3.        LOANS AND ALLOWANCE FOR CREDIT LOSSES

The following table presents the summary of the loan portfolio by the major classification of the loan at the periods indicated:

Lending activities primarily consist of commercial real estate loans, commercial and industrial loans, residential real estate loans, and to a lesser degree, consumer loans.

Loans Pledged as Collateral.

At December 31, 2025 and December 31, 2024, the carrying value of eligible loans pledged as collateral to support borrowing capacity at the FHLB were $932.3 million and $906.0 million, respectively. The outstanding balance of FHLB advances was $83.0 million and $98.0 million at December 31, 2025 and December 31, 2024, respectively.

At December 31, 2025 and December 31, 2024, the carrying value of eligible loans pledged as collateral to support borrowing capacity at the Federal Reserve Bank (“FRB”) was $307.3 million and $377.0 million, respectively, with no outstanding borrowings at December 31, 2025 and at December 31, 2024.

Loans Serviced for Others.

The Company has transferred a portion of its originated commercial loans to participating lenders. The amounts transferred have been accounted for as sales and are therefore not included in our accompanying consolidated balance sheets. We continue to service the loans on behalf of the participating lenders. We share with participating lenders, on a pro-rata basis, any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. At December 31, 2025 and December 31, 2024, the Company was servicing commercial loans participated out to various other institutions totaling $66.9 million and $65.3 million, respectively.

Residential real estate mortgages are originated by the Company both for its portfolio and for sale into the secondary market. The Company may sell its loans to institutional investors such as the FHLMC. Under loan sale and servicing agreements with the investor, the Company generally continues to service the residential real estate mortgages. The Company pays the investor an agreed upon rate on the loan, which is less than the interest rate received from the borrower. The Company retains the difference as a fee for servicing the residential real estate mortgages. The Company capitalizes mortgage servicing rights at their fair value upon sale of the related loans, amortizes the asset over the estimated life of the serviced loan, and periodically assesses the asset for impairment. The significant assumptions used by a third party to estimate the fair value of capitalized servicing rights at December 31, 2025, include weighted average prepayment speed for the portfolio using the Public Securities Association Standard Prepayment Model (188 PSA), average internal rate of return (10.01%), weighted average servicing fee (0.25%), and average cost to service loans ($83.18 per loan). The estimated fair value of capitalized servicing rights may vary significantly in subsequent periods primarily due to changing market interest rates, and their effect on prepayment speeds and discount rates.

At December 31, 2025 and December 31, 2024, the Company was servicing residential mortgage loans owned by investors totaling $77.1 million and $84.8 million, respectively. Servicing fee income of $204,000 and $189,000 was recorded for the years ended December 31, 2025 and December 31, 2024, respectively, and is included in service charges and fees on the consolidated statements of net income.

A summary of the activity in the balances of mortgage servicing rights follows:

Allowance for Credit Losses.

The allowance for credit losses is an estimate of expected losses inherent within the Company's existing loans held for investment portfolio. The allowance for credit losses for loans held for investment, as reported in our consolidated balance sheet, is adjusted by a credit loss expense, which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries. Accrued interest receivable on loans held for investment was $7.6 million at December 31, 2025 and $7.4 million at December 31, 2024 and is excluded from the estimate of credit losses.

An analysis of changes in the allowance for credit losses for loans and off-balance sheet commitments by segment for the years ended December 31, 2025 and 2024 is as follows:

During the year ended December 31, 2025, the Company recorded a provision for credit losses of $335,000, compared to a reversal of credit losses of $665,000 during the twelve months ended December 31, 2024. The $1.0 million increase in the provision for credit losses was primarily due to an increase in total loans of $113.2 million, or 5.5%.

The provision for (reversal of) credit losses was determined by a number of factors: the continued strong credit performance of the Company’s loan portfolio, changes in the loan portfolio mix and Management’s consideration of existing economic conditions and the economic outlook from the Federal Reserve Bank’s actions to control inflation. Management continues to monitor macroeconomic variables related to increasing interest rates, inflation and the concerns of an economic downturn, and believes it is appropriately reserved for the current economic environment and supportable forecast period.

Past Due and Nonaccrual Loans.

The following tables present an age analysis of past due loans as of the dates indicated:

At December 31, 2025 and December 31, 2024, total past due loans totaled $3.1 million, or 0.14% of total loans, and $5.0 million, or 0.24% of total loans, respectively.

Nonaccrual Loans.

Accrual of interest on loans is generally discontinued when contractual payment of principal or interest becomes past due 90 days or, if in management's judgment, reasonable doubt exists as to the full timely collection of interest. Exceptions may be made if the loan has matured and is in the process of renewal or is well-secured and in the process of collection. When a loan is placed on nonaccrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current interest income. Interest payments on nonaccrual loans are generally applied to principal. If collection of the principal is reasonably assured, interest payments are recognized as income on the cash basis. Loans are generally returned to accrual status when principal and interest payments are current, full collectability of principal and interest is reasonably assured and a consistent record of at least six consecutive months of performance has been achieved.

The following table is a summary of the Company’s nonaccrual loans by major categories at December 31, 2025 and December 31, 2024:

At December 31, 2025 and December 31, 2024, nonaccrual loans totaled $5.2 million, or 0.24% of total loans and $5.4 million, or 0.26% of total loans, respectively. The Company did not recognize any interest income on nonaccrual loans for the years ended December 31, 2025 and December 31, 2024. At December 31, 2025 and December 31, 2024, there were no commitments to lend additional funds to any borrower on nonaccrual status. At December 31, 2025 and December 31, 2024, there were no loans 90 or more days past due and still accruing interest. There was no other real estate owned at December 31, 2025 or December 31, 2024.

Individually Evaluated Collateral Dependent Loans.

Loans that do not share similar risk characteristics with loans that are pooled into portfolio segments are individually evaluated. A loan is considered collateral dependent when, based on current information and events, the borrower is experiencing financial difficulty and repayment, both principal and interest, is expected to be provided substantially through the operation or sale of the collateral. Loans that are rated Substandard, have a loan-to-value above 85% or have demonstrated a specific weakness (e.g., slow payment history, industry weakness, or other clear credit deterioration) may be considered for individual evaluation if they are determined not to share similar risk characteristics within the segment. Individually evaluated assets will be measured primarily using the collateral dependent financial asset practical expedient, although the discounted cash flow method may be used when management deems it more appropriate or collateral values cannot be supported. For individually evaluated assets, an ACL is determined separately for each financial asset. At December 31, 2025, the Company had $1.0 million in individually evaluated commercial loans, collateralized by business assets, and $4.9 million in individually evaluated real estate loans, collateralized by real estate property.

The following table summarizes the Company’s individually evaluated collateral dependent loans by class as of the dates indicated:

Modified Loans to Borrowers Experiencing Financial Difficulty.

The Company will modify the contractual terms of loans to a borrower experiencing financial difficulties as a way to mitigate loss and comply with regulations regarding bankruptcy and discharge situations. Loans are designated as modified when, as part of an agreement to modify the original contractual terms of the loan as a result of financial difficulties of the borrower, the Company grants the borrower a concession on the terms that would not otherwise be considered. Typically, such concessions may consist of a reduction in interest rate to a below market rate, taking into account the credit quality of the note, extension of additional credit based on receipt of adequate collateral, or a deferment or reduction of payments (principal or interest) which materially alters the Company's position or significantly extends the note's maturity date, such that the present value of cash flows to be received is materially less than those contractually established at the loan's origination.

There were no loan modifications granted based on borrower financial difficulty during the years ended December 31, 2025 and December 31, 2024. During the years ended December 31, 2025 and December 31, 2024, no modified loans defaulted (defined as 30 days or more past due) within 12 months of restructuring. There were no charge-offs on modified loans during the years ended December 31, 2025 or 2024.

Credit Quality Information.

The Company monitors the credit quality of its loan portfolio by using internal risk ratings that are based on regulatory guidance. The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company utilizes an eight-grade internal loan rating system for commercial real estate and commercial and industrial loans.

The grades assigned and definitions are as follows: loans graded excellent, above average, good are classified as “Pass” for grading purposes (risk ratings 1-4). All loans risk rated Special Mention (5), Substandard (6), Doubtful (7) and Loss (8) are listed on the Company’s criticized report and are reviewed not less than on a quarterly basis to assess the level of risk and to ensure that appropriate actions are being taken to minimize potential loss exposure. In addition, the Company closely monitors classified loans, defined as Substandard, Doubtful, and Loss for signs of deterioration to mitigate the growth in nonaccrual loans, including performing additional due diligence, updating valuations and requiring additional financial reporting from the borrower. Loans identified as containing a loss are partially charged-off or fully charged-off. Performing residential real estate, home equity and consumer loans are grouped with “Pass” rated loans. Nonaccrual residential real estate, home equity and consumer loans are risk rated as “Substandard” and individually evaluated.

Loans rated 1 – 4: Loans rated 1-4 are classified as “Pass” and have quality metrics to support that the loan will be repaid according to the terms established and are not subject to adverse criticism as defined in regulatory guidance. Pass loans exhibit characteristics that represent acceptable risk and are not considered problem loans.

Loans rated 5: Loans rated 5 are classified as “Special Mention” and have potential weaknesses that deserve management’s close attention. Special mention loans are currently performing but with potential weaknesses including adverse trends in borrower’s operations, credit quality, financial strength, or possible collateral deficiency. Loans in this category are currently protected based on collateral and repayment capacity and do not constitute undesirable credit risk, but have potential weakness that may result in deterioration of the repayment process at some future date. Special Mention loans do not sufficiently expose the Company to warrant adverse classification.

Loans rated 6: Loans rated 6 are classified as “Substandard” and have an identified definitive weakness which may make full collection of contractual cash flows questionable and/or jeopardize the liquidation of the debt.

Loans rated 7: Loans rated 7 are classified as “Doubtful” and have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation of the loan highly questionable and improbable. The possibility of some loss is extremely high, but because of specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.

Loans rated 8: Loans rated 8 are classified a “Loss” and are considered uncollectible and are charged to the allowance for credit losses. The loss classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the asset because recovery and collection time may be affected in the future.

On an annual basis, or more often if needed, the Company formally reviews the ratings on all commercial real estate loans over $3 million and commercial and industrial loans over $1 million. On an ongoing basis, Management utilizes delinquency reports, interim customer financials, the criticized loan report and other loan reports to monitor credit quality and adjust risk ratings accordingly. In addition, at least on an annual basis, the Company contracts with an independent third-party to review the internal credit ratings assigned to loans in the commercial loan portfolio on a pre-determined schedule, based on the type, size, rating, and overall risk of the loan. During the course of its review, the third party examines a sample of loans, including new loans, existing relationships over certain dollar amounts and classified assets.

The following tables summarize the amortized cost basis by aggregate Pass and criticized categories of Special Mention and Substandard within the Company’s internal risk rating system by year of origination as of December 31, 2025 and December 31, 2024. The tables also summarize gross charge-offs by year of origination for the years ended December 31, 2025 and December 31, 2024.