7. Loans and Related Allowance for Loan Losses

The following table summarizes the primary segments of the loan portfolio as of December 31, 2019 and December 31, 2018:



(in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Consumer		Total
December 31, 2019
Individually evaluated for impairment	$	3,179	$	8,570	$	30	$	3,391	$	4	$	15,174
Collectively evaluated for impairment	$	332,325	$	109,320	$	122,322	$	436,782	$	36,195	$	1,036,944
Total loans	$	335,504	$	117,890	$	122,352	$	440,173	$	36,199	$	1,052,118
December 31, 2018
Individually evaluated for impairment	$	5,239	$	693	$	17	$	4,616	$	10	$	10,575
Collectively evaluated for impairment	$	301,682	$	117,667	$	111,449	$	432,291	$	34,050	$	997,139
Total loans	$	306,921	$	118,360	$	111,466	$	436,907	$	34,060	$	1,007,714

The segments of the Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The CRE loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include loans secured by farmland, multifamily structures and owner-occupied commercial structures. The A&D loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. All other A&D loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. These loans have a higher risk profile because the ultimate buyer, once development is completed, is generally not known at the time of the A&D loan. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment is further disaggregated into two classes: amortizing term loans, which are primarily first liens, and home equity lines of credit, which are generally second liens. The consumer loan segment consists primarily of installment loans (direct and indirect) and overdraft lines of credit connected with customer deposit accounts.

In the ordinary course of business, executive officers and directors of the Corporation, including their families and companies in which certain directors are principal owners, were loan customers of the Bank. Pursuant to the Bank’s lending policies, such loans were made on the same terms, including collateral, as those prevailing at the time for comparable transactions with persons who are not related to the Corporation and do not involve more than the normal risk of collectability. Changes in the dollar amount of loans outstanding to officers, directors and their associates were as follows for the year ended December 31:



(in thousands)	2019
Balance at January 1	$	8,949
Loans or advances		5,046
Repayments		(4,518)
Balance at December 31	$	9,477

Management uses a 10-point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Only the portion of a specific allocation of the allowance for loan losses that management believes is associated with a pending event that could trigger loss in the short term is classified in the Doubtful category. Any portion of a loan that has been charged off is placed in the Loss category. It is possible for a loan to be classified as Substandard in the internal risk rating system, but not considered impaired under GAAP, due to the broader reach of “well-defined weaknesses” in the application of the Substandard definition.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in the commercial segments at origination and on an ongoing basis. The Bank’s experienced Credit Quality and Loan Review Department performs an annual review of all commercial relationships of $500,000 or greater. Confirmation of the appropriate risk grade is included as part of the review process on an ongoing basis. The Credit Quality and Loan Review Department continually reviews and assesses loans within the portfolio. In addition, the Bank engages an external consultant to conduct loan reviews on at least an annual basis. Generally, the external consultant reviews commercial relationships greater than $1,000,000 and/or criticized non-consumer loans greater than $500,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention and Substandard. There were no loans classified as Doubtful within the internal risk rating system as of December 31, 2019 and 2018:


(in thousands)	Pass		Special Mention		Substandard		Total
December 31, 2019
Commercial real estate
Non owner-occupied	$	164,584	$	2,765	$	1,864	$	169,213
All other CRE		157,407		6,556		2,328		166,291
Acquisition and development
1-4 family residential construction		10,781		—		—		10,781
All other A&D		98,823		18		8,268		107,109
Commercial and industrial		116,221		2,896		3,235		122,352
Residential mortgage
Residential mortgage - term		365,899		59		5,597		371,555
Residential mortgage – home equity		67,143		139		1,336		68,618
Consumer		36,047		4		148		36,199
Total	$	1,016,905	$	12,437	$	22,776	$	1,052,118
December 31, 2018
Commercial real estate
Non owner-occupied	$	145,260	$	2,904	$	2,348	$	150,512
All other CRE		149,076		1,752		5,581		156,409
Acquisition and development
1-4 family residential construction		16,003		—		—		16,003
All other A&D		94,428		7,378		551		102,357
Commercial and industrial		107,174		3,703		589		111,466
Residential mortgage
Residential mortgage - term		359,305		—		4,703		364,008
Residential mortgage – home equity		71,666		143		1,090		72,899
Consumer		33,952		4		104		34,060
Total	$	976,864	$	15,884	$	14,966	$	1,007,714

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. A loan is considered to be past due when a payment has not been received for 30 days past its contractual due date. For all loan segments, the accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured and in the process of collection. All non-accrual loans are considered to be impaired. Interest payments received on non-accrual loans are applied as a reduction of the loan principal balance. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Corporation’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

The increase in substandard loans was primarily due to one large A&D loan totaling $8.0 million. This loan is a participation development loan originally booked in 2013, which entered into a forbearance agreement in the first quarter 2019.

The following table presents the classes of the loan portfolio at December 31, 2019 and December 31, 2018, summarized by the aging categories of performing loans and non-accrual loans:



(in thousands)	Current		30-59 Day Past Due		60-89 Days Past Due		90 Days+ Past Due		Total Past Due and still accruing		Non- Accrual		Total Loans
December 31, 2019
Commercial real estate
Non owner-occupied	$	169,180	$	—	$	—	$	—	$	—	$	33	$	169,213
All other CRE		165,289		—		355		—		355		647		166,291
Acquisition and development
1-4 family residential construction		10,781		—		—		—		—		—		10,781
All other A&D		98,916		—		—		135		135		8,058		107,109
Commercial and industrial		122,050		272		—		—		272		30		122,352
Residential mortgage
Residential mortgage - term		368,631		267		967		471		1,705		1,219		371,555
Residential mortgage – home equity		67,121		288		286		65		639		858		68,618
Consumer		35,834		261		46		54		361		4		36,199
Total	$	1,037,802	$	1,088	$	1,654	$	725	$	3,467	$	10,849	$	1,052,118
December 31, 2018
Commercial real estate
Non owner-occupied	$	150,339	$	—	$	—	$	—	$	—	$	173	$	150,512
All other CRE		153,977		464		—		—		464		1,968		156,409
Acquisition and development
1-4 family residential construction		16,003		—		—		—		—		—		16,003
All other A&D		94,540		197		7,411		62		7,670		147		102,357
Commercial and industrial		111,436		29		1		—		30		—		111,466
Residential mortgage
Residential mortgage - term		360,073		302		1,359		363		2,024		1,911		364,008
Residential mortgage – home equity		71,611		461		114		—		575		713		72,899
Consumer		33,832		140		73		5		218		10		34,060
Total	$	991,811	$	1,593	$	8,958	$	430	$	10,981	$	4,922	$	1,007,714

Non-accrual loans which have been subject to a partial charge-off totaled $.1 million at December 31, 2019, compared to $.3 million at December 31, 2018. The amount of loans secured by 1-4 family residential real estate properties in the process of foreclosure was $.1 million at December 31, 2019 and $.3 million at December 31, 2018.

The ALL is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35, Receivables-Overall-Subsequent Measurement, for loans individually evaluated for impairment and ASC Subtopic 450-20, Contingencies-Loss Contingencies, for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Bank’s ALL.



(in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Consumer		Unallocated		Total
December 31, 2019
Individually evaluated for impairment	$	9	$	2,142	$	—	$	22	$	—	$	—	$	2,173
Collectively evaluated for impairment	$	2,873	$	1,532	$	1,341	$	3,806	$	312	$	500	$	10,364
Total ALL	$	2,882	$	3,674	$	1,341	$	3,828	$	312	$	500	$	12,537
December 31, 2018
Individually evaluated for impairment	$	13	$	25	$	—	$	106	$	—	$	—	$	144
Collectively evaluated for impairment	$	2,767	$	1,696	$	1,187	$	4,438	$	315	$	500	$	10,903
Total ALL	$	2,780	$	1,721	$	1,187	$	4,544	$	315	$	500	$	11,047

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $500,000 or is part of a relationship that is greater than $750,000 and (i) is either in non-accrual status or (ii) is risk-rated Substandard and is greater than 60 days past due. Loans are considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Bank does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of larger relationship that is impaired; otherwise loans in these segments are considered impaired when they are classified as non-accrual.

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management utilizing the fair value of collateral method for all of the analyses. If the fair value of the collateral less selling costs method is utilized for collateral securing loans in the commercial segments, then an updated external appraisal is ordered on the collateral supporting the loan if the loan balance is greater than $500,000 and the existing appraisal is greater than 18 months old. If the loan balance is less than $500,000, then the estimated fair value of the collateral is determined by adjusting the existing appraisal by the appropriate percentage from an internally prepared appraisal discount grid. This grid considers the age of a third-party appraisal and the geographic region where the collateral is located in order to discount an appraisal. The discount rates in the appraisal discount grid are updated at least annually to reflect the most current knowledge that management has available, including the results of current appraisals. If there is a delay in receiving an updated appraisal or if the appraisal is found to be deficient in our internal appraisal review process and re-ordered, the Bank continues to use a discount factor from the appraisal discount grid based on the collateral location and current appraisal age in order to determine the estimated fair value. If management believes that general market conditions in that geographic market have changed considerably, the property has deteriorated or perhaps lost an income stream, or a recent appraisal for a similar property indicates a significant change, then management may adjust the fair value indicated by the existing appraisal until a new appraisal is obtained. A specific allocation of the ALL is recorded if there is any deficiency in collateral value determined by comparing the estimated fair value to the recorded investment of the loan. When updated appraisals are received and reviewed, adjustments are made to the specific allocation as needed.

The evaluation of the need and amount of a specific allocation of the ALL and whether a loan can be removed from impairment status is made on a quarterly basis.

The following table presents impaired loans by class, at December 31, 2019 and December 31, 2018, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary:



	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance		Total Impaired Loans
(in thousands)	Recorded Investment		Related Allowances		Recorded Investment		Recorded Investment		Unpaid Principal Balance
December 31, 2019
Commercial real estate
Non owner-occupied	$	116	$	9	$	33	$	149	$	8,224
All other CRE		—		—		3,030		3,030		3,030
Acquisition and development
1-4 family residential construction		—		—		291		291		291
All other A&D		8,219		2,142		60		8,279		8,340
Commercial and industrial		—		—		30		30		2,266
Residential mortgage
Residential mortgage - term		865		22		1,668		2,533		2,724
Residential mortgage – home equity		—		—		858		858		986
Consumer		—		—		4		4		4
Total impaired loans	$	9,200	$	2,173	$	5,974	$	15,174	$	25,865
December 31, 2018
Commercial real estate
Non owner-occupied	$	121	$	13	$	173	$	294	$	8,488
All other CRE		—		—		4,945		4,945		4,945
Acquisition and development
1-4 family residential construction		—		—		316		316		316
All other A&D		230		25		147		377		525
Commercial and industrial		—		—		17		17		2,231
Residential mortgage
Residential mortgage - term		993		106		2,910		3,903		4,130
Residential mortgage – home equity		—		—		713		713		726
Consumer		—		—		10		10		10
Total impaired loans	$	1,344	$	144	$	9,231	$	10,575	$	21,371

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors.

The classes described above, which are based on the Federal call code assigned to each loan, provide the starting point for the ALL analysis. Management tracks the historical net charge-off activity (full and partial charge-offs, net of full and partial recoveries) at the call code level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical quarters. Consumer pools currently utilize a rolling 12 quarters, while Commercial pools currently utilize a rolling eight quarters.

“Pass” rated credits are segregated from “Criticized” credits for the application of qualitative factors. The un-criticized (“pass”) pools for commercial and residential real estate are further segmented based upon the geographic location of the underlying collateral. There are seven geographic regions utilized – six that represent the Bank’s lending footprint and a seventh for all out-of-market credits. Different economic environments and resultant credit risks exist in each region that are acknowledged in the assignment of qualitative factors. Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.

Management supplements the historical charge-off factor with a number of additional qualitative factors that are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors, which are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources, are: (i) national and local economic trends and conditions; (ii) levels of and trends in delinquency rates and non-accrual loans; (iii) trends in volumes and terms of loans; (iv) effects of changes in lending policies; (v) experience, ability, and depth of lending staff; (vi) value of underlying collateral; and (vii) concentrations of credit from a loan type, industry and/or geographic standpoint.

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL. Residential mortgage and consumer loans are charged off after they are 120 days contractually past due. All other loans are charged off based on an evaluation of the facts and circumstances of each individual loan. When the Bank believes that its ability to collect is solely dependent on the liquidation of the collateral, a full or partial charge-off is recorded promptly to bring the recorded investment to an amount that the Bank believes is supported by an ability to collect on the collateral. The circumstances that may impact the Bank’s decision to charge-off all or a portion of a loan include default or non-payment by the borrower, scheduled foreclosure actions, and/or prioritization of the Bank’s claim in bankruptcy. There may be circumstances where due to pending events, the Bank will place a specific allocation of the ALL on a loan for which a partial charge-off has been previously recognized. This specific allocation may be either charged-off or removed depending upon the outcome of the pending event. Full or partial charge-offs are not recovered until full principal and interest on the loan have been collected, even if a subsequent appraisal supports a higher value. In most cases, loans with partial charge-offs remain in non-accrual status. Both full and partial charge-offs reduce the recorded investment of the loan and the ALL and are considered to be charge-offs for purposes of all credit loss metrics and trends, including the historical rolling charge-off rates used in the determination of the ALL.

Activity in the ALL is presented for the years ended December 31, 2019 and December 31, 2018:



(in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Consumer		Unallocated		Total
ALL balance at January 1, 2019	$	2,780	$	1,721	$	1,187	$	4,544	$	315	$	500	$	11,047
Charge-offs		(41)		(29)		(126)		(200)		(320)		—		(716)
Recoveries		150		165		77		347		147		—		886
Provision		(7)		1,817		203		(863)		170		—		1,320
ALL balance at December 31, 2019	$	2,882	$	3,674	$	1,341	$	3,828	$	312	$	500	$	12,537
ALL balance at January 1, 2018	$	3,699	$	1,257	$	869	$	3,444	$	203	$	500	$	9,972
Charge-offs		(1,298)		(170)		(32)		(368)		(422)		—		(2,290)
Recoveries		319		344		89		353		149		—		1,254
Provision		60		290		261		1,115		385		—		2,111
ALL balance at December 31, 2018	$	2,780	$	1,721	$	1,187	$	4,544	$	315	$	500	$	11,047

The ALL is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

The following table presents the average recorded investment in impaired loans and related interest income recognized for the years ended December 31, 2019 and 2018:



	2019						2018
(in thousands)	Average investment		Interest income recognized on an accrual basis		Interest income recognized on a cash basis		Average investment		Interest income recognized on an accrual basis		Interest income recognized on a cash basis
Commercial real estate
Non owner-occupied	$	222	$	12	$	—	$	1,432	$	12	$	66
All other CRE		4,322		149		73		5,385		195		59
Acquisition and development
1-4 family residential construction		244		11		—		443		24		—
All other A&D		6,505		19		—		355		12		—
Commercial and industrial		26		—		—		265		13		—
Residential mortgage
Residential mortgage - term		2,971		96		10		3,632		124		2
Residential mortgage – home equity		870		—		4		611		—		7
Consumer		10		—		—		22		—		—
Total	$	15,170	$	287	$	87	$	12,145	$	380	$	134

In the normal course of business, the Bank modifies loan terms for various reasons. These reasons may include as a retention strategy to compete in the current interest rate environment, and to re-amortize or extend a loan term to better match the loan’s payment stream with the borrower’s cash flows. A modified loan is considered to be a TDR when the Bank has determined that the borrower is troubled (i.e. experiencing financial difficulties). The Bank evaluates the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification. To make this determination, the Bank performs a global financial review of the borrower and loan guarantors to assess their current ability to meet their financial obligations.

When the Bank restructures a loan to a troubled borrower, the loan terms (i.e. interest rate, payment, amortization period and/or maturity date) are modified in such a way to enable the borrower to cover the modified debt service payments based on current financials and cash flow adequacy. If a borrower’s hardship is thought to be temporary, then modified terms are only offered for that time period. Where possible, the Bank obtains additional collateral and/or secondary payment sources at the time of the restructure in order to put the Bank in the best possible position if the borrower is not able to meet the modified terms. To date, the Bank has not forgiven any principal as a restructuring concession. The Bank will not offer modified terms if it believes that modifying the loan terms will only delay an inevitable permanent default.

All loans designated as TDRs are considered impaired loans and may be in either accruing or non-accruing status. The Corporation’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition. Accordingly, the accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured and in the process of collection. If the loan was accruing at the time of the modification, then it continues to be in accruing status subsequent to the modification. Non-accrual TDRs may return to accruing status when there has been sufficient payment performance for a period of at least six months. TDRs are considered to be in payment default if, subsequent to modification, the loans are transferred to non-accrual status or to foreclosure. A loan may be removed from being reported as a TDR in the calendar year following the modification if the interest rate at the time of modification was consistent with the interest rate for a loan with comparable credit risk and the loan has performed according to its modified terms for at least six months. Further, a loan that has been removed from TDR reporting status and has been subsequently re-modified at standard market terms, may be removed from impaired status as well.

The volume, type and performance of TDR activity is considered in the assessment of the local economic trend qualitative factor used in the determination of the ALL for loans that are evaluated collectively for impairment.

There were 15 loans totaling $4.2 million and 16 loans totaling $4.9 million that were classified as TDRs at December 31, 2019 and December 31, 2018, respectively. The following table presents the volume and recorded investment at the time of modification of TDRs by class and type of modification that occurred during the periods indicated:



	Temporary Rate Modification			Extension of Maturity			Modification of Payment and Other Terms
(Dollars in thousands)	Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment
For the year ended December 31, 2019
Commercial real estate
Non owner-occupied	—	$	—	—	$	—	—	$	—
All other CRE	—		—	—		—	—		—
Acquisition and development
1-4 family residential construction	—		—	—		—	—		—
All other A&D	—		—	—		—	1		227
Commercial and industrial	—		—	—		—	—		—
Residential mortgage
Residential mortgage – term	2		244	—		—	1		243
Residential mortgage – home equity	—		—	—		—	—		—
Consumer	—		—	—		—	—		—
Total	2	$	244	—	$	—	2	$	470
For the year ended December 31, 2018
Commercial real estate
Non owner-occupied	—	$	—	—	$	—	3	$	358
All other CRE	—		—	1		179	—		—
Acquisition and development
1-4 family residential construction	—		—	1		387	—		—
All other A&D	—		—	—		—	—		—
Commercial and industrial	—		—	—		—	—		—
Residential mortgage
Residential mortgage – term	—		—	—		—	1		435
Residential mortgage – home equity	—		—	—		—	—		—
Consumer	—		—	—		—	—		—
Total	—	$	—	2	$	566	4	$	793

During the year ended December 31, 2019, there were two new TDRs totaling $.2 million, and two existing TDRs that had reached their original modification maturity were re-modified. These re-modifications did not impact the ALL.

During the year ended December 31, 2019, there were no payment defaults. There were no additional funds committed to be advanced in connection with TDRs at December 31, 2019 or 2018.