5. Loans and leases

The classifications of loans and leases at March 31, 2020 and December 31, 2019 are summarized as follows:



(dollars in thousands)	March 31, 2020		December 31, 2019
Commercial and industrial	$	118,140	$	122,594
Commercial real estate:
Non-owner occupied		95,630		99,801
Owner occupied		125,976		130,558
Construction		3,196		4,654
Consumer:
Home equity installment		35,456		36,631
Home equity line of credit		46,850		47,282
Auto loans		102,213		105,870
Direct finance leases		17,356		16,355
Other		7,025		5,634
Residential:
Real estate		175,453		167,164
Construction		18,767		17,770
Total		746,062		754,313
Less:
Allowance for loan losses		(10,017)		(9,747)
Unearned lease revenue		(938)		(903)
Loans and leases, net	$	735,107	$	743,663

Net deferred loan costs of $3.0 million have been included in the carrying values of loans at both March 31, 2020 and December 31, 2019.

Direct finance leases include the lease receivable and the guaranteed lease residual. Unearned lease revenue represents the difference between the lessor’s investment in the property and the gross investment in the lease. Unearned revenue is accrued over the life of the lease using the effective interest method.

The Company services real estate loans for investors in the secondary mortgage market which are not included in the accompanying consolidated balance sheets. The approximate unpaid principal balance of mortgages serviced amounted to $299.0 million as of March 31, 2020 and $302.3 million as of December 31, 2019. Mortgage servicing rights amounted to $1.0 million and $1.0 million as of March 31, 2020 and December 31, 2019, respectively.

Management is responsible for conducting the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial and industrial and commercial real estate loans. Commercial and industrial and commercial real estate loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed as the case may be. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The Company utilizes an external independent loan review firm that reviews and validates the credit risk program on at least an annual basis. Results of these reviews are presented to management and the board of directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Non-accrual loans

The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. C&I and CRE loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by real estate and residential mortgage loans are placed on non-accrual status at 120 days past due as to principal and interest and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. The Company considers all non-accrual loans to be impaired loans.

Non-accrual loans, segregated by class, at March 31, 2020 and December 31, 2019, were as follows:



(dollars in thousands)	March 31, 2020		December 31, 2019
Commercial and industrial	$	310	$	336
Commercial real estate:
Non-owner occupied		419		510
Owner occupied		1,465		1,447
Consumer:
Home equity installment		62		65
Home equity line of credit		340		294
Auto loans		92		16
Residential:
Real estate		966		1,006
Total	$	3,654	$	3,674

Troubled Debt Restructuring (TDR)

A modification of a loan constitutes a troubled debt restructuring (TDR) when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company considers all TDRs to be impaired loans. The Company typically considers the following concessions when modifying a loan, which may include lowering interest rates below the market rate, temporary interest-only payment periods, term extensions at interest rates lower than the current market rate for new debt with similar risk and/or converting revolving credit lines to term loans. The Company typically does not forgive principal when granting a TDR modification. Of the TDRs outstanding as of March 31, 2020 and December 31, 2019, when modified, the concessions granted consisted of temporary interest-only payments, extensions of maturity date, or a reduction in the rate of interest to a below-market rate for a contractual period of time. Other than the TDRs that were placed on non-accrual status, the TDRs were performing in accordance with their modified terms.

There were no loans modified as TDRs for the three months ended March 31, 2020 and 2019. Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. There were no loans modified as a TDR within the previous twelve months that subsequently defaulted during the three months ended March 31, 2020 and 2019.

The allowance for loan losses (allowance) may be increased, adjustments may be made in the allocation of the allowance or partial charge-offs may be taken to further write-down the carrying value of the loan. An allowance for impaired loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price. If the loan is collateral dependent, the estimated fair value of the collateral is used to establish the allowance. As of March 31, 2020 and 2019, respectively, the allowance for impaired loans that have been modified in a TDR was $0.2 million and $0.2 million, respectively.

Past due loans

Loans are considered past due when the contractual principal and/or interest is not received by the due date. For loans reported 30-59 days past due, certain categories of loans are reported past due as and when the loan is in arrears for two payments or billing cycles. An aging analysis of past due loans, segregated by class of loans, as of the period indicated is as follows (dollars in thousands):



														Recorded
					Past due									investment past
	30 - 59 Days		60 - 89 Days		90 days		Total				Total			due ≥ 90 days
March 31, 2020	past due		past due		or more (1)		past due		Current		loans (3)			and accruing

Commercial and industrial	$	1,590	$	1,009	$	310	$	2,909	$	115,231	$	118,140		$	-
Commercial real estate:
Non-owner occupied		1,137		380		419		1,936		93,694		95,630			-
Owner occupied		783		360		1,465		2,608		123,368		125,976			-
Construction		-		-		-		-		3,196		3,196			-
Consumer:
Home equity installment		63		28		62		153		35,303		35,456			-
Home equity line of credit		362		13		340		715		46,135		46,850			-
Auto loans		888		23		92		1,003		101,210		102,213			-
Direct finance leases		294		-		-		294		16,124		16,418	(2)		-
Other		25		3		-		28		6,997		7,025			-
Residential:
Real estate		-		1,350		966		2,316		173,137		175,453			-
Construction		-		-		-		-		18,767		18,767			-
Total	$	5,142	$	3,166	$	3,654	$	11,962	$	733,162	$	745,124		$	-

(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $0.9 million. (3) Includes net deferred loan costs of $3.0 million.



														Recorded
					Past due									investment past
	30 - 59 Days		60 - 89 Days		90 days		Total				Total			due ≥ 90 days
December 31, 2019	past due		past due		or more (1)		past due		Current		loans (3)			and accruing

Commercial and industrial	$	33	$	171	$	336	$	540	$	122,054	$	122,594		$	-
Commercial real estate:
Non-owner occupied		-		70		510		580		99,221		99,801			-
Owner occupied		180		89		1,447		1,716		128,842		130,558			-
Construction		-		-		-		-		4,654		4,654			-
Consumer:
Home equity installment		-		5		65		70		36,561		36,631			-
Home equity line of credit		49		-		294		343		46,939		47,282			-
Auto loans		316		46		16		378		105,492		105,870			-
Direct finance leases		59		79		-		138		15,314		15,452	(2)		-
Other		15		1		-		16		5,618		5,634			-
Residential:
Real estate		29		224		1,006		1,259		165,905		167,164			-
Construction		-		-		-		-		17,770		17,770			-
Total	$	681	$	685	$	3,674	$	5,040	$	748,370	$	753,410		$	-

(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $0.9 million. (3) Includes net deferred loan costs of $3.0 million.

Impaired loans

A loan is considered impaired when, based on current information and events; it is probable that the Company will be unable to collect the payments in accordance with the contractual terms of the loan. Factors considered in determining impairment include payment status, collateral value and the probability of collecting payments when due. The significance of payment delays and/or shortfalls is determined on a case-by-case basis. All circumstances surrounding the loan are taken into account. Such factors include the length of the delinquency, the underlying reasons and the borrower’s prior payment record. Impairment is measured on these loans on a loan-by-loan basis. Impaired loans include non-accrual loans, TDRs and other loans deemed to be impaired based on the aforementioned factors.

At March 31, 2020, impaired loans totaled $4.6 million consisting of $1.0 million in accruing TDRs and $3.6 million in non-accrual loans. At December 31, 2019, impaired loans totaled $4.7 million consisting of $1.0 million in accruing TDRs and $3.7 million in non-accrual loans. As of March 31, 2020, the non-accrual loans included two TDRs to two unrelated borrowers totaling $0.6 million compared with two TDRs to two unrelated borrowers totaling $0.6 million as of December 31, 2019.

Impaired loans, segregated by class, as of the period indicated are detailed below:



			Recorded		Recorded
	Unpaid		investment		investment		Total
	principal		with		with no		recorded		Related
(dollars in thousands)	balance		allowance		allowance		investment		allowance
March 31, 2020
Commercial and industrial	$	310	$	310	$	-	$	310	$	195
Commercial real estate:
Non-owner occupied		1,098		203		628		831		118
Owner occupied		2,352		1,121		920		2,041		194
Consumer:
Home equity installment		104		39		23		62		1
Home equity line of credit		407		135		205		340		74
Auto loans		108		-		92		92		-
Residential:										-
Real estate		1,044		627		339		966		137
Total	$	5,423	$	2,435	$	2,207	$	4,642	$	719



			Recorded		Recorded
	Unpaid		investment		investment		Total
	principal		with		with no		recorded		Related
(dollars in thousands)	balance		allowance		allowance		investment		allowance
December 31, 2019
Commercial and industrial	$	336	$	336	$	-	$	336	$	221
Commercial real estate:
Non-owner occupied		1,047		333		591		924		232
Owner occupied		2,336		1,052		972		2,024		194
Consumer:
Home equity installment		106		-		65		65		-
Home equity line of credit		362		88		206		294		87
Auto loans		32		-		16		16		-
Residential:										-
Real estate		1,053		678		328		1,006		174
Total	$	5,272	$	2,487	$	2,178	$	4,665	$	908

The following table presents the average recorded investments in impaired loans and related amount of interest income recognized during the periods indicated below. The average balances are calculated based on the quarter-end balances of impaired loans. Payments received from non-accruing impaired loans are first applied against the outstanding principal balance, then to the recovery of any charged-off amounts. Any excess is treated as a recovery of interest income. Payments received from accruing impaired loans are applied to principal and interest, as contractually agreed upon.



	March 31, 2020						March 31, 2019
					Cash basis						Cash basis
	Average		Interest		interest		Average		Interest		interest
	recorded		income		income		recorded		income		income
(dollars in thousands)	investment		recognized		recognized		investment		recognized		recognized

Commercial and industrial	$	252	$	-	$	-	$	178	$	1	$	-
Commercial real estate:
Non-owner occupied		884		6		-		1,701		8		-
Owner occupied		2,327		6		-		2,589		10		-
Construction		-		-		-		75		-		-
Consumer:
Home equity installment		49		-		-		381		-		-
Home equity line of credit		245		-		-		42		-		-
Auto Loans		52		-		-		35		-		-
Other		-		-		-		4		-		-
Residential:
Real estate		1,102		-		-		1,347		9		-
Total	$	4,911	$	12	$	-	$	6,352	$	28	$	-

Credit Quality Indicators

Commercial and industrial and commercial real estate

The Company utilizes a loan grading system and assigns a credit risk grade to its loans in the C&I and CRE portfolios. The grading system provides a means to measure portfolio quality and aids in the monitoring of the credit quality of the overall loan portfolio. The credit risk grades are arrived at using a risk rating matrix to assign a grade to each of the loans in the C&I and CRE portfolios.

The following is a description of each risk rating category the Company uses to classify each of its C&I and CRE loans:

Pass

Loans in this category have an acceptable level of risk and are graded in a range of one to five. Secured loans generally have good collateral coverage. Current financial statements reflect acceptable balance sheet ratios, sales and earnings trends. Management is considered to be competent, and a reasonable succession plan is evident. Payment experience on the loans has been good with minor or no delinquency experience. Loans with a grade of one are of the highest quality in the range. Those graded five are of marginally acceptable quality.

Special Mention

Loans in this category are graded a six and may be protected but are potentially weak. They constitute a credit risk to the Company, but have not yet reached the point of adverse classification. Some of the following conditions may exist: little or no collateral coverage; lack of current financial information; delinquency problems; highly leveraged; available financial information reflects poor balance sheet ratios and profit and loss statements reflect uncertain trends; and document exceptions. Cash flow may not be sufficient to support total debt service requirements.

Substandard

Loans in this category are graded a seven and have a well-defined weakness which may jeopardize the ultimate collectability of the debt. The collateral pledged may be lacking in quality or quantity. Financial statements may indicate insufficient cash flow to service the debt; and/or do not reflect a sound net worth. The payment history indicates chronic delinquency problems. Management is considered to be weak. There is a distinct possibility that the Company may sustain a loss. All loans on non-accrual are rated substandard. Other loans that are included in the substandard category can be accruing, as well as loans that are current or past due. Loans 90 days or more past due, unless otherwise fully supported, are classified substandard. Also, borrowers that are bankrupt or have loans categorized as TDRs can be graded substandard.

Doubtful

Loans in this category are graded an eight and have a better than 50% possibility of the Company sustaining a loss, but the loss cannot be determined because of specific reasonable factors which may strengthen credit in the near-term. Many of the weaknesses present in a substandard loan exist. Liquidation of collateral, if any, is likely. Any loan graded lower than an eight is considered to be uncollectible and charged-off.

Consumer and residential

The consumer and residential loan segments are regarded as homogeneous loan pools and as such are not risk rated. For these portfolios, the Company utilizes payment activity and history in assessing performance. Non-performing loans are comprised of non-accrual loans and loans past due 90 days or more and accruing. All loans not classified as non-performing are considered performing.

The following table presents loans including $3.0 million and $3.0 million of deferred costs, segregated by class, categorized into the appropriate credit quality indicator category as of March 31, 2020 and December 31, 2019, respectively:

Commercial credit exposure

Credit risk profile by creditworthiness category




	March 31, 2020
(dollars in thousands)	Pass		Special mention		Substandard		Doubtful		Total

Commercial and industrial	$	110,927	$	1,820	$	5,393	$	-	$	118,140
Commercial real estate - non-owner occupied		88,576		1,090		5,964		-		95,630
Commercial real estate - owner occupied		117,458		1,890		6,628		-		125,976
Commercial real estate - construction		2,389		56		751		-		3,196
Total commercial	$	319,350	$	4,856	$	18,736	$	-	$	342,942

Consumer & Mortgage lending credit exposure

Credit risk profile based on payment activity



	March 31, 2020
(dollars in thousands)	Performing		Non-performing		Total

Consumer
Home equity installment	$	35,394	$	62	$	35,456
Home equity line of credit		46,510		340		46,850
Auto loans		102,121		92		102,213
Direct finance leases (1)		16,418		-		16,418
Other		7,025		-		7,025
Total consumer		207,468		494		207,962
Residential
Real estate		174,487		966		175,453
Construction		18,767		-		18,767
Total residential		193,254		966		194,220
Total consumer & residential	$	400,722	$	1,460	$	402,182

(1)Net of unearned lease revenue of $0.9 million.

Commercial credit exposure

Credit risk profile by creditworthiness category


	December 31, 2019
(dollars in thousands)	Pass		Special mention		Substandard		Doubtful		Total

Commercial and industrial	$	115,585	$	2,061	$	4,948	$	-	$	122,594
Commercial real estate - non-owner occupied		92,016		1,360		6,425		-		99,801
Commercial real estate - owner occupied		121,887		2,065		6,606		-		130,558
Commercial real estate - construction		3,687		17		950		-		4,654
Total commercial	$	333,175	$	5,503	$	18,929	$	-	$	357,607

Consumer & Mortgage lending credit exposure

Credit risk profile based on payment activity


	December 31, 2019
(dollars in thousands)	Performing		Non-performing		Total

Consumer
Home equity installment	$	36,566	$	65	$	36,631
Home equity line of credit		46,988		294		47,282
Auto loans		105,854		16		105,870
Direct finance leases (2)		15,452		-		15,452
Other		5,634		-		5,634
Total consumer		210,494		375		210,869
Residential
Real estate		166,158		1,006		167,164
Construction		17,770		-		17,770
Total residential		183,928		1,006		184,934
Total consumer & residential	$	394,422	$	1,381	$	395,803

(2)Net of unearned lease revenue of $0.9 million.

Allowance for loan losses

Management continually evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, past experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:

identification of specific impaired loans by loan category;

identification of specific loans that are not impaired, but have an identified potential for loss;

calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;

determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;

application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation;

application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio.

Qualitative factor adjustments include:

levels of and trends in delinquencies and non-accrual loans;

levels of and trends in charge-offs and recoveries;

trends in volume and terms of loans;

changes in risk selection and underwriting standards;

changes in lending policies and legal and regulatory requirements;

experience, ability and depth of lending management;

national and local economic trends and conditions; and

changes in credit concentrations.

Allocation of the allowance for different categories of loans is based on the methodology as explained above. A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual C&I and CRE loans. C&I and CRE loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed as the case may be. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The credit risk grades for the C&I and CRE loan portfolios are taken into account in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what we believe to be best practices and common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the C&I and CRE loan portfolio from period to period are based upon the credit risk grading system and from periodic reviews of the loan 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 the methodologies.

Each quarter, management performs an assessment of the allowance. The Company’s Special Assets Committee meets quarterly and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due in payment. The assessment process also includes the review of all loans on a non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating.

The Company’s policy is to charge-off unsecured consumer loans when they become 90 days or more past due as to principal and interest. In the other portfolio segments, amounts are charged-off at the point in time when the Company deems the balance, or a portion thereof, to be uncollectible.

Information related to the change in the allowance and the Company’s recorded investment in loans by portfolio segment as of the period indicated is as follows:



As of and for the three months ended March 31, 2020
	Commercial &		Commercial					Residential
(dollars in thousands)	industrial		real estate		Consumer			real estate		Unallocated		Total
Allowance for Loan Losses:
Beginning balance	$	1,484	$	3,933	$	2,013		$	2,278	$	39	$	9,747
Charge-offs		(64)		(163)		(43)			(31)		-		(301)
Recoveries		12		2		64			193		-		271
Provision		121		171		60			(47)		(5)		300
Ending balance	$	1,553	$	3,943	$	2,094		$	2,393	$	34	$	10,017
Ending balance: individually evaluated for impairment	$	195	$	312	$	75		$	137	$	-	$	719
Ending balance: collectively evaluated for impairment	$	1,358	$	3,631	$	2,019		$	2,256	$	34	$	9,298
Loans Receivables:
Ending balance (2)	$	118,140	$	224,802	$	207,962	(1)	$	194,220	$	-	$	745,124
Ending balance: individually evaluated for impairment	$	310	$	2,872	$	494		$	966	$	-	$	4,642
Ending balance: collectively evaluated for impairment	$	117,830	$	221,930	$	207,468		$	193,254	$	-	$	740,482

(1) Net of unearned lease revenue of $0.9 million. (2) Includes $3.0 million of net deferred loan costs.



As of and for the year ended December 31, 2019
	Commercial &		Commercial					Residential
(dollars in thousands)	industrial		real estate		Consumer			real estate		Unallocated		Total
Allowance for Loan Losses:
Beginning balance	$	1,432	$	3,901	$	2,548		$	1,844	$	22	$	9,747
Charge-offs		(184)		(597)		(398)			(330)		-		(1,509)
Recoveries		32		317		67			8		-		424
Provision		204		312		(204)			756		17		1,085
Ending balance	$	1,484	$	3,933	$	2,013		$	2,278	$	39	$	9,747
Ending balance: individually evaluated for impairment	$	221	$	426	$	87		$	174	$	-	$	908
Ending balance: collectively evaluated for impairment	$	1,263	$	3,507	$	1,926		$	2,104	$	39	$	8,839
Loans Receivables:
Ending balance (2)	$	122,594	$	235,013	$	210,869	(1)	$	184,934	$	-	$	753,410
Ending balance: individually evaluated for impairment	$	336	$	2,948	$	375		$	1,006	$	-	$	4,665
Ending balance: collectively evaluated for impairment	$	122,258	$	232,065	$	210,494		$	183,928	$	-	$	748,745

(1) Net of unearned lease revenue of $0.9 million. (2) Includes $3.0 million of net deferred loan costs.



As of and for the three months ended March 31, 2019
	Commercial &		Commercial				Residential
(dollars in thousands)	industrial		real estate		Consumer		real estate		Unallocated		Total
Allowance for Loan Losses:
Beginning balance	$	1,432	$	3,901	$	2,548	$	1,844	$	22	$	9,747
Charge-offs		(28)		(361)		(89)		(35)		-		(513)
Recoveries		6		2		25		-		-		33
Provision		(3)		485		(354)		101		26		255
Ending balance	$	1,407	$	4,027	$	2,130	$	1,910	$	48	$	9,522

Direct finance leases

On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842), and subsequent related updates to revise the accounting for leases. Lessor accounting was largely unchanged as a result of the standard. Additional disclosures required under the standard are included in this section and in Footnote 12, “Leases”.

The Company originates direct finance leases through two automobile dealerships. The carrying amount of the Company’s lease receivables, net of unearned income, was $5.0 million and $4.7 million as of March 31, 2020 and December 31, 2019, respectively. The residual value of the direct finance leases is fully guaranteed by the dealerships. Residual values amounted to $11.4 million and $10.8 million at March 31, 2020 and December 31, 2019, respectively, and are included in the carrying value of direct finance leases.

The undiscounted cash flows to be received on an annual basis for the direct finance leases are as follows:



(dollars in thousands)	Amount

2020	$	5,344
2021		6,005
2022		3,720
2023		2,039
2024		248
Total future minimum lease payments receivable		17,356
Less: Unearned income		(938)
Undiscounted cash flows to be received	$	16,418