7. Loans Receivable and Allowance for Loan Losses

Set forth below is selected data relating to the composition of the loan portfolio at the dates indicated:



	Types of loans
	(dollars in thousands)

	September 30, 2016				December 31, 2015
Real Estate Loans:
Residential	$	237,897	33.7	%	$	161,820	28.9	%
Commercial		315,270	44.6			279,123	49.8
Construction		20,056	2.8			18,987	3.4
Commercial, financial and agricultural		85,145	12.1			71,090	12.7
Consumer loans to individuals		48,225	6.8			29,231	5.2
Total loans		706,593	100.0	%		560,251	100.0	%
Deferred fees, net		(394)				(326)
Total loans receivable		706,199				559,925
Allowance for loan losses		(6,164)				(7,298)
Net loans receivable	$	700,035			$	552,627

The following table presents the components of the purchase accounting adjustments related to the purchased impaired loans acquired:



(In Thousands)

Contractually required principal and interest	$	2,621
Non-accretable discount		(1,014)
Expected cash flows		1,607
Accretable discount		(239)
Estimated fair value	$	1,368

Changes in the amortizable yield for purchased credit-impaired loans were as follows for the nine month periods ended September 30:



	2016		2015
Balance at beginning of period	$	-	$	8
Additions		239		-
Accretion		(12)		(1)
Reclassification and other		-		-
Balance at end of period	$	227	$	7

The following table presents information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands):



	September 30, 2016		December 31, 2015

Outstanding Balance	$	1,855	$	498
Carrying Amount	$	1,368	$	498

As a result of the acquisition of Delaware, the Company added $1,397,000 of loans that were accounted for in accordance with ASC 310-30. Based on a review of the loans acquired by senior lending management, which included an analysis of credit deterioration of the loans since origination, the Company recorded a specific credit fair value adjustment of $499,000. For loans that were acquired with specific evidence of deterioration in credit quality, loan losses will be accounted for through a reduction of the specific reserve and will not impact the allowance for loan losses until actual losses exceed the allotted reserves. For loans acquired without a deterioration of credit quality, losses incurred will result in adjustments to the allowance for loan losses through the allowance for loan loss adequacy calculation. As of September 30, 2016, the outstanding balance of ASC 310-30 loans acquired from Delaware was $1,410,000 and the carrying value was $911,000, while one loan with an outstanding balance and carrying value of $445,000 remained from a prior acquisition.

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.

Foreclosed assets acquired in settlement of loans are carried at fair value less estimated costs to sell and are included in foreclosed real estate owned on the Consolidated Balance Sheets. As of September 30, 2016 and December 31, 2015, foreclosed real estate owned totaled $5,386,000 and $2,847,000, respectively. As of September 30, 2016, included within foreclosed real estate owned is $306,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of September 30, 2016, the Company has initiated formal foreclosure proceedings on $222,000 of consumer residential mortgages.

The following table shows the amount of loans in each category that were individually and collectively evaluated for impairment at the dates indicated:



	Real Estate Loans
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
September 30, 2016	(In thousands)

Individually evaluated for impairment	$	24	$	2,791	$	-	$	-	$	-	$	2,815
Loans acquired with deteriorated credit quality		797		571		-		-		-		1,368
Collectively evaluated for impairment		237,076		311,908		20,056		85,145		48,225		702,410
Total Loans	$	237,897	$	315,270	$	20,056	$	85,145	$	48,225	$	706,593



	Real Estate Loans
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
	(In thousands)
December 31, 2015

Individually evaluated for impairment	$	28	$	8,660	$	-	$	43	$	-	$	8,731
Loans acquired with deteriorated credit quality		140		358		-		-		-		498
Collectively evaluated for impairment		161,652		270,105		18,987		71,047		29,231		551,022
Total Loans	$	161,820	$	279,123	$	18,987	$	71,090	$	29,231	$	560,251

The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired.



			Unpaid
	Recorded		Principal		Associated
	Investment		Balance		Allowance
September 30, 2016				(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	1,003	$	1,189	$	-
Commercial		3,349		4,267		-
Subtotal		4,352		5,456		-
With an allowance recorded:
Real Estate Loans
Commercial		74		1,020		15
Subtotal		74		1,020		15
Total:
Real Estate Loans
Residential		1,003		1,189		-
Commercial		3,423		5,287		15
Total Impaired Loans	$	4,426	$	6,476	$	15



			Unpaid
	Recorded		Principal		Associated
	Investment		Balance		Allowance
December 31, 2015				(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	168	$	173	$	-
Commercial		2,644		4,610		-
Commercial, financial and agriculture		43		43		-
Subtotal		2,855		4,826		-
With an allowance recorded:
Real Estate Loans
Commercial		6,373		6,446		1,613
Subtotal		6,373		6,446		1,613
Total:
Real Estate Loans
Residential		168		173		-
Commercial		9,017		11,056		1,613
Commercial, financial and agriculture		43		43		-
Total Impaired Loans	$	9,228	$	11,272	$	1,613

The following information for impaired loans is presented (in thousands) for the nine months ended September 30, 2016 and 2015:



	Average Recorded				Interest Income
	Investment				Recognized
	2016		2015		2016		2015

Real Estate Loans:
Residential	$	372	$	236	$	3	$	3
Commercial		3,249		10,477		90		510
Total	$	3,621	$	10,713	$	93	$	513

The following information for impaired loans is presented (in thousands) for the three months ended September 30, 2016 and 2015:



	Average Recorded				Interest Income
	Investment				Recognized
	2016		2015		2016		2015

Real Estate Loans:
Residential	$	579	$	249	$	1	$	1
Commercial		3,253		10,294		33		45
Total	$	3,832	$	10,543	$	34	$	46

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources. As of September 30, 2016, troubled debt restructured loans totaled $1.6 million and resulted in specific reserves of $15,000. As of December 31, 2015, troubled debt restructured loans totaled $6.8 million and resulted in specific reserves of $1,613,000. For the period ended September 30, 2016, there were no new loans identified as troubled debt restructurings. During 2016, the Company has recognized write-downs of $2,519,000 on loans that were previously identified as troubled debt restructurings.

For the period ended September 30, 2015, there were no new loans identified as troubled debt restructurings. During the 2015 period, the Company recognized write-downs in the amount of $439,000 on three loans previously identified as troubled debt restructures with a carrying value of $2.5 million as of September 30, 2015.

Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first four 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. Any portion of a loan that has been charged off is placed in the Loss category.

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 non performance, repossession, or death occurs to raise awareness of a possible credit event. The Company’s Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis. Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration. Loan Review also annually reviews relationships of $1,000,000 and over to assign or re-affirm risk ratings. Loans in the 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, Substandard, Doubtful and Loss within the internal risk rating system as of September 30, 2016 and December 31, 2015 (in thousands):



			Special					Doubtful
	Pass		Mention		Substandard		or Loss		Total
September 30, 2016
Commercial real estate loans	$	306,177	$	4,442	$	4,651	$	-	$	315,270
Commercial loans		85,087		35		23		-		85,145
Total	$	391,264	$	4,477	$	4,674	$	-	$	400,415



			Special					Doubtful
	Pass		Mention		Substandard		or Loss		Total
December 31, 2015
Commercial real estate loans	$	267,892	$	1,837	$	9,394	$	-	$	279,123
Commercial loans		71,047		-		43		-		71,090
Total	$	338,939	$	1,837	$	9,437	$	-	$	350,213

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits. The following table presents the recorded investment in the loan classes based on payment activity as of September 30, 2016 and December 31, 2015 (in thousands):



	Performing		Nonperforming		Total
September 30, 2016
Residential real estate loans	$	236,711	$	1,186	$	237,897
Construction		20,028		28		20,056
Consumer loans		48,225		-		48,225
Total	$	304,964	$	1,214	$	306,178



	Performing		Nonperforming		Total
December 31, 2015
Residential real estate loans	$	161,380	$	440	$	161,820
Construction		18,987		-		18,987
Consumer loans		29,231		-		29,231
Total	$	209,598	$	440	$	210,038

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. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of September 30, 2016 and December 31, 2015 (in thousands):



	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
September 30, 2016
Real Estate loans
Residential	$	234,857	$	1,548	$	306	$	-	$	1,186	$	3,040	$	237,897
Commercial		313,916		198		131		49		976		1,354		315,270
Construction		20,028		-		-		-		28		28		20,056
Commercial loans		85,083		62		-		-		-		62		85,145
Consumer loans		48,118		96		11		-		-		107		48,225
Total	$	702,002	$	1,904	$	448	$	49	$	2,190	$	4,591	$	706,593



	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2015
Real Estate loans
Residential	$	160,683	$	646	$	51	$	-	$	440	$	1,137	$	161,820
Commercial		272,125		310		39		-		6,649		6,998		279,123
Construction		18,959		28		-		-		-		28		18,987
Commercial loans		71,043		4		-		-		43		47		71,090
Consumer loans		29,179		41		11		-		-		52		29,231
Total	$	551,989	$	1,029	$	101	$	-	$	7,132	$	8,262	$	560,251

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 allowance for loan losses. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the allowance. The following table presents the allowance for loan losses by the classes of the loan portfolio:



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, December 31, 2015	$	1,069	$	5,506	$	90	$	397	$	236	$	7,298
Charge Offs		(32)		(2,670)		-		(15)		(71)		(2,788)
Recoveries		4		11		-		-		39		54
Provision for loan losses		15		1,516		(12)		(46)		127		1,600
Ending balance, September 30, 2016	$	1,056	$	4,363	$	78	$	336	$	331	$	6,164
Ending balance individually evaluated for impairment	$	-	$	15	$	-	$	-	$	-	$	15
Ending balance collectively evaluated for impairment	$	1,056	$	4,348	$	78	$	336	$	331	$	6,149



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, June 30, 2016	$	976	$	4,191	$	59	$	293	$	279	$	5,798
Charge Offs		(15)		(28)		-		(15)		(41)		(99)
Recoveries		2		9		-		-		4		15
Provision for loan losses		93		191		19		58		89		450
Ending balance, September 30, 2016	$	1,056	$	4,363	$	78	$	336	$	331	$	6,164



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, December 31, 2014	$	1,323	$	3,890	$	222	$	256	$	184	$	5,875
Charge Offs		(159)		(1,692)		-		-		(59)		(1,910)
Recoveries		4		-		-		-		18		22
Provision for loan losses		(181)		1,980		(137)		28		70		1,760
Ending balance, September 30, 2015	$	987	$	4,178	$	85	$	284	$	213	$	5,747
Ending balance individually evaluated for impairment	$	-	$	389	$	-	$	-	$	-	$	389
Ending balance collectively evaluated for impairment	$	987	$	3,789	$	85	$	284	$	213	$	5,358



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, June 30, 2015	$	1,085	$	4,152	$	97	$	405	$	208	$	5,947
Charge Offs		(46)		(865)		-		-		(16)		(927)
Recoveries		-		-		-		-		7		7
Provision for loan losses		(52)		891		(12)		(121)		14		720
Ending balance, September 30, 2015	$	987	$	4,178	$	85	$	284	$	213	$	5,747

The Company’s primary business activity as of December 31, 2015 was with customers located in northeastern Pennsylvania. As of September 30, 2016, the Company has added the New York counties of Delaware and Sullivan to its market as a result of the acquisition of Delaware Bancshares, Inc. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy.

As of September 30, 2016, the Company considered its concentration of credit risk to be acceptable. The highest concentrations are in commercial rentals with $64.8 million of loans outstanding, or 9.2% of total loans outstanding, and the hospitality/lodging industry with loans outstanding of $51.6 million, or 7.3% of loans outstanding. During 2016, the Company recognized a write down of $3,000 in the named concentrations.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $54,000 and $0, respectively, in the first nine months of 2016 compared to $56,000 and $0, respectively, in the same period in 2015. The proceeds from the sales of residential mortgage loans totaled $1.7 million and $2.7 million for the nine months ended September 30, 2016 and 2015, respectively.

There were no sales of residential mortgage loans during the three months ended September 30, 2016. Gross realized gains and gross realized losses on sales of residential mortgage loans were $16,000 and $0, respectively, in the same period in 2015. The proceeds from the sales of residential mortgage loans totaled $818,000 for the three months ended September 30, 2015.