Note 4 - Loans

6 Months Ended

Jun. 30, 2020

Notes to Financial Statements

Loans, Notes, Trade and Other Receivables Disclosure [Text Block]

NOTE 4. LOANS

Outstanding loan balances consisted of the following at June 30, 2020, and December 31, 2019.

	June 30,			December 31,
(Amounts in thousands)	2020			2019
Loan Portfolio:
Commercial	$	126,024		$	141,197
Paycheck protection program		162,189			—
Commercial real estate:
Real estate - construction and land development		41,371			26,830
Real estate - commercial non-owner occupied		521,004			493,920
Real estate - commercial owner occupied		215,799			218,833
Residential real estate:
Real estate - residential - Individual Tax Identification Number (“ITIN”)		31,083			33,039
Real estate - residential - 1-4 family mortgage		60,756			63,661
Real estate - residential - equity lines		20,938			22,099
Consumer and other		27,176			33,324
Gross loans		1,206,340			1,032,903
Deferred (fees) and costs		(1,603	)		2,162
Loans, net of deferred fees and costs		1,204,737			1,035,065
Allowance for loan and lease losses		(16,089	)		(12,231	)
Net loans	$	1,188,648		$	1,022,834

Certain loans are pledged as collateral for lines of credit with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank. Pledged loans totaled $536.8 million and $542.1 million at June 30, 2020 and December 31, 2019, respectively.

In April of 2020, we received approval to participate in the Federal Reserve Bank Paycheck Protection Program Liquidity Facility (‘PPPLF”). The credit facility provides term funding for loans made under the SBA’s Paycheck Protection Program (“PPP”). If we take advances under the PPPLF, they will be collateralized with PPP loans.

Gross loan balances in the table above include discounts on purchased loans and fair value discounts on loans acquired in conjunction with our acquisition of Merchants during the first quarter of 2019.

Discounts on purchased loans - Gross loan balances include net purchase discounts of $1.2 million and $1.5 million as of June 30, 2020, and December 31, 2019, respectively. When we purchase loans, they are typically purchased at a discount to enhance yield and compensate for credit risk. We have no purchased credit impaired loans as of June 30, 2020, and December 31, 2019.

Fair value discount - Gross loan balances include a fair value discount of $1.3 million and $1.7 million at June 30, 2020 and December 31, 2019, respectively for loans acquired in conjunction with our acquisition of Merchants during the first quarter of 2019. We recorded $216 thousand and $190 thousand in accretion of the discount for these loans during the three months ended June 30, 2020 and 2019, respectively. We recorded $379 thousand and $238 thousand in accretion of the discount for these loans during the six months ended June 30, 2020 and 2019, respectively.

Past Due Loans

Past due loans (gross), segregated by loan portfolio were as follows, as of June 30, 2020, and December 31, 2019.

(Amounts in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 or Greater Days Past Due		Total Past Due		Current		Total		Recorded Investment > 90 Days and Accruing
Past Due Loans at June 30, 2020
Commercial	$	23	$	—	$	—	$	23	$	126,001	$	126,024	$	—
Paycheck protection program		—		—		—		—		162,189		162,189		—
Commercial real estate:
Real estate - construction and land development		—		—		—		—		41,371		41,371		—
Real estate - commercial non-owner occupied		—		—		1,062		1,062		519,942		521,004		—
Real estate - commercial owner occupied		—		—		2,993		2,993		212,806		215,799		—
Residential real estate:
Real estate - residential - ITIN		196		60		106		362		30,721		31,083		—
Real estate - residential - 1-4 family mortgage		443		—		31		474		60,282		60,756		—
Real estate - residential - equity lines		148		—		—		148		20,790		20,938		—
Consumer and other		120		47		—		167		27,009		27,176		—
Total	$	930	$	107	$	4,192	$	5,229	$	1,201,111	$	1,206,340	$	—

(Amounts in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 or Greater Days Past Due		Total Past Due		Current		Total		Recorded Investment > 90 Days and Accruing
Past Due Loans at December 31, 2019
Commercial	$	71	$	—	$	—	$	71	$	141,126	$	141,197	$	—
Commercial real estate:
Real estate - construction and land development		—		—		—		—		26,830		26,830		—
Real estate - commercial non-owner occupied		—		—		—		—		493,920		493,920		—
Real estate - commercial owner occupied		655		—		3,103		3,758		215,075		218,833		—
Residential real estate:
Real estate - residential - ITIN		371		323		43		737		32,302		33,039		—
Real estate - residential - 1-4 family mortgage		—		—		—		—		63,661		63,661		—
Real estate - residential - equity lines		100		—		—		100		21,999		22,099		—
Consumer and other		200		50		—		250		33,074		33,324		—
Total	$	1,397	$	373	$	3,146	$	4,916	$	1,027,987	$	1,032,903	$	—

In accordance with the CARES act and regulatory guidance, we have granted 244 short-term COVID-19 related loan payment deferrals on loans totaling $123.3 million. The loans are not considered past due while they are in the deferral period. Without these deferrals past due loan totals would have been higher at June 30, 2020. We cannot predict the impact to past due loan totals once the deferral periods end.

Nonaccrual Loans

Nonaccrual loans, segregated by loan portfolio, were as follows as of June 30, 2020 and December 31, 2019.

	June 30,		December 31,
(Amounts in thousands)	2020		2019
Nonaccrual Loans:
Commercial	$	7	$	61
Commercial real estate:
Real estate - commercial non-owner occupied		1,062		—
Real estate - commercial owner occupied		3,647		3,103
Residential real estate:
Real estate - residential - ITIN		1,738		2,221
Real estate - residential - 1-4 family mortgage		180		191
Consumer and other		37		40
Total	$	6,671	$	5,616

Had nonaccrual loans performed in accordance with their contractual terms, we would have recognized additional interest income, net of tax, of approximately $84 thousand and $229 thousand for the three months ended June 30, 2020 and 2019, respectively. We would have recognized additional interest income, net of tax, of approximately $140 thousand and $376 thousand for the six months ended June 30, 2020 and 2019, respectively.

Impaired Loans

A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. The following tables summarize impaired loans by loan portfolio as of June 30, 2020 and December 31, 2019.

	As of June 30, 2020
			Unpaid
	Recorded		Principal		Related
(Amounts in thousands)	Investment		Balance		Allowance
Impaired Loans:
With no related allowance recorded:
Commercial	$	52	$	215	$	—
Commercial real estate:
Real estate - commercial non-owner occupied		1,062		1,097		—
Real estate - commercial owner occupied		3,647		3,757		—
Residential real estate:
Real estate - residential - ITIN		5,203		6,896		—
Real estate - residential - 1-4 family mortgage		180		308		—
Total with no related allowance recorded	$	10,144	$	12,273	$	—
With an allowance recorded:
Commercial	$	547	$	547	$	137
Residential real estate:
Real estate - residential - ITIN		177		177		13
Real estate - residential - equity lines		221		221		110
Consumer and other		37		38		10
Total with an allowance recorded	$	982	$	983	$	270
By loan portfolio:
Commercial	$	599	$	762	$	137
Commercial real estate		4,709		4,854		—
Residential real estate		5,781		7,602		123
Consumer and other		37		38		10
Total impaired loans	$	11,126	$	13,256	$	270

	As of December 31, 2019
			Unpaid
	Recorded		Principal		Related
(Amounts in thousands)	Investment		Balance		Allowance
Impaired Loans:
With no related allowance recorded:
Commercial	$	94	$	251	$	—
Commercial real estate:
Real estate - commercial owner occupied		3,103		3,103		—
Residential real estate:
Real estate - residential - ITIN		5,723		7,386		—
Real estate - residential - 1-4 family mortgage		191		313		—
Total with no related allowance recorded	$	9,111	$	11,053	$	—
With an allowance recorded:
Commercial	$	562	$	563	$	159
Residential real estate:
Real estate - residential - ITIN		455		455		38
Real estate - residential - equity lines		231		231		116
Consumer and other		40		40		11
Total with an allowance recorded	$	1,288	$	1,289	$	324
By loan portfolio:
Commercial	$	656	$	814	$	159
Commercial real estate		3,103		3,103		—
Residential real estate		6,600		8,385		154
Consumer and other		40		40		11
Total impaired loans	$	10,399	$	12,342	$	324

The following tables summarize average recorded investment and interest income recognized on impaired loans by loan portfolio for the three and six months ended June 30, 2020 and 2019.

	Three Months Ended				Three Months Ended
	June 30, 2020				June 30, 2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Amounts in thousands)	Investment		Recognized		Investment		Recognized
Average Recorded Investment and Interest Income:
Commercial	$	613	$	9	$	1,304	$	16
Commercial real estate:
Real estate - commercial non-owner occupied		708		—		11,622		11
Real estate - commercial owner occupied		3,284		—		—		—
Residential real estate:
Real estate - residential - ITIN		5,440		34		6,719		41
Real estate - residential - 1-4 family mortgage		181		—		192		—
Real estate - residential - equity lines		222		4		277		5
Consumer and other		38		—		22		—
Total	$	10,486	$	47	$	20,136	$	73

	Six Months Ended				Six Months Ended
	June 30, 2020				June 30, 2019
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Amounts in thousands)	Investment		Recognized		Investment		Recognized
Average Recorded Investment and Interest Income:
Commercial	$	626	$	17	$	1,662	$	32
Commercial real estate:
Real estate - commercial non-owner occupied		354		—		10,017		23
Real estate - commercial owner occupied		3,193		—		—		—
Residential real estate:
Real estate - residential - ITIN		5,698		72		6,797		83
Real estate - residential - 1-4 family mortgage		184		—		188		—
Real estate - residential - equity lines		225		7		340		10
Consumer and other		39		—		22		—
Total	$	10,319	$	96	$	19,026	$	148

The impaired loans on which these interest income amounts were recognized are primarily accruing troubled debt restructured loans. Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) significantly, or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement.

Troubled Debt Restructurings

At June 30, 2020 and December 31, 2019, impaired loans of $4.5 million and $4.8 million, respectively, were classified as performing troubled debt restructured loans.

For a troubled debt restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to 100% of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of June 30, 2020 and December 31, 2019, we had no obligations to lend additional funds on any troubled debt restructured loans. There was one new troubled debt restructuring on one $654 thousand commercial real estate loan during the six months ended June 30, 2020. The borrower was impacted by COVID-19 but the loan did not qualify to be exempt from TDR status under the new TDR guidance issued by the financial institution regulators or under the CARES act.

As of June 30, 2020, we had $6.6 million in troubled debt restructurings compared to $6.5 million as of December 31, 2019. As of June 30, 2020, we had 97 loans that qualified as troubled debt restructurings, of which 95 were performing according to their restructured terms. Troubled debt restructurings represented 0.55% of gross loans (0.64% of gross loans excluding PPP loans) as of June 30, 2020, compared to 0.63% at December 31, 2019.

The types of modifications offered can generally be described in the following categories:

Maturity – A modification in which the maturity date, timing of payments or frequency of payments are changed.

Payment – A modification in which a portion of the owning principal is decreased.

The following tables present the period ended balances of newly restructured loans and the types of modifications that occurred during the three and six months ended June 30, 2020 and 2019.

	Modification Types For the Three Months Ended June 30, 2020						Modification Types For the Three Months Ended June 30, 2019
(Amounts in thousands)	Maturity		Payment Deferral		Total		Maturity		Payment Deferral		Total
Troubled Debt Restructuring:
Commercial	$	—	$	—	$	—	$	86	$	—	$	86
Commercial real estate:
Real estate - commercial owner occupied		—		654		654		—		—		—
Residential real estate:
Real estate - residential - equity lines		—		—		—		—		39		39
Total	$	—	$	654	$	654	$	86	$	39	$	125

	Modification Types For the Six Months Ended June 30, 2020						Modification Types For the Six Months Ended June 30, 2019
(Amounts in thousands)	Maturity		Payment Deferral		Total		Maturity		Payment Deferral		Total
Troubled Debt Restructuring:
Commercial	$	—	$	—	$	—	$	86	$	—	$	86
Commercial real estate:
Real estate - commercial owner occupied		—		654		654		—		—		—
Residential real estate:
Real estate - residential - equity lines		—		—		—		—		39		39
Total	$	—	$	654	$	654	$	86	$	39	$	125

For the three and six month periods ended June 30, 2020 and 2019, the tables below provide information regarding the number of loans where the contractual terms have been restructured in a manner, which grants a concession to a borrower experiencing financial difficulties.

	For the Three Months Ended June 30, 2020						For the Three Months Ended June 30, 2019
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
			Outstanding		Outstanding				Outstanding		Outstanding
	Number of		Recorded		Recorded		Number of		Recorded		Recorded
(Collars in thousands)	Contracts		Investment		Investment		Contracts		Investment		Investment
Troubled Debt Restructurings:
Commercial		—	$	—	$	—		1	$	99	$	99
Commercial real estate:
Real estate - commercial owner occupied		1		654		654		—		—		—
Residential real estate:
Real estate - residential - equity lines		—		—		—		1		39		39
Total		1	$	654	$	654		2	$	138	$	138

	For the Six Months Ended June 30, 2020						For the Six Months Ended June 30, 2019
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
			Outstanding		Outstanding				Outstanding		Outstanding
	Number of		Recorded		Recorded		Number of		Recorded		Recorded
(Dollars in thousands)	Contracts		Investment		Investment		Contracts		Investment		Investment
Troubled Debt Restructurings:
Commercial		—	$	—	$	—		1	$	99	$	99
Commercial real estate:
Real estate - commercial owner occupied		1		654		654		—		—		—
Residential real estate:
Real estate - residential - equity lines		—		—		—		1		39		39
Total		1	$	654	$	654		2	$	138	$	138

There were no loans modified as a troubled debt restructuring within the previous twelve months for which there was a payment default (after restructuring) during the three and six months ended June 30, 2020 and 2019.

Performing and Nonperforming Loans

We define a performing loan as a loan where any installment of principal or interest is not 90 days or more past due, and management believes the ultimate collection of original contractual principal and interest is likely. We define a nonperforming loan as an impaired loan, which may be on nonaccrual, or is 90 days past due and still accruing, or has been restructured and does not comply with its modified terms, and our ultimate collection of original contractual principal and interest is uncertain. Performing and nonperforming loans, segregated by loan portfolio, were as follows at June 30, 2020 and December 31, 2019.

	June 30, 2020
(Amounts in thousands)	Performing		Nonperforming		Total
Performing and Nonperforming Loans:
Commercial	$	126,017	$	7	$	126,024
Paycheck protection program		162,189		—		162,189
Commercial real estate:
Real estate - construction and land development		41,371		—		41,371
Real estate - commercial non-owner occupied		519,942		1,062		521,004
Real estate - commercial owner occupied		212,152		3,647		215,799
Residential real estate:
Real estate - residential - ITIN		29,345		1,738		31,083
Real estate - residential - 1-4 family mortgage		60,576		180		60,756
Real estate - residential - equity lines		20,938		—		20,938
Consumer and other		27,139		37		27,176
Total	$	1,199,669	$	6,671	$	1,206,340

	December 31, 2019
(Amounts in thousands)	Performing		Nonperforming		Total
Performing and Nonperforming Loans:
Commercial	$	141,136	$	61	$	141,197
Commercial real estate:
Real estate - construction and land development		26,830		—		26,830
Real estate - commercial non-owner occupied		493,920		—		493,920
Real estate - commercial owner occupied		215,730		3,103		218,833
Residential real estate:
Real estate - residential - ITIN		30,818		2,221		33,039
Real estate - residential - 1-4 family mortgage		63,470		191		63,661
Real estate - residential - equity lines		22,099		—		22,099
Consumer and other		33,284		40		33,324
Total	$	1,027,287	$	5,616	$	1,032,903

Short-Term Loan Modifications 

We have responded to the needs of our borrowers in accordance with the CARES act and regulatory guidance to grant short-term COVID-19 related loan payment deferrals. These modified loans are not troubled debt restructurings and are not considered to be past due or non-performing. We have granted deferrals ranging from one to six months determined on a case-by-case basis considering the nature of the business and the impact of COVID-19. As of June 30, 2020, we have approved 244 short-term loan payment deferrals on loans totaling $123.3 million, only one of which meets the definition of a troubled debt restructuring.

Credit Quality Ratings

Management assigns a credit quality rating (risk grade) to each loan. The foundation or primary factor in determining the appropriate credit quality rating is the degree of a debtor’s willingness and ability to perform as agreed. In conjunction with evaluating the performing versus nonperforming nature of our loan portfolio, management evaluates the following credit risk and other relevant factors in determining the appropriate credit quality indicator (rating) for each loan portfolio:

Pass Grade: A Pass loan is a strong credit with no existing or known weaknesses that may require management’s close attention. Some pass loans require short-term enhanced monitoring to determine when the credit relationship would merit either an upgrade or a downgrade. Loans classified as Pass Grade specifically demonstrate:

● Strong Cash Flows – borrower’s cash flows must meet or exceed our minimum debt service coverage ratio.

● Collateral Margin – generally, the borrower must have pledged an acceptable collateral class with an adequate collateral margin.

● Qualitative Factors – in addition to meeting our minimum cash flow and collateral requirements, a number of other qualitative factors are also factored into assigning a Pass Grade including the borrower’s level of leverage (debt to equity), prospects, history and experience in their industry, credit history, and any other relevant factors including a borrower’s character.

Those borrowers who qualify for unsecured loans must fully demonstrate above average cash flows and strong secondary sources of repayment to mitigate the lack of unpledged collateral.

Watch Grade: The credit is acceptable but the borrower has experienced a temporary setback or adverse information has been received, and may exhibit one or more of the characteristics shown in the list below. This risk grade could apply to credits on a temporary basis pending a full review. Credits with this risk grade will require more handling time and increased management. The list below contains characteristics of this risk grade, but individually do not automatically cause the loan to be assigned a Watch Grade.

● The primary source of repayment may be weakening causing greater reliance on the secondary source of repayment or

● The primary source of repayment is adequate, but the secondary source of repayment is insufficient

● In-depth financial analysis would compare to the lower quartile in two or more of the major components of the Risk Management Association Annual Statement Studies

● Volatile or deteriorating collateral

● Management decisions may be called into question

● Delinquencies in bank credits or other financial/trade creditors

● Frequent overdrafts

● Significant change in management/ownership

Special Mention Grade: Credits in this grade are potentially weak and deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects of the credit. Special Mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. The list below exhibits the characteristics of this grade, but individually do not automatically cause the borrower to be assigned a grade of Special Mention:

● Inadequate or incomplete loan documentation or perfection of collateral, or any other deviation from prudent lending practices

● Credit is structured in a manner in which the timing of the repayment source does not match the payment schedule or maturity, materially jeopardizing repayment

● Current economic or market conditions exist which may affect the borrower's ability to perform or affect the Bank's collateral position

● Adverse trends in the borrower's operations or continued deterioration in the borrower’s financial condition that has not yet reached a point where the retirement of debt is jeopardized. A credit in this grade should have favorable prospects of the deteriorating financial trends reversing within a reasonable timeframe.

● The borrower is less than cooperative or unable to produce current and adequate financial information

Substandard Grade: A Substandard credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard credits have a well-defined weakness or weaknesses that jeopardize the liquidation or timely collection of the debt. Substandard credits are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. However, a potential loss does not have to be recognizable in an individual credit for it to be considered a substandard credit. As such, substandard credits may or may not be graded as impaired.

The following represents, but is not limited to, the potential characteristics of a Substandard Grade and do not necessarily generate automatic reclassification into this loan grade:

● Sustained or substantial deteriorating financial trends,

● Unresolved management problems,

● Collateral is insufficient to repay debt; collateral is not sufficiently supported by independent sources, such as asset-based financial audits, appraisals, or equipment evaluations,

● Improper perfection of lien position, which is not readily correctable,

● Unanticipated and severe decline in market values,

● High reliance on secondary source of repayment,

● Legal proceedings, such as bankruptcy or a divorce, which has substantially decreased the borrower’s capacity to repay the debt,

● Fraud committed by the borrower,

● IRS liens that take precedence,

● Forfeiture statutes for assets involved in criminal activities,

● Protracted repayment terms outside of policy that are for longer than the same type of credit in our portfolio,

● Any other relevant quantitative or qualitative factor that negatively affects the current net worth and paying capacity of the borrower or of the collateral pledged, if any.

Doubtful Grade: A Doubtful loan has all the weaknesses inherent in one classified 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. The possibility of loss is extremely high, but because of certain pending factors that may work to the advantage and strengthening of the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include, but are not limited to:

● Proposed merger(s),

● Acquisition or liquidation procedures,

● Capital injection,

● Perfecting liens on additional collateral,

● Refinancing plans.

Generally, a Doubtful Grade does not remain outstanding for a period greater than six months. Within six months, the pending events should have been resolved. Based on resolution of the pending events, the credit grade should have improved or the principal balance charged against the ALLL.

The following tables summarize loans by internal risk grades and by loan class as of June 30, 2020 and December 31, 2019.

	As of June 30, 2020
					Special
(Amounts in thousands)	Pass		Watch		Mention		Substandard		Doubtful		Total
Loan Portfolio:
Commercial	$	111,609	$	8,907	$	5,440	$	68	$	—	$	126,024
Paycheck protection program		162,189		—		—		—		—		162,189
Commercial real estate:
Real estate - construction and land development		39,482		1,889		—		—		—		41,371
Real estate - commercial non-owner occupied		495,927		17,652		6,363		1,062		—		521,004
Real estate - commercial owner occupied		160,561		42,453		—		12,785		—		215,799
Residential real estate:
Real estate - residential - ITIN		27,407		—		—		3,676		—		31,083
Real estate - residential - 1-4 family mortgage		59,008		220		650		878		—		60,756
Real estate - residential - equity lines		20,853		—		—		85		—		20,938
Consumer and other		27,139		—		—		37		—		27,176
Total	$	1,104,175	$	71,121	$	12,453	$	18,591	$	—	$	1,206,340

	As of December 31, 2019
					Special
(Amounts in thousands)	Pass		Watch		Mention		Substandard		Doubtful		Total
Loan Portfolio:
Commercial	$	125,222	$	14,974	$	833	$	168	$	—	$	141,197
Commercial real estate:
Real estate - construction and land development		26,810		20		—		—		—		26,830
Real estate - commercial non-owner occupied		454,493		32,902		5,424		1,101		—		493,920
Real estate - commercial owner occupied		195,950		7,224		1,220		14,439		—		218,833
Residential real estate:
Real estate - residential - ITIN		28,609		—		—		4,430		—		33,039
Real estate - residential - 1-4 family mortgage		62,485		985		—		191		—		63,661
Real estate - residential - equity lines		22,012		—		—		87		—		22,099
Consumer and other		33,283		—		—		41		—		33,324
Total	$	948,864	$	56,105	$	7,477	$	20,457	$	—	$	1,032,903

The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $83 thousand and $100 thousand at June 30, 2020 and December 31, 2019, respectively.

Allowance for Loan and Lease Losses

Our ALLL is based on management’s estimate of future loan and lease losses and risks inherent in the loan portfolio in accordance with ASC Topics 450 and 310. In June of 2016, the FASB issued a new standard under ASC 326 the Current Expected Credit Losses methodology (“CECL”). We have the option to delay until January 2023 the implementation of the new methodology and have not determined when it will be implemented or the financial impact.

The following tables summarize the ALLL by portfolio for the three and six months ended June 30, 2020 and 2019.

	For the Three Months Ended June 30, 2020
				Paycheck
				Protection		Commercial			Residential
(Amounts in thousands)	Commercial			Program		Real Estate			Real Estate			Consumer			Unallocated		Total
ALLL by Loan Portfolio:
Beginning balance	$	2,483		$	—	$	9,899		$	1,281		$	972		$	432	$	15,067
Charge-offs		—			—		(145	)		(29	)		(182	)		—		(356	)
Recoveries		14			—		—			18			46			—		78
Provision		(97	)		—		1,182			36			34			145		1,300
Ending balance	$	2,400		$	—	$	10,936		$	1,306		$	870		$	577	$	16,089

	For the Three Months Ended June 30, 2019
				Paycheck
				Protection		Commercial			Residential
(Amounts in thousands)	Commercial			Program		Real Estate			Real Estate			Consumer			Unallocated		Total
ALLL by Loan Portfolio:
Beginning balance	$	2,479		$	—	$	6,956		$	1,211		$	1,056		$	540	$	12,242
Charge-offs		(145	)		—		(233	)		(71	)		(210	)		—		(659	)
Recoveries		757			—		—			18			87			—		862
Provision		(987	)		—		875			(88	)		137			63		—
Ending balance	$	2,104		$	—	$	7,598		$	1,070		$	1,070		$	603	$	12,445

	For the Six Months Ended June 30, 2020
			Paycheck
			Protection		Commercial			Residential
(Amounts in thousands)	Commercial		Program		Real Estate			Real Estate			Consumer			Unallocated		Total
ALLL by Loan Portfolio:
Beginning balance	$	1,822	$	—	$	8,096		$	1,032		$	933		$	348	$	12,231
Charge-offs		—		—		(145	)		(35	)		(345	)		—		(525	)
Recoveries		22		—		—			62			149			—		233
Provision		556		—		2,985			247			133			229		4,150
Ending balance	$	2,400	$	—	$	10,936		$	1,306		$	870		$	577	$	16,089

	For the Six Months Ended June 30, 2019
				Paycheck
				Protection		Commercial			Residential
(Amounts in thousands)	Commercial			Program		Real Estate			Real Estate			Consumer			Unallocated		Total
ALLL by Loan Portfolio:
Beginning balance	$	2,205		$	—	$	7,116		$	1,173		$	1,356		$	442	$	12,292
Charge-offs		(145	)		—		(233	)		(139	)		(490	)		—		(1,007	)
Recoveries		911			—		—			100			149			—		1,160
Provision		(867	)		—		715			(64	)		55			161		—
Ending balance	$	2,104		$	—	$	7,598		$	1,070		$	1,070		$	603	$	12,445

While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs may occur, actual amounts may differ. The unallocated portion of the ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component, or in the specific impairment reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of June 30, 2020 and December 31, 2019, the unallocated allowance amount represented 4% and 3% of the ALLL, respectively. The following tables summarize the ALLL and the recorded investment in loans and leases as of June 30, 2020 and December 31, 2019.

	As of June 30, 2020
			Paycheck
			Protection		Commercial		Residential
(Amounts in thousands)	Commercial		Program		Real Estate		Real Estate		Consumer		Unallocated		Total
ALLL:
Individually evaluated for impairment	$	137	$	—	$	—	$	123	$	10	$	—	$	270
Collectively evaluated for impairment		2,263		—		10,936		1,183		860		577		15,819
Total	$	2,400	$	—	$	10,936	$	1,306	$	870	$	577	$	16,089
Gross loans:
Individually evaluated for impairment	$	599	$	—	$	4,709	$	5,781	$	37	$	—	$	11,126
Collectively evaluated for impairment		125,425		162,189		773,465		106,996		27,139		—		1,195,214
Total gross loans	$	126,024	$	162,189	$	778,174	$	112,777	$	27,176	$	—	$	1,206,340

	As of December 31, 2019
			Paycheck
			Protection		Commercial		Residential
(Amounts in thousands)	Commercial		Program		Real Estate		Real Estate		Consumer		Unallocated		Total
ALLL:
Individually evaluated for impairment	$	159	$	—	$	—	$	154	$	11	$	—	$	324
Collectively evaluated for impairment		1,663		—		8,096		878		922		348		11,907
Total	$	1,822	$	—	$	8,096	$	1,032	$	933	$	348	$	12,231
Gross loans:
Individually evaluated for impairment	$	656	$	—	$	3,103	$	6,600	$	40	$	—	$	10,399
Collectively evaluated for impairment		140,541		—		736,480		112,199		33,284		—		1,022,504
Total gross loans	$	141,197	$	—	$	739,583	$	118,799	$	33,324	$	—	$	1,032,903

The ALLL totaled $16.1 million or 1.33% of total gross loans (1.54% of gross loans excluding PPP loans) at June 30, 2020 and $12.2 million or 1.18% at December 31, 2019. As of June 30, 2020 and December 31, 2019, we had commitments to extend credit of $281.2 million and $275.1 million, respectively. The reserve for unfunded commitments recorded in Other Liabilities in the Consolidated Balance Sheets at June 30, 2020 and December 31, 2019 was $800 thousand and $695 thousand, respectively.

We believe that the ALLL was adequate as of June 30, 2020. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.

COVID‐19

The COVID‐19 Pandemic which suddenly unfolded in Q1 2020 is having a dramatic worldwide economic effect, with significant drop in GDP’s projected for 2020. This will inevitably result in continuing economic recession and increased loan losses, particularly in certain hard hit industries such as airlines, travel and hospitality, retail and energy sectors. As a result, we have significantly increased our qualitative credit risk factors for “changes in international, national, regional and local conditions” and “changes in the volume and severity of past due loans and other similar conditions”.

ALLL Methodology

We have lending policies and procedures in place with the objective of optimizing loan income within an accepted risk tolerance level. We review and approve these policies and procedures annually. Monitoring and reporting systems supplement the review process with regular frequency as related to loan production, loan quality, concentrations of credit, potential problem loans, loan delinquencies, and nonperforming loans.

We formally assess the adequacy of the ALLL on a quarterly basis. The ALLL is based upon estimates of future loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan and lease portfolio. Our ALLL methodology incorporates management’s current judgments, and reflects management’s estimate of future loan and lease losses and risks inherent in the loan portfolio in accordance with ASC Topic 450 Contingencies (“ASC 450”) and ASC Topic 310 Receivables (“ASC 310”).

Management’s assessment of the ALLL is based on our continuing evaluation of all known relevant quantitative and qualitative internal and external risk factors provides the foundation for the three major components of the ALLL:

(1) Historical valuation allowances established in accordance with ASC 450, for groups of similarly situated loan pools.

(2) General valuation allowances established in accordance with ASC 450 that are based on qualitative credit risk factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Loss estimation factors are based on analysis of local economic factors. Allowances for changing environmental factors are management’s best estimate of the probable impact these changes have had on the loan portfolio as a whole.

(3) Specific valuation allowances established in accordance with ASC 310, that are based on estimated probable losses on specific impaired loans.

All three components are aggregated and constitute the ALLL; while portions of the allowance may be allocated to specific credits, the allowance net of specific reserves is available for the remaining credits that management deems as “loss.” It is our policy to classify a credit as loss with a concurrent charge-off when management considers the credit uncollectible and of such little value that its continuance as a bankable asset is not warranted. A loss classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer recognizing the likely credit loss of a valueless asset even though partial recovery may occur in the future.

The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors.

Our assessment of the adequacy of the ALLL includes the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially rated when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default.

Our loan portfolio is evaluated by general loan class including commercial, commercial real estate (which includes construction and other real estate), residential real estate (which includes 1-4 family and home equity loans), consumer and other loans. In accordance with ASC 450, historical valuation allowances are established for loan pools with similar risk characteristics common to each loan grouping. These loan pools are similarly risk-graded and each portfolio is evaluated by identifying all relevant risk characteristics that are common to these segmented groups of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. We periodically review and update our historical loss ratios based on net charge-off experience for each loan and lease class. Other credit risk factors are also reviewed periodically and adjusted as necessary to account for any changes in potential loss exposure.

General valuation allowances, as prescribed by ASC 450, are based on qualitative factors such as changes in asset quality trends, concentrations of credit or changes in concentrations of credit, changes in underwriting standards, changes in experience or depth of lending staff or management, the effectiveness of loan grading and the internal loan review function, and any other relevant factors. Management evaluates each qualitative component quarterly to determine the associated risks to the quality of our loan portfolio.

Impaired loans

Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, a formal impairment measurement is performed at least quarterly on a loan-by-loan basis. If the measurement of each impaired loans’ value is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. For collateral dependent loans, this can be accomplished by charging off the impaired portion of the loan based on the underlying value of the collateral. For non-collateral dependent loans, we establish a specific component within the ALLL based on the present value of the future cash flows. If we determine the sources of repayment will not result in a reasonable probability that the carrying value of a loan can be recovered, the amount of a loan’s specific impairment is charged off against the ALLL. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.

Risk Characteristics and Underwriting

The following is a brief summary, by loan type, of management’s evaluation of the general risk characteristics and underwriting standards:

Commercial Loans – Commercial loans are underwritten after evaluating the borrower’s financial ability to maintain profitability including future expansion objectives. In addition, the borrower’s qualitative qualities are evaluated, such as management skills and experience, ethical traits, and overall business acumen. Commercial loans are primarily extended based on the cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower’s cash flow may deviate from initial projections, and the value of collateral securing these loans may change.

Most commercial loans are generally secured by the assets being financed and other business assets such as accounts receivable or inventory. Management may also incorporate a personal guarantee; however, some short-term loans may be extended on an unsecured basis. Repayment of commercial loans secured by accounts receivable may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

PPP Loans -. The Paycheck Protection Program (“PPP”) launched in April of 2020 to provide small businesses assistance in the form of forgiveable 100% guaranteed U.S. Small Business Administration (“SBA”) loans. We have actively participated in the PPP, funding $162.2 million to 594 existing customers as of June 30, 2020. This financial support of our customers’ businesses may help moderate other Commercial and Commercial Real Estate loan losses. The loans are underwritten following the guidelines and approval process from the SBA and pose essentially no credit risk to the loan portfolio.

Commercial Real Estate (“CRE”) Loans – CRE loans are subject to similar underwriting standards and processes as commercial loans. CRE loans are viewed predominantly as cash flow loans and secondarily as loans collateralized by real estate. Generally, CRE lending involves larger principal amounts with repayment largely dependent on the successful operation of the property securing the loan or the business conducted on the collateralized property. CRE loans tend to be more adversely affected by conditions in the real estate markets or by general economic conditions.

The properties securing the CRE portfolio are diverse in terms of type and primary source of repayment. This diversity helps reduce our exposure to adverse economic events that affect any single industry. We monitor and evaluate CRE loans based on occupancy status (investor versus owner occupied), collateral, geography, and risk grade criteria.

Generally, CRE loans are made to developers and builders that are secured by non-owner occupied properties require the borrower to have had an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment largely dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property, or an interim loan commitment from the Company until permanent financing is secured. These loans are closely monitored by on-site inspections, and are considered to have higher inherent risks than other CRE loans due to their ultimate repayment sensitivity to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.

Residential Real Estate Loans – We do not originate consumer real estate mortgage loans. The majority of our loans secured by non owner occupied residential real estate are made either as part of a commercial relationship and subject to similar underwriting standards and processes as the CRE portfolio, or loans that were purchased in a prior year as part of a pool of loans. Purchased loan pools are evaluated based on risk characteristics established for each segmented group of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. Residential equity lines of credit are included in the discussion of consumer loans below.

We originate some single-family residence construction loans. The loan amounts are no greater than $1 million and are short-term real estate secured financing for the construction of a single-family residence to be occupied by the owner. The loans have a draw down feature with interest only payments, and a balloon payment at the 12-month maturity. All of these loans are refinanced and paid-off by the borrower’s permanent mortgage lender who provided the initial pre-approved mortgage financing. These loans are underwritten utilizing financial analysis of the borrower and are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. The loan disbursement and monitoring process is controlled utilizing similar processes as our CRE construction loans.

Consumer Loans – Our consumer loan originations are generally limited to home equity loans with nominal originations in unsecured personal loans. The portfolio also includes unsecured consumer home improvement loans and residential solar panel loans secured by UCC filings. We are highly dependent on third party credit scoring analysis to supplement the internal underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by management and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.

Concentrations of Credit Risk

As of June 30, 2020, approximately 75% of our gross loan portfolio (85% excluding PPP loans) is secured by real estate, and a significant decline in real estate market values may require an increase in the ALLL. Deterioration in economic conditions particularly in our markets may adversely affect our loan portfolio and may lead to additional charges to the provision for loan and lease losses.

Credit review

Confirmation of the quality of our loan grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. We maintain an independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to the Board of Directors, Loan Committee and Audit Committee. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.