Note 3: Loans and allowance for loan losses

A summary of loans by major category as of September 30, 2022 and December 31, 2021 is as follows:

First mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balance of these loans totaled $14.2 million and $15.8 million at September 30, 2022 and December 31, 2021, respectively. Custodial escrow balances maintained in connection with the loans serviced were $175,000 and $270,000 at September 30, 2022 and December 31, 2021, respectively.

In the normal course of business, loans are made to directors and officers of the Bank. The terms of these loans, including interest rate and collateral, are similar to those prevailing for comparable transactions with other customers and do not involve more than a normal risk of collectability. At  September 30, 2022 and December 31, 2021, such borrowers were indebted to the Bank in the aggregate amount of $581,000 and $556,000, respectively.

Changes in the allowance for loan losses as of and for the three and nine months ended September 30, 2022 and 2021 were as follows:

The balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of  September 30, 2022 and December 31, 2021, were as follows:

The Bank evaluates collectability based on payment activity and other factors. The Bank uses a graded loan rating system as a means of identifying potential problem loans, as follows:

Pass

Loans in these categories are performing as expected with low to average risk.

Special Mention

Loans in this category are internally designated by management as “watch loans.” These loans are starting to show signs of potential weakness and are closely monitored by management.

Substandard

Loans in this category are internally designated by management as “substandard.” Generally, a loan is considered substandard if it is inadequately protected by the paying capacity of the obligors or the current net worth of the collateral pledged. Substandard loans present a distinct possibility that the Bank will sustain losses if such weaknesses are not corrected.

Doubtful

Loans classified as doubtful have all the weaknesses inherent in those designated as “substandard” with the added characteristic that the weaknesses may make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.

On an annual basis, or more often if needed, the Bank formally reviews the ratings on commercial loans. In addition, the Bank performs an independent review of a significant portion of the commercial loan portfolio. Management uses the results of the independent review as part of its annual review process.

The following table presents loan balances based on risk rating as of September 30, 2022 and December 31, 2021:

The aging of the Bank’s loan portfolio as of September 30, 2022 and December 31, 2021, is as follows:

Loans individually evaluated for impairment as of September 30, 2022 and December 31, 2021, were as follows:

The average recorded investment and interest income recognized for the loans individually evaluated for impairment for the three months ended September 30, 2022 and 2021, were as follows:

The average recorded investment and interest income recognized for the loans individually evaluated for impairment for the nine months ended September 30, 2022 and 2021, were as follows:

Troubled debt restructurings provide for modifications to repayment terms; more specifically, modifications to loan interest rates. Management performs an impairment analysis at the time of restructuring and periodically thereafter. Any reserve required is recorded through a provision to the allowance for loan losses.

There were no new troubled debt restructurings during the three and nine months ended months ended September 30, 2022 or 2021. In March 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed into law. Among other things, the CARES Act suspended the requirements related to accounting for TDRs for certain loan modifications related to the COVID-19 pandemic.

The Bank has minimal direct exposure to consumer, commercial, and other small businesses that may be negatively impacted by COVID-19, but management has analyzed and increased the qualitative factors in these and other loan categories for incurred, but not yet identified loan losses attributable to COVID-19. As of September 30, 2022, management did not see significant disruption with existing customers related to COVID-19. However, during the years ended December 31, 2020 and 2021, management did grant customer requests to defer payments on 50 loans with unpaid balances of $9.7 million. As of September 30, 2022, all COVID-19 loan modifications have returned to repayment. Management has also assisted small businesses that could benefit from the CARES Act, particularly in the SBA’s Paycheck Protection Program (“PPP”). As of September 30, 2022, all PPP loans have been forgiven by the SBA.