NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

A summary of the loan portfolio as of September 30, 2018 and December 31, 2017 follows (dollars in thousands):

	September 30, 2018			December 31, 2017
Commercial real estate	$	404,753		$	350,622
Consumer real estate		112,957			102,581
Construction and land development		129,799			82,586
Commercial and industrial		398,626			373,248
Consumer		8,274			6,862
Other		19,793			31,983
Total		1,074,202			947,882
Less net unearned income		(332	)		(345	)
Total loans		1,073,870			947,537
Allowance for loan losses		(15,218	)		(13,721	)
Total loans, net	$	1,058,652		$	933,816

The adequacy of the allowance for loan losses (ALL) is assessed at the end of each quarter. The ALL includes a specific component related to loans that are individually evaluated for impairment and a general component related to loans that are segregated into homogenous pools and collectively evaluated for impairment. The ALL factors applied to these pools are an estimate of probable incurred losses based on management’s evaluation of historical net losses from loans with similar characteristics, which are adjusted by management to reflect current events, trends, and conditions. The adjustments include consideration of the following: changes in lending policies and procedures, economic conditions, nature and volume of the portfolio, experience of lending management, volume and severity of past due loans, quality of the loan review system, value of underlying collateral for collateral dependent loans, concentrations, and other external factors.

The Company categorizes loans into risk categories based on relevant information about the ability of 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 all commercial loans, and consumer relationships with an outstanding balance greater than $500,000, individually and assigns each loan a risk rating. This analysis is performed on a continual basis by the relationship managers and credit department personnel. On at least an annual basis an independent party performs a formal credit risk review of a sample of the loan portfolio. Among other things, this review assesses the appropriateness of the loan’s risk rating. The Company uses the following definitions for risk ratings:

Special Mention – A special mention asset possesses deficiencies or potential weaknesses deserving of management’s attention. If uncorrected, such weaknesses or deficiencies may expose the Company to an increased risk of loss in the future.

Substandard – A substandard asset is inadequately protected by the current sound net 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 Company will sustain some loss if deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard.

Doubtful – A doubtful asset has all weaknesses inherent in one classified substandard, with the added characteristic that weaknesses make collection or liquidation in full, on the basis of existing facts, conditions, and values, highly questionable and improbable. The probability of loss is extremely high, but certain important and reasonable specific pending factors which may work to the advantage and strengthening of the asset exist, therefore, its classification as an estimated loss is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans.

Loans not falling into the criteria above are considered to be pass-rated loans. The Company utilizes six loan grades within the pass risk rating.

The following tables present the loan balances by category as well as risk rating (dollars in thousands):

	Non-impaired Loans
September 30, 2018	Pass/Watch		Special Mention		Substandard		Total Non-impaired		Total Impaired Loans		Total
Commercial real estate	$	402,254	$	—	$	1,353	$	403,607	$	1,146	$	404,753
Consumer real estate		112,640		—		225		112,865		92		112,957
Construction and land development		129,799		—		—		129,799		—		129,799
Commercial and industrial		379,446		6,992		6,769		393,207		5,419		398,626
Consumer		8,174		—		—		8,174		100		8,274
Other		19,793		—		—		19,793		—		19,793
Total	$	1,052,106	$	6,992	$	8,347	$	1,067,445	$	6,757	$	1,074,202

December 31, 2017
Commercial real estate	$	349,415	$	—	$	—	$	349,415	$	1,207	$	350,622
Consumer real estate		102,571		—		10		102,581		—		102,581
Construction and land development		82,586		—		—		82,586		—		82,586
Commercial and industrial		349,494		11,193		11,073		371,760		1,488		373,248
Consumer		6,849		—		13		6,862		—		6,862
Other		31,983		—		—		31,983		—		31,983
Total	$	922,898	$	11,193	$	11,096	$	945,187	$	2,695	$	947,882

None of the Company’s loans had a risk rating of “Doubtful” as of September 30, 2018 or December 31, 2017.

The following tables detail the changes in the ALL for the three and nine months ended September 30, 2018 and 2017 (dollars in thousands):

	Commercial real estate			Consumer real estate			Construction and land development		Commercial and industrial			Consumer			Other			Total
Three Months Ended September 30, 2018
Balance, beginning of period	$	3,551		$	1,057		$	1,764	$	7,779		$	120		$	434		$	14,705
Charged-off loans		—			—			—		—			—			—			—
Recoveries		6			1			—		22			3			—			32
Provision for loan losses		(412	)		(75	)		449		767			(30	)		(218	)		481
Balance, end of period	$	3,145		$	983		$	2,213	$	8,568		$	93		$	216		$	15,218

Three Months Ended September 30, 2017
Balance, beginning of period	$	3,533		$	1,081		$	911	$	6,395		$	57		$	477		$	12,454
Charged-off loans		—			—			—		—			—			—			—
Recoveries		3			—			—		1,860			—			—			1,863
Provision for loan losses		(242	)		(97	)		576		(306	)		22			(148	)		(195	)
Balance, end of period	$	3,294		$	984		$	1,487	$	7,949		$	79		$	329		$	14,122

	Commercial real estate			Consumer real estate			Construction and land development			Commercial and industrial			Consumer			Other			Total
Nine Months Ended September 30, 2018
Balance, beginning of period	$	3,324		$	1,063		$	1,628		$	7,209		$	91		$	406		$	13,721
Charged-off loans		—			—			—			(226	)		(25	)		—			(251	)
Recoveries		16			4			—			348			52			—			420
Provision for loan losses		(195	)		(84	)		585			1,237			(25	)		(190	)		1,328
Balance, end of period	$	3,145		$	983		$	2,213		$	8,568		$	93		$	216		$	15,218

Nine Months Ended September 30, 2017
Balance, beginning of period	$	2,655		$	1,013		$	1,574		$	5,618		$	76		$	698		$	11,634
Charged-off loans		—			—			—			(12,369	)		—			—			(12,369	)
Recoveries		4			—			—			1,862			91			—			1,957
Provision for loan losses		635			(29	)		(87	)		12,838			(88	)		(369	)		12,900
Balance, end of period	$	3,294		$	984		$	1,487		$	7,949		$	79		$	329		$	14,122

A breakdown of the ALL and the loan portfolio by loan category at September 30, 2018 and December 31, 2017 follows (dollars in thousands):

	Commercial real estate		Consumer real estate		Construction and land development		Commercial and industrial		Consumer		Other		Total
September 30, 2018
Allowance for Loan Losses:
Collectively evaluated for impairment	$	3,145	$	983	$	2,213	$	5,868	$	93	$	216	$	12,518
Individually evaluated for impairment		—		—		—		2,700		—		—		2,700
Balances, end of period	$	3,145	$	983	$	2,213	$	8,568	$	93	$	216	$	15,218
Loans:
Collectively evaluated for impairment	$	403,607	$	112,865	$	129,799	$	393,207	$	8,174	$	19,793	$	1,067,445
Individually evaluated for impairment		1,146		92		—		5,419		100		—		6,757
Balances, end of period	$	404,753	$	112,957	$	129,799	$	398,626	$	8,274	$	19,793	$	1,074,202

December 31, 2017
Allowance for Loan Losses:
Collectively evaluated for impairment	$	3,324	$	1,063	$	1,628	$	7,109	$	91	$	406	$	13,621
Individually evaluated for impairment		—		—		—		100		—		—		100
Balances, end of period	$	3,324	$	1,063	$	1,628	$	7,209	$	91	$	406	$	13,721
Loans:
Collectively evaluated for impairment	$	349,415	$	102,581	$	82,586	$	371,760	$	6,862	$	31,983	$	945,187
Individually evaluated for impairment		1,207		—		—		1,488		—		—		2,695
Balances, end of period	$	350,622	$	102,581	$	82,586	$	373,248	$	6,862	$	31,983	$	947,882

The following table presents the allocation of the ALL for each respective loan category with the corresponding percentage of the ALL in each category to total loans, net of deferred fees as of September 30, 2018 and December 31, 2017 (dollars in thousands):

	September 30, 2018					December 31, 2017
	Amount		Percent of total loans, net of deferred fees			Amount		Percent of total loans, net of deferred fees
Commercial real estate	$	3,145		0.29	%	$	3,324		0.35	%
Consumer real estate		983		0.09			1,063		0.11
Construction and land development		2,213		0.21			1,628		0.17
Commercial and industrial		8,568		0.80			7,209		0.77
Consumer		93		0.01			91		0.01
Other		216		0.02			406		0.04
Total allowance for loan losses	$	15,218		1.42	%	$	13,721		1.45	%

The following table presents the Company’s impaired loans that were evaluated for specific loss allowance as of September 30, 2018 and December 31, 2017 (dollars in thousands):


	September 30, 2018						December 31, 2017
	Recorded investment		Unpaid principal balance		Related allowance		Recorded investment		Unpaid principal balance		Related allowance
With no related allowance recorded:
Commercial real estate	$	1,146	$	1,617	$	—	$	1,207	$	1,645	$	—
Consumer real estate		92		92		—		—		—		—
Construction and land development		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—
Consumer		100		100		—		—		—		—
Other		—		—		—		—		—		—
Subtotal		1,338		1,809		—		1,207		1,645		—
With an allowance recorded:
Commercial real estate		—		—		—		—		—		—
Consumer real estate		—		—		—		—		—		—
Construction and land development		—		—		—		—		—		—
Commercial and industrial		5,419		5,419		2,700		1,488		2,770		100
Consumer		—		—		—		—		—		—
Other		—		—		—		—		—		—
Subtotal		5,419		5,419		2,700		1,488		2,770		100
Total	$	6,757	$	7,228	$	2,700	$	2,695	$	4,415	$	100

The following table presents information related to the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2018 and 2017 (dollars in thousands):

	Three Months Ended				Three Months Ended				Nine Months Ended				Nine Months Ended
	September 30, 2018				September 30, 2017				September 30, 2018				September 30, 2017
	Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized
With no related allowance recorded:
Commercial real estate	$	1,159	$	15	$	1,245	$	—	$	1,189	$	25	$	1,272	$	—
Consumer real estate		92		—		—		—		92		3		—		—
Construction and land development		—		—		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—		—		—
Consumer		100		—		—		—		100		3		—		—
Other		—		—		—		—		—		—		—		—
Subtotal		1,351		15		1,245		—		1,381		31		1,272		—
With an allowance recorded:
Commercial real estate		—		—		—		—		—		—		—		—
Consumer real estate		—		—		—		—		—		—		—		—
Construction and land development		—		—		—		—		—		—		—		—
Commercial and industrial		5,419		—		1,941		—		5,369		118		2,141		—
Consumer		—		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—		—
Subtotal		5,419		—		1,941		—		5,369		118		2,141		—
Total	$	6,770	$	15	$	3,186	$	—	$	6,750	$	149	$	3,413	$	—

Interest income recognized on a cash basis for impaired loans amounted to $15,000 and $25,000 for the three and nine months ended September 30, 2018. No interest income was recognized on a cash basis for impaired loans during the three or nine months ended September 30, 2017.

The following table presents the aging of the recorded investment in past-due loans as of September 30, 2018 and December 31, 2017 by class of loans (dollars in thousands):

	30 - 59		60 - 89		Greater Than
	Days		Days		89 Days		Total		Loans Not
	Past Due		Past Due		Past Due		Past Due		Past Due		Total
September 30, 2018
Commercial real estate	$	2,474	$	—	$	—	$	2,474	$	402,279	$	404,753
Consumer real estate		220		—		215		435		112,522		112,957
Construction and land development		133		—		—		133		129,666		129,799
Commercial and industrial		—		563		4,856		5,419		393,207		398,626
Consumer		—		—		—		—		8,274		8,274
Other		307		—		—		307		19,486		19,793
Total	$	3,134	$	563	$	5,071	$	8,768	$	1,065,434	$	1,074,202

December 31, 2017
Commercial real estate	$	—	$	—	$	—	$	—	$	350,622	$	350,622
Consumer real estate		—		—		218		218		102,363		102,581
Construction and land development		—		—		—		—		82,586		82,586
Commercial and industrial		1,967		209		—		2,176		371,072		373,248
Consumer		—		—		13		13		6,849		6,862
Other		—		—		—		—		31,983		31,983
Total	$	1,967	$	209	$	231	$	2,407	$	945,475	$	947,882

The following table presents the recorded investment in non-accrual loans, past due loans over 89 days outstanding and accruing and troubled debt restructurings (“TDR”) by class of loans as of September 30, 2018 and December 31, 2017 (dollars in thousands):

	Non-Accrual		Past Due Over 89 Days and Accruing		Troubled Debt Restructurings
September 30, 2018
Commercial real estate	$	—	$	—	$	1,146
Consumer real estate		92		215		—
Construction and land development		—		—		—
Commercial and industrial		5,419		—		—
Consumer		100		—		—
Other		—		—		—
Total	$	5,611	$	215	$	1,146

December 31, 2017
Commercial real estate	$	1,207	$	—	$	1,207
Consumer real estate		—		218		—
Construction and land development		—		—		—
Commercial and industrial		1,488		—		—
Consumer		—		13		—
Other		—		—		—
Total	$	2,695	$	231	$	1,207

As of September 30, 2018 and December 31, 2017, all loans classified as nonperforming were deemed to be impaired.

As of both September 30, 2018 and December 31, 2017, the Company had a recorded investment in TDR of $1.1 million. The Company had no specific allowance for those loans at September 30, 2018 or December 31, 2017 and there were no commitments to lend additional amounts. Loans accounted for as TDR include modifications from original terms such as those due to bankruptcy proceedings, certain modifications of amortization periods or extended suspension of principal payments due to customer financial difficulties. In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Bank’s loan policy. Loans accounted for as TDR are individually evaluated for impairment.

There were no TDR identified during the three or nine months ended September 30, 2018 or 2017. There were no TDR for which there was a payment default within twelve months following the modification during the three or nine months ended September 30, 2018 or 2017.

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.