NOTE 4 – LOANS, ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, deferred fees or costs on originated loans, and any premiums or discounts on purchased loans.

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 related loan yield using the interest method.

The accrual of interest on all loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Payments received on impaired loans are applied to reduce the recorded investment in the loan principal to the extent necessary to eliminate doubt as to the collectability of the net carrying amount of the loan. Some or all of the payments received on impaired loans are recognized as interest income if the remaining net carrying amount of the loan is deemed to be fully collectible. When recognition of interest income on an impaired loan on a cash basis is appropriate, the amount of income that is recognized is limited to that which would have been accrued on the net carrying amount of the loan at the contractual interest rate. Any cash interest payments received in excess of the limit and not applied to reduce the net carrying amount of the loan are recorded as recoveries of charge-offs until the charge-offs are fully recovered.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, allocated and unallocated components, as further described below.

General Component:

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, home equity lines of credit, commercial real estate, construction, commercial, indirect auto and other consumer. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no changes in the Company’s policies or methodology pertaining to the general component of the allowance for loan losses during the nine months ended September 30, 2016 or during fiscal year 2015.

The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

Residential real estate loans and home equity lines of credit – The Company generally does not originate or purchase loans with a loan-to-value ratio greater than 80 percent and generally does not grant subprime loans. Loans in this segment are generally collateralized by owner-occupied residential real estate and repayment is dependent on the cash flow and credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.

Commercial real estate loans – Loans in this segment are primarily secured by income-producing properties in eastern Massachusetts. The underlying cash flows generated by the properties may be adversely impacted by a downturn in the economy and increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. Management generally obtains rent rolls annually and continually monitors the cash flows of these borrowers.

Construction loans – Loans in this segment primarily include speculative real estate development loans for which payment is derived from sale and/or lease up of the property. Credit risk is affected by cost overruns, time to sell, or lease at adequate prices, and market conditions.

Commercial loans – Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer and business spending, will have an effect on the credit quality in this segment.

Indirect auto loans – Loans in this segment are secured installment loans that were originated through a network of select regional automobile dealerships. The Company’s interest in the vehicle is secured with a recorded lien on the state title of each automobile. Collections are sensitive to changes in borrower financial circumstances, and the collateral can depreciate or be damaged in the event of repossession. Repayment is primarily dependent on the credit worthiness and the cash flow of the individual borrower and secondarily, liquidation of the collateral.

Other consumer loans - Loans in this segment include secured and unsecured consumer loans including passbook loans, consumer lines of credit and overdraft protection, and consumer unsecured loans. Repayment is dependent on the credit quality and the cash flow of the individual borrower.

Allocated Component:

The allocated component relates to loans that are classified as impaired. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment 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.

The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (“TDR”). All TDRs are classified as impaired.

Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral-dependent. Generally, TDRs are measured for impairment using the discounted cash flow method except in instances where foreclosure is probable in which case the fair value of collateral method is used. When the fair value of the impaired loan is determined to be less than the recorded investment in the loan, the impairment is recorded through the valuation allowance. However, for collateral dependent loans, the amount of the recorded investment in a loan that exceeds the fair value of the collateral is charged-off against the allowance for loan losses in lieu of an allocation of a specific allowance amount when such an amount has been identified definitively as uncollectable.

Unallocated Component:

An unallocated component may be 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 allocated and general reserves in the portfolio. At September 30, 2016 (unaudited) and December 31, 2015, the Company had unallocated reserves of $492,000 and $213,000, respectively.

 

Loans consisted of the following (dollars in thousands):

 

		September 30, 2016								December 31, 2015
		Amount				Percent				Amount				Percent
		(unaudited)
Mortgage loans:
Residential one-to-four family		$	947,667				52.96	%		$	709,426				46.15	%
Commercial real estate loans (1)			462,600				25.85				449,391				29.24
Home equity lines of credit			170,857				9.55				160,040				10.41
Construction loans			76,681				4.29				60,722				3.95
Total mortgage loans			1,657,805				92.65				1,379,579				89.75
Commercial loans			61,314				3.43				53,192				3.46
Consumer loans:
Indirect auto loans			69,865				3.90				103,965				6.76
Other consumer loans			433				0.02				453				0.03
			131,612				7.35				157,610				10.25
Total loans			1,789,417				100.00	%			1,537,189				100.00	%
Net deferred loan costs			3,814								4,663
Net unamortized mortgage premiums			6,100								4,345
Allowance for loan losses			(12,969	)							(11,240	)
Total loans, net		$	1,786,362							$	1,534,957

 

(1)	Includes multi-family real estate loans.

The following tables (in thousands) present the activity in the allowance for loan losses by portfolio class for the three and nine months ended September 30, 2016 and 2015 (unaudited); and the balances of the allowance for loan losses and recorded investment in loans by portfolio class based on impairment method at September 30, 2016 (unaudited) and December 31, 2015. The recorded investment in loans in any of the following tables does not include accrued and unpaid interest or any deferred loan fees or costs, as amounts are not significant.

 

		Three Months Ended September 30, 2016
		Beginning balance				Provision (benefit)				Charge-offs				Recoveries				Ending balance
Residential one-to-four family		$	4,155			$	439			$	—			$	—			$	4,594
Commercial real estate			4,810				(171	)			—				—				4,639
Construction			864				187				—				—				1,051
Commercial			698				12				—				—				710
Home equity lines of credit			1,038				3				—				—				1,041
Indirect auto			492				(43	)			(31	)			15				433
Other consumer			10				—				(3	)			2				9
Unallocated			476				16				—				—				492
Total		$	12,543			$	443			$	(34	)		$	17			$	12,969

 

		Three Months Ended September 30, 2015
		Beginning balance				Provision (benefit)				Charge-offs				Recoveries				Ending balance
Residential one-to-four family		$	2,740			$	627			$	(64	)		$	—			$	3,303
Commercial real estate			4,122				14				—				—				4,136
Construction			585				248				—				—				833
Commercial			355				44				—				24				423
Home equity lines of credit			827				(196	)			—				199				830
Indirect auto			713				(27	)			(39	)			5				652
Other consumer			12				—				(3	)			4				13
Unallocated			183				17				—				—				200
Total		$	9,537			$	727			$	(106	)		$	232			$	10,390

 

		Nine Months Ended September 30, 2016
		Beginning balance				Provision (benefit)				Charge-offs				Recoveries				Ending balance
Residential one-to-four family		$	3,574			$	1,020			$	—			$	—			$	4,594
Commercial real estate			4,478				161				—				—				4,639
Construction			801				250				—				—				1,051
Commercial			613				97				—				—				710
Home equity lines of credit			928				113				—				—				1,041
Indirect auto			623				(143	)			(73	)			26				433
Other consumer			10				6				(11	)			4				9
Unallocated			213				279				—				—				492
Total		$	11,240			$	1,783			$	(84	)		$	30			$	12,969

 

		Nine Months Ended September 30, 2015
		Beginning balance				Provision (benefit)				Charge-offs				Recoveries				Ending balance
Residential one-to-four family		$	2,364			$	1,003			$	(64	)		$	—			$	3,303
Commercial real estate			4,043				93				—				—				4,136
Construction			228				605				—				—				833
Commercial			458				(59	)			—				24				423
Home equity lines of credit			828				(197	)			—				199				830
Indirect auto			778				(52	)			(98	)			24				652
Other consumer			11				8				(11	)			5				13
Unallocated			171				29				—				—				200
Total		$	8,881			$	1,430			$	(173	)		$	252			$	10,390

 

		September 30, 2016
		Individually evaluated for impairment								Collectively evaluated for impairment								Total
		Loan balance				Allowance				Loan balance				Allowance				Loan balance				Allowance
Residential one-to-four family		$	4,851			$	163			$	942,816			$	4,431			$	947,667			$	4,594
Commercial real estate			3,456				2				459,144				4,637				462,600				4,639
Construction			—				—				76,681				1,051				76,681				1,051
Commercial			—				—				61,314				710				61,314				710
Home equity lines of credit			200				—				170,657				1,041				170,857				1,041
Indirect auto			7				—				69,858				433				69,865				433
Other consumer			—				—				433				9				433				9
Unallocated			—				—				—				492				—				492
Total		$	8,514			$	165			$	1,780,903			$	12,804			$	1,789,417			$	12,969

 

		December 31, 2015
		Individually evaluated for impairment								Collectively evaluated for impairment								Total
		Loan balance				Allowance				Loan balance				Allowance				Loan balance				Allowance
Residential one-to-four family		$	4,341			$	260			$	705,085			$	3,314			$	709,426			$	3,574
Commercial real estate			6,083				133				443,308				4,345				449,391				4,478
Construction			—				—				60,722				801				60,722				801
Commercial			—				—				53,192				613				53,192				613
Home equity lines of credit			200				—				159,840				928				160,040				928
Indirect auto			15				—				103,950				623				103,965				623
Other consumer			—				—				453				10				453				10
Unallocated			—				—				—				213				—				213
Total		$	10,639			$	393			$	1,526,550			$	10,847			$	1,537,189			$	11,240

 

Information about loans that meet the definition of an impaired loan in ASC 310-10-35 is as follows as of September 30, 2016 (unaudited and in thousands):

 

		Impaired loans with a related allowance for credit losses
		Recorded  Investment				Unpaid  Principal  Balance				Specific  Allowance
Residential one-to-four family		$	1,111			$	1,137			$	163
Commercial real estate			2,957				2,957				2
Totals		$	4,068			$	4,094			$	165

 

		Impaired loans with no related allowance for credit losses
		Recorded  Investment				Unpaid  Principal  Balance				Specific  Allowance
Residential one-to-four family		$	3,740			$	3,820			$	—
Commercial real estate			499				499				—
Home equity lines of credit			200				200
Indirect Auto			7				7				—
Totals		$	4,446			$	4,526			$	—

Information about loans that meet the definition of an impaired loan in ASC 310-10-35 is as follows as of December 31, 2015 (in thousands):

 

		Impaired loans with a related allowance for credit losses
		Recorded  Investment				Unpaid  Principal  Balance				Specific  Allowance
Residential one-to-four family		$	1,450			$	1,476			$	260
Commercial real estate			5,426				5,426				133
Totals		$	6,876			$	6,902			$	393

 

		Impaired loans with no related allowance for credit losses
		Recorded  Investment				Unpaid  Principal  Balance				Specific  Allowance
Residential one-to-four family		$	2,891			$	2,933			$	—
Commercial real estate			657				657				—
Home equity lines of credit			200				200				—
Indirect auto			15				15				—
Totals		$	3,763			$	3,805			$	—

 

The following tables set forth information regarding interest income recognized on impaired loans, by portfolio, for the periods indicated (unaudited and in thousands):

 

		Three months ended September 30, 2016								Three months ended September 30, 2015
With an allowance recorded		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
Residential one-to-four family		$	1,295			$	8			$	1,248			$	8
Commercial real estate			2,962				30				3,021				31
Totals		$	4,257			$	38			$	4,269			$	39

 

		Three months ended September 30, 2016								Three months ended September 30, 2015
Without an allowance recorded		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
Residential one-to-four family		$	2,952			$	19			$	4,206			$	24
Commercial real estate			517				6				727				8
Home equity lines of credit			200				2				291				2
Indirect auto			8				—				12				—
Totals		$	3,677			$	27			$	5,236			$	34

 

		Nine months ended September 30, 2016								Nine months ended September 30, 2015
With an allowance recorded		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
Residential one-to-four family		$	1,370			$	25			$	1,202			$	25
Commercial real estate			3,509				115				3,036				93
Totals		$	4,879			$	140			$	4,238			$	118

 

		Nine months ended September 30, 2016								Nine months ended September 30, 2015
Without an allowance recorded		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
Residential one-to-four family		$	3,115			$	58			$	4,764			$	74
Commercial real estate			569				19				767				23
Home equity lines of credit			200				6				293				6
Indirect auto			15				—				8				—
Totals		$	3,899			$	83			$	5,832			$	103

The following is a summary of past due and non-accrual loans (in thousands):

 

		September 30, 2016 (unaudited)
		30–59 Days				60–89 Days				90 Days  or More				Total  Past Due				90 days or more  and accruing				Loans on  Non-accrual
Real estate loans:
Residential one-to-four family		$	79			$	747			$	497			$	1,323			$	—			$	1,749
Home equity lines of credit			290				—				—				290				—				—
Other loans:
Indirect auto			367				30				7				404				—				7
Total		$	736			$	777			$	504			$	2,017			$	—			$	1,756

 

		December 31, 2015
		30–59 Days				60–89 Days				90 Days  or More				Total  Past Due				90 days or more  and accruing				Loans on  Non-accrual
Real estate loans:
Residential one-to-four family		$	1,579			$	81			$	411			$	2,071			$	—			$	1,192
Commercial real estate			—				—				—				—				—				2,424
Home equity lines of credit			634				—				—				634				—				—
Other loans:
Indirect auto			551				47				15				613				—				15
Total		$	2,764			$	128			$	426			$	3,318			$	—			$	3,631

 

Credit Quality Information

The Company utilizes a nine grade internal loan rating system for commercial, commercial real estate and construction loans, and a five grade internal loan rating system for certain residential real estate and home equity lines of credit that are rated if the loans become delinquent.

Loans rated 1, 2, 2.5, 3 and 3.5: Loans in these categories are considered “pass” rated loans with low to average risk.

Loans rated 4: Loans in this category are considered “special mention.” These loans are starting to show signs of potential weakness and are being closely monitored by management.

Loans rated 5: Loans in this category are considered “substandard.” Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.

Loans rated 6: Loans in this category are considered “doubtful.” Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.

Loans rated 7: Loans in this category are considered uncollectible (“loss”) and of such little value that their continuance as loans is not warranted.

On an annual basis, or more often if needed, the Company formally reviews the ratings on all commercial, commercial real estate loans, and construction loans. On an annual basis, the Company engages an independent third party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process.

On a quarterly basis, the Company formally reviews the ratings on all residential real estate and home equity lines of credit if they have become delinquent. Criteria used to determine the rating consists of loan-to-value and days delinquent.

The following tables present the Company’s loans by risk rating at September 30, 2016 (unaudited and in thousands) and December 31, 2015 (in thousands). There were no loans rated as 6 (“doubtful”) or 7 (“loss”) at the dates indicated.

 

		September 30, 2016
		Loans rated 1-3.5				Loans rated 4				Loans rated 5				Loans not rated (A)				Total
Residential one-to-four family		$	—			$	2,090			$	2,460			$	943,117			$	947,667
Commercial real estate			443,732				14,452				4,416				—				462,600
Construction			76,681				—				—				—				76,681
Commercial			61,314				—				—				—				61,314
Home equity lines of credit			—				—				799				170,058				170,857
Indirect auto			—				—				—				69,865				69,865
Other consumer			—				—				—				433				433
Total		$	581,727			$	16,542			$	7,675			$	1,183,473			$	1,789,417

 

		December 31, 2015
		Loans rated 1-3.5				Loans rated 4				Loans rated 5				Loans not rated (A)				Total
Residential one-to-four family		$	—			$	359			$	1,915			$	707,152			$	709,426
Commercial real estate			427,160				15,159				7,072				—				449,391
Construction			56,459				4,263				—				—				60,722
Commercial			53,192				—				—				—				53,192
Home equity lines of credit			—				—				799				159,241				160,040
Indirect auto			—				—				—				103,965				103,965
Consumer			—				—				—				453				453
Total		$	536,811			$	19,781			$	9,786			$	970,811			$	1,537,189

 

(A)	Residential real estate and home equity lines of credit are not formally risk rated by the Company unless the loans become delinquent.

The Company periodically modifies loans to extend the term or make other concessions to help a borrower stay current on their loan and to avoid foreclosure. Any loans that are modified are reviewed by the Company to identify if a TDR has occurred, which is when, for economic or legal reasons related to a borrower’s financial difficulties, the Bank grants a concession to the borrower that it would not otherwise consider. During the three and nine months ended September 30, 2016 (unaudited), there were no loans modified and determined to be a TDR. During the three and nine months ended September 30, 2015 (unaudited), there was one loan modified and determined to be a TDR. At September 30, 2016 (unaudited), the Company had $7.5 million of troubled debt restructurings related to ten loans.

The following table shows the Company’s total TDRs and other pertinent information as of the dates indicated (in thousands):

 

		September 30, 2016				December 31, 2015
		(unaudited)
TDRs on Accrual Status		$	6,758			$	7,007
TDRs on Nonaccrual Status			766				781
Total TDRs		$	7,524			$	7,788
Amount of specific allocation included in the allowance for loan losses associated with TDRs		$	159			$	170
Additional commitments to lend to a borrower who has been a party to a TDR		$	—			$	—

The following tables show the troubled debt restructuring modifications which occurred during the periods indicated and the change in the recorded investment subsequent to the modifications occurring (dollars in thousands and unaudited):

 

		Three months ended September 30, 2016												Three months ended September 30, 2015
		# of Contracts				Pre-modification outstanding recorded investment				Post-modification outstanding recorded investment				# of Contracts				Pre-modification outstanding recorded investment				Post-modification outstanding recorded investment
Real estate loans:
Residential one-to-four family			—			$	—			$	—				1			$	463			$	507
Total			—			$	—			$	—				1			$	463			$	507

 

		Nine months ended September 30, 2016												Nine months ended September 30, 2015
		# of Contracts				Pre-modification outstanding recorded investment				Post-modification outstanding recorded investment				# of Contracts				Pre-modification outstanding recorded investment				Post-modification outstanding recorded investment
Real estate loans:
Residential one-to-four family			—			$	—			$	—				1			$	463			$	507
Total			—			$	—			$	—				1			$	463			$	507

 

The following table shows the Company’s post-modification balance of TDRs listed by type of modification during the periods indicated (in thousands):

 

		Three months ended September 30, 2016				Three months ended September 30, 2015
		(unaudited)				(unaudited)
Interest only period		$	—			$	507
Total		$	—			$	507

 

		Nine months ended September 30, 2016				Nine months ended September 30, 2015
		(unaudited)				(unaudited)
Interest only period		$	—			$	507
Total		$	—			$	507

For purposes of this table the Company generally considers a loan to have defaulted when it reaches 90 days past due. The following table shows the loans that have been modified during the past twelve months which have subsequently defaulted during the periods indicated (unaudited and in thousands except for number of contracts):

 

		For the three months ended September 30,
		2016								2015
		Number of Contracts				Recorded Investment				Number of Contracts				Recorded Investment
Real estate loans:
Residential one-to-four family			—			$	—				—			$	—
Total			—			$	—				—			$	—

 

		For the nine months ended September 30,
		2016								2015
		Number of Contracts				Recorded Investment				Number of Contracts				Recorded Investment
Real estate loans:
Residential one-to-four family			1			$	497				—			$	—
Total			1			$	497				—			$	—

Foreclosure Proceedings

Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $497,000 as of September 30, 2016 (unaudited) and $412,000 as of December 31, 2015. We did not have any foreclosed residential real estate property as of September 30, 2016 (unaudited) and as of December 31, 2015.