Note 3 - Loans Receivable and Allowance for Loan Losses

Loans receivable are summarized as follows at December 31:


	2019		2018
	(dollars in thousands)
Residential mortgage	$	269,654	$	276,389
Commercial		43,127		35,884
Commercial real estate		229,257		244,088
Construction, land acquisition, and development		92,822		114,540
Home equity/2nds		12,031		13,386
Consumer		1,541		1,087
Total loans receivable		648,432		685,374
Unearned loan fees, net		(2,747)		(3,025)
Loans receivable	$	645,685	$	682,349

Certain loans in the amount of $158.9 million have been pledged under a blanket floating lien to the FHLB as collateral against advances.

At December 31, 2019, the Bank was servicing $25.9 million in loans for the Federal National Mortgage Association and $13.0 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 both December 31, 2019 and 2018.

At December 31, 2018, due to a reevaluation of its qualitative factors, the Company changed its estimates of the Allowance relative to historical loss experience within specific loan portfolio segments in order to better align its 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 and $1.1 million, respectively, while Allowance allocated to residential mortgage loans and commercial real estate loans decreased $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, 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.

Commercial 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 loans and lines of credit, 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. 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. Any or all of these costs and valuation estimates could 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 junior 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:


	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)		—		(537)		—		—		(14)		—		(571)
Recoveries		14		—		130		5		11		5		—		165
Net (charge-offs) recoveries		(6)		—		(407)		5		11		(9)		—		(406)
Provision for (reversal of) loan losses		46		(1,315)		934		42		(99)		8		(116)		(500)
Ending Balance	$	2,264	$	1,421	$	984	$	2,286	$	134	$	—	$	49	$	7,138

Ending balance - individually evaluated for impairment	$	752	$	—	$	64	$	32	$	2	$	—	$	—	$	850
Ending balance - collectively evaluated for impairment		1,512		1,421		920		2,254		132		—		49		6,288
	$	2,264	$	1,421	$	984	$	2,286	$	134	$	—	$	49	$	7,138

Ending loan balance -individually evaluated for impairment	$	11,517	$	—	$	1,221	$	880	$	563	$	69			$	14,250
Ending loan balance -collectively evaluated for impairment		256,635		43,127		226,791		91,942		11,468		1,472				631,435
	$	268,152	$	43,127	$	228,012	$	92,822	$	12,031	$	1,541			$	645,685


	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		(534)		—		(38)		(34)		—		—		—		(606)
Recoveries		228		—		424		—		243		—		—		895
Net (charge-offs) recoveries		(306)		—		386		(34)		243		—		—		289
(Reversal of) provision for loan losses		(569)		2,209		(2,734)		1,037		(407)		(1)		165		(300)
Ending Balance	$	2,224	$	2,736	$	457	$	2,239	$	222	$	1	$	165	$	8,044

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

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


	2019
			Special
	Pass		Mention		Substandard		Total
	(dollars in thousands)
Residential mortgage	$	264,008	$	—	$	4,144	$	268,152
Commercial		41,927		1,200		—		43,127
Commercial real estate		224,118		2,835		1,059		228,012
ADC		92,304		—		518		92,822
Home equity/2nds		11,490		402		139		12,031
Consumer		1,541		—		—		1,541
	$	635,388	$	4,437	$	5,860	$	645,685


	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 as of December 31:


	2019
	30-59		60-89		90+
	Days		Days		Days		Total						Non-
	Past Due		Past Due		Past Due		Past Due		Current		Total		Accrual
	(dollars in thousands)
Residential mortgage	$	3,183	$	81	$	2,200	$	5,464	$	262,688	$	268,152	$	3,766
Commercial		—		—		—		—		43,127		43,127		—
Commercial real estate		—		—		126		126		227,886		228,012		237
ADC		—		89		—		89		92,733		92,822		89
Home equity/2nds		—		—		139		139		11,892		12,031		150
Consumer		—		15		—		15		1,526		1,541		—
	$	3,183	$	185	$	2,465	$	5,833	$	639,852	$	645,685	$	4,242


	2018
	30-59		60-89		90+
	Days		Days		Days		Total						Non-
	Past Due		Past Due		Past Due		Past Due		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 December 31, 2019 or 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 $537,000 and $716,000 for the years ended December 31, 2019 and 2018, respectively. The actual interest income recorded on those loans was approximately $184,000 and $273,000 for the years ended December 31, 2019 and 2018, respectively.

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


	2019						2018
	Unpaid						Unpaid
	Principal		Recorded		Related		Principal		Recorded		Related
	Balance		Investment		Allowance		Balance		Investment		Allowance
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	7,258	$	7,035	$	—	$	7,054	$	6,808	$	—
Commercial		—		—		—		—		—		—
Commercial real estate		908		668		—		1,244		1,206		—
ADC		752		752		—		1,142		1,143		—
Home equity/2nds		996		553		—		1,290		859		—
Consumer		69		69		—		76		76		—
With a related Allowance:
Residential mortgage		4,604		4,482		752		5,888		5,771		927
Commercial		—		—		—		476		430		430
Commercial real estate		553		553		64		795		786		142
ADC		128		128		32		135		135		32
Home equity/2nds		12		10		2		13		12		2
Consumer		—		—		—		—		—		—
Totals:
Residential mortgage		11,862		11,517		752		12,942		12,579		927
Commercial		—		—		—		476		430		430
Commercial real estate		1,461		1,221		64		2,039		1,992		142
ADC		880		880		32		1,277		1,278		32
Home equity/2nds		1,008		563		2		1,303		871		2
Consumer		69		69		—		76		76		—


	2019				2018
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
With no related Allowance:	(dollars in thousands)
Residential mortgage	$	6,844	$	318	$	9,232	$	344
Commercial		—		—		47		30
Commercial real estate		1,105		63		1,223		52
ADC		891		36		542		52
Home equity/2nds		730		28		570		42
Consumer		73		5		80		2
With a related Allowance:
Residential mortgage		5,322		259		6,673		288
Commercial		86		—		86		71
Commercial real estate		639		33		1,151		26
ADC		132		8		909		8
Home equity/2nds		16		1		7		1
Consumer		—		—		—		—
Totals:
Residential mortgage		12,166		577		15,905		632
Commercial		86		—		133		101
Commercial real estate		1,744		96		2,374		78
ADC		1,023		44		1,451		60
Home equity/2nds		746		29		577		43
Consumer		73		5		80		2

There were $1.4 million in consumer mortgage properties included in real estate acquired through foreclosure at both December 31, 2019 and 2018. 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 $2.3 million as of December 31, 2019.

TDRs

There were no loans modified during the year ended December 31, 2019 that were deemed to be TDRs.

The following table presents loans that were modified (as TDRs) during the year ended December 31, 2018:


		Recorded		Recorded
		Investment		Investment
	Number of	Prior to		After
	Modifications	Modification		Modification
	(dollars in thousands)
Residential Mortgage	1	$	127	$	127
	1	$	127	$	127

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


	2019
							Total	Total
	Number of	Accrual		Number of	Nonaccrual		Number of	Balance of
	Modifications	Status		Modifications	Status		Modifications	Modifications
	(dollars in thousands)
Residential mortgage	31	$	7,675	1	$	85	32	$	7,760
Commercial real estate	2		984	—		—	2		984
ADC	1		130	—		—	1		130
Consumer	2		69	—		—	2		69
	36	$	8,858	1	$	85	37	$	8,943


	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

During 2019 and 2018, there were no TDRs that subsequently defaulted during the 12 month period ended December 31, 2019 and 2018.