Note 4 - Loans Receivable and Allowance for Loan Losses

Loans receivable are summarized as follows at December 31:

	2017			2016
	(dollars in thousands)
Residential mortgage	$	287,656		$	260,603
Commercial		37,356			46,468
Commercial real estate		236,302			195,710
Construction, land acquisition, and development		93,060			90,102
Home equity/2nds		15,703			19,129
Consumer		1,084			1,210
Total loans receivable		671,161			613,222
Unearned loan fees		(3,010	)		(2,944	)
Net loans receivable	$	668,151		$	610,278

Certain loans in the amount of $196.9 million have been pledged under a blanket floating lien to the FHLB as collateral against advances.

At December 31, 2017, the Bank was servicing $33.5 million in loans for the Federal National Mortgage Association and $16.0 million in loans for the Federal Home Loan Mortgage Corporation.

Credit Quality

An Allowance is provided through charges to income in an amount that management believes will be adequate to absorb losses on existing loans that may become uncollectible, based on evaluations of the collectability of loans and prior loan loss experience. Management has an established methodology to determine the adequacy of the Allowance that assesses the risks and losses inherent in the loan portfolio. The methodology takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers’ ability to pay. Determining the amount of the Allowance requires the use of estimates and assumptions. Actual results could differ significantly from those estimates. While management uses available information to estimate losses on loans, future additions to the Allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies periodically review the Allowance as an integral part of their examination process. Such agencies may require us to recognize additions to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as of December 31, 2017 and December 31, 2016.

For purposes of determining the Allowance, we have segmented our loan portfolio by product type. Our portfolio loan segments are residential mortgage, commercial, commercial real estate, construction, land acquisition, and development (“ADC”), home equity/2nds, and consumer. We have looked at all segments and have determined that no additional subcategorization is warranted based upon our credit review methodology and our portfolio classes are the same as our portfolio segments.

Inherent Credit Risks

The inherent credit risks within the loan portfolio vary depending upon the loan class as follows:

Residential mortgage - secured by one to four family dwelling units. The loans have limited risk as they are secured by first mortgages on the unit, which are generally the primary residence of the borrower, at a LTV of 80% or less.

Commercial - underwritten in accordance with our policies and include evaluating historical and projected profitability and cash flow to determine the borrower’s ability to repay the obligation as agreed. Commercial loans are made primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral supporting the loan. Accordingly, the repayment of a commercial loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. Additionally, lines of credit are subject to the underwriting standards and processes similar to commercial loans, in addition to those underwriting standards for real estate loans. These loans are viewed primarily as cash flow dependent and, secondarily, as loans secured by real-estate and/or other assets. Repayment of these loans is generally dependent upon the successful operation of the property securing the loan or the principal business conducted on the property securing the loan. Line of credit loans may be adversely affected by conditions in the real estate markets or the economy in general. Management monitors and evaluates line of credit loans based on collateral and risk-rating criteria.

Commercial real estate - subject to the underwriting standards and processes similar to commercial and industrial loans, in addition to those underwriting standards for real estate loans. These loans are viewed primarily as cash flow dependent and secondarily as loans secured by real estate. Repayment of these loans is generally dependent upon the successful operation of the property securing the loan or the principal business conducted on the property securing the loan. Commercial real estate loans may be adversely affected by conditions in the real estate markets or the economy in general. Management monitors and evaluates commercial real estate loans based on collateral and risk-rating criteria. The Bank also utilizes third-party experts to provide environmental and market valuations. The nature of commercial real estate loans makes them more difficult to monitor and evaluate.

ADC - underwritten in accordance with our underwriting policies which include a financial analysis of the developers, property owners, construction cost estimates, and independent appraisal valuations. These loans will rely on the value associated with the project upon completion. These cost and valuation estimates may be inaccurate. Construction loans generally involve the disbursement of substantial funds over a short period of time with repayment substantially dependent upon the success of the completed project rather than the ability of the borrower or guarantor to repay principal and interest. Additionally, land is underwritten according to our policies which include independent appraisal valuations as well as the estimated value associated with the land upon completion of development. These cost and valuation estimates may be inaccurate.

Sources of repayment of these loans typically are permanent financing expected to be obtained upon completion or sales of developed property. These loans are closely monitored by onsite inspections and are considered to be of a higher risk than other real estate loans due to their ultimate repayment being sensitive to general economic conditions, availability of long-term financing, interest rate sensitivity, and governmental regulation of real property.

If the Bank is forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that the Bank will be able to recover all of the unpaid balance of the loan as well as related foreclosure and holding costs. In addition, the Bank may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time.

Home equity/2nds - subject to the underwriting standards and processes similar to residential mortgages and are secured by one to four family dwelling units. Home equity/2nds loans have greater risk than residential mortgages as a result of the Bank generally being in a second lien position.

Consumer - consist of loans to individuals through the Bank’s retail network and are typically unsecured or secured by personal property. Consumer loans have a greater credit risk than residential loans because of the lower value of the underlying collateral, if any.

The following tables present, by portfolio segment, the changes in the Allowance and the recorded investment in loans as of and for the years ended December 31:

	2017
	Residental Mortgage			Commercial		Commercial Real Estate		ADC			Home Equity/ 2nds			Consumer			Total
	(dollars in thousands)
Beginning Balance	$	3,833		$	478	$	2,535	$	1,390		$	728		$	5		$	8,969
Charge-offs		(726	)		-		-		-			(98	)		(2	)		(826	)
Recoveries		375			-		157		-			30			-			562
Net (charge-offs) recoveries		(351	)		-		157		-			(68	)		(2	)		(264	)
(Reversal of) provision for loan losses		(383	)		49		113		(154	)		(274	)		(1	)		(650	)
Ending Balance	$	3,099		$	527	$	2,805	$	1,236		$	386		$	2		$	8,055

Ending balance - individually evaluated for impairment	$	1,181		$	-	$	182	$	48		$	-		$	2		$	1,413
Ending balance - collectively evaluated for impairment		1,918			527		2,623		1,188			386			-			6,642
	$	3,099		$	527	$	2,805	$	1,236		$	386		$	2		$	8,055

Ending loan balance - individually evaluated for impairment	$	18,219		$	-	$	2,917	$	991		$	-		$	84		$	22,211
Ending loan balance - collectively evaluated for impairment		266,427			37,356		233,385		92,069			15,703			1,000			645,940
	$	284,646		$	37,356	$	236,302	$	93,060		$	15,703		$	1,084		$	668,151

	2016
	Residental Mortgage			Commercial			Commercial Real Estate			ADC			Home Equity/ 2nds			Consumer			Total
	(dollars in thousands)
Beginning Balance	$	4,188		$	291		$	2,792		$	956		$	528		$	3		$	8,758
Charge-offs		(151	)		(17	)		(178	)		(72	)		(50	)		-			(468	)
Recoveries		324			54			23			157			421			50			1,029
Net recoveries (charge-offs)		173			37			(155	)		85			371			50			561
(Reversal of) provision for loan losses		(528	)		150			(102	)		349			(171	)		(48	)		(350	)
Ending Balance	$	3,833		$	478		$	2,535		$	1,390		$	728		$	5		$	8,969

Ending balance - individually evaluated for impairment	$	1,703		$	15		$	196		$	53		$	402		$	4		$	2,373
Ending balance - collectively evaluated for impairment		2,130			463			2,339			1,337			326			1			6,596
	$	3,833		$	478		$	2,535		$	1,390		$	728		$	5		$	8,969

Ending loan balance - individually evaluated for impairment	$	20,403		$	148		$	5,656		$	858		$	3,137		$	96		$	30,298
Ending loan balance - collectively evaluated for impairment		237,256			46,320			190,054			89,244			15,992			1,114			579,980
	$	257,659		$	46,468		$	195,710		$	90,102		$	19,129		$	1,210		$	610,278

The following tables present the credit quality breakdown of our loan portfolio by class as of December 31:

	2017
	Pass		Special Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	277,867	$	1,563	$	5,216	$	284,646
Commercial		37,312		44		-		37,356
Commercial real estate		228,746		4,615		2,941		236,302
ADC		91,868		-		1,192		93,060
Home equity/2nds		14,384		465		854		15,703
Consumer		1,084		-		-		1,084
	$	651,261	$	6,687	$	10,203	$	668,151

	2016
	Pass		Special Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	248,819	$	4,316	$	4,524	$	257,659
Commercial		46,011		204		253		46,468
Commercial real estate		184,820		7,420		3,470		195,710
ADC		89,324		-		778		90,102
Home equity/2nds		16,056		472		2,601		19,129
Consumer		1,210		-		-		1,210
	$	586,240	$	12,412	$	11,626	$	610,278

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

The following tables present the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31:

	2017
	30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Total Past Due		Current		Total		Non- Accrual
	(dollars in thousands)
Residential mortgage	$	1,006	$	-	$	-	$	1,006	$	283,640	$	284,646	$	3,891
Commercial		-		-		-		-		37,356		37,356		78
Commercial real estate		948		-		-		948		235,354		236,302		159
ADC		-		-		-		-		93,060		93,060		314
Home equity/2nds		-		-		-		-		15,703		15,703		1,268
Consumer		-		-		-		-		1,084		1,084		-
	$	1,954	$	-	$	-	$	1,954	$	666,197	$	668,151	$	5,710

	2016
	30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Total Past Due		Current		Total		Non- Accrual
	(dollars in thousands)
Residential mortgage	$	1,472	$	2,074	$	964	$	4,510	$	253,149	$	257,659	$	3,580
Commercial		-		-		-		-		46,468		46,468		151
Commercial real estate		-		171		515		686		195,024		195,710		2,938
ADC		106		-		6		112		89,990		90,102		269
Home equity/2nds		34		-		2,174		2,208		16,921		19,129		2,914
Consumer		4		-		-		4		1,206		1,210		-
	$	1,616	$	2,245	$	3,659	$	7,520	$	602,758	$	610,278	$	9,852

We do not have any loans greater than 90 days past due and still accruing as of December 31, 2017 or 2016.

The interest which would have been recorded on the above nonaccrual loans if those loans had been performing in accordance with their contractual terms was approximately $688,000 and $933,000 for the years ended December 31, 2017 and 2016, respectively. The actual interest income recorded on those loans was approximately $282,000 and $427,000 for the years ended December 31, 2017 and 2016, respectively.

The following tables summarize impaired loans as of and for the years ended December 31:

	2017						2016
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Unpaid Principal Balance		Recorded Investment		Related Allowance
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	12,929	$	11,572	$	-	$	9,854	$	9,338	$	-
Commercial		-		-		-		-		-		-
Commercial real estate		1,562		1,507		-		3,900		3,698		-
ADC		636		636		-		441		441		-
Home equity/2nds		-		-		-		2,139		1,529		-
Consumer		-		-		-		-		-		-
With a related Allowance:
Residential mortgage		6,761		6,647		1,181		11,176		11,065		1,703
Commercial		-		-		-		148		148		15
Commercial real estate		1,410		1,410		182		1,958		1,958		196
ADC		392		355		48		417		417		53
Home equity/2nds		-		-		-		1,608		1,608		402
Consumer		84		84		2		96		96		4
Totals:
Residential mortgage		19,690		18,219		1,181		21,030		20,403		1,703
Commercial		-		-		-		148		148		15
Commercial real estate		2,972		2,917		182		5,858		5,656		196
ADC		1,028		991		48		858		858		53
Home equity/2nds		-		-		-		3,747		3,137		402
Consumer		84		84		2		96		96		4

	2017				2016
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	10,072	$	504	$	12,747	$	521
Commercial		-		44		145		2
Commercial real estate		2,423		70		4,021		187
ADC		516		29		1,234		36
Home equity/2nds		543		46		1,889		75
Consumer		-		-		17		-
With a related Allowance:
Residential mortgage		8,714		294		10,785		463
Commercial		30		-		174		8
Commercial real estate		1,817		73		2,020		100
ADC		379		22		489		26
Home equity/2nds		572		1		679		7
Consumer		90		2		79		2
Totals:
Residential mortgage		18,786		798		23,532		984
Commercial		30		44		319		10
Commercial real estate		4,240		143		6,041		287
ADC		895		51		1,723		62
Home equity/2nds		1,115		47		2,568		82
Consumer		90		2		96		2

Consumer mortgage loans included in real estate acquired through foreclosure amounted to $206,000 at December 31, 2016. There were no such loans included in real estate acquired through foreclosure at December 31, 2017. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction totaled $3.1 million as of December 31, 2017.

TDRs

The following table presents loans that were modified during the years ended December 31:

		2017						2016
		Number of Modifications		Recorded Investment Prior to Modification		Recorded Investment After Modification		Number of Modifications		Recorded Investment Prior to Modification		Recorded Investment After Modification
	(dollars in thousands)
Residential Mortgage		$	-	$	-	$	-		3	$	624	$	624
		$	-	$	-	$	-		3	$	624	$	624

Interest on our portfolio of TDRs was accounted for under the following methods as of December 31:

	2017
	Number of Modifications		Accrual Status		Number of Modifications		Nonaccrual Status		Total Number of Modifications		Total Balance of Modifications
	(dollars in thousands)
Residential mortgage		41	$	11,404		2	$	736		43	$	12,140
Commercial real estate		3		1,862		1		78		4		1,940
ADC		1		137		1		6		2		143
Home equity/2nds		1		227		-		-		1		227
Consumer		4		84		-		-		4		84
		50	$	13,714		4	$	820		54	$	14,534

	2016
	Number of Modifications		Accrual Status		Number of Modifications		Nonaccrual Status		Total Number of Modifications		Total Balance of Modifications
	(dollars in thousands)
Residential mortgage		47	$	15,648		4	$	2,137		51	$	17,785
Commercial real estate		3		1,914		2		249		5		2,163
ADC		2		170		1		6		3		176
Home equity/2nds		1		238		-		-		1		238
Consumer		5		96		-		-		5		96
		58	$	18,066		7	$	2,392		65	$	20,458

During 2017 and 2016, there were no TDRs that subsequently defaulted during the 12 month period ended December 31, 2017 and 2016.