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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

 

 

NATIONAL BANKSHARES, INC.

 (Exact name of registrant as specified in its charter)

Commission File Number 0-15204

 

Virginia (State or other jurisdiction of incorporation or organization)

54-1375874 (I.R.S. Employer Identification No.)

 

101 Hubbard Street Blacksburg, Virginia 24062-9002

(Address of principal executive offices, including zip code)

(540) 951-6300

(Registrant's telephone number, including area code)

 

(Not applicable)

(Former name, former address and former fiscal year, if changed since last report)

 

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $1.25 per share	NKSH	Nasdaq Capital Market

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  [x] Yes   [  ] No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). [x] Yes   [ ] No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b–2 of the Exchange Act.

 

Large accelerated filer [  ]         Accelerated filer [x]         Non-accelerated filer [  ]         Smaller reporting company [x]          Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ] Yes [ ] No

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ]    No [x]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Outstanding shares of common stock at May 6, 2020 6,489,574

 

 

 

 

 

NATIONAL BANKSHARES, INC.

Form 10-Q

Index

 

Part I – Financial Information		Page
Item 1	Financial Statements	3
	Consolidated Balance Sheets, March 31, 2020 (Unaudited) and December 31, 2019	3 - 4
	Consolidated Statements of Income for the Three Months Ended March 31, 2020 and 2019 (Unaudited)	5 – 6
	Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2020 and 2019 (Unaudited)	7
	Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2020 and 2019 (Unaudited)	8
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019 (Unaudited)	9 – 10
	Notes to Consolidated Financial Statements (Unaudited)	11 – 35
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3	Quantitative and Qualitative Disclosures About Market Risk	55
Item 4	Controls and Procedures	55
Part II – Other Information
Item 1	Legal Proceedings	56
Item 1A	Risk Factors	56
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 3	Defaults Upon Senior Securities	56
Item 4	Mine Safety Disclosures	56
Item 5	Other Information	56
Item 6	Exhibits	57 - 58
Signatures		59
Certifications

 

 

 

		(Unaudited)
		March 31,				December 31,
(in thousands, except share and per share data)		2020				2019
Assets
Cash and due from banks		$	12,404			$	10,290
Interest-bearing deposits			71,898				76,881
Securities available for sale, at fair value			439,019				435,263
Restricted stock, at cost			1,279				1,220
Loans held for sale			1,787				905
Loans:
Loans, net of unearned income and deferred fees and costs			729,483				733,451
Less allowance for loan losses			(7,240	)			(6,863	)
Loans, net			722,243				726,588
Premises and equipment, net			10,058				8,919
Accrued interest receivable			4,280				4,285
Other real estate owned, net			1,584				1,612
Goodwill			5,848				5,848
Bank-owned life insurance			35,788				35,567
Other assets			12,788				14,459
Total assets		$	1,318,976			$	1,321,837
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits		$	210,131			$	201,866
Interest-bearing demand deposits			624,412				643,482
Savings deposits			149,842				146,377
Time deposits			123,798				128,028
Total deposits			1,108,183				1,119,753
Accrued interest payable			137				144
Other liabilities			19,097				18,214
Total liabilities			1,127,417				1,138,111
Commitments and contingencies

Stockholders' Equity
Preferred stock, no par value, 5,000,000 shares authorized; none issued and outstanding			---				---
Common stock of $1.25 par value. Authorized 10,000,000 shares; issued and outstanding 6,489,574 shares at March 31, 2020 and December 31, 2019			8,112				8,112
Retained earnings			188,099				184,120
Accumulated other comprehensive loss, net			(4,652	)			(8,506	)
Total stockholders' equity			191,559				183,726
Total liabilities and stockholders' equity		$	1,318,976			$	1,321,837

 

		March 31,				March 31,
(in thousands, except share and per share data)		2020				2019
Interest Income
Interest and fees on loans		$	8,466			$	8,269
Interest on interest-bearing deposits			217				259
Interest on securities – taxable			2,356				1,683
Interest on securities – nontaxable			349				927
Total interest income			11,388				11,138
Interest Expense
Interest on time deposits			559				297
Interest on other deposits			1,237				1,496
Total interest expense			1,796				1,793
Net interest income			9,592				9,345
Provision for loan losses			479				200
Net interest income after provision for loan losses			9,113				9,145
Noninterest Income
Service charges on deposit accounts			582				590
Other service charges and fees			39				52
Credit and debit card fees			306				309
Trust income			434				397
BOLI income			221				219
Other income			533				910
Realized securities gain, net			20				12
Total noninterest income			2,135				2,489
Noninterest Expense
Salaries and employee benefits			3,979				3,821
Occupancy, furniture and fixtures			450				465
Data processing and ATM			791				751
FDIC assessment			---				85
Net costs of other real estate owned			22				25
Franchise taxes			343				314
Other operating expenses			882				1,004
Total noninterest expense			6,467				6,465
Income before income taxes			4,781				5,169
Income tax expense			802				726

Net Income		$	3,979			$	4,443
Basic net income per common share		$	0.61			$	0.65
Fully diluted net income per common share		$	0.61			$	0.65
Weighted average number of common shares outstanding – basic and diluted			6,489,574				6,839,733
Dividends declared per common share			---				---

 

		March 31,				March 31,
(in thousands)		2020				2019
Net Income		$	3,979			$	4,443
Other Comprehensive Income, Net of Tax
Unrealized holding gain on available for sale securities net of tax of $1,028 and $1,209 for the periods ended March 31, 2020 and 2019, respectively			3,870				4,553
Reclassification adjustment for gain included in net income, net of tax of ($4) for the period ended March 31, 2020 and ($3) for the period ended March 31, 2019			(16	)			(9	)
Other comprehensive income, net of tax			3,854				4,544
Total Comprehensive Income		$	7,833			$	8,987

 

(in thousands, except share data)		Common Stock				Retained Earnings				Accumulated Other Comprehensive Loss				Total
Balances at December 31, 2018		$	8,698			$	193,625			$	(12,085	)		$	190,238
Net income			---				4,443				---				4,443
Common stock repurchased, 452,400 shares			(566	)			(17,431	)			---				(17,997	)
Other comprehensive income, net of tax of $1,206			---				---				4,544				4,544
Balances at March 31, 2019		$	8,132				180,637				(7,541	)			181,228
Balances at December 31, 2019		$	8,112			$	184,120			$	(8,506	)		$	183,726
Net income			---				3,979				---				3,979
Other comprehensive income, net of tax of $1,024			---				---				3,854				3,854
Balances at March 31, 2020		$	8,112			$	188,099			$	(4,652	)		$	191,559

 

		March 31,				March 31,
(in thousands)		2020				2019
Cash Flows from Operating Activities
Net income		$	3,979			$	4,443
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			479				200
Depreciation of bank premises and equipment			176				173
Amortization of premiums and accretion of discounts, net			193				14
Gains on disposal of fixed assets			---				(2	)
Gain on sales and calls of securities available for sale, net			(20	)			(12	)
Loss and write-down on other real estate owned, net			4				5
Gain on disposal of repossessed assets			---				(1	)
Increase in cash value of bank-owned life insurance			(221	)			(219	)
Origination of mortgage loans held for sale			(6,428	)			(2,604	)
Proceeds from sale of mortgage loans held for sale			5,639				2,113
Gain on sale of mortgage loans held for sale			(94	)			(39	)
Net change in:
Accrued interest receivable			5				(241	)
Other assets			625				740
Accrued interest payable			(7	)			51
Other liabilities			883				475
Net cash provided by operating activities			5,213				5,096
Cash Flows from Investing Activities
Net change in interest-bearing deposits			4,983				(9,890	)
Proceeds from calls, principal payments, sales and maturities of securities available for sale			53,872				26,113
Purchase of securities available for sale			(52,923	)			---
Net change in restricted stock			(59	)			---
Purchase of loan participations			(18	)			(189	)
Collection of loan participations			87				3,150
Loan originations and principal collections, net			3,720				(11,864	)
Proceeds from sale of other real estate owned			24				22
Proceeds from disposal of repossessed assets			27				3
Recoveries on loans charged off			73				98
Proceeds from sale and purchases of premises and equipment, net			(1,315	)			(355	)
Net cash provided by investing activities			8,471				7,088

Cash Flows from Financing Activities
Net change in time deposits			(4,230	)			8,055
Net change in other deposits			(7,340	)			208
Common stock repurchased			---				(17,997	)
Net cash used in financing activities			(11,570	)			(9,734	)
Net change in cash and due from banks			2,114				2,450
Cash and due from banks at beginning of period			10,290				12,882
Cash and due from banks at end of period		$	12,404			$	15,332
Supplemental Disclosures of Cash Flow Information
Interest paid on deposits		$	1,803			$	1,742
Income taxes paid			---				---
Supplemental Disclosure of Noncash Activities
Loans charged against the allowance for loan losses		$	175			$	328
Loans transferred to other real estate owned			---				---
Unrealized net gain on securities available for sale			4,878				5,750
Increase in operating lease right-of-use asset upon adoption of ASU 2016-02			---				684
Increase in operating lease liability upon adoption of ASU 2016-02			---				684

 

Note 1:  General

 

The consolidated financial statements of National Bankshares, Inc. (“NBI”) and its wholly-owned subsidiaries, The National Bank of Blacksburg (the “Bank” or “NBB”) and National Bankshares Financial Services, Inc. (“NBFS”) (collectively, the “Company”), conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and to general practices within the banking industry. The accompanying interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments consisting of normal recurring adjustments, which are necessary for a fair presentation of the consolidated financial statements, have been included.  The results of operations for the three month period ended March 31, 2020 are not necessarily indicative of results of operations for the full year or any other interim period.  The interim period consolidated financial statements and financial information included in this Form 10-Q should be read in conjunction with the notes to consolidated financial statements included in the Company’s 2019 Form 10-K.  The Company posts all reports required to be filed under the Securities Exchange Act of 1934 on its web site at www.nationalbankshares.com.

 

Risks and Uncertainties

 

The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company.  The World Health Organization declared COVID-19 to be a global pandemic and almost all public commerce and related business activities have been, to varying degrees, curtailed in order to reduce the rate of new infections. The pandemic and efforts to reduce its spread have caused significant disruptions in the U.S. economy and negatively impacted banking and other financial activity in the Company’s market.  The Company’s employees have, at this time, avoided any confirmed infection however an outbreak amongst employees could create widespread business continuity issues for the Company.

The Congress of the United States, along with the President of the United States and the Federal Reserve have taken historic actions. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 and provides $2 trillion to cushion the economic fallout. The CARES Act employs various measures in an attempt to prevent a severe economic downturn, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. Certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on the Company’s operations. 

The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions.  If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full extent that the impact COVID-19 will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.

 

Financial position and results of operations

The Company’s fee income may be reduced.  In keeping with guidance from regulators, the Company is actively working with COVID-19 affected customers and may waive various fees related to deposit and lending activities.  The Company is continuously monitoring the situation and expects to continue to work with affected customers throughout the crisis in order to preserve its customer base.  The Company will resume normal practices related to fees when the crisis eases.  At this time, the Company is unable to project the materiality of such an impact, but recognize the economic impact on fee income will extend to future periods.

The Company’s interest income in the short term will be reduced due to COVID-19.  In keeping with guidance from regulators, the Company is actively working with COVID-19 affected borrowers to defer payments, interest, and fees.  For certain real estate secured loans, payment extensions result in reversal of previously accrued interest, immediately reducing interest income.  Interest begins accruing again at the next payment date and the reversed interest will be recognized at the end of the loan term.  Accrued interest on other loans is not reversed when the payment is extended.  If eventual credit losses are identified on any loan that has received a payment extension, interest and fee income accrued pursuant to U.S. GAAP accounting would be reversed at the time the loss is identified.  In such a scenario, interest income in future periods could be negatively impacted.  At this time, the Company is unable to project the materiality of such an impact, but recognizes economic impact may affect its borrowers’ ability to repay in future periods.  

 

Capital and Liquidity

While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by further credit losses.

The Company maintains access to multiple sources of liquidity.  Wholesale funding markets are currently available to the Company, but rates for short term funding have recently been volatile.  If funding costs are elevated for an extended period of time it becomes necessary for the Company to access wholesale funding, the Company’s net interest margin could be adversely affected.  If an extended recession causes large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

 

Asset valuation

Currently, the Company does not expect COVID-19 to affect its ability to account timely for the assets on its balance sheet; however if the impact of the pandemic worsens, valuation procedures in future periods could be negatively affected. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances, such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with U.S. GAAP.

COVID-19 could cause a further and sustained decline in the Company’s stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances prescribed by U.S. GAAP, require the Company to perform a goodwill impairment test.  In the event that the Company concludes that all or a portion of its goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.

 

 

 

Processes, controls and business continuity plan

In response to the pandemic, the Company deployed its business continuity plan, including a remote working strategy for certain employees. The Company does not anticipate incurring additional material cost related to its continued deployment of the remote working strategy.  No material operational or internal control challenges or risks have been identified to date.  The Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures the Company has taken to prevent the spread of COVID-19.  The Company does not currently face any material resource constraint through the implementation of its business continuity plans.

 

Lending operations and accommodations to borrowers

In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company is providing a payment deferral program for its borrowers who are adversely affected by the pandemic.  Depending on the demonstrated need of the borrower, the Company has provided payment deferrals for 30 or 60 days.  As of April 30, 2020, the Company has deferred payment on 221 loans with aggregate outstanding loan balances of $85,883.  Additionally, 9 loans totaling $19,700 received other modifications to provide short-term payment relief. In accordance with interagency guidance issued in March 2020, these short term deferrals are not considered troubled debt restructurings (“TDRs”).

With the passage of the Paycheck Protection Program (“PPP”), administered by the Small Business Administration (“SBA”), the Company is actively participating in assisting its customers with applications for resources through the program.  PPP loans have a two-year term and earn interest at 1%. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.  As of April 30, 2020, the Company has input to the SBA system 717 loans totaling $56.1 million.  Of these, 575 loans have completed approval procedures and 516 loans totaling $48.2 million have been funded.  It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan loss through additional loan loss expense.

 

Credit 

The Company is working with customers directly affected by COVID-19, providing short-term assistance in accordance with regulator guidelines.  As a result of the current economic environment caused by the COVID-19 pandemic, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions worsen, the Company could experience further increases in its required allowance for loan losses and record additional loan loss expense. It is possible that the Company’s asset quality measures could worsen at future measurement periods if effects of the COVID-19 pandemic are prolonged.

 

Accounting Standards Adopted as of January 1, 2020

 

ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350)”

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The amendments in this ASU eliminate Step 2 from the goodwill impairment test. Step 2 measured goodwill impairment by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Instead, annual or interim goodwill impairment testing will compare the fair value of a reporting unit with its carrying amount. The ASU still provides the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.

                The Company adopted ASU 2017-04 on January 1, 2020 under the prospective application approach as required by the ASU.  The Company plans to perform its annual test for impairment during the fourth quarter of 2020. The adoption of ASU 2017-04 did not have a material impact on the Company’s consolidated financial statements.

 

ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.”

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified.

The Company adopted ASU 2018-13 as of January 1, 2020. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. The adoption of ASU 2018-13 did not have a material impact on the Company’s consolidated financial statements.

 

Interagency Statement on Loan Modifications

                In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the Coronavirus. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” (“ASC 310-40”), a restructuring of debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. This interagency guidance is expected to have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time.

 

 

 

Note 2:

Loan Portfolio

 

The loan portfolio, excluding loans held for sale, was comprised of the following.

 

 

 

Note 3:

Allowance for Loan Losses, Nonperforming Assets and Impaired Loans

 

The allowance for loan losses methodology incorporates individual evaluation of impaired loans and collective evaluation of groups of non-impaired loans. The Company performs ongoing analysis of the loan portfolio to determine credit quality and to identify impaired loans. Credit quality is rated based on the loan’s payment history, the borrower’s current financial situation and value of the underlying collateral.

 

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts will not be collected when due according to the contractual terms of the loan agreement. Impaired loans are those loans that have been modified in a TDR and larger, usually non-homogeneous loans that are in nonaccrual or exhibit payment history or financial status that indicate that collection probably will not occur when due according to the loan’s terms. Generally, impaired loans are given risk ratings that indicate higher risk, such as “classified” or “special mention.” Impaired loans are individually evaluated to determine appropriate reserves and are measured at the lower of the invested amount or the fair value. Impaired loans that are not TDRs and for which fair value measurement indicates an impairment loss are designated nonaccrual. A restructured loan that maintains current status for at least six months may be in accrual status. Please refer to the Company’s 2019 Form 10-K, Note 1: Summary of Significant Accounting Policies for additional information on evaluation of impaired loans and associated specific reserves, and policies regarding nonaccruals, past due status and charge-offs.

TDRs impact the estimation of the appropriate level of the allowance for loan losses. If the restructuring included forgiveness of a portion of principal or accrued interest, the charge-off is included in the historical charge-off rates applied to the collective evaluation methodology. Restructured loans are individually evaluated for impairment, and the amount of a restructured loan’s book value in excess of its fair value is accrued as a specific allocation in the allowance for loan losses. If a TDR loan payment exceeds 90 days past due, it is examined to determine whether the late payment indicates collateral dependency or cash flows below those that were used in the fair value measurement. TDRs, as well as all impaired loans, that are determined to be collateral dependent are charged down to fair value. Deficiencies indicated by impairment measurements for TDRs that are not collateral dependent may be accrued in the allowance for loan losses or charged off if deemed uncollectible.

 

Collectively Evaluated Loans

The Company evaluated characteristics in the loan portfolio and determined major segments and smaller classes within each segment. These characteristics include collateral type, repayment sources, and (if applicable) the borrower’s business model. The methodology for calculating reserves for collectively evaluated loans is applied at the class level.

 

 

Portfolio Segments and Classes

The segments and classes used in determining the allowance for loan losses are as follows.

Real Estate Construction Construction, residential Construction, other   Consumer Real Estate Equity lines Residential closed-end first liens Residential closed-end junior liens Investor-owned residential real estate   Commercial Real Estate Multifamily real estate Commercial real estate, owner-occupied Commercial real estate, other

Commercial Non-Real Estate Commercial and industrial   Public Sector and IDA Public sector and IDA   Consumer Non-Real Estate Credit cards Automobile Other consumer loans

 

Historical Loss Rates

The Company’s allowance methodology for collectively evaluated loans applies historical loss rates by class to current class balances as part of the process of determining required reserves. Class loss rates are calculated as the net charge-offs for the class as a percentage of average class balance. The Company averages loss rates for the most recent 8 quarters to determine the historical loss rate for each class.

Two loss rates for each class are calculated: total net charge-offs for the class as a percentage of average class loan balance (“class loss rate”), and total net charge-offs for the class as a percentage of average classified loans in the class (“classified loss rate”). Classified loans are those with risk ratings of “substandard” or lower. Net charge-offs in both calculations include charge-offs and recoveries of classified and non-classified loans as well as those associated with impaired loans. Class historical loss rates are applied to non-classified loan balances at the reporting date, and classified historical loss rates are applied to classified balances at the reporting date. 

 

Risk Factors

In addition to historical loss rates, risk factors pertinent to credit risk for each class are analyzed to estimate reserves for collectively evaluated loans. Factors include changes in national and local economic and business conditions, the nature and volume of classes within the portfolio, loan quality, loan officers’ experience, lending policies and the Company’s loan review system.

        The analysis of certain factors results in standard allocations to all segments and classes. These factors include the risk from changes in lending policies, loan officers’ average years of experience, unemployment levels, bankruptcy rates, interest rate environment, and competition/legal/regulatory environments. Factors analyzed for each class, with resultant allocations based upon the level of risk assessed for each class, include the risk from changes in loan review, levels of past due loans, levels of nonaccrual loans, current class balance as a percentage of total loans, and the percentage of high risk loans within the class. Additionally, factors specific to each segment are analyzed and result in allocations to the segment. Please refer to the Company’s 2019 Form 10-K, Note 1: Summary of Significant Accounting Policies for a discussion of risk factors pertinent to each class.

Real estate construction loans are subject to general risks from changing commercial building and housing market trends and economic conditions that may impact demand for completed properties and the costs of completion. These risks are measured by market-area unemployment rates, bankruptcy rates, building market trends, and interest rates.

The credit quality of consumer real estate is subject to risks associated with the borrower’s repayment ability and collateral value, measured generally by analyzing local unemployment and bankruptcy trends, local housing market trends, and interest rates.

The commercial real estate segment includes loans secured by multifamily residential real estate, commercial real estate occupied by the owner/borrower, and commercial real estate leased to non-owners. Loans in the commercial real estate segment are impacted by economic risks from changing commercial real estate markets, rental markets for multi-family housing and commercial buildings, business bankruptcy rates, local unemployment and interest rate trends that would impact the businesses housed by the commercial real estate.

Commercial non-real estate loans are secured by collateral other than real estate, or are unsecured. Credit risk for commercial non-real estate loans is subject to economic conditions, generally monitored by local business bankruptcy trends, and interest rates.

Public sector and Industrial Development Authority (“IDA”) loans are extended to municipalities and related entities. Credit risk is based upon the entity’s ability to repay and interest rate trends.

Consumer non-real estate includes credit cards, automobile and other consumer loans. Credit cards and certain other consumer loans are unsecured, while collateral is obtained for automobile loans and other consumer loans. Credit risk stems primarily from the borrower’s ability to repay, measured by average unemployment, average personal bankruptcy rates and interest rates.

 

 

Factor allocations applied to each class are increased for loans rated special mention and increased to a greater extent for loans rated classified. The Company allocates additional reserves for “high risk” loans. High risk loans include junior liens, interest only and high loan to value loans.

A detailed analysis showing the allowance roll-forward by portfolio segment and related loan balance by segment follows.

 

 

 

 

 

 

 

 

 

A summary of ratios for the allowance for loan losses follows.

 

 

(1)	Net charge-offs are on an annualized basis.

 

 

A summary of nonperforming assets follows.

 

 

(1)	The Company defines nonperforming loans as nonaccrual loans and restructured loans that are nonaccrual. Nonperforming loans do not include loans 90 days past due and still accruing or accruing restructured loans.

 

A summary of loans past due 90 days or more and impaired loans follows.

 

 

⁽¹⁾      Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.

 

Nonaccrual loan relationships that meet the Company’s balance threshold of $250 and all TDRs are designated as impaired. The Company also designates as impaired other loan relationships that meet the Company’s balance threshold of $250 and for which the Company does not expect to collect according to the note’s contractual terms. No interest income was recognized on nonaccrual loans for the three months ended March 31, 2020 or March 31, 2019 or for the year ended December 31, 2019.

 

 

A detailed analysis of investment in impaired loans and associated reserves, segregated by loan class follows.     

 

 

(1)	Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.

(2)	Only classes with impaired loans are shown.

 

 

(1)	Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.

(2)	Only classes with impaired loans are shown.

 

 

The following tables show the average recorded investment and interest income recognized for impaired loans.

 

 

(1)	Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.

(2)	Only classes with impaired loans are shown.

 

 

(1)	Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.

(2)	Only classes with impaired loans are shown.

 

 

 

(1)	Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.

(2)	Only classes with impaired loans are shown.

 

The Company reviews nonaccrual loans on an individual loan basis to determine whether future payments are reasonably assured. To satisfy this criteria, the Company’s evaluation must determine that the underlying cause of the original delinquency or weakness that indicated nonaccrual status has been resolved, such as receipt of new guarantees, increased cash flows that cover the debt service or other resolution. Nonaccrual loans that demonstrate reasonable assurance of future payments and that have made at least six consecutive payments in accordance with repayment terms and timeframes may be returned to accrual status.

 

An analysis of past due and nonaccrual loans follows.

 

 

(1)	Only classes with past due or nonaccrual loans are shown.

(2)	Includes current and past due loans in nonaccrual status. Includes impaired loans in nonaccrual status.

 

 

 

(1)	Only classes with past due or nonaccrual loans are shown.

(2)	Includes current and past due loans in nonaccrual status. Includes impaired loans in nonaccrual status.

 

 

The estimate of credit risk for non-impaired loans is obtained by applying allocations for internal and external factors. The allocations are increased for loans that exhibit greater credit quality risk.

Credit quality indicators, which the Company terms risk grades, are assigned through the Company’s credit review function for larger loans and selective review of loans that fall below credit review thresholds. Loans that do not indicate heightened risk are graded as “pass.” Consumer loans are risk graded “classified” when they become 60 days past due.  Loans that are not consumer loans that appear to have elevated credit risk because of frequent or persistent past due status, which is less than 75 days, or that show weakness in the borrower’s financial condition are risk graded “special mention.” Loans that are not consumer loans with frequent or persistent delinquency exceeding 75 days or that exhibit a higher level of weakness in the borrower’s financial condition are graded classified. Classified loans have regulatory risk ratings of “substandard” and “doubtful.” Allocations are increased by 50% and by 100% for loans with grades of “special mention” and “classified,” respectively.

Determination of risk grades was completed for the portfolio as of March 31, 2020 and December 31, 2019.

 

The following displays collectively evaluated loans by credit quality indicator.

 

 

(1)	Excludes impaired, if any.

 

 

The following displays collectively evaluated loans by credit quality indicator.

 

 

(1)	Excludes impaired, if any.

 

Sales, Purchases and Reclassification of Loans

The Company finances mortgages under “best efforts” contracts with mortgage purchasers. The mortgages are designated as held for sale upon initiation. There have been no major reclassifications from portfolio loans to held for sale. Occasionally, the Company purchases or sells participations in loans. All participation loans purchased met the Company’s normal underwriting standards at the time the participation was entered. Participation loans are included in the appropriate portfolio balances to which the allowance methodology is applied.

 

 

Troubled Debt Restructurings

 

From time to time the Company modifies loans in a TDR. Total TDRs amounted to $4,783 at March 31, 2020, $4,940 at December 31, 2019, and $5,435 at March 31, 2019. All of the Company’s TDR loans are fully funded and no further increase in credit is available.

During the three months ended March 31, 2020 and 2019, the Company classified no additional loans as TDRs. As of March 31, 2020, the Company executed principal and/or interest deferrals on 72 loans with balances totaling $37,703 for COVID-19 related hardship. These deferrals were no more than six months in duration and were for loans not more than 30 days past due as of December 31, 2019.  As such, they were not considered TDRs based on the relief provisions of the CARES Act and recent interagency regulatory guidance. The Company also provided relief to 1 loan affected by the pandemic with a rate reduction, which is not considered a TDR at this time. In the period subsequent to March 31, 2020 and through April 30, 2020, the Company continued to provide COVID-19 related relief and executed additional deferrals of principal and/or interest on 149 loans with outstanding balances of $48,180, and other modifications to 8 loans with balances aggregating to $19,683. 

The Company analyzed its TDR portfolio for loans that defaulted during the three month periods ended March 31, 2020 and March 31, 2019, and that were modified within 12 months prior to default. The Company defines default as one or more payments that occur more than 90 days past the due date, charge-offs, or foreclosure after the date of restructuring.

Of the Company’s TDRs at March 31, 2020, none of the defaulted TDRs were modified within 12 months prior to default.  All of the defaulted TDRs are in nonaccrual status as of March 31, 2020.

Of the Company's TDRs at March 31, 2019, 7 consumer real estate loans totaling $263, all part of one relationship, defaulted within 12 months of modification.  The impairment measurement was based upon the fair value of collateral, less estimated cost to sell, and resulted in no allocation. One commercial real estate loan defaulted within 12 months of modification.  The impairment measurement was based upon the fair value of collateral, less estimated cost to sell, and resulted in no allocation.  All of the defaulted loans were in nonaccrual status while the Company works with the borrowers to recover its investment.