LOANS AND ALLOWANCE FOR LOAN LOSSES

12 Months Ended

Dec. 31, 2018

4. LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the net loans is as follows:

	December 31,			December 31,
(In 000’s)	2018			2017
Commercial and industrial:
Commercial	$	1,055		$	909
SBA loans		18			19
Asset-based		472			870
Total commercial and industrial		1,545			1,798
Commercial real estate:
Commercial mortgages		9,532			11,671
SBA loans		248			669
Construction		-			419
Religious organizations		7,257			8,630
Total commercial real estate		17,038			21,389
Consumer real estate:
Home equity loans		628			641
Home equity lines of credit		15			17
1-4 family residential mortgages		583			1,071
Total consumer real estate		1,226			1,729
Consumer and other:
Student loans		622			700
Other		112			109
Total consumer and other		734			809
Allowance for loan losses		(278	)		(180	)
Loans, net	$	20,265		$	25,545

At December 31, 2018 there was no unearned discount. At December 31, 2017, the unearned discount totaled $10,858, and is included in the related loan accounts.

Loan Origination/Risk Management. The Bank has lending policies and procedures in place to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with periodic reports related to loan origination, asset quality, concentrations of credit, loan delinquencies and non-performing and emerging problem loans. Diversification in the portfolio is a means of managing risk with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate prudently to service the projected debt. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Bank’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable. The Bank may also seek credit enhancements for commercial and industrial loans from the Small Business Administration, Department of Transportation or other available programs. Generally, the Bank utilizes an advance formula for loans secured by eligible accounts receivable and other available programs to mitigate risk.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans. These loans are viewed as cash flow loans first and secondarily as loans secured by real estate. Commercial real estate loans typically have higher principal amounts and the repayment of these loans is dependent on the successful operation of property securing the loan or business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The Bank tracks the level of owner occupied versus nonowner-occupied loans. Typically, owner-occupied real estate loans represent less risk for the Bank.

The Bank’s commercial real estate loans are largely concentrated in loans to religious organizations. These loans are generally made to these organizations are primarily for expansion and repair of church facilities (construction loans). The source of repayment is viewed as cash flow from tithes and offerings and secondarily as loans secured by real estate.

The Bank’s construction lending has primarily involved lending for construction of commercial properties although the Bank does lend funds for construction of single-family residences. Construction loans are underwritten utilizing feasibility studies, independent appraisals, analysis of lease rates, and the financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates can be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Loan proceeds are disbursed during the construction phase according to a draw schedule based on the stage of completion. Construction projects are inspected by contracted inspectors or bank personnel. These loans are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, regulations of real property, general economic conditions and the availability of long-term financing.

Consumer loans are underwritten after an analysis of the borrower’s past and present financial information including credit score, personal financial statements, tax returns and other information deemed necessary to calculate debt service ratios that determine the ability of a borrower to repay the loan. Minimum debt service ratios have been established by policy. Underwriting standards for home equity loans are also heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80% and documentation requirements.

The Bank performs an annual loan review by an independent third-party firm that reviews and validates the credit risk program. The results of these reviews are presented to the board and management. The loan review process reinforces the risk identification and assessment decisions made by lenders and credit administration personnel, as well as the Bank’s policies and procedures.

Concentrations of Credit. The Bank’s loan portfolio is concentrated in commercial real estate and commercial and industrial loans. Approximately $16.2 million of these loans are secured by owner occupied commercial real estate as of December 31, 2018. The Bank continues to have a significant concentration in lending to religious organizations for which total loans at December 31, 2018 were $7.3 million, or 35%, of the loan portfolio.

Related Party Loans. In the ordinary course of business, the Bank granted loans to certain directors, executive officers and their affiliates (collectively referred to as “related parties”). These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other unaffiliated persons and do not involve more than normal risk of collectability. Disaffiliations include directors who do not stand for re-election and are no longer affiliated with the Bank. Activity in related party loans is presented in the following table.

	2018			2017
Balance outstanding at December 31,	$	679,612		$	866,934
Principal additions (affiliations)		-			-
Disaffiliations		-			-
Principal reductions		(224,288	)		(187,322	)
Balance outstanding at December 31,	$	455,324		$	679,612

Non-accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received 30 days as of the date such payments were due. The Bank generally places a loan on non-accrual status when interest or principal is past due 90 days or more unless the loan is well secured and in the process of collection. If it otherwise appears doubtful that the loan will be repaid, management may place the loan on nonaccrual status before the lapse of 90 days. Interest on loans past due 90 days or more ceases to accrue except for loans that are well collateralized and in the process of collection. When a loan is placed on nonaccrual status, previously accrued and unpaid interest is reversed out of income. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

An age analysis of past due loans, segregated by class of loans, as of December 31, 2018 is as follows:

(In 000’s)
			Accruing
	Loans		Loans 90 or
	30-89 Days		More Days				Total Past		Current
	Past Due		Past Due		Nonaccrual		Due Loans		Loans		Total Loans
Commercial and industrial:
Commercial	$	-	$	-	$	-	$	-	$	1,055	$	1,055
SBA loans		-		-		18		18		-		18
Asset-based		-		-		76		76		396		472
Total commercial and industrial		-		-		94		94		1,451		1,545

Commercial real estate:
Commercial mortgages		-		45		902		947		8,585		9,532
SBA loans		-		-		69		69		179		248
Construction		-		-		-		-		-		-
Religious organizations		-		-		179		179		7,078		7,257
Total commercial real estate		-		45		1,150		1,195		15,843		17,038

Consumer real estate:
Home equity loans		-		150		281		431		197		628
Home equity lines of credit		-		-		-		-		15		15
1-4 family residential mortgages		-		-		85		85		498		583
Total consumer real estate		-		150		366		516		710		1,226

Consumer and other:
Student loans		14		57		-		71		551		622
Other		1		-		-		1		111		112
Total consumer and other		15		57		-		72		662		734

Total loans	$	15	$	252	$	1,661	$	1,928	$	18,615	$	20,543

An age analysis of past due loans, segregated by class of loans, as of December 31, 2017 is as follows:

(In 000’s)
			Accruing
	Loans		Loans 90 or
	30-89 Days		More Days				Total Past		Current
	Past Due		Past Due		Nonaccrual		Due Loans		Loans		Total Loans
Commercial and industrial:
Commercial	$	-	$	-	$	-	$	-	$	909	$	909
SBA loans		-		-		-		-		19		19
Asset-based		-		-		76		76		794		794
Total commercial and industrial		-		-		76		76		1,722		1,798

Commercial real estate:
Commercial mortgages		50		208		935		1,193		10,478		11,671
SBA loans		-		-		81		81		588		669
Construction		-		-		-		-		419		419
Religious organizations		-		-		187		187		8,443		8,630
Total commercial real estate		50		208		1,203		1,461		19,928		21,389

Consumer real estate:
Home equity loans		38		123		289		450		191		641
Home equity lines of credit		-		-		-		-		17		17
1-4 family residential mortgages		64		-		48		112		959		1,071
Total consumer real estate		102		123		337		561		1,168		1,729

Consumer and other:
Student loans		32		55		-		87		613		700
Other		6		1		-		7		102		109
Total consumer and other		38		56		-		94		715		809

Total loans	$	190	$	387	$	1,616	$	2,192	$	23,533	$	25,725

Impaired Loans. The Bank identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The Bank recognizes interest income on impaired loans under the cash basis when the collateral on the loan is sufficient to cover the outstanding obligation to the Bank. If these factors do not exist, the Bank will record interest payments on the cost recovery basis.

In accordance with guidance provided by ASC 310-10, Accounting by Creditors for Impairment of a Loan, management employs one of three methods to determine and measure impairment: the Present Value of Future Cash Flow Method; the Fair Value of Collateral Method; or the Observable Market Price of a Loan Method. To perform an impairment analysis, the Company reviews a loan’s internally assigned grade, its outstanding balance, guarantors, collateral, strategy, and a current report of the action being implemented. Based on the nature of the specific loans, one of the impairment methods is chosen for the respective loan and any impairment is determined, based on criteria established in ASC 310-10.

The Company records partial charge-offs of impaired loans when the impairment is deemed permanent and is considered a loss. To date, these charge-offs have only included the unguaranteed portion of Small Business Administration (“SBA”) loans. Specific reserves are allocated to cover “other-than-permanent”impairment for which the underlying collateral value may fluctuate with market conditions. In 2018 and 2017, the Bank made partial charge-offs totaling approximately $18,000 and $52,000, respectively, related several impaired commercial real estate loans. Consumer real estate and other loans are not individually evaluated for impairment, but collectively evaluated, because they are pools of smaller balance homogeneous loans.

Year-end 2018 impaired loans are set forth in the following table.

(In 000’s)
	Unpaid Contractual		Recorded Investment		Recorded Investment		Total				Average		Interest recognized
	Principal		With No		With		Recorded		Related		Recorded		on impaired
	Balance		Allowance		Allowance		Investment		Allowance		Investment		loans
Commercial and industrial:
Commercial	$	213	$	-	$	213	$	213	$	81	$	213	$	2
SBA		-		-		-		-		-		-		-
Asset based		76		-		76		76		14		76		-
Total Commercial and industrial		289		-		289		289		95		289		2

Commercial real estate:
Commercial mortgages		898		739		159		898		13		948		-
SBA Loans		71		71		-		71		-		74		-
Religious Organizations		179		-		179		179		31		182		-
Total Commercial real estate		1,148		810		338		1,148		44		1,204		-

Total Loans	$	1,437	$	810	$	627	$	1,437	$	139	$	1,493	$	2

Year-end 2017 impaired loans are set forth in the following table.

(In 000’s)
	Unpaid Contractual		Recorded Investment		Recorded Investment		Total				Average		Interest recognized
	Principal		With No		With		Recorded		Related		Recorded		on impaired
	Balance		Allowance		Allowance		Investment		Allowance		Investment		loans
Commercial and industrial:
Commercial	$	-	$	-	$	-	$	-	$	-	$	14	$	30
SBA		-		-		-		-		-		-		-
Asset based		76		76		-		76		-		256		-
Total Commercial and industrial		-		-		-		-		-		270		30

Commercial real estate:
Commercial mortgages		933		933		-		933		-		1,215		-
SBA Loans		81		81		-		81		-		208		10
Religious Organizations		187		187		-		187		-		191		-
Total Commercial real estate		1,201		1,201		-		1,201		-		1,613		10

Total Loans	$	1,277	$	1,277	$	-	$	1,277	$	-	$	1,883	$	40

Credit Quality Indicators. For commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. Each loan’s internal risk weighting is assigned at origination and updated at least annually and more frequently if circumstances warrant a change in risk rating. The Bank uses a 1 through 8 loan grading system that follows regulatory accepted definitions as follows:

	·	Risk ratings of “1” through “3” are used for loans that are performing and meet and are expected to continue to meet all of the terms and conditions set forth in the original loan documentation and are generally current on principal and interest payments. Loans with these risk ratings are reflected as “Good/Excellent” and “Satisfactory” in the following table.

	·	Risk ratings of “4” are assigned to “Pass/Watch” loans which may require a higher degree of regular, careful attention. Borrowers may be exhibiting weaker balance sheets and positive but inconsistent cash flow coverage. Borrowers in this classification generally exhibit a higher level of credit risk and are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Loans with this rating would not normally be acceptable as new credits unless they are adequately secured and/or carry substantial guarantors. Loans with this rating are reflected as “Pass” in the following table.

	·	Risk ratings of “5” are assigned to “Special Mention” loans that do not presently expose the Bank to a significant degree of risks, but have potential weaknesses/deficiencies deserving Management’s closer 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. No loss of principal or interest is envisioned. Borrower is experiencing adverse operating trends, which potentially could impair debt, services capacity and may necessitate restructuring of credit. Secondary sources of repayment are accessible and considered adequate to cover the Bank’s exposure. However a restructuring of the debt should result in repayment. The asset is currently protected, but is potentially weak. This category may include credits with inadequate loan agreements, control over the collateral or an unbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized but exceptions are considered material. These borrowers would have limited ability to obtain credit elsewhere.

	·	Risk ratings of “6” are assigned to ‘Substandard” loans which are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets must have a well-defined weakness. They are characterized by the distinct possibility that some loss is possible if the deficiencies are not corrected. The borrower’s recent performance indicated an inability to repay the debt, even if restructured. Primary source of repayment is gone or severely impaired and the Bank may have to rely upon the secondary source. Secondary sources of repayment (e.g., guarantors and collateral) should be adequate for a full recovery. Flaws in documentation may leave the bank in a subordinated or unsecured position when the collateral is needed for the repayment.

	·	Risk ratings of “7” are assigned to “Doubtful” loans which have all the weaknesses inherent in those classified “Substandard” with the added characteristic that the weakness makes the collection or liquidation in full, on the basis of current existing facts, conditions, and values, highly questionable and improbable. The borrower’s recent performance indicates an inability to repay the debt. Recovery from secondary sources is uncertain. The possibility of a loss is extremely high, but because of certain important and reasonably- specific pending factors, its classification as a loss is deferred.

	·	Risk rating of “8” are assigned to “Loss” loans which are considered non-collectible and do not warrant classification as active assets. They are recommended for charge-off if attempts to recover will be long term in nature. This classification does not mean that an asset has no recovery or salvage value, but rather, that it

is not practical or desirable to defer writing off the loss, although a future recovery may be possible. Loss should always be taken in the period in which they surface and are identified as non-collectible as a result there is no tabular presentation.

For consumer and residential mortgage loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to contractual terms is in doubt as well as loans that are 90 days or more past due and have not been placed on nonaccrual. These credit quality indicators are updated on an ongoing basis. A loan is placed on nonaccrual status as soon as management believes there is doubt as to the ultimate ability to collect interest on a loan.

The tables below detail the Bank’s loans by class according to their credit quality indictors discussed above.

(In 000’s)	Commercial Loans, December 31, 2018
	Good/ Excellent		Satisfactory		Pass		Special Mention		Substandard		Doubtful		Total

Commercial and industrial:
Commercial	$	250	$	592	$	-	$	-	$	213	$	-	$	1,055
SBA loans		-		-		-		-		18		-		18
Asset-based		-		272		124		-		-		76		472
		250		864		124		-		231		76		1,545
Commercial real estate:
Commercial mortgages		-		5,814		2,759		52		703		204		9,532
SBA Loans		-		179		-		-		69		-		248
Construction		-		-		-		-		-		-		-
Religious organizations		24		5,041		2,013		-		180		-		7,258
		24		11,034		4,772		52		952		204		17,038

Total commercial loans	$	274	$	11,898	$	4,896	$	52	$	1,183	$	280	$	18,583

	Residential Mortgage and Consumer Loans December 31, 2018

	Performing		Nonperforming		Total

Consumer Real Estate:
Home equity	$	197	$	431	$	628
Home equity line of credit		15		-		15
1-4 family residential mortgages		498		85		583
		710		516		1,226

Consumer Other:
Student loans		565		57		622
Other		112		-		112
		677		57		734

Total consumer loans	$	1,387	$	573	$	1,960

(In 000’s)	Commercial Loans, December 31, 2017
	Good/ Excellent		Satisfactory		Pass		Special Mention		Substandard		Doubtful		Total
Commercial and industrial:
Commercial	$	250	$	423	$	-	$	19	$	217	$	-	$	909
SBA loans		-		-		19		-		-		-		19
Asset-based		-		549		152		-		93		76		870
		250		972		171		19		310		76		1,798
Commercial real estate:
Commercial mortgages		-		7,876		2,764		17		797		217		11,671
SBA Loans		-		588		-		-		81		-		669
Construction		-		419		-		-		-		-		419
Religious organizations		48		7,560		835		-		187		-		8,630
		48		16,049		3,599		17		1,065		217		21,389

Total commercial loans	$	298	$	17,021	$	3,770	$	36	$	1,375	$	293	$	23,187

	Residential Mortgage and Consumer Loans December 31, 2017
	Performing		Nonperforming		Total
Consumer Real Estate:
Home equity	$	229	$	412	$	641
Home equity line of credit		17		-		17
1-4 family residential mortgages		1,023		48		1,071
		1,269		460		1,729

Consumer Other:
Student loans		645		55		700
Other		108		1		109
		753		56		809

Total consumer loans	$	2,022	$	516	$	2,538

Allowance for loan losses. The determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance is the accumulation of three components that are calculated based on various independent methodologies that are based on management’s estimates. The three components are as follows:

·	Specific Loan Evaluation Component – Includes the specific evaluation of impaired loans.
·	Historical Charge-Off Component – Applies a rolling, eight-quarter historical charge-off rate to all pools of non-classified loans.
·	Qualitative Factors Component – The loan portfolio is broken down into multiple homogenous sub classifications, upon which multiple factors (such as delinquency trends, economic conditions, concentrations, growth/volume trends, and management/staff ability) are evaluated, resulting in an allowance amount for each of the sub classifications. The sum of these amounts comprises the Qualitative Factors Component.

All of these factors may be susceptible to significant change. There were no changes in qualitative factors in 2018. There was a decrease in the historical loss factor for commercial and industrial loans in 2017 as a result of no charge-offs during the eight rolling quarters. In addition, the average balance of commercial and industrial loans declined because of loan paydowns and a shift in strategy away from this loan type. There were no changes in qualitative factors. The overall result was a reduction in the general reserve requirement for commercial and industrial loans.

There was a decrease in the historical loss factor for consumer real estate loans when comparing in 2017 as a result of a reduction in the average balance of consumer real estate loans declined as a result of loan paydowns coupled with a shift in strategy away from this loan type. There were no changes in qualitative factors. The overall result was a reduction in the general reserve requirement for consumer real estate loans.

To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods.

According to the Bank’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectible. All credits that are 90 days or more past due must be analyzed for the Bank’s ability to collect the outstanding principal and/or interest. Once a loss is known to exist, the charge-off approval process must be followed for all loan types. An analysis of the activity in the allowance for loan losses for the years 2018 and 2017 is as follows:

(in 000’s)	Year to Date ended December 31, 2018
	Commercial and industrial			Commercial real estate			Consumer real estate			Consumer loans other			Unallocated		Total
Beginning balance	$	7		$	155		$	10		$	8		$	-	$	180
Provision for possible loan losses		300			(3	)		(6	)		(7	)		33		317

Charge-offs		(208	)		(18	)		-			(8	)		-		(234	)
Recoveries		3			5			-			7			-		15
Net charge-offs		(205	)		(13	)		-			-			-		(219	)

Ending balance	$	102		$	139		$	4		$	-		$	33	$	278

(in 000’s)	Year to Date ended December 31, 2017
	Commercial and industrial			Commercial real estate			Consumer real estate			Consumer loans other			Unallocated			Total
Beginning balance	$	68		$	179		$	10		$	11		$	32		$	300
Credit for possible loan losses		(65	)		28			(10	)		(3	)		(32	)		(82	)

Charge-offs		-			(52	)		(18	)		(5	)		-			(75	)
Recoveries		4			-			28			5			-			37
Net charge-offs		4			(52	)		10			-			-			(38	)

Ending balance	$	7		$	155		$	10		$	8		$	-		$	180

There was an increase in the historical loss factor for commercial and industrial loans when comparing 2017 and 2018 due to net charge-off activity; however, this increase was offset by a decline in the average balances because of a reduction in loan balances as the Bank shifted away from non-SBA commercial and industrial loan originations. There were no changes in qualitative factors. The overall result was the general reserve requirement for commercial and industrial loans remained relatively unchanged from 2017.

There was a decrease in the historical loss factor for consumer installment loans when comparing 2017 and 2018 as a result of net recoveries coupled with a reduction in the average balance of consumer installment loans as a result of loan paydowns without replacement as the Bank no longer originates consumer loans. There were no changes in qualitative factors. The overall result was a reduction in the general reserve requirement for consumer real estate loans.

There was a decrease in the historical loss factor for consumer real estate loans when comparing 2016 and 2017 as a result of a reduction in the average balance of consumer real estate loans declined as a result of loan paydowns coupled with a shift in strategy away from this loan type. There were no changes in qualitative factors. The overall result was a reduction in the general reserve requirement for consumer real estate loans.

(in 000’s)	Year to Date ended December 31, 2018
	Commercial and industrial		Commercial real estate		Consumer real estate		Consumer loans other		Unallocated		Total
Period-end amount allocated to:

Loans individually evaluated for impairment	$	95	$	44	$	-	$	-	$	-	$	139
Loans collectively evaluated for impairment		7		95		4		-		33		139
	$	102	$	139	$	4	$	-	$	33	$	278

Loans, ending balance:
Loans individually evaluated for impairment	$	289	$	1,148	$	-	$	-	$	-	$	1,437
Loans collectively evaluated for impairment		1,256		15,890		1,226		734		-		19,106
Total	$	1,545	$	17,038	$	1,226	$	734	$	-	$	20,543

(in 000’s)	Year to Date ended December 31, 2017
	Commercial and industrial		Commercial real estate		Consumer real estate		Consumer loans other		Unallocated		Total
Period-end amount allocated to:

Loans individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-
Loans collectively evaluated for impairment		7		155		10		8				180
	$	7	$	155	$	10	$	8	$	-	$	180

Loans, ending balance:
Loans individually evaluated for impairment	$	76	$	1,201	$	-	$	-	$	-	$	1,277
Loans collectively evaluated for impairment		1,722		20,188		1,729		809				24,448
Total	$	1,798	$	21,389	$	1,729	$	809	$	-	$	25,725

Troubled debt restructurings (“TDRs”). TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, such as a below market interest rate, extending the maturity of a loan, or a combination of both. The Company made modifications to certain loans in its commercial loan portfolio that included the term out of lines of credit to begin the amortization of principal. The terms of these loans do not include any financial concessions and are consistent with the current market. Management reviews all loan modifications to determine whether the modification qualifies as a TDR (i.e. whether the creditor has been granted a concession or is experiencing financial difficulties). Based on this review and evaluation, none of the loans modified during 2018 and 2017 met the criteria of a TDR. In addition, the Company had no loans classified as TDRs at December 31, 2018 and 2017.

UNITED BANCSHARES INC /PA 10-K