)

Includes home equity lines of credit.

Troubled Debt Restructurings

A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower. The Bank determines that a borrower may be experiencing financial difficulty if the borrower is currently delinquent on any of its debt, or if the Bank is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future. Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk and borrower/guarantor structures. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness. When evaluating whether a concession has been granted, the Bank also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Bank for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers. The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.

Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reduction in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.

As of March 31, 2019, we had two loans in TDRs. One loan was modified in TDRs during the year ending December 31, 2018. One TDR which had been modified in 2013 defaulted in 2015. This loan, in the amount of $656 thousand, was current as of March 31, 2019.

Credit Quality Indicators

Through its system of internal controls, Southern National evaluates and segments loan portfolio credit quality on a quarterly basis using regulatory definitions for Special Mention, Substandard and Doubtful. Special Mention loans are considered to be criticized. Substandard and Doubtful loans are considered to be classified.

Special Mention loans are loans that have a potential weakness that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position.

Substandard loans may be inadequately protected by the current net worth and paying capacity of the obligor 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 institution will sustain some loss if the deficiencies are not corrected.

Doubtful loans 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. Southern National had no loans classified Doubtful at March 31, 2019 or December 31, 2018.

As of March 31, 2019 and December 31, 2018, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):


	Total Loans
	Special
March 31, 2019	Mention		Substandard (3)		Pass		Total
Commercial real estate - owner occupied	$	3,596	$	5,519	$	407,635	$	416,750
Commercial real estate - non-owner occupied (1)		4,255		185		648,352		652,792
Construction and land development		—		—		149,054		149,054
Commercial loans		5,327		3,218		209,830		218,375
Residential 1-4 family (2)		393		1,957		687,402		689,752
Other consumer loans		137		—		30,182		30,319
Total	$	13,708	$	10,879	$	2,132,455	$	2,157,042


	Total Loans
	Special
December 31, 2018	Mention		Substandard (3)		Pass		Total
Commercial real estate - owner occupied	$	6,611	$	2,810	$	397,610	$	407,031
Commercial real estate - non-owner occupied (1)		4,382		189		639,609		644,180
Construction and land development		—		—		146,654		146,654
Commercial loans		2,373		2,689		250,379		255,441
Residential 1-4 family (2)		395		1,982		690,931		693,308
Other consumer loans		142		—		32,205		32,347
Total	$	13,903	$	7,670	$	2,157,388	$	2,178,961

(1)

Includes loans secured by farmland and multi-family residential loans.

(2)

Includes home equity lines of credit.

(3)

Includes SBA guarantees of $4.8 million and $3.4 million as of March 31, 2019 and December 31, 2018.

The amount of foreclosed residential real estate property held at March 31, 2019 and December 31, 2018 was $1.2 million. The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $1.1 million and $1.5 million at March 31, 2019 and December 31, 2018, respectively.