LOANS AND ALLOWANCE FOR CREDIT LOSSES

3 Months Ended

Mar. 31, 2023

LOANS AND ALLOWANCE FOR CREDIT LOSSES

LOANS AND ALLOWANCE FOR CREDIT LOSSES

NOTE 3.           LOANS AND ALLOWANCE FOR CREDIT LOSSES

We evaluate risk characteristics of loans based on regulatory call report code with segmentation based on the underlying collateral for certain loan types. The following is a summary of total loans by regulatory call report code segmentation based on underlying collateral for certain loan types:

	March 31,		December 31,
(in thousands)	2023		2022
Commercial construction	$	132,960	$	117,577
Commercial real estate owner occupied		261,365		244,814
Commercial real estate non-owner occupied		1,149,030		1,146,674
Tax exempt		43,253		42,879
Commercial and industrial		298,384		297,112
Residential real estate		961,701		954,968
Home equity		89,777		90,865
Consumer other		7,535		7,801
Total loans		2,944,005		2,902,690
Allowance for credit losses		26,607		25,860
Net loans	$	2,917,398	$	2,876,830

Total unamortized net costs and premiums included in loan totals were as follows:

	March 31,		December 31,
(in thousands)	2023		2022
Net unamortized loan origination costs	$	3,233	$	3,184
Net unamortized fair value discount on acquired loans		(3,339)		(3,506)
Total	$	(106)	$	(322)

We exclude accrued interest receivable from the amortized cost basis of loans disclosed throughout this footnote. As of March 31, 2023 and December 31, 2022, accrued interest receivable for loans totaled $11.2 million and $10.7 million, respectively, and is included in the “other assets” line item on the consolidated balance sheets.

Characteristics of each loan portfolio segment are as follows:

Commercial construction - Loans in this segment primarily include raw land, land development and construction of commercial and multifamily residential properties.  Collateral values are determined based upon appraisals and evaluations of the completed structure in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy guidelines that are more restrictive than on stabilized commercial real estate transactions.  Construction loans are primarily paid by the cash flow generated from the completed structure, such as operating leases, rents, or other operating cash flows from the borrower.

Commercial real estate owner occupied and non-owner occupied - Loans in these segments are primarily owner-occupied or income-producing properties.  Loans to Real Estate Investment Trusts and unsecured loans to developers that closely correlate to the inherent risk in commercial real estate markets are also included.  Commercial real estate loans are typically written with amortizing payment structures. Collateral values are determined based upon appraisals and evaluations in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy and regulatory guidelines.  Commercial real estate loans are primarily paid by the cash flow generated from the real property, such as operating leases, rents, or other operating cash flows from the borrower.

Tax Exempt - Loans in this segment primarily include loans to various state and municipal government entities. Loans made to these borrowers may provide us with tax-exempt income. While governed and underwritten similar to commercial loans they do have unique requirements based on established polices. Almost all state and municipal loans are considered a general obligation of the issuing entity. Given the size of many municipal borrowers, borrowings are normally not rated by major rating agencies.

Commercial and industrial loans - Loans consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital and/or capital investment in this segment.  Generally loans are secured by assets of the business such as accounts receivable, inventory, marketable securities, other liquid collateral, equipment and other business assets.  Some loans in this category may be unsecured or guaranteed by government agencies such as the U.S. Small Business Administration.  Loans are primarily paid by the operating cash flow of the borrower.

Residential real estate - All loans in this segment are collateralized by one-to-four family homes.  Residential real estate loans held in the loan portfolio are made to borrowers who demonstrate the ability to make scheduled payments with full consideration to various underwriting factors. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.

Home equity - All loans and lines of credit are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied one- to four-family homes, condominiums, or vacation homes. The home equity loan has a fixed rate and is billed as equal payments comprised of principal and interest. The home equity line of credit has a variable rate and is billed as interest-only payments during the draw period. At the end of the draw period, the home equity line of credit is billed as a percentage of the principal balance plus all accrued interest. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.

Consumer other - Loans in this segment include personal lines of credit and amortizing loans made to qualified individuals for various purposes such as auto loans, recreational equipment, overdraft protection or other consumer loans. Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines, as applicable.

Allowance for Credit Losses

The Allowance for Credit Losses (“ACL”) is comprised of the allowance for loan losses and the allowance for unfunded commitments which is accounted for as a separate liability in other liabilities on the balance sheet. The level of the ACL represents management’s estimate of expected credit losses over the expected life of the loans at the balance sheet date.

The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off.  The ACL is comprised of reserves measured on a collective (pool) basis based on a lifetime loss-rate model when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis, generally larger non-accruing commercial loans.

The activity in the ACL for the periods ended are as follows:

	At or for the Three Months Ended March 31, 2023
	Balance at
	Beginning of								Balance at
(in thousands)	Period		Charge Offs		Recoveries		Provision		End of Period
Commercial construction	$	2,579	$	—	$	—	$	455	$	3,034
Commercial real estate owner occupied		2,189		—		—		159		2,348
Commercial real estate non-owner occupied		9,341		—		—		3		9,344
Tax exempt		93		—		—		—		93
Commercial and industrial		3,493		(1)		6		117		3,615
Residential real estate		7,274		(4)		8		27		7,305
Home equity		811		—		2		(21)		792
Consumer other		80		(63)		1		58		76
Total	$	25,860	$	(68)	$	17	$	798	$	26,607

	At or for the Three Months Ended March 31, 2022
	Balance at
	Beginning of								Balance at
(in thousands)	Period		Charge Offs		Recoveries		Provision		End of Period
Commercial construction	$	2,111	$	—	$	—	$	(1,110)	$	1,001
Commercial real estate owner occupied		2,751		—		54		(132)		2,673
Commercial real estate non-owner occupied		5,650		—		—		1,357		7,007
Tax exempt		86		—		—		(86)		—
Commercial and industrial		5,369		—		25		(655)		4,739
Residential real estate		5,862		(15)		91		940		6,878
Home equity		814		(2)		5		10		827
Consumer other		75		(66)		3		53		65
Total	$	22,718	$	(83)	$	178	$	377	$	23,190

Unfunded Commitments

The ACL on unfunded commitments is recognized as a liability (other liabilities on the consolidated balance sheet), with adjustments to the reserve recognized in other non-interest expense in the consolidated statement of operations. The activity in the ACL on unfunded commitments for the periods ended was as follows:

(in thousands)	Three Months Ended March 31, 2023		Three Months Ended March 31, 2022
Beginning Balance	$	3,910	$	2,152
Provision for credit losses		(175)		30
Ending Balance	$	3,735	$	2,182

Loan Origination/Risk Management: We have certain lending policies and procedures in place designed to maximize loan income within an acceptable level of risk. Our Board of Directors reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Board of Directors with frequent reports related to loan production, loan quality, and concentration of credit, loan delinquencies, non-performing loans and potential problem loans. We seek to diversify the loan portfolio as a means of managing risk associated with fluctuations in economic conditions.

Credit Quality Indicators:  In monitoring the credit quality of the portfolio, management applies a credit quality indicator and uses an internal risk rating system to categorize commercial loans. These credit quality indicators range from one through nine, with a higher number correlating to increasing risk of loss.  Consistent with regulatory guidelines, the Company provides for the classification of loans which are considered to be of lesser quality as special mention, substandard, doubtful, or loss (i.e. risk-rated 6, 7, 8 and 9, respectively).

The following are the definitions of our credit quality indicators:

Pass: Loans we consider in the commercial portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes there is a low risk of loss related to these loans considered pass-rated.

Special Mention: Loans considered having some potential weaknesses, but are deemed to not carry levels of risk inherent in one of the subsequent categories, are designated as special mention. A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. This might include loans which may require a higher level of supervision or internal reporting because of: (i) declining industry trends; (ii) increasing reliance on secondary sources of repayment; (iii) the poor condition of or lack of control over collateral; or (iv) failure to obtain proper documentation or any other deviations from prudent lending practices. Economic or market conditions which may, in the future, affect the obligor may warrant special mention of the asset. Loans for which an adverse trend in the borrower's operations or an imbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized may be included in this classification. Special mention loans are not adversely classified and do not expose us to sufficient risks to warrant classification.

Substandard: Loans we consider as substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well-defined weakness that jeopardizes liquidation of the debt. Substandard loans include those loans where there is the distinct possibility of some loss of principal, if the deficiencies are not corrected.

Doubtful: Loans we consider as doubtful have all of the weaknesses inherent in those loans that are classified as substandard. These loans have the added characteristic of a well-defined weakness which is inadequately protected by the current sound worth and paying capacity of borrower or of the collateral pledged, if any, and calls into question the collectability of the full balance of the loan. The possibility of loss is high but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the loan, its classification as loss is

deferred until its more exact status is determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans. The entire amount of the loan might not be classified as doubtful when collection of a specific portion appears highly probable. Loans are generally not classified doubtful for an extended period of time (i.e., over a year).

Loss: Loans we consider as losses are those considered uncollectible and of such little value that their continuance as an asset is not warranted and the uncollectible amounts are charged-off. This classification does not mean the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this worthless asset even though partial recovery may be effected in the future. Losses are taken in the period in which they are determined to be uncollectible.

The following table presents our loans by year of origination, loan segmentation and risk indicator as of March 31, 2023:

(in thousands)	2023		2022		2021		2020		2019		Prior		Total
Commercial construction
Risk rating:
Pass	$	375	$	67,868	$	36,035	$	3,541	$	—	$	954	$	108,773
Special mention		—		—		—		24,187		—		—		24,187
Substandard		—		—		—		—		—		—		—
Total	$	375	$	67,868	$	36,035	$	27,728	$	—	$	954	$	132,960
Current period gross write-offs		—		—		—		—		—		—		—
Commercial real estate owner occupied
Risk rating:
Pass	$	2,829	$	30,185	$	23,375	$	22,719	$	30,348	$	146,061	$	255,517
Special mention		—		—		—		240		659		531		1,430
Substandard		—		—		—		—		—		4,282		4,282
Doubtful		—		—		—		—		—		136		136
Total	$	2,829	$	30,185	$	23,375	$	22,959	$	31,007	$	151,010	$	261,365
Current period gross write-offs		—		—		—		—		—		—		—
Commercial real estate non-owner occupied
Risk rating:
Pass	$	2,795	$	372,122	$	228,413	$	144,782	$	89,518	$	270,794	$	1,108,424
Special mention		—		—		21,498		—		—		4,135		25,633
Substandard		—		—		—		—		115		14,722		14,837
Doubtful		—		—		—		—		—		136		136
Total	$	2,795	$	372,122	$	249,911	$	144,782	$	89,633	$	289,787	$	1,149,030
Current period gross write-offs		—		—		—		—		—		—		—
Tax exempt
Risk rating:
Pass	$	2	$	10,612	$	946	$	247	$	714	$	30,732	$	43,253
Special mention		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—
Total	$	2	$	10,612	$	946	$	247	$	714	$	30,732	$	43,253
Current period gross write-offs		—		—		—		—		—		—		—
Commercial and industrial
Risk rating:
Pass	$	14,313	$	74,242	$	26,272	$	59,235	$	29,188	$	88,912	$	292,162
Special mention		45		1,403		—		48		956		735		3,187
Substandard		—		102		142		120		335		2,336		3,035
Doubtful		—		—		—		—		—		—		—
Total	$	14,358	$	75,747	$	26,414	$	59,403	$	30,479	$	91,983	$	298,384
Current period gross write-offs		—		—		—		—		—		1		1

(in thousands)	2023		2022		2021		2020		2019		Prior		Total
Residential real estate
Performing	$	21,385	$	196,948	$	176,209	$	109,432	$	67,756	$	385,905	$	957,635
Nonperforming		—		—		43		—		48		3,975		4,066
Total	$	21,385	$	196,948	$	176,252	$	109,432	$	67,804	$	389,880	$	961,701
Current period gross write-offs		—		—		—		—		—		4		4
Home equity
Performing	$	3,428	$	18,315	$	10,306	$	7,383	$	5,953	$	43,459	$	88,844
Nonperforming		—		—		—		—		—		933		933
Total	$	3,428	$	18,315	$	10,306	$	7,383	$	5,953	$	44,392	$	89,777
Current period gross write-offs		—		—		—		—		—		—		—
Consumer other
Performing	$	1,862	$	2,659	$	1,150	$	718	$	181	$	961	$	7,531
Nonperforming		—		—		—		4		—		—		4
Total	$	1,862	$	2,659	$	1,150	$	722	$	181	$	961	$	7,535
Current period gross write-offs		—		52		8		2		—	$	1		63
Total Loans	$	47,034	$	774,456	$	524,389	$	372,656	$	225,771	$	999,699	$	2,944,005

The following table presents our loans by year of origination, loan segmentation and risk indicator as of December 31, 2022:

(in thousands)	2022		2021		2020		2019		2018		Prior		Total
Commercial construction
Risk rating:
Pass	$	49,722	$	38,837	$	2,865	$	1,011	$	964	$	—	$	93,399
Special mention		—		—		24,178		—		—		—		24,178
Substandard		—		—		—		—		—		—		—
Total	$	49,722	$	38,837	$	27,043	$	1,011	$	964	$	—	$	117,577
Commercial real estate owner occupied
Risk rating:
Pass	$	22,371	$	11,290	$	23,014	$	31,352	$	46,398	$	103,295	$	237,720
Special mention		—		—		243		666		173		1,870		2,952
Substandard		—		—		—		—		77		3,924		4,001
Doubtful		—		—		—		—		—		141		141
Total	$	22,371	$	11,290	$	23,257	$	32,018	$	46,648	$	109,230	$	244,814
Commercial real estate non-owner occupied
Risk rating:
Pass	$	370,856	$	228,414	$	145,096	$	88,111	$	35,213	$	238,395	$	1,106,085
Special mention		—		21,390		—		127		911		16,612		39,040
Substandard		—		—		—		—		—		1,404		1,404
Doubtful		—		—		—		—		—		145		145
Total	$	370,856	$	249,804	$	145,096	$	88,238	$	36,124	$	256,556	$	1,146,674
Tax exempt
Risk rating:
Pass	$	8,686	$	1,020	$	252	$	772	$	13,231	$	18,918	$	42,879
Special mention		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—
Total	$	8,686	$	1,020	$	252	$	772	$	13,231	$	18,918	$	42,879
Commercial and industrial
Risk rating:
Pass	$	83,151	$	26,948	$	62,835	$	27,491	$	9,511	$	81,316	$	291,252
Special mention		1,450		—		53		803		201		619		3,126
Substandard		—		113		111		65		299		2,106		2,694
Doubtful		—		—		—		—		—		40		40
Total	$	84,601	$	27,061	$	62,999	$	28,359	$	10,011	$	84,081	$	297,112

(in thousands)	2022		2021		2020		2019		2018		Prior		Total
Residential real estate
Performing	$	195,320	$	177,480	$	111,021	$	69,170	$	47,797	$	349,795	$	950,583
Nonperforming		—		45		—		49		641		3,650		4,385
Total	$	195,320	$	177,525	$	111,021	$	69,219	$	48,438	$	353,445	$	954,968
Home equity
Performing	$	17,107	$	10,638	$	8,139	$	6,830	$	6,997	$	40,191	$	89,902
Nonperforming		—		—		—		—		—		963		963
Total	$	17,107	$	10,638	$	8,139	$	6,830	$	6,997	$	41,154	$	90,865
Consumer other
Performing	$	4,321	$	1,341	$	863	$	265	$	64	$	942	$	7,796
Nonperforming		—		—		5		—		—		—		5
Total	$	4,321	$	1,341	$	868	$	265	$	64	$	942	$	7,801
Total Loans	$	752,984	$	517,516	$	378,675	$	226,712	$	162,477	$	864,326	$	2,902,690

Past Dues

The following is a summary of past due loans for the periods ended:

	March 31, 2023
(in thousands)	30-59		60-89		90+		Total Past Due		Current		Total Loans
Commercial construction	$	—	$	—	$	—	$	—	$	132,960	$	132,960
Commercial real estate owner occupied		197		227		308		732		260,633		261,365
Commercial real estate non-owner occupied		352		—		133		485		1,148,545		1,149,030
Tax exempt		—		—		—		—		43,253		43,253
Commercial and industrial		261		281		134		676		297,708		298,384
Residential real estate		5,325		393		1,728		7,446		954,255		961,701
Home equity		821		—		276		1,097		88,680		89,777
Consumer other		14		9		—		23		7,512		7,535
Total	$	6,970	$	910	$	2,579	$	10,459	$	2,933,546	$	2,944,005

	December 31, 2022
(in thousands)	30-59		60-89		90+		Total Past Due		Current		Total Loans
Commercial construction	$	—	$	—	$	—	$	—	$	117,577	$	117,577
Commercial real estate owner occupied		385		—		—		385		244,429		244,814
Commercial real estate non-owner occupied		45		145		139		329		1,146,345		1,146,674
Tax exempt		—		—		—		—		42,879		42,879
Commercial and industrial		169		—		9		178		296,934		297,112
Residential real estate		803		348		2,029		3,180		951,788		954,968
Home equity		216		160		246		622		90,243		90,865
Consumer other		41		8		—		49		7,752		7,801
Total	$	1,659	$	661	$	2,423	$	4,743	$	2,897,947	$	2,902,690

Non-Accrual Loans

The following is a summary of non-accrual loans for the periods ended:

	March 31, 2023
			Nonaccrual With No		90+ Days Past
(in thousands)	Nonaccrual		Related Allowance		Due and Accruing
Commercial construction	$	—	$	—	$	—
Commercial real estate owner occupied		432		362		—
Commercial real estate non-owner occupied		529		396		—
Tax exempt		—		—		—
Commercial and industrial		1,832		138		—
Residential real estate		4,066		1,181		93
Home equity		933		51		45
Consumer other		4		—		—
Total	$	7,796	$	2,128	$	138

	December 31, 2022
			Nonaccrual With No		90+ Days Past
(in thousands)	Nonaccrual		Related Allowance		Due and Accruing
Commercial construction	$	—	$	—	$	—
Commercial real estate owner occupied		439		360		—
Commercial real estate non-owner occupied		550		411		—
Tax exempt		—		—		—
Commercial and industrial		207		145		—
Residential real estate		4,385		1,361		202
Home equity		963		57		14
Consumer other		5		—		—
Total	$	6,549	$	2,334	$	216

Collateral Dependent Loans

Loans that do not share risk characteristics are evaluated on an individual basis. For loans that are individually evaluated and collateral dependent, financial loans where we have determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and we expect repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date.

The following table presents the amortized cost basis of collateral-dependent loans by loan portfolio segment for the periods ended.

	March 31, 2023				December 31, 2022
(in thousands)	Real Estate		Other		Real Estate		Other
Commercial construction	$	—	$	—	$	—	$	—
Commercial real estate owner occupied		432		—		439		—
Commercial real estate non-owner occupied		529		—		550		—
Tax exempt		—		—		—		—
Commercial and industrial		222		1,610		91		116
Residential real estate		4,066		—		4,385		—
Home equity		933		—		963		—
Consumer other		4		—		5		—
Total	$	6,186	$	1,610	$	6,433	$	116

Loan Modifications to Borrowers Experiencing Financial Difficulty

In January 2023, the Company adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for TDRs while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. This guidance was applied on a prospective basis. Upon adoption of this guidance, we no longer establish a specific reserve for modifications to borrowers experiencing financial difficulty. Instead, these modifications are included in their respective category and a historical loss rate is applied to the current loan balance to arrive at the quantitative baseline portion of the ACL.

These modifications typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. There were no qualifying modifications for the three months ended March 31, 2023 and 2022.

Foreclosure

Residential mortgage loans collateralized by real estate that are in the process of foreclosure as of March 31, 2023 and December 31, 2022 totaled $570 thousand and $253 thousand, respectively.

Mortgage Banking

Loans held for sale at March 31, 2023 had an unpaid principal balance of $463 thousand and there were no loans held for sale as of December 31, 2022.  The interest rate exposure on loans held for sale is mitigated through forward delivery commitments with certain approved secondary market investors. We had no open forward delivery commitments at March 31, 2023 and December 31, 2022, respectively.

For the three months ended March 31, 2023 and 2022, we sold $691 thousand and $22.2 million, respectively, of residential mortgage loans on the secondary market, which resulted in a net loss on sale of loans (net of costs, including direct and indirect origination costs) of $8 thousand and a gain of $182 thousand, respectively.

We sell residential loans on the secondary market while primarily retaining the servicing of these loans.  Servicing sold loans helps to maintain customer relationships and earn fees over the servicing period. Loans serviced for others are not included in the accompanying consolidated balance sheets. The risks inherent in servicing assets relate primarily to level of prepayments that result from shifts in interest rates.  We obtain third-party valuations of our servicing assets portfolio quarterly, and the assumptions are reflected in Fair Value disclosures.