NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Major classifications of loans at June 30, 2020 and December 31, 2019 are summarized as follows:


	June 30,		December 31,
(Dollars in thousands)	2020		2019
Construction and development	$	42,847	$	31,739
Commercial real estate		429,019		424,950
Commercial and industrial		141,540		53,105
Residential real estate		755,521		651,645
Consumer and other		967		1,768
Total loans receivable		1,369,894		1,163,207
Unearned income		(4,905)		(2,045)
Allowance for loan losses		(7,894)		(6,839)
Loans, net	$	1,357,095	$	1,154,323

Included in the commercial and industrial loans are PPP loans totaling $96.1 million as of June 30, 2020.

The Company is not committed to lend additional funds to borrowers with non-accrual or restructured loans.

In the normal course of business, the Company may sell and purchase loan participations to and from other financial institutions and related parties. Loan participations are typically sold to comply with the legal lending limits per borrower as imposed by regulatory authorities. The participations are sold without recourse and the Company imposes no transfer or ownership restrictions on the purchaser.

A summary of changes in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2020 and 2019 is as follows:


	Three Months Ended June 30, 2020
	Construction
	and		Commercial		Commercial		Residential		Consumer
(Dollars in thousands)	Development		Real Estate		and Industrial		Real Estate		and Other		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	152	$	2,647	$	523	$	3,473	$	64	$	—	$	6,859
Charge-offs		—		—		—		—		(48)		—		(48)
Recoveries		—		3		—		—		19		—		22
Provision		111		1,118		(119)		(50)		1		—		1,061
Ending balance	$	263	$	3,768	$	404	$	3,423	$	36	$	—	$	7,894


	Three Months Ended June 30, 2019
	Construction
	and		Commercial		Commercial		Residential		Consumer
(Dollars in thousands)	Development		Real Estate		and Industrial		Real Estate		and Other		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	163	$	2,433	$	334	$	3,100	$	266	$	230	$	6,526
Charge-offs		—		—		(14)		—		(92)				(106)
Recoveries		—		6		—		—		57				63
Provision		(34)		(55)		267		65		(34)		(209)		—
Ending balance	$	129	$	2,384	$	587	$	3,165	$	197	$	21	$	6,483


	Six Months Ended June 30, 2020
	Construction
	and		Commercial		Commercial		Residential		Consumer
(Dollars in thousands)	Development		Real Estate		and Industrial		Real Estate		and Other		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	131	$	2,320	$	448	$	3,457	$	91	$	392	$	6,839
Charge-offs		—		—		—		—		(71)		—		(71)
Recoveries		—		5		25		—		35		—		65
Provision		132		1,443		(69)		(34)		(19)		(392)		1,061
Ending balance	$	263	$	3,768	$	404	$	3,423	$	36	$	—	$	7,894


	Six Months Ended June 30, 2019
	Construction
	and		Commercial		Commercial		Residential		Consumer
(Dollars in thousands)	Development		Real Estate		and Industrial		Real Estate		and Other		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	235	$	2,601	$	380	$	3,042	$	387	$	—	$	6,645
Charge-offs		—		—		(14)		—		(331)		—		(345)
Recoveries		—		11		—		—		172		—		183
Provision		(106)		(228)		221		123		(31)		21		—
Ending balance	$	129	$	2,384	$	587	$	3,165	$	197	$	21	$	6,483

The following tables present, by portfolio segment, the balance in the allowance for loan losses disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans as of June 30, 2020 and December 31, 2019.


	June 30, 2020
	Construction
	and		Commercial		Commercial		Residential		Consumer
(Dollars in thousands)	Development		Real Estate		and Industrial		Real Estate		and Other		Unallocated		Total
Allowance for loan losses:
Individually evaluated for impairment	$	—	$	540	$	29	$	—	$	—	$	—	$	569
Collectively evaluated for impairment		263		3,228		375		3,423		5		—		7,294
Acquired with deteriorated credit quality		—		—		—		—		31		—		31
Total ending allowance balance	$	263	$	3,768	$	404	$	3,423	$	36	$	—	$	7,894
Loans:
Individually evaluated for impairment	$	—	$	6,370	$	249	$	7,348	$	—	$	—	$	13,967
Collectively evaluated for impairment		42,820		420,927		138,135		748,173		567		—		1,350,622
Acquired with deteriorated credit quality		—		—		—		—		400		—		400
Total ending loans balance	$	42,820	$	427,297	$	138,384	$	755,521	$	967	$	—	$	1,364,989


	December 31, 2019
	Construction
	and		Commercial		Commercial		Residential		Consumer
(Dollars in thousands)	Development		Real Estate		and Industrial		Real Estate		and Other		Unallocated		Total
Allowance for loan losses:
Individually evaluated for impairment	$	—	$	716	$	30	$	—	$	—	$	—	$	746
Collectively evaluated for impairment		131		1,604		418		3,457		9		392		6,011
Acquired with deteriorated credit quality		—		—		—		—		82		—		82
Total ending allowance balance	$	131	$	2,320	$	448	$	3,457	$	91	$	392	$	6,839
Loans:
Individually evaluated for impairment	$	1,360	$	7,527	$	957	$	7,936	$	—	$	—	$	17,780
Collectively evaluated for impairment		30,076		415,773		52,056		643,709		958		—		1,142,572
Acquired with deteriorated credit quality		—		—		—		—		810		—		810
Total ending loans balance	$	31,436	$	423,300	$	53,013	$	651,645	$	1,768	$	—	$	1,161,162

Impaired loans as of June 30, 2020 and December 31, 2019, by portfolio segment, are as follows. The recorded investment consists of the unpaid total principal balance plus accrued interest receivable.


	Unpaid		Recorded		Recorded
	Total		Investment		Investment		Total
(Dollars in thousands)	Principal		With No		With		Recorded		Related
June 30, 2020	Balance		Allowance		Allowance		Investment		Allowance
Construction and development	$	—	$	—	$	—	$	—	$	—
Commercial real estate		6,370		4,435		2,001		6,436		540
Commercial and industrial		249		216		35		251		29
Residential real estate		7,348		7,348		—		7,348		—
Total	$	13,967	$	11,999	$	2,036	$	14,035	$	569


	Unpaid		Recorded		Recorded
	Total		Investment		Investment		Total
(Dollars in thousands)	Principal		With No		With		Recorded		Related
December 31, 2019	Balance		Allowance		Allowance		Investment		Allowance
Construction and development	$	1,360	$	1,360	$	—	$	1,360	$	—
Commercial real estate		7,527		4,716		2,882		7,598		716
Commercial and industrial		957		925		39		964		30
Residential real estate		7,936		7,936		—		7,936		—
Total	$	17,780	$	14,937	$	2,921	$	17,858	$	746

The average recorded investment in impaired loans and interest income recognized on the cash and accrual basis for the three and six months ended June 30, 2020 and 2019, by portfolio segment, are summarized in the tables below.


	Three Months Ended June 30,
	2020				2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
Construction and development	$	—	$	—	$	1,360	$	—
Commercial real estate		6,413		66		8,017		88
Commercial and industrial		277		5		970		8
Residential real estate		7,546		13		5,725		3
Total	$	14,236	$	84	$	16,072	$	99


	Six Months Ended June 30,
	2020				2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
Construction and development	$	194	$	—	$	1,360	$	6
Commercial real estate		6,575		195		8,067		169
Commercial and industrial		566		15		976		14
Residential real estate		7,663		96		4,556		41
Total	$	14,998	$	306	$	14,959	$	230

A primary credit quality indicator for financial institutions is delinquent balances. Delinquencies are updated on a daily basis and are continuously monitored. Loans are placed on nonaccrual status as needed based on repayment status and consideration of accounting and regulatory guidelines. Nonaccrual balances are updated and reported on a daily basis. Following are the delinquent amounts, by portfolio segment, as of June 30, 2020 and December 31, 2019:


					Accruing		Total				Total
(Dollars in thousands)					Greater than		Accruing				Financing
June 30, 2020	Current		30-89 Days		90 Days		Past Due		Nonaccrual		Receivables
Construction and development	$	42,820	$	—	$	—	$	—	$	—	$	42,820
Commercial real estate		424,348		—		—		—		2,949		427,297
Commercial and industrial		138,346		—		—		—		38		138,384
Residential real estate		743,015		5,158		—		5,158		7,348		755,521
Consumer and other		967		—		—		—		—		967
Total	$	1,349,496	$	5,158	$	—	$	5,158	$	10,335	$	1,364,989


					Accruing		Total				Total
(Dollars in thousands)					Greater than		Accruing				Financing
December 31, 2019	Current		30-89 Days		90 Days		Past Due		Nonaccrual		Receivables
Construction and development	$	30,076	$	—	$	—	$	—	$	1,360	$	31,436
Commercial real estate		419,406		973		—		973		2,921		423,300
Commercial and industrial		52,936		58		—		58		19		53,013
Residential real estate		625,222		18,487		—		18,487		7,936		651,645
Consumer and other		1,768		—		—		—		—		1,768
Total	$	1,129,408	$	19,518	$	—	$	19,518	$	12,236	$	1,161,162

⁽¹⁾

For the June 30, 2020 table above, nonperforming and past due loans exclude COVID-19 loan modifications.

The Company utilizes a ten grade loan rating system for its loan portfolio as follows:

Loans rated Pass – Loans in this category have low to average risk.

Loans rated Special Mention – Loans do not presently expose the Company to a sufficient degree of risk to warrant adverse classification, but do possess deficiencies deserving close attention.

Loans rated Substandard – Loans are inadequately protected by the current credit-worthiness and paying capability of the obligor or of the collateral pledged, if any.

Loans rated Doubtful – Loans which have all the weaknesses inherent in loans classified Substandard, with the added characteristic that the weaknesses make collections or liquidation in full, or on the basis of currently known facts, conditions and values, highly questionable or improbable.

Loans rated Loss – Loans classified Loss are considered uncollectible and such little value that their continuance as bankable assets is not warranted.

Loan grades are monitored regularly and updated as necessary based upon review of repayment status and consideration of periodic updates regarding the borrower’s financial condition and capacity to meet contractual requirements.

The following presents the Company’s loans, included purchased loans, by risk rating based on the most recent information available:


	Construction
(Dollars in thousands)	and		Commercial		Commercial		Residential		Consumer
June 30, 2020	Development		Real Estate		and Industrial		Real Estate		and Other		Total
Rating:
Pass	$	42,820	$	420,756	$	137,481	$	748,173	$	967	$	1,350,197
Special Mention		—		800		—		—		—		800
Substandard		—		5,741		903		7,348		—		13,992
Doubtful		—		—		—		—		—		—
Loss		—		—		—		—		—		—
Total	$	42,820	$	427,297	$	138,384	$	755,521	$	967	$	1,364,989


	Construction
(Dollars in thousands)	and		Commercial		Commercial		Residential		Consumer
December 31, 2019	Development		Real Estate		and Industrial		Real Estate		and Other		Total
Rating:
Pass	$	30,076	$	416,183	$	52,033	$	641,544	$	1,768	$	1,141,604
Special Mention		—		800		—		—		—		800
Substandard		1,360		6,317		980		10,101		—		18,758
Doubtful		—		—		—		—		—		—
Loss		—		—		—		—		—		—
Total	$	31,436	$	423,300	$	53,013	$	651,645	$	1,768	$	1,161,162

Troubled Debt Restructures:

In this current real estate environment it has become more common to restructure or modify the terms of certain loans under certain conditions (i.e. troubled debt restructures or “TDRs”), especially due to the impact of the COVID-19 pandemic. In those circumstances it may be beneficial to restructure the terms of a loan and work with the borrower for the benefit of both parties, versus forcing the property into foreclosure and having to dispose of it in an unfavorable real estate market. When we have modified the terms of a loan, we usually either reduce or defer payments for a period of time. We have not forgiven any material principal amounts on any loan modifications to date. Nonperforming TDRs are generally placed on non-accrual under the same criteria as all other loans.

TDRs as of June 30, 2020 and December 31, 2019 quantified by loan type classified separately as accrual and nonaccrual are presented in the table below.


(Dollars in thousands)
June 30, 2020	Accruing		Nonaccrual		Total
Commercial real estate	$	2,896	$	479	$	3,375
Commercial and industrial		—		25		25
Total	$	2,896	$	504	$	3,400


(Dollars in thousands)
December 31, 2019	Accruing		Nonaccrual		Total
Commercial real estate	$	2,437	$	482	$	2,919
Commercial and industrial		22		5		27
Total	$	2,459	$	487	$	2,946

Our policy is to return nonaccrual TDR loans to accrual status when all the principal and interest amounts contractually due, pursuant to its modified terms, are brought current and future payments are reasonably assured. Our policy also considers payment history of the borrower, but is not dependent upon a specific number of payments. The Company allocated a specific reserve of $405,000 and $344,000, as of June 30, 2020 and December 31, 2019, respectively, and recognized no partial charge offs on the TDR loans described above during the three and six months ended June 30, 2020 and 2019. TDR commercial and industrial loans totaling $21,000 defaulted during the three and six months ended June 30, 2020. TDR commercial real estate loans totaling $482,000 and $777,000 defaulted during the three and six months ended June 30, 2019, respectively. These defaults did not have a material impact on the Company’s allowance for loan loss.

During the six months ended June 30, 2020, we modified one commercial real estate loan. The total recorded investment in this modified loan was $511,000 as of June 30, 2020. During the year ended December 31, 2019, we modified one commercial and industrial loan. The total recorded investment in the modified loan was $25,000 as of December 31, 2019. The modification of these loans did not result in a permanent reduction of the recorded investment in the loan, but did result in a payment deferment period on the loans. At June 30, 2020, the Company did not have any commitments to lend additional funds to debtors whose terms have been modified in troubled restructurings.

Loans are modified to minimize loan losses when we believe the modification will improve the borrower’s financial condition and ability to repay the loan. We typically do not forgive principal. We generally either defer, or decrease monthly payments for a temporary period of time. A summary of the types of concessions for loans classified as troubled debt restructurings are presented in the table below:


(Dollars in thousands)	June 30,		December 31,
Type of Concession	2020		2019
Deferral of payments	$	508	$	22
Extension of maturity date		2,892		2,924
Total TDR loans	$	3,400	$	2,946

The following table presents loans by portfolio segment modified as TDRs and the corresponding recorded investment, which includes accrued interest and fees, as of June 30, 2020 and December 31, 2019:


	June 30, 2020			December 31, 2019
(Dollars in thousands)	Number of	Recorded		Number of	Recorded
Type	Loans	Investment		Loans	Investment
Commercial real estate	5	$	3,429	4	$	2,923
Commercial and industrial	2		25	2		31
Total	7	$	3,454	6	$	2,954

Modifications in Response to COVID-19

Certain borrowers are currently unable to meet their contractual payment obligations because of the adverse effects of COVID-19. To help mitigate these effects, loan customers may apply for a deferral of payments, or portions thereof, for up to three months. In the absence of other intervening factors, such short-term modifications made on a good faith basis are not categorized as troubled debt restructurings, nor are loans granted payment deferrals related to COVID-19 reported as past due or placed on nonaccrual status (provided the loans were not past due or on nonaccrual status prior to the deferral). See Note 1 - Summary of Significant Accounting Policies for more information.

As of June 30, 2020, we had non-SBA commercial loans and residential mortgages with outstanding balances of $157.5 million and $145.3 million, respectively, that had been approved for a three month payment deferral. The Small Business Administration (“SBA”) has guaranteed the principal and interest payments of all our SBA loan customers for six months through the end of September 2020.