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LOANS AND THE ALLOWANCE FOR LOAN LOSSES

9 Months Ended

Sep. 30, 2020

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):


	September 30,		December 31,
	2020		2019
Cash, Securities and Other⁽¹⁾	$	371,481	$	146,701
Construction and Development		105,717		28,120
1-4 Family Residential		446,959		400,134
Non-Owner Occupied CRE		243,564		165,179
Owner Occupied CRE		154,138		127,968
Commercial and Industrial		185,625		128,457
Total loans held for investment		1,507,484		996,559
Deferred costs (fees) and unamortized premiums/(unaccreted discounts), net		(1,408)		1,448
Allowance for loan losses		(11,845)		(7,875)
Loans, net	$	1,494,231	$	990,132

______________________________________

⁽¹⁾ Includes PPP loans of $206.1 million as of September 30, 2020.

As of September 30, 2020, total loans held for investment include $124.7 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 September 30, 2020 the Cash, Securities and Other portion of the loan portfolio included $206.1 million of PPP loans, or 55.5% of the total category.

The Company is a participant in the Federal Reserve’s MSLP to support lending to small and medium-sized for profit businesses and nonprofit organizations that were in sound financial condition before the onset of the COVID-19 pandemic. As of September 30, 2020, the Company’s Commercial and Industrial loans included one MSLP loan with the net carrying amount of $2.4 million.

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.

As of September 30, 2020, the Company’s loans include forty-four modified loans, including acquired loans, across multiple industries in the amount of $66.7 million.

The following presents loan modifications as a result of COVID-19 as of September 30, 2020 (dollars in thousands):


	Total Loans		# of Modified Loans		Outstanding Balance of Modified Loans		% of Total Loan Balance Modified
Cash, Securities and Other	$	371,481		1	$	1,496		0.40	%
Construction and Development		105,717		—		—		—
1-4 Family Residential		446,959		6		4,441		0.99
Non-Owner Occupied CRE		243,564		22		38,229		15.70
Owner Occupied CRE		154,138		10		17,524		11.37
Commercial and Industrial		185,625		5		5,048		2.72
Total Loans	$	1,507,484		44	$	66,738		4.43	%

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 September 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 accommodations, transportation and restaurant 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. The portion of our credit exposure to the highest risk industries impacted by COVID-19, such as accommodations, transportation and restaurants, is less than 3.0% of our loan portfolio. Management believes the diversity of the loan portfolio is prudent and remains consistent with the credit culture and goals of the Bank.

Interest accrued during the modification term on modified loans is deferred to the end of the loan term. As of September 30, 2020, no allowance for loan loss was deemed necessary on the accrued interest balances related to loan modifications.

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


	30-59		60-89		90 or		Total				Total
	Days		Days		More Days		Loans				Recorded
September 30, 2020	Past Due		Past Due		Past Due		Past Due		Current		Investment
Cash, Securities and Other	$	30	$	—	$	66	$	96	$	371,385	$	371,481
Construction and Development		—		—		—		—		105,717		105,717
1-4 Family Residential		4,883		1,197		—		6,080		440,879		446,959
Non-Owner Occupied CRE		1,022		—		—		1,022		242,542		243,564
Owner Occupied CRE		—		—		—		—		154,138		154,138
Commercial and Industrial		522		—		3,679		4,201		181,424		185,625
Total	$	6,457	$	1,197	$	3,745	$	11,399	$	1,496,085	$	1,507,484


	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 September 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):


	September 30,		December 31,
	2020		2019
Cash, Securities and Other	$	66	$	2,803
Commercial and Industrial		3,679		4,412
Total	$	3,745	$	7,215

Non-accrual loans classified as TDR accounted for $3.7 million of the recorded investment at September 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):


	September 30,		December 31,
	2020		2019
Accruing
Commercial and Industrial	$	6,136	$	5,055
Non-accrual
Cash, Securities, and Other		64		2,803
Commercial and Industrial		3,679		4,412

Allowance for loan losses associated with TDR		(1,421)		(833)
Net recorded investment	$	8,458	$	11,437

The Company extended additional principal allowed under the commitment to a Commercial and Industrial borrower for operational needs, subsequent to the loan being classified as a TDR, in the amounts of $1.3 million and $0.2 million at September 30, 2020 and December 31, 2019, respectively. 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 did not modify any loans into TDR status during the three months ended September 30, 2020. The Company modified one loan into a TDR during the nine months ended September 30, 2020. The Borrower was having difficulty making 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 has paid off in full as of September 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. These two loans are currently on non-accrual and the borrower was not making payments as agreed for the three and nine months ended September 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):


	September 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:
Cash, Securities, and Other	$	2	$	2	$	2	$	—	$	—	$	—
Commercial and Industrial		3,419		3,419		1,421		4,412		4,412		833
Total	$	3,421	$	3,421	$	1,423	$	4,412	$	4,412	$	833

Impaired loans with no related valuation allowance:
Cash, Securities, and Other	$	64	$	64	$	—	$	2,803	$	2,803	$	—
Commercial and Industrial		6,396		6,396		—		5,055		5,055		—
Total	$	6,460	$	6,460	$	—	$	7,858	$	7,858	$	—

Total impaired loans:
Cash, Securities, and Other	$	66	$	66	$	2	$	2,803	$	2,803	$	—
Commercial and Industrial		9,815		9,815		1,421		9,467		9,467		833
Total	$	9,881	$	9,881	$	1,423	$	12,270	$	12,270	$	833

The recorded investment in loans in the previous tables excludes accrued interest, deferred costs (fees) and unamortized premiums/ (unaccreted 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 September 30, 2020 and 2019 are included in the table below (in thousands):


	Three Months Ended September 30,
	2020				2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
Impaired loans with a valuation allowance:
Cash, Securities, and Other	$	1	$	—	$	185	$	—
Commercial and Industrial		3,427		—		1,035		—
Total	$	3,428	$	—	$	1,220	$	—

Impaired loans with no related valuation allowance:
Cash, Securities, and Other	$	779	$	—	$	5,062	$	—
Commercial and Industrial		6,462		85		5,958		138
1-4 Family Residential		—		—		1,213		26
Total	$	7,241	$	85	$	12,233	$	164

Total impaired loans:
Cash, Securities, and Other	$	780	$	—	$	5,247	$	—
Commercial and Industrial		9,889		85		6,993		138
1-4 Family Residential		—		—		1,213		26
Total	$	10,669	$	85	$	13,453	$	164

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


	Nine Months Ended September 30,
	2020				2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
Impaired loans with a valuation allowance:
Cash, Securities, and Other	$	1	$	—	$	185	$	—
Commercial and Industrial		3,462		—		1,310		—
Total	$	3,463	$	—	$	1,495	$	—

Impaired loans with no related valuation allowance:
Cash, Securities, and Other	$	1,463	$	—	S	8,088	S	—
Commercial and Industrial		6,088		250		5,463		326
1-4 Family Residential		—		—		1,213		77
Total	$	7,551	$	250	$	14,764	$	403

Total impaired loans:
Cash, Securities, and Other	$	1,464	$	—	$	8,273	$	—
Commercial and Industrial		9,550		250		6,773		326
1-4 Family Residential		—		—		1,213		77
Total	$	11,014	$	250	$	16,259	$	403

Allowance for Loan Losses

The provision for loan losses for the nine months ended September 30, 2020 was $4.0 million compared to $0.2 million for the same period in 2019, primarily reflecting an increase based on the additional variability surrounding the COVID-19 loan modifications made during the prior quarter and increased economic uncertainty along with strong loan growth.

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 September 30, 2020
Beginning balance	$	2,425	$	484	$	2,708	$	1,483	$	760	$	2,494	$	10,354
Provision for (recovery of) loan losses		192		249		392		207		309		147		1,496
Charge-offs		(6)		—		—		—		—		—		(6)
Recoveries		1		—		—		—		—		—		1
Ending balance	$	2,612	$	733	$	3,100	$	1,690	$	1,069	$	2,641	$	11,845

Changes in allowance for loan losses for the nine months ended September 30, 2020
Beginning balance	$	1,058	$	200	$	2,850	$	1,176	$	911	$	1,680	$	7,875
Provision for (recovery of) loan losses		1,571		533		250		514		158		961		3,987
Charge-offs		(30)		—		—		—		—		—		(30)
Recoveries		13		—		—		—		—		—		13
Ending balance	$	2,612	$	733	$	3,100	$	1,690	$	1,069	$	2,641	$	11,845

Allowance for loan losses at September 30, 2020 allocated to loans evaluated for impairment:
Individually	$	2	$	—	$	—	$	—	$	—	$	1,421	$	1,423
Collectively		2,610		733		3,100		1,690		1,069		1,220		10,422
Ending balance	$	2,612	$	733	$	3,100	$	1,690	$	1,069	$	2,641	$	11,845

Loans at September 30, 2020, evaluated for impairment:
Individually	$	66	$	—	$	—	$	—	$	—	$	9,815	$	9,881
Collectively		371,415		105,717		446,959		243,564		154,138		175,810		1,497,603
Ending balance	$	371,481	$	105,717	$	446,959	$	243,564	$	154,138	$	185,625	$	1,507,484


	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 September 30, 2019
Beginning balance	$	1,049	$	290	$	2,650	$	1,086	$	800	$	1,700	$	7,575
Provision for (recovery of) loan losses		258		18		27		(68)		76		(211)		100
Charge-offs		—		—		—		—		—		—		—
Recoveries		—		—		—		—		—		—		—
Ending balance	$	1,307	$	308	$	2,677	$	1,018	$	876	$	1,489	$	7,675

Changes in allowance for loan losses for the nine months ended September 30, 2019
Beginning balance	$	764	$	232	$	2,552	$	1,264	$	789	$	1,850	$	7,451
Provision for (recovery of) loan losses		535		76		125		(246)		87		(361)		216
Charge-offs		—		—		—		—		—		—		—
Recoveries		8		—		—		—		—		—		8
Ending balance	$	1,307	$	308	$	2,677	$	1,018	$	876	$	1,489	$	7,675

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 September 30, 2020 and December 31, 2019 (in thousands):


			Special
September 30, 2020	Pass		Mention		Substandard			Total
Cash, Securities and Other	$	371,415	$	—	$	66	$	371,481
Construction and Development		105,717		—		—		105,717
1-4 Family Residential		442,076		—		4,883		446,959
Non-Owner Occupied CRE		232,010		11,554		—		243,564
Owner Occupied CRE		153,656		482		—		154,138
Commercial and Industrial		173,061		—		12,564		185,625
Total	$	1,477,935	$	12,036	$	17,513	$	1,507,484


			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 September 30, 2020 and December 31, 2019.