UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________

FORM 10-Q

(Mark One)



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

For the quarterly period ended September 30, 2019



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

For the transition period from _____ to _____

Commission file number: 000-51889



	TWO RIVER BANCORP
	(Exact Name of Registrant as Specified in Its Charter)



New Jersey		20-3700861
(State of Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)



766 Shrewsbury Avenue, Tinton Falls, New Jersey		07724
(Address of Principal Executive Offices)		(Zip Code)



	(732) 389-8722
	(Registrant’s Telephone Number, Including Area Code)




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

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, no par value per share	TRCB	The NASDAQ Stock Market LLC

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. 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). 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	☒
Non-accelerated filer	☐	Smaller reporting company	☒
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. ☐

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

As of November 6, 2019, there were 8,723,977 shares of the registrant’s common stock, no par value, outstanding.

TWO RIVER BANCORP

FORM 10-Q

INDEX



PART I.			FINANCIAL INFORMATION	Page

	Item 1.	Financial Statements		4

			Consolidated Balance Sheets (unaudited) at September 30, 2019 and December 31, 2018	4

			Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2019 and 2018	5

			Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2019 and 2018	6

			Consolidated Statements of Shareholders' Equity (unaudited) for the three and nine months ended September 30, 2019 and 2018	7

			Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2019 and 2018	9

			Notes to Consolidated Financial Statements (unaudited)	11

	Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	39

	Item 3.		Quantitative and Qualitative Disclosures About Market Risk	61

	Item 4.		Controls and Procedures	61

PART II.			OTHER INFORMATION

	Item 1.		Legal Proceedings	62

	Item 1A.		Risk Factors	62

	Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	62

	Item 3.		Defaults Upon Senior Securities	62

	Item 4.		Mine Safety Disclosures	62

	Item 5.		Other Information	63

	Item 6.		Exhibits	64

SIGNATURES				66

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

TWO RIVER BANCORP

CONSOLIDATED BALANCE SHEETS (Unaudited)

(in thousands, except share data)



	September 30, 2019			December 31, 2018
ASSETS
Cash and due from banks	$	28,416		$	24,067
Interest-bearing deposits in bank	35,004			24,059
Cash and cash equivalents	63,420			48,126

Securities available for sale, at fair value (amortized cost of $21,374 and $25,017 at September 30, 2019 and December 31, 2018, respectively)	21,031			24,407
Securities held to maturity, at amortized cost (fair value of $41,515 and $47,266 at September 30, 2019 and December 31, 2018, respectively)	39,935			47,455
Equity securities, at fair value	2,582			2,451
Restricted investments, at cost	6,772			6,082
Loans held for sale	1,357			1,496
Loans	959,864			921,301
Allowance for loan losses	(11,811		)	(11,398		)
Net loans	948,053			909,903

Other real estate owned ("OREO")	2,501			585
Bank owned life insurance	22,315			22,098
Premises and equipment, net	6,658			5,917
Operating lease right-of-use assets	4,698			—
Accrued interest receivable	2,560			2,583
Goodwill	18,109			18,109
Other assets	7,003			7,207

Total Assets	$	1,146,994		$	1,096,419

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest-bearing	$	179,610		$	176,655
Interest-bearing	783,687			740,699
Total Deposits	963,297			917,354

Securities sold under agreements to repurchase	15,084			19,402
FHLB and other borrowings	19,700			22,500
Subordinated debt	9,951			9,923
Accrued interest payable	81			119
Operating lease liabilities	4,833			—
Other liabilities	10,676			10,623

Total Liabilities	1,023,622			979,921

Shareholders' Equity
Preferred stock, no par value; 6,500,000 shares authorized, no shares issued and outstanding	—			—
Common stock, no par value; 25,000,000 shares authorized;
Issued – 9,076,305 and 8,935,437 at September 30, 2019 and December 31, 2018, respectively
Outstanding – 8,715,338 and 8,606,992 at September 30, 2019 and December 31, 2018, respectively	81,405			80,481
Retained earnings	45,355			39,109
Treasury stock, at cost; 360,967 and 328,445 shares at September 30, 2019 and December 31, 2018, respectively	(3,135		)	(2,647		)
Accumulated other comprehensive loss	(253		)	(445		)
Total Shareholders' Equity	123,372			116,498

Total Liabilities and Shareholders’ Equity	$	1,146,994		$	1,096,419

See notes to the unaudited consolidated financial statements.

TWO RIVER BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

For the Three and Nine Months Ended September 30, 2019 and 2018

(in thousands, except per share data)



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
Interest Income
Loans, including fees	$	11,707	$	10,656	$	34,750	$	30,720
Securities:
Taxable	293		274		922		861
Tax-exempt	224		280		697		842
Interest-bearing deposits	260		132		663		293
Total Interest Income	12,484		11,342		37,032		32,716
Interest Expense
Deposits	2,981		1,924		8,170		4,923
Securities sold under agreements to repurchase	10		14		30		43
FHLB and other borrowings	99		136		332		382
Subordinated debt	166		165		497		495
Total Interest Expense	3,256		2,239		9,029		5,843
Net Interest Income	9,228		9,103		28,003		26,873
Provision for Loan Losses	125		150		650		775
Net Interest Income after Provision for Loan Losses	9,103		8,953		27,353		26,098

Non-Interest Income
Service fees on deposit accounts	197		236		536		713
Mortgage banking	373		239		1,077		986
Other loan fees	155		378		453		626
Earnings from investment in bank owned life insurance	127		133		398		395
Gain on sale of SBA loans	42		203		378		921
Net realized gain on sale of securities	—		—		1		—
Other income	230		166		670		520
Total Non-Interest Income	1,124		1,355		3,513		4,161

Non-Interest Expenses
Salaries and employee benefits	3,756		4,024		11,539		11,919
Occupancy and equipment	1,076		966		3,148		3,099
Professional	355		432		1,261		1,260
Insurance	70		59		201		180
FDIC insurance and assessments	—		128		238		374
Advertising	90		90		280		280
Data processing	209		184		571		510
Outside services fees	65		89		179		250
OREO expenses, impairments and sales, net	448		7		298		(8		)
Loan workout expenses	8		28		17		124
Merger related expenses	828		—		828		—
Other operating	364		454		1,358		1,251
Total Non-Interest Expenses	7,269		6,461		19,918		19,239

Income before Income Taxes	2,958		3,847		10,948		11,020
Income tax expense	843		1,013		3,002		2,860
Net Income	$	2,115	$	2,834	$	7,946	$	8,160

Earnings Per Common Share:
Basic	$	0.25	$	0.33	$	0.92	$	0.96
Diluted	$	0.24	$	0.33	$	0.91	$	0.94
Weighted average common shares outstanding
Basic	8,619		8,513		8,605		8,489
Diluted	8,720		8,700		8,721		8,695

See notes to the unaudited consolidated financial statements.

TWO RIVER BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

For the Three and Nine Months Ended September 30, 2019 and 2018

(in thousands)



	Three Months Ended
	September 30,
	2019		2018
Net income	$	2,115	$	2,834
Other comprehensive income (loss):

Unrealized holdings gain (loss) on securities available for sale, net of income tax expense (benefit) 2019: $5, 2018: ($11)	13		(24		)

Other comprehensive income (loss)	13		(24		)

Total comprehensive income	$	2,128	$	2,810



	Nine Months Ended
	September 30,
	2019		2018
Net income	$	7,946	$	8,160
Other comprehensive income (loss):

Unrealized holdings gain (loss) on securities available for sale, net of income tax expense (benefit) 2019: $75; 2018: ($85)	192		(218		)

Other comprehensive income (loss):	192		(218		)

Total comprehensive income	$	8,138	$	7,942

See notes to the unaudited consolidated financial statements.

TWO RIVER BANCORP

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

For the Three Months Ended September 30, 2019 and 2018

(dollars in thousands, except per share data)



	Common Stock										Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
	Outstanding Shares		Amount		Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
Balance, July 1, 2019	8,656,830		$	80,954	$	43,857		$	(3,129	)	$	(266	)	$	121,416
Net income	—		—		2,115			—			—			2,115
Other comprehensive income	—		—		—			—			13			13
Stock-based compensation expense	—		117		—			—			—			117
Cash dividends on common stock ($0.07 per share)	—		—		(617		)	—			—			(617		)
Options exercised	57,796		314		—			—			—			314
Employee stock purchase program	1,389		20		—			—			—			20
Common stock repurchased	(277	)						(6		)				(6		)
Shares forfeited	(400	)	$	—	$	—		$	—		$	—		$	—
Balance, September 30, 2019	8,715,338		$	81,405	$	45,355		$	(3,135	)	$	(253	)	$	123,372

Balance, July 1, 2018	8,555,243		$	80,088	$	34,173		$	(2,396	)	$	(518	)	$	111,347
Net income	—		—		2,834			—			—			2,834
Other comprehensive income	—		—		—			—			(24		)	(24		)
Stock-based compensation expense	—		82		—			—			—			82
Cash dividends on common stock ($0.055 per share)	—		—		(472		)	—			—			(472		)
Options exercised	28,064		107		—			—			—			107
Employee stock purchase program	872		17		—			—			—			17
Balance, September 30, 2018	8,584,179		$	80,294	$	36,535		$	(2,396	)	$	(542	)	$	113,891

See notes to the unaudited consolidated financial statements.

TWO RIVER BANCORP

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

For the Nine Months Ended September 30, 2019 and 2018

(dollars in thousands, except per share data)



	Common Stock										Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
	Outstanding Shares		Amount		Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
Balance, January 1, 2019	8,606,992		$	80,481	$	39,109		$	(2,647	)	$	(445	)	$	116,498
Net income	—		—		7,946			—			—			7,946
Other comprehensive income	—		—		—			—			192			192
Stock-based compensation expense	—		312		—			—			—			312
Cash dividends on common stock ($0.195 per share)	—		—		(1,700		)	—			—			(1,700		)
Options exercised	116,561		558		—			—			—			558
Employee stock purchase program	3,557		54		—			—			—			54
Common stock repurchased	(32,522	)						(488		)				(488		)
Restricted stock and other awards	21,150		—		—			—			—			—
Shares forfeited	(400	)	$	—	$	—		$	—		$	—		$	—
Balance, September 30, 2019	8,715,338		$	81,405	$	45,355		$	(3,135	)	$	(253	)	$	123,372

Balance, January 1, 2018	8,470,030		$	79,678	$	29,593		$	(2,396	)	$	(304	)	$	106,571
Net income	—		—		8,160			—			—			8,160
Other comprehensive loss	—		—		—			—			(218		)	(218		)
Stock-based compensation expense	—		222		—			—			—			222
Cash dividends on common stock ($0.145 per share)	—		—		(1,238		)	—			—			(1,238		)
Options exercised	92,560		345		—			—			—			345
AOCI reclassification related to Tax Reform	—		—		59			—			(59		)	—
AOCI reclassification due to adoption of ASU 2016-01	—		—		(39		)	—			39			—
Employee stock purchase program	2,689		49		—			—			—			49
Restricted stock and other awards	19,400		—		—			—			—			—
Shares forfeited	(500	)	—		—			—			—			—
Balance, September 30, 2018	8,584,179		$	80,294	$	36,535		$	(2,396	)	$	(542	)	$	113,891

See notes to the unaudited consolidated financial statements.

TWO RIVER BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

For the Nine Months Ended September 30, 2019 and 2018



	Nine Months Ended September 30,
	2019			2018
	(in thousands)
Cash Flows From Operating Activities
Net income	$	7,946		$	8,160
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	501			480
Provision for loan losses	650			775
Amortization of subordinated debt issuance costs	28			26
Deferred income tax benefit	(41		)	(111		)
Net amortization of securities premiums and discounts	437			597
Earnings from investment in bank owned life insurance	(381		)	(395		)
Proceeds from sale of mortgage loans held for sale	48,814			37,904
Origination of mortgage loans held for sale	(47,787		)	(37,210		)
Gain on sale of mortgage loans held for sale	(888		)	(655		)
Gain on sale of loans transferred from held for investment to held for sale	(59		)	(200		)
Net realized gain on sale of OREO	(188		)	—
OREO writedown	411			—
Stock-based compensation expense	312			222
Death benefit on bank owned life insurance	(17		)	—
Net realized gain on sale of securities available for sale	(1		)	—
Proceeds from sale of SBA loans held for sale	5,194			3,088
Origination of SBA loans held for sale	(4,816		)	(1,086		)
Gain from sale of SBA loans held for sale	(378		)	(921		)
Unrealized (gain) loss on equity securities	(86		)	77
Net non-cash operating lease right-of-use assets and lease liabilities	135			—
Decrease (increase) in assets:
Accrued interest receivable	23			(428		)
Other assets	125			(922		)
Increase (decrease) in liabilities:
Accrued interest payable	(38		)	27
Other liabilities	53			1,207
Net Cash Provided by Operating Activities	9,949			10,635
Cash Flows From Investing Activities
Purchase of securities available for sale	(3,757		)	(4,245		)
Purchase of securities held to maturity	—			(5,035		)
Proceeds from repayments, calls and maturities of securities available for sale	4,545			7,148
Proceeds from repayments, calls and maturities of securities held to maturity	7,165			5,092
Proceeds from sales of securities available for sale	2,774			—
Proceeds from sale of loans transferred from held for investment to held for sale	3,079			10,030
Net increase in loans	(44,637		)	(60,489		)
Purchases of premises and equipment	(1,242		)	(252		)
Purchase of restricted investments, net	(690		)	(567		)
Proceeds from death benefit of bank owned life insurance	181			—
Proceeds from sale of OREO	678			—
Net Cash Used In Investing Activities	(31,904		)	(48,318		)
Cash Flows From Financing Activities
Net increase in deposits	45,943			44,188
Net decrease in securities sold under agreements to repurchase	(4,318		)	(4,967		)
Proceeds from FHLB and other borrowings	20,000			—
Repayment of FHLB and other borrowings	(22,800		)	(1,300		)
Cash dividends paid – common stock	(1,700		)	(1,238		)
Proceeds from employee stock purchase plan	54			49
Proceeds from exercise of stock options	558			345
Common stock repurchased	(488		)	—
Net Cash Provided by Financing Activities	37,249			37,077
Net Increase (Decrease) in Cash and Cash Equivalents	15,294			(606		)
Cash and Cash Equivalents – Beginning	48,126			48,219
Cash and Cash Equivalents - Ending	$	63,420		$	47,613

TWO RIVER BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued)

For the Nine Months Ended September 30, 2019 and 2018




	Nine Months Ended September 30,
	2019		2018
	(in thousands)
Supplementary cash flow information:
Interest paid	$	9,067	$	3,577
Income taxes paid	$	3,251	$	3,539
Supplemental schedule of non-cash activities:
Other real estate acquired in settlement of loans	$	2,817	$	585
Transfer of loans held for investment to loans held for sale	$	3,020	$	9,830

See notes to the unaudited consolidated financial statements.

TWO RIVER BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts of Two River Bancorp (the “Company”), a bank holding company, and its wholly-owned subsidiary, Two River Community Bank (“Two River” or the “Bank”); Two River’s wholly-owned subsidiaries, TRCB Investment Corporation and TRCB Holdings Nine LLC. All inter-company balances and transactions have been eliminated in the consolidated financial statements. On August 9, 2019, the Company entered into a definitive merger agreement (the “Merger Agreement”) with OceanFirst Financial Corp. (NASDAQ: OCFC) (“OceanFirst”), a parent company of OceanFirst Bank N.A. (“OceanFirst Bank”). Under the Merger Agreement, the Company will merge into OceanFirst, and, upon completion of that merger, the Bank will merge into OceanFirst Bank. The mergers are expected to close in the first quarter of 2020, subject to the Company receiving the requisite approval of its shareholders, receipt of all required regulatory approvals, and fulfillment of other customary closing conditions.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”), including the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for full year financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2019 (the “2018 Form 10-K”). For a description of the Company’s significant accounting policies, refer to Note 1 of the Notes to Consolidated Financial Statements in the 2018 Form 10-K.

The Company has evaluated events and transactions occurring subsequent to the balance sheet date of September 30, 2019 for items that should potentially be recognized or disclosed in these consolidated financial statements.

NOTE 2 – NEW ACCOUNTING STANDARDS

ASU 2016-02: In February 2016, the FASB issued ASU No. 2016-02, Leases, which requires lessees to recognize leases on-balance sheet, makes targeted changes to lessor accounting, and disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; and ASU No. 2018-11, Targeted Improvements.

ASC 842 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2018. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. An entity may choose to use either (1) the effective date or (2) the beginning of the earliest comparative period presented in the financial statements as its date of initial application. The Company has elected to use the effective date, January 1, 2019, as the date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019.

From the lessee's perspective, the new standard establishes a right-of-use ("ROU") model that requires a lessee to recognize a ROU asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months, subject to a policy election. The Company has elected the short-term lease recognition exemption such that the Company will not recognize ROU assets or lease liabilities for leases with a term of less than 12 months from the commencement date. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a leasee. Additionally, the ASU expands quantitative and qualitative disclosures to help financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases.

The new leasing standard provides a number of optional practical expedients in transition. The Company has elected the "package of practical expedients," which permits the Company not to reassess prior conclusions about lease identification, lease classification and initial direct costs. The Company does not expect to elect the use-of-hindsight or the practical expedient pertaining to land easements; the latter not being applicable to the Company. ASC 842 also provides certain accounting policy elections for an entity's

NOTE 2 - NEW ACCOUNTING STANDARDS (Continued)

ongoing accounting. For operating leases wherein the Company is the lessee, the Company has elected the practical expedient to not separate lease and non-lease components.

Under legacy lease accounting, all of the Company's leases, which primarily relate to office space and bank branches, were classified as operating leases and, as such, are not recognized on the Company's Consolidated Balance Sheet for periods prior to the adoption of ASC 842. The Company engaged a third-party vendor and used their software to assist in implementing this ASU. Due to the adoption of ASU 2016-02, the Company recognized an operating right-of-use asset of $4.7 million and a lease liability of $4.8 million on its balance sheet as of September 30, 2019. This negatively impacted the Company's capital ratios by approximately 5 basis points compared to December 31, 2018. See Note 8, Leases, for more information.

ASU 2016-13: In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). This ASU requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Entities will now use forward-looking information to better form their credit loss estimates. The ASU also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. In April 2019, the FASB issued ASU 2019-04, which clarifies the scope of the credit losses standard and addresses issues related to accrued interest receivable balances, recoveries, variable interest rates and prepayments, among other things. With respect to Topic 825, Financial Instruments, on recognizing and measuring financial instruments, ASU 2019-04 addresses the scope of the guidance, the requirement for remeasurement under ASC 820 when using the measurement alternative, certain disclosure requirements and which equity securities have to be remeasured at historical exchange rates. In May 2019, the FASB issued ASU No. 2019-05, "Financial Instruments - Credit Losses (Topic 326); Targeted Transition Relief." This ASU allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. The Company does not expect to elect the fair value option. In October 2019, the FASB affirmed its decision to extend the deadline to implement these ASU's. For public entities that are SEC filers, excluding Smaller Reporting Companies, these ASUs are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. However for Smaller Reporting Companies, such as the Company, these ASU's are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company has formed a CECL committee, which has assessed our data and system needs, and has engaged a third-party vendor to assist in analyzing our data and developing a CECL model. The Company, in conjunction with this vendor, has researched and analyzed modeling standards, loan segmentation, as well as potential external inputs to supplement our historical loss history. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the ASUs are effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of these ASUs on our consolidated financial statements.

ASU 2017-04: In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350). ASU 2017-04 removes Step 2 from the goodwill impairment test. Under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The Board also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. For public entities that are SEC filers, this ASU is effective for its annual, or any goodwill impairment tests in fiscal years, beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the new guidance but has determined that this standard should not have a material impact on its consolidated financial statements.

ASU 2017-08: In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities. ASU No. 2017-08 shortens the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 will be effective for public business entities for fiscal years beginning after December 15,

NOTE 2 - NEW ACCOUNTING STANDARDS (Continued)

2019, and interim periods within fiscal years beginning after December 15, 2020. We are currently evaluating this ASU to determine the impact on our consolidated financial statements.

ASU 2018-13: 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. ASU 2018-13 includes certain removals, modifications and additions to the disclosure requirements on fair value measurements in Topic 820. The updated guidance is effective for fiscal years and interim periods beginning after December 15, 2019. Early adoption is permitted. The Company is permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until their effective date. The impact on the consolidated financial statements of the Company will depend on the facts and circumstances of any specific future transactions. The Company has elected not to early adopt the additional disclosures required by the ASU until their effective date.

ASU 2019-01: In March 2019, the FASB issued ASU No. 2019-01, Leases: Codification Improvements. This ASU (1) states that for lessors that are not manufacturers or dealers, the fair value of the underlying asset is its cost, less any volume or trade discounts, as long as there isn’t a significant amount of time between acquisition of the asset and lease commencement; (2) clarifies that lessors in the scope of ASC 942 (such as the Company) must classify principal payments received from sales-type and direct financing leases in investing activities in the statement of cash flows; and (3) clarifies the transition guidance related to certain interim disclosures provided in the year of adoption. To coincide with the adoption of ASU No. 2016-02, the Company elected to early adopt ASU 2019-01 on January 1, 2019. The adoption of this ASU did not have a material impact on its consolidated financial statements.

NOTE 3 - REVENUE RECOGNITION

On January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), and all subsequent ASUs that modified Topic 606. As stated in Note 1, New Accounting Standards, the implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain non-interest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to non-interest revenue streams, such as deposit related fees, interchange fees, merchant income, and brokerage and investment advisory service commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Non-interest revenue streams in-scope of Topic 606 are discussed below.

Service Fees on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

Other Income

Other non-interest income consists of other recurring revenue streams such as debit card income, credit card income, ATM fees, merchant services income, commissions from sales of mutual funds and other investments provided through a third party brokerage and investment advisory service firm, safe deposit box rental fees, and other miscellaneous revenue streams. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are processed through card payment networks, such as MasterCard. Credit card income is realized through a third party provider who issues credit cards as private label in the Company's name. ATM fees are primarily generated when a non-Company cardholder uses a Company ATM. The income is primarily comprised as a percentage of interchange fees earned whenever the issuer's card is processed through card payment networks, such as Visa and/or American Express. Merchant services income is realized through a third party service provider who is contracted by the Bank under a referral arrangement. Such fees represent fees charged to merchants to process their debit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically

NOTE 3 - REVENUE RECOGNITION (Continued)

received immediately or in the following month. Commissions received from the third party brokerage and investment advisory service firm from the sale of mutual funds and other investments are recognized when the firm has satisfied its performance obligation. The Company also receives periodic service fees (i.e., trailers) from this advisory service firm typically based on a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

The following presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and nine months ended September 30, 2019 and 2018.



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
	(Dollars in Thousands)
Non-Interest Income
In-scope of Topic 606
Service fees on deposit accounts	$	197	$	236	$	536	$	713
Other income	163		127		472		405
Non-Interest Income (in-scope of Topic 606)	360		363		1,008		1,118
Non-Interest Income (out-of-scope of Topic 606)	764		992		2,505		3,043
Total Non-Interest Income	$	1,124	$	1,355	$	3,513	$	4,161

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s non-interest revenue streams are largely based on transactional activity, or standard month-end revenue accruals. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of September 30, 2019 and December 31, 2018, the Company did not have any significant contract balances.

Contract Acquisition Costs

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition cost.

NOTE 4 – GOODWILL

The Company’s goodwill was recognized in connection with the acquisition of The Town Bank (“Town Bank”) in April 2006. GAAP requires that goodwill be tested for impairment annually or more frequently if impairment indicators arise utilizing a two-step methodology. However, a qualitative factor test can be performed to determine whether it is necessary to perform the two-step quantitative impairment test. If this qualitative test determines it is not likely (less than 50% probability) the fair value of the reporting unit is less than book value, then the Company does not have to perform a step one quantitative test and goodwill can be considered not impaired. The Company reviewed the requirements of ASU 350-20 and examples of qualitative assessments to determine whether the weight of evidence indicates greater than 50% likelihood exists that the carrying value of the reporting unit exceeds it's fair value. The nine qualitative assessments used are macroeconomic factors, banking industry conditions, banking industry merger and acquisition trends, bank historical performance, parent stock price, expected bank performance, change of control premium (parent), change of control premium (peer), and other factors.

NOTE 4 - GOODWILL (Continued)

The Company performed its annual qualitative factor impairment test as of August 31, 2019. Based on the results of this analysis, the Company determined that there was no impairment on the current goodwill balance of $18,109,000.

NOTE 5 – EARNINGS PER COMMON SHARE

Basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding excluding restricted stock awards outstanding during the period. Diluted earnings per common share reflects additional shares of common stock that would have been outstanding if dilutive potential shares of common stock had been issued relating to outstanding stock options and restricted stock awards. Potential shares of common stock issuable upon the exercise of stock options are determined using the treasury stock method.

The following table sets forth the computations of basic and diluted earnings per common share:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
	(In Thousands, Except Per Share Data)

Net income	$	2,115	$	2,834	$	7,946	$	8,160

Weighted average common shares outstanding – Basic	8,619		8,513		8,605		8,489

Effect of dilutive securities, stock options and restricted stock	101		187		116		206

Weighted average common shares outstanding – Diluted	8,720		8,700		8,721		8,695

Basic earnings per common share	$	0.25	$	0.33	$	0.92	$	0.96

Diluted earnings per common share	$	0.24	$	0.33	$	0.91	$	0.94

Dilutive securities in the table above exclude common stock options with exercise prices that exceed the average market price of the Company’s common stock during the periods presented. Inclusion of these common stock options would be anti-dilutive to the diluted earnings per common share calculation. There were no stock options that were anti-dilutive for the three and nine months ended September 30, 2019 and 2018.

NOTE 6 - SECURITIES

The amortized cost, gross unrealized gains and losses, and fair values of the Company’s securities are summarized as follows:



(In Thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

September 30, 2019:

Securities available for sale:
U.S. Government agency securities	$	7,905	$	—	$	(123	)	$	7,782
Municipal securities	481		2		—			483
U.S. Government-sponsored enterprises (“GSE”) – residential mortgage-backed securities	7,177		26		(66		)	7,137
U.S. Government collateralized residential mortgage obligations	3,812		30		(121		)	3,721
Corporate debt securities, primarily financial institutions	1,999		2		(93		)	1,908

Total securities available for sale	$	21,374	$	60	$	(403	)	$	21,031

Total equity securities	$	2,604	$	—	$	(22	)	$	2,582

Securities held to maturity:
Municipal securities	$	30,712	$	1,699	$	—		$	32,411
GSE – Residential mortgage-backed securities	5,913		13		(14		)	5,912
U.S. Government collateralized residential mortgage obligations	1,480		7		(7		)	1,480
Corporate debt securities, primarily financial institutions	1,830		—		(118		)	1,712

Total securities held to maturity	$	39,935	$	1,719	$	(139	)	$	41,515

NOTE 6 – SECURITIES (Continued)



(In Thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

December 31, 2018:

Securities available for sale:
U.S. Government agency securities	$	11,800	$	5	$	(170	)	$	11,635
Municipal securities	487		—		—			487
GSE – residential mortgage-backed securities	6,131		1		(185		)	5,947
U.S. Government collateralized residential mortgage obligations	4,600		1		(178		)	4,423
Corporate debt securities, primarily financial institutions	1,999		3		(87		)	1,915

Total securities available for sale	$	25,017	$	10	$	(620	)	$	24,407

Total equity securities	$	2,559	$	—	$	(108	)	$	2,451

Securities held to maturity:
Municipal securities	$	36,436	$	389	$	(111	)	$	36,714
GSE – residential mortgage-backed securities	7,423		—		(211		)	7,212
U.S. Government collateralized residential mortgage obligations	1,769		—		(57		)	1,712
Corporate debt securities, primarily financial institutions	1,827		—		(199		)	1,628

Total securities held to maturity	$	47,455	$	389	$	(578	)	$	47,266

The amortized cost and fair value of the Company’s debt securities at September 30, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In Thousands)

Due in one year or less	$	4,555	$	4,555	$	920	$	921
Due in one year through five years	286		288		1,752		1,824
Due in five years through ten years	4,019		3,929		6,902		7,100
Due after ten years	1,525		1,401		22,968		24,278

Sub-total	10,385		10,173		32,542		34,123


GSE – residential mortgage-backed securities	7,177		7,137		5,913		5,912
U.S. Government collateralized residential mortgage obligations	3,812		3,721		1,480		1,480

Total	$	21,374	$	21,031	$	39,935	$	41,515

The Company had no security sales for the three months ended September 30, 2019 and two security sales totaling $2.8 million for the nine months ended September 30, 2019 and recorded gross realized gains and losses of $8,000 and $7,000, respectively. There were no security sales for the three and nine months ended September 30, 2018.

NOTE 6 – SECURITIES (Continued)

Investment securities with a carrying value of $23.4 million and $24.7 million at September 30, 2019 and December 31, 2018, respectively, were pledged as collateral to secure securities sold under agreements to repurchase and public deposits as required or permitted by law.

The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at September 30, 2019 and December 31, 2018:



	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
September 30, 2019:	(In Thousands)

U.S. Government agency securities	$	1,120	$	(12	)	$	5,161	$	(111	)	$	6,281	$	(123	)
GSE – residential mortgage-backed securities	3,535		(7		)	5,276		(73		)	8,811		(80		)
U.S. Government collateralized residential mortgage obligations	493		(3		)	3,505		(125		)	3,998		(128		)
Corporate debt securities, primarily financial institutions	499		(1		)	2,330		(210		)	2,829		(211		)
Total temporarily impaired securities	$	5,647	$	(23	)	$	16,272	$	(519	)	$	21,919	$	(542	)



	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
December 31, 2018:	(In Thousands)

U.S. Government agency securities	$	4,842	$	(72	)	$	5,470	$	(98	)	$	10,312	$	(170	)
Municipal securities	5,227		(24		)	8,378		(87		)	13,605		(111		)
GSE – residential mortgage-backed securities	1,330		(10		)	11,675		(386		)	13,005		(396		)
U.S. Government collateralized residential mortgage obligations	146		—			5,938		(235		)	6,084		(235		)
Corporate debt securities, primarily financial institutions	493		(8		)	2,548		(278		)	3,041		(286		)
Total temporarily impaired securities	$	12,038	$	(114	)	$	34,009	$	(1,084	)	$	46,047	$	(1,198	)

The Company had 44 securities in an unrealized loss position at September 30, 2019. In management’s opinion, the unrealized losses in corporate debt, U.S. Government agencies, U.S. Government collateralized residential mortgage obligations and GSE residential mortgage-backed securities reflect changes in interest rates subsequent to the acquisition of specific securities. The unrealized loss for corporate debt securities also reflects a widening of spreads due to the liquidity and credit concerns in the financial markets. The Company may, if conditions warrant, elect to sell debt securities at a loss and redeploy the proceeds into other investments in an effort to improve returns, risk profile and overall portfolio diversification. The Company will recognize any losses when the decision is made. As of September 30, 2019, the Company did not intend to sell these debt securities prior to market recovery.

NOTE 6 – SECURITIES (Continued)

Included in corporate debt securities are three individual trust preferred securities issued by large financial institutions, all with a Moody’s rating of Baa1. At September 30, 2019, all of these securities are current with their scheduled interest payments. These single issue securities are all from large money center banks. Management concluded that these securities were not other-than-temporarily impaired as of September 30, 2019. These three securities have an amortized cost value of $2.3 million and a fair value of $2.1 million at September 30, 2019.

There were no other-than-temporary impairments recognized during the three and nine months ended September 30, 2019 and 2018.

Equity securities consist solely of the Community Reinvestment Act ("CRA") Mutual Fund. As a result of the adoption of ASU 2016-01 in January 2018, the Company determined that the CRA Mutual Fund falls under the provisions of ASU 2016-01and accordingly, this fund was transferred from available for sale and reclassified into equity securities on the balance sheet. These securities are measured at fair value with unrealized holding gains and losses reflected in net income. Effective January 1, 2018, the Company recorded a cumulative effect adjustment of $39,000 as a reclassification from accumulated other comprehensive loss to retained earnings. Additionally as noted above, all future unrealized gains and losses will be recognized in the Statements of Operations. As such, during the three and nine months ended September 30, 2019, an unrealized gain of $19,000 and $86,000, respectively, was recorded in Other income. For the three and nine months ended September 30, 2018, an unrealized loss of $19,000 and $77,000, respectively, was recorded in Other income.

NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loans receivable, which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.

Loans held for sale are designated at time of origination. They generally consist of newly originated fixed rate residential mortgage loans and salable SBA loans and are recorded at the lower of aggregate cost or estimated fair value in the aggregate. The Company typically retains adjustable-rate mortgages ("ARM") loans in its portfolio, however occasionally, the Company may elect to sell a small pool of these loans as a part of its strategy to manage interest rate risk. During the three months ended September 30, 2019 and 2018, the Company had no transfers from held for investment to held for sale, therefore, there were no gains from such sales for the three months ended September 30, 2019 and 2018. For the nine months ended September 30, 2019 and 2018, the Company transferred $3.0 million and $9.8 million, respectively, from held for investment to held for sale. Gains from such sales were $59,000 and $200,000 for the nine months ended September 30, 2019 and 2018, respectively. Transfers from held for investment occur at the lower of cost or fair value, less costs to sell. Gains are recognized on a settlement-date basis and are determined by the difference between the net sales proceeds and the carrying value of the loans, including any net deferred fees or costs. Depending on the type of loan sold, servicing may or may not be retained.

The loans receivable portfolio is segmented into five categories, those being a) Commercial and industrial, b) Real estate-construction (consisting of both residential and commercial construction), c) Real estate-commercial, d) Real estate-residential, and e) Consumer.

For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest previously accrued on these loans is reversed from income. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.

The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated balance sheet, which at September 30, 2019 and December 31, 2018, the Company had no such reserves. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectable are charged against the allowance for loan losses,

NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a monthly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of the loan. The specific component relates to loans that are classified as impaired. When a loan is impaired, there are three acceptable methods under ASC 310-10-35 for measuring the impairment:


1.	The loan’s observable market price;


2.	The fair value of the underlying collateral; or


3.	The present value (PV) of expected future cash flows.

Loans that are considered “collateral-dependent” should be evaluated under the “Fair market value of collateral.” Loans that are still expected to be supported by repayment from the borrower should be evaluated under the “Present value of future cash flows.”

For the most part, the Company measures impairment under the “Fair market value of collateral” for any loan that would rely on the value of collateral for recovery in the event of default. The individual impairment analysis for each loan is clearly documented as to the chosen valuation method.

The general component covers pools of loans by loan class including commercial and industrial, real estate-construction and real estate-commercial not considered impaired as well as smaller balance homogeneous loans such as real estate-residential and consumer.

These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include:


1.	Changes in lending policy and procedures, including changes in underwriting standards and collection practices not previously considered in estimating credit losses.


2.	Changes in relevant economic and business conditions.


3.	Changes in nature and volume of the loan portfolio and in the terms of loans.


4.	Changes in experience, ability and depth of lending management and staff.


5.	Changes in the volume and severity of past due loans, the volume of non-accrual loans and the volume and severity of adversely classified loans.


6.	Changes in the quality of the loan review system.


7.	Changes in the value of underlying collateral for collateral-dependent loans.


8.	The existence and effect of any concentration of credit and changes in the level of such concentrations.


9.	The effect of other external forces such as competition, legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

Each factor is assigned a risk value to reflect low, moderate or high risk assessments based on management’s best judgment using current market, macro and other relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation in each factor and accompany the allowance for loan loss calculation.

NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

During the fourth quarter of 2018, management employed a more refined estimation in determining the risk levels assigned to each of its qualitative factors in the allowance for loan losses. While this did not result in a significant change to the allowance for loan losses as a whole, it did result in increasing or decreasing the provision for certain loan categories in which the Company either had experienced more or less historical net charge-offs.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial, real estate-commercial, real estate-construction, real estate-residential and consumer loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.

An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.

For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristics that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectable and are charged to the allowance for loan losses. Loans not classified are rated pass.

In addition, federal and state regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.

NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The components of the loan portfolio held for investment at September 30, 2019 and December 31, 2018 are as follows:



	September 30,			December 31,
	2019			2018
	(In Thousands)

Commercial and industrial	$	107,944		$	109,362
Real estate – construction	144,577			144,865
Real estate – commercial	579,214			552,549
Real estate – residential	98,047			84,123
Consumer	30,791			31,144

	960,573			922,043
Allowance for loan losses	(11,811		)	(11,398		)
Net unearned fees	(709		)	(742		)

Net Loans	$	948,053		$	909,903

The performance and credit quality of the loan portfolio is monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the past due status as of September 30, 2019 and December 31, 2018:



	30-59 Days Past Due		60-89 Days Past Due		90 Days & Greater		Total Past Due		Current		Total Loans Receivable		Loans Receivable >90 Days and Accruing
September 30, 2019:					(In Thousands)

Commercial and industrial	$	34	$	—	$	498	$	532	$	107,412	$	107,944	$	—
Real estate – construction	—		—		150		150		144,427		144,577		—
Real estate – commercial	4,073		—		—		4,073		575,141		579,214		—
Real estate – residential	—		279		500		779		97,268		98,047		—
Consumer	—		—		193		193		30,598		30,791		—

Total	$	4,107	$	279	$	1,341	$	5,727	$	954,846	$	960,573	$	—



	30-59 Days Past Due		60-89 Days Past Due		90 Days & Greater		Total Past Due		Current		Total Loans Receivable		Loans Receivable >90 Days and Accruing
December 31, 2018:					(In Thousands)

Commercial and industrial	$	100	$	—	$	765	$	865	$	108,497	$	109,362	$	—
Real estate – construction	3,575		—		150		3,725		141,140		144,865		—
Real estate – commercial	563		—		54		617		551,932		552,549		—
Real estate – residential	—		564		227		791		83,332		84,123		—
Consumer	—		—		194		194		30,950		31,144		—

Total	$	4,238	$	564	$	1,390	$	6,192	$	915,851	$	922,043	$	—

NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following table presents non-accrual loans by classes of the loan portfolio at September 30, 2019 and December 31, 2018:



	September 30,		December 31,
	2019		2018
	(In Thousands)

Commercial and industrial	$	498	$	765
Real estate – construction	150		150
Real estate – commercial	—		54
Real estate – residential	500		227
Consumer	193		194

Total	$	1,341	$	1,390

There were no new troubled debt restructurings ("TDRs") that occurred during the three and nine months ended September 30, 2019 or 2018.

Loans whose terms are modified are classified as TDRs if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a TDR generally involve a temporary reduction in interest rate or a modification of a loan’s amortization schedule. Non-accrual TDRs are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after the modification is in place. Loans classified as TDRs, including those restored to accrual status, are designated as impaired.

The Company’s TDR modifications are made on terms typically up to 12 months in order to aggressively monitor and track performance of the credit. The short-term modifications are monitored for continued performance for an additional period of time after the expiration of the concession. Balance reductions and annualized loss rates are also important metrics that are monitored. The main objective of the modification program is to reduce the payment burden for the borrower and to deleverage the Company’s exposure.

At September 30, 2019, TDRs totaled $5.6 million, including $5.0 million that were current and three non-accrual loans totaling $555,000. As of December 31, 2018, TDRs totaled $7.7 million, including $6.8 million that were current and six non-accrual loans totaling $877,000. At both September 30, 2019 and December 31, 2018, the Company had no specific reserve against any loan relationship classified as TDR.

There were no loans receivable modified as TDRs and with a payment default occurring within 12 months of the restructure date, and the payment default occurring during the three and nine months ended September 30, 2019 and 2018, respectively.

It is the Company’s policy to classify a TDR that is either 90 days or greater delinquent or that has been placed on a non-accrual status as a subsequently defaulted TDR.

Impaired loans are individually assessed to determine that the loan’s carrying value is not in excess of the estimated fair value of the collateral (less cost to sell), if the loan is collateral dependent, or the present value of the expected future cash flows, if the loan is not collateral dependent. Management performs a detailed evaluation of each impaired loan and generally obtains updated appraisals as part of the evaluation. In addition, management adjusts estimated fair value down to appropriately consider recent market conditions, our willingness to accept a lower sales price to effect a quick sale, and costs to dispose of any supporting collateral.

The following tables summarize information in regards to both the recorded investment balance information for impaired loans by loan portfolio class at September 30, 2019 and December 31, 2018, and the average recorded investment balance information for impaired loans by loan portfolio class for the three and nine months ended September 30, 2019 and 2018, respectively:

NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)



	As of September 30, 2019						For the three months ended September 30, 2019				For the nine months ended September 30, 2019
	Recorded Investment, Net of Charge-offs		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In Thousands)
With no related allowance recorded:
Commercial and industrial	$	3,658	$	3,658	$	—	$	3,683	$	42	$	3,782	$	129
Real estate – construction	1,659		1,659		—		1,624		19		4,187		85
Real estate – commercial	—		—		—		—		—		93		2
Real estate – residential	856		856		—		859		4		863		18
Consumer	193		193		—		194		—		194		—

With an allowance recorded:
Commercial and industrial	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Real estate – construction	—		—		—		—		—		—		—
Real estate – commercial	—		—		—		—		—		—		—
Real estate – residential	—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—

Total:
Commercial and industrial	$	3,658	$	3,658	$	—	$	3,683	$	42	$	3,782	$	129
Real estate – construction	1,659		1,659		—		1,624		19		4,187		85
Real estate – commercial	—		—		—		—		—		93		2
Real estate – residential	856		856		—		859		4		863		18
Consumer	193		193		—		194		—		194		—

Total	$	6,366	$	6,366	$	—	$	6,360	$	65	$	9,119	$	234

NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)



	As of December 31, 2018						For the three months ended September 30, 2018				For the nine months ended September 30, 2018
	Recorded Investment, Net of Charge-offs		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In Thousands)
With no related allowance recorded:
Commercial and industrial	$	4,200	$	4,200	$	—	$	3,080	$	29	$	3,190	$	96
Real estate – construction	3,082		3,082		—		3,101		34		3,126		101
Real estate – commercial	168		168		—		173		1		175		4
Real estate – residential	589		589		—		592		4		594		13
Consumer	194		194				194		—		194		—

With an allowance recorded:
Commercial and industrial	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Real estate – construction	—		—		—		—		—		—		—
Real estate – commercial	—		—		—		—		—		—		—
Real estate – residential	—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—

Total:
Commercial and industrial	$	4,200	$	4,200	$	—	$	3,080	$	29	$	3,190	$	96
Real estate – construction	3,082		3,082		—		3,101		34		3,126		101
Real estate – commercial	168		168		—		173		1		175

TWO RIVER BANCORP 10-Q