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Loans and the Allowance for Loan Losses

6 Months Ended

Jun. 30, 2022

Loans and the Allowance for Loan Losses [Abstract]

Note 3. Loans and the Allowance for Loan Losses

The following is a summary of the balances in each class of the Company’s portfolio of loans held for investment as of the dates indicated:

(dollars in thousands)	June 30, 2022		December 31, 2021
Mortgage loans on real estate:
Residential 1-4 family	$	164,257	$	130,776
Commercial - owner occupied		199,121		198,413
Commercial - non-owner occupied		200,318		184,190
Multifamily		25,051		19,050
Construction		64,789		58,440
Second mortgages		8,207		7,877
Equity lines of credit		52,664		48,665
Total mortgage loans on real estate		714,407		647,411
Commercial and industrial loans		63,163		68,690
Consumer automobile loans		104,462		85,023
Other consumer loans		24,094		33,418
Other ⁽¹⁾		8,146		8,984
Total loans, net of deferred fees		914,272		843,526
Less: Allowance for loan losses		9,896		9,865
Loans, net of allowance and deferred fees ⁽²⁾	$	904,376	$	833,661

(1)	Overdrawn accounts are reclassified as loans and included in the Other category in the table above. Overdrawn deposit accounts, excluding internal use accounts, totaled $337 thousand and $304 thousand at June 30, 2022 and December 31, 2021, respectively.

(2)	Net deferred loan fees totaled $761 thousand and $1.3 million at June 30, 2022 and December 31, 2021, respectively.

CREDIT QUALITY INFORMATION

The Company uses internally-assigned risk grades to estimate the capability of borrowers to repay the contractual obligations of their loan agreements as scheduled or at all. The Company’s internal risk grade system is based on experiences with similarly graded loans. Credit risk grades are updated at least quarterly as additional information becomes available, at which time management analyzes the resulting scores to track loan performance.

The Company’s internally assigned risk grades are as follows:

•

Pass: Loans are of acceptable risk.

•

Other Assets Especially Mentioned (OAEM): Loans have potential weaknesses that deserve management’s close attention.

•

Substandard: Loans reflect significant deficiencies due to several adverse trends of a financial, economic or managerial nature.

•

Doubtful: Loans have all the weaknesses inherent in a substandard loan with added characteristics that make collection or liquidation in full based on currently existing facts, conditions and values highly questionable or improbable.

•

Loss: Loans have been identified for charge-off because they are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

The following tables present credit quality exposures by internally assigned risk ratings as of the dates indicated:

Credit Quality Information
As of June 30, 2022
(dollars in thousands)	Pass		OAEM		Substandard		Doubtful		Total
Mortgage loans on real estate:
Residential 1-4 family	$	164,096	$	-	$	161	$	-	$	164,257
Commercial - owner occupied		195,462		1,548		2,111		-		199,121
Commercial - non-owner occupied		199,506		263		549		-		200,318
Multifamily		25,051		-		-		-		25,051
Construction		63,437		354		998		-		64,789
Second mortgages		8,207		-		-		-		8,207
Equity lines of credit		52,664		-		-		-		52,664
Total mortgage loans on real estate	$	708,423	$	2,165	$	3,819	$	-	$	714,407
Commercial and industrial loans		62,908		-		255		-		63,163
Consumer automobile loans		104,444		-		18		-		104,462
Other consumer loans		24,094		-		-		-		24,094
Other		8,146		-		-		-		8,146
Total	$	908,015	$	2,165	$	4,092	$	-	$	914,272

Credit Quality Information
As of December 31, 2021
(dollars in thousands)	Pass		OAEM		Substandard		Doubtful		Total
Mortgage loans on real estate:
Residential 1-4 family	$	130,584	$	-	$	192	$	-	$	130,776
Commercial - owner occupied		195,512		788		2,113		-		198,413
Commercial - non-owner occupied		183,093		434		663		-		184,190
Multifamily		19,050		-		-		-		19,050
Construction		57,224		218		998		-		58,440
Second mortgages		7,877		-		-		-		7,877
Equity lines of credit		48,665		-		-		-		48,665
Total mortgage loans on real estate	$	642,005	$	1,440	$	3,966	$	-	$	647,411
Commercial and industrial loans		68,261		-		429		-		68,690
Consumer automobile loans		85,002		-		21		-		85,023
Other consumer loans		33,418		-		-		-		33,418
Other		8,984		-		-		-		8,984
Total	$	837,670	$	1,440	$	4,416	$	-	$	843,526

As of June 30, 2022 and December 31, 2021, the Company did not have any loans internally classified as Doubtful or Loss.

AGE ANALYSIS OF PAST DUE LOANS BY CLASS

All classes of loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Interest and fees continue to accrue on past due loans until the date the loan is placed in nonaccrual status, if applicable. The following table includes an aging analysis of the recorded investment in past due loans as of the dates indicated. Also included in the table below are loans that are 90 days or more past due as to interest and principal and still accruing interest, because they are well-secured and in the process of collection.

Age Analysis of Past Due Loans as of June 30, 2022
(dollars in thousands)	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due and still Accruing		Nonaccrual ⁽²⁾		Total Current Loans ⁽¹⁾		Total Loans
Mortgage loans on real estate:
Residential 1-4 family	$	-	$	234	$	-	$	161	$	163,862	$	164,257
Commercial - owner occupied		-		-		-		2,111		197,010		199,121
Commercial - non-owner occupied		263		-		-		549		199,506		200,318
Multifamily		-		-		-		-		25,051		25,051
Construction		293		-		-		998		63,498		64,789
Second mortgages		-		-		22		-		8,185		8,207
Equity lines of credit		15		12		-		-		52,637		52,664
Total mortgage loans on real estate	$	571	$	246	$	22	$	3,819	$	709,749	$	714,407
Commercial and industrial loans		35		-		-		255		62,873		63,163
Consumer automobile loans		1,109		100		400		-		102,853		104,462
Other consumer loans		314		200		143		-		23,437		24,094
Other		38		1		-		-		8,107		8,146
Total	$	2,067	$	547	$	565	$	4,074	$	907,019	$	914,272

(1)	For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

(2)	For purposes of this table, if a loan is past due and on nonaccrual, it is included in the nonaccural column and not also in its respective past due column.

In the table above, the past due totals include student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $143 thousand at June 30, 2022.

Age Analysis of Past Due Loans as of December 31, 2021
(dollars in thousands)	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due and still Accruing		Nonaccrual (2)		Total Current Loans ⁽¹⁾		Total Loans
Mortgage loans on real estate:
Residential 1-4 family	$	120	$	-	$	-	$	191	$	130,465	$	130,776
Commercial - owner occupied		-		-		-		-		198,413		198,413
Commercial - non-owner occupied		-		-		-		113		184,077		184,190
Multifamily		-		-		-		-		19,050		19,050
Construction		-		-		-		-		58,440		58,440
Second mortgages		24		-		-		-		7,853		7,877
Equity lines of credit		51		-		-		-		48,614		48,665
Total mortgage loans on real estate	$	195	$	-	$	-	$	304	$	646,912	$	647,411
Commercial and industrial loans		37		-		169		174		68,310		68,690
Consumer automobile loans		814		118		296		-		83,795		85,023
Other consumer loans		1,284		439		550		-		31,145		33,418
Other		31		3		10		-		8,940		8,984
Total	$	2,361	$	560	$	1,025	$	478	$	839,102	$	843,526

(1)	For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

(2)	For purposes of this table, if a loan is past due and on nonaccrual, it is included in the nonaccural column and not also in its respective past due column.

In the table above, the past due totals include small business and student loans with principal and interest amounts that are 97 - 100% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $1.4 million at December 31, 2021.

Although the portions of the student loan portfolios that are 90 days or more past due would normally be considered impaired, the Company does not include these loans in its impairment analysis. Because the federal government has provided guarantees of repayment of these student loans in an amount ranging from 97% to 98% of the total principal and interest of the loans as of June 30, 2022, management does not expect significant increases in delinquencies of these loans to have a material effect on the Company.

NONACCRUAL LOANS

The Company generally places commercial and industrial loans (including construction loans and commercial loans secured and not secured by real estate) in nonaccrual status when the full and timely collection of interest or principal becomes uncertain, part of the principal balance has been charged off and no restructuring has occurred or the loan reaches 90 days past due, unless the credit is well-secured and in the process of collection.

Under regulatory rules, consumer loans, which are loans to individuals for household, family and other personal expenditures, and consumer loans secured by real estate (including residential 1 - 4 family mortgages, second mortgages, and equity lines of credit) are not required to be placed in nonaccrual status. Although consumer loans and consumer loans secured by real estate are not required to be placed in nonaccrual status, the Company may elect to place these loans in nonaccrual status, if necessary to avoid a material overstatement of interest income. Generally, consumer loans secured by real estate are placed in nonaccrual status only when payments are 120 days past due.

Generally, consumer loans not secured by real estate are placed in nonaccrual status only when part of the principal has been charged off. If a charge-off has not occurred sooner for other reasons, a consumer loan not secured by real estate will generally be placed in nonaccrual status when payments are 120 days past due. These loans are charged off or written down to the net realizable value of the collateral when deemed uncollectible, when classified as a “loss,” when repayment is unreasonably protracted, when bankruptcy has been initiated, or when the loan is 120 days or more past due unless the credit is well-secured and in the process of collection.

When management places a loan in nonaccrual status, the accrued unpaid interest receivable is reversed against interest income and the loan is accounted for by the cost recovery method, until it qualifies for return to accrual status or is charged off. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, or when the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments for at least six months.

The following table presents loans in nonaccrual status by class of loan as of the dates indicated:

Nonaccrual Loans by Class

(dollars in thousands)	June 30, 2022		December 31, 2021
Mortgage loans on real estate:
Residential 1-4 family	$	161	$	191
Commercial - owner occupied		2,111		-
Commercial - non-owner occupied		549		113
Construction and land development		998		-
Total mortgage loans on real estate		3,819		304
Commercial and industrial loans		255		174
Total	$	4,074	$	478

The following table presents the interest income that the Company would have earned under the original terms of its nonaccrual loans and the actual interest recorded by the Company on nonaccrual loans for the periods presented:

	Six Months Ended June 30,
(dollars in thousands)	2022			2021
Interest income that would have been recorded under original loan terms		$	132		$	61
Actual interest income recorded for the period			4			-
Reduction in interest income on nonaccrual loans		$	128		$	61

TROUBLED DEBT RESTRUCTURINGS

The Company’s loan portfolio may include certain loans classified as TDRs, where economic concessions have been granted to borrowers who are experiencing financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reduction in the interest rate below current market rates for borrowers with similar risk profiles, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The Company defines a TDR as nonperforming if the TDR is in nonaccrual status or is 90 days or more past due and still accruing interest at the report date.

When the Company modifies a loan, management evaluates any possible impairment as discussed further below under Impaired Loans.

There were no new TDRs in the six months ended June 30, 2022 and 2021.

At June 30, 2022 and 2021, the Company had no outstanding commitments to disburse additional funds on any TDR. The Company had no loans secured by residential 1 - 4 family real estate in the process of foreclosure at June 30, 2022 and 2021.

In the three and six months ended June 30, 2022 and 2021, there were no defaulting TDRs where the default occurred within twelve months of restructuring. The Company considers a TDR in default when any of the following occurs: the loan, as restructured, becomes 90 days or more past due; the loan is moved to nonaccrual status following the restructure; the loan is restructured again under terms that would qualify it as a TDR if it were not already so classified; or any portion of the loan is charged off.

All TDRs are factored into the determination of the allowance for loan losses and included in the impaired loan analysis, as discussed below.

IMPAIRED LOANS

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans and loans modified in a TDR. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole or remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of the discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific allocation in the allowance or a charge-off to the allowance.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cash basis method. For financial statement purposes, the recorded investment in the loan is the actual principal balance reduced by partial charge-offs and payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if these partial charge-offs did not occur and as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes.

The following table includes the recorded investment and unpaid principal balances (a portion of which may have been charged off) for impaired loans with the associated allowance amount, if applicable, as of the dates presented. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized for the periods presented. The average balances are calculated based on daily average balances.

Impaired Loans by Class
	As of June 30, 2022								For the Six Months Ended June 30, 2022
(Dollars in thousands)	Unpaid Principal Balance		Without Valuation Allowance		With Valuation Allowance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Mortgage loans on real estate:
Residential 1-4 family	$	296	$	47	$	243	$	26	$	293	$	4
Commercial		4,580		4,417		100		1		4,570		-
Construction		1,077		1,076		-		-		1,076		-
Second mortgages		-		-		-		-		-		-
Total mortgage loans on real estate		5,953		5,540		343		27		5,939		4
Commercial and industrial loans		255		255		-		-		255		1
Other consumer loans		5		3		-		-		4		-
Total	$	6,213	$	5,798	$	343	$	27	$	6,198	$	5

Impaired Loans by Class
	As of December 31, 2021								For the Year Ended December 31, 2021
(Dollars in thousands)	Unpaid Principal Balance		Without Valuation Allowance		With Valuation Allowance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Mortgage loans on real estate:
Residential 1-4 family	$	353	$	25	$	300	$	30	$	328	$	7
Commercial		610		178		413		8		601		1
Construction		80		79		-		-		80		4
Second mortgages		127		-		125		3		126		5
Total mortgage loans on real estate		1,170		282		838		41		1,135		17
Commercial and industrial loans		188		-		174		87		181		17
Other consumer loans		9		7		-		-		8		-
Total	$	1,367	$	289	$	1,012	$	128	$	1,324	$	34

ALLOWANCE FOR LOAN LOSSES

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and probable losses inherent in the loan portfolio. The Company segments the loan portfolio into categories as defined by Schedule RC-C of the Federal Financial Institutions Examination Council Consolidated Reports of Condition and Income Form 041 (Call Report). Loans are segmented into the following pools: commercial, real estate-construction, real estate-mortgage, consumer and other loans. The Company also sub-segments the real estate-mortgage segment into six classes: residential 1-4 family, commercial real estate - owner occupied, commercial real estate - non-owner occupied, multifamily, second mortgages and equity lines of credit.

The Company uses an internally developed risk evaluation model in the estimation of the credit risk process. The model and assumptions used to determine the allowance are independently validated and reviewed to ensure that the theoretical foundation, assumptions, data integrity, computational processes and reporting practices are appropriate and properly documented.

Each portfolio segment has risk characteristics as follows:

•

Commercial and industrial: Commercial and industrial loans carry risks associated with the successful operation of a business or project, in addition to other risks associated with the ownership of a business. The repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.

•

Real estate-construction: Construction loans carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be the loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

•

Real estate-mortgage: Residential mortgage loans and equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Commercial real estate loans carry risks associated with the successful operation of a business if owner occupied. If non-owner occupied, the repayment of these loans may be dependent upon the profitability and cash flow from rent receipts.

•

Consumer loans: Consumer loans carry risks associated with the continued credit-worthiness of the borrowers and the value of the collateral. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.

•

Other loans: Other loans are loans to mortgage companies, loans for purchasing or carrying securities, and loans to insurance, investment and finance companies. These loans carry risks associated with the successful operation of a business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time, depend on interest rates or fluctuate in active trading markets.

Each segment of the portfolio is pooled by risk grade or by days past due. Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on days past due, while all other loans, including loans to consumers that are secured by real estate, are segmented by risk grades. A historical loss percentage is then calculated by migration analysis and applied to each pool. The migration analysis applied to all pools is able to track the risk grading and historical performance of individual loans throughout a number of periods set by management, which provides management with information regarding trends (or migrations) in a particular loan segment. At June 30, 2022 and December 31, 2021 management used eight twelve-quarter migration periods.

Management also provides an allocated component of the allowance for loans that are specifically identified as impaired, and are individually analyzed for impairment. An allocated allowance is established when the present value of expected future cash flows from the impaired loan (or the collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan.

Loans collectively evaluated for impairment are pooled with a historical loss rate, based on migration analysis, applied to each pool, segmented by risk grade or past due, depending on the type of loan. Based on credit risk assessments and management’s analysis of qualitative factors, additional loss factors are applied to loan balances. These additional qualitative factors include: economic conditions (including uncertainties associated with the COVID-19 pandemic), trends in growth, loan concentrations, changes in certain loans, changes in underwriting, changes in management and changes in the legal and regulatory environment.

Based on capital levels, stress testing indications, prudent underwriting policies, watch credit processes, and loan concentration diversification, the Company currently expects to be able to manage the economic risks and uncertainties associated with the pandemic, increases in market interest rates, and potential effects on credit quality, which may result in additional increases in the provision for loan losses.

ALLOWANCE FOR LOAN LOSSES BY SEGMENT

The total allowance reflects management’s estimate of losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $9.9 million adequate to cover estimable and probable loan losses inherent in the loan portfolio at June 30, 2022.

The following tables present, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods presented. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS
For the six months ended June 30, 2022
(Dollars in thousands)	Commercial and Industrial			Real Estate Construction		Real Estate - Mortgage ⁽¹⁾			Real Estate - Commercial			Consumer ⁽²⁾			Other			Unallocated		Total
Allowance for loan losses:
Balance, beginning	$	683		$	459	$	2,390		$	4,787		$	1,362		$	184		$	-	$	9,865
Charge-offs		(296	)		-		(3	)		-			(622	)		(190	)		-		(1,111	)
Recoveries		127			-		40			-			219			85			-		471
Provision for loan losses		82			20		249			(351	)		523			148			-		671
Ending Balance	$	596		$	479	$	2,676		$	4,436		$	1,482		$	227		$	-	$	9,896

Individually evaluated for impairment	$	-		$	-	$	26		$	1		$	-		$	-		$	-	$	27
Collectively evaluated for impairment		596			479		2,650			4,435			1,482			227			-		9,869

Ending Balance	$	596		$	479	$	2,676		$	4,436		$	1,482		$	227		$	-	$	9,896

Loans Balances:
Individually evaluated for impairment		255			1,076		290			4,517			3			-			-		6,141
Collectively evaluated for impairment		62,908			63,713		249,889			394,922			128,553			8,146			-		908,131
Ending Balance	$	63,163		$	64,789	$	250,179		$	399,439		$	128,556		$	8,146		$	-	$	914,272

(1)	The real estate-mortgage segment includes residential 1 – 4 family, multi-family, second mortgages and equity lines of credit.

(2)	The consumer segment includes consumer automobile loans.

For the Year ended December 31, 2021
(Dollars in thousands)	Commercial and Industrial			Real Estate Construction		Real Estate - Mortgage ⁽¹⁾			Real Estate - Commercial		Consumer ⁽²⁾			Other			Unallocated			Total
Allowance for loan losses:
Balance, beginning	$	650		$	339	$	2,560		$	4,434	$	1,302		$	123		$	133		$	9,541
Charge-offs		(27	)		-		(14	)		-		(800	)		(278	)		-			(1,119	)
Recoveries		41			-		76			44		390			98			-			649
Provision for loan losses		19			120		(232	)		309		470			241			(133	)		794
Ending Balance	$	683		$	459	$	2,390		$	4,787	$	1,362		$	184		$	-		$	9,865

Individually evaluated for impairment	$	87		$	-	$	33		$	8	$	-		$	-		$	-		$	128
Collectively evaluated for impairment		596			459		2,357			4,779		1,362			184			-			9,737

Ending Balance	$	683		$	459	$	2,390		$	4,787	$	1,362		$	184		$	-		$	9,865

Loans Balances:
Individually evaluated for impairment		174			79		450			591		7			-			-			1,301
Collectively evaluated for impairment		68,516			58,361		205,918			382,012		118,434			8,984			-			842,225
Ending Balance	$	68,690		$	58,440	$	206,368		$	382,603	$	118,441		$	8,984		$	-		$	843,526

(1)	The real estate-mortgage segment includes residential 1 – 4 family, multi-family, second mortgages and equity lines of credit.

(2)	The consumer segment includes consumer automobile loans.