9. Allowance for Loan Losses

The following tables summarize the rollforward of the allowance for loan losses by portfolio segment for the three month periods ending March 31, 2021 and 2020 (in thousands).


	Three months ended March 31, 2021
	Balance at		Charge-						Balance at
	December 31, 2020		Offs		Recoveries		Provision		March 31, 2021
Commercial	$	3,472	$	(122)	$	17	$	205	$	3,572
Commercial loans secured by non-owner occupied real estate		5,373		—		13		62		5,448
Real estate-residential mortgage		1,292		(17)		5		49		1,329
Consumer		115		(24)		14		16		121
Allocation for general risk		1,093		—		—		68		1,161
Total	$	11,345	$	(163)	$	49	$	400	$	11,631


	Three months ended March 31, 2020
	Balance at		Charge-				Provision		Balance at
	December 31, 2019		Offs		Recoveries		(Credit)		March 31, 2020
Commercial	$	3,951	$	—	$	—	$	(91)	$	3,860
Commercial loans secured by non-owner occupied real estate		3,119		—		14		155		3,288
Real estate-residential mortgage		1,159		(92)		6		68		1,141
Consumer		126		(62)		14		42		120
Allocation for general risk		924		—		—		1		925
Total	$	9,279	$	(154)	$	34	$	175	$	9,334

The Company recorded a $400,000 provision expense for loan losses in the first quarter of 2021 compared to a $175,000 provision expense recorded in the first quarter of 2020. Although higher than the first quarter of 2020 by $225,000, an improved credit quality outlook for the overall portfolio resulted in a lower loan loss provision in the first quarter of 2021 after three consecutive quarters of a provision increase. The Company, however, continues to believe that a strong allowance for loan losses is needed given the overall economic climate and the uncertainty that remains because of the impact that the COVID-19 pandemic is having on certain borrowers. The first quarter 2021 provision primarily reflects an increased allocation on two commercial loan relationships transferred into non-accrual status during the quarter and the rating downgrade of a loan in the health care industry. As a result, non-performing assets, while still well controlled, totaled $4.2 million, or 0.43% of total loans, at March 31, 2021 compared to $3.3 million, or 0.34% of total loans, at December 31, 2020. It should be noted that the 100% SBA guarantee on PPP loans minimizes the level of credit risk associated with the loans. As a result, such loans are assigned a 0% risk weight for purposes of calculating the Bank’s risk-based capital ratios. Therefore, it was deemed appropriate to not allocate any portion of the loan loss reserve for the PPP loans.

The Company experienced low net loan charge-offs of $114,000, or 0.05% of total loans, in the first quarter of 2021 which was comparable to net loan charge-offs of $120,000, or 0.06% of total loans, in the first quarter of 2020. As a result of the provision expense sharply exceeding net loan charge-offs over the last 12 months, the balance in the allowance for loan losses increased by $2.3 million, or 24.6%, to $11.6 million at March 31, 2021. The allowance for loan losses provided 274% coverage of non-performing assets, and 1.18% of total loans, at March 31, 2021, compared to 341% coverage of non-performing assets, and 1.16% of total loans, at December 31, 2020.

The following tables summarize the loan portfolio and allowance for loan loss by the primary segments of the loan portfolio (in thousands).


	At March 31, 2021
			Commercial Loans
			Secured by
			Non-Owner		Real Estate-
			Occupied		Residential				Allocation for
	Commercial		Real Estate		Mortgage		Consumer		General Risk		Total
Loans:
Individually evaluated for impairment	$	2,574	$	8	$	—	$	—			$	2,582
Collectively evaluated for impairment		303,839		407,424		255,319		16,085				982,667
Total loans	$	306,413	$	407,432	$	255,319	$	16,085			$	985,249
Allowance for loan losses:
Specific reserve allocation	$	472	$	8	$	—	$	—	$	—	$	480
General reserve allocation		3,100		5,440		1,329		121		1,161		11,151
Total allowance for loan losses	$	3,572	$	5,448	$	1,329	$	121	$	1,161	$	11,631


	At December 31, 2020
			Commercial Loans
			Secured by
			Non-Owner		Real Estate-
			Occupied		Residential				Allocation for
	Commercial		Real Estate		Mortgage		Consumer		General Risk		Total
Loans:
Individually evaluated for impairment	$	847	$	8	$	—	$	—			$	855
Collectively evaluated for impairment		304,145		400,743		249,989		16,363				971,240
Total loans	$	304,992	$	400,751	$	249,989	$	16,363			$	972,095
Allowance for loan losses:
Specific reserve allocation	$	96	$	8	$	—	$	—	$	—	$	104
General reserve allocation		3,376		5,365		1,292		115		1,093		11,241
Total allowance for loan losses	$	3,472	$	5,373	$	1,292	$	115	$	1,093	$	11,345

The segments of the Company’s loan portfolio are disaggregated into classes that allows management to monitor risk and performance. The loan classes used are consistent with the internal reports evaluated by the Company’s management and Board of Directors to monitor risk and performance within various segments of its loan portfolio. The commercial loan segment includes both the commercial and industrial and the owner occupied commercial real estate loan classes while the remaining segments are not separated into classes as management monitors risk in these loans at the segment level. The residential mortgage loan segment is comprised of first lien amortizing residential mortgage loans and home equity loans secured by residential real estate. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts.

Management evaluates for possible impairment any individual loan in the commercial or commercial real estate segment that is in nonaccrual status or classified as a Troubled Debt Restructure (TDR). In addition, consumer and residential mortgage loans with a balance of $150,000 or more are evaluated for impairment. Loans are considered to be impaired when, based on current information and events, it is probable that the Company 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.

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: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs for collateral dependent loans. The method is selected on a loan-by-loan basis, with management primarily utilizing either the discounted cash flows or the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

The need for an updated appraisal on collateral dependent loans is determined on a case-by-case basis. The useful life of an appraisal or evaluation will vary depending upon the circumstances of the property and the economic conditions in the marketplace. A new appraisal is not required if there is an existing appraisal which, along with other information, is sufficient to determine a reasonable value for the property and to support an appropriate and adequate allowance for loan losses. At a minimum, annual documented reevaluation of the property is completed by the Bank’s internal Assigned Risk Department to support the value of the property.

When reviewing an appraisal associated with an existing real estate collateral dependent transaction, the Bank’s internal Assigned Risk Department must determine if there have been material changes to the underlying assumptions in the appraisal which affect the original estimate of value. Some of the factors that could cause material changes to reported values include:

the passage of time;

the volatility of the local market;

the availability of financing;

natural disasters;

the inventory of competing properties;

new improvements to, or lack of maintenance of, the subject property or competing properties upon physical inspection by the Bank;

changes in underlying economic and market assumptions, such as material changes in current and projected vacancy, absorption rates, capitalization rates, lease terms, rental rates, sales prices, concessions, construction overruns and delays, zoning changes, etc.; and/or

environmental contamination.

The value of the property is adjusted to appropriately reflect the above listed factors and the value is discounted to reflect the value impact of a forced or distressed sale, any outstanding senior liens, any outstanding unpaid real estate taxes, transfer taxes and closing costs that would occur with sale of the real estate. If the Assigned Risk Department personnel determine that a reasonable value cannot be derived based on available information, a new appraisal is ordered. The determination of the need for a new appraisal, versus completion of a property valuation by the Bank’s Assigned Risk Department personnel, rests with the Assigned Risk Department and not the originating account officer.

The following tables present impaired loans by portfolio segment, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary.


	At March 31, 2021
					IMPAIRED
					LOANS WITH
	IMPAIRED LOANS WITH				NO SPECIFIC
	SPECIFIC ALLOWANCE				ALLOWANCE		TOTAL IMPAIRED LOANS
									UNPAID
	RECORDED		RELATED		RECORDED		RECORDED		PRINCIPAL
	INVESTMENT		ALLOWANCE		INVESTMENT		INVESTMENT		BALANCE
	(IN THOUSANDS)
Commercial	$	2,574	$	472	$	—	$	2,574	$	2,577
Commercial loans secured by non-owner occupied real estate		8		8		—		8		30
Total impaired loans	$	2,582	$	480	$	—	$	2,582	$	2,607


	At December 31, 2020
					IMPAIRED
					LOANS WITH
	IMPAIRED LOANS WITH				NO SPECIFIC
	SPECIFIC ALLOWANCE				ALLOWANCE		TOTAL IMPAIRED LOANS
									UNPAID
	RECORDED		RELATED		RECORDED		RECORDED		PRINCIPAL
	INVESTMENT		ALLOWANCE		INVESTMENT		INVESTMENT		BALANCE
	(IN THOUSANDS)
Commercial	$	847	$	96	$	—	$	847	$	850
Commercial loans secured by non-owner occupied real estate		8		8		—		8		30
Total impaired loans	$	855	$	104	$	—	$	855	$	880

The following table presents the average recorded investment in impaired loans and related interest income recognized for the periods indicated (in thousands).


	Three months ended
	March 31,
	2021		2020
Average impaired balance:
Commercial	$	1,711	$	825
Commercial loans secured by non-owner occupied real estate		8		8
Average investment in impaired loans	$	1,719	$	833
Interest income recognized:
Commercial	$	12	$	12
Commercial loans secured by non-owner occupied real estate		—		—
Interest income recognized on a cash basis on impaired loans	$	12	$	12

Management uses a nine-point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized. The first five “Pass” categories are aggregated, while the Pass‑6, Special Mention, Substandard and Doubtful categories are disaggregated to separate pools. 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, or for which any portion of the loan represents a specific allocation of the allowance for loan losses are placed in Substandard or Doubtful.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan rating process, which dictates that, at a minimum, credit reviews are mandatory for all commercial and commercial mortgage loan relationships with aggregate balances in excess of $1,000,000 within a 12‑month period. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, delinquency, or death occurs to raise awareness of a possible credit event. The Company’s commercial relationship managers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. Risk ratings are assigned by the account officer, but require independent review and rating concurrence from the Company’s internal Loan Review Department. The Loan Review Department is an experienced, independent function which reports directly to the Board’s Audit Committee. The scope of commercial portfolio coverage by the Loan Review Department is defined and presented to the Audit Committee for approval on an annual basis. The approved scope of coverage for 2021 requires review of a minimum of 36% of the commercial loan portfolio.

In addition to loan monitoring by the account officer and Loan Review Department, the Company also requires presentation of all credits rated Pass‑6 with aggregate balances greater than $2,000,000, all credits rated Special Mention or Substandard with aggregate balances greater than $250,000, and all credits rated Doubtful with aggregate balances greater than $100,000 on an individual basis to the Company’s Loan Loss Reserve Committee on a quarterly basis. Additionally, the Asset Quality Task Force, which is a group comprised of senior level personnel, meets monthly to monitor the status of problem loans.

The following table presents the classes of the commercial and commercial real estate loan portfolios summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system.


	At March 31, 2021
			SPECIAL
	PASS		MENTION		SUBSTANDARD		DOUBTFUL		TOTAL
	(IN THOUSANDS)
Commercial and industrial	$	126,834	$	12,401	$	2,828	$	1,740	$	143,803
Paycheck Protection Program (PPP)		67,253		—		—		—		67,253
Commercial loans secured by owner occupied real estate		93,296		928		1,133		—		95,357
Commercial loans secured by non-owner occupied real estate		377,352		25,124		4,948		8		407,432
Total	$	664,735	$	38,453	$	8,909	$	1,748	$	713,845


	At December 31, 2020
			SPECIAL
	PASS		MENTION		SUBSTANDARD		DOUBTFUL		TOTAL
	(IN THOUSANDS)
Commercial and industrial	$	134,186	$	13,722	$	3,254	$	—	$	151,162
Paycheck Protection Program (PPP)		58,344		—		—		—		58,344
Commercial loans secured by owner occupied real estate		92,189		2,154		1,143		—		95,486
Commercial loans secured by non-owner occupied real estate		371,815		23,980		4,948		8		400,751
Total	$	656,534	$	39,856	$	9,345	$	8	$	705,743

It is generally the policy of the Bank that the outstanding balance of any residential mortgage loan that exceeds 90‑days past due as to principal and/or interest is transferred to non-accrual status and an evaluation is completed to determine the fair value of the collateral less selling costs, unless the balance is minor. A charge down is recorded for any deficiency balance determined from the collateral evaluation. The remaining non-accrual balance is reported as impaired with no specific allowance. It is generally the policy of the Bank that the outstanding balance of any consumer loan that exceeds 90‑days past due as to principal and/or interest is charged off. The following tables present the performing and non-performing outstanding balances of the residential and consumer portfolio classes.


	At March 31, 2021
			NON-
	PERFORMING		PERFORMING		TOTAL
	(IN THOUSANDS)
Real estate – residential mortgage	$	253,663	$	1,656	$	255,319
Consumer		16,078		7		16,085
Total	$	269,741	$	1,663	$	271,404


	At December 31, 2020
			NON-
	PERFORMING		PERFORMING		TOTAL
	(IN THOUSANDS)
Real estate – residential mortgage	$	247,520	$	2,469	$	249,989
Consumer		16,356		7		16,363
Total	$	263,876	$	2,476	$	266,352

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 tables present the classes of the loan portfolio summarized by the aging categories of performing loans and non-accrual loans.


	At March 31, 2021
													90 DAYS
			30 – 59		60 – 89								PAST DUE
			DAYS		DAYS		90 DAYS		TOTAL		TOTAL		AND STILL
	CURRENT		PAST DUE		PAST DUE		PAST DUE		PAST DUE		LOANS		ACCRUING
	(IN THOUSANDS)
Commercial and industrial	$	143,803	$	—	$	—	$	—	$	—	$	143,803	$	—
Paycheck Protection Program (PPP)		67,253		—		—		—		—		67,253	$	—
Commercial loans secured by owner occupied real estate		95,266		91		—		—		91		95,357		—
Commercial loans secured by non-owner occupied real estate		407,432		—		—		—		—		407,432		—
Real estate – residential mortgage		252,395		1,918		22		984		2,924		255,319		—
Consumer		16,059		18		1		7		26		16,085		—
Total	$	982,208	$	2,027	$	23	$	991	$	3,041	$	985,249	$	—


	At December 31, 2020
													90 DAYS
			30 – 59		60 – 89								PAST DUE
			DAYS		DAYS		90 DAYS		TOTAL		TOTAL		AND STILL
	CURRENT		PAST DUE		PAST DUE		PAST DUE		PAST DUE		LOANS		ACCRUING
	(IN THOUSANDS)
Commercial and industrial	$	148,023	$	536	$	2,603	$	—	$	3,139	$	151,162	$	—
Paycheck Protection Program (PPP)		58,344		—		—		—		—		58,344	$	—
Commercial loans secured by owner occupied real estate		95,486		—		—		—		—		95,486		—
Commercial loans secured by non-owner occupied real estate		399,850		230		671		—		901		400,751		—
Real estate – residential mortgage		246,279		776		1,178		1,756		3,710		249,989		—
Consumer		16,274		82		—		7		89		16,363		—
Total	$	964,256	$	1,624	$	4,452	$	1,763	$	7,839	$	972,095	$	—

An allowance for loan losses (“ALL”) is maintained to support loan growth and cover charge-offs 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.

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 complemented by consideration of other qualitative factors.

Management tracks the historical net charge-off activity at each risk rating grade level for the entire commercial portfolio and at the aggregate level for the consumer, residential mortgage and small business portfolios. A historical charge-off factor is calculated utilizing a rolling 12 consecutive historical quarters for the commercial portfolios. This historical charge-off factor for the consumer, residential mortgage and small business portfolios are based on a three-year historical average of actual loss experience.

The Company uses a comprehensive methodology and procedural discipline to maintain an ALL to absorb inherent losses in the loan portfolio. The Company believes this is a critical accounting policy since it involves significant estimates and judgments. The allowance consists of three elements: (1) an allowance established on specifically identified problem loans, (2) formula driven general reserves established for loan categories based upon historical loss experience and other qualitative factors which include delinquency, non-performing and TDR loans, loan trends, economic trends, concentrations of credit, trends in loan volume, experience and depth of management, examination and audit results, effects of any changes in lending policies, and trends in policy, financial information, and documentation exceptions, and (3) a general risk reserve which provides support for variance from our assessment of the previously listed qualitative factors, provides protection against credit risks resulting from other inherent risk factors contained in the Company’s loan portfolio, and recognizes the model and estimation risk associated with the specific and formula driven allowances. The qualitative factors used in the formula driven general reserves are evaluated quarterly (and revised if necessary) by the Company’s management to establish allocations which accommodate each of the listed risk factors.

“Pass” rated credits are segregated from “Criticized” and “Classified” credits for the application of qualitative factors.

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.