Note 3 - Loans Receivable and Allowance for Loan Losses

Loans receivable are summarized as follows:


	September 30, 2019		December 31, 2018
	(dollars in thousands)
Residential mortgage	$	271,336	$	276,389
Commercial		44,774		35,884
Commercial real estate		240,764		244,088
Construction, land acquisition, and development		93,350		114,540
Home equity/2nds		11,930		13,386
Consumer		1,545		1,087
Total loans receivable		663,699		685,374
Unearned loan fees		(2,820)		(3,025)
Loans receivable	$	660,879	$	682,349

Certain loans in the amount of $162.3 million have been pledged under a blanket floating lien to the Federal Home Loan Bank of Atlanta (“FHLB”) as collateral against advances at September 30, 2019.

At September 30, 2019, the Bank was servicing $27.0 million in loans for the Federal National Mortgage Association (“FNMA”) and $13.6 million in loans for the Federal Home Loan Mortgage Corporation (“FHLMC”). At December 31, 2018, the Bank was servicing $29.4 million in loans for FNMA and $15.1 million in loans for FHLMC.

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 all available information to estimate losses on loans, future additions to the Allowance may be necessary based on changes in economic conditions and our actual loss experience. 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 September 30, 2019 and December 31, 2018.

At December 31, 2018, due to a re-evaluation of our qualitative factors, we changed our estimates of the Allowance relative to historical loss experience within specific loan portfolio segments in order to better align our qualitative factors with historical losses experienced over a longer period of time, relative to those specific loan segments. The result of this change in estimate did not result in a material increase in the Allowance compared to the year ended December 31, 2017, however there were material changes to the Allowance between loan segments. Due to the change in accounting estimate, Allowance allocated to commercial loans and ADC loans increased approximately $2.2 million and $1.1 million, respectively, while the Allowance allocated to residential mortgage loans and commercial real estate loans decreased approximately $600,000 and $2.7 million, respectively, as of December 31, 2018. This change in accounting estimate had no impact on earnings or diluted earnings per share.

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 consideration of risk. 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, and are generally at a loan-to-value ratio (“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. 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 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, in addition to those underwriting standards for real estate loans. These loans are viewed primarily as loans secured by real estate and secondarily as cash flow dependent. As repayment of these loans is generally dependent upon the successful operation of the property securing the loan, we look closely at the cash flows generated by the property securing the loan, although the primary underwriting criteria for these loan types is the sufficient value of the underlying collateral. 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.

The sources of repayment of these loans is typically 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 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 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:


	Three Months Ended September 30, 2019
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	2,566	$	1,566	$	792	$	2,683	$	223	$	—	$	263	$	8,093
Charge-offs		—		—		(199)		—		—		(2)		—		(201)
Recoveries		3		—		30		—		3		3		—		39
Net (charge-offs) recoveries		3		—		(169)		—		3		1		—		(162)
Provision for (reversal of) loan losses		(182)		(54)		346		(370)		—		(1)		(239)		(500)
Ending Balance	$	2,387	$	1,512	$	969	$	2,313	$	226	$	—	$	24	$	7,431


	Nine Months Ended September 30, 2019
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	2,224	$	2,736	$	457	$	2,239	$	222	$	1	$	165	$	8,044
Charge-offs		(20)		—		(199)		—		—		(14)		—		(233)
Recoveries		11		—		97		—		9		3		—		120
Net (charge-offs) recoveries		(9)		—		(102)		—		9		(11)		—		(113)
Provision for (reversal of) loan losses		172		(1,224)		614		74		(5)		10		(141)		(500)
Ending Balance	$	2,387	$	1,512	$	969	$	2,313	$	226	$	—	$	24	$	7,431

Ending balance - individually evaluated for impairment	$	799	$	—	$	65	$	32	$	2	$	—	$	—	$	898
Ending balance - collectively evaluated for impairment		1,588		1,512		904		2,281		224		—		24		6,533
	$	2,387	$	1,512	$	969	$	2,313	$	226	$	—	$	24	$	7,431

Ending loan balance -individually evaluated for impairment	$	11,272	$	—	$	1,685	$	729	$	579	$	71			$	14,336
Ending loan balance -collectively evaluated for impairment		258,518		44,774		237,805		92,621		11,351		1,474				646,543
	$	269,790	$	44,774	$	239,490	$	93,350	$	11,930	$	1,545			$	660,879


	December 31, 2018
	Residential				Commercial					Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Ending balance - individually evaluated for impairment	$	927	$	430	$	142	$	32	$	2	$	—	$	—	$	1,533
Ending balance - collectively evaluated for impairment		1,297		2,306		315		2,207		220		1		165		6,511
	$	2,224	$	2,736	$	457	$	2,239	$	222	$	1	$	165	$	8,044

Ending loan balance - individually evaluated for impairment	$	12,579	$	430	$	1,992	$	1,278	$	871	$	76			$	17,226
Ending loan balance - collectively evaluated for impairment		262,180		35,454		240,701		113,262		12,515		1,011				665,123
	$	274,759	$	35,884	$	242,693	$	114,540	$	13,386	$	1,087			$	682,349


	Three Months Ended September 30, 2018
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	2,962	$	414	$	2,591	$	2,060	$	229	$	1	$	—	$	8,257
Charge-offs		(148)		—		—		(6)		—		—		—		(154)
Recoveries		3		—		31		—		219		—		—		253
Net (charge-offs) recoveries		(145)		—		31		(6)		219		—		—		99
Provision for (reversal of) loan losses		204		219		10		(494)		(267)		—		28		(300)
Ending Balance	$	3,021	$	633	$	2,632	$	1,560	$	181	$	1	$	28	$	8,056


	Nine Months Ended September 30, 2018
	Residential				Commercial				Home Equity/
	Mortgage		Commercial		Real Estate		ADC		2nds		Consumer		Unallocated		Total
	(dollars in thousands)
Beginning Balance	$	3,099	$	527	$	2,805	$	1,236	$	386	$	2	$	—	$	8,055
Charge-offs		(508)		—		—		(19)		—		—		—		(527)
Recoveries		225		—		364		—		239		—		—		828
Net (charge-offs) recoveries		(283)		—		364		(19)		239		—		—		301
Provision for (reversal of) loan losses		205		106		(537)		343		(444)		(1)		28		(300)
Ending Balance	$	3,021	$	633	$	2,632	$	1,560	$	181	$	1	$	28	$	8,056

Ending balance - individually evaluated for impairment	$	1,090	$	—	$	166	$	900	$	2	$	1	$	—	$	2,159
Ending balance - collectively evaluated for impairment		1,931		633		2,466		660		179		—		28		5,897
	$	3,021	$	633	$	2,632	$	1,560	$	181	$	1	$	28	$	8,056

Ending loan balance - individually evaluated for impairment	$	15,038	$	—	$	2,053	$	1,582	$	772	$	78			$	19,523
Ending loan balance - collectively evaluated for impairment		270,432		43,180		232,777		111,412		11,401		987				670,189
	$	285,470	$	43,180	$	234,830	$	112,994	$	12,173	$	1,065			$	689,712

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


	September 30, 2019
			Special
	Pass		Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	266,224	$	—	$	3,566	$	269,790
Commercial		43,571		1,203		—		44,774
Commercial real estate		235,048		2,965		1,477		239,490
ADC		92,914		—		436		93,350
Home equity/2nds		11,375		410		145		11,930
Consumer		1,545		—		—		1,545
	$	650,677	$	4,578	$	5,624	$	660,879


	December 31, 2018
			Special
	Pass		Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	270,727	$	827	$	3,205	$	274,759
Commercial		35,435		19		430		35,884
Commercial real estate		237,387		3,523		1,783		242,693
ADC		113,072		—		1,468		114,540
Home equity/2nds		12,536		434		416		13,386
Consumer		1,087		—		—		1,087
	$	670,244	$	4,803	$	7,302	$	682,349

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:


	September 30, 2019
	Past Due
	30-59		60-89		90+								Non-
	Days		Days		Days		Total		Current		Total		Accrual
	(dollars in thousands)
Residential mortgage	$	1,382	$	293	$	3,326	$	5,001	$	264,789	$	269,790	$	3,386
Commercial		—		—		—		—		44,774		44,774		—
Commercial real estate		—		—		578		578		238,912		239,490		692
ADC		76		391		—		467		92,883		93,350		99
Home equity/2nds		—		—		145		145		11,785		11,930		156
Consumer		—		16		—		16		1,529		1,545		—
	$	1,458	$	700	$	4,049	$	6,207	$	654,672	$	660,879	$	4,333


	December 31, 2018
	Past Due
	30-59		60-89		90+								Non-
	Days		Days		Days		Total		Current		Total		Accrual
	(dollars in thousands)
Residential mortgage	$	1,060	$	—	$	1,794	$	2,854	$	271,905	$	274,759	$	2,580
Commercial		—		—		430		430		35,454		35,884		430
Commercial real estate		137		—		660		797		241,896		242,693		660
ADC		255		—		387		642		113,898		114,540		558
Home equity/2nds		96		—		428		524		12,862		13,386		428
Consumer		13		—		—		13		1,074		1,087		—
	$	1,561	$	—	$	3,699	$	5,260	$	677,089	$	682,349	$	4,656

We did not have any loans greater than 90 days past due and still accruing as of September 30, 2019 or December 31, 2018.

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 $440,000 and $713,000 for the nine months ended September 30, 2019 and 2018, respectively. The actual interest received on such loans amounted to $107,000 and $208,000 for the nine months ended September 30, 2019 and 2018, respectively.

The following tables summarize impaired loans:


	September 30, 2019						December 31, 2018
	Unpaid						Unpaid
	Principal		Recorded		Related		Principal		Recorded		Related
	Balance		Investment		Allowance		Balance		Investment		Allowance
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	6,534	$	6,339	$	—	$	7,054	$	6,808	$	—
Commercial		—		—		—		—		—		—
Commercial real estate		1,363		1,126		—		1,244		1,206		—
ADC		599		599		—		1,142		1,143		—
Home equity/2nds		1,010		566		—		1,290		859		—
Consumer		68		68		—		76		76		—
With a related Allowance:
Residential mortgage		5,053		4,933		799		5,888		5,771		927
Commercial		—		—		—		476		430		430
Commercial real estate		559		559		65		795		786		142
ADC		130		130		32		135		135		32
Home equity/2nds		13		13		2		13		12		2
Consumer		3		3		—		—		—		—
Totals:
Residential mortgage		11,587		11,272		799		12,942		12,579		927
Commercial		—		—		—		476		430		430
Commercial real estate		1,922		1,685		65		2,039		1,992		142
ADC		729		729		32		1,277		1,278		32
Home equity/2nds		1,023		579		2		1,303		871		2
Consumer		71		71		—		76		76		—


	Three Months Ended September 30,								Nine Months Ended September 30,
	2019				2018				2019				2018
	Average		Interest		Average		Interest		Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized		Investment		Recognized
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	6,355	$	57	$	6,718	$	75	$	6,797	$	198	$	9,618	$	229
Commercial		—		—		6		—		—		—		59		—
Commercial real estate		1,259		15		1,572		21		1,215		52		1,240		56
ADC		599		8		674		7		925		22		547		20
Home equity/2nds		574		11		371		10		775		32		552		34
Consumer		68		1		—		—		52		4		—		—
With a related Allowance:
Residential mortgage		4,943		66		6,020		79		5,532		206		6,899		219
Commercial		—		—		—		—		108		—		—		—
Commercial real estate		561		6		774		4		660		25		1,243		19
ADC		130		2		176		2		133		6		1,103		9
Home equity/2nds		11		—		400		4		17		1		6		11
Consumer		3		—		79		1		22		—		81		2
Totals:
Residential mortgage		11,298		123		12,738		154		12,329		404		16,517		448
Commercial		—		—		6		—		108		—		59		—
Commercial real estate		1,820		21		2,346		25		1,875		77		2,483		75
ADC		729		10		850		9		1,058		28		1,650		29
Home equity/2nds		585		11		771		14		792		33		558		45
Consumer		71		1		79		1		74		4		81		2

There were $1.3 million and $1.4 million in consumer mortgage properties included in real estate acquired through foreclosure at September 30, 2019 and December 31, 2018, respectively. 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 $3.5 million as of September 30, 2019 and $1.9 million at December 31, 2018.

Troubled Debt Restructure Loans (“TDR” or “TDRs”)

Our portfolio of TDRs was accounted for under the following methods:


	September 30, 2019
							Total	Total
	Number of	Accrual		Number of	Nonaccrual		Number of	Balance of
	Modifications	Status		Modifications	Status		Modifications	Modifications
	(dollars in thousands)
Residential mortgage	32	$	7,828	2	$	292	34	$	8,120
Commercial real estate	2		993	—		—	2		993
ADC	1		131	—		—	1		131
Consumer	3		71	—		—	3		71
	38	$	9,023	2	$	292	40	$	9,315


	December 31, 2018
							Total	Total
	Number of	Accrual		Number of	Nonaccrual		Number of	Balance of
	Modifications	Status		Modifications	Status		Modifications	Modifications
	(dollars in thousands)
Residential mortgage	36	$	9,469	3	$	446	39	$	9,915
Commercial real estate	2		1,019	—		—	2		1,019
ADC	1		134	—		—	1		134
Consumer	3		76	—		—	3		76
	42	$	10,698	3	$	446	45	$	11,144

There were no TDRs that defaulted during the three and nine months ended September 30, 2019 or 2018 which were modified during the previous 12 month period.

We did not modify any loans during the three and nine months ended September 30, 2019 or 2018.