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Loans and Allowance for Loan Losses

12 Months Ended

Dec. 31, 2021

Loans, Notes, Trade and Other Receivables Disclosure [Text Block]

Note 3. Loans and Allowance for Loan Losses

Major classifications of loans held for investment are as follows:

(In thousands)	December 31, 2021		December 31, 2020
Commercial and industrial	$	83,348	$	79,864
Consumer installment		1,099		10,259
Real estate – residential		5,452		4,319
Real estate – commercial		62,966		44,484
Real estate – construction and land		2,585		8,396
SBA:
SBA 7(a) guaranteed		145,983		164,687
SBA 7(a) unguaranteed		52,524		52,179
SBA 504		35,348		35,553
USDA		806		801
Factored receivables		38,636		-
Gross loans		428,747		400,542
Less:
Allowance for loan losses		4,152		2,941
Net loans	$	424,595	$	397,601

During the second quarter of 2020, the Company began participating in the Paycheck Protection Program (“PPP”) which was established by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in response to the COVID-19 pandemic and administered by the SBA. The PPP loans may be forgiven by the SBA and are 100 percent guaranteed by the SBA. Therefore, no allowance for loan losses is allocated to PPP loans. Included in SBA 7(a) guaranteed loans, there were $34.1 million of PPP loans outstanding at December 31, 2021, as compared to $82.5 million of PPP loans outstanding at December 31, 2020.

As of December 31, 2021, our loan portfolio included $67.3 million of loans, approximately 15.7% of our total funded loans (17.1% of total funded loans, net of the SBA PPP loans), to the dental industry, as compared to $67.2 million of loans, or 16.8% of total funded loans (21.1% of total funded loans, net of PPP loans), at December 31, 2020. The Bank believes that these loans are to credit worthy borrowers and are diversified geographically.

The Company serves the small business community by offering loans promulgated under the SBA’s 7(a) and 504 loan programs, and loans guaranteed by the USDA. SBA 7(a) and USDA loans are typically guaranteed by each agency in amounts ranging from 75% to 80% of the principal balance. For SBA construction loans, the Company records the guaranteed funded portion of the loans as held for sale. When the SBA loans are fully funded, the Company may sell the guaranteed portion into the secondary market, on a servicing-retained basis, or reclassify from loans held for sale to loans held for investment if the Company determines that holding these loans provide better long-term risk adjusted returns than selling the loans. In calculating gain on the sale of loans, the Company performs an allocation based on the relative fair values of the sold portion and retained portion of the loan. The Company’s assumptions are validated by reference to external market information.

The Company had $33.8 million and $14.9 million of non-PPP SBA loans held for sale as of December 31, 2021 and 2020, respectively. During the year ended December 31, 2021, the Company sold one non-PPP SBA loan for $1.1 million, resulting in a gain on sale of loans of $101,000. In connection with the sale, the Company recorded a servicing asset of $19,000. The Company elected to reclassify $42.8 million of the SBA 7(a) loans held for sale to loans held for investment during the year ended December 31, 2021.

During the year ended December 31, 2020, the Company sold $9.8 million of SBA loans, resulting in a gain on sale of loans of $722,000. In connection with the sales, the Company recorded a servicing asset of $152,000. The Company elected to reclassify $26.4 million of the SBA 7(a) loans held for sale to loans held for investment during the year ended December 31, 2020.

Loan Origination/Risk Management.

The Company maintains written loan origination policies, procedures, and processes which address credit quality at several levels including individual loan level, loan type, and loan portfolio levels.

Commercial and industrial loans, which are predominantly loans to dentists, are underwritten based on historical and projected income of the business and individual borrowers and guarantors. The Company utilizes a comprehensive global debt service coverage analysis to determine debt service coverage ratios. This analysis compares global cash flow of the borrowers and guarantors on an individual credit to existing and proposed debt after consideration of personal and business related other expenses. Collateral is generally a lien on all available assets of the business borrower including intangible assets. Credit worthiness of individual borrowers and guarantors is established through the use of credit reports and credit scores.

Consumer loans are evaluated on the basis of credit worthiness as established through the use of credit reports and credit scores. Additional credit quality indicators include borrower debt to income ratios based on verifiable income sources.

Real estate mortgage loans are evaluated based on collateral value as well as global debt service coverage ratios based on historical and projected income from all related sources including the collateral property, the borrower, and all guarantors where applicable.

The Company originates SBA loans which are sometimes sold into the secondary market. The Company continues to service these loans after sale and is required under the SBA programs to retain specified amounts. The two primary SBA loan programs that the Company offers are the basic 7(a) loan guaranty program and the 504 loan program in conjunction with junior lien financing from a Certified Development Company (“CDC”).

The 7(a) program serves as the SBA’s primary business loan program to help qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels. Loan proceeds under this program can be used for most business purposes including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements and debt refinancing. Loan maturity is generally up to 10 years for non-real estate collateral and up to 25 years for real estate collateral. The 7(a) loan is approved and funded by a qualified lender, partially guaranteed by the SBA and subject to applicable regulations. In general, the SBA guarantees up to 75% (100% for PPP loans) of the loan amount depending on loan size. The Company is required by the SBA to service the loan and retain a contractual minimum of 5% on all SBA 7(a) loans, but generally retains 25% (the unguaranteed portion). The servicing spread is 1% of the guaranteed portion of the loan that is sold in the secondary market. Included in the 7(a) loans reflected in this Form 10-K are the PPP loans originated by the Company and outstanding as of December 31, 2021 and 2020.

The 504 program is an economic development-financing program providing long-term, low down payment loans to businesses. Typically, a 504 project includes a loan secured from a private-sector lender with a senior lien, a loan secured from a CDC (funded by a 100% SBA-guaranteed debenture) with a junior lien covering up to 40% of the total cost, and a contribution of at least 10% equity from the borrower. Debenture limits are $5.0 million for regular 504 loans and $5.5 million for those 504 loans that meet a public policy goal.

The SBA has designated the Bank as a “Preferred Lender”. As a Preferred Lender, the Bank has been delegated loan approval, closing and most servicing and liquidation authority from the SBA.

The Company also offers Business & Industry (“B&I”) program loans through the USDA. These loans are similar to the SBA product, except they are guaranteed by the USDA. The guaranteed amount is generally 80%. B&I loans are made to businesses in designated rural areas and are generally larger loans to larger businesses than the SBA 7(a) loans. Similar to the SBA 7(a) product, they can be sold into the secondary market. These loans can be utilized for rural commercial real estate and equipment. The loans can have maturities up to 30 years and the rates can be fixed or variable.

Construction and land development loans are evaluated based on the borrower’s and guarantor’s credit worthiness, past experience in the industry, track record and experience with the type of project being considered, and other factors. Collateral value is determined generally by independent appraisal utilizing multiple approaches to determine value based on property type.

For all loan types, the Company establishes guidelines for its underwriting criteria including collateral coverage ratios, global debt service coverage ratios, and maximum amortization or loan maturity terms.

At the portfolio level, the Company monitors concentrations of loans based on several criteria including loan type, collateral type, industry, geography, and other factors. The Company also performs periodic market research and economic analysis at a local geographic and national level. Based on this research, the Company may from time to time change the minimum or benchmark underwriting criteria applied to the above loan types.

Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period of repayment performance by the borrower.

As of December 31, 2021 and December 31, 2020, there were no loans identified as troubled debt restructurings. There were no new troubled debt restructurings during the years ended December 31, 2021 and 2020.

Certain borrowers are currently unable to meet their contractual payment obligations because of the adverse effects of COVID-19. To help mitigate these effects, loan customers may apply for a deferral of payments, or portions thereof, for up to 90 days. After 90 days, customers may apply for an additional deferral, and a small proportion of our customers have requested such an additional deferral. In the absence of other intervening factors, such short-term modifications made on a good faith basis are not categorized as troubled debt restructurings, nor are loans granted payment deferrals related to COVID-19 reported as past due or placed on non-accrual status (provided the loans were not past due or on non-accrual status prior to the deferral). At December 31, 2021, there were two loans in COVID-19 related deferment with an aggregate outstanding balance of approximately $679,000. At December 31, 2020, there were 11 loans in COVID-19 related deferment with an aggregate outstanding balance of approximately $4.3 million.

Non-accrual loans, segregated by class of loans, were as follows:

(In thousands)	December 31, 2021		December 31, 2020
Non-accrual loans:
Commercial and industrial	$	-	$	158
Real estate – commercial		149		-
SBA guaranteed		2,039		1,118
SBA unguaranteed		-		517
Total	$	2,188	$	1,793

The Company’s impaired loans and related allowance is summarized in the following table:

	Unpaid		Recorded		Recorded
	Contractual		Investment		Investment		Total				Average		Interest
	Principal		With No		With		Recorded		Related		Recorded		Income
(In thousands)	Balance		Allowance		Allowance		Investment		Allowance		Investment		Recognized
December 31, 2021											Year Ended
Commercial and industrial	$	-	$	-	$	-	$	-	$	-	$	73	$	4
SBA		3,658		3,071		-		3,071		-		6,333		21
Total	$	3,658	$	3,071	$	-	$	3,071	$	-	$	6,406	$	25

December 31, 2020											Year Ended
Commercial and industrial	$	-	$	-	$	-	$	-	$	-	$	10	$	-
Real estate – construction and land		-		-		-		-		-		313		-
SBA		6,649		2,976		-		2,976		-		3,206		61
Total	$	6,649	$	2,976	$	-	$	2,976	$	-	$	3,529	$	61

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The Company’s past due loans are as follows:

											Total 90
			90 Days								Days Past
	30-89 Days		or More		Total		Total		Total		Due Still
(In thousands)	Past Due		Past Due		Past Due		Current		Loans		Accruing
December 31, 2021
Commercial and industrial	$	4	$	-	$	4	$	83,344	$	83,348	$	-
Consumer installment		-		-		-		1,099		1,099		-
Real estate – residential		-		-		-		5,452		5,452		-
Real estate – commercial		219		-		219		62,747		62,966		-
Real estate – construction and land		-		-		-		2,585		2,585		-
SBA		1,762		-		1,762		232,093		233,855		-
USDA		-		-		-		806		806		-
Factored receivables		1,743		400		2,143		36,493		38,636		400
Total	$	3,728	$	400	$	4,128	$	424,619	$	428,747	$	400

December 31, 2020
Commercial and industrial	$	-	$	-	$	-	$	79,864	$	79,864	$	-
Consumer installment		-		-		-		10,259		10,259		-
Real estate – residential		-		-		-		4,319		4,319		-
Real estate – commercial		121		158		279		44,205		44,484		-
Real estate – construction and land		-		-		-		8,396		8,396		-
SBA		-		1,635		1,635		250,784		252,419		-
USDA		-		-		-		801		801		-
Total	$	121	$	1,793	$	1,914	$	398,628	$	400,542	$	-

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including internal credit risk based on past experiences as well as external statistics and factors. Loans are graded in one of six categories: (i) pass, (ii) pass-watch, (iii) special mention, (iv) substandard, (v) doubtful, or (vi) loss. Loans graded as loss are charged-off.

The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on credits quarterly. No significant changes were made to the loan risk grading system definitions and allowance for loan loss methodology during the past year. Ratings are adjusted to reflect the degree of risk and loss that is felt to be inherent in each credit. The Company’s methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

Credits rated pass are acceptable loans, appropriately underwritten, bearing an ordinary risk of loss to the Company. Loans in this category are loans to highly credit worthy borrowers with financial statements presenting a good primary source as well as an adequate secondary source of repayment.

Credits rated pass-watch loans have been determined to require enhanced monitoring for potential weaknesses which require further investigation. They have no significant delinquency in the past twelve months. This rating causes the loan to be actively monitored with greater frequency than pass loans and allows appropriate downgrade transition if verifiable adverse events are confirmed. This category may also include loans that have improved in credit quality from special mention but are not yet considered pass loans.

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness; however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed. Guaranteed portions of SBA loans graded substandard are generally on non-accrual due to the limited amount of interest covered by the guarantee, usually 60 days maximum. However, there typically will be no exposure to loss on the principal amount of these guaranteed portions of the loan.

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss.

Loans classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this asset even though partial recovery may be affected in the future.

The following table summarizes the Company’s internal ratings of its loans as of the dates indicated:

			Pass-		Special
(In thousands)	Pass		Watch		Mention		Substandard		Doubtful		Total
December 31, 2021
Commercial and industrial	$	82,105	$	1,243	$	-	$	-	$	-	$	83,348
Consumer installment		1,099		-		-		-		-		1,099
Real estate – residential		5,242		-		-		210		-		5,452
Real estate – commercial		62,817		-		-		149		-		62,966
Real estate – construction and land		2,585		-		-		-		-		2,585
SBA		213,630		16,265		2,659		1,301		-		233,855
USDA		806		-		-		-		-		806
Factored receivables		38,636		-		-		-		-		38,636
Total	$	406,920	$	17,508	$	2,659	$	1,660	$	-	$	428,747

December 31, 2020
Commercial and industrial	$	79,134	$	730	$	-	$	-	$	-	$	79,864
Consumer installment		10,259		-		-		-		-		10,259
Real estate – residential		4,319		-		-		-		-		4,319
Real estate – commercial		44,326		-		-		158		-		44,484
Real estate – construction and land		8,396		-		-		-		-		8,396
SBA		243,533		5,242		1,794		1,850		-		252,419
USDA		801		-		-		-		-		801
Total	$	390,768	$	5,972	$	1,794	$	2,008	$	-	$	400,542

The activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2021 and 2020 is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the losses in various categories of the loan portfolio.

(In thousands)	Commercial and Industrial		Consumer Installment			Real Estate Residential		Real Estate Commercial		Real Estate Construction and Land			SBA			USDA		Factored Receivables			Total
December 31, 2021
Beginning Balance	$	928	$	91		$	52	$	527	$	100		$	1,225		$	18	$	-		$	2,941
Provision for loan losses		189		(76	)		24		342		(60	)		1,031			2		762			2,214
Charge-offs		-		-			-		-		-			(952	)		-		(168	)		(1,120	)
Recoveries		37		-			-		-		-			20			-		60			117
Net recoveries (charge-offs)		37		-			-		-		-			(932	)		-		(108	)		(1,003	)
Ending balance	$	1,154	$	15		$	76	$	869	$	40		$	1,324		$	20	$	654		$	4,152

December 31, 2020
Beginning Balance	$	501	$	27		$	22	$	347	$	76		$	435		$	-	$	-		$	1,408
Provision for loan losses		394		64			30		180		24			999			18		-			1,709
Charge-offs		-		-			-		-		-			(218	)		-		-			(218	)
Recoveries		33		-			-		-		-			9			-		-			42
Net recoveries		33		-			-		-		-			(209	)		-		-			(176	)
Ending balance	$	928	$	91		$	52	$	527	$	100		$	1,225		$	18	$	-		$	2,941

The Company’s allowance for loan losses as of December 31, 2021 and 2020 by portfolio segment and detailed on the basis of the Company’s impairment methodology was as follows:

(In thousands)	Commercial and Industrial		Consumer Installment		Real Estate Residential		Real Estate Commercial		Real Estate Construction and Land		SBA		USDA		Factored Receivables		Total
December 31, 2021
Loans individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Loans collectively evaluated for impairment		1,154		15		76		869		40		1,324		20		654		4,152
Ending balance	$	1,154	$	15	$	76	$	869	$	40	$	1,324	$	20	$	654	$	4,152

December 31, 2020
Loans individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Loans collectively evaluated for impairment		928		91		52		527		100		1,225		18		-		2,941
Ending balance	$	928	$	91	$	52	$	527	$	100	$	1,225	$	18	$	-	$	2,941

The Company’s recorded investment in loans as of December 31, 2021 and 2020 related to each balance in the allowance for loan losses by portfolio segment and detailed on the basis of the Company’s impairment methodology was as follows:

(In thousands)	Commercial and Industrial		Consumer Installment		Real Estate Residential		Real Estate Commercial		Real Estate Construction and Land		SBA		USDA		Factored Receivables		Total
December 31, 2021
Loans individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	3,071	$	-	$	-	$	3,071
Loans collectively evaluated for impairment		83,348		1,099		5,452		62,966		2,585		230,784		806		38,636		425,676
Ending balance	$	83,348	$	1,099	$	5,452	$	62,966	$	2,585	$	233,855	$	806	$	38,636	$	428,747

December 31, 2020
Loans individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	2,976	$	-	$	-	$	2,976
Loans collectively evaluated for impairment		79,864		10,259		4,319		44,484		8,396		249,443		801		-		397,566
Ending balance	$	79,864	$	10,259	$	4,319	$	44,484	$	8,396	$	252,419	$	801	$	-	$	400,542