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LOANS AND ALLOWANCE FOR CREDIT LOSSES

3 Months Ended

Mar. 31, 2022

LOANS AND ALLOWANCE FOR CREDIT LOSSES

NOTE 3. LOANS AND ALLOWANCE FOR CREDIT LOSSES

We evaluate risk characteristics of loans based on regulatory call report code with segmentation based on the underlying collateral for certain loan types. The following is a summary of total loans by regulatory call report code segmentation based on underlying collateral for certain loan types:


	March 31,		December 31,
(in thousands)	2022		2021
Commercial construction	$	80,264	$	56,263
Commercial real estate owner occupied		249,460		257,122
Commercial real estate non-owner occupied		966,739		887,092
Tax exempt		38,634		41,280
Commercial and industrial		293,816		307,112
Residential real estate		933,559		888,263
Home equity		84,217		86,657
Consumer other		7,873		8,121
Total loans		2,654,562		2,531,910
Allowance for credit losses		23,190		22,718
Net loans	$	2,631,372	$	2,509,192

Total unamortized net costs and premiums included in loan totals were as follows:


	March 31,		December 31,
(in thousands)	2022		2021
Net unamortized loan origination costs	$	4,384	$	3,014
Net unamortized fair value discount on acquired loans		(4,507)		(4,758)
Total	$	(123)	$	(1,744)

We exclude accrued interest receivable from the amortized cost basis of loans disclosed throughout this footnote. As of March 31, 2022 and December 31, 2021, accrued interest receivable for loans totaled $8.7 million and $6.3 million, respectively, and is included in the “other assets” line item on the consolidated balance sheets.

The CARES Act and subsequent legislation established the Payroll Protection Program (PPP), administered directly by the Small Business Administration (SBA). As of March 31, 2022 and December 31, 2021, we had 9 and 61 PPP loans outstanding, with an outstanding principal balance of $1.1 million and $6.7 million, respectively. PPP loans are included in the commercial and industrial portfolio segment.

Characteristics of each loan portfolio segment are as follows:

Commercial construction - Loans in this segment primarily include raw land, land development and construction of commercial and multifamily residential properties. Collateral values are determined based upon appraisals and evaluations of the completed structure in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy guidelines that are more restrictive than existing structures. Construction loans are primarily paid by the cash flow generated from the completed structure, such as operating leases, rents, or other operating cash flows from the borrower.

Commercial real estate owner occupied and non-owner occupied - Loans in these segments are primarily owner-occupied or income-producing properties. Loans to Real Estate Investment Trusts (REITs) and unsecured loans to developers that closely correlate to the inherent risk in commercial real estate markets are also included. Commercial real estate loans are typically written with amortizing payment structures. Collateral values are determined based upon appraisals and evaluations in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy and regulatory guidelines. Commercial real estate loans are primarily paid by the cash flow generated from the real property, such as operating leases, rents, or other operating cash flows from the borrower.

Tax Exempt - Loans in this segment primarily include loans to various state and municipal government entities. Loans made in these borrowers may provide us with tax-exempt income. While governed and underwritten similar to commercial loans they do have unique requirements based on established polices. Almost all state and municipal loans are considered a general obligation of the issuing entity. Given the size of many municipal borrowers, borrowings are normally not rated by major rating agencies.

Commercial and industrial loans - Loans consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital and/or capital investment in this segment. Generally loans are secured by assets of the business such as accounts receivable, inventory, marketable securities, other liquid collateral, equipment and other business assets. Some loans in this category may be unsecured or guaranteed by government agencies such as the SBA. Loans are primarily paid by the operating cash flow of the borrower.

Residential real estate - All loans in this segment are collateralized by one-to-four family homes. Residential real estate loans held in the loan portfolio are made to borrowers who demonstrate the ability to make scheduled payments with full consideration to various underwriting factors. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.

Home equity - All loans and lines of credit are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied one- to four-family homes, condominiums, or vacation homes. The home equity loan has a fixed rate and is billed as equal payments comprised of principal and interest. The home equity line of credit has a variable rate and is billed as interest-only payments during the draw period. At the end of the draw period, the home equity line of credit is billed as a percentage of the principal balance plus all accrued interest. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.

Consumer other - Loans in this segment include personal lines of credit and amortizing loans made to qualified individuals for various purposes such as auto loans, recreational equipment, overdraft protection or other consumer loans. Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines, as applicable.

Allowance for Credit Losses

The Allowance for Credit Losses (ACL) is comprised of the allowance for loan losses and the allowance for unfunded commitments which is accounted for as a separate liability in other liabilities on the balance sheet. The level of the ACL represents management’s estimate of expected credit losses over the expected life of the loans at the balance sheet date.

The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off. The ACL is comprised of reserves measured on a collective (pool) basis based on a lifetime loss-rate model when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis, generally larger non-accruing commercial loans and TDRs.

The activity in the allowance for credit losses for the periods ended are as follows:


	Three Months Ended March 31, 2022
	Balance at
	Beginning of								Balance at
(in thousands)	Period		Charge Offs		Recoveries		Provision		End of Period
Commercial construction	$	2,111	$	—	$	—	$	(1,110)	$	1,001
Commercial real estate owner occupied		2,751		—		54		(132)		2,673
Commercial real estate non-owner occupied		5,650		—		—		1,357		7,007
Tax exempt		86		—		—		(86)		—
Commercial and industrial		5,369		—		25		(655)		4,739
Residential real estate		5,862		(15)		91		940		6,878
Home equity		814		(2)		5		10		827
Consumer other		75		(66)		3		53		65
Total	$	22,718	$	(83)	$	178	$	377	$	23,190



	Three Months Ended March 31, 2021
	Balance at
	Beginning of		Impact of ASC								Balance at
(in thousands)	Period		326		Charge Offs		Recoveries		Provision		End of Period
Commercial construction	$	824	$	1,196	$	—	$	18	$	(246)	$	1,792
Commercial real estate owner occupied		1,783		708		(153)		—		1,014		3,352
Commercial real estate non-owner occupied		7,864		(2,008)		—		4		42		5,902
Tax exempt		58		40		—		—		(4)		94
Commercial and industrial		3,137		2,996		—		1		(1,094)		5,040
Residential real estate		5,010		1,732		(40)		13		(146)		6,569
Home equity		285		603		(22)		11		(54)		823
Consumer other		121		(39)		(1)		1		(1)		81
Total	$	19,082	$	5,228	$	(216)	$	48	$	(489)	$	23,653

Unfunded Commitments

The allowance for credit losses on unfunded commitments is recognized as a liability (other liabilities on the consolidated balance sheet), with adjustments to the reserve recognized in other non-interest expense in the consolidated statement of operations. The activity in the allowance for credit losses on unfunded commitments for the periods ended was as follows:


(in thousands)	Three Months Ended March 31, 2022		Three Months Ended March 31, 2021
Beginning Balance	$	2,152	$	359
Impact of CECL adoption		—		1,616
Provision for credit losses		30		(156)
Ending Balance	$	2,182	$	1,819

Loan Origination/Risk Management: We have certain lending policies and procedures in place designed to maximize loan income within an acceptable level of risk. Our Board of Directors review and approve these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Board of Directors with frequent reports related to loan production, loan quality, and concentration of credit, loan delinquencies, non-performing loans and potential problem loans. We seek to diversify the loan portfolio as a means of managing risk associated with fluctuations in economic conditions.

Credit Quality Indicators: In monitoring the credit quality of the portfolio, management applies a credit quality indicator and uses an internal risk rating system to categorize commercial loans. These credit quality indicators range from one through nine, with a higher number correlating to increasing risk of loss. Consistent with regulatory guidelines, the Company provides for the classification of loans which are considered to be of lesser quality as special mention, substandard, doubtful, or loss (i.e. risk-rated 6, 7, 8 and 9, respectively).

The following are the definitions of our credit quality indicators:

Pass: Loans we consider in the commercial portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes there is a low risk of loss related to these loans considered pass-rated.

Special Mention: Loans considered having some potential weaknesses, but are deemed to not carry levels of risk inherent in one of the subsequent categories, are designated as special mention. A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. This might include loans which may require a higher level of supervision or internal reporting because of: (i) declining industry trends; (ii) increasing reliance on secondary sources of repayment; (iii) the poor condition of or lack of control over collateral; or (iv) failure to obtain proper documentation or any other deviations from prudent lending practices. Economic or market conditions which may, in the future, affect the obligor may warrant special mention of the asset. Loans for which an adverse trend in the borrower's operations or an imbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized may be included in this classification. Special mention loans are not adversely classified and do not expose us to sufficient risks to warrant classification.

Substandard: Loans we consider as substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well-defined weakness that jeopardizes liquidation of the debt. Substandard loans include those loans where there is the distinct possibility of some loss of principal, if the deficiencies are not corrected.

Doubtful: Loans we consider as doubtful have all of the weaknesses inherent in those loans that are classified as substandard. These loans have the added characteristic of a well-defined weakness which is inadequately protected by the current sound worth and paying capacity of borrower or of the collateral pledged, if any, and calls into question the collectability of the full balance of the loan. The possibility of loss is high but because of certain important and reasonably

specific pending factors which may work to the advantage and strengthening of the loan, its classification as loss is deferred until its more exact status is determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans. The entire amount of the loan might not be classified as doubtful when collection of a specific portion appears highly probable. Loans are generally not classified doubtful for an extended period of time (i.e., over a year).

Loss: Loans we consider as losses are those considered uncollectible and of such little value that their continuance as an asset is not warranted and the uncollectible amounts are charged-off. This classification does not mean the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this worthless asset even though partial recovery may be affected in the future. Losses are taken in the period in which they are determined to be uncollectible.

The following tables present our loans by year of origination, loan segmentation and risk indicator as of March 31, 2022 and December 31, 2021:



(in thousands)	2022		2021		2020		2019		2018		Prior		Total
Commercial construction
Risk rating:
Pass	$	2,227	$	19,550	$	28,953	$	19,964	$	9,570	$	—	$	80,264
Special mention		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—
Total	$	2,227	$	19,550	$	28,953	$	19,964	$	9,570	$	—	$	80,264

Commercial real estate owner occupied
Risk rating:
Pass	$	1,262	$	12,627	$	24,927	$	34,006	$	45,905	$	118,517	$	237,244
Special mention		—		—		—		753		—		2,155		2,908
Substandard		—		—		—		1		853		8,129		8,983
Doubtful		—		—		—		—		167		158		325
Total	$	1,262	$	12,627	$	24,927	$	34,760	$	46,925	$	128,959	$	249,460

Commercial real estate non-owner occupied
Risk rating:
Pass	$	131,384	$	245,340	$	150,428	$	92,441	$	38,769	$	290,549	$	948,911
Special mention		—		—		—		163		—		15,068		15,231
Substandard		—		—		—		—		—		2,434		2,434
Doubtful		—		—		—		—		—		163		163
Total	$	131,384	$	245,340	$	150,428	$	92,604	$	38,769	$	308,214	$	966,739

Tax exempt
Risk rating:
Pass	$	—	$	1,176	$	294	$	961	$	13,680	$	22,523	$	38,634
Special mention		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—
Total	$	—	$	1,176	$	294	$	961	$	13,680	$	22,523	$	38,634

Commercial and industrial
Risk rating:
Pass	$	27,529	$	71,666	$	55,877	$	30,770	$	11,643	$	93,834	$	291,319
Special mention		—		—		15		148		450		622		1,235
Substandard		—		58		2		476		—		594		1,130
Doubtful		—		—		—		—		—		132		132
Total	$	27,529	$	71,724	$	55,894	$	31,394	$	12,093	$	95,182	$	293,816

(continued)







(in thousands)	2022		2021		2020		2019		2018		Prior		Total
Residential real estate
Performing	$	82,004	$	189,709	$	117,170	$	77,932	$	58,274	$	402,431	$	927,520
Nonperforming		—		—		—		—		683		5,356		6,039
Total	$	82,004	$	189,709	$	117,170	$	77,932	$	58,957	$	407,787	$	933,559

Home equity
Performing	$	2,352	$	11,323	$	10,513	$	8,247	$	7,136	$	43,369	$	82,940
Nonperforming		—		—		—		—		—		1,277		1,277
Total	$	2,352	$	11,323	$	10,513	$	8,247	$	7,136	$	44,646	$	84,217

Consumer other
Performing	$	826	$	2,215	$	1,382	$	603	$	558	$	2,285	$	7,869
Nonperforming		—		—		—		—		—		4		4
Total	$	826	$	2,215	$	1,382	$	603	$	558	$	2,289	$	7,873

Total Loans	$	247,584	$	553,664	$	389,561	$	266,465	$	187,688	$	1,009,600	$	2,654,562



(in thousands)	2021		2020		2019		2018		2017		Prior		Total
Commercial construction
Risk rating:
Pass	$	22,866	$	4,787	$	19,211	$	9,399	$	—	$	—	$	56,263
Special mention		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—
Total	$	22,866	$	4,787	$	19,211	$	9,399	$	—	$	—	$	56,263

Commercial real estate owner occupied
Risk rating:
Pass	$	12,940	$	25,240	$	34,782	$	49,136	$	19,292	$	103,144	$	244,534
Special mention		—		—		760		—		—		2,659		3,419
Substandard		—		—		1		853		247		7,737		8,838
Doubtful		—		—		—		167		—		164		331
Total	$	12,940	$	25,240	$	35,543	$	50,156	$	19,539	$	113,704	$	257,122

Commercial real estate non-owner occupied
Risk rating:
Pass	$	235,646	$	172,785	$	119,326	$	39,663	$	136,120	$	165,329	$	868,869
Special mention		—		—		174		—		—		14,789		14,963
Substandard		—		—		—		—		—		3,097		3,097
Doubtful		—		—		—		—		—		163		163
Total	$	235,646	$	172,785	$	119,500	$	39,663	$	136,120	$	183,378	$	887,092

Tax exempt
Risk rating:
Pass	$	1,249	$	299	$	968	$	14,408	$	5,329	$	19,027	$	41,280
Special mention		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—
Total	$	1,249	$	299	$	968	$	14,408	$	5,329	$	19,027	$	41,280

Commercial and industrial
Risk rating:
Pass	$	77,608	$	80,569	$	33,405	$	16,457	$	33,413	$	61,594	$	303,046
Special mention		—		—		584		468		172		1,396		2,620
Substandard		58		3		512		—		48		578		1,199
Doubtful		—		—		—		—		92		155		247
Total	$	77,666	$	80,572	$	34,501	$	16,925	$	33,725	$	63,723	$	307,112

(continued)





(in thousands)	2021		2020		2019		2018		2017		Prior		Total
Residential real estate
Performing	$	191,466	$	120,495	$	83,044	$	62,299	$	59,642	$	364,482	$	881,428
Nonperforming		—		—		—		286		178		6,371		6,835
Total	$	191,466	$	120,495	$	83,044	$	62,585	$	59,820	$	370,853	$	888,263

Home equity
Performing	$	12,770	$	10,461	$	9,005	$	7,855	$	6,474	$	38,823	$	85,388
Nonperforming		—		—		—		—		—		1,269		1,269
Total	$	12,770	$	10,461	$	9,005	$	7,855	$	6,474	$	40,092	$	86,657

Consumer other
Performing	$	2,525	$	1,659	$	792	$	669	$	92	$	2,379	$	8,116
Nonperforming		—		—		—		—		—		5		5
Total	$	2,525	$	1,659	$	792	$	669	$	92	$	2,384	$	8,121

Total Loans	$	557,128	$	416,298	$	302,564	$	201,660	$	261,099	$	793,161	$	2,531,910

Past Dues

The following is a summary of past due loans for the periods ended:


	March 31, 2022
(in thousands)	30-59		60-89		90+		Total Past Due		Current		Total Loans
Commercial construction	$	—	$	—	$	—	$	—	$	80,264	$	80,264
Commercial real estate owner occupied		7		—		—		7		249,453		249,460
Commercial real estate non-owner occupied		83		—		—		83		966,656		966,739
Tax exempt		—		—		—		—		38,634		38,634
Commercial and industrial		82		—		145		227		293,589		293,816
Residential real estate		4,327		673		2,330		7,330		926,229		933,559
Home equity		638		9		408		1,055		83,162		84,217
Consumer other		28		—		2		30		7,843		7,873
Total	$	5,165	$	682	$	2,885	$	8,732	$	2,645,830	$	2,654,562


	December 31, 2021
(in thousands)	30-59		60-89		90+		Total Past Due		Current		Total Loans
Commercial construction	$	—	$	—	$	—	$	—	$	56,263	$	56,263
Commercial real estate owner occupied		1,190		7		1		1,198		255,924		257,122
Commercial real estate non-owner occupied		—		—		—		—		887,092		887,092
Tax exempt		—		—		—		—		41,280		41,280
Commercial and industrial		31		318		185		534		306,578		307,112
Residential real estate		5,010		1,238		1,416		7,664		880,599		888,263
Home equity		699		149		101		949		85,708		86,657
Consumer other		29		—		2		31		8,090		8,121
Total	$	6,959	$	1,712	$	1,705	$	10,376	$	2,521,534	$	2,531,910

Non-Accrual Loans

The following is a summary of non-accrual loans for the periods ended:


	March 31, 2022
			Nonaccrual With No		90+ Days Past
(in thousands)	Nonaccrual		Related Allowance		Due and Accruing
Commercial construction	$	—	$	—	$	—
Commercial real estate owner occupied		748		395		—
Commercial real estate non-owner occupied		610		610		—
Tax exempt		—		—		—
Commercial and industrial		535		415		—
Residential real estate		6,039		1,080		828
Home equity		1,277		296		15
Consumer other		4		—		—
Total	$	9,213	$	2,796	$	843


	December 31, 2021
			Nonaccrual With No		90+ Days Past
(in thousands)	Nonaccrual		Related Allowance		Due and Accruing
Commercial construction	$	—	$	—	$	—
Commercial real estate owner occupied		783		424		—
Commercial real estate non-owner occupied		622		459		—
Tax exempt		—		—		—
Commercial and industrial		677		542		30
Residential real estate		6,835		2,537		41
Home equity		1,269		305		63
Consumer other		5		—		—
Total	$	10,191	$	4,267	$	134

Collateral Dependent Loans

Loans that do not share risk characteristics are evaluated on an individual basis. For loans that are individually evaluated and collateral dependent, financial loans where we have determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and we expect repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date.

The following table presents the amortized cost basis of collateral-dependent loans by loan portfolio segment for the periods ended.


	March 31, 2022				December 31, 2021
(in thousands)	Real Estate		Other		Real Estate		Other
Commercial construction	$	—	$	—	$	—	$	—
Commercial real estate owner occupied		748		—		783		—
Commercial real estate non-owner occupied		610		—		622		—
Tax exempt		—		—		—		—
Commercial and industrial		274		261		385		292
Residential real estate		6,039		—		6,835		—
Home equity		1,277		—		1,269		—
Consumer other		4		—		5		—
Total	$	8,952	$	261	$	9,899	$	292

Troubled Debt Restructuring Loans

The loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (TDR), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as non-performing at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. TDRs are evaluated individually for impairment and may result in a specific allowance amount allocated to an individual loan. There were no modifications qualifying as TDR’s for the three months ended March 31, 2022 and 2021.

Foreclosure

Residential mortgage loans collateralized by real estate that are in the process of foreclosure as of March 31, 2022 and December 31, 2021 totaled $569 thousand and $574 thousand, respectively.

Mortgage Banking

We have identified and designated loans with an unpaid principal balance of $2.9 million and $5.4 million as residential loans held for sale at March 31, 2022 and December 31, 2021, respectively. The interest rate exposure on loans held for sale are mitigated through forward delivery commitments with certain approved secondary market investors. Forward delivery commitments were $9.5 million, and $16.6 million, respectively. Refer to Note 8 for further discussion of forward delivery commitments.

For the three months ended March 31, 2022 and 2021, we sold $22.2 million and $69.2 million, respectively, of residential mortgage loans on the secondary market, which resulted in a net gain on sale of loans (net of costs, including direct and indirect origination costs) of $182 thousand and $1.9 million, respectively.

We sell residential loans on the secondary market while primarily retaining the servicing of these loans. Servicing sold loans helps to maintain customer relationships and earn fees over the servicing period. Loans serviced for others are not included in the accompanying consolidated balance sheets. The risks inherent in servicing assets relate primarily to level of prepayments that result from shifts in interest rates. We obtain third party valuations of our servicing assets portfolio quarterly, and the assumptions are reflected in Fair Value disclosures.