LOANS AND THE ALLOWANCE FOR LOAN LOSSES

6 Months Ended

Jun. 30, 2020

LOANS AND THE ALLOWANCE FOR LOAN LOSSES

LOANS AND THE ALLOWANCE FOR LOAN LOSSES

NOTE 4 - LOANS AND THE ALLOWANCE FOR LOAN LOSSES

The following presents a summary of the Company’s loans as of the dates noted (in thousands):

	June 30,		December 31,
	2020		2019
Cash, Securities and Other(1)	$	371,111	$	146,701
Construction and Development		74,793		28,120
1-4 Family Residential		418,409		400,134
Non-Owner Occupied CRE		229,150		165,179
Owner Occupied CRE		117,426		127,968
Commercial and Industrial		213,271		128,457
Total loans		1,424,160		996,559
Deferred costs (fees) and unamortized premium/(unaccreted discounts), net		(1,720)		1,448
Allowance for loan losses		(10,354)		(7,875)
Loans, net	$	1,412,086	$	990,132

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⁽¹⁾ Includes PPP loans of $204.6 million as of June 30, 2020.

As of June 30, 2020, total loans include $123.8 million of performing loans purchased as part of the Branch Acquisition. See Note 2 – Acquisitions for more information.

The CARES Act created the PPP, which is administered by the SBA. The PPP is intended to provide loans to small businesses to pay their employees, rent, mortgage interest and utilities. The loans may be forgiven conditioned upon the client providing payroll documentation evidencing their compliant use of funds and otherwise complying with the terms of the program. The Bank is an approved SBA lender and at June 30, 2020 the Cash, Securities and Other portion of the loan portfolio included $204.6 million of PPP loans, or 55.1% of the total category.

Loan Modifications

As a result of the COVID-19 pandemic, a loan modification program was designed and implemented to assist our clients experiencing financial stress resulting from the economic impacts caused by the global pandemic. The Company was offering loan extensions, temporary payment moratoriums, and financial covenant waivers for commercial and consumer borrowers impacted by the pandemic who have a pass risk rating and have not been delinquent over 30 days on payments in the last two years.

The Company modified 98 loans, including acquired loans, across multiple industries in the amount of $176.9 million during the six months ended June 30, 2020.

	Total Loans		# of Loans Modified		Outstanding Balance of Modified Loans		% of Total Loan Balance Modified
Cash, Securities and Other	$	371,111		7	$	5,570		1.50	%
Construction and Development		74,793		1		3,814		5.10
1-4 Family Residential		418,409		31		41,690		9.96
Non-Owner Occupied CRE		229,150		30		65,491		28.58
Owner Occupied CRE		117,426		10		17,524		14.92
Commercial and Industrial		213,271		19		42,765		20.05
Total Loans	$	1,424,160		98	$	176,854		12.42	%

The CARES Act provides banks optional, temporary relief from accounting for certain loan modifications as a TDR. The modifications must be related to the adverse effects of COVID-19, and certain other criteria are required to be met in order to apply the relief. Interagency guidance from Federal Reserve and the FDIC confirmed with the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. We believe our loan modification program meets that definition. In accordance with that guidance, the Company is recognizing interest income on all loans modified for temporary payment moratoriums, primarily for a period of 180 days or less.

All loans modified in response to COVID-19 are classified as performing and pass rated as of June 30, 2020. These loans are included in the allowance for loan loss general reserve in accordance with ASC 450-20. Management has increased our loan level reviews and portfolio monitoring to address the changing environment. The Company continues to meet regularly with clients who could be more highly impacted by the recent COVID-19 pandemic. These are borrowers in industries we believe may be more impacted by the pandemic, for instance those loans where there may be a greater than 50% probability of a downgrade, covenant violation or 20% reduction in collateral position. Management believes the diversity of the loan portfolio is prudent and remains consistent with the credit culture and goals of the Bank.

The following presents, by class, an aging analysis of the recorded investments (excluding accrued interest receivable, deferred loan fees, deferred costs, unamortized premium, and unaccreted discounts which are not material) in loans past due as of June 30, 2020 and December 31, 2019 (in thousands):

	30-59		60-89		90 or		Total				Total
	Days		Days		More Days		Loans				Recorded
June 30, 2020	Past Due		Past Due		Past Due		Past Due		Current		Investment
Cash, Securities and Other	$	1,199	$	400	$	1,493	$	3,092	$	368,019	$	371,111
Construction and Development		2,567		—		—		2,567		72,226		74,793
1-4 Family Residential		3,151		737		—		3,888		414,521		418,409
Non-Owner Occupied CRE		—		—		—		—		229,150		229,150
Owner Occupied CRE		—		—		—		—		117,426		117,426
Commercial and Industrial		379		—		3,506		3,885		209,386		213,271
Total	$	7,296	$	1,137	$	4,999	$	13,432	$	1,410,728	$	1,424,160

	30-59		60-89		90 or		Total				Total
	Days		Days		More Days		Loans				Recorded
December 31, 2019	Past Due		Past Due		Past Due		Past Due		Current		Investment
Cash, Securities and Other	$	525	$	—	$	—	$	525	$	146,176	$	146,701
Construction and Development		—		—		—		—		28,120		28,120
1-4 Family Residential		5,688		—		—		5,688		394,446		400,134
Non-Owner Occupied CRE		—		—		—		—		165,179		165,179
Owner Occupied CRE		—		—		—		—		127,968		127,968
Commercial and Industrial		—		3,110		907		4,017		124,440		128,457
Total	$	6,213	$	3,110	$	907	$	10,230	$	986,329	$	996,559

At June 30, 2020 and December 31, 2019, the Company did not have any loans which were more than 90 days delinquent and accruing interest.

Non-Accrual Loans and Troubled Debt Restructurings

The following presents the recorded investment in non-accrual loans by class as of the dates noted (in thousands):

	June 30,		December 31,
	2020		2019
Cash, Securities and Other	$	1,493	$	2,803
Commercial and Industrial		4,325		4,412
Total	$	5,818	$	7,215

Non-accrual loans classified as TDR accounted for $5.8 million of the recorded investment at June 30, 2020 and $7.2 million at December 31, 2019, respectively. Non-accrual loans are classified as impaired loans and individually evaluated for impairment.

The following presents a summary of the unpaid principal balance of loans classified as TDRs by loan type and delinquency status as of the dates noted (in thousands):

	June 30,		December 31,
	2020		2019
Accruing
Commercial and Industrial	$	5,636	$	5,055
Non-accrual
Cash, Securities, and Other		1,493		2,803
Commercial and Industrial		4,325		4,412
Allowance for loan associated with TDR		(1,179)		(833)
Net recorded investment	$	10,275	$	11,437

At June 30, 2020 and December 31, 2019, the Company had extended an additional $0.8 million and $0.2 million to a Commercial and Industrial borrower with a loan classified as a TDR for operational needs as allowed under the commitment. The majority owner for this borrower provided $1.5 million of pledged cash as collateral in 2019 which is still held by the Company, in exchange for this additional funding.

The Company modified one loan into a TDR during the three and six months ended June 30, 2020. The Borrower was struggling to make payments in accordance with the original contract terms. The Company restructured the loan including receiving a large paydown and extended the maturity and lowered the interest rate as a result of the Borrower’s financial difficulties. The loan was making payments as agreed for the three and six months ended June 30, 2020.

The Company modified one borrower relationship with two loans into a TDR for the year ended December 31, 2019. The borrower, who has loans that are classified as Commercial and Industrial, was not making payments in accordance with the original contract terms. The modification included an extension of the maturity date that the Company would not have otherwise considered as a result of the Borrower’s difficulties. The extension of maturity was for a period of approximately nine months. The borrower was not making payments as agreed for the three and six months ended June 30, 2020.

TDRs are reviewed individually for impairment and are included in the Company’s specific reserves in the allowance for loan losses. If charged off, the amount of the charge-off is included in the Company’s charge-off factors, which impact the Company’s reserves on non-impaired loans.

The following table presents impaired loans by portfolio and related valuation allowance as of the periods presented (in thousands):

	June 30, 2020						December 31, 2019
			Unpaid		Allowance				Unpaid		Allowance
	Total		Contractual		for		Total		Contractual		for
	Recorded		Principal		Loan		Recorded		Principal		Loan
	Investment		Balance		Losses		Investment		Balance		Losses
Impaired loans with a valuation allowance:
Commercial and Industrial	$	3,434	$	3,434	$	1,179	$	4,412	$	4,412	$	833
Total	$	3,434	$	3,434	$	1,179	$	4,412	$	4,412	$	833
Impaired loans with no related valuation allowance:
Cash, Securities, and Other	$	1,493	$	1,493	$	—	$	2,803	$	2,803	$	—
Commercial and Industrial		6,527		6,527		—		5,055		5,055		—
Total	$	8,020	$	8,020	$	—	$	7,858	$	7,858	$	—
Total impaired loans:
Cash, Securities, and Other	$	1,493	$	1,493	$	—	$	2,803	$	2,803	$	—
Commercial and Industrial		9,961		9,961		1,179		9,467		9,467		833
Total	$	11,454	$	11,454	$	1,179	$	12,270	$	12,270	$	833

The recorded investment in loans in the previous tables excludes accrued interest, deferred loan fees and costs and unamortized premium/discounts which are not material. Interest income, if any, was recognized on the cash basis on non-accrual loans.

The average balance of impaired loans and interest income recognized on impaired loans during the three months ended June 30, 2020 and 2019 are included in the table below (in thousands):

	Three Months Ended June 30,
	2020				2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
Impaired loans with a valuation allowance:
Commercial and Industrial	$	3,462	$	—	$	1,235	$	—
Total	$	3,462	$	—	$	1,235	$	—
Impaired loans with no related valuation allowance:
Cash, Securities, and Other	$	1,493	$	—	$	8,042	$	—
Commercial and Industrial		5,998		84		5,268		68
1-4 Family Residential		—		—		412		26
Total	$	7,491	$	84	$	13,722	$	94
Total impaired loans:
Cash, Securities, and Other	$	1,493	$	—	$	8,042	$	—
Commercial and Industrial		9,460		84		6,503		68
1-4 Family Residential		—		—		412		26
Total	$	10,953	$	84	$	14,957	$	94

The average balance of impaired loans and interest income recognized on impaired loans during the six months ended June 30, 2020 and 2019 are included in the table below (in thousands):

	Six Months Ended June 30,
	2020				2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
Impaired loans with a valuation allowance:
Commercial and Industrial	$	3,476	$	—	$	1,398	$	—
Total	$	3,476	$	—	$	1,398	$	—
Impaired loans with no related valuation allowance:
Cash, Securities, and Other	$	1,925	$	—	$	9,072	$	—
Commercial and Industrial		5,991		165		5,131		188
1-4 Family Residential		—		—		412		51
Total	$	7,916	$	165	$	14,615	$	239
Total impaired loans:
Cash, Securities, and Other	$	1,925	$	—	$	9,072	$	—
Commercial and Industrial		9,467		165		6,529		188
1-4 Family Residential		—		—		412		51
Total	$	11,392	$	165	$	16,013	$	239

Allowance for Loan Losses

The provision for loan losses for the six months ended June 30, 2020 was $2.5 million compared to $0.1 million for the same period in 2019, primarily reflecting strong loan growth along with an increase based on the additional variability surrounding the COVID-19 loan modifications made during the quarter and increased economic uncertainty.

Allocation of a portion of the allowance for loan losses to one category of loans does not preclude its availability to absorb losses in other categories. The following presents the activity in the Company’s allowance for loan losses by portfolio class for the periods presented (in thousands):

	Cash,		Construction		1-4		Non-Owner		Owner		Commercial
	Securities		and		Family		Occupied		Occupied		and
	and Other		Development		Residential		CRE		CRE		Industrial		Total
Changes in allowance for loan losses for the three months ended June 30, 2020
Beginning balance	$	1,092	$	186	$	3,008	$	1,403	$	884	$	1,669	$	8,242
Provision for (recovery of) loan losses		1,345		298		(300)		80		(124)		825		2,124
Charge-offs		(24)		—		—		—		—		—		(24)
Recoveries		12		—		—		—		—		—		12
Ending balance	$	2,425	$	484	$	2,708	$	1,483	$	760	$	2,494	$	10,354
Changes in allowance for loan losses for the six months ended June 30, 2020
Beginning balance	$	1,058	$	200	$	2,850	$	1,176	$	911	$	1,680	$	7,875
Provision for (recovery of) loan losses		1,379	$	284	$	(142)	$	307	$	(151)	$	814		2,491
Charge-offs		(24)	$	—	$	—	$	—	$	—	$	—		(24)
Recoveries		12	$	—	$	—	$	—	$	—	$	—		12
Ending balance	$	2,425	$	484	$	2,708	$	1,483	$	760	$	2,494	$	10,354
Allowance for loan losses at June 30, 2020 allocated to loans evaluated for impairment:
Individually	$	—	$	—	$	—	$	—	$	—	$	1,179	$	1,179
Collectively		2,425		484		2,708		1,483		760		1,315		9,175
Ending balance	$	2,425	$	484	$	2,708	$	1,483	$	760	$	2,494	$	10,354
Loans at June 30, 2020, evaluated for impairment:
Individually	$	1,493	$	—	$	—	$	—	$	—	$	9,961	$	11,454
Collectively		369,618		74,793		418,409		229,150		117,426		203,310		1,412,706
Ending balance	$	371,111	$	74,793	$	418,409	$	229,150	$	117,426	$	213,271	$	1,424,160

	Cash,		Construction		1-4		Non-Owner		Owner		Commercial
	Securities		and		Family		Occupied		Occupied		and
	and Other		Development		Residential		CRE		CRE		Industrial		Total
Changes in allowance for loan losses for the three months ended June 30, 2019
Beginning balance	$	877	$	266	$	2,588	$	1,235	$	780	$	1,899	$	7,645
Provision for (recovery of) loan losses		164		24		62		(149)		20		(199)		(78)
Charge-offs		—		—		—		—		—		—		—
Recoveries		8		—		—		—		—		—		8
Ending balance	$	1,049	$	290	$	2,650	$	1,086	$	800	$	1,700	$	7,575
Changes in allowance for loan losses for the six months ended June 30, 2019
Beginning balance	$	764	$	232	$	2,552	$	1,264	$	789	$	1,850	$	7,451
Provision for (recovery of) loan losses		277		58		98		(178)		11		(150)		116
Charge-offs		—		—		—		—		—		—		—
Recoveries		8		—		—		—		—		—		8
Ending balance	$	1,049	$	290	$	2,650	$	1,086	$	800	$	1,700	$	7,575
Allowance for loan losses at December 31, 2019 allocated to loans evaluated for impairment:
Individually	$	—	$	—	$	—	$	—	$	—	$	833	$	833
Collectively		1,058		200		2,850		1,176		911		847		7,042
Ending balance	$	1,058	$	200	$	2,850	$	1,176	$	911	$	1,680	$	7,875
Loans at December 31, 2019, evaluated for impairment:
Individually	$	2,803	$	—	$	—	$	—	$	—	$	9,467	$	12,270
Collectively		143,898		28,120		400,134		165,179		127,968		118,990		984,289
Ending balance	$	146,701	$	28,120	$	400,134	$	165,179	$	127,968	$	128,457	$	996,559

The Company categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans by credit risk on a quarterly basis. The Company uses the following definitions for risk ratings:

Special Mention—Loans classified as special mention have a potential weakness or borrowing relationships that require more than the usual amount of management attention. Adverse industry conditions, deteriorating financial conditions, declining trends, management problems, documentation deficiencies or other similar weaknesses may be evident. Ability to meet current payment schedules may be questionable, even though interest and principal are still being paid as agreed. The asset has potential weaknesses that may result in deteriorating repayment prospects if left uncorrected. Loans in this risk grade are not considered adversely classified.

Substandard—Substandard loans are considered “classified” and are inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardizes 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. Loans in this category may be placed on non-accrual status and may individually be evaluated for impairment if indicators of impairment exist.

Doubtful—Loans graded doubtful are considered “classified” and 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 known facts, conditions and values, highly questionable and improbable. However, the amount of certainty of eventual loss is not known because of specific pending factors.

Loans not meeting any of the three criteria above are considered to be pass-rated loans. The following presents, by class and by credit quality indicator, the recorded investment in the Company’s loans as of June 30, 2020 and December 31, 2019 (in thousands):

			Special
June 30, 2020	Pass		Mention		Substandard			Total
Cash, Securities and Other	$	369,618	$	—	$	1,493	$	371,111
Construction and Development		74,793		—		—		74,793
1-4 Family Residential		413,514		—		4,895		418,409
Non-Owner Occupied CRE		223,903		5,247		—		229,150
Owner Occupied CRE		116,933		493		—		117,426
Commercial and Industrial		200,556		—		12,715		213,271
Total	$	1,399,317	$	5,740	$	19,103	$	1,424,160

			Special
December 31, 2019	Pass		Mention		Substandard			Total
Cash, Securities and Other	$	143,898	$	—	$	2,803	$	146,701
Construction and Development		28,120		—		—		28,120
1-4 Family Residential		395,224		—		4,910		400,134
Non-Owner Occupied CRE		164,021		1,158		—		165,179
Owner Occupied CRE		127,968		—		—		127,968
Commercial and Industrial		114,241		—		14,216		128,457
Total	$	973,472	$	1,158	$	21,929	$	996,559

The Company had no loans graded doubtful as of June 30, 2020 and December 31, 2019.