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Loans and Allowance for Loan Losses

9 Months Ended

Sep. 30, 2019

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoffs, are reported at their outstanding principal balances adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Generally, all loan classes are placed on nonaccrual status not later than 90 days past due, unless the loan is well-secured and in the process of collection. All interest accrued, but not collected, for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the non-collectability of a loan balance is probable. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as new information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Company's internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected on the historical loss or risk rating data.

A loan is considered impaired when, based on current information and events, it is probable that State 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 determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration each 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. Impairment is measured on a loan-by-loan basis for commercial, agricultural, and construction loans by either 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.

When State Bank moves a loan to nonaccrual status, total unpaid interest accrued to date is reversed from income. Subsequent payments are applied to the outstanding principal balance with the interest portion of the payment recorded on the balance sheet as a contra-loan. Interest received on impaired loans may be realized once all contractual principal amounts are received or when a borrower establishes a history of six consecutive timely principal and interest payments. It is at the discretion of management to determine when a loan is placed back on accrual status upon receipt of six consecutive timely payments.

Large groups of smaller balance homogenous loans are collectively evaluated for impairment. Accordingly, State Bank does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

Categories of loans at September 30, 2019 and December 31, 2018 include:

	Total Loans						Nonaccrual Loans
($ in thousands)	September 2019			December 2018			September 2019		December 2018

Commercial & industrial	$	144,462		$	127,041		$	834	$	730
Commercial real estate - owner occupied		97,470			95,651			-		-
Commercial real estate - nonowner occupied		263,869			245,140			262		218
Agricultural		51,946			52,012			-		-
Residential real estate		202,021			187,104			1,811		1,752
Home equity line of credit (HELOC)		48,027			47,382			362		195
Consumer		14,888			16,954			6		11

Total Loans	$	822,683		$	771,284		$	3,275	$	2,906

Net deferred costs	$	684		$	599

Total Loans, net deferred costs	$	823,367		$	771,883

Allowance for loan losses	$	(8,492	)	$	(8,167	)

The risk characteristics of each loan portfolio segment are as follows:

Commercial & Industrial and Agricultural

Commercial & industrial and agricultural loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may include a personal guarantee. Short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial Real Estate (Owner and Nonowner Occupied)

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The characteristics of properties securing the Company's commercial real estate portfolio are diverse, but with geographic location almost entirely in the Company's market area. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In general, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate versus non-owner-occupied loans.

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential Real Estate, HELOC and Consumer

Residential and consumer loans consist of two segments – residential mortgage loans and personal loans. Residential mortgage loans are secured by 1-4 family residences and are generally owner-occupied, and the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. HELOCs are typically secured by a subordinate interest in 1-4 family residences, and consumer personal loans are secured by consumer personal assets, such as automobiles or recreational vehicles. Some consumer personal loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that these loans are of smaller individual amounts and spread over a large number of borrowers.

The following tables present the activity in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of September 30, 2019, December 31, 2018 and September 30, 2018.

Allowance for loan losses ($ in thousands)	Commercial & industrial			Commercial real estate			Agricultural			Residential real estate			Consumer			Total
For the Three Months Ended September 30, 2019
Beginning balance	$	1,378		$	3,448		$	509		$	2,287		$	684		$	8,306
Charge offs		(95	)		-			-			(23	)		(10	)		(128	)
Recoveries		7			-			-			1			6			14
Provision		103			72			(16	)		128			13			300
Ending balance	$	1,393		$	3,520		$	493		$	2,393		$	693		$	8,492

For the Nine Months Ended September 30, 2019

Beginning balance	$	1,435		$	2,923		$	482		$	2,567		$	760		$	8,167
Charge offs		(143	)		-			-			(23	)		(42	)		(208	)
Recoveries		8			-			-			2			23			33
Provision		93			597			11			(153	)		(48	)		500
Ending Balance	$	1,393		$	3,520		$	493		$	2,393		$	693		$	8,492

($ in thousands)	Commercial & industrial			Commercial real estate			Agricultural			Residential real estate			Consumer			Total
For the Three Months Ended September 30, 2018
Beginning balance	$	1,061		$	3,720		$	488		$	2,550	#	$	675		$	8,494
Charge offs		-			-			-			-			(11	)		(11	)
Recoveries		-			-			-			-			6			6
Provision		13			5			(9	)		(39	)		30			-
Ending balance	$	1,074		$	3,725		$	479		$	2,511		$	700		$	8,489

For the Nine Months Ended September 30, 2018

Beginning balance	$	823		$	3,779		$	505		$	2,129		$	694		$	7,930
Charge offs		-			(36	)		-			(26	)		(23	)		(85	)
Recoveries		-			29			-			2			13			44
Provision		251			(47	)		(26	)		406			16			600
Ending balance	$	1,074		$	3,725		$	479		$	2,511		$	700		$	8,489

($ in thousands)	Commercial & industrial			Commercial real estate			Agricultural			Residential real estate			Consumer			Total
Loans Receivable at September 30, 2019
Allowance:
Ending balance: individually evaluated for impairment	$	-		$	-		$	-		$	45		$	-		$	45
Ending balance: collectively evaluated for impairment	$	1,393		$	3,520		$	493		$	2,348		$	693		$	8,447

Loans:
Ending balance: individually evaluated for impairment	$	784		$	203		$	-		$	2,007		$	34		$	3,028
Ending balance: collectively evaluated for impairment	$	143,678		$	361,136		$	51,946		$	200,014		$	62,881		$	819,655

($ in thousands)	Commercial & industrial		Commercial real estate		Agricultural		Residential real estate		Consumer		Total
Loans Receivable at December 31, 2018
Allowance:
Ending balance: individually evaluated for impairment	$	61	$	-	$	-	$	73	$	4	$	138
Ending balance: collectively evaluated for impairment	$	1,374	$	2,923	$	482	$	2,494	$	756	$	8,029

Loans:
Ending balance: individually evaluated for impairment	$	700	$	283	$	-	$	2,111	$	190	$	3,284
Ending balance: collectively evaluated for impairment	$	126,341	$	340,508	$	52,012	$	184,993	$	64,146	$	768,000

Credit Risk Profile

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $100 thousand and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

Pass (grades 1 – 4): Loans which management has determined to be performing as expected and in agreement with the terms established at the time of loan origination.

Special Mention (5): Assets have 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 Company's credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification. Ordinarily, special mention credits have characteristics which corrective management action would remedy.

Substandard (6): Loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful (7): Loans classified as doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of current known facts, conditions and values, highly questionable and improbable.

Loss (8): Loans are considered uncollectable and of such little value that continuing to carry them as assets on the Company's financial statement is not warranted. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The following tables present the credit risk profile of the Company's loan portfolio based on rating category as of September 30, 2019 and December 31, 2018.

($ in thousands) September 30, 2019	Commercial & industrial		Commercial real estate - owner occupied		Commercial real estate - nonowner occupied		Agricultural		Residential real estate		HELOC		Consumer		Total
Pass (1 - 4)		141,927		97,175		260,730		51,706		199,387		47,554		14,856		813,335
Special Mention (5)		1,638		295		1,956		240		-		-		-		4,129
Substandard (6)		530		-		921		-		2,601		473		32		4,557
Doubtful (7)		367		-		262		-		33		-		-		662
Loss (8)		-		-		-		-		-		-		-		-
Total Loans	$	144,462	$	97,470	$	263,869	$	51,946	$	202,021	$	48,027	$	14,888	$	822,683

($ in thousands) December 31, 2018	Commercial & industrial		Commercial real estate - owner occupied		Commercial real estate - nonowner occupied		Agricultural		Residential real estate		HELOC		Consumer		Total
Pass (1 - 4)	$	123,861	$	95,651	$	243,188	$	51,702	$	184,581	$	47,148	$	16,854	$	762,985
Special Mention (5)		680		-		20		310		-		-		-		1,010
Substandard (6)		2,305		-		1,714		-		2,488		234		100		6,841
Doubtful (7)		195		-		218		-		35		-		-		448
Loss (8)		-		-		-		-		-		-		-		-
Total Loans	$	127,041	$	95,651	$	245,140	$	52,012	$	187,104	$	47,382	$	16,954	$	771,284

The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis.

The following tables present the Company's loan portfolio aging analysis as of September 30, 2019 and December 31, 2018.

($ in thousands) September 30, 2019	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans Receivable

Commercial & industrial	$	62	$	-	$	301	$	363	$	144,099	$	144,462
Commercial real estate - owner occupied		-		-		-		-		97,470		97,470
Commercial real estate - nonowner occupied		279		-		59		338		263,531		263,869
Agricultural		-		-		-		-		51,946		51,946
Residential real estate		85		269		677		1,031		200,990		202,021
HELOC		102		-		124		226		47,801		48,027
Consumer		19		19		2		40		14,848		14,888
Total Loans	$	547	$	288	$	1,163	$	1,998	$	820,685	$	822,683

($ in thousands) December 31, 2018	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans Receivable

Commercial & industrial	$	120	$	-	$	661	$	781	$	126,260	$	127,041
Commercial real estate - owner occupied		-		-		-		-		95,651		95,651
Commercial real estate - nonowner occupied		342		1		-		343		244,797		245,140
Agricultural		-		-		-		-		52,012		52,012
Residential real estate		2,391		824		372		3,587		183,517		187,104
HELOC		163		16		55		234		47,148		47,382
Consumer		14		63		23		100		16,854		16,954
Total Loans	$	3,030	$	904	$	1,111	$	5,045	$	766,239	$	771,284

All loans past due 90 days are systematically placed on nonaccrual status.

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable State Bank will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

The following tables present impaired loan information as of and for the nine months ended September 30, 2019 and 2018, and for the twelve months ended December 31, 2018:

Nine Months Ended September 30, 2019 ($ in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial & industrial	$	784	$	1,154	$	-	$	1,432	$	76
Commercial real estate - owner occupied		-		-		-		-		-
Commercial real estate - nonowner occupied		203		203		-		259		15
Agricultural		-		-		-		-		-
Residential real estate		1,481		1,524		-		1,808		74
HELOC		17		17				19		1
Consumer		17		17		-		20		1
With a specific allowance recorded:
Commercial & industrial		-		-		-		-		-
Commercial real estate - owner occupied		-		-		-		-		-
Commercial real estate - nonowner occupied		-		-		-		-		-
Agricultural		-		-		-		-		-
Residential real estate		526		526		45		538		19
HELOC		-		-		-		-		-
Consumer		-		-		-		-		-
Totals:
Commercial & industrial	$	784	$	1,154	$	-	$	1,432	$	76
Commercial real estate - owner occupied	$	-	$	-	$	-	$	-	$	-
Commercial real estate - nonowner occupied	$	203	$	203	$	-	$	259	$	15
Agricultural	$	-	$	-	$	-	$	-	$	-
Residential real estate	$	2,007	$	2,050	$	45	$	2,346	$	93
HELOC	$	17	$	17	$	-	$	19	$	1
Consumer	$	17	$	17	$	-	$	20	$	1

Three Months Ended September 30, 2019 ($ in thousands)	Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial & industrial	$	1,202	$	22
Commercial real estate - owner occupied		-		-
Commercial real estate - nonowner occupied		259		5
Agricultural		-		-
Residential real estate		1,793		24
HELOC		17		-
Consumer		18		-
With a specific allowance recorded:
Commercial & industrial		-		-
Commercial real estate - owner occupied		-		-
Commercial real estate - nonowner occupied		-		-
Agricultural		-		-
Residential real estate		533		6
HELOC		-		-
Consumer		-		-
Totals:
Commercial & industrial	$	1,202	$	22
Commercial real estate - owner occupied	$	-	$	-
Commercial real estate - nonowner occupied	$	259	$	5
Agricultural	$	-	$	-
Residential real estate	$	2,326	$	30
HELOC	$	17	$	-
Consumer	$	18	$	-

Twelve Months Ended December 31, 2018 ($ in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial & industrial	$	575	$	802	$	-	$	370	$	21
Commercial real estate - owner occupied		-		-		-		-		-
Commercial real estate - nonowner occupied		283		283		-		336		21
Agricultural		-		-		-		-		-
Residential real estate		1,249		1,292		-		1,995		91
HELOC		20		20		-		21		1
Consumer		93		93		-		104		7
With a specific allowance recorded:
Commercial & industrial		125		125		61		127		21
Commercial real estate - owner occupied		-		-		-		-		-
Commercial real estate - nonowner occupied		-		-		-		-		-
Agricultural		-		-		-		-		-
Residential real estate		862		888		73		426		20
HELOC		-		-		-		-		-
Consumer		77		77		4		91		6
Totals:
Commercial & industrial	$	700	$	927	$	61	$	497	$	42
Commercial real estate - owner occupied	$	-	$	-	$	-	$	-	$	-
Commercial real estate - nonowner occupied	$	283	$	283	$	-	$	336	$	21
Agricultural	$	-	$	-	$	-	$	-	$	-
Residential real estate	$	2,111	$	2,180	$	73	$	2,421	$	111
HELOC	$	20	$	20	$	-	$	21	$	1
Consumer	$	170	$	170	$	4	$	195	$	13

	Nine Months Ended				Three Months Ended
September 30, 2018 ($ in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial & industrial	$	777	$	19	$	763	$	(9	)
Commercial real estate - owner occupied		-		-		-		-
Commercial real estate - nonowner occupied		336		17		336		5
Agricultural		-		-		-		-
Residential real estate		1,745		57		1,733		16
HELOC		-		-		-		-
Consumer		106		5		102		2
With a specific allowance recorded:
Commercial & industrial		-		-		-		-
Commercial real estate - owner occupied		-		-		-		-
Commercial real estate - nonowner occupied		-		-		-		-
Agricultural		-		-		-		-
Residential real estate		428		15		424		5
HELOC		-		-		-		-
Consumer		92		4		90		1
Totals:
Commercial & industrial	$	777	$	19	$	763	$	(9	)
Commercial real estate - owner occupied	$	-	$	-	$	-	$	-
Commercial real estate - nonowner occupied	$	336	$	17	$	336	$	5
Agricultural	$	-	$	-	$	-	$	-
Residential real estate	$	2,173	$	72	$	2,157	$	21
HELOC	$	-	$	-	$	-	$	-
Consumer	$	198	$	9	$	192	$	3

Impaired loans less than $100,000 are included in groups of homogenous loans. These loans are evaluated based on delinquency status.

Interest income recognized on a cash basis does not materially differ from interest income recognized on an accrual basis.

Troubled Debt Restructured (TDR) Loans

TDRs are modified loans where a concession was provided to a borrower experiencing financial difficulties. Loan modifications are considered TDRs when the concessions provided are not available to the borrower through either normal channels or other sources. However, not all loan modifications are TDRs.

TDR Concession Types

The Company's standards relating to loan modifications consider, among other factors, minimum verified income requirements, cash flow analysis, and collateral valuations. Each potential loan modification is reviewed individually and the terms of the loan are modified to meet a borrower's specific circumstances at a point in time. All loan modifications, including those classified as TDRs, are reviewed and approved by management. The types of concessions provided to borrowers include:

●

Interest rate reduction: A reduction of the stated interest rate to a nonmarket rate for the remaining original life of the loan. The Company also may grant interest rate concessions for a limited timeframe on a case by case basis.

●

Amortization or maturity date change: A change in the amortization or maturity date beyond what the collateral supports, including a concession that does any of the following:

(1)

Lengthens the amortization period of the amortized principal beyond market terms. This concession reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven.

(2)

Reduces the amount of loan principal to be amortized. This concession also reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven.

(3)

Extends the maturity date or dates of the debt beyond what the collateral supports. This concession generally applies to loans without a balloon payment at the end of the term of the loan. In addition, there may be instances where renewing loans potentially require non-market terms and would then be reclassified as TDRs.

●

Other: A concession that is not categorized as one of the concessions described above. These concessions include, but are not limited to: principal forgiveness, collateral concessions, covenant concessions, and reduction of accrued interest. Principal forgiveness may result from any TDR modification of any concession type.

During the three months ended September 30, 2019, the Company had no new TDR activity.

The following table represents new TDR activity for the nine months ended September 30, 2019:

($ in thousands)	Number of Loans		Pre- Modification Recorded Balance		Post Modification Recorded Balance

Commercial & industrial		3	$	763	$	763

Total Modifications		3	$	763	$	763

	Interest						Total
	Only		Term		Combination		Modification

Commercial & industrial	$	150	$	613	$	-	$	763

Total Modifications	$	150	$	613	$	-	$	763

During the three and nine months ended September 30, 2018, the Company had no new TDR activity.

There were no TDR's modified during the past twelve months that have subsequently defaulted.