Loans

The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses as of March 31, 2020 and December 31, 2019:



(In thousands)	March 31, 2020		December 31, 2019
SBA loans held for investment	$	37,074	$	35,767
Commercial loans
SBA 504 loans	25,185		26,726
Commercial other	120,029		112,014
Commercial real estate	586,336		578,643
Commercial real estate construction	54,528		47,649
Residential mortgage loans	456,072		467,706
Consumer loans
Home equity	75,240		69,589
Consumer other	74,455		73,935
Total loans held for investment	$	1,428,919	$	1,412,029
SBA loans held for sale	10,726		13,529
Total loans	$	1,439,645	$	1,425,558

Loans are made to individuals as well as commercial entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type. A description of the Company's different loan segments follows:

SBA Loans: SBA 7(a) loans, on which the SBA has historically provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses' major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Loans will generally be guaranteed in full or for a meaningful amount by the businesses' major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.

Residential Mortgage and Consumer Loans: The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans and consumer construction lines. The Company originates qualified mortgages which are generally sold in the secondary market and nonqualified mortgages which are generally held for investment. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and Company’s relationship with the borrower.

Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality which in part is derived from ongoing collection and review of borrowers’ financial information, as well as independent credit reviews by an outside firm.

The Company's extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company's loans. This policy and the underlying procedures are reviewed and approved by the Board of Directors on a regular basis.

Credit Ratings

For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.

Pass: Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed “Pass”.

Special Mention: Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in startup or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. This definition is intended to ensure that the “Special Mention” category is not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.

Substandard: Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”. A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.

A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.

Loss: Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.

For residential mortgage and consumer loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.

At March 31, 2020, the Company owned $1.5 million in residential consumer properties that were included in OREO in the Consolidated Balance Sheets, compared to $1.7 million at December 31, 2019. Additionally, there were $4.3 million of residential consumer loans in the process of foreclosure at March 31, 2020, compared to $3.6 million at December 31, 2019.

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of March 31, 2020:



	March 31, 2020
	SBA, SBA 504 & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	35,994	$	—	$	1,080	$	37,074
Commercial loans
SBA 504 loans	23,374		1,779		32		25,185
Commercial other	114,840		3,525		1,664		120,029
Commercial real estate	584,044		749		1,543		586,336
Commercial real estate construction	54,528		—		—		54,528
Total commercial loans	776,786		6,053		3,239		786,078
Total SBA, SBA 504 and commercial loans	$	812,780	$	6,053	$	4,319	$	823,152

	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	449,162	$	6,910	$	456,072
Consumer loans
Home equity			74,735		505		75,240
Consumer other			74,455		—		74,455
Total consumer loans			149,190		505		149,695
Total residential mortgage and consumer loans			$	598,352	$	7,415	$	605,767

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2019:



	December 31, 2019
	SBA, SBA 504 & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	34,202	$	1,115	$	450	$	35,767
Commercial loans
SBA 504 loans	24,878		1,808		40		26,726
Commercial other	107,220		3,361		1,433		112,014
Commercial real estate	576,326		758		1,559		578,643
Commercial real estate construction	47,649		—		—		47,649
Total commercial loans	756,073		5,927		3,032		765,032
Total SBA, SBA 504 and commercial loans	$	790,275	$	7,042	$	3,482	$	800,799

	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	463,770	$	3,936	$	467,706
Consumer loans
Home equity			69,589		—		69,589
Consumer other			73,915		20		73,935
Total consumer loans			143,504		20		143,524
Total residential mortgage and consumer loans			$	607,274	$	3,956	$	611,230

Nonperforming and Past Due Loans

Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well collateralized and in the process of collection. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.

The following tables set forth an aging analysis of past due and nonaccrual loans as of March 31, 2020 and December 31, 2019:



	March 31, 2020
(In thousands)	30-59 days past due		60-89 days past due		90+ days and still accruing		Nonaccrual (1)		Total past due		Current		Total loans
SBA loans held for investment	$	131	$	154	$	—	$	1,627	$	1,912	$	35,162	$	37,074
Commercial loans
SBA 504 loans	—		—		—		—		—		25,185		25,185
Commercial other	566		71		—		—		637		119,392		120,029
Commercial real estate	785		75		—		613		1,473		584,863		586,336
Commercial real estate construction	—		—		—		—		—		54,528		54,528
Residential mortgage loans	5,880		373		—		6,910		13,163		442,909		456,072
Consumer loans
Home equity	561		329		—		505		1,395		73,845		75,240
Consumer other	—		—		—		—		—		74,455		74,455
Total loans held for investment	$	7,923	$	1,002	$	—	$	9,655	$	18,580	$	1,410,339	$	1,428,919
SBA loans held for sale	—		—		—		—		—		10,726		10,726
Total loans	$	7,923	$	1,002	$	—	$	9,655	$	18,580	$	1,421,065	$	1,439,645


(1)	At March 31, 2020, nonaccrual loans included $427 thousand of loans guaranteed by the SBA.



	December 31, 2019
(In thousands)	30-59 days past due		60-89 days past due		90+ days and still accruing		Nonaccrual (1)		Total past due		Current		Total loans
SBA loans held for investment	$	1,048	$	—	$	—	$	1,164	$	2,212	$	33,555	$	35,767
Commercial loans
SBA 504 loans	—		1,808		—		—		1,808		24,918		26,726
Commercial other	71		—		—		316		387		111,627		112,014
Commercial real estate	215		—		—		213		428		578,215		578,643
Commercial real estate construction	—		—		—		—		—		47,649		47,649
Residential mortgage loans	4,383		1,676		930		3,936		10,925		456,781		467,706
Consumer loans
Home equity	1,446		178		—		—		1,624		67,965		69,589
Consumer other	—		113		—		20		133		73,802		73,935
Total loans held for investment	$	7,163	$	3,775	$	930	$	5,649	$	17,517	$	1,394,512	$	1,412,029
SBA loans held for sale	—		—		—		—		—		13,529		13,529
Total loans	$	7,163	$	3,775	$	930	$	5,649	$	17,517	$	1,408,041	$	1,425,558


(1)	At December 31, 2019, nonaccrual loans included $59 thousand of loans guaranteed by the SBA.

Impaired Loans

The Company has defined impaired loans to be all nonperforming loans individually evaluated for impairment and TDRs. Management considers a loan impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract. Impairment is evaluated on an individual basis for SBA and commercial loans.

The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of March 31, 2020:



	March 31, 2020
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	1,221	$	1,062	$	—
Commercial loans
Commercial other	500		—		—
Commercial real estate	913		613		—
Total commercial loans	1,413		613		—
Total impaired loans with no related allowance	2,634		1,675		—

With an allowance:
SBA loans held for investment (1)	163		138		138
Commercial loans
Commercial real estate	694		694		46
Total commercial loans	694		694		46
Total impaired loans with a related allowance	857		832		184

Total individually evaluated impaired loans:
SBA loans held for investment (1)	1,384		1,200		138
Commercial loans
Commercial other	500		—		—
Commercial real estate	1,607		1,307		46
Total commercial loans	2,107		1,307		46
Total individually evaluated impaired loans	$	3,491	$	2,507	$	184


(1)	Balances are reduced by amount guaranteed by the SBA of $427 thousand at March 31, 2020.

The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of December 31, 2019:



	December 31, 2019
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	1,224	$	1,064	$	—
Commercial loans
Commercial real estate	213		213		—
Total commercial loans	213		213		—
Total impaired loans with no related allowance	1,437		1,277		—

With an allowance:
SBA loans held for investment (1)	157		41		41
Commercial loans
Commercial other	816		316		316
Commercial real estate	705		705		57
Total commercial loans	1,521		1,021		373
Total impaired loans with a related allowance	1,678		1,062		414

Total individually evaluated impaired loans:
SBA loans held for investment (1)	1,381		1,105		41
Commercial loans
Commercial other	816		316		316
Commercial real estate	918		918		57
Total commercial loans	1,734		1,234		373
Total individually evaluated impaired loans	$	3,115	$	2,339	$	414


(1)	Balances are reduced by amount guaranteed by the SBA of $59 thousand at December 31, 2019.

Impaired loans increased $376 thousand at March 31, 2020 compared to December 31, 2019. The increase in impaired loans was primarily due to the addition of one commercial loan totaling $913 thousand, partially offset by paydowns on two commercial loans totaling $529 thousand.

The following table presents the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the three months ended March 31, 2020 and 2019. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, and therefore no interest income is recognized. The interest income recognized on impaired loans noted below represents primarily accruing TDRs and nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.



	For the three months ended March 31,
	2020				2019
(In thousands)	Average recorded investment		Interest income recognized on impaired loans		Average recorded investment		Interest income recognized on impaired loans
SBA loans held for investment (1)	$	1,128	$	3	$	1,183	$	4
Commercial loans
SBA 504 loans	600		32		—		—
Commercial other	5		10		7		—
Commercial real estate	1,047		12		1,789		9
Total	$	2,780	$	57	$	2,979	$	13


(1)	Balances are reduced by the average amount guaranteed by the SBA of $182 thousand and $100 thousand for the three months ended March 31, 2020 and 2019, respectively.

TDRs

The Company's loan portfolio also includes certain loans that have been modified as TDRs. TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs if the loan is collateral-dependent. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.

The Company had one performing TDR with a balance of $694 thousand and $705 thousand as of March 31, 2020 and December 31, 2019, respectively, which was included in the impaired loan numbers as of such dates. At March 31, 2020 and December 31, 2019, there were specific reserves on the performing TDR of $46 thousand and $57 thousand, respectively. The loan remains in accrual status since it continues to perform in accordance with the restructured terms.

To date, the Company’s TDRs consisted of interest rate reductions, interest only periods, principal balance reductions, and maturity extensions. There were no loans modified during the three months ended March 31, 2020 and 2019 that were deemed to be TDRs. There were no loans modified as a TDR within the previous 12 months that subsequently defaulted at some point during the three months ended March 31, 2020. In this case, the subsequent default is defined as 90 days past due or transferred to nonaccrual status.