NOTE 5 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The fundamental lending business of the Company is based on understanding, measuring, and controlling the credit risk inherent in the loan portfolio. The Company's loan portfolio is subject to varying degrees of credit risk. These risks entail both general risks, which are inherent in the lending process, and risks specific to individual borrowers. The Company's credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry or collateral type.

The Company currently manages its credit products and the respective exposure to loan losses by the following specific portfolio segments, which are levels at which the Company develops and documents its systematic methodology to determine the allowance for loan losses. The Company considers each loan type to be a portfolio segment having unique risk characteristics.


	March 31,			December 31,
	2020			2019
(dollars in thousands)	Amount		%	Amount		%
Consumer	$	12,700	5	$	12,076	4
Residential real estate		80,782	29		81,033	28
Indirect		95,093	34		102,384	36
Commercial		13,172	5		11,907	4
Construction		2,563	1		3,317	1
Commercial real estate		72,650	26		74,021	27
Loans, net of deferred fees and costs		276,960	100		284,738	100
Less: Allowance for loan losses		(1,918)			(2,066)
Loans, net	$	275,042		$	282,672

The Bank’s net loans totaled $275.0 million at March 31, 2020, compared to $282.7 million at December 31, 2019, a decrease of $7.7 million, or 2.73%. Consumer loans increased from $12.1 million at December 31, 2019 to $12.7 million at March 31, 2020, an increase of $0.6 million, or 5.17%. Residential real estate loans decreased by $0.2 million, or 0.19%, from $81.0 million at December 31, 2019 to $80.8 million at March 31, 2020. Indirect loans decreased from $102.4 million at December 31, 2019 to $95.1 million at March 31, 2020, a decrease of $7.3 million, or 7.12%. Commercial loans increased $1.3 million, or 10.62%, to $13.2 million at March 31, 2020, compared to $11.9 million at December 31, 2019. Construction loans decreased by $0.7 million, or 19.71% to $2.6 million at March 31, 2020, compared to $3.3 million at December 31, 2019. Commercial real estate loans decreased from $74.0 million at December 31, 2019 to $72.7 million at March 31, 2020, a decrease of $1.3 million or 1.72%.

Credit Risk and Allowance for Loan Losses. Credit risk is the risk of loss arising from the inability of a borrower to meet his or her obligations and entails both general risks, which are inherent in the process of lending, and risks specific to individual borrowers. Credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry, or collateral type. Residential mortgage and home equity loans and lines generally have the lowest credit loss experience. Loans secured by personal property, such as auto loans, generally experience medium credit losses. Unsecured loan products, such as personal revolving credit, have the highest credit loss experience and for that reason, the Bank has chosen not to engage in a significant amount of this type of lending. Credit risk in commercial lending can vary significantly, as losses as a percentage of outstanding loans can shift widely during economic cycles and are particularly sensitive to changing economic conditions. Generally, improving economic conditions result in improved operating results on the part of commercial customers, enhancing their ability to meet their particular debt service requirements. Improvements, if any, in operating cash flows can be offset by the impact of rising interest rates that may occur during improved economic times. Inconsistent economic conditions may have an adverse effect on the operating results of commercial customers, reducing their ability to meet debt service obligations.

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. The allowance, based on evaluations of the collectability of loans and prior loan loss experience, is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The evaluations are performed for each class of loans and take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, value of collateral securing the loans and current economic conditions and trends that may affect the borrowers’ ability to pay. For example, delinquencies in unsecured loans and indirect automobile installment loans will be reserved for at significantly higher ratios than loans secured by real estate. Based on that analysis, the Bank deems its allowance for loan losses in proportion to the total nonaccrual loans and past due loans to be sufficient.

For purposes of determining the allowance for loan losses, the Bank segments the loan portfolio into the following classifications:

Consumer

Residential Real Estate

Indirect

Commercial

Construction

Commercial Real Estate

Each of these segments are reviewed and analyzed quarterly using the average historical charge-offs over a forty-eight to sixty month period for their respective segments as well as the following qualitative factors:

Changes in asset quality metrics including past due loans (30 - 89 days), nonaccrual loans, classified assets, watch list loans all in relation to total loans. Also policy exceptions in relationship to loan volume.

Changes in the rate and direction of the loan volume by portfolio segment.

Concentration of credit including the concentration percentages, changes in concentration and concentrations relative to goals.

Changes in macro-economic factors including the rates and direction of unemployment, median income and population.

Changes in internal factors including external loan review required reserve changes, internal review penetration, internal required reserve changes, and weighted required reserve trends.

Changes in rate and direction of charge offs and recoveries.

Transactions in the allowance for loan losses for the three months ended March 31, 2020 and the year ended December 31, 2019 were as follows:



March 31, 2020			Residential								Commercial
(dollars in thousands)	Consumer		Real Estate		Indirect		Commercial		Construction		Real Estate		Total

Balance, beginning of year	$	122	$	589	$	917	$	38	$	11	$	389	$	2,066
Charge-offs		—		—		(125)		—		—		—		(125)
Recoveries		4		3		30		20		—		—		57
Provision for loan losses		(4)		(45)		20		(21)		(2)		(28)		(80)

Balance, end of quarter	$	122	$	547	$	842	$	37	$	9	$	361	$	1,918

Individually evaluated for impairment:
Balance in allowance	$	11	$	—	$	—	$	—	$	—	$	—	$	11
Related loan balance		86		617		—		—		—		3,627		4,330

Collectively evaluated for impairment:
Balance in allowance	$	111	$	547	$	842	$	37	$	9	$	361	$	1,907
Related loan balance		12,614		80,165		95,093		13,172		2,563		69,023		272,630



December 31, 2019			Residential								Commercial
(dollars in thousands)	Consumer		Real Estate		Indirect		Commercial		Construction		Real Estate		Total

Balance, beginning of year	$	161	$	864	$	988	$	241	$	4	$	283	$	2,541
Charge-offs		(69)		(16)		(504)		(27)		—		—		(616)
Recoveries		16		5		225		10		—		—		256
Provision for loan losses		14		(264)		208		(186)		7		106		(115)

Balance, end of year	$	122	$	589	$	917	$	38	$	11	$	389	$	2,066

Individually evaluated for impairment:
Balance in allowance	$	15	$	—	$	—	$	—	$	—	$	—	$	15
Related loan balance		86		631		—		—		—		3,680		4,397

Collectively evaluated for impairment:
Balance in allowance	$	107	$	589	$	917	$	38	$	11	$	389	$	2,051
Related loan balance		11,990		80,402		102,384		11,907		3,317		70,341		280,341

Management believes the allowance for credit losses is at an appropriate level to absorb inherent probable losses in the portfolio.


	March 31,			March 31,
(dollars in thousands)	2020			2019
Average loans	$	281,335		$	299,506
Net charge offs to average loans (annualized)		0.10	%		0.15	%

During the three-month period ended March 31, 2020, loans to 14 borrowers and related entities totaling approximately $125,000 were determined to be uncollectible and were charged off. During the three-month period ending March 31, 2019, loans to 19 borrowers and related entities totaling approximately $205,000 were determined to be uncollectible and were charged off.

Reserve for Unfunded Commitments. Loan commitments and unused lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Bank generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments. The collateral requirement is based on management's credit evaluation of the counter party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

As of March 31, 2020, and 2019, the Bank had outstanding commitments totaling $38.0 million and $33.0 million, respectively. These outstanding commitments consisted of letters of credit, undrawn lines of credit, and other loan commitments. The following table shows the Bank’s reserve for unfunded commitments arising from these transactions:


	Three Months Ended
	Ended March 31,
(dollars in thousands)	2020		2019
Beginning balance	$	37	$	35
Reduction of unfunded reserve		—		(9)
Provisions charged to operations		13		—

Ending balance	$	50	$	26

Contractual Obligations and Commitments. No material changes, outside the normal course of business, have been made during the first quarter of 2020.

Asset Quality. The following tables set forth the amount of the Bank’s current, past due, and non-accrual loans by categories of loans and restructured loans, at the dates indicated.


At March 31, 2020					90 Days or
(dollars in thousands)			30-89 Days		More and
	Current		Past Due		Still Accruing		Nonaccrual		Total

Consumer	$	12,522	$	46	$	—	$	132	$	12,700
Residential Real Estate		80,042		8		19		713		80,782
Indirect		94,393		564		—		136		95,093
Commercial		13,172		—		—		—		13,172
Construction		2,563		—		—		—		2,563
Commercial Real Estate		68,808		735		—		3,107		72,650

	$	271,500	$	1,353	$	19	$	4,088	$	276,960


At December 31, 2019					90 Days or
(dollars in thousands)			30-89 Days		More and
	Current		Past Due		Still Accruing		Nonaccrual		Total

Consumer	$	11,865	$	74	$	—	$	137	$	12,076
Residential Real Estate		80,192		92		21		728		81,033
Indirect		101,605		656		—		123		102,384
Commercial		11,907		—		—		—		11,907
Construction		3,317		—		—		—		3,317
Commercial Real Estate		70,882		—		—		3,139		74,021

	$	279,768	$	822	$	21	$	4,127	$	284,738

The balances in the above charts have not been reduced by the allowance for loan loss. For the period ending March 31, 2020, the allowance for loan loss is $1.9 million. For the period ending December 31, 2019, the allowance for loan loss is $2.1 million.

At March 31, 2020, there was $0.5 million in loans outstanding that were in an accrual status, but known information about possible credit problems of borrowers caused management to have doubts as to the ability of such borrowers to comply with present loan repayment terms. Such loans consist of loans which were not 90 days or more past due but where the borrower is in bankruptcy or has a history of delinquency, or the loan to value ratio is considered excessive due to deterioration of the collateral or other factors. The one loan outstanding, totaling $0.5 million was as follows: $505,000 Commercial Real Estate loan where the guarantor is in bankruptcy and the loan has an accelerated payoff since we have an assignment of rents from the property which has a very long-term national tenant.

Non-accrual loans with specific reserves at March 31, 2020 are comprised of:

Consumer loans – One loan to one borrower that totaled $40,311 with specific reserves of $10,882 established for the loan, which was also a Troubled Debt Restructured loan.

Below is a summary of the recorded investment amount and related allowance for losses of the Bank’s impaired loans at March 31, 2020 and December 31, 2019.


March 31, 2020			Unpaid		Interest				Average
(dollars in thousands)	Recorded		Principal		Income		Specific		Recorded
	Investment		Balance		Recognized		Reserve		Investment
Impaired loans with specific reserves:
Consumer	$	40	$	40	$	1	$	11	$	50
Total impaired loans with specific reserves		40		40		1		11		50


Impaired loans with no specific reserve:
Consumer	$	92	$	92	$	—	$	n/a	$	116
Residential Real Estate		713		768		3		n/a		1,918
Indirect		136		136		—		n/a		152
Commercial Real Estate		3,627		3,627		31		n/a		3,749
Total impaired loans with no specific reserve	$	4,568	$	4,623	$	34		—	$	5,935


December 31, 2019			Unpaid		Interest				Average
(dollars in thousands)	Recorded		Principal		Income		Specific		Recorded
	Investment		Balance		Recognized		Reserve		Investment
Impaired loans with specific reserves:
Consumer	$	26	$	41	$	2	$	15	$	50
Total impaired loans with specific reserves	$	26	$	41	$	2	$	15	$	50

Impaired loans with no specific reserve:
Consumer	$	96	$	96	$	8		n/a	$	122
Residential Real Estate		728		1,497		14		n/a		1,928
Indirect		123		123		6		n/a		—
Commercial Real Estate		3,680		3,680		81		n/a		3,845
Total impaired loans with no specific reserve	$	4,627	$	5,396	$	109		—	$	5,895


	March 31,			December 31,
(dollars in thousands)	2020			2019

Troubled debt restructured loans	$	40		$	41
Non-accrual and 90+ days past due and still accruing loans to average loans		1.46	%		1.45	%
Allowance for loan losses to nonaccrual & 90+ days past due and still accruing loans		46.7	%		49.8	%

At March 31, 2020, there was one troubled debt restructured loans consisting of a consumer loan of $40,000. The consumer loan is in a nonaccrual status.

The following table shows the activity for non-accrual loans for the quarters ended March 31, 2019 and 2020.



		Residential			Commercial
(dollars in thousands)	Consumer	Real Estate	Indirect	Commercial	Real Estate	Totals

December 31, 2018	186	956	116	27	662	1,947
Transfers into nonaccrual	134	571	270	86	—	1,061
Loans paid down/payoffs	(8)	(283)	(8)	—	(16)	(315)
Loans returned to accrual status	—	—	(19)	—	—	(19)
Loans charged off	—	(12)	(173)	(27)	—	(212)

March 31, 2019	312	1,232	186	86	646	2,462


December 31, 2019	137	728	123	—	3,139	4,127
Transfers into nonaccrual	—	—	177	—	—	177
Loans paid down/payoffs	(5)	(15)	(22)	—	(32)	(74)
Loans returned to accrual status	—	—	(17)	—	—	(17)
Loans charged off	—	—	(125)	—	—	(125)

March 31, 2020	132	713	136	—	3,107	4,088

Other Real Estate Owned. At March 31, 2020 and December 31, 2019, the Company had $705,000 in real estate acquired in partial or total satisfaction of debt. All such properties are initially recorded at the lower of cost or fair value (net realizable value) at the date acquired and carried on the balance sheet as other real estate owned. Losses arising at the date of acquisition are charged against the allowance for credit losses. Subsequent write-downs that may be required and expense of operation are included in noninterest expense. Gains and losses realized from the sale of other real estate owned were included in noninterest income.

Credit Quality Information

In addition to monitoring the performance status of the loan portfolio, the Company utilizes a risk rating scale (1-8) to evaluate loan asset quality for all loans. Loans that are rated 1-4 are classified as pass credits. For the pass rated loans, management believes there is a low risk of loss related to these loans and, as necessary, credit may be strengthened through improved borrower performance and/or additional collateral.

The Bank’s internal risk ratings are as follows:

Superior – minimal risk. (normally supported by pledged deposits, United States government securities, etc.)

Above Average - low risk. (all of the risks associated with this credit based on each of the bank’s creditworthiness criteria are minimal)

Average – moderately low risk. (most of the risks associated with this credit based on each of the bank’s creditworthiness criteria are minimal)

Acceptable – moderate risk. (the weighted overall risk associated with this credit based on each of the bank’s creditworthiness criteria is acceptable)

Other Assets Especially Mentioned – moderately high risk. (possesses deficiencies which corrective action by the bank would remedy; potential watch list)

Substandard – (the bank is inadequately protected and there exists the distinct possibility of sustaining some loss if not corrected)

Doubtful – (weaknesses make collection or liquidation in full, based on currently existing facts, improbable)

Loss – (of little value; not warranted as a bankable asset)

The following tables provides information with respect to the Company's credit quality indicators by loan portfolio segment at March 31, 2020 and December 31, 2019:



March 31, 2020			Residential								Commercial
(dollars in thousands)	Consumer		Real Estate		Indirect		Commercial		Construction		Real Estate		Total

Pass	$	12,568	$	80,069	$	94,957	$	13,172	$	2,563	$	69,023	$	272,352
Special mention		—		—		—		—		—		—		—
Substandard		132		713		83		—		—		3,627		4,555
Doubtful		—		—		53		—		—		—		53
Loss		—		—		—		—		—		—		—

	$	12,700	$	80,782	$	95,093	$	13,172	$	2,563	$	72,650	$	276,960

Nonaccrual	$	132	$	713	$	136	$	—	$	—	$	3,107	$	4,088
Troubled debt restructures	$	40	$	—	$	—	$	—	$	—	$	—	$	40
Number of TDRs accounts		1		—		—		—		—		—		1
Non-performing TDRs	$	40	$	—	$	—	$	—	$	—	$	—	$	40
Number of non-performing TDR accounts		1		—		—		—		—		—		1



December 31, 2019			Residential								Commercial
(dollars in thousands)	Consumer		Real Estate		Indirect		Commercial		Construction		Real Estate		Total

Pass	$	11,939	$	80,305	$	102,261	$	11,907	$	3,317	$	70,341	$	280,070
Special mention		—		—		—		—		—		—		—
Substandard		137		728		44		—		—		3,680		4,589
Doubtful		—		—		79		—		—		—		79
Loss		—		—		—		—		—		—		—

	$	12,076	$	81,033	$	102,384	$	11,907	$	3,317	$	74,021	$	284,738

Nonaccrual	$	137	$	728	$	123	$	—	$	—	$	3,139	$	4,127
Troubled debt restructures	$	41	$	—	$	—	$	—	$	—	$	—	$	41
Number of TDRs accounts		1		—		—		—		—		—		1
Non-performing TDRs	$	41	$	—	$	—	$	—	$	—	$	—	$	41
Number of non-performing TDR accounts		1		—		—		—		—		—		1