Note 5 - Loans and allowance for loan losses

The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

Management has an established methodology used to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented certain loans in the portfolio by product type. Within these segments, the Bank has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes. The classifications set forth below do not correspond directly to the classifications set forth in the call report (Form FFIEC 041). Management has determined that the classifications set forth below are more appropriate for use in identifying and managing risk in the loan portfolio.


Loan Segments:	Loan Classes:
Commercial	Commercial and industrial loans
Commercial real estate	Commercial mortgages – owner occupied Commercial mortgages – non-owner occupied Commercial construction
Consumer	Consumer unsecured Consumer secured
Residential	Residential mortgages Residential consumer construction

Note 5 - Loans and allowance for loan losses (continued)

The evaluation also considers the following risk characteristics of each loan segment:

Commercial loans carry risks associated with the successful operation of a business because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.

Commercial real estate loans carry risks associated with a real estate project and other risks associated with the ownership of real estate. In addition, for real estate construction loans there is a risk that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

Consumer loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly-depreciating assets such as automobiles), or lack thereof. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy. Unsecured consumer loans carry additional risks associated with the continued credit-worthiness of borrowers who may be unable to meet payment obligations.

Residential mortgage and construction loans carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

The Bank’s internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrower’s individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

Below is a summary and definition of the Bank’s risk rating categories:


RATING 1	Excellent
RATING 2	Above Average
RATING 3	Satisfactory
RATING 4	Acceptable / Low Satisfactory
RATING 5	Monitor
RATING 6	Special Mention
RATING 7	Substandard
RATING 8	Doubtful
RATING 9	Loss

Based on the above criteria, we segregate loans into the above categories for special mention, substandard, doubtful and loss from non-classified, or pass rated, loans. We review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

Note 5 - Loans and allowance for loan losses (continued)

“Pass.” These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

“Monitor.” These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may currently or in the future be characterized by late payments. The Bank’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

“Special Mention.” These are loans having a risk rating of 6. Special Mention loans have 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 Bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

“Substandard.” These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts due.

“Doubtful.” These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is high.

“Loss.” These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

Note 5 - Loans and allowance for loan losses (continued)

The Bank grants primarily commercial, real estate, and installment loans to customers throughout its market area. The real estate portfolio can be affected by the condition of the local real estate markets. The commercial and installment loan portfolio can be affected by the local economic conditions.

A summary of loans, net is as follows:



	December 31,
	2019	2018

Commercial	$114,257	$92,877
Commercial real estate	303,900	289,171
Consumer	89,945	86,191
Residential	70,001	66,358

Total loans (1)	578,103	534,597

Less allowance for loan losses	4,829	4,581

Net loans	$573,274	$530,016

(1)

Includes net deferred costs and premiums of $572 and $457, respectively.

The amounts of overdraft reclassified as loans were $86 and $27 as of December 31, 2019 and 2018, respectively.

The Company’s officers, directors and their related interests have various types of loan relationships with the Bank. The total outstanding balances of these related party loans at December 31, 2019 and 2018 were $12,682 and $14,213 respectively. During 2019, new loans and advances amounted to $1,585 and repayments amounted to $3,116.

Note 5 - Loans and allowance for loan losses (continued)

The following tables set forth information regarding impaired and non-accrual loans as of December 31, 2019 and 2018:



Loans on Non-Accrual Status


	As of December 31,
	2019	2018
Commercial	$262	$973
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	262	317
Commercial Mortgages-Non-Owner Occupied	450	173
Commercial Construction	-	-
Consumer
Consumer Unsecured	-	-
Consumer Secured	47	84
Residential:
Residential Mortgages	280	1,391
Residential Consumer Construction	-	-

Totals	$1,301	$2,939

Note 5 - Loans and allowance for loan losses (continued)


		Impaired Loans
		As of and for the Year Ended December 31, 2019
			Unpaid		Average	Interest
		Recorded	Principal	Related	Recorded	Income
2019		Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
	Commercial	$ 468	$ 1,036	$ -	$ 949	$ 26
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	2,467	2,643	-	2,441	183
	Commercial Mortgage Non-Owner Occupied	563	585	-	347	32
	Commercial Construction	-	-	-	-	-
	Consumer
	Consumer Unsecured	-	-	-	-	-
	Consumer Secured	107	107	-	98	7
	Residential
	Residential Mortgages	1,290	1,290	-	1,583	68
	Residential Consumer Construction	-	-	-	-	-

With an Allowance Recorded:
	Commercial	$ 7	$ 7	$ 7	$ 19	$ 1
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	12	12	12	26	1
	Commercial Mortgage Non-Owner Occupied	14	14	3	52	1
	Commercial Construction	-	-	-	-	-
	Consumer
	Consumer Unsecured	-	-	-	1	-
	Consumer Secured	-	-	-	53	-
	Residential
	Residential Mortgages	139	158	33	257	4
	Residential Consumer Construction	-	-	-	-	-

Totals:
	Commercial	$ 475	$ 1,043	$ 7	$ 968	$ 27
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	2,479	2,655	12	2,467	184
	Commercial Mortgage Non-Owner Occupied	577	599	3	399	33
	Commercial Construction	-	-	-	-	-
	Consumer
	Consumer Unsecured	-	-	-	1	-
	Consumer Secured	107	107	-	151	7
	Residential
	Residential Mortgages	1,429	1,448	33	1,840	72
	Residential Consumer Construction	-	-	-	-	-
		$ 5,067	$ 5,852	$ 55	$ 5,826	$ 323

Note 5 - Loans and allowance for loan losses (continued)


		Impaired Loans
		As of and for the Year Ended December 31, 2018
			Unpaid		Average	Interest
		Recorded	Principal	Related	Recorded	Income
2018		Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
	Commercial	$ 1,430	$ 1,922	$ -	$ 1,178	$ 24
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	2,414	2,511	-	2,421	167
	Commercial Mortgage Non-Owner Occupied	131	132	-	403	8
	Commercial Construction	-	-	-	-	-
	Consumer
	Consumer Unsecured	-	-	-	-	-
	Consumer Secured	88	88	-	184	6
	Residential
	Residential Mortgages	1,876	1,953	-	1,728	89
	Residential Consumer Construction	-	-	-	-	-

With an Allowance Recorded:
	Commercial	$ 31	$ 31	$ 15	$ 174	$ 3
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	39	132	36	352	3
	Commercial Mortgage Non-Owner Occupied	90	90	20	82	6
	Commercial Construction	-	-	-	85	-
	Consumer
	Consumer Unsecured	1	1	1	2	-
	Consumer Secured	105	105	105	266	7
	Residential
	Residential Mortgages	375	390	61	263	11
	Residential Consumer Construction	-	-	-	-	-

Totals:
	Commercial	$ 1,461	$ 1,953	$ 15	$ 1,352	$ 27
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	2,453	2,643	36	2,773	170
	Commercial Mortgage Non-Owner Occupied	221	222	20	485	14
	Commercial Construction	-	-	-	85	-
	Consumer
	Consumer Unsecured	1	1	1	2	-
	Consumer Secured	193	193	105	450	13
	Residential
	Residential Mortgages	2,251	2,343	61	1,991	100
	Residential Consumer Construction	-	-	-	-	-
		$ 6,580	$ 7,355	$ 238	$ 7,138	$ 324

Note 5 - Loans and allowance for loan losses (continued)

The following tables set forth the allowance for loan losses activity for the years ended December 31, 2019 and 2018:

Allowance for Loan Losses and Recorded Investment in Loans

As of and for the Year Ended December 31, 2019


		Commercial
2019	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:

Beginning Balance	$1,136	$1,831	$956	$658	$4,581
Charge-offs	(106)	(26)	(189)	(42)	(363)
Recoveries	35	5	44	4	88
Provision	265	122	54	82	523
Ending Balance	$1,330	$1,932	$865	$702	$4,829

Ending Balance: Individually evaluated for impairment	$7	$15	$ -	$33	$55

Ending Balance: Collectively evaluated for impairment	1,323	1,917	865	669	4,774


Totals:	$1,330	$1,932	$865	$702	$4,829

Loans:

Ending Balance: Individually evaluated for impairment	$475	$3,056	$107	$1,429	$5,067

Ending Balance: Collectively evaluated for impairment	113,782	300,844	89,838	68,572	573,036

Totals:	$114,257	$303,900	$89,945	$70,001	$578,103

Note 5 - Loans and allowance for loan losses (continued)

Allowance for Loan Losses and Recorded Investment in Loans

As of and for the Year Ended December 31, 2018



		Commercial
2018	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:

Beginning Balance	$1,264	$1,738	$1,172	$578	$4,752
Charge-offs	(395)	(230)	(405)	(34)	(1,064)
Recoveries	113	4	60	-	177
Provision	154	319	129	114	716
Ending Balance	$1,136	$1,831	$956	$658	$4,581

Ending Balance: Individually evaluated for impairment	$15	$56	$106	$61	$238

Ending Balance: Collectively evaluated for impairment	1,121	1,775	850	597	4,343


Totals:	$1,136	$1,831	$956	$658	$4,581

Loans:

Ending Balance: Individually evaluated for impairment	$1,461	$2,674	$194	$2,251	$6,580

Ending Balance: Collectively evaluated for impairment	91,416	286,497	85,997	64,107	528,017

Totals:	$92,877	$289,171	$86,191	$66,358	$534,597

Note 5 - Loans and allowance for loan losses (continued)


Age Analysis of Past Due Loans as of December 31, 2019
2019	30-59 Days Past Due	60-89 Days Past Due	Greater than 90 Days	Total Past Due	Current	Total Loans	Recorded Investment > 90 Days & Accruing
Commercial	$146	$1,084	$116	$1,346	$112,911	$114,257	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	234	192	143	569	104,223	104,792	-
Commercial Mortgages-Non-Owner Occupied	58	9	450	517	181,730	182,247	-
Commercial Construction	-	-	-	-	16,861	16,861	-
Consumer:
Consumer Unsecured	52	3	-	55	6,812	6,867	-
Consumer Secured	316	130	21	467	82,611	83,078	-
Residential:
Residential Mortgages	595	576	280	1,451	53,833	55,284	-
Residential Consumer Construction	492	-	-	492	14,225	14,717	-
Total	$1,893	$1,994	$1,010	$4,897	$573,206	$578,103	$ -


Age Analysis of Past Due Loans as of December 31, 2018
2018	30-59 Days Past Due	60-89 Days Past Due	Greater than 90 Days	Total Past Due	Current	Total Loans	Recorded Investment > 90 Days & Accruing
Commercial	$54	$56	$220	$330	$92,547	$92,877	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	209	-	307	516	97,910	98,426	-
Commercial Mortgages-Non-Owner Occupied	149	468	-	617	174,657	175,274	-
Commercial Construction	-	-	-	-	15,471	15,471	-
Consumer:
Consumer Unsecured	8	1	-	9	8,745	8,754	-
Consumer Secured	369	44	-	413	77,024	77,437	-
Residential:
Residential Mortgages	882	164	567	1,613	56,559	58,172	-
Residential Consumer Construction	-	-	-	-	8,186	8,186	-
Total	$1,671	$733	$1,094	$3,498	$531,099	$534,597	$ -

Note 5 - Loans and allowance for loan losses (continued)

Credit Quality Information - by Class

December 31, 2019

2019	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$108,907	$313	$4,518	$519	$ -	$114,257
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	93,553	446	8,316	2,477	-	104,792
Commercial Mortgages-Non-Owner Occupied	175,471	5,118	994	664	-	182,247
Commercial Construction	16,572	289	-	-	-	16,861
Consumer
Consumer Unsecured	6,867	-	-	-	-	6,867
Consumer Secured	82,860	-	-	218	-	83,078
Residential:
Residential Mortgages	53,714	-	-	1,570	-	55,284
Residential Consumer Construction	14,416	301	-	-	-	14,717

Totals	$552,360	$6,467	$13,828	$5,448	$ -	$578,103

Credit Quality Information - by Class

December 31, 2018

2018	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$90,142	$818	$374	$1,543	$ -	$92,877
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	90,995	1,461	3,517	2,453	-	98,426
Commercial Mortgages-Non-Owner Occupied	172,342	2,285	332	315	-	175,274
Commercial Construction	14,892	579	-	-	-	15,471
Consumer
Consumer Unsecured	8,747	-	6	1	-	8,754
Consumer Secured	77,092	-	88	257	-	77,437
Residential:
Residential Mortgages	55,336	334	-	2,502	-	58,172
Residential Consumer Construction	8,186	-	-	-	-	8,186

Totals	$517,732	$5,477	$4,317	$7,071	$ -	$534,597

Note 5 - Loans and allowance for loan losses (continued)

Troubled Debt Restructurings (TDRs)

There were no loan modifications that would have been classified as Troubled Debt Restructurings (TDR) during the twelve months ended December 31, 2019 or 2018.

Loans that were previously classified as TDRS and currently on the Bank’s balance sheet are factored into the determination of the allowance for loan losses as of the period indicated and are included in the Bank’s impaired loan analysis and individually evaluated for impairment.

At December 31, 2019 and December 31, 2018, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.

There were no loan modifications classified as TDRs within the last twelve months that defaulted (90 days past due) during the twelve months ended December 31, 2019 and 2018.