NOTE 9. Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

Allowance for Loan Losses

The Company has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. At a minimum, the adequacy of the allowance for loan losses is reviewed by management on a quarterly basis. For purposes of determining the allowance for loan losses, the Company has segmented the loans in its portfolio by loan type. Loans are segmented into the following pools: SBA 7(a), SBA 504, commercial, residential mortgages, and consumer loans. Certain portfolio segments are further broken down into classes based on the associated risks within those segments and the type of collateral underlying each loan. Commercial loans are divided into the following four classes: commercial real estate, commercial real estate construction, unsecured business line of credit and commercial other. Consumer loans are divided into two classes as follows: Home equity and other.

The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The same standard methodology is used, regardless of loan type. Specific reserves are made to individual impaired loans and TDRs (see Note 1 for additional information on this term). The general reserve is set based upon a representative average historical net charge-off rate adjusted for the following environmental factors: delinquency and impairment trends, charge-off and recovery trends, changes in the volume of restructured loans, volume and loan term trends, changes in risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. Within the five-year historical net charge-off rate, the Company weights the past three years more heavily as it believes it is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate and high risk. Each environmental factor is evaluated separately for each class of loans and risk weighted based on its individual characteristics.

For SBA 7(a), SBA 504 and commercial loans, the estimate of loss based on pools of loans with similar characteristics is made through the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The loan grading system incorporates reviews of the financial performance of the borrower, including cash flow, debt-service coverage ratio, earnings power, debt level and equity position, in conjunction with an assessment of the borrower's industry and future prospects. It also incorporates analysis of the type of collateral and the relative loan to value ratio.

For residential mortgage and consumer loans, the estimate of loss is based on pools of loans with similar characteristics. Factors such as credit score, delinquency status and type of collateral are evaluated. Factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the reserve factors are made as needed.

According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited. This charge-off policy is followed for all loan types.

The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in methodologies for estimating allocated and general reserves in the portfolio. The unallocated portion of the allowance increased during the quarter ended March 31, 2016, to $284 thousand from $162 thousand at December 31, 2015. The increase in the unallocated portion of the allowance was due to improvements in current period charge off percentages and the rolling off of larger losses in the 2011 period offset by an increase in the environmental factors.

The following tables detail the activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2016 and 2015:


	For the three months ended March 31, 2016
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Balance, beginning of period	$	1,961	$	741	$	6,309	$	2,769	$	817	$	162	$	12,759
Charge-offs		(86)		-		(228)		-		(28)		-		(342)
Recoveries		11		-		6		-		-		-		17
Net (charge-offs) recoveries		(75)		-		(222)		-		(28)		-		(325)
Provision for loan losses charged to expense		(173)		(143)		224		123		47		122		200
Balance, end of period	$	1,713	$	598	$	6,311	$	2,892	$	836	$	284	$	12,634


	For the three months ended March 31, 2015
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Balance, beginning of period	$	1,883	$	1,337	$	6,270	$	2,289	$	667	$	105	$	12,551
Charge-offs		(128)		(589)		(100)		-		(30)		-		(847)
Recoveries		37		-		201		39		-		-		277
Net (charge-offs) recoveries		(91)		(589)		101		39		(30)		-		(570)
Provision for loan losses charged to expense		81		414		(747)		13		73		366		200
Balance, end of period	$	1,873	$	1,162	$	5,624	$	2,341	$	710	$	471	$	12,181

The following tables present loans and their related allowance for loan losses, by portfolio segment, as of March 31, 2016 and December 31, 2015:


	March 31, 2016
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses ending balance:
Individually evaluated for impairment	$	567	$	-	$	151	$	-	$	-	$	-	$	718
Collectively evaluated for impairment		1,146		598		6,160		2,892		836		284		11,916
Total	$	1,713	$	598	$	6,311	$	2,892	$	836	$	284	$	12,634
Loan ending balances:
Individually evaluated for impairment	$	1,655	$	513	$	1,743	$	-	$	-	$	-	$	3,911
Collectively evaluated for impairment		37,208		26,969		465,523		260,957		79,198		-		869,855
Total	$	38,863	$	27,482	$	467,266	$	260,957	$	79,198	$	-	$	873,766


	December 31, 2015
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses ending balance:
Individually evaluated for impairment	$	705	$	-	$	137	$	-	$	-	$	-	$	842
Collectively evaluated for impairment		1,256		741		6,172		2,769		817		162		11,917
Total	$	1,961	$	741	$	6,309	$	2,769	$	817	$	162	$	12,759
Loan ending balances:
Individually evaluated for impairment	$	1,907	$	2,226	$	3,040	$	-	$	-	$	-	$	7,173
Collectively evaluated for impairment		37,486		27,127		462,478		264,523		77,057		-		868,671
Total	$	39,393	$	29,353	$	465,518	$	264,523	$	77,057	$	-	$	875,844

Changes in Methodology:

The Company did not make any changes to its allowance for loan losses methodology in the current period.

Reserve for Unfunded Loan Commitments

In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is classified as other liabilities. At March 31, 2016, a $162 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $138 thousand commitment reserve at December 31, 2015.